SOCIAL SAVING OF THE PANAMAbyWilliam K. Hutchinson and Ricardo UngoWorking Paper No. 04-W23December 2004DEPARTMENT OF ECONOMICSVANDERBILT UNIVERSITYNASHVILLE, TN 37235www.vanderbilt.edu/econSocial Saving of the Panama Canal William K. Hutchinson* and Ricardo Ungo** December, 2004 *Department of Economics Vanderbilt University Nashville, TN 37235-1819 **Department of Economic Universidad Latina Panama [email protected] [email protected] JEL Code: N72 Key Words: Social Saving, Transport cost, Canals The authors wish to thank Robert Margo, William Collins, and members of the Brown Bag Seminar at Vanderbilt University for helpful comments on earlier versions of this paper. Any remaining errors are the responsibility of the authors.2 Social Saving of the Panama Canal Abstract At the time when the Panama Canal was handed over to Panama, most people believed that the Canal was of little material worth to the United States. However, what was the value of this canal to the United States in the 1920s? We estimate the social savings generated by the Panama Canal for the United States in 1924 in order to assess the contribution it made to the social welfare of the United States. We estimate the direct social savings that resulted from lower shipping costs for both international and coastwise trade. Additionally, we estimate the benefits from two sources of indirect social savings. The first was generated as a result of the expansion of the feasible market area, due to reduced transport costs. The second source of indirect social savings is what we refer to as the pro-competitive effect of the competition between the water shipping via the Panama Canal and shipping via the transcontinental railroad. We argue that this competition resulted in lower freight rates for all railroad traffic due to the way in which the Interstate Commerce Commission regulated railroad freight rates. Estimates of total social saving range from 0.58 percent of GNP to 1.97 percent of GNP in 1924. Even the lower estimate of social saving is a value that is one quarter larger than the total cost of acquiring the land and constructing the Panama Canal.31 Introduction Robert Fogel (1964) shocked the Economic History profession when he challenged the notion that railroads were a necessary component of nineteenth century US growth. Since Fogel’s investigation into the “social saving” of the railroad, others have applied this technique to assess the contribution of various innovations, such as canals (Ransom, 1970) and the inflow of immigrants (Neal and Uselding, 1972), to the growth process. Savings associated with these innovations are thought to have provided a significant stimulus to economic growth in the nineteenth century United States. One measures these social savings as the difference in GNP with and without the particular innovation under consideration. Calculating social saving requires that one posit the counterfactual question: How would GNP differ if innovation X did not exist? We propose to calculate the social saving associated with the Panama Canal. That is, how much would United States GNP have differed from that which actually existed, if the Panama Canal had not been built? We shall evaluate the social saving of the Panama Canal for 1924.1 This is a relatively stable period in which the there are few international disturbances and the world economy is neither at the peak nor at the trough of an economic cycle. We provide a brief historical account of the building of the Panama Canal in the next section of the paper, followed in part three by a sketch of how one measures the social savings associated with a transport improvement such as the Panama Canal. Section four provides estimates of both the direct and indirect social savings that one may attribute to the Panama Canal. We conclude by offering some reflections on the significance of the canal to the United States and the world more generally. 1 We use averages for 1923, 1924, and 1925 to avoid the idiosyncratic variation in data that might be associated with a particular year. When comparing 1924 with 1912 we use the average of data for 1911, 1912, 1913.42 Background In 1870, any sailor would have told you that finding a way to avoid Cape Horn and cut the travel time between the Atlantic and the Pacific would be a welcome discovery. The French were the first to attempt building a canal across the isthmus of Panama, employing the knowledge and skills accumulated from building the Suez canal. Ferdinand de Lesseps, builder of the Suez Canal, proposed building a sea level canal across the isthmus of Panama.2 The cost of the canal was estimated to be $240 million in 1881 and de Lesseps thought that it would take approximately 12 years to construct. At more than twice the cost of the Suez, building the Panama canal would require the removal of nearly a third more earth than was necessary to build the Suez. (McCullough, 1977, p. 83) Forecasting traffic of some 60 million tons of cargo per year3, de Lesseps estimated that the canal would generate gross revenues of around $18 million per year. Thus, with $60 million in capital the French company, Compagnie Universelle, started work on the canal in February, 1881. Compagnie Universelle also purchased the Panama Railroad for $17 million to assist in the building of the canal. (McCullough, 1977, pp. 73, 125, 135-136.)4 Significant differences between the Suez and Panama doomed the French endeavor to failure: 1) the scale of the project was substantially larger; and 2) the climate and tropical diseases increased the casualty rate among canal workers. French equipment was not capable of efficiently removing the vast amounts of earth that building the canal required. The project would take sufficiently long that the company would expend all the capital available to finance 2 Eventually de Lesseps realized that a system of locks would be necessary due to the topography of Panama. 3 One should note that this estimated tonnage is approximately twice that which traversed through the Canal in any single year prior to World War II. 4 The Panama Railroad offered an alternative to shipping around Cape Horn, but the unloading and loading costs at both ends increased costs sufficiently to make it an unacceptable alternative.5the project. More than 20,000 workers lost their lives working for the French on the canal. Thus, after
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