It’s funny how the same reading of history leads to different conclusions. The young investor in the 1840s Punch cartoon above stands in a back alley outside the Capel Court stock exchange asking a purveyor of dubious scrip how to honestly make £10,000 in railways. It is the end of a technology hype cycle in which the modern-day equivalent of $2 trillion was pumped into an investment bubble. The picture on the right is a desolate and economically insignificant outpost connected by some of the 2,148 miles of railway capacity that entrepreneurs built during the British railway investment mania of the 1830s. The conclusion is that early investors in British railway companies were played for suckers.
The mania probably started with an announcement in the May 1, 1829 edition of the Liverpool Mercury:
“To engineers and iron founders
The directors of the Liverpool and Manchester Railway hereby offer a premium of £500 (over and above the cost price) for a locomotive engine which shall be a decided improvement on any hitherto constructed, subject to certain Stipulations and Conditions, a copy of which may be had at the Railway Office, or will be forwarded. As may be directed, on application for the same, if by letter or post paid.
HENRY BOOTH Treasurer Railway Office, 25 April 1829
The Liverpool and Manchester Railway was not the first railroad in England, but the competition drew enormous interest. Contestants used everything from “legacy technology” — horses on treadmills — to lightweight steam engines that could reach up-hill speeds of 24 miles per hour. The legacy technology defeated itself when a horse crashed through a wooden floorboard. It did not hurt that Queen Victoria declared herself “charmed” by the winning steam technology.
Business innovation — ticketing, first-class seating, and agreements allowing passengers to change carriers mid-trip — was rapid and fueled as much by intense competition as by a chaotic, frenzied stock market in which valuations soared beyond any seeming sense of proportion, causing John Francis in 1845 to despair: “The more worthless the article the greater the struggle to attain it.” When the market crashed during the week of October 17, 1847 — in no small measure due to to the 1845-6 crop failure and potato famine — and established companies failed, financiers like George Hudson were exposed as swindlers. Thomas Carlyle demanded public hanging.
The collapsing bubble is not the end of the story. Between 1845 and 1855 an additional 9,000 miles of track were constructed. By 1915 England’s rail capacity was 21,000 miles. British railways had entered a golden age. The lesson that observers like Carlotta Perez and others draw is that there is a pattern to technological revolutions:
- Innovation enables technology clusters, some of which transform the way that business is done.
- Early successes and intense competition give rise to new companies and an unregulated free-for-all that leads to a crash.
- Collapse is followed by sustained build-out during which the allure of glamor is replaced by real value.
- This leads to a golden age that results in more innovation as lives are structured around the new technology.
This is a Schumpeterian analysis of innovation that is reflected everywhere, but particularly in the economics of the new technologies of the late twentieth century. The stamp of the the 1840s British railway mania can be seen in Gartner’s technology hype cycle and in nearly every discussion of the 2000 dot-com collapse. It is an analysis that is a special problem for angel and other early-stage investors because there is no real guide to tell you when the bubble will burst. Unless you are George Hudson, what investor will find the risk acceptable? A rational early investor will steer clear of technologies that radiate this kind of exuberance.
But what really happened to all that investment in the 1830s? I was amazed to see the recent article by my long-time colleague Andrew Odlyzko at the University of Minnesota who analyzes the British railway mania example and concludes that the early investments did quite well:
The standard literature in this area, starting from Juglar, and continuing through Schumpeter to more recent authors, almost uniformly ignores or misrepresents the large investment mania of the 1830s, whose nature does not fit the stereotypical pattern.
Andrew enjoys taking contrary — often cranky but always well-thought out– positions on conventional wisdom, so I approached his article with cautious interest. After all, I thought I knew a little about the railway mania episode. I had used it myself to illustrate innovation cycles. Like most people, I had focused on the disaster of the 1840’s, so I was drawn immediately into Odlyzko’s argument that during the mania of the 1830’s, “railways built during this period were viewed as triumphant successes in the end.”:
After the speculative excitement died down, there was a period of about half a dozen years during which investors kept pumping money into railway construction. This was done in the face of adverse, occasionally very adverse, monetary conditions, wide public skepticism, and a market that was consistently telling them through the years that they were wrong.
In other words, the end result of the wildly speculative exuberance of the 1830s was the “creation of a productive transportation system that had a deep and positive effect on the economy.” Investors saw great returns. A shareholder in London and South Western Railway (LSWR) who in 1834 paid a £2 deposit on a share worth £50 and who paid all subsequent calls (totaling £95.5) would have watched the investment grow to 2.31 shares valued at £200 by mid-1844 and would have received in 1843 alone £4.62 in dividends — a 9.68% annual return. This defied the more rational demand and cost forecasts:
at the start of the period…in June 1835, such investor would have paid £10, and seen the market value it at £5.5. In fact, over most of the next two and a half years, the market was telling this investor that the LSWR venture was a mistake, as prices were mostly below the paid-up values.
Andrew Odlyzko is a seasoned mathematician who knows better than try to prove a general principle by example. He says as much in his paper. On the other hand, railway mania has been used for years as an illustration of an innovation cycle, and Odlyzko has a very different reading of history. The conclusion that is usually drawn from the Railway Mania may lead markets and investors astray because it seriously misrepresents actual patterns. The whole point of a cycle — hype, innovation, or investment mania — is that it can be used as a risk-averse template for rejecting sales pitches that start with “This time is different“. But that does not mean that it is never different.