FUNDING LATIN AMERICAN RAILWAYS, 1860-1913. A COMPARATIVE STUDY IN SPECULATION, CORRUPTION AND MARKET POWER

Project supported by a 2016 Leonardo Grant for Researchers and Cultural Creators, BBVA Foundation

OVERVIEW OF THE PROJECT

During the first globalization of the late 19th and early 20th centuries, railways became a key factor for the export-led growth process of most Latin American economies. Due to the scarcity of alternative infrastructure and the limited reach of the available water routes in most of the region, domestic transport costs before the railways were too high to allow a sustained and rapid growth of exports, except in areas with good access to waterways or for commodities with very high value-to-weight ratios. This helps to explain the massive process of railway construction in the region before 1914. The first Latin American railway line was opened in Cuba in 1837, only 12 years after the inauguration of the first British steam-driven public railway. In the 1850s, Cuba would be joined by Argentina, Brazil, Chile, Colombia, Costa Rica, Mexico and Peru, and by 1900 all Latin American countries had some railways in operation.

Latin American railway map

 

Despite their essential role, however, the expansion of the new infrastructure was very uneven across countries. Whereas some countries, such as Argentina, Uruguay, Chile, Cuba or Mexico, could benefit from relatively dense networks, in most other countries the expansion of the new infrastructure was extremely slow and, by 1914, railway systems consisted just of a few isolated lines that connected particular production areas with the main ports, while hardly affecting large swathes of the territory. Apparently, and despite the high potential economic impact of railways, many Latin American countries were unable to attract enough capital and, as a consequence, their export expansion and their economic growth were limited.

Since most Latin American railways were financed with foreign capital, railway expansion in each country largely depended on the ability to attract capital from abroad. Railways were actually the main destination of Latin American capital imports during the late 19th and early 20th centuries. Foreign investment entered the region mainly in the form of new construction initiatives, but also by taking over publicly-owned and domestic private firms. The prominence of foreign capital was favoured by the dramatic reduction that took place in the costs of transmission of information from the 1860s, although inflows substantially accelerated in the last years of the 19th century and, specially, since the Baring crisis led to the failure of several locally-funded initiatives. As a result, by 1899 foreign enterprises controlled almost 75 per cent of the Latin American railway mileage, and an even higher percentage (80 to 90 per cent) in the years immediately before 1914. Among foreign investors, capital raised in London was absolutely dominant during the late nineteenth century, accounting for 70 per cent of the mileage under foreign operation in 1899. Only after 1900 the prominence of British capital was partially challenged by US capital, although only in the US closest area of influence (Mexico, the Caribbean and Central America). As a consequence, during the last decades of the 19th century and the early years of the 20th century, the London Stock Exchange became the most important listing venue for Latin American railways in the whole world (Sanz Fernández, 1998).

Havana and Marianao Railway Company (Prospectus), 1862

 

Since the majority of Latin American railway investment was financed by foreign capital, those factors that made some destinations more attractive than others to foreign investors may account for cross-country differences in railway development and economic growth. Previous literature has identified some factors of capital attraction, such as the degree of institutional stability; increasing international demand for each country’s main exports, and governments’ financial capacity to subsidize the railway system (see Sanz Fernández, 1998). In a previous research (Bignon, Esteves and Herranz-Loncán, 2015), we have shown the latter to be especially relevant. All over the region, government involvement was crucial for railway development to take off, and the lack of government resources is one of the factors that explain the delay in railway construction in several countries (see also Lewis, 1983, or Summerhill, 2003, among others). In the aforementioned paper, we also showed that the dependence of railway investment on government resources posed a complex puzzle in a period in which the revenues of Latin American governments mainly derived from trade taxes, and were therefore limited by the degree of trade expansion. As long as trade was hindered in some economies by insufficient transportation infrastructure and the scarcity of railways, this would indicate a mutual causation relationship between government revenues and railway development. During the first globalisation, increasing government revenues triggered railway infrastructure development, which was instrumental in opening up the economies of Latin America to world oceanic trade. In turn, trade growth increased government revenues, which made the guarantees and subsidies to railways companies credible. This mutual causation relationship is consistent with the existence of multiple equilibria and the possibility of some countries being caught in a non-development trap of low foreign trade and low railway construction.

The dependence of Latin American railway expansion on government resources, however, admits several alternative explanations. On the one hand, it could be rationalized in the context of ‘big push’ models, in which government intervention was required to overcome coordination failures and bring an economy from a low to a high-level equilibrium.  Given the high fixed costs, indivisible capital and the long time that had to pass until full potential traffic and profits were reached, investors in the new railways required some guarantee of return, in order to compensate for the perceived uncertainty as to whether export activities would take off and make the railway investment profitable (see, e.g. Summerhill, 2003, or Lewis, 1983). However, on the other hand, it would also be consistent with a ‘big grab’ explanation, in which government and investors’ money was necessary to pay for greasing the corrupted wheels of politics, and/or to channel rents to railway promoters with high market powers (see, e.g. Flandreau, 2016; Bulmer-Thomas, 1994; Lewis, 1983, or Connolly, 1997). And, finally, it could also stem from the redistributive effects of infrastructure, which could generate resistance and the need to compensate losers in exchange for their approval.

Shares of Buenos Aires and San Fernando Railway, 1860

 

The macro approach of our previous research, in which we tried to explain the size and growth of the whole railway network of each country, did not allow us to assess the relative importance of each of those alternative explanations. We could only show that the build-up of state capacity was a necessary condition for the extension of railways, despite their high potential social returns and a capital-abundant international economy. In this project, we aim at providing a microeconomic counterpart to our previous macro-analysis, which would allow disentangling to some extent the reasons for such need of government resources. In order to do this, instead of analysing the aggregate relationship between each country’s railway development and government revenues, we aim at searching evidence on the promotion of individual Latin American railways’ securities in the London market (the main origin of foreign investment) and at investigating the drivers of the success and failure of those individual promotions. The final objective of this project is to analyse the relative influence on the success of each promotion of those variables that would be more consistent with a “big push” model (such as, for instance, sound and safe regulation of investment in the country of destination), or those more related to a “big grab” story (such as the presence of certain types of intermediaries –e.g. engineering companies- in the promotion). To our knowledge, this will be the first systematic quantitative approach to the determinants of the failure or success of Latin American railway promotions in the international markets (a related research for US railways, although with different objectives, can be seen in Chambers et al., 2015).

Arauco Company, annual report (1902)

 

With this research we hope to make several contributions. First, our results will be potentially relevant for a better understanding of Latin American development during the first globalisation. By providing explanations for the success of failures of the different individual railway projects in international capital markets, we hope to throw additional light on the reasons why some countries could not benefit from a sufficient infrastructure and remained relatively underdeveloped during the period, while in others railway construction was massive and rates of economic growth remained high. More broadly speaking, the conclusions of this research may be of interest for debates on the determinants of infrastructure investment in developing countries. And, finally, we aim at contributing to the knowledge on the expansion of international capital markets in the late 19th century and the reasons that allowed certain overseas investment initiatives to obtain funding in London, whereas others, which ex post might have comparable profitability prospects, were excluded from this source of capital. In this way, we hope to provide evidence on the determinants of efficiency of capital markets in funding of developing countries’ investment projects.

MAIN OBJECTIVES

  • To compile micro-level evidence on the promotion of Latin American railway securities in the London market before 1914.
  • To investigate the main drivers of the success or failure of those promotions.

 

MAIN INFORMATION SOURCES

The project is based on a process of exhaustive data collection on Latin American railway promotions in London. The main sources of information on the characteristics of each company and promotion are the following (most of them available at Guildhall Library, London):

  1. Burdett’s Official Intelligence (1882-1898) and Stock Exchange Official Intelligence (1899-1914). Yearly volumes with exhaustive information on the companies listed in the London Stock Exchange.
  2. Companies’ prospectuses of every individual promotion.
  3. London Stock Exchange application files of every individual promotion.
  4. Companies’ annual reports.
  5. London Stock Exchange’s report books.
  6. The minutes of the London Stock Exchange General Purposes Committee.

In addition, information about the evolution of the market prices of each promotion are obtained from the following sources:

  1. The daily price lists of the London Stock Exchange (Course of the Exchange, London Daily Stock and Share List and Stock Exchange Daily Official List).
  2. The Investors’ Monthly Manual, published by the Economist, which includes monthly prices since 1869.

 

MAIN OUTCOMES

The main outcome of the project is a database of all promotions of Latin American railways in London before 1914. This database includes 1399 observations, with the following information:

  • Company’s name.
  • Issues’ name.
  • Total value.
  • London Stock Exchange application file code.
  • Type of listing (SSD or Qn).
  • Type of security (ordinary shares, preferred shares, bonds).
  • Application date.
  • Characteristics of the railway (opening date, length, gauge, etc.).
  • Table 1 presents the distribution of promotions by country, and Figure 1 and 2 show the evolution of the number of promotions and their value over time.

Table 1. Distribution of LSE railway promotions, by country

Nº issues

Nº companies

Total value (£)

%

Argentina

537

40

361,571,952

49.46

Bolivia

16

1

13,455,810

1.84

Brazil

232

40

133,427,866

18.25

Chile

60

12

25,533,610

3.49

Colombia

39

9

8,831,690

1.21

Costa Rica

20

1

5,515,196

0.75

Cuba

105

11

63,499,840

8.69

Dominican R.

1

1

426,850

0.06

Ecuador

24

1

23,900,055

3.27

Guatemala

5

1

400,000

0.05

Mexico

207

18

40,222,057

5.50

Panama

5

1

4,200,000

0.57

Peru

8

5

2,940,300

0.40

Puerto Rico

3

1

600,000

0.08

Paraguay

15

1

3,244,213

0.44

Salvador

8

1

1,879,100

0.26

Uruguay

72

10

31,469,047

4.30

Venezuela

41

10

9,953,394

1.36

 

 

Figure 1. Number of Latin American railway promotion in the LSE, by year.

 

 

Figure 2. Total value of Latin American railway promotion, by year (pounds)

 

 

 

The second outcome is a smaller database, with 188 promotions (13% of the total), with much more complete information about the characteristics of each promotion (taken from the Prospectuses, the Official Intelligence volumes and other sources), the company’s financial indicators (taken from the Annual Reports and other sources) and the evolution of prices in the first years of quotation at the LSE. More specifically, this database has, in addition to the aforementioned information for the whole sample, the following data:

  • For ordinary shares only: payment schedule.
  • For preferred shares only: guaranteed dividend and any other rule to split the remaining profits with the ordinary shares.
  • For bonds only: the reschedule of repayment (whether they had a sinking or redemption fund and of how much; the maturity of the bond; the coupon interest rate; the price at which the bonds would be amortized).
  • Who was involved in the company at the time of each issue. The idea is to know the networks of railway promoters, bankers, lawyers and engineers and to see how they intersected. The database includes the names of the directors, solicitors, bankers, brokers, and engineers involved in each promotion.
  • Details of the government’s guarantee.
  • Financial data (gearing; return on assets; dividends distributed to the ordinary shares in the previous years; dividend rate).
  • Directors’ qualifications (no. of shares of the company that the directors had to buy to join the board).
  • Whether the company was in default or insolvency on the interest of its bonds.
  • The prices of shares and bonds the 1st day, 2nd day, 1st week, 2nd week, 1st, 3rd, 6th months and 1st, 2nd and 3rd years of quotation.

On the basis of this database, the different promotions can be classified as relatively successful or failed, based on the evolution of their prices. Table 2 and 3 shows some basic features of each of those categories.

Table 2. Successful promotions

 

Average

Maximum Minimum

Price evolution over the first three years

+23%

+122% +0,5%

Total value (pounds)

560.539

2.000.000 67.230

Security type (0: ord. shares; 1: pref. shares; 2: bonds)

1.83

2 0

Starting year

1881

1911 1869

Main location

Brazil (57%)

 

Table 3. Failed promotions

 

Average

Maximum

Minimum

Price evolution over the first three years

-26%

-79%

-1%

Total value (pounds)

1.126.393

8.500.000

250.000

Security type (0: ord. shares; 1: pref. shares; 2: bonds)

1.63

2

0

Starting year

1887

1912

1856

Main locations

Argentina (32%); Mexico (26%)

 

This database will be the basis for a detailed explanatory analysis of the success of failure of each promotion. Both the databases and the outcomes of the explanatory analysis will be available here soon.

 

REFERENCES

Bignon, V., Esteves, R. and Herranz-Loncán, A. (2015), “Big Push or Big Grab? Railways, Government Activism and Export Growth in Latin America, 1865-1913”, Economic History Review 68 (4) (2015), pp. 1277-1305.

Bulmer-Thomas, V. (1994), The economic history of Latin America since independence, Cambridge, Cambridge U.P.

Chambers, D.; Sarkissian, S,; Schill, M. J. (2015), “Market and Regional Segmentation and Risk Premia in the First Era of Financial Globalization”, Unpublished research paper.

Connolly, P. (1997), El contratista de Don Porfirio. Obras públicas, deuda y desarrollo regional, Zamora, Colegio de Michoacán.

Lewis, C. M., 1983, British railways in Argentina 1857-1914, London, Institute of Latin American Studies.

Sanz Fernández, J., (coord.) (1998), Historia de los ferrocarriles de Iberoamérica (1837-1995), Madrid, Fundación de los Ferrocarriles Españoles.

Summerhill, W. (2003), Order against progress. Government, foreign investment, and railroads in Brazil, 1854-1913, Stanford, Stanford U.P.

 

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