Panama Canal: Troubled History, Astounding Turnaround

A favorite topic of historians and palindrome fans alike, the Panama Canal has perpetually changed the international trade business.

In their new book, The Big Ditch: How America Took, Built, Ran, and Ultimately Gave Away the Panama Canal (Princeton University Press), Harvard Business School professor Noel Maurer and economic historian Carlos Yu discuss the canal's complicated economic and political history—including the first proposals dating back to 1529, the massive cost overruns associated with digging the canal in the early 20th century, the first commercial traffic in 1914, the rise and fall of the canal's importance to the United States, the handover of the canal to Panama in 1999, and the way the canal has thrived under Panamanian control.

In this e-mail interview, Maurer discusses the factors that make the canal such a fascinating economic case study.

Sarah Jane Gilbert: What led you to write the book?

Noel Maurer: The idea of the book grew out of two conundrums. First, why wasn't Panama richer in 1999, after [nearly] 100 years of the Panama Canal? After all, the United States and Panama were joined at the hip for decades, in what looks a lot like the kind of close relationship that many scholars have claimed could greatly improve governance in many third world nations: the United States ran the currency, provided aid, posted an official inside the Panamanian government, and operated one of the great commercial arteries of our time. Yet as late as 1999, the place appeared to be run little better than and little richer than most of Latin America.

Second, why was the canal so much better run after the handoff to Panama than it had been before? The turnaround has been astounding. The answer to these two questions seemed to be related-and vital to understanding the limits of attempts by outside governments to improve business and political conditions in other countries. Answering them, however, required a long and detailed romp through the history of US involvement with what Secretary of War Henry Stimson described as "the one spot external to our shores which nature has decreed to be most vital to our national safety, not to mention our prosperity."

Q: You describe the US involvement in the construction and administration of the Panama Canal as a "successful American venture into imperialism." Can you discuss our role as imperialists?

A: Americans never like to use that word in describing our actions! I certainly don't. But it fits our behavior in Panama. The "successful" part happened under Teddy Roosevelt: the United States used military force and the threat of military force against Colombia (to detach Panama from Colombia) and against the new Panamanian government (to get a better deal for the Panama Canal).

The Colombians wanted to hold out until 1904 to make a deal with the United States to build a canal. The reason was that the properties of the failed French canal company (worth about $22 billion in 2010 terms, as a share of national income) were scheduled to revert to Colombian ownership in that year. The money to buy them for the new canal effort, then, would have gone to Bogotá instead of the shareholders in the moribund French company. Those shareholders, however, contributed large sums of money to Senator Mark Hanna [R-OH] and the leaders of a Panamanian independence movement. Hanna, in turn, convinced President Roosevelt to support the independentistas.

American warships prevented Colombia from responding to Panama's declaration of independence. The new government then appointed the head counsel of the French company as their foreign minister. (He was not Panamanian and in fact lived in New York.) The lawyer drafted a treaty that gave Panama a far lower share of the canal revenues than the United States could have received in a fair negotiation. When the new government balked at the treaty, Secretary of State John Hay warned of "grave consequences" and threatened to send the Marines. The Panamanians soon capitulated.

The whole thing was quite sordid, although the cynic in me can't help but admire the way self-interest was couched as high principle.

Q: For the United States, what were the economic and political advantages of building and managing the canal?

A: The Panama Canal provided massive cost savings to intercoastal commerce. Before the Second World War, the vast majority of the cargo transiting the Panama Canal consisted of oil and lumber from the West Coast headed to eastern ports, with a smaller flow of manufactured goods and agricultural products headed the other way. The canal supercharged the growth of the West Coast (at the expense of Venezuela in oil and the South in timber) and generated economic benefits several times greater than its cost. By 1940, America's national income was around 4 percent higher than it would have been without the canal—a very large gain from a single infrastructure project. Moreover, by keeping the Panama Canal in American hands, the United States ensured that transit rates would remain low. An independent Panama or private canal operator would have charged profit-maximizing rates and captured much of that surplus of itself. Under US public ownership, however, low tolls ensured that most of the surplus would flow to American producers and consumers.

Q: The canal's importance to the United States declined after World War II. What happened?

A: In defense terms, the United States finally had to recognize something that naval strategists had long realized: The Panama Canal had no strategic value. Military analysts recognized as early as 1925 that a suicide ship loaded with explosives (or a sufficiently motivated group of commandos) could knock the canal out for at least a year. Sabotage would be harder during wartime, of course—the only battle during World War II that would have been affected by adding 17 days of additional travel and replenishment time to the warships that passed through the Panama Canal was the Battle of Guadalcanal … and the United States had the initiative at Guadalcanal, and could therefore choose when it wanted to attack.

Shutting down the Panama Canal for a year would have raised the fiscal cost of the war effort, but it would have had little effect on military operations. The Japanese did not attack the canal, of course, but the knowledge that the Soviet Union could knock the Panama Canal out of operation whenever it wanted meant that the United States needed to maintain a massive two-ocean Navy with or without the Panama Canal. By the late 1940s, many voices in the Defense Department were calling for the United States to reduce its involvement. President Truman even called for turning the canal over to the United Nations, baldly stating, "Why don't we get out of Panama [gracefully], before we are kicked out?"

Technologically, three big changes greatly reduced the canal's economic value to the United States: the dieselization of the railroads, the Interstate Highway System, and the rise of California as a market for its own natural resources. The first two meant that by the 1970s, a midwestern farmer faced an almost even cost between transporting Asia-bound exports down to the Gulf and through the canal and shipping them out to Seattle by land. Conversely, eastern-bound cargoes no longer consisted of strategic raw materials from California but inexpensive manufactured goods from Asia. A rise in Panama Canal tolls, therefore, would no longer hurt American interests—its incidence would fall on Japanese, Korean, and Taiwanese manufacturers trying to sell into the highly competitive American market.

Q: President Jimmy Carter ceded formal control. Why did our interest decline? Was it in our best interest to step away?

A: The big reason was that the United States no longer had any need to control Panama Canal tolls. There was no longer any reason to prevent a Panamanian canal operator from trying to charge as much as the market would bear.

Additionally, the Panama Canal had become a fiscal drain by 1970. On one end, the canal was squeezed by rising costs due to American mismanagement. Panama Canal employees in essence captured canal management and ran it for their own benefit: salaries escalated, along with costs and accident rates, and the administration didn't even bother to do simple things such as deepen shallows or install lights. In this, canal employees were greatly aided by the peculiar place the canal held in America's national mythology. Conservatives who would have been horrified at employee capture of other public enterprises such as, say, the Tennessee Valley Authority or National Aeronautics and Space Administration not only tolerated but applauded the phenomenon in the Canal Zone. The result was that American aid transfers to Panama soon began to overshadow the revenues from the canal.

In short, the United States no longer had any interest in owning the canal. American end users no longer needed to ensure that Washington kept tolls low, and American taxpayers no longer gained from the canal's profits. Jimmy Carter struck a deal in which the United States would slowly turn the Panama Canal over to Panama, in return for the elimination of almost most aid transfers—with the Neutrality Treaty tacked on to ensure that the United States retained the right to return should canal operations be threatened. President Carter's national security advisor, Zbigniew Brzezinski, said it best when asked by Congress what would happen if a future Panamanian government shut down the Panama Canal "for repairs." He responded, "In that case, according to the provisions of the Neutrality Treaty, we will move in and close down the Panamanian government for repairs."

When you add together the lack of strategic value, the decline and disappearance of the economic value of ownership (although the existence of the canal remained important), and the guarantee of the Neutrality Treaty, then the Panama Canal treaties start to look like a no-brainer … and that is why Harry Truman first proposed "ditching the Big Ditch," andLyndon Johnson, Richard Nixon, and Gerald Ford all made serious efforts to negotiate a handover. That said, it took Jimmy Carter's willingness to cut endless deals and risk political suicide to get the Panama Canal treaties through the Senate. The reason was that a large swath of American public opinion opposed the Panama Canal treaties, but their motivation was a defensive American nationalism, not American national defense.

Q: What role did the corrupt governments of dictators Torrijos and Noriega play in the handover of the canal back to the Panamanians in 1999?

A: Ironically, the two dictators set the stage for Panama's ability to run the canal as astoundingly well as it has. Omar Torrijos started the destruction of the patronage networks through which the old oligarchy controlled Panamanian politics, and Manuel Noriega completed it. Torrijos launched the attack as part of an attempt to create a broad-based populist movement to sustain his regime and transform Panamanian society; Noriega continued it in order to destroy anyone who threatened his control over the profits from corruption and cocaine. Once the United States removed Noriega through the brute application of military force, a large bloc of Panamanian swing voters emerged—and for those voters, the inviolability of the Panama Canal became one of their key issues. Panama's new government passed a constitutional amendment to make the Panama Canal Authority as independent as humanly possible, and credible accusations of interference in the management of the canal soon became the electoral kiss of death for Panamanian politicians.

Q: What has happened since the transfer of control?

A: After the United States removed Noriega, the Panama Canal underwent a management revolution. Once the political conditions were met to prevent the canal from becoming a source of elite patronage, the canal could operate as a commercial enterprise free of adverse political interference. Under the Panama Canal Authority, the canal professionalized its management and began making long-term investments with an eye to the commercial potential of the canal for the first time since the 1920s. Most importantly, for the first time in its history, the Panama Canal was no longer run as a public utility. Rather, it became a profit-making enterprise run for the benefit of its shareholder: the Republic of Panama. The canal has been able not only to meet the added payments to the Panamanian government specified in the Panama Canal Treaty, but also to turn itself into one of the most profitable transportation enterprises on the planet, despite continuing steep competition from trucks, railroads, and intermodal transportation within the United States.

Q: What role does the canal play in the global marketplace currently and in the future?

A: The Panama Canal will never again be as important to the United States as it was before World War II, but its importance to the world economy is set to grow. The continuing growth of the Chinese economy is stimulating a wave of new eastbound exports through the canal coming from the growing links between Brazil and China and to a lesser extent between China and Europe.

If the Panama Canal declines in the future, it will be because of shifts in the global economy or, more likely, shifts in global geography: for example, the opening of the Northwest Passage as a result of climate change.

In 2006, the Panamanian electorate voted in favor of a plan to expand the Panama Canal. The reason is not that the canal had reached full capacity: in fact, a back-of-envelope calculation shows that the Panama Canal is at roughly half its maximum throughput in terms of the number of ships. Rather, the reason is that 35 percent of the planet's commercial shipping consists of ships too large to fit through the current locks, and Panama wants a piece of that business. The current locks measure 1,050' x 110' x 85', accommodating ships measuring up to 965' x 106'. The new locks will measure 1,400' × 180' × 60' and be capable of accommodating ships up to 1,315' × 176'. This is big enough to accommodate Nimitz-class aircraft carriers and most cargo ships short of a supertanker.

Q: Have you ever visited the Panama Canal, and if so, what were your impressions?

A: Yes. The transit is not to be missed. Traveling through the channels blasted out of the rock is worth the price of admission, but the truly breathtaking sight is watching a gigantic containership slip through the locks ahead of you with only inches to spare on either side. [Maurer posts photos and impressions of Panama on his blog, The Power and the Money—Ed.]

Q: What are you working on next? Will you be doing more research in this area?

A: Right now, I'm finishing what I consider an academic trilogy. My next book is called The Empire Trap. It asks how American firms convinced Washington to protect their property rights outside the United States. It also asks when and why the U.S. government got out of the business of sanctioning foreign governments that expropriated American properties.

Most of my research deals with the problem of doing business in places where the rule of law doesn't function. My first book projects—The Power and the Money and The Politics of Property Rights—looked at how businesses solved that problem in revolutionary Mexico. Firms in Mexico, both foreign and domestic, dealt with the insecurity of violence and dictatorship by striking deals with individual politicians, powerful organizations, other firms, and armed (or potentially armed) factions. The goal of these deals was to defend their property rights by raising the political costs of interference with their operations. They were remarkably successful, although the deals they struck effectively institutionalized corruption and slowed growth in the long-run.

A second possible solution to the problem, of course, is to get another more powerful country to create the rule of law where it does not exist. The US-Panama relationship between 1903 and 1989 represents the best possible case of that solution, at least in a modern context. It did not work particularly well. The United States could intervene to promote democracy and the rule of law, but those interventions failed until the Panamanians developed their own internal political norms to support it. At that point, the United States could help by knocking Manuel Noriega out of power, but despite the most fortuitous conditions possible—the presence of the canal on Panamanian soil—the United States was not able to promote prosperity or democracy in our pseudocolony, and it seems unlikely that the United States is going to succeed in doing so today. In a sense, then, The Big Ditch isn't just about the Panama Canal but about the inability of the United States to transform foreign societies, even under the most favorable conditions.

There is, however, a third way between having foreign firms strike private deals with local actors and having a foreign state attempt a wholesale transformation of society. Firms operating in unstable environments can try to persuade their home governments to protect their property rights. No need to promote democracy or create courts; just convince Washington use economic and military sticks to prevent foreign governments or foreign armed factions from confiscating American¬-owned properties. My new book (the third part of the trilogy) examines how firms convinced Washington to defend them, when and why Washington stopped doing so, and what the effects of that latter change have been on the security of US overseas investments.

Book Excerpt From the Big Ditch: How America Took, Built, Ran, And Ultimately Gave Away The Panama Canal

By Noel Maurer and Carlos Yu

The Many Costs of the Panama Canal

The American effort to build the Panama Canal began in 1904. The first ship sailed through the canal in 1914, ten years and $326 million later—a considerable increase over the $144 million originally planned. In fact, the canal would not be fully open to commercial traffic for another six years. Landslides shut it down for most of 1915 and 1916, and then again briefly in 1917 and 1920. Strikes hit the canal in 1916 and 1917. World War I practically closed it to commercial traffic, and work continued on clearing dangerous hills, fixing locks, and finishing all the ancillary construction required by the canal. The Panama Canal finally opened to civilian traffic on July 12, 1920, after an additional six years and $53 million.

By the time all was said and done, the construction of the Panama Canal cost 2.0 times its initial estimate, after adjusting for inflation. The overruns exceeded those on the Massachusetts Turnpike (1.1), the Hoover Dam (1.1), the Erie Canal (1.5),the Bay Area Rapid Transport system (1.6), and the Washington Metro (1.8), although the Panama Canal's construction overruns do compare favorably to the Miami Metrorail (2.1), Boston's infamous Big Dig (2.9), and the Brooklyn-Queens Expressway (5.1).

Obviously, the United States did not set out to build the Panama Canal a decade late and double over budget. The Americans hoped that their $40 million purchase of the New Panama Canal Company's assets in Panama would greatly speed construction. Sadly, that did not turn out to be the case. The French had excavated seventy-eight million cubic yards, but most of those excavations had been designed for a sea-level canal and proved useless for the American effort. (In fact, most of the French excavations sank below Lake Gatun when the Americans dammed the Chagres River.) The Panama Railroad proved to be in such bad condition that the Americans needed to rebuild it twice: once to handle the initial excavations, and then again when Lake Gatun drowned much of the original route. The New Company owned most of the city of Colon, but its buildings were so dilapidated and disease-ridden that the Americans built a practically all-new town, Cristobal, across Limon Bay. About the only substantial savings that the Americans received from their purchase of the French assets were some old dredges that could be repaired or reconstructed for $500,000 less than it would have cost to purchase new equipment.

Management Missteps

The first few years of construction of the Panama Canal proved to be a management foul-up of the first order. The Isthmian Canal Commission tried to supervise construction from Washington. This would have been a bad idea with the communications technology of the first decade of the twenty-first century; it was an unmitigated disaster with the communications available in the first decade of the twentieth. Shipments arrived late, or piled up on docks with no means to unload them. By 1905 the New York Times was complaining that the Isthmian Canal Commission was on track to have spent $66 million by the end of the year, with "no dirt flying." In response, Theodore Roosevelt sacked the first commission. The replacement commissioners selected a civilian railroad engineer from Maine, John Stevens, to go to Panama to supervise the construction of the canal. The same Brooklyn lobbyist who had greased Congress's wheels in approving the Panama route for the canal, William Cromwell, convinced Stevens to take the job. Stevens accepted on condition that he "was not to hampered or handicapped by anyone, high or low."

“There are three diseases in Panama . . . yellow fever, malaria, and cold feet."
—John Stevens

Stevens arrived in Panama in early 1905. He approached the construction of the canal more systematically than the early, almost random efforts. His first task was to replace railroad "lines which, by the utmost stretch of the imagination, could not be termed railroad tracks." With his typical style, he wrote, "The only claim for good work . . . was that there had been no collisions for some time. A collision has its good points as well as its bad ones—it indicates that there is something moving." Unfortunately, Stevens had to deal with shifting design plans back in Washington. A board convened by President Roosevelt on June 24, 1905, came back with recommendations for four different lock-canal designs and one sea-level plan. After several months of squabbling, it decided on a lock-canal plan on February 19, 1906, which Congress approved on June 29.

Political infighting continued on the new Isthmian Canal Commission. Theodore Roosevelt travelled to Panama in November 1906—not coincidentally right before the midterm elections and during the worst part of Panama's rainy season—returning convinced that it was time to junk the multiple-member commission and put one person in charge. The results of the closed bidding for construction contracts only reinforced that decision: the commission invited bids on the entire project on October 9, 1906—and rejected all four bids in January 1907. Stevens resigned on April 1, 1907, amid rumors of conflict. Roosevelt replaced Stevens with Colonel George Washington Goethals.

Goethals was a cold, withdrawn man of many prejudices, including ones both common and uncommon for the time. He disdained blacks and loathed obese people, with the exception of William Howard Taft, who was "the only clean fat man he had ever known." Goethals moved to the Canal Zone and required the other members of the Isthmian Canal Commission to follow him. He definitively rejected the government's plan to contract construction to the private sector. He established clear chains of command and authority, delegating authority whenever possible but personally investigating and inspecting all aspects of the construction effort. At the same time, however, he eschewed all military overtones, banning salutes and military uniforms, in order to keep up relations with his overwhelmingly civilian professional workforce.

Goethals quickly moved to neuter the Isthmian Canal Commission. "The whole definition of a board is applicable to the Commission, namely, it is long, narrow, and wooden," said Goethals. Goethals persuaded Roosevelt to sign an executive order in January 1908 that gave him sweeping authority over the entire canal project, including the right to fire commission members. Secretary of War William Howard Taft had doubts about the legality of granting the chief engineer control over the commission, which was technically governed by civil service rules and had been created by an act of Congress. "That order is not in accordance with the law on the subject," he told Roosevelt. "Damn the law, I want the canal," replied the president.

Goethals continued to fight to cement his control over the project. The first challenge came from the head of the Department of Civil Administration, Maurice Thatcher, who proposed that the U.S. government create an elected civil government in the Panama Canal Zone, with the aim of promoting permanent settlement. "We must have courts . . . I would like to see an American civil population here," Thatcher told Congress. "These Americans would come here to live, make their homes here, and they would prefer to live under the dominion of the American government, under American laws."

Thatcher's plan to create civil government in the Canal Zone would have had dramatic consequences for the future. The Zone would have accrued a truly permanent population, possibly in large numbers, who would have been able to own private property, enjoy the jurisdiction of American courts, and vote for their own elected government. Under such circumstances, it is difficult to imagine the U.S. Congress ever returning the Canal Zone to Panama, with far-reaching implications for Panamanian economic development and U.S. relations with Latin America.

Goethals mobilized a strong lobbying effort to kill the proposal to give the Canal Zone a civil government. "Introduce the franchise, and we'd go to pieces," he wrote. His lawyer, Judge Frank Feuille, wrote that the Zone should be "like a large corporate enterprise," for the "management of a great public work, and not the government of a local republic." Taft, now president, backed Goethals. The Panama Canal Act of 1912 cemented Goethals's control over all aspects of the canal enterprise, at least until the end of construction, when the Isthmian Canal Commission would shut down. In the interim, the act effectively abolished private ownership of land inside the U.S. Canal Zone. The Panama Canal Act's stipulations would far outlast the end of construction—in fact, they would last until the Republic of Panama took back jurisdiction over the Canal Zone.