Question

John Adams, Thomas Jefferson, and the Barbary Pirates: An Illustration of Relevant Costs for Decision Making

Dennis Caplan, Assistant Professor

Iowa State University.

The concepts of incremental cost, opportunity cost, sunk cost, and cost allocation are identified and discussed in the context of early U.S. foreign policy. The case is derived from an authentic exchange of views between Thomas Jefferson and John Adams about how the United States should protect its merchant shipping against the Barbary pirates. Both men compare the cost of waging war against the Barbary States with the cost of paying ransom for captured U.S. seamen and bribes to protect future shipping. Adams quantifies the opportunity cost associated with not taking any action. Jefferson articulates an incremental costing argument, on the assumption that the U.S. should build a navy regardless of U.S. policy toward the Barbary States. The case constitutes a brief introduction to management accounting by illustrating various cost concepts. The case lends itself to a discussion of how cost information can be chosen to support a particular course of action, and it can also prompt a discussion of the historical origins of management accounting.

The Barbary Pirates Throughout the seventeenth and eighteenth centuries, the North African Barbary States of Morocco, Algiers, Tunis, and Tripoli engaged in piracy of European merchant shipping. The Barbary pirates routinely captured and confiscated ships and cargo, and enslaved or ransomed their crews and passengers. England, France, and Spain entered into treaties with the Barbary States, in effect, paying ìprotection moneyî for their merchant shipping. These powerful European nations preferred bribery to war, in part because they perceived an economic benefit from the threat the pirates posed to the merchant shipping of other European nations. John Adams, Thomas Jefferson, and the Barbary Pirates: An Illustration 267 Issues in Accounting Education, August 2003 Until the Revolutionary War, merchant ships from the American Colonies were protected by the British Navy and by treaties between England and the Barbary States. American shipping lost this protection after the war. Within three years of the Treaty of Paris, which formally ended the war in 1783, three American ships were captured, one by Morocco and two by Algiers. Morocco soon freed the American crew in exchange for a ransom of 5,000 pounds sterling (about $25,000).1 The crews held by the Algerians were captive throughout 1786 and for some time thereafter. See Exhibit 1. Historical Background The capture of American ships by the Barbary pirates created an early and important foreign policy crisis for the United States. The U.S. response to the Barbary crisis was strongly influenced by two factors: one military and the other financial. The military consideration was that the U.S. had no navy. The Continental Navy of the Revolutionary War was disbanded in 1784, and the navy was not reestablished until the Navy Act of 1794. During the intervening years, the U.S. had minimal naval power. Disbanding the Continental Navy was primarily a cost-savings measure. However, there were also important nonfinancial arguments for and against the navy. Some Americans who favored reestablishing close ties with England feared that the presence of a U.S. navy on the high seas would lead to confrontations with the British Navy. Other Americans, including John Adams, viewed a strong navy as the best national defense against foreign threats. Many Americans preferred the prospect of building a navy over an army due to their general distrust of standing armiesóthe result of their experience with the British occupation in America during the latter part of the Colonial Era. The financial factor that influenced the U.S. response to the Barbary pirates was that any effective response would require a significant expense relative to the governmentís available funds. The U.S. government found itself in a precarious financial condition in the years immediately following the Revolutionary War. The Continental Congress and individual states borrowed over $40 million to finance the war, including about $6 million from France. From 1781 to 1788, the period during which the United States operated under the Articles of Confederation, the federal government did not have the power to tax its citizens, levy tariffs, or regulate commerce. The cost of operating the government during this time was about $500,000 annually, not including funding the debt (Hicks et al. 1970, 103). Some income was generated by the post office and from sales of public lands, but the two principal revenue sources available to the government were requesting support from the states and issuing paper money. State contributions to the federal government constituted only a small fraction of what was needed, and issuing paper money was an inflationary measure that had already been used extensively during the Revolutionary War. The financial plight of the new nation was sufficiently acute that during this period, the government borrowed from foreign sources just to meet the interest obligations on existing foreign debt. The ratification of the Constitution in 1788 greatly enhanced the powers of the federal government and allowed the new Congress to levy and collect duties and taxes. However, the ability of the new government to actually enact and enforce revenue-generating measures was untested, and evolved over time. In 1786, during the Confederation period, and again in 1794, during Washingtonís presidency, popular opposition to taxation led to civil unrest. The first incident, Shaysí Rebellion, arose in Massachusetts when the State Legislature levied taxes to pay off the war debt. The second incident, the Whiskey Rebellion, occurred in Western Pennsylvania when the federal government imposed an excise tax on distilled liquor. Also, although the federal government had more potential resources under the Constitution than under the Articles of Confederation, it soon had more obligations. In 1790, under a plan advanced by Secretary of the Treasury Alexander Hamilton, the federal government assumed the remaining war debts that were owed by the individual states. However, despite financial tribulations at both the state and federal levels, economic conditions in the United States during this period were generally good. A short recession that occurred after the Revolutionary War was followed by a period of economic growth. The strong economy led to increased federal revenues, and that fact, combined with the success of American leaders in keeping the nation out of the growing conflict between England and France, enabled the government to become current on its obligations under the national debt during Jeffersonís administration. THE ADAMSñJEFFERSON CORRESPONDENCE In 1786, John Adams was the leading U.S. diplomat in London, and Thomas Jefferson was the U.S. ambassador to France. A few years earlier, in 1784, the Continental Congress had authorized Adams and Jefferson to negotiate treaties with the Barbary States (Kitzen 1993, 10). Consequently, the responsibility to negotiate the release of the captured American seamen, and to establish U.S. foreign policy that would protect U.S. shipping in the Mediterranean, fell largely to these two men. Against this backdrop, Adams sent Jefferson a letter that included the following analysis: Adams to Jefferson Grosvenor Square June 6. 1786 Dear Sir ... The first Question is, what will it cost us to make Peace with all [of the Barbary States]? Set it if you will at five hundred Thousand Pounds Sterling, tho I doubt not it might be done for Three or perhaps for two. The Second Question is, what Damage shall we suffer, if we do not treat. Compute Six or Eight Per Cent Insurance upon all your Exports, and Imports. Compute the total EXHIBIT 1 Timeline Government under Articles of Washingtonís Adamsís Jeffersonís Madisonís Confederation Presidency Presidency Presidency Presidency 1781ñ1788 1789ñ1797 1797ñ1801 1801ñ1809 1809ñ1817 1783: Treaty of Paris 1793: Algiers 1797: U.S.S. 1801: Start of 1812: Jefferson ends the Revolutionary seizes more Constitution Tripolitan and Adams War ships and launched War resume hostages correspondence 1784ñ1785: Jefferson 1798ñ1801: 1803ñ1804: after 12-year hiatus joins Adams in Europe; 1794: Quasi-War Heaviest they are authorized Congress with France naval action 1812ñ1814: to negotiate with the passes Navy of the war War of 1812 Barbary States; Morocco Act and Algiers seize three 1805: 1815: Naval merchant ships; 1795ñ1797: Tripoli action against Continental Navy Algiers signs signs treaty Algiers disbanded treaty, favorable to hostages U.S. 1786: Morocco signs released treaty John Adams, Thomas Jefferson, and the Barbary Pirates: An Illustration 269 Issues in Accounting Education, August 2003 Loss of all the Mediterranean and Levant Trade. Compute the Loss of half your Trade to Portugal and Spain. These computations will amount to more than half a Million sterling a year. The third Question is what will it cost to fight them? I answer, at least half a Million sterling a year without protecting your Trade, and when you leave off fighting you must pay as much Money as it would cost you now for Peace. The Interest of half a Million Sterling is, even at Six Per Cent, Thirty Thousand Guineas a year. For an Annual Interest of 30,000 £ st. then and perhaps for 15,000 or 10,000, we can have Peace, when a War would sink us annually ten times as much. (Cappon [1959] 1988, 133ñ134) In the last paragraph of the excerpt, Adams states interest expense in terms of guineas. A guinea was worth about one pound sterling. Jefferson responded to Adams a few weeks later: Jefferson to Adams Paris July 11. 1786 Dear Sir ... I ask a fleet of 150. guns, the one half of which shall be in constant cruise. This fleet built Ö will cost 450,000 £ sterling. Its annual expence is 300 £ sterl. a gun, including every thing: this will be 45,000 £ sterl. a year. Ö Were we to charge all this to the Algerine war it would amount to little more than we must pay if we buy peace. But as it is proper and necessary that we should establish a small marine force (even were we to buy a peace from the Algerines,) and as that force laid up in our dockyards would cost us half as much annually as if kept in order for service, we have a right to say that only 22,500 £ sterl. per ann. should be charged to the Algerine war. (Cappon [1959] 1988, 142ñ143) Correspondence between Adams and Jefferson tapered off in the early 1790s, when their political differences became increasingly irreconcilable, and ceased altogether shortly after Jefferson defeated Adams in the Presidential election of 1800. However, beginning in 1812, after both men had retired from public life, they renewed their friendship and began an active correspondence that would continue for the rest of their lives. Adams and Jefferson both died on July 4, 1826, the fiftieth anniversary of the signing of the Declaration of Independence. One of the letters from this latter period is relevant to the current discussion, because it reveals Jeffersonís attitude toward the navy, and more specifically, his assessment of the economic life of a ship: Jefferson to Adams Monticello Nov. 1. 1822. Dear Sir ... Yet a navy is a very expensive engine. It is admitted that in 10. or 12. years a vessel goes to entire decay; or, if kept in repair costs as much as would build a new one. And that a nation who could count on 12. or 15. years of peace would gain by burning itís navy and building a new one in time. (Cappon [1959] 1988, 584ñ585)

questions:

5- Adams advocates negotiating with the Barbary States, and Jefferson argues in favor of fighting them. In comparing Adamsís letter to Jeffersonís 1786 letter, where do these men agree, and where do they disagree? How does each man present cost data in a way that supports his position? Your analysis should distinguish between differences in underlying cost assumptions, and differences in the types of costs that each man proposes are relevant. Do you consider either man more ìcorrectî in his analysis?

6. A complete analysis of the alternative courses of action for responding to the pirates requires a consideration of noneconomic factors. What noneconomic factors can you identify that you think Adams and Jefferson should consider in weighing the pros and cons of fighting the pirates?

Answer 1

5) Adams argument for negotiation of peace with the barbary states is based upon the assumption that war is costlier than peace at any given time which he supports with the cost analysis of potential trade revenue loss being more than 5,00,000 Pound Sterling per year.

In case of peace cost of 200,000 to 500,000 as interest is 6% equalling 10,000 to 30,000 annually. This is a mistaken assumption as the cost is considered as a one time cost when it is in fact recurring cost.

In case of war initial investment for readiness is atleast 500,000 pounds even if war does not occur in the form of setup costs of a Navy. Variable costs of additional Pounds 200,000 to 500,000 in case of actual occurrence of war. This has been assumed to be recurring annual cost when in fact it is a one time investment cost, with further future costs being Asset Management costs rather than capital investment. The comparison was therefore of different types of course with different bases which are not subject to equal comparison for rational analysis.

Jefferson's argument is that building a fleet is mandatory for availing restrictive advantage and is not as costly as assumed by Adams. Is argument is based on the assumption that the cost of war should be split into the fixed cost and variable cost. he believed that fixed setup cost for a one time investment and not to be used for comparison of cost with only variables being compared. The fleet setup cost of 450,000 pound sterling is a fixed cost which is to be incurred in any case, hence not to be considered. The additional cost of Pounds 22,500 per year was considered as the only variable cost of keeping half the fleet in service. The comparison only variable cost be undertaken was a rational argument but it was a rational to consider only maintenance of the fleet as the cost incurred no consideration being given for the cost required to fight the war which was the major reason for setting up of a Navy.

The actual consideration for Cost of peace would be

Pounds 200,000 to 500,000 annual recurring cost with an average of annual recurring cost of 350,000.

Cost of war

One time capital cost for fleet setup which would be a fixed cost pounds 450,000

Recurring annual cost of pounds 22,500 upto 45,000 as maintenance cost

Pounds 350,000 whenever war is indulged in requiring provision as a reserve to cover against risk. It is a probable expense with benefits accruing in case of victory rendering the pirates ineffective over a long time period. The most beneficial suggestion would be to risk indulging in a one time war for obtaining competitive advantage against the pirates by reducing the bargaining power entirely over a long period of time during which peace should be maintained.

6) The non economic factors Adams and Jefferson did not consider for fighting the pirates was an analysis of the strengths and weaknesses of the enemy in comparison to their own strengths and weaknesses. A SWOT analysis is not restricted to only the economic environment and can be extended to apply to various situations in life. Consideration of war is based upon the probable outcome which requires a clear definition of the strategy to be adopted. Wars are won solely on the basis of superior strategy more than any other single factor. The weakness of the pirates was the lack of access to latest technology weaponry and vessels so to defeat them a Navy with superior technology and better vessels was the answer. The government was undergoing financial crisis in any case so it made better sense to take debt for investment in capital assets which would protect the nation in the long run rather than to avail debt to make payments to the pirates. The major consideration in times when communication was heavily restricted with devices and individuals who are involved in the war and those controlling it through the goverment, was adequate delegation of authority to take decisions which would have large impact. This was a major weakness as the pirate ships and the leader on board who take instant decisions for maximizing the end and change strategy is required whereas the naval fleet obtained phased repeated failures due to lack of adequate authority to take stringent action against the pirates, whatever the consequences. what was an important consideration was that one time work with pirates was not possible and as John Adams foresaw that they ought not to be fought unless we are ready to fight for forever.