Market Conditions in the Late 19th Century
P.J. Hill, Wheaton College, The Property and Environment Research Center
“It was the best of times, it was the worst of times. . . .”
A Tale of Two Cities —Charles Dickens
In this paper I take up market conditions in the late nineteenth century, surely a controversial period in American economic history. For many people this period is characterized by laissez faire run amuck, a time when one could observe the worst excesses of modern industrial capitalism. I shall offer a different perspective here, arguing that instead one should see it as a time of a dynamic, growing economy with new forms of production and distribution. During this period entrepreneurs and innovators played an important role in transforming economic life and all of these factors led to substantial increases in economic well being for almost all of the population. However, it is not a period to be universally celebrated, but the fault lay not in the fact that there was too much laissez faire, but rather that the seeds of a regulated, rent-seeking economy1 were established during this time.
II. The Best of Times
Generally I will deal with the period from 1870 through 1900, although in some cases I will cite evidence and trends to 1914, the beginning of World War I. In 1870 gross domestic product in 1996 dollars was 2.4 billion dollars and by 1900 it had risen to 4.2 billion, a 77 per cent increase (Historical Statistics 2006, Table CA9-19, 3-24, 25). Of course this is also a period of rapid population growth, both through natural increase and immigration, so the more relevant measure of the performance of the economy is the rate of change in real gross domestic product per capita. From 1870 through 1900 GDP per capita in real terms increased at an annual rate of 1.9 per cent, substantially above the long-term historical rate of 1.6 percent (Historical Statistics 2006, Table Ca-c, 3-5). Although this was a period of increasing inequality of wealth,2 the increases in inequality were not substantial enough to alter the overall conclusion that this was a period of increasing economic well being for almost all of the population. As will be discussed later, the dramatic increase in the availability of new products and services and the decrease in hours worked per week substantiate this conclusion.
Given the overall record of rapid increases in both the total economy and per capita income during the thirty years from 1870 through 1900 it is worth examining in more detail the background conditions that led to this increase. It is also important to take up some of the major historical issues that have been raised with respect to the performance of the economy and the role of business enterprises.
Douglass North (2005) is perhaps the leading exponent of an increasingly important field known as the new institutional economics (NIE) that sees the most important determinant of economic activity as the underlying rules of the game, both formal and informal. North argues that it is difficult for societies to construct the rules so that order prevails over disorder and in fact disorder― revolution, lack of personal security, chaos― has characterized a great deal of the human condition (2005, 7). In this framework, economic growth occurs when stable rules exist that define and enforce property rights through the rule of law. Richard Epstein (1995, 53) sets forth a set of rules have the virtue of preventing people from predating on one another and also foster human cooperation. In his framework “the simple rules are self-ownership, or autonomy; first possession; voluntary exchange; protection against aggression; limited privilege for cases of necessity; and taking of property for public use on payment of just compensation.” (1995, 53). Although these rules are limited in number and relatively simple, they promote gains from trade between individuals and also encourage innovations which creates complex economic organizations. These organizations, and the voluntary relationships between them, are the basis for specialization, which is crucial for economic growth (Demsetz 2002).
One of the most significant contributions to the expansion of market conditions in the late nineteenth century was the granting of self-ownership to all people in the United States. The emancipation of slaves dramatically changed conditions in the labor market in that the former slaves were able to contract freely for their own labor. Thus the ending of one of the most substantial interferences with a well-functioning and just market order, the ownership of some people by others, meant that markets could flourish in a way that they hadn’t in the past.3
The last three decades of the nineteenth century were marked by dramatic decreases in transaction costs that led to greater specialization, increases in productivity, and gains from trade,all of which are at the heart of economic growth. Numerous factors contributed to the decrease in transaction costs. These included the extension of the railroad network, the increased use of the telegraph for communication, the refinement and increased sophistication of the capital market, the rise of the modern corporation, the integration of American markets into world trade,and the movement of capital and labor across national boundaries.
Although 30,000 miles of railroads had been constructed by the eve of the Civil War, the continue expansion of the railroad network in the latter part of the century decreased costs of transportation and integrated the U.S. economy, making the transportation of goods and passengers cheaper. In 1869 the transcontinental railroad was completed and from 1868 through 1892, 115,960 miles of railroad were constructed (Fishlow 2000, 584). Accompanying the increased railroad mileage was an enormous investment in upgrading existing mileage and purchasing of rolling stock. The gross investment in construction and equipment from 1870 through 1900 (in 1909 dollars) was four times that of the period from 1840 through 1870 (Fishlow 2000, Table 13.13). Railroad rates also fell dramatically from approximately three cents a ton mile in 1870 to three-quarters of a cent by the end of the period (North 1965) and overall real freight rates fell by one third from 1870 to 1900 (Gunderson 1976, 321).
The telegraph accompanied railroad construction since in many cases telegraph lines could use the railroad right-of-way and by 1861 there was a telegraph linkage between San Francisco and the eastern part of the United States (Historical Statistics 2006, 4-986). In 1866 the transatlantic cable was completed and the average message time across the Atlantic fell from ten days to a few minutes, which led to a rapid convergence of stock prices in Europe and the U.S. (Hoag 2006). Average message rates in the U.S. fell about 40 per cent in real terms from 1867 through 1898 (Historical Statistics 2006, 4-986) and the number of messages handled by Western Union, the dominant company in the field, increased from 9,158,000 in 1870 to 63,168,000 in 1900 (Historical Statistics, 2006, Table Dg8-21). The telegraph improved in 1874 when Thomas Edison invented a quadruplex system that allowed two messages to be sent in both directions at the same time. In 1876 Alexander Graham Bell patented the telephone system for voice transmission, which further lowered transaction costs. In 1880, the American Bell Telephone Company was created with an initial capitalization of six million dollars, and by 1882 the firm had over a million dollars of gross earnings (Historical Statistics 2006, 4-989).
During this period the capital market also became more integrated and numerous financial instruments developed that lowered the cost of capital. The New York Stock Exchange became a center of sophisticated credit markets, investment bankers who practiced an active role in the management of firms and the marketing of securities grew rapidly, the insurance industry matured and offered a wider variety of products, and the technological improvements in communication all lowered the transaction costs of amassing capital for projects and moving capital from places of lower to higher return (Rockoff 2000, 675-683). The gross savings rate averaged about 25 per cent of gross domestic product for the period which aided capital formation (Davis and Cull 2000, 784). The changes in technology and the decrease in transaction costs in capital markets led to a remarkable increase in capital per manufacturing establishment, from $8,400 in 1870 to $18,400 in 1890 (Lamoreaux 2000, 424).
Of course one of the most well-known aspects of this period was the rise of the large business enterprise, first characterized by railroads and then moving to manufacturing and the distribution of goods and services. The ability to incorporate without special permission of a state legislature was important as it removed incorporation from the political arena.4 Alfred Chandler (1977) has detailed the importance of economies of scale and managerial hierarchies in the rise of big business and the modern corporation. The right of an organization to exist beyond the life span of the owners meant that firms could continue to capture economies of scale over the long-run and limited liability made acquisition of capital from a wide range of owners possible.
Oliver Williamson (1985) gives a transaction cost explanation for the rise of the modern corporation and argues that the wide variety of governance structures and forms of organization were an evolutionary response by businesses to lower the information and coordination costs involved in production. Thus the period from 1870 through 1900 was characterized by freedom of contract which enabled entrepreneurs to discover and use new forms of governance and organization that lowered the costs of production and provided enormous benefits to consumers.
The rapid increase in the variety of consumer goods available during this period of time lends support to this conclusion. After 1860 kerosene replaced animal oils as a source of lighting and in the 1880s electricity provided both public and private illumination (Gunderson, 1976, 287,411). Rolled oats were marketed in small two and three-pound packages by the 1880s. The food processing industry was able to seal canned meats, vegetables, and soup, thus lowering food storage costs and improving health standards. Soft drinks became widely available and in the 1870s packaged yeast meant that neither bakeries nor homes had to maintain a stock of starter in order to get bread to rise. Bakeries replaced home production of breads and by 1900 crackers were cheap and widely available (Gunderson 1976, 388-393). All of this decreased food preparation costs in the home.
Men’s clothing and shoes that had different shapes for the left and right feet also entered the marketplace. Standardized clothing sizes developed because of the measurements taken during the Civil War by the Army for soldiers’ uniforms and in the 1870s rotary cutting machines and reciprocating knives made it possible to cut multiple layers of cloth at one time (Walton and Rockoff 2005, 328-329).
Cities grew rapidly as the labor force moved from farming to manufacturing.5 Inter-urban railroads allowed the development of suburbs and the substitution of pulpwood for cloth dramatically lowered the cost of paper, which led to a rapid increase in the availability of newspapers and books (Gunderson 1976, 391). The camera became widely available for the average consumer, dropping in price from $49.58 in 1877 to $1 by 1900 (Micklethwait and Wooldridge 2003, 77). Department stores, chain stores, and mail-order houses made consumer goods accessible to a wide spectrum of the American population and dramatically lowered the cost of distribution (Walton and Rockoff 2005, 396-397). Brand names became important guarantors of quality and for the first time retailers introduced the “money back if not satisfied” guarantee (Gunderson 1976, 421). Along with the increased availability of consumer goods, the average worker had more leisure time, with the average work week in manufacturing falling from 63 hours per week in 1870 to 54 hours in 1900 (Historical Statistics 2006, Figure Ba-O, 2-47).
Prior to the 1880s it was difficult to construct a building taller than eight stories, but new building technologies and materials, combined with a better understanding of engineering principles, meant that high-rise office buildings became feasible (Gunderson 1976, 408-409). This allowed the rise of concentrated business districts, which were another contributor to the lowering of transaction costs of production and distribution. Electric motors also replaced steam as a power source for factories, leading to wide-ranging changes in organization that increased productivity (Mokyr 2002, 91-92).
All of the above paints a very positive picture of the rise of the modern corporation, the increase in size of industrial production, and the vastly increased availability of consumer goods. However, it is clear that for many historians the rise of large business organizations represented the worst excesses of laissez faire capitalism and are to be condemned rather than applauded. In 1934 Matthew Josephson wrote his famous book, The Robber Barons. He argued that those playing a leading role in the transformation of economic life “were robber barons as were their medieval counterparts, the dominating figures of an aggressive economic age” (1934, vii). Economic activity was carried out “in the name of an uncontrolled appetite for private profit –-here surely is the great inherent contradiction whence so much disaster, outrage and misery has flowed” (1934 viii). Modern writers have conveyed a similar picture of the period. “Social Darwinism became a means of excusing as well as explaining the competitive process from which some emerged with power, and some were ground into poverty” (Heilbroner and Singer 1984, 156).
Given these different perspectives on the growth of large business and the increased prevalence of the corporate structure it is important to examine more closely the evidence with respect to the actual economic conditions of the time. Is this period best characterized as a time of monopoly capitalism, under which business owners exploited workers and consumers or was this a period of a general increase in economic well-being? The first piece of evidence is the overall increase in per capita income during this period that was presented earlier. The fact that real per capita incomes grew at 1.9 per cent during this period casts doubt upon the hypothesis that this was a period of general economic immiseration. Of course it is possible that the income distribution changed so dramatically that the bottom portion of the population suffered economic hardship. However, increases in the inequality of wealth distribution were slight during this period and there was substantial occupational and intergenerational mobility (Pope 2000). Thus the data indicates that most Americans had rising incomes during this period of time even though there were periods of economic hardship.6
The increased specialization and interdependence of the economy did mean that people were more subject to economic fluctuations outside of their control. There were two economic crises in this period of time, in 1873 and 1893, and both caused the collapse of financial markets and increased unemployment. The 1893 one was the most significant and substantial numbers of workers became unemployed (Rockoff 2000, 667-672).
Agriculture was another sector that suffered in relative terms. Agricultural products were integrated into the world market during this period and farmers found themselves subject to economic forces that impinged upon their economic wellbeing more substantially than in the past. Agricultural productivity increased during this time and over 400 million acres were added to farms between 1870 and 1900 (Historical Statistics 2006, Table Da14-27, 4-43). The relative decline in farm income compared to the rest of economy led to agrarian protests and was the source of some of the changes in the institutional structure to be discussed later. All of these forces were the natural result of the creative destruction of a growing economy and most of the hardship was either short-lived or in relative terms, i.e. some people were not doing as well as others in terms of personal income growth.
However, one must deal directly with the charge that the large corporations that emerged during the last third of the century represented a force for evil rather than for good. Part of the confusion comes because the increase in corporate size occurred at the same time that the economy was growing overall; hence the growth in businesses and their number of workers is not as substantial when compared to the overall economy as when viewed in isolation. More importantly, careful examination of the record disputes the numerous claims of predatory pricing7 or increased monopoly power. For instance McGee (1958) finds that Standard Oil did not engaged in predatory pricing in an effort to increase its market share. Thomas DiLorenzo has also examined seventeen industries that were charged, in Congressional debates on the Sherman Act, with restricting output and raising prices. He finds that while real GNP increased approximately 25 per cent from 1880-1890, those industries that were supposedly restricting output increased their production, on average, by 175 per cent. Likewise, prices fell more rapidly in these industries than they did in the general economy. The consumer price index declined by 7 percent from 1880 to 1890, but the prices charged by the alleged monopolistic trusts fell even more rapidly; refined sugar declined by 22 per cent, steel rails by 53 per cent, lead by 12 per cent, zinc by 20 percent, while the price of bituminous coal did not change (DiLorenzo 2004, 140-141). In 1872 the world price of steel was $56 per ton, but by 1900 Carnegie Steel had introduced enough production efficiencies that the company was producing steel for $11.50 per ton (Folsom 2003, 126).
Seth Norton and I have calculated the potential loss in consumer welfare because of monopoly practices in certain industries and have compared that to the gain to consumers from increased economies of scale and lower prices. In the two industries for which we have made calculations, oil and steel, we find that using reasonable estimates about the elasticity of demand and the extra monopoly profits that were earned because of restrictions on competition, the gain to consumers from reduced prices and increased output was from three to ten times any potential loses due to monopoly power (Hill and Norton, 1998).
In fact, throughout this period, the large producers acted as aggressive competitors, continually introducing new products and lowering the costs of production. For instance, Rockefeller drove the price of kerosene from 58 cents a gallon in 1865 to eight cents a gallon by the end of the 1870s. He also competed vigorously in the international market to capture a share of the oil market from the Russians (Folsom 2003, 83-100). Other producers, while undoubtedly pursuing private gain, were the source of increased efficiency and lower costs which resulted in large gains for American consumers. Several of the large industries were not loath to attempt to cartelize their industries but their efforts generally failed for three reasons. First, any contracts in restraint of trade were unenforceable in a court of law; second, there were always strong incentives for members of a cartel to cheat, which made the cartels unstable; and third, the threat of entry whenever cartels produced excess profits made it unlikely that excess returns could last for long (Lamoreaux 2000).
The lowering of transaction costs and the subsequent specialization and production of wealth that occurred in the domestic market extended, during this period of time, to international exchange. In fact, the period from 1870 to 1914 has been called the first era of globalization (Williamson 1996). This was a period of rapidly increasing international trade relative to population and income and also one in which prices of traded commodities converged (Bordo 2002, 21). U.S. trade also grew during this period, despite relatively high tariffs for much of the time, to the point where in 1900 U.S. exports were 15 per cent of world exports (Lipsey 2000, 688).8
Capital flows were massive during this period of time, especially from Western Europe to the overseas regions of more recent settlement. However, despite receiving capital from Europe,the U.S. also invested in Mexico and Canada, with 50 firms building branches in Canada between 1875 and 1887 (Davis and Cull 2000, 793). The worldwide movement of capital was accompanied by massive labor migration and during the last three decades of the nineteenth century, over 13 million people arrived in the U.S. (Historical Statistics 2006, Table Ad23). Most of these immigrants were of prime working ages, between 15 and 45 years, and hence were substantial contributors to domestic output. This meant that during the period of mass immigration, from the end of the Civil War until World War I, immigration was responsible for between one-third and one-half of U.S. population growth (Historical Statistics 2006, 1-524).
It is interesting to note that during this period of massive immigration, workers were coming to a place with no minimum wage, no affirmative action quotas, few workplace safety rules, and no regulation of maximum hours worked. The doctrine of contract at will, whereby a worker could quit by simply by giving notice and an employer could fire an employee without supplying reasons, ruled in the workplace. Since there was widespread competition for workers in almost all situations, this meant that exchanges freely agreed upon between employer and employee were the rule and complicated determinations by third parties of just or unjust firings were not required (Epstein 1995, 156-159).
Thus, in one sense, one can argue that the late nineteenth century was “the best of times.”Slavery had ended and labor markets operated relatively freely. Transaction costs dropped dramatically during this period of time through transportation and communication technology. Great gains from specialization occurred through the limited liability corporation which provided a mechanism for massive accumulations of capital, capital which was necessary in order to achieve the spectacular gains in productivity that occurred throughout the latter part of the nineteenth century.9 Free flows of workers and capital within and across national borders facilitated gains from exchange and the reallocation of resources to higher valued uses. The first era of globalization meant that gains from trade were not limited to domestic markets; rather both producers and consumers could profit from the specialization and movement of resources that increased because of this globalization. Thus it was a dynamic, relatively open economy which produced enormous economic gains for the population.
However, despite the fact that this was a period of well-defined and enforced property rights, with the judicial system enforcing contracts and the rule of law dominating the legal framework, all was not well. During this time there were changes that laid the groundwork for “the worst of times.” In the next section I take up three important economic and institutional changes that led to dramatic alterations in the role of government and the freedom of asset owners to employ their resources as they wished.
III. The Worst of Times
The changes discussed in this section did not create immediate problems, but were portentous of future changes in the institutional framework that made the overall economy less free, less viable, and one in which government was more likely to interfere with market exchanges. The three significant events were the passage of the Homestead Act in 1862, the dramatic increase in veterans benefits after the Civil War, and the beginnings of the regulatory state, starting with Munn v. Illinois in 1877.
The Homestead Act is generally seen as a positive move in that it extended the overall privatization of land program of the United States. Starting with the Northwest Land Ordinance of 1785, the United States government engaged in a massive program of privatization of the federal estate. As new states entered the Union, that estate expanded and the government continued privatization through a series of acts that provided for the sale of land. The minimum sale price and acreage varied over time and there was some recognition of the rights of first possession through a series of pre-emption acts. These acts granted settlers who arrived on the land prior to surveying the right to purchase their acreage at the minimum price when an auction was held.
However, the Homestead Act of 1862 represented a substantial change in ideology, because it represented a commitment to the concept that the federal government could and should bestow gifts upon its citizenry. The Homestead Act was driven by the idea that free land was something that settlers both deserved and could acquire. The question of deservedness is complex and, as with many federal grant programs, it is difficult to assess in terms of equity issues. However, more importantly, the concept that the national government could be an effective agent of bestowing net benefits upon the citizenry was fraught with problems and created long-term negative consequences for the involvement of government in the economy.
The offer of free land would appear to have been an opportunity to capture a net benefit for the settler. But when benefits are made available, people will compete for them, and this was clearly the case with claiming property rights to land. Settlers calculated the stream of benefits that would be available from ownership of the land and bid for it, not through cash payments, but by pre-mature settlement (Anderson and Hill 1983). The Homestead Act stipulated that a bona fide settler could receive title to 160 acres free and clear, provided that he or she lived on the land and cultivated it for five years. However, when land was first opened for settlement, residing on the land and producing from it actually produced negative returns for a period until settlement expanded to the point where land rents became positive. But the settlers could not bid on the land with cash, and then wait to produce from it until the time at which the returns were positive. Instead they bid with pre-mature settlement, calculating the stream of benefits from arriving early (Anderson and Hill 2004).
The hardship suffered by the settlers and the high failure rate in many areas are indicative of the willingness of people to make efforts to obtain “free goods,” and it is likely that the homestead policy of the U.S. government actually slowed down economic growth as well as causing considerable personal suffering. Competition among settlers meant that they had to estimate how long they could possibly survive with negative returns in order to capture the period of later returns. In the limit, they would arrive on the land at the point at which the discounted present value of the positive returns was equal to the discounted present value of the negative returns. The fact that in some areas the failure rate was as high as 70 per cent (Anderson and Hill 2004) indicates that settlers were continually trying to find the margin of settlement that would just allow them to be able to make it. In other words, the land wasn’t free; rather people pursuing the free land dissipated most of the gain from ownership.
The implications for the desire of the federal government to give away free goods and free entitlements have turned out to be enormous. For a period of time electromagnetic spectrum licenses were allocated by a standard of worthiness, but like the “free land” the spectrum was bid for and, as in the case of premature settlement of the West, the bidding encouraged resource waste.10 In other areas the idea that the government can bestow net benefits on people through numerous transfer programs has become all pervasive. But, unless people cannot take actions that make themselves more worthy or more likely to receive those benefits, the actual net benefit bestowed upon the recipient is much smaller than the size of the grant. People bid for the opportunity to receive the transfer through a wide variety of activities, many of which they would not engage in as a part of standard economic production and exchange.11 Thus, the concept that the government can and should be in the business of transferring resources and rights to individuals has had a significant negative effect on the U.S. economy.
Along with the ideological change represented by the Homestead Act, the postbellum economy also saw the rise of the first substantial organized interest group, the veterans lobby. The federal government had not been completely uninvolved in the economy prior to this time and the land grants for the transcontinental railroads represented one form of government subsidy.12 Nevertheless, the idea of an organized interest group with substantial voting power lobbying the federal government for significant transfers first came about through the veteran benefits that were awarded after the Civil War.
Of course a reasonable case can be made for the overall tax-paying public transferring resources to survivors or families of survivors who had fought in the war. These veterans and their relatives had undergone substantial personal cost during the conflict. Nevertheless, the payments to Union veterans (there were no benefits for Confederacy veterans) were the first large-scale transfer payments from the federal government to citizens deemed worthy of such support (Sylla 2000, 534-535). This category of federal expenditures grew more rapidly than any other portion of the federal budget from the mid-1870s to the mid-1890s (Holcombe 2002, 146).
The Grand Army of the Republic (GAR) became the first organized lobbying group with the explicit purpose of pressuring Congress to extend benefits. Their influence was substantial; in 1872 there were 1.8 million veterans and 6.5 million votes were cast in the presidential election that year (Holcombe 2002, 147). The GAR succeeded in getting the Pension Arrears Act passed in 1879, which lead to an enormous increase in pensioners from 26,000 in 1879 to 345,000 in 1885 and a doubling of pension payments between 1878 and 1885 (Sylla 2000, 535). By 1890, transfers to veterans represented approximately one-third of total federal expenditures (Historical Statistics 2006, Table Ea, 636-643, 5-91.). Thus another milestone in the evolution of the American economy occurred during the latter part of the nineteenth century. Organized lobbying groups which made claims upon government for their members had their origin during this period and the growth of lobbying throughout the rest of the nineteenth century and all of the twentieth century was substantial (Anderson and Hill 1980). This was an important part of the general change in the role of government from a keeper of the peace and an enforcer of contracts to a source of redistribution among the population.
Finally, important changes in the constitutional framework made it possible for government to expand its role beyond its more traditional functions. Throughout the latter part of the nineteenth century agriculture struggled because integration into the world market meant that farmers were becoming more subject to forces outside of their control. The rapid expansion of agricultural lands also meant that increased population and increased demand for agricultural products did not translate into substantial increases in farm income. The growth of industrial production required moving labor out of agriculture into other sectors, and this process was carried out through price signals, which meant lower returns for agriculture. In response to these conditions the National Grange was organized in 1867 and by 1875 it had over 850,000 members, with most of its power concentrated in the Midwest.13
Because of their unhappiness with economic conditions in agriculture and their belief that part of their economic hardship was because of the monopoly power of railroads and grain elevators, the farm protest movement succeeded in passing legislation in several states that regulated the rates of railroads and other input suppliers. Prior to this time, there had been limited regulation of prices, but usually under the guise of the police power of the government and it needed to be justified through considerations of health or morals. In 1876, Munn v. Illinois was argued before the U.S. Supreme Court and the Court held that
Property does become clothed with a public interest when used in a manner to make it a public consequence, and affect the community at large. When, therefore, one devotes his property to a use in which the public has an interest, he,in effect, grants to the public an interest in that use, and must submit to be controlled by the public for the common good to the extent of the interest he has created (Munn v. Illinois 94 U.S. 126 ).
This meant that the government had brand new authority to interfere with contracts and private property, in particular to outlaw the terms of economic exchange. However, Munn v. Illinois did not have an immediate and dramatic impact on the growth of government because of the ambiguity of the public interest doctrine. For a period of time, the Supreme Court interpreted the public interest doctrine rather narrowly and hence it did not lead to massive interference with contracts. However, William C. Goudy (1875, 50-51) was quite prophetic in his brief before the Illinois Supreme Court, when he said:
If a majority of one legislature can fix prices for the minority, so in turn, that minority can obtain power at another legislature and fix prices for the products or merchandise of their adversaries. When capital is in control, the price will be fixed; when labor holds the power the investment of the capitalists must suffer. The price of corn may be made high today, and reduced tomorrow. All trade and commerce will be destroyed, and a struggle at the polls will be the substitute for the natural laws of supply and demand.
Although Goudy was engaging in rhetorical overkill, he was certainly accurate in his description of political struggles substituting for the natural laws of supply and demand. The fixing of prices in the terms of contract by the government waxed and waned over the next fifty years,14 until 1934 when Nebbia v. New York came before the Supreme Court. The issue was the minimum price regulation that the State of New York had set for milk of nine cents per quart. Nebbia was charged with selling milk below the regulated price and the United States Supreme Court used the Munn case to declare that “there is no closed class or category of business affected with a public interest,” and “a state is free to adopt whatever economic policy may reasonably be deemed to promote public welfare” (Nebbia v. New York, 291 U.S..536 ). ThusMunn v. Illinois was the beginning of a long set of cases that gradually expanded the power of government, both state and federal, to interfere with contracts by setting terms and duration. Minimum wage laws, regulation of hours worked, retail price fixing, and numerous other interferences with the market became commonplace.15
Another important case at the end of this period of time was McCray v. United States, which was decided in 1904. In that ruling, the Court upheld a statute that regulated margarine production by placing a tax of ten cents per pound on artificially-colored margarine but only one-fourth cent per pound on the uncolored product. Prior to this time, the taxing power had to be directly related to revenue functions, but this case meant that interest groups could try to capture the government’s power to tax to either advantage themselves or disadvantage competitors. Again, it took several decades for the full effect of this court ruling to be felt, but the lack of limitation on the taxing power of both state and the federal government led to an increase in special interest lobbying by various groups.
The changes outlined above did not lead to an immediate sizable increase in the size of government. In 1902, all sectors of government collected and spent approximately eight per cent of gross domestic product. However, by the end of the twentieth century, the expanded role for government meant that it represented approximately 34 per cent of the economy (Sylla 2000, 502-503). Despite the fact that the impact of the Homestead Act, the veterans transfer programs,and the Supreme Court cases did not cause an immediate increase in government expenditures does not mean that they were unimportant. They laid the groundwork for institutional changes that had a marked effect on the economy throughout the twentieth century.
The paper begins with the epigraph from Charles Dickens about the best of times and the worst of times. This captures well what was happening during the late nineteenth century in terms of market conditions in the United States. The overall framework was one of well-defined and enforced property rights and freedom of contract. The evolution of large corporations and technological innovations which lowered the cost of transportation and communication meant that production costs fell dramatically and specialization increased rapidly. All of this lead to a vibrant, dynamic economy with rapid increases in per capita income and enormous changes in the variety of consumer goods available for the general public. Because it was a dynamic economy, resources were continually being moved from places of lower value to uses where they earned a higher return. This meant that there was a substantial amount of Schumpeterian creative destruction in the economy. Farmers were unhappy with their inability to share fully in the increases in income and labor unrest marked the latter part of the period. Undoubtedly, some people suffered as integration of the economy meant that interdependence and the move from subsistence farming made people more vulnerable to economic fluctuations. Nevertheless, the overall picture of market conditions during this period of time is positive. Markets were succeeding as a social coordination mechanism that was creating wealth for the U. S. population.
Despite the fact that market conditions were generally propitious, there were several changes that did not auger well for the long term market economy, an economy where government performed its functions of protecting property and enforcing contracts but did not interfere with market exchanges. The Homestead Act formalized the concept that government could be a source of transfers and in the process could bestow large net benefits upon individuals and groups; the Civil War veterans organized the first successful lobbying group that pressured government for income transfers; and constitutional changes such as Munn v. Illinois removed the constitutional restrictions on government involvement in the economy.
Thus one should view the last three decades of the nineteenth century as a positive example of how markets can successfully create wealth for almost all of the population but also as a warning about how institutional changes can lead to substantial interferences with market activity.
2 The general conclusion of economic historians is that the period between 1774 and 1929 was one of increasing inequality of wealth, with a leveling era from 1929 to 1953, and a renewed rise in inequality from 1977-1995 (Historical Statistics 2-624).
3 The fact that self-ownership was granted to the slave population is surely one of the most significant events in the move to a true market economy in the nineteenth century. However, the freeing of slaves did not entirely end some of the debilitating aspects of slavery in that slaves had not been able to engage in human capital formation at the rate that free people did during the antebellum period and racism, often expressed in Jim Crow laws, continued to interfere with market exchanges. Nevertheless, the end of slavery should not be overlooked as one of the most significant movements to a true market order under the rule of law in American history.
4 In 1811 New York passed the first general law of incorporation that allowed the formation of an organization with perpetual life and limited liability and Connecticut followed in 1837. However, generalized incorporation did not become common in most of the states until the1870s (Hughes and Cain 1998, 135).
5 In 1870 agriculture accounted for 33 percent of GNP and manufacturing 24 percent. By 1900 agriculture’s share had declined to 18 percent and manufacturing had risen to 31 percent (Gallman 2000, Table 1.14).
6 Immigrants were one group that had low incomes. However, those low incomes were only for the first years of arrival, and a few years after coming to the United States their incomes reached levels comparable to the native born. (Hill 1975).
7 Predatory pricing occurs when firms price below cost in order to drive other firms out of the market, then raise their prices to capture above normal profits because of the elimination of competition.
8 Bohanon and Van Cott (2005) have argued that the period from 1870 through 1900 were not as protectionistic as sometimes argued because the relatively free flow of immigration and capital offset the high tariff rates.
9 Timur Kuran (2003) has argued that Islamic economies fell behind the rest of the world during the industrial revolution because Islamic legal system, especially its inheritance laws, prevented the formation of the modern corporation.
10 In this case the waste occurred through lobbying the FCC in order to meet the standards of worthiness. Congress replaced that process with a lottery, but since it did not place any limits on the number of applicants, waste occurred because firms submitted multiple applications in order to increase their likelihood of receiving a license. At one point the commission received over 400,000 applications for cellular licenses ((McMillan 1994).
12 The actual amount of the subsidy involved in the grants to the railroad is controversial because the federal government was giving to the railroads, in return for their construction, alternate sections of land alongside the road. However, much of that land would have been essentially worthless for a long period of time if it weren’t for the railroad, hence the increase in land value because of the existence of the railroad meant that the railroad could capture, more rapidly than otherwise, some of the return from the extension of their lines (Fishlow 2000, 583-587). For a more complete discussion of subsidies in early U.S. history see Folsom (2003).
13 One could argue that the Granger movement was a lobbying force similar to the veterans group and hence they both were significant in terms of altering the political framework. The substantial difference was that the Grangers were not asking for direct transfer payments from the federal government, although their influence was important in terms of the alterations in the institutional framework.
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