Pass ri\5 n\ (ybWitW.. \^j\G> CDEflRIGHT DEPOSIT. 'f(Tl f . ^^"? ^■'- 5^- S / ^c/4-l\ OUTLINES OF ECONOMICS THE MACMILLAN COMPANY NEW YORK • BOSTON - CHICAGO • DALLAS ATLANTA • SAN FRANCISCO MACMILLAN & CO., Limited LONDON • BOMBAY • CALCUTTA MELBOURNE THE MACMILLAN CO. OF CANADA, Ltd. TORONTO OUTLINES OF ECONOMICS (THIRD REVISED EDITION) BY RICHARD T. ELY PROFESSOR OF POLITICAL ECONOMY IN THE UNIVERSITY OF WISCONSIN THOMAS S. ADAMS PROFESSOR OF POLITICAL ECONOMY IN THE SHEFFIELD SCIENTIFIC SCHOOL OF YALE UNIVERSITY MAX O. LORENZ ASSOCIATE STATISTICIAN, INTERSTATE COMMERCE COMMISSION ALLYN A. YOUNG PROFESSOR OF ECONOMICS AND FINANCE IN CORNELL UNIVERSITY THE MACMILLAN COMPANY 1916 A^i rights reserved vre |7l ■ Es-f Copyright, 1893, By hunt & EATON. Copyright, 1908, and 1916, / By the MACMILLAN COMPANY. First published elsewhere. Reprinted May, 1900; July, October, 1901 ; August, 1903; July, September, 1904; July, 1905; January. August, 1906; July, 1907; April, 1908. New edition, revised and enlarged, September, 1908. Third edition, revised and enlarged, September, 1916. SEP 30 1916 NotfajootJ J^ress J. S. Cushins Co. — Berwick & Smith Co, Norwood, Mass., U.S.A. 'ci.A4:n9ooc;/r" PREFACE The first edition of the Outlines of Economics, written by Professor Ely, was published in 1893. Four persons cooperated in the preparation of a revised and enlarged edition, which appeared in 1908. This was in many respects a new book, although much matter from the earlier edition was incorpo- rated in it, and although pains were taken to retain the general organization and especially the general point of view of the older volume. The present edition does not differ so much from its predecessor as that differed from the first edition, but it is, nevertheless, the result of a more thoroughgoing revision than is usually given to books of this kind. Some minor changes have been made in the order in which the chapters appear ; two chapters have been omitted ; and a chapter on labor legislation has been added. No chapter in the book remains unaltered, and the larger part of Books II and III has been virtually rewritten. While the number of different subjects treated has been slightly reduced, the treat- ment of the more fundamental subjects has been considerably expanded. Each of us has undertaken the revision of a definite portion of the book and, to secure unity, Professor Young has had general editorial supervision of the revision as a whole. Some of the changes are such as are necessary by reason of eight years of progress in industrial life, in legislation, and in economic thought. Other changes are the outgrowth of the experience gained in eight years' use of the book in university and college courses. Among the many persons to whom we are indebted for helpful criticisms and suggestions are Dr. John Cummings, Professor H. J. Davenport, Dr. C. S. Duncan, Professor L. C. Gray, Professor J. E. Le Rossignol, Professor VI PREFACE W. C. Mitchell, Professor T. W. Page, Professor F. M. Taylor, Mr. Ray S. Trent, and Professor N. A. Weston. The instructors in charge of the course in elementary eco- nomics at the University of Wisconsin have generously cooperated by submitting carefully prepared lists of definite, well-con- sidered, and pointed suggestions for the betterment of the book. We make grateful acknowledgment to Professors T. K. Urdahl, W. I. King, and H. D. Simpson, and to Messrs. Harry Jerome, A. H. Hansen, J. G. McKay, and F. L. Vaughan. THE AUTHORS. September, 1916. Preface CONTENTS BOOK I. — INTRODUCTION Chapter I. — The Nature and Scope or Economics Diversity of economic study, 3 ; Definition of economics, 4 ; A social science, 5 ; Studies man in process of development, 6 ; Eco- nomic laws, 7 ; Relation of economics to other sciences, 1 1 ; Prin- cipal divisions of economics, 15. Chapter II. — The Characteristics of the Present Economic System Human and physical conditions of economic activity, 1 7 ; Private enterprise and state activity, 17 ; Division of labor and exchange, 19 ; Economic classes, 21 ; Private property, 21 ; Trade-marks, copy- rights, and patents, 23 ; Inheritance, 24 ; Contract, 25 ; Vested in- terests, 25 ; Freedom, 26 ; Competition and markets, 28 ; Fair competition, 29; Cooperation, 30; Monopoly, 30; Custom, 31. Chapter III. — The Evolution of Economic Society Basis of the economic stages, 33; Direct appropriation, 34; Primitive man, 35; Pastoral stage, 36; Agricultural stage, 37; Manorial economy in England, 37; Handicraft stage, 39; Gilds, 39; Domestic system, 40 ; Agricultural changes, 41 ; The mercan- tile system, 42 ; Industrial stage, 44 ; Other classifications, 44. v^l Chapter IV. — The Evolution of Economic Society {Continued) Industrial Revolution, 47 ; England in 1760, 47 ; Mechanical in- ventions, 49 ; Agricultural changes, 50 ; Effects of industrial revolu- tion, 51; The factory system, 51; Industrial specialization, 2; Evils of the transition, 52 ; Competition and laissez-faire, 53 ; Re- action against the passive policy, 54; Quality of goods, 55; Pro- tection of labor, 55 ; Labor organizations, 57 ; E.xtension of govern- ment enterprise, 58 ; Summary, 59. /P -v Vlll CONTENTS Chapter V. — The Economic Development of the United States Economic stages in American industrial history, 6i; Sectional- ism, 62; Characteristics of the American people, 63; Growth of population, 64 ; Slavery and the negro problem, 66 ; Immigration, 68;- Natural resources, 74; Public lands, 75. Chapter VI. — The Economic Development of the United States {Continued) Mercantilism in America, 79 ; English colonial policy, 80 ; American industries in 1776, 81; The Industrial Revolution in America, 81 ; The development of agriculture, 84; Manufactures, 86 ; Transportation, 90 ; The labor movement, 93 ; State regula- tion of industry, 96. BOOK II. — PRINCIPLES AND PROBLEMS PART I. — PRODUCTION AND CONSUMPTION: Chapter VII. — Elementary Concepts Motives in economic activity, 103 ; Utility, 105 ; Free and eco- nomic goods, 105 ; Effort and waiting, 106 ; Risk, 106 ; Personal quahties as goods, 107 ; Wealth and income, 108 ; Individual and society, 109 ; Wealth and value, 109 ; Capital and other forms of wealth, no; Capital goods and capital value, no; Social and in- dividual capital, in ; National wealth and national dividend, in. Chapter VIII. — Production Production defined, 116; Production of values, 118; Factors of production, 119; Saving and capital formation, 122; Production and sacrifice, 124; Organization of productive factors, 123; The entrepreneur, 1 23 ; Division of labor, 124; Advantages of division of labor, 126 ; Effects upon the worker, 127 ; Territorial division of ■ labor, 128; Productive organization of the American people, 129. Chapter IX. — Consumption Consumption defined, 132; Productive and final consumption, 132; Human wants, 133; Law of diminishing utility, 133; Mar- ginal utility, 135 ; Subjective value, 137 ; Economic order of con- sumption, 139 ; Future wants, 140 ; Consumption and saving, 142 ; Alleged present consumption of future products, 142 ; Luxury, 143 ; Harmful consumption, 144; Statistics of consumption, 144; Pro- duction and sacrifice, 146 ; Cost of production, expense of produc- tion, and opportunity cost, 148. -f CONTENTS ix / PART II. — VALUE AND EXCHANGE Chapter X. — Value and Price Meaning and significance of value, 151 ; The market, 153 ; Ex- change value and subjective value, 155 ; Supply and demand, 156 ; Nature of demand, 156; Elasticity of demand, 159; Nature of supply, 162; The determination of price, 164. Chapter XL — Value and Price {Continued) Prices and the expenses of production, 167; Normal price, 169; Different conditions of supply, 170; Fixed. and variable expenses, 174 ; Joint expenses of production, 179 ; Surplus of bargaining, 181 ; Non-reproducible goods, 182 ; Retail prices, 182 ; Public authority and value, 183; Imputed value, 184; Valuation of production goods, 185; Other theories of value, 186. Chapter XII. — Monopoly The idea of monopoly, 189; Classification and causes, 193; Social and natural, 195 ; Monopoly price, 200 ; Effect of a tax, 202 ; Relation of demand to monopoly price, 203; Class price, 204; Monopoly price, high price, 205 ; Monopolies and distribution of wealth, 207 ; Public policy toward monopolies, 208. Chapter XIII. — Business Organization The meaning of "business," 212 ; The nature of business units, 212; The business unit in accounting, 213; The individual entre- preneur, 214; Partnerships, 215; The business corporation, 216; The corporation charter, 217; Lack of uniformity in state laws, 218; Corporation capital and capitalization, 219; Overcapitaliza- tion, 221 ;^ Form of capitalization, 225 ; Corporation management, 226; Advantages of the corporation, 228; Social aspects of cor- porations, 228; Trusts, 230; Causes of combination, 232; Anti- trust laws, 235 ; Unfair competition, 239 ; Public policy towards industrial combinations, 243 ; Federal control of Corporations, 245 ; Industrial combinations in other countries, 245. Chapter XIV. — Money Metallic money, 248; Coinage, 249; The meaning of "money," 250; The media of exchange, 252; The monetary standard, 255; Seigniorage, 255; Limited coinage, 259; BimetalHsm, 260; Bi- metallism in the United States, 263 ; The gold-exchange standard, 269; Government paper money, 271 ; Colonial and Revolutionary bills of credit, 273; The greenbacks, 273; Fiat money, 278. Xj -p- f: CONTENTS Chapter XV. — Credit and Banking Credit transactions, 282 ; Personal credit, 285 ; Bank credit, 286 ; Bank notes, 290 ; State banks of issue, 290 ; National bank- ing system, 291; The reserv^e system, 292; New York money market, 293 ; Speculation, 295 ; Independent treasury system, 297 ; The movement of money, 298 ; Inelastic currency, 300 ; In- elastic reserves, 301 ; Absence of centralized control, 303 ; Steps toward reform, 304 ; Federal reserve system, 307 ; State and private banks, 313. Chapter XVI. — Other Problems in Money and Banking The value of money, 317; Quantity of money and the values of money, 319; Equation of exchange, 321; Mechanism of general changes in prices, 325; Industrial uses of gold, 327; Expenses of gold production, 328; Increase in gold production, 329; Effects of changes in prices, 331; Crises, t,;^,^; Standard of deferred pay- ments, 336; Index numbers, 337. Chapter XVII. — International Trade Foreign exchange, 345; Regulation of the gold supply, 350; Balance of trade, 354; Restriction of international trade, 35S; Advantages of international trade, 361. Chapter XVIII. — Protection and Free Trade The case for protection, 368; Arguments of free-traders, 374; General considerations, 380; Conclusions, 381. yr^ PART III. — DISTRIBUTION Chapter XIX. — Distribution as an Economic Problem 0i The problem of distribution, 384; Distribution controlled by existing institutions, 386 ; Money incomes, 387 ; Law of diminish- ing productivity, 388 ; Marginal product of labor, 390 ; Marginal products of land and capital, 392 ; Marginal productivity and the prices of production goods, 398; The meaning of "productivity," 400; Social aspects of diminishing productivity, 404. Chapter XX. — The Rent of L.and Rent defined, 407 ; The services of land, 408 ; Rent under uni- form intensivity of cultivation, 410 ; Rent under actual conditions, 413; The different uses of land, 416; The capitalization of rent, 418; Rent and social progress, 419; The unearned increment, 422; Urban lands, 426. CONTENTS XI Chapter XXI. — The Wages of Labor Wages as the price of labor, 427 ; Demand for labor, 428 ; Labor- saving machinery, 430; Supply of labor, 431 ; Growth of popula- tion, 434; Subsistence theory of wages, 437 ; The standard of life and wages, 438 ; Supply of labor in different occupations, 439 ; The wage contract, 442. Chapter XXII. — Labor Problems Tjrpes of labor organizations, 444 ; Economic justification of labor organizations, 445 ; Labor organizations and monopoly, 446 ; Methods and policies of labor organizations, 447 ; The closed shop, 448 ; Limitation of output, 449 ; Educational and fraternal activi- ties, 451; The strike, 452; Employers' associations, 454; Trade arbitration, 457 ; Voluntary arbitration, 458 ; Compulsory arbitra- tion, 459; Profit sharing, 461; Industrial democracy, 463; Co- operation, 465 ; The future of the union, 469. Chapter XXIII. — Labor Legislation Freedom of contract, conspiracy, and injunctions, 472 ; Child labor laws, 476 ; The labor of women, 479 ; Minimum wage laws, 480 ; Factory acts, 484 ; Employers' liability, 486 ; Philosophy of labor legislation, 488. Chapter XXIV. — Interest Interest defined, 493 ; Inadequate explanations, 494 ; How in- terest is possible, 495 ; Why interest is necessary, 496 ; Invest- ment, 499 ; Replacement, 501 ; Shifting of investment, 502 ; Expense and price of capital, 504; Free and specialized capital, 506 ; Capital and land, 507 ; Capital and consumption goods, 512 ; Capital and wages, 512; Competitive investment, 513; The flow of money income, 515; The annual product and the social dividend, 517 ; Sourcesof investment funds, 523 ; The interest rate, 521 ; Gross and net interest, 523 ; Usury laws, 524. A^*>g» Chapter XXV. — Profits Profits a surplus, 525; Entrepreneur's wage, 526; Pure profits impossible under certain conditions, 527; Sources of pure profits, 528; Marginal productivity and profits, 532; Profits for the in- dustry and profits for the establishment, 533 ; Good-will, 535 ; The relation of risks to profits, 536 ; The entrepreneur, 537 ; Profits and the defense of the competitive system, 538. Xll CONTENTS Chapter XXVI. — The Personal Distribution of Wealth Wealth and income, 542 ; Absolute and relative well-being, 542 ; Concentration of wealth and large-scale production, 542 ; Methods of measuring concentration, 543; Statistics of distribution, 544; Causes of poverty and riches, 549; Is greater diffusion possible? 551 ; Modifying the methods of wealth acquisition, 553. Chapter XXVII. — Transportation Economics Scope and significance, 557; Nature of the railway industry, 558; Railway competition, 560; Pooling and consolidation, 561; •The movement of rates, 563 ; The level of rates, 565 ; Relative rates, 567; Distance, 570; Government ownership, 571 ; Regula- tion, 573 ; The Interstate Commerce Commission, 574. Chapter XXVIII. — Insurance Nature of insurance, 577 ; Origin and development, 578; Forms of insurance organization, 580; Life tables, 581; Reserve, 583; Surplus, 583; Endowments, 584 ; Industrial insurance, 585 ; State insurance, 585 ; State regulation, 586 ; Social insurance, 587 ; Workmen's compensation, 588; Sickness insurance, 591; Old-age insurance, 592 ; Unemployment insurance, 592 ; Objections to social insurance, 593. Chapter XXIX. — Agmcultural Problems Size of farms, 596 ; Ownership and tenancy, 603 ; Farm labor, 606 ; Farm indebtedness and agricultural credit, 609 ; Tenancy vs. encumbered ownership, 615; Marketing of farm products. 618; Speculation, 622. Chapter XXX. — Socialism Socialism defined, 627; Distributive justice, 627; Varieties of socialism, 628; Communism, 631; Socialism an extension of existing institutions, 632; The strength of socialism, 632; The weakness of sociahsm, 634 ; The sociahst movement, 636 ; Anar- chism, 638. BOOK III. —PUBLIC FINANCE Chapter XXXI. — Public Expenditures Nature and significance of public finance, 643 ; Public and pri- vate expenditures contrasted, 646 ; The proper proportion between the total income of society and pubhc expenditures, 648 ; Economy CONTENTS Xlll vs. parsimony, 652; Historical development, 654; Development of public expenditures with respect to regularity and irregularity, 659 ; Classification of public expenditures, 660. Chapter XXXII. — Public Revenues from Loans and Government Ownership nnf Public debts, 666 ; Public domains, 671 ; Land policy of the United States, 673 ; Forest lands, 674; Mineral lands, 675 ; Success of our land policy, 677 ; Land nationalization and municipalization, 679; Public industries, 682. Chapter XXXIII. — Public Revenues : Derivative Revenues, Fees, Special Assessments, and Taxes Definitions, 689 ; Fees, 690; Special assessments, 692; Taxes, 694 ; Justice in taxation, 696 ; Progressive taxation, 699 ; Direct and indirect taxes, 702 ; The shifting of taxes, 703. Chapter XXXIV. — Public Revenues : Federal, State, and Local .^^ Taxes n Constitutional limitations, 710 ; Use of direct taxes by the federal government, 712; Customs duties, 713; Internal revenue duties, 717; Taxes on transactions, 719; Income taxes, 720; Inheritance taxes, 723; General property tax, 726; Corporation taxes, 731; Business and license taxes, 733; Poll taxes, 734; A balanced revenue system, 735. Appendix A : History of Economic Thought 741 Appendix B : Suggestions for Students and Teachers . . . 754 Index 761 7/^ BOOK I INTRODUCTION OUTLINES OF ECONOMICS CHAPTER I THE NATURE AND SCOPE OF ECONOMICS The most striking characteristics of the great field of knowl- edge the Outlines of which we attempt to sketch in the present volume are its rich diversity and spacious amplitude. Start- ing from psychology in its analysis of the human needs which explain or condition wealth, it traverses the entire field of social activities and institutions arising from man's efforts to supply his material needs. It touches on one side the physical sciences, from which it borrows some of its most fundamental prin- ciples ; occupies joint territory at places with politics, ethics, and law, although their respective jurisdictions are in the main distinct ; and forms at once the most fertile and most thoroughly developed province of the broad science of human society. Within its borders, if we may continue to compare the scientific possibilities of economics with the natural resources of an opu- lent territory, opportunity is offered for the exercise of every mental aptitude and every scientific method. The historian's gift is needed to unravel the past and trace the development of the industrial institutions whose present-day problems, in turn, offer indefinite scope for the studies of the more practical student with a taste for administration or business manage- ment. For the legal mind there are the subtle problems of property, inheritance, labor legislation, and corporation con- trol ; for the mathematically inclined, insurance and modern statistics ; for students with practical political interests, the tariff, currency reform, and a score of important problems in which economics and politics are inextricably interwoven ; for 3 4 OUTLINES OF ECONOMICS the philanthropic, unemployment, accident insurance, and a number of social problems growing out of the maladjustments pi modern industry. Animating the entire subject, blended with the love of truth for truth's sake common to all sciences, is the persistent hope that by systematic study we may eventually abolish the material poverty which deadens and dwarfs the lives of millions of our fellows. Economics is a science, but something more than a science ; a science shot through with the infinite variety of human life, calling not only for systematic, ordered thinking, but for human sympathy, imagination, and in an unusual degree for the saving grace of common sense. To define such a subject adequately in a few sentences is manifestly impossible. It is frequently said that economics treats of man's efforts to earn a living, and this definition is not inaccurate if by " man " we understand " mankind," and if we fully appreciate that the individual's efforts to turn an honest penny's profit receive but little attention in comparison with the community's efforts to feed, clothe, and shelter itself. Satisfaction of social need, and not individual profit, is the objective point of the science. So, similarly, economics has been characterized as the philosophy of human industry ; and this description is illuminating provided we interpret " indus- try " broadly enough. Even the old traditional definition, that economics is the science of wealth, is true enough if we clearly understand that there can be no wealth without man, and that the science which deals with wealth, so far from being a " gospel of mammon," necessarily begins and ends in the study of man. As we prefer to define it, however, economics is the science which treats of those social phenomena that are due to the wealth-getting and wealth-using activities of man. Economics treats of Man. — The supreme importance of man in the study of wealth has not always been appreciated by those who have expounded the science. Too often they have considered man simply as a producer of wealth, the one " by whom " the necessaries, conveniences, and luxuries of life are created, whereas the infinitely greater truth is that man is the one " for whom " they are all produced. Of course no THE NATURE AND SCOPE OF ECONOMICS 5 one denies this truth, but one might almost as well deny it as to leave it out of account. The result of such neglect is that men devise with great skill rules by which man may be made the best possible manufacturing machine. It sometimes quite escapes the notice of these persons that in making man the best possible manufacturing machine they may make him a very poor sort of a man ; that in teaching him to supply his wants very bountifully they may prevent his developing and correct- ing those same wants. They forget that there are two kinds of poverty — one a lack of goods for the higher wants, the other a lack of wants for the higher goods. To become rich in goods while losing at the same time the power to profit by them is unfortunately one of the commonest retrogressions in human experience. We do not mean that the whole problem of human [ development is the subject of economics, but simply that man- hood, rounded human development, and the equitable organiza- ^ tion of human relationships are the objects of all social sciences, and none must consider its subject so narrowly as to exclude 1 these objects. Another common mistake has been to regard as of chief importance the economic activities of one particular dass^ especially the employer. Other men were treated simply as " a factor in production." An English writer speaks of dear labor as one of the chief obstacles to England's economic pros- perity. Could anything be more utterly an oversight of general human well-being? Dear labor should be the very goal of England's economic effort, for that means abundant supply of the wants of the great mass of her people ; and the fact that labor is dear, so far from being an obstacle to prosperity, is the very proof and substance of that prosperity. A glance at history indicates that men have made these mistakes not only in theory but in practice. Industries have been developed to majestic proportions while man was sinking into deeper deg- radation ; wealth has at times grown at the expense of that human weal in whose service it won its name. Economics treats of Man in Society. — This is one of those truisms which only history can make real to us. As we pass 6 OUTLINES OF ECONOMICS from the savage and cannibal, up through all the stages of ^ development, we find an ever-increasing interdependence among men. Man is least dependent when he wants least, cares least, has least, knows least, and is least. With every betterment of condition and character he is more dependent than before, more dependent and yet more free. The beginnings of barter are a confession of mutual need ; the coining of money is a declaration of dependence to all men. We look with pride upon a century of progress, but that progress has consisted in little else than a growth of dependence, an ever-increasing de- parture from that rude kind of literal self-help in which each one does everything for himself. Our fathers drew water, each for himself, in " the moss-covered bucket," while our mothers dipped candles for the evening's light. If one was negligent, the rest did not suffer. Today a network of pipes radiates from a common center to enter a thousand households. An engi- neer makes a blunder at the station, and thousands are in dark- ness or drought. Progress is a passage from independence to dependence, from distrust to confidence, from hostihty to amity, from helplessness to helpfulness, while the great law of social solidarity gains ever-increasing importance. Our science, then, is interested primarily in man in his relations to others, and not in man by himself. Moreover, as a science which studies the present in order that it may predict and prepare for the V future, and discovering that interdependence is the law of progress, it must not hesitate to shape its principles with refer- ence to a solidarity which shall grow more rather than less, stronger rather than weaker. Economics treats of Man as in Process of Development. — Few truths are more easily admitted or more persistently ig- nored than that of change in human life and condition. His- tory makes it real. Man now wanders about by force of necessity and age-long habit, now starves rather than be moved from his home. Land is now free to all, now parceled out with well-nigh absolute right of individual possession. The seem- ingly eternal features of the social structure are gone in a few generations. Nothing so invalidates theories, laws, ..general THE NATURE AND SCOPE OF ECONOMICS 7 principles, institutions, and enterprises as this great law of change of which we seldom take full account. Take, for in- stance, bequests. Nothing is commoner than for a man to leave a legacy under specified and detailed regulations, binding for all time. One leaves money to endow a religious service in a language which in a few generations no one understands ; another founds a college to teach certain doctrines which in a century no one believes ; and so on indefinitely. These and a thousand other laborious efforts of statesman, warrior, or philosopher quite lose their worth for the future because their authors assumed that the future would be like their present. Even the wages system and the division between capital and labor which seem rooted in the constitution of society are scarcely two centuries old as a general system. One must never forget in the study of economics that the phenomena with which it deals are pervaded by the spirit of life, moving forward or back- ward, progressing or decaying, under those influences which control the rise and fall of social institutions. The science is biological rather than mechanical. The Laws with which Economics Deals. — The evolutionary character and complexity of economic phenomena, which ac- count for much of the charm of the subject, endow it also with unusual difiiculties. Conclusions true for one generation are invalid in the next. Terms and definitions appropriate to one stage of industry are misleading in a succeeding stage. Gen- eralizations valid for one nation and government are inappli- cable to another. Even those laws or uniformities which the science prizes as the finest product of its research are but state- ments of probabilities — declarations of what is most likely to occur for the mass of men in the long run under certain specified circumstances. In no department of knowledge, consequently, is there greater need of temperate statement and of that humility of mind which is the surest safe- guard against bigotry and dogmatism. No system of economics is appli- cable unchanged to all times and all places : the premises of the arguments change; the ingredients of nearly every problem present themselves in different proportions ; and the conditions of almost every question vary from 8 OUTLINES OF ECONOMICS country to country and from generation to generation. The student must not expect rules of thumb by which he can decide offhand the economic prob- lems of the particular city or country district in which he is for the moment interested. No general treatise on economics can authoritatively decide the practical problems of particular times and places; although the econ- omist, before all other students, is forced to deal with practical problems. What such a treatise can do is to point out mistakes of logic common in the current discussions of economic questions, call attention to obscure factors — sometimes of great importance — which the practical man is likely to overlook, give solutions of typical problems which are likely to arise, and thus afford a training which will assist the student in solving practical problems for himself. The peculiar and distinctive office of the economic scientist, however, is to emphasize the less tangible truths, the remoter consequences, the deeper and consequently less obvious forces of economic society. The impulses of the moment, the immediate demands of the hour, the present "fact" that stares us in the face (and sometimes blinds us) , are not likely to lack vigorous champions; and to preserve the balance there is need of a craft of thinkers far enough removed from the battle to preserve the wider outlook, mindful of the lessons of the past, jealous for the rights of the future, insistent upon the less obvious truths. This is why economics so frequently appears to the practical man strained and academic. This impression arises from a difference of emphasis which in the main is as salutary as it is inevitable. The academic quality of the economist's work arises sometimes from igno- rance, sometimes from pedantry, but more frequently from his courageous insistence upon the importance of the less tangible truths and the distant consequences of present action. Is not economics, then, a science based upon natural law? The question is largely a verbal one. What do we mean by natural law? In the narrowest sense natural laws are the habits of nature which are subject to absolutely no variation. Such are gravitation and chemical affinity; and the sciences based upon such laws — astronomy, physics, and chemistry — were the first to develop, and have attained a maximum degree of exactitude. The term " science " is sometimes used in a way to imply only sciences of this character. These sciences are more properly known as exact sciences, and they are char- acterized by the fact that the relations with which they deal can usually be expressed quantitatively. When we come in contact with life, however, and especially with its higher forms, the exactness with which an astronomer THE NATURE AND SCOPE OF ECONOMICS 9 predicts an eclipse or a chemist anticipates a reaction becomes impossible. Not that life is without laws ; very far from it. There is, in the first place, the basis of physical nature, with its perfect regularity, upon which all life rests and to which it must conform. Then, too, there are laws governing life directly and pertaining to it. These form the subject of the group of sciences known as biology. We must remember, however, that all we can say of natural laws is that they are habits, apparent regularities or uniformities in the succession of events ; not, so far as we know, compulsory necessities of nature. And the laws of Hf e seem to differ from those of inanimate nature / in that they are not quite invariable habits. Variability seems to be inherent in life, increasing as life rises in the scale of development. It is often assumed, to be sure, that these laws are as invariable as any other, and that this- seeming variability is only a greater complexity which we do not yet understand. However that may be, the result is the same for the present. The sciences of life are not exact in the sense we have defined. We must further note that in so far as a science deals with facts which seem to be governed by no invariable law, or whose law has not been discovered, it must content itself with a description of this part of its subject. Thus we have the term " descriptive science." We might better speak of the descriptive part of a science, for all sciences are able in part to reduce their facts to law. What has been said of the sciences dealing with life applies to an even greater extent to those sciences which deal with man. It is true that within certain limits man is governed by ab- solutely invariable laws. He is as much bound by gravitation as anything else, and if he falls over a precipice, we can predict the results as certainly as though a stone fell over. But, with- out entering the bog of discussion as to the nature of human freedom, we may safely assume, for practical purposes, that man is also, within certain limits, a law unto himself. No- where do we find an element of variability so great and so seem- ingly ultimate as here. We must remember, therefore, that the sciences which deal with man deal with a being who is modified lO OUTLINES OF ECONOMICS by his environment, but who has the power of modifying that environment by his own conscious effort. Let us consider very carefully what this means. It does not mean simply that man modifies his environment^ because he has been modified by it and so reacts upon it, just as things do when they come in contact. If we accept this view, we shall come to Herbert Spencer's theory of natural selection. The forces at work accomplish their own results, according to this theory, whether man will or will not, simply by natural action and reaction. This implies that man is modified by his envi- ronment, and that he in turn modifies that environment with- out conscious effort. This theory is based on an assumption that man has no power of initiating an influence, and consist- ently concludes that social development, like geological develop- ment, must be left to work itself out. Spencer, however, goes farther, and stoutly maintains that man, by conscious effort, especially by collective or state effort, not only does not help this development, but actually hinders it. In this the whole theory is abandoned, for it is plain that if man by conscious effort can hinder a process, he can help that process in the same way, if he only has enough wisdom and sense. These it is the purpose of science to give him. In opposition to the theory of natural selection, or unconscious development, has been urged the theory of artificial selection, or conscious development. Ages of natural selection made of the potato a lean, watery, unpalatable tuber ; a relatively few years of artificial selection made it a valuable food product and a table delicacy. Compare the development of domestic ani- mals in the last few years, under man's conscious guidance, with their slow and meager development in a state of nature. Man has precisely this power of consciously modifying the natural and artificial elements of his environment, and this power continually enlarges. So, when we ask if economics deals with natural laws, we really ask whether this being, whose activity in a certain line we are studying, is governed by such laws. If we mean by this to ask whether his action is characterized by absolutely THE NATURE AND SCOPE OF ECONOMICS II invariable habits, like the forces of physics, we must plainly answer, no. If man had no'power of initiative, or, on the other hand, were so perfectly rational as always to do the wisest thing, there would be a regularity in his action which might perhaps form the basis of a complicated, but exact, science. As it is, all social sciences are approximate and partly descriptive. There is much in man's action which is exceedingly (though not perfectly) regular, and hence we have general, though appar- ently not invariable, laws. There is a part of his action, how- ever, that seems as yet to be capricious, and we can only make note of it till we have more knowledge. The laws of economics are not comparable to the laws of inanimate nature in invariability, but they are of very general applicability, and are wholly in line with the action and intent of nature, and are, in this sense, " natural." But the laws of economics are not natural laws in the sense in which the word is often used ; namely, laws external to man and not at all the product of man. The laws of economics have been designated as social laws to distinguish them from those of physical science. Social laws describe tendencies, or regularities, which appear especially in the consideration of large masses of facts. Human mortality serves as an illustration. When and how a certain man, as A,, will die, is proverbially uncertain ; but when we speak of hundreds of thousands of lives, we can predict with such an approximation of accuracy that the vast business of life insurance can be built upon the regularity of the action of death. The foregoing discussion enables us to answer in a word the much-mooted question, " Is 'economics a science? " It is not an exact or mathematical science, though certain portions of the subject may possibly become so. It is an approximate and partially descriptive science, like all sciences dealing with man, or even with life. The inexactness of the social sciences is due to the very thing which gives them their supreme value, the nature of man and the greatness of their subject. The Relation of Economics to other Sciences. — We have already referred briefly to the relations between economics and some of the other sciences, but the topic is one which re- 12 OUTLINES OF ECONOMICS quires fuller treatment. In one sense, economics may be said to be dependent upon practically every other science, since the discoveries in every field of knowledge almost inevitably react upon the economic life of man. Modern chemistry, to take a single example, has revolutionized some industries, wholly created others, and, through the agency of the pure-food laws, may claim most of the credit for entirely suppressing others. From psychology economics takes the axiomatic principles upon which the laws of value rest ; from physical science the law of diminishing returns, which plays a very important part in the theory of distribution ; and from mathematics the methods by which to ascertain how insurance may be safely supplied against accidents, death, and loss by fire. But it is to the sister sciences dealing primarily with man that economics is most vitally related. Man has been busy from the first in several lines of effort. He has talked, worshiped, fought, studied, and each of these lines of effort has developed its own faculties and institutions. For convenience we may arrange these in eight groups, as follows : language, art, education, religion, family life, society life, political life, economic life. Each of these is the subject of a science more or less developed. The group of society life — that is, the life of polite society, calls, parties, balls, and the like — has been studied but little, and we know few of its governing principles.^ Language, on the other hand, has a science which has attained to very complete development. The rest lie scattered between these extremes. A peculiar feature of these activities is that they are all of them collective activities, activities which one man cannot well carry on alone. This is obviously true of family and political life, language, and others ; and on careful examination it proves to be true of the rest. It is now admitted, after many experi- ments, that art and even religion do not thrive in solitude. It ' An attempt to examine scientifically some, at least, of the phenomena of polite society has been made by a learned jurist, the late Professor Rudolph von Ihering, in his Zwcck im Rccht. Professor Thorstein Vebleii in his Theory of the Leisure Class gives a brilliant though half-satirical explanation of social conventions in terms of origins and survivals. THE NATURE AND SCOPE OF ECONOMICS 1 3 would seem that if a man could do anything by himself, it would be to get a living ; but the study of economic history impresses us with the insignificance of all such effort and the inevitable tendency of men to drift together in their economic activity. If it were possible for men to live in isolation, every one of the eight lines of effort we have mentioned would soon dwindle into insignificance or altogether cease. So these sciences are all of them social sciences ; and as the sciences that deal with life are now grouped together under the name biology (science of life), so the social sciences may be grouped under the title of sociology, or the science of society, although some sociologists do not define the word " sociology " in this broad sense of an all-embracing science of human association. Economics, then, is a branch of sociology thus conceived. We have already defined it as the science which treats of those social phenomena that are due to the wealth-getting and wealth- using activities of man. We may speak of the wealth-getting and wealth-using activities in all their relations as economic life or economy. Accordingly, economics is the science which deajs with the economy of man. A useful distinction in lan- guage is thus made between economy, the life itself, and eco- nomics, the science dealing with that life. If this distinction could always be observed, much confusion would be avoided. We have economies of various sorts : the economy of an individual, of a family, a tribe, a city, a state, or a nation, and we have, correspondingly, many economic units. The domi- nant unit in ancient Greece, for example, was the household, which included the family and all the slaves and other depend- ents. These lived together and formed a little group by them- selves. The economic life of Greece meant, largely, a sum of the economic activities of these households, each of which strove to be sufficient unto itself. It is interesting to know that many a well-managed Southern plantation before the Civil War endeavored to produce nearly all the means of life on the planta- tion, and in this respect, as in others, resembled a Greek house- hold. But as time has progressed, these old groups have been partially dissolved, and in many instances in modern 14 OUTLINES OF ECONOMICS times the individual, in his economic activity, constitutes a unit, although the family is still the prevalent economic unit. It is a natural outcome of economic progress, as already ex- plained, that the relations between these units have multiplied indefinitely in number and in importance. This is simply another way of describing the growing interdependence of men. Economics deals especially with the mutual relations of econo- mies of all kinds, private and public. It is chiefly, if not exclusively, a science of human relations, and without these relations could not exist. Because of the organic connection of these relations in their common origin, man, and because economics deals with the individual as he is, and not with an artificially simplified " eco- nomic man," it is impossible wholly to dissociate the social sciences, and particularly impossible to divorce economics completely from ethics and politics. This does not mean that these sciences are all one and cannot be profitably subdivided. On the contrary, because of the limitations of the human mind, they must be studied separately so far as is possible. Scientific progress, like industrial progress, comes largely through spe- cialization and the division of labor. Man cannot profitably study things in general. What it does mean is that there is some territory common to all these sciences, and that occa- sionally the economist is forced to pass ethical judgments and to decide political questions. In the consideration of railway rates, for instance, the economist may be compelled to pass judgment upon what is just and reasonable, and he discovers upon investigation that by common consent what is fair or reasonable must be decided largely upon economic grounds. The same is true of the apportionment of taxes, in which subject ethical, legal, and economic questions are inextricably inter- woven. Commercial policies, restrictive regulations,, and sump- tuary laws have been the very stuff and subject-matter of the science of economics from its first beginning. In analyzing the progress of the past or the conditions of the present, we are forced to pass judgment upon the success or failure of many laws and policies which are still in force or under active dis- THE NATURE AND SCOPE OF ECONOMICS 1 5 cussion. Many of these must be indorsed or repudiated either solely or largely upon economic grounds ; and because of these facts, the economist cannot, even if he would, refrain from pass- ing judgment upon laws and political policies. Nevertheless, as was stated before, economics does not undertake the complete and systematic study of law, ethics, and politics, and its conclu- sions must almost always be supplemented by non-economic considerations which the economist may not have taken into account. Principal Divisions of Economics. — This view of the in- evitably practical character of economic science is carried out in the treatment of the subject in the following pages. The history of the evolution of economic society, sketched in Book I, is followed, in Book II, by a discussion of the production, con- sumption, exchange, and distribution of wealth. These sub- jects are treated in close connection with those illustrative economic problems of which the so-called " economic theory," at its best, is but a more comprehensive and consequently more abstract analysis. Book III has been reserved for the subject of public finance, and in an appendix is given a brief sketch of the history of economic thought. QUESTIONS 1. What is the most essential characteristic of economics? Define eco- nomics. 2. Is man or goods the more prominent thing in economic study? Does economics teach the student how to succeed in business? 3. What determines ultimately whether a man is poor or not? What kinds of poverty are there ? 4. What is meant by "dear labor"? Is it a good thing for society in general? for employers in general ? for an individual employer? 5. What is the difference between natural and artificial selection ? Which applies to human society ? 6. Are practical ethical and political judgments the chief ends and prod- ucts of economic science? 7. Is economics concerned with the negro question? bank notes? prohibi- tion? anti-trust laws? race suicide? protection? 8. What is a scientific law? Contrast with a statutory law ; with a moral law; with the laws of mathematics. 1 6 OUTLINES OF ECONOMICS REFERENCES Cairnes, J. E. The Character and Logical Method of Political Economy. CossA, L. An Introduction to the Study of Political Economy. Dunbar, C. F. "The Academic Study of Political Economy," in his Economic Essays. Ingram, J. K. A History of Political Economy. Chap. vii. Keynes, J. N. The Scope and Method of Political Economy. Marshall, Alfred. Principles of Economics, 6th ed.. Appendixes C and D. Mill, J. S. Essays on Some Unsettled Questions of Political Economy. SiDGWiCK, Henry. The Scope and Method of Economic Science. Wagner, Adolph. "On the Present State of Political Economy," Quarterly Journal of Economics, Vol. i. CHAPTER II THE CHARACTERISTICS OF THE PRESENT ECONOMIC SYSTEM Our Environment. — Lying back of all of our economic ac- tivity is the fact that we live in an environment in which the things that we desire are not furnished spontaneously in un- limited quantities. Whether it be looked upon as due to the niggardliness of nature or to the insatiability of human wants, the fact is that, for the most part, the material things that we use must be economized. We must put forth effort and exer- cise self-denial in order to enjoy the good things of life. Those human arrangements which help to determine how much of ef- fort, of self-denial, and of enjoyment is to fall to the lot of each of us are the characteristics to which we now turn our attention. There are, however, a number of social institutions which do not fall within the scope of the present chapter. We deal here only with the social conditions directly underlying our economic activity, which is but one aspect of our social life. We must leave to the sociologists and other students of society a discus- sion of such topics as the family, religion, morality, ceremonial institutions, and the nature of government, although, to be sure, these also have their effect upon the economic sphere and are in turn affected by it. Private Enterprise and State Activity. — We live in an age when private enterprise, for the most part, is relied upon to furnish us with the necessities and enjoyments of life. The cultivation of the soil, the exploitation of the mines, transport, the various stages of manufacture, and the distribution of the finished product are all left mainly ^ to private initiative. The 1 This applies especially to the United States and England so far as transport is concerned ; it would not hold true of every country. c 17 1 8 OUTLINES OF ECONOMICS discovery of new processes, invention, and experimentation are carried on mostly by private individuals or corporations who take upon their own shoulders the risk of failure. The State, on the other hand, participates in this activity in a variety of ways. It maintains order, promotes the public health and safety, provides roads, and takes complete charge of some industries. In its educational institutions the State, through its agents, un- dertakes various experiments, and encourages the growth and diffusion of knowledge, an indispensable condition of continuous advancement in our economic life. The state university and the experiment farms may be mentioned, and also the large and extremely useful Department of Agriculture of the United States, with its annual expenditure of about twenty million dollars. Certainly in the vast majority of the enterprises with which we are familiar, private and public activities are combined in vary- ing proportions. In speaking of "State" activity, the reference is to organized society acting through any one of the various governmental agencies, such as the township, city, or national governments, and not merely the political unit which we know in this country as the state government. The term " govern- mental activity" is sometimes employed but is less desirable. The word "government" suggests to the ordinary mind a power apart from and superior to the people — a restraining or punishing power — whereas the modern concept of the State is that of a cooperative institution, main- tained to safeguard and promote the general welfare. "Private" activity, it should be noted, is a broader term than "individual" activity. It includes all forms of joint or associated action except those which consti- tute the activities of the State. Let us take the case of an industry which is as nearly private, perhaps, as any we can find — that of agriculture — and notice the part which public activities play in securing the farmer's re- sult. First, we may say that the farmer owns the farm that he cultivates ; this is private property. But how comes it that the farm is his? Why does not a stronger man drive him off and take the farm himself? Plainly because the State protects him in the possession of the farm. When he bought the farm, he took his deed to a government official, who recorded it, and thus gave him an additional guarantee of possession. A neighbor's dog THE PRESENT ECONOMIC SYSTEM 19 kills his sheep, and an appeal to the State compels the neighbor to redress the grievance. Another, far below, dams a river and backs the water up so that it overflows his land. Another appeal to the State removes the dam or secures compensation. When wheat is raised, the farmer hauls it to market by a road built, not by private, but by public, activity. The railway lowers the price of his wheat by a discriminating rate, and again government in- terferes in his behalf. But manifold and important as are the regulations of the government. State activity seems very much restricted when we reflect that it might extend over the entire industrial field. Today the distinctive characteristic of our eco- nomic life is private, not public, enterprise. Division of Labor and Exchange. — It is commonly taken for granted that every man should prepare himself for some special occupation, that one should plow while another builds or sings. Hardly any civilization seems possible without some industrial specialization, but our own age is peculiar on account of the ex- tent to which this has been carried. The introduction of machin- ery and the development of large-scale production have split up the work of men so minutely that the products which they turn out are not only of no immediate use to themselves in most cases, but they are also useless to any one else until combined with the results of other men's labor, often performed years before or afterwards. It is a long and complicated process from the man who mines the ore which is to reappear in a steel plow, to the man who bakes the bread. This specialization of employment has some far-reaching results : I. It implies the exchange of goods. If we produce things we do not need, we must find some one else who does want them and some one who has the things we desire. Money, banks, and transportation agencies could largely be dispensed with if each family produced for itself alone. There would be none of the complex problems that center about the question of how much each of us is to receive in exchange for his services. One of the striking characteristics of this process of exchange is the great extent to which it is automatic. There is no government official whose business it is to discover how much of each commodity 20 OUTLINES OF ECONOMICS will be needed, and to direct that that amount shall be produced. - Men are legally allowed to engage in almost any undertaking that attracts them, and yet we take it for granted that somehow things will get produced in the proper proportions. A hundred men are set to work in a factory making nothing but hats, many more than they or their friends can use, but the manager has faith that heads will be found to wear them all. Farmers con- fidently proceed to raise wheat, never troubling themselves about the grinding and baking. Neither workmen nor em- ployers in general know why wages are as they are. Men lend money or goods, now for one price, now for another, but few know why they demand interest or why the rate changes. These processes go on visibly before us, but the governing laws are hidden except to the careful investigator. In this respect they are like the laws of physiology. We eat and digest our food, but how many people know how or why digestion takes place? It is easy, however, to overemphasize this idea, for a great deal of our economic activity is conscious and volitional. When we decide to make a law or levy a tax, we do it consciously, considering arguments, and finally will to do the thing in ques- tion. And even in business undertakings there must be much careful study of the probable demand for various kinds of goods and of the most economical ways of producing them. 2. The specialization of work and exchange of goods just referred to necessarily imply that mutual dependence briefly considered in the preceding chapter. Instead of a number of distinct, self-sufficient units, we have a coherent society where one individual relies upon many others to complete his own one- sided economic activity. A strike of street-car employees, or of teamsters, or the destruction of an electric lighting plant, would each send a shock of inconvenience through a community. A prolonged railway strike would be felt as a national misfortune. Indeed, this interdependence is international in its scope. Eng- land relies on other nations to send her food in exchange for her > The government does help, however, by collecting and publishing information, such as crop reports, statistics of the amount of cotton ginned, consular reports as to opportunities in foreign markets, and in various other ways. THE PRESENT ECONOMIC SYSTEM 21 manufactured products, and many a German workman would be in distress if our exports of cotton or copper should suddenly cease, as is happening in the great European War, in progress at the time that this is being penned. The United States is more self-sufficient economically than many other nations, but we are nevertheless dependent upon international trading for our supplies of many things. Economic Classes. — In part, also, the specialization of work is responsible for the division of society into classes, but only in part. The differences in the work of the carpenter, machinist, and railway brakeman do not result in the formation of classes of a higher and lower rank. On the other hand, the professional brain worker enjoys some social esteem that does not fall to the lot of the manual worker. But doubtless the most important basis of social classification is the possession of wealth. The power to spend freely, while not the only test, is today the most widely recognized test of social status, regrettable as this may be. Private Property. — We proceed now to examine the founda- tion stones of this system of private enterprise. Private prop- erty is the most important of these. For our present purpose we may define private property as the exclusive control over valu- able things by private persons. It is to be distinguished from mere possession. The possessor has the use of the thing for the time being, but unless he is at the same time the owner, he is depend- ent upon the will of another for the use of it. Ownership implies the right of excluding other persons from the employment of a thing. The exclusive right must be recognized and guaranteed effectively by third parties. If the exclusive right of control over some valuable thing is asserted simply by the strength ot\ one's right arm, the right of private property is not thereby established. The exclusive right of control must be recognized by others and must be maintained by them. Over against private property we have public property, and there are some things, such as air, which fall in neither of these categories. The sphere of private property at present includes, not only food, clothes, and other things of personal use, but also the instruments of production — land, buildings, and machinery. 2 2 OUTLINES OF ECONOMICS In the most important productive processes the tools are in gen- eral not owned by the persons who use them. It may be said that property is the chief seat of social authority. As property carries with it the exclusive right to control things, others may have access to these things only on conditions named by their owners. If we look about us, we find men organized and acting together under direction for purposes of production. In a factory we find an organization of men like that of an army. We discover men moving here and there and per- forming arduous tasks in obedience to command. If we examine the nature of the authority which some thus exercise over others, we shall find that it resides in property. The law of the land to some extent establishes the authority of man over man; but where one man obeys another because the law in so many words tells him to do so, we find a hundred men obeying others because these others have the authority which resides in exclusive control over valuable things. Indirectly this latter sort of authority rests back upon the laws in so far as these are responsible for the establishment of property. But the chief seat of authority in society is based only indirectly upon the government ; it rests immediately upon private property. The right of private property is one so fundamental in our modern life that we scarcely think of it as a creation of man, maintained by constant vigilance on the part of the State, and subject to human modification. It seems like bed rock, an ulti- mate right, needing no other justification than its own obvious- ness. When a custom has obtained very widely and is deeply rooted in human life there is often a tendency to claim it as a " natural right." But the right of private property as we know it now did not always exist. It has not always been so extensive or exclusive as at present. This is especially marked in the case of individuals, whose claims as opposed to those of the tribe were at first slight and vague ; but these claims gradually grew, especially in the case of the chieftain, until tribal or communal rights broke down before them. The time was when a Scottish clan had absolute right to the territory it occupied, and no chief- tain, however powerful, could have abridged that right. Now there are beautiful tracts of country in Scotland which are almost denuded of their agricultural population because the owners, the descendants of these same chieftains, preferred to raise game on their estates. All are familiar with the liberty generally allowed in this country of hunting and fishing on private estates. This THE PRESENT ECONOMIC SYSTEM 23 is unheard of in Europe. Slowly, however, we are extending our property claims to game and fish, and the former leniency of ownership is disappearing. But the modern State is continually placing limitations and restrictions on the right of private property. Our cities regulate the height of buildings and prescribe the material from which they must be made and the kind of plumbing which must be in- stalled. Restrictions of the uses to which land may be put are common, and no one can use his property in ways that constitute a public " nuisance." The nature and extent of these changes in private property must be controlled by the State in the public interest. How far interference with the right is justified cannot be discussed in general terms : such a discussion must deal with the specific problems of municipal ownership, railway regula- tion, and innumerable others. The point to be emphasized here is that in solving such problems the mere fact that a proposed solution restricts or enlarges the right of private property cannot in itself be given much weight. Trademarks, Copyrights, and Patents. — These are legal arrangements whereby exclusive privileges are awarded in return for certain services to society. These privileges become a special form of private property. Their justification lies in the fact that they are a means of promoting " the progress of science and useful arts." It must be remembered, however, that all such progress is a historical product. The telephone, for example, was preceded by a century of scientific invention and discovery, most of it poorly remunerated. The telegraph was, similarly, the result of the careful plodding industry of scores of men. Professor Henry, of Princeton College, whose services in connec- tion with the completion of the telegraph were most distinguished, conscientiously refused to take out any patent. It often happens that several persons almost simultaneously and independently make the same discoveries and inventions. Our patent laws seem frequently to reward the man who makes the finishing touches which lead to the utilization of a long line of work. But it is the hope of being the one who may give the practical turn to an idea that lures many a man on to undertake the laborious 24 OUTLINES OF ECONOMICS task of doing the extensive experimentation often necessary to place an article on the market. In order that patents and copyrights may not become the bases of burdensome monopolies, they are of limited duration. Patents in the United States run for seventeen years, and copy- rights for a period of twenty-eight years. Copyrights may be renewed for another term of the same length. These legal privi- leges have resulted in an enormous amount of litigation and have given rise to special problems. One of these is the question of the extent to which the manufacturer of a patented article should have the right to control the price after the article has left his hands. It is frequently asserted that owners of patents should be compelled to permit other persons to use them upon the pay- ment of royalty, so as to promote competition in manufacture. But there is some danger that such legislation would defeat the primary object of the patent system. Even with the exclusive right to manufacture an article it frequently requires a long struggle to make an invention a commercial success. It has also been suggested that the United States government should re- serve the right to purchase a patent, but it is improbable that this right, if reserved, would be often exercised. Inheritance. — Inheritance is often regarded as a necessary part of the right of private property, and it is true that the entire abolition of the right of inheritance would result in a great en- largement of public property at the expense of private property, unless gifts were used to replace inheritance as a means of trans- ferring property from one generation to the next. But, in truth, property and inheritance are two distinct rights. Private property is an exclusive right of control, whereas inheritance is the transmission of this right from one generation to another. As in the case of private property itself, the right of inheritance is not recognized today as absolute. Detailed regulations exist on our statute books regarding the making of wills and regulating the descent of property where no will is made, and there is an increasing tendency to limit the right of inheritance by taxation. That which seems a mere natural right at one time seems a wrong at another, as is illustrated in the changing ideas and practices THE PRESENT ECONOMIC SYSTEM 25 concerning the share of a father's estate to be inherited by the oldest son. Contract. — Hardly second in importance to the right of pri- vate property is the right of contract, for the maintenance of which we are equally dependent on the State. Some sort of contract lies at the basis of all associated activity. To secure the condition of such activity, it is necessary, first, that men should be allowed to bind themselves ; and, second, that they should be compelled to abide by the agreement thus entered into. The entrance into a valid contract is ordinarily voluntary, but once entered into with due formality, the State will use its superior power to enforce it. To the anarchist this seems oppressive, and it is true that a state of society is conceivable in which the ele- ment of force might be removed from the idea of contract, but something else would have to be substituted to make the keeping of agreements the general rule. There are doubtless many people living today with whom the feeling of honor or the fear of social disapprobation would be sufl&cient for the enforcement of contracts, just as these persons might not need the threat of a jail sentence to keep them from stealing. The economic ties which hold men together in industrial society are, on their legal side, very generally contracts. The organization of an industrial corporation implies many contracts. Our property is acquired very largely through contract, and through contract we determine the conditions under which we do our work, such as the length of the working day. The continu- ity of our economic life rests upon contracts, which bind together past, present, and future. Still, all that we have by no means comes to us through contract. " Contract " does not exhaust the significance of parentage, home, and education, and much wealth changes hands through gifts and inheritance. Laws are frequently enacted regulating contract in the general interest. This is especially marked in labor legislation, which will be discussed in another chapter. Certain contracts cannot be enforced by law, because they are held to be against public policy, as, for example, gambling contracts and contracts in restraint of trade. In some cases statutes make it illegal to enter into such contracts. Vested Interests. — A few words should be said about vested 26 OUTLINES OF ECONOMICS - interests.^ Vested interests are legally recognized pecuniary interests which cannot be impaired by public action without indemnification. Vested interests generally arise through prop- erty and contract. Outside of property and contract, however, there may be vested interests. Leeds was compelled by a feudal arrangement to grind its corn, grain, and meal at the lord's mill till well on in the last century, and finally had to pay £ 13,000 to terminate this obligation. When Prussia bought the railways, the railway presidents were indemnified for the loss of their posi- tions by large payments ; in other words, their offices were looked upon as vested interests. England is the classic land of vested interests. An office in the army was until recently looked upon as such, and so was an appointment in the established church. It is generally held that keepers of public houses in England li- censed to sell beer and spirits have a vested interest in their busi- ness, so that they must be indemnffied if their licenses are taken from them. Workingmen have frequently claimed that they have a vested interest in the advantages which their skill in their trades gives them, and that if through industrial changes this skill ceases to be of as great value as formerly, they ought to be indemnified and in some way their former income continued. This claim of the workingmen, however, unlike many other claims put forward in the name of vested interests, has not re- ceived recognition, either by Parliament or the courts. Vested interests, apart from property and contract, are of less signffi- cance in the United States than in most countries, but they may become of more significance in the future. Freedom. — The freedom to do certain things is legally guaranteed at the present time, such as moving from one part of the country to another, choosing one's own occupation, and acquiring property. These, together with the absence of slavery and of imprisonment for debt, are characteristic features of the present economic order as distinguished from past conditions. The right to manufactyre and sell what and when one pleases is also comparatively recent. It has often been greatly limited by despotic governments, and has been made a matter of sale for 'The term "vested rights" is also used. THE PRESENT ECONOMIC SYSTEM 27 the purpose of raising revenue. Such Hmitations gave rise to many abuses, and our own time has seen the abolition of an im- mense number of hampering and vexatious restrictions often designed for extortion rather than for the promotion of private enterprise. So far as the absence of legal restrictions on the actions of individuals is concerned, the past century has been distinctively an age of economic freedom. Restrictive laws, however, are not the only limitations on eco- nomic freedom. The system of private property itself means that certain individuals in the community have power to com- mand other people to work, and the lack of an income under our present regime implies the lack of the real freedom to do things. The cost of a railway ticket may be quite as effective as a legal barrier would be in preventing movement from one state to an- other. We say involuntary servitude, except as punishment for crime, has been abolished, yet men are compelled to work by the threat of economic distress, in most cases quite as effectively as by means of the slave-driver's whip. Again, the choice of an occupation is free according to the law, but we may find that a long and expensive course of training is necessary, or trades- unions ef[ective*ly limit the number who can learn a given trade. The right to establish enterprises is granted to all alike according to the law, but today most persons would find it difficult and hazardous to embark upon the refining of oil or the manufac- ture of steel. For most men, the freedom to establish new en- terprises has been growing less and less in this era of large-scale production. This leads us to a distinction between what have been called negative freedom and positive freedom. Mere absence of re- straint (negative freedom) is one thing, and the power to develop our activities to the fullest extent (positive freedom) is a very different thing. Legal restrictions may actually be the means of increasing positive freedom. Thus, a library placed at the disposal of the public without rule or regulation would result in a smaller total utilization of the books than one in which the ob- servance of certain rules is strictly enforced. All laws which limit the power of the strong to oppress and which help to open 28 OUTLINES OF ECONOMICS the gates of opportunity to all must of necessity increase positive freedom. The newer idea of freedom aims at the development of such social arrangements that sane and complete lives will be possible for the largest number of persons. Competition and Markets. — As a result of the legal conditions that have been mentioned, we find men engaged in many kinds of rivalry. Our economic society is often called " competitive " for this reason. But this term does not apply to all forms of rivalry, for economic competition is based on private property and free contract. There might still be conflicts between races and nations if private property and free contract were abolished. The men of any single nation might still vie with one another to prove their superiority in the eyes of womankind or to gain posi- tions of public honor and power. The kind of competition which is distinctive of the present economic order is the all-pervading endeavor to obtain the largest possible amount of wealth in ex- change for commodities produced or services rendered. If we except the idlers, the parasites, and the cheats, men are every- where endeavoring to discover what other people urgently want, and then to satisfy these wants in the most efficient manner possible. Moreover, they attempt to give as little as possible of their own products in exchange for the things they themselves desire. Business competition thus has two sides : rivalry in rendering a service, and alertness in exacting a return. Each individual takes part in the competitive contest in two ways : first, as a seller of goods or services, in which case he finds that others are anxious to render the same service ; and second, as a buyer of the things he wants, in which case he finds that these same things are sought by other people. The intensity of the competitive struggle is subject to a good deal of variation. At times it may be characterized as cut- throat, where the slashing of prices has for its object the elimina- tion of one or more of the contestants. But in most lines of endeavor many competitors may continue to exist side by side indefinitely, each being confronted by the ever present threat that, if his service becomes very poor, some other man will our- strip him. Various as may be the character of competition, now THE PRESENT ECONOMIC SYSTEM 29 predatory, now a friendly rivalry, there is no resting place in the contest unless one secures some special privilege as a shelter. He who is energetic, and wins success in a certain line of business, must continue to defend himself from a host of imitators who are anxious to snatch his gains from him. Most of the competitors are successful in getting something, some more than others, but many fail altogether. These last, the inefl&cient, whether made so by sickness, by inherited weakness, or by lack of proper train- ing, fall by the wayside and must be cared for by private charity or by the State. The process is cruel in many of its details, but there is also a beneficent aspect in its sifting out of the incompe- tent and in its encouragement of the strong. Here, again, the automatic character of the present industrial system manifests itself. It is through competition and bargain- ing in the market that the prices of goods and services are fixed, and it is to the variations in these prices that men look for indi- cations as to what people want. Price is the universal barometer that indicates changes in the demand for goods of all kinds. Fair Competition. — Competition has been spoken of as a struggle, a contest, accompanied by success and failure, elation and disappointment. But the State sets limits to the rivalry, — it makes regulations and acts as an umpire to compel fair play. It attempts to eliminate fraud and brute force ; it trains the ris- ing generations for an entrance into the struggle by a system of free education ; it insists that no person shall sacrifice the life and limb of another in the rush for wealth ; and it protects chil- dren and women when they seem compelled to labor under un- healthful conditions. Those who fail entirely in the struggle it tries to rescue from suffering. Libelous and fraudulent state- ments about a competitor's business are illegal. So are efforts to induce his customers or employees to break their contracts with him. Competition designed to drive a rival out of business is illegal, whatever its methods, if it is prompted by sheer malice or is part of an effort to establish a monopoly. The Federal Trade Commission, established in 19 14, is empowered to issue orders restraining the use of unfair methods of competition by persons engaged in interstate commerce. In short, the State aims to 30 OUTLINES OF ECONOMICS raise the plane or ethical level of competition, changing it from brutal warfare into a contest in which there are prizes for all, but in which the prizes are graded according to the energy and ability of the contestants. Cooperation. — The statement that our age is one of competi- tion is misleading if it gives the impression that every individual is always struggling against all of his fellows. On the con- trary, the achievements of modern industrial civilization would be impossible without a far-reaching cooperation between in- dividuals. Employers and employees may quarrel and bargain about the wage contract, but when they have settled their rela- tions for a week or a year, they become cooperators for that period in the conduct of the business enterprise in which they are engaged. Again, there is an unconscious cooperation between those who work upon a commodity in the different stages of the process from raw material to finished product. The division of labor itself is cooperation on a splendid scale. Competition merely determines the conditions on which the cooperation takes place. If these conditions could be determined in some other manner, it would be possible to conceive of the elimination of competition from our industrial system, but cooperation itself is so vital and fundamental that its elimination would mean a return to barbarism. Monopoly. — Everywhere in the industrial field the tendency toward monopoly is present. Business men endeavor so far as possible to shelter themselves from the effects of the competitive struggle by means of some privilege, but if none is to be foimd, and if competition becomes very keen, they endeavor to combine with other business men. But while this attempt to escape com- petition is universal, it is only under certain conditions, not gen- erally present, that it is at all likely to succeed. The possibility of success is least in agriculture and in mercantile business, where new enterprises are started rather easily because no special privi- leges stand in the way and because no very large capital is re- quired to work efficiently. It is greatest in mining and trans- portation, where special privileges are present and where large fixed capital is required. Scarcely anywhere is it possible wholly THE PRESENT ECONOMIC SYSTEM 31 to escape competition, and we are still warranted in speaking of the present era as a competitive rather than a monopolistic age. Side by side with the growth of monopoly there is an increase in government control of industry. The desire of the business man is to be uncontrolled, but wherever he succeeds in throw- ing off the control exercised by his competitors, he inevitably substitutes that of the government. Custom. — Custom plays an important part in our economic activity as well as in every other department of social life, al- though its sway is not so marked as in former ages or among primitive peoples. The custom of giving gratuities, or tips, to servants is in many places so strong as to have almost the force of law. Again, today much of our personal expenditure is con- trolled by what custom has declared to be proper rather than by any act of our own individual reason. Any attempt to lower wages which would make impossible the maintenance of a cus- tomary standard of living would be stubbornly resisted. And, as we shall see in a later chapter, the " good- will " of a business, which is often a durable source of business profits, is built up, in large measure, on its ability to get people into the habit or custom of trading with it. Custom is the result of habit, and is continually broken into by our tendency to imitate a leader who proposes a new line of action. While custom may have its benefi- cent aspect in preventing hasty and impulsive changes, it fre- quently retards progress and causes our legislation and judicial decisions to lag behind industrial development, QUESTIONS AND EXERCISES 1. Give further illustrations of the difference between positive and nega- tive freedom. 2. Describe the property relations existing in the Amana Society, or in other communistic groups. 3. What regulations concerning the inheritance of property are in force in your state? 4. To what extent are gambling contracts valid? Why does the law differentiate them from ordinary business contracts? 5. Compare the legal freedom of workingmen today with the conditions described in the Wealth of NaliPiis, Book i, Chap, x, Part ii. 32 OUTLINES OF ECONOMICS 6. Compare the rights of patentees in Bauer v. O'Donnell, 229 U. S. i (1912), with those allowed in Henry v. Dick Co., 224 U. S. i (1911). 7. What do you regard as " unfair " advertising ? Give examples. REFERENCES Bliss, W. D. P. Encyclopedia of Social Reform (new ed.), article on Amana Community. See also on same subject, Ely, R. T., in Harper's Monthly Magazine, October, 1902. Ely, R. T. Property and Contract, in their Relations to the Distribution of Wealth, Vol. i, pp. 94 and ff.; Vol. ii, pp. 755-821. Green, T. H. "Liberal Legislation and Freedom of Contract," in his Works (edited by Nettleship), Vol. iii. Lewinski, J. S. The Origin of Property. Mill, J. S. On Liberty, Chap. iv. Mill, J. S. Principles of Political Economy, Book ii. Chaps, i. and ii. Nicholson, J. Shield. Principles of Political Economy, Vol. i, Book ii. Chaps, ii-viii. Reports of the United States Commissioner of Patents. Rogers, E. S. Good Will, Trade Marks, and Unfair Trading. SiDGWiCK, Henry. Principles of Politual Economy, Book ii. Chap. xii. Stephens, J. F. Liberty, Equality, and Fraternity. Webb, Sidney and Beatrice. Industrial Democracy, Vol. ii, pp. 562-572. Wyman, Bruce. The Control of the Market. CHAPTER III THE EVOLUTION OF ECONOMIC SOCIETY The evolution of economic society is but one of many points of view from which the development of mankind may be consid- ered. The history of literature, the history of government, the history of religion, each treats of man in one line of his activities. Many thinkers have considered the economic activities of man- kind as the one fundamental factor in social progress, deter- mining in the long run even our moral and religious ideas. But human life is complex, and it is improbable that any simple explanation suffices for all of its aspects. The economic factor, however, is clearly of fundamental importance in the sense that the higher things in life cannot be gained if man's entire time is spent in getting a mere subsistence, so that economic progress, or increasing control over the forces of nature, must accompany general social advancement, at least for the mass of the commu- nity. Under primitive methods of production, only a select few can have the leisure which is a necessary condition of a high stand- ard of living. The greater the total social product, the better the possible satisfaction of the true economic wants of all ; and, other things being equal, the more satisfactory the founda- tion on which to rear a high democratic civilization. The Economic Stages. — Many attempts have been made to divide economic history into different stages through which mankind passed in arriving at modern industrial civilization. These attempts have been the subject of lively criticism, but it appears that the classification which in the past has been most widely used is still, with some modifications, the most serviceable, and in the main, this will be followed in the present chapter. The basis of this classification is the increasing power of man 34 OUTLINES OF ECONOMICS over nature. This is the fundamental fact in man's economic development, and his position in the scale of economic civiliza- tion is higher in proportion as this power over nature increases. Increasing control of nature is accompanied by changes in man himself, especially by a growth and diversification of his wants, so that we may say that economic civilization consists largely in wanting many things and in learning how to make and use them. From this standpoint economic history may be divided into the following stages : (I) Direct Appropriation ; (II) The Pastoral Stage; (III) The Agricultural Stage; (IV) The Handicraft Stage ; (V) The Industrial Stage. I. Direct Appropriation Primitive man depends upon finding things, not upon making them. This does not mean that the lowest examples of man- kind that we know do absolutely nothing in the way of trans- forming the materials of nature for use. The lowest types know the use of fire and have rude tools, but, nevertheless, the farther back we go, the more complete do we find the reliance on nature. One cannot read descriptions of the Negritos, Veddahs, Fuegians, or native Australians without being impressed with the simi- larity between the economy of these peoples and that of the lower animals. But there are many tribes commonly regarded as savages that show a great advancement over those that have been mentioned. Among the North American Indians, for example, we find a rude sort of cultivation of the soil along with hunting and fishing. Such soil cultivation has been termed " hoe-culture," and is to be distinguished from agriculture with the aid of domesticated animals found in a later stage of devel- opment. This kind of agriculture is found in its highest state of development among the Negroes of Africa. " The ground for cultivation," says Ratzel, "is cleared by means of fire, or with the hatchet or small ax. On the east coast a broad chopper with a spear-shaped blade and short handle is also used. The lance or spearhead has, in general, to serve many peaceful purposes. Larger trees are killed by barking. Thorny branches are placed as a border to the iields, under the shelter of which close, quick hedges gradually grow up. The THE EVOLUTION OF ECONOMIC SOCIETY 35 ground is broken and cleared of weeds with a wooden spade sharpened to an edge at either end. Many peoples have hitherto not ventured to use iron tools, since they keep away the rain. When the ground has been got ready, somewhere about the beginning of the rainy season, the sower walks over the field, scraping a hole with his naked foot at every step, into which he lets some grains fall from his hand ; the foot covers them up, and if the good witch doctor makes rain enough, and the bad one does not keep it back, there is nothing more to be done until harvest, unless to hoe the weeds once. . . . To the present day the plow is practically strange to them." ^ The following characterization of the economy of primitive man applies with varying accuracy to the many tribes that may be placed in this first stage. Characteristics of Primitive Man. — The range of wants is narrow : the savage is generally satisfied if he obtains mere subsistence of the rudest sort. In the satisfaction of these few wants he is, according to our modern standards, remark- ably inefficient. From even the best natural resources he manages to get but a very poor living, depending as he does largely on the spontaneous products of nature. Magic and ritual are very generally relied upon as aids to wealth produc- tion. He is improvident, for he does not feel keenly the un- certainties of the future, and fails to make provision for them. Hence he has alternate periods of starvation and plenty. Only a small population is possible in this stage, as a tribe must have a large expanse of territory from which to draw its sustenance. The place of abode is easily changed, and warfare with neighboring tribes frequent. Private property in land is absent, although the beginning of the institution of ownership appears in the recognition of the individual's right to articles of personal use. There is little division of labor. What one man can do, all can do. The cultivation of the soil by the women and the specialized work of the medicine man are ex- ceptions. As each tribe produces or finds for itself all that it uses there is little or no trade. The beginnings of slavery are found, but this institution plays no important part in the economy of primitive man, except among the most advanced tribes. 'Ratzel, History of Mankind, trans, by A. J. Butler, vol. ii, pp. 380-382. 36 OUTLINES OF ECONOMICS II. The Pastoral Stage In the older accounts of economic evolution, the impression is given that hunting peoples learned to domesticate animals and then led a pastoral life, later learning to subdue the vegetable kingdom, thus becoming agriculturalists. This is not alto- gether accurate. It is possible that the domestication of animals was developed in regions where considerable progress had been made in hoe-culture. As this knowledge spread, certain tribes became and remained pastoral nomads in regions where agriculture was impossible. But whatever the actual steps may have been, the pastoral peoples represent a type of culture that is lower than that of the agricultural stage (as distinguished from hoe-culture), and higher than that of the hunter. Within this stage also are classed together tribes of varying advancement. Illustrations of existing pastoral life are found in the tribes of central Asia, many of the Arabian and African tribes, and the Todas of India. Attempts have been made to trace the pastoral stage in the early history of the Hebrews, Germans, Greeks, and Britons. Characteristics of Pastoral Peoples. — Some marked features of the first stage are found also among pastoral peoples. A fixed abode is not possible, as food must be found for the herds and flocks. Cities do not develop. Moreover, while the land will now support many more inhabitants per square mile than before, much land is still needed for pasture, and there is frequent collision and warfare between neighboring tribes. It follows also that there is very little private ownership of land among these peoples. Tribes as a whole lay claim to certain districts and try to keep other tribes from pasturing their flocks on them. In this stage there are frequently individual accumula- tions of wealth, consisting mostly of herds or flocks, and thus the contrast between rich and poor makes its appearance. Cus- tomary rules regarding the inheritance of wealth are recognized. But this early wealth does not produce commerce to any con- siderable extent, simply because there is little division of labor either between localities or within the tribe. THE EVOLUTION OF ECONOMIC SOCIETY 37 III. The Agricultural Stage In this stage there is an enormous increase in man's power over nature. The production of wealth is increased especially by the use of animal power in cultivating the soil. One result is increased population. Land which under the more primitive methods of getting a living would give a scanty support to a small tribe for a part of the year will now maintain a whole community with a fixed abode. It is necessary for human development that men should live in definite places and have homes and a country. This results in new relations between men, new duties, new arts, and new possibilities. The beginning of the institution of private ownership in land falls within this stage, although it is difficult to trace the actual steps in the process. A most important characteristic of this period is slavery. Slavery begins long before improved agriculture, but it now attains its full magnitude as an institution. Slavery occupies a prominent place in the history of Greece and Rome, and in the Middle Ages develops into serfdom. Commercial intercourse is still comparatively slight in this stage. Fixed residence develops village communities, and these are economically self-sufficient. That is, they produce the things that they consume, and do not as a rule have surplus products to dispose of to others. Hence money does not at this time play an important part in the every-day life. The economic condition of Europe during the Middle Ages, before the growth of cities, illustrates the agricultural stage. The Manorial Economy in England. — England was almost wholly agricultural for three centuries following the Norman Conquest. In the thirteenth century the population for the most part lived in villages or manors, each controlled by a lord to whom the rest of the inhabitants were bound by custom- ary rules to render certain assistance, as in the cultivation of his land. The villagers were of various classes, according to the amount of land which they held and according to the services which they were required to perform. The land of ^S OUTLINES OF ECONOMICS each tenant was not a compact area, but was composed of strips scattered in the three great fields into which the arable land was divided for purposes of crop rotation. Some handicraftsmen were also found upon the estate, but they do not occupy an important place in the economy of the village. For the most part, they were probably slaves or household servants. Slaves in England con- stituted at the time of the Conquest about nine per cent of the population, but "in some of the eastern and midland shires do not appear at all, or fall to a percentage of four or five," while they rise to as much as twenty-four per cent in other parts of the country. " We cannot but explain this ' by the supposition that in the later stages of the English conquest a greater number of the British cultivators were spared, so that in these districts slaves came to form a considerable part of the rural population. Absolute slavery, how- ever, disappeared in less than a century after the Conquest, and the servi became customary holders of small plots, like the cotters elsewhere, but on more onerous conditions." ^ These manors were largely self-sufficient in their economic life. There was, to be sure, some trade. England exported raw products to the continent and received back some of the finer forms of manufacture. But the ordinary needs of the very frugal life which the tenants had to live were supplied by prod- ucts of the manor itself. During the centuries following the Norman Conquest important changes took place in the manorial system : (i) a rapid growth in the number of free tenants ; (2) the commutation of customary services into fixed payments in money or kind ; and (3) the appearance of a class of agri- cultural laborers dependent on the wages which they received. In contrasting the manorial economy with the village of the present day, Professor W. J. Ashley has pointed out the follow- ing differences : (i) Now English farmers generally live in separate homesteads among the fields they rent, but then all the cultivators lived side by side in the village street. (2) Now each farmer follows his own judgment as to his agricultural operations, but in this early period he took his share in the common method of cultivation, which was regulated by custom, enforced by the manor courts. (3) Today, if the landlord himself engages in farming, his management is independent 1 See Ashley, English Economic History, vol. i, pp. 17-18. THE EVOLUTION OF ECONOMIC SOCIETY 39 of that of his tenants, but under the manorial system he de- pended almost exclusively upon the labor of his tenants, who contributed plows, oxen, and men. (4) Aside from the great gulf between lord and tenants., there was then no such social separation between the cultivators as there is today between large and small farmers. The manorial economy of England was a type, though somewhat more systematically developed, of conditions on the continent of Europe. IV. The Handicraft Stage This stage begins with the development of towns as centers of trade and handicraft in the latter part of the Middle Ages and extends to the introduction of power manufacture in the latter part of the eighteenth century. During such a long period many changes took place in the economic life of the people of Europe, but so far as the growth of man's power over nature is concerned the whole period is in marked contrast with the modern era of machine production. The Gild System. — The growth of trade brought with it the merchant gild, the purpose of which was to regulate the conduct of trade and to keep a monopoly of it for the merchants of the town. Merchant gilds appeared in all the larger towns of Eng- land in the twelfth century. But a new class was developing in the towns, — the craftsmen who were engaged in the making of things for sale. As this . handicraft grew in importance, the merchant gild was superseded by the craft gild, which in England attained its fullest development in the first half of the fourteenth century. Each craft had its gild, which specified in detail how the business should be carried on, how many should be admitted to it, and how the trade should be learned. This growth in spe- cialization meant also a growth in trade, but in this early part of the handicraft period, commerce was much restricted as com- pared with that of the present day. The towns made exchanges mostly with the country surrounding them, there being as yet no national or world market of any importance. Plainly such a general system of exchange could not be carried on by barter, and in this period money became increasingly important. V 40 OUTLINES OF ECONOMICS The agricultural stage had in the greater part of Europe cul- minated in the feudal system. The nobility maintained order and attended to the fighting while the serfs tilled the soil. The manufacturing cities became the rivals of the feudal lords, who felt their power threatened, and hence they bitterly opposed the cities. The cities were free, and the serfs who fled to them were accepted and made freemen. The Domestic System. — With the beginning of the modern period the town system gave way to a larger economy. The towns lost the control of trade. The gild system was gradually succeeded by tlie domestic system, which developed in the sixteenth and seventeenth centuries and was a characteristic feature of English industry until the middle of the eighteenth century. As in the gild system, industry was carried on by hand in a small way, but the functions of merchant and workman were now separated. The gild master sold the goods which he produced in his shop directly to the customers who were to use the goods, but under the domestic system the workman came to be less independent. He received the raw material from a middleman, to whom he also delivered the finished product. Much of this work was done outside of the towns, the artisans thus being enabled to devote part of their time to agriculture. Defoe, in his tour through Great Britain (1724-1726), describes the methods employed as follows : The land "was divided into small inclosures from two acres to six or seven each, seldom more ; every three or four pieces of land had an house belonging to them, . . . hardly an house standing out of a speaking distance from another. . . . We could see at every house a tenter, and on almost every tenter a piece of cloth or kersie or shaloon. ... At every considerable house was a manufactury. . . . Every clothier keeps one horse, at least, to carry his manufactures to the market, and every one generally keeps a cow or two or more for his family. By this means the small pieces of in- closed land about each house are occupied, for they scarce sow corn enough to feed their poultry. . . . The houses are full of lusty fellows, some at the dye-vat, some at the looms, others dressing the cloths ; the women or chil- dren carding or spinning, being all employed, from the youngest to the oldest." Agricultural Changes. — Many important changes in the agriculture of England took place during the handicraft stage. THE EVOLUTION OF ECONOMIC SOCIETY 41 The most prominent of these is the process called inclosure. Under the manorial system the lands in the common fields were the property of a landlord, but his rights were not exclusive and were qualified by rights of the tenants. There existed a certain kind of partnership of landlord and tenant in the culti- vation of the land. Inclosure is the term used to designate the dissolution of the partnership, or the separation of rights. After inclosure the tenant had generally a farm which was in one piece of land, instead of being in scattered strips in different fields, and for this he paid usually a definite money rent. The farmer could make improvements on his own account, which was impossible when he held scattered strips in great fields. Inclosures were made during this whole period and especially during the Tudor period. Farms became larger and when labor was scarce and wages high, sheep farming, requiring few laborers, was rapidly extended. Inclosures resulted in great agricultural improvement, but at the same time they were frequently attended with hardship for the poorer people. Some- times the common rights, especially those of common pasturage, were not fully paid for, although the rule was that of compensa- tion. But the result was to separate many people from the land; frequently the payment received by the poorer people was wasted. The right to pasture a cow meant a definite con- nection with the soil ; the money received in payment for this right might quickly disappear. Even now in English villages it is possible to find those who receive small sums for ancient rights, and these are too often used in dissipation. In Epworth, England, the villagers formerly had a right to cut turf in a field which is now let for a money rent, and this is used to buy coal which is distributed among the people in payment of their an- cient rights. Convertible husbandry, rotation of crops, the cultivation of root crops, improved breeds of animals and other forms of agricultural progress accompanied inclosure, which is still going forward, although the process is nearly completed so far as the arable land is concerned. A halt has now been called to the inclosure of forests and common fields, especially when used 42 OUTLINES OF ECONOMICS for pasturage, and these are now found scattered over England and used as public parks and playgrounds ; but often with certain private rights of pasturage which have descended to their owners by inheritance or which have been acquired other- wise, as by the purchase of a cottage to which the rights are attached. An illustration of a village with extensive common fields is afforded today by Stelling Minnis, near Canterbury, England. The Mercantile System. — The decay of town authority did not mean that industry and commerce were left to the free play of competition. The supervision of the central government took the place of that of the towns. The national system of regulation has been called the Mercantile System, which pre- vailed in England (and in other countries) from the sixteenth century to the nineteenth. Its essential idea is the guidance of economic affairs in such a way as to increase the commercial and military power of the nation as a whole. The navigation laws which the student has met with in his study of American history were a part of this system. An attempt was made to create a " favorable " balance of trade and to maintain a good supply of the precious metals. Agriculture was fostered with the aim of promoting the growth of population. The mercantile system has" often been described as consisting chiefly of trade restrictions, but it is the contention of Professor Schmoller that in its essence the system meant " the replacing of a local and territorial economic policy by that of the national state." It was characteristic of the mercantile system, too, to interfere in the conduct of internal trade. Prices, wages, and the rules of apprenticeship were fixed by public authority. The quality of goods was inspected by public ofhcials. Patents of monopoly on the sale of certain commodities, such as gunpowder, matches, and playing cards, were extensively granted by royal authority to favored individuals or companies, ostensibly to foster new industries. "At the Council of York, Charles was obliged to declare many of the industrial patents void; but enough remained to call forth an indignant declamation from Sir. J. Colepepper in the Long Parhament: 'I have but THE EVOLUTION. OF ECONOMIC SOCIETY 43 one Grievance more to offer unto you; but this one compriseth many; it is a nest of wasps, or swarm of vermin, which have overcrept the land, I mean the monopoler and polers of the people. These like the frogs of Egypt, have got possession of our dwellings, and we have scarce a room free from them ; they sip in our cup, they dip in our dish, they sit by our fire ; we find them in the dye- vat, wash-bowl, and powdery tub ; they share with the butler in his box, they have marked us and sealed us from head to foot. Mr. Speaker, they will not bate us a pin ; we may not buy our own cloaths without their brokage. These are the leeches that have sucked the com- monwealth so hard that it is almost become hectical. And some of these are ashamed of their right names; they have a vizard to hide the brand made by that good law in the last Parliament of King James ; they shelter themselves under the name of a corporation; they make bye-laws which serve their turns to squeeze us and to fill their purses ; unface these and they will prove as bad curs as any in the pack. These are not petty chapmen, but wholesale men.'" ^ A full account of this stage in English history would deal with (i) the regulation of labor, including the Statute of Artificers passed in the reign of Elizabeth, which provided that all able- bodied men might be compelled to serve as agricultural laborers, and that all artificers, rural or urban, should undergo an appren- ticeship of at least seven years. In this same reign provision was made for the assessment of wages by the Justices of the Peace. Every year in each locality the justices were to assemble, and, " calling to them such discreet and grave persons ... as they shall think meet, and conferring together respecting the plenty or scarcity of the time," they were to fix the wages for every kind of manual labor, skilled or unskilled, by the year, week, or day, and with or without allowance of food. A full account would deal also with : (2) the development of systematic poor relief by civil authority ; (3) the encouragement of shipping and of (4) the immigration of foreign artisans to introduce new in- dustries ; (5) the regulation of the corn trade ; (6) the establish- ing of plantations in the colonies ; (7) the regulation of the coin- age ; (8) the development of banking, insurance, and foreign commerce, and the decay of the old notions regarding the sinful- ness of interest taking. 1 Cunningham, English Commerce and IiuJiislry. Modern Times, Part i, pp. 307-308. 44 OUTLINES OF ECONOMICS V. The Industrial Stage In the latter part of the eighteenth century, the slow-going methods of the handicraft stage were radically changed by the Industrial Revolution. The fundamental feature of this change is the introduction of power manufacture. The industrial revo- lution and the chief features of the industrial stage will be dis- cussed in the following chapter. Before proceeding to the consideration of the last stage, it will be well to notice some of the other views which have been expressed concerning the periods of economic development. The German economist, Hildebrand, has taken as his principle of classification the method of exchanging goods, and from this standpoint he gets the following three stages : (i) barter, (2) money, and (3) credit. All three methods of exchanging, to be sure, are in use at the present time, but the extensive use of credit is the new and characteristic thing about present-day exchange. It has been objected that the period before the use of money became prominent is characterized not so much by the barter of goods as by the fact that exchange itself is unim- portant. Another writer (Biicher) has divided economic history accord- ing to the nature and size of the normal self-sufficing economic unit, as follows : (i) the independent domestic economy, (2) the town economy, (3) the national economy. In the first stage the interval between production and consumption is small. Things are produced where they are consumed, as in the village communities of the early middle ages. In the town economy the interval is somewhat greater. The artisans in the town produce for the consumption of other persons, for the most part in the immediate neighborhood, so that the producer meets the consumer without intermediaries. In the third stage, production is for a national market, so that goods may pass through many hands before reaching the consumer, and the system of cooperative division of labor embraces the whole nation. Possibly, according to this view, a fourth stage might be added, — that of a nascent world economy. THE EVOLUTION OF ECONOMIC SOCIETY 45 Again, we might pay attention chiefly to the condition of labor. Beginning with a condition where there is no distinct laboring class, we pass through slavery and serfdom to free labor, regulated at first by law and custom, then by individual contract, and finally in large measure by group contract or col- lective bargaining supplemented to an increasing extent by legal regulations of a new kind. THE ECONOMIC STAGES From the Standpoint OF Produc- tion From Bucher's Standpoint From Hildebrand's Standpoint From THE Labor Standpoint Illustrations FROM English History I. Direct Ap- propriation Independent Domestic Economy Barter Economy Laboring class not dif- ferentiated Prehistoric 2. Pastoral Before Christ 3- Agricultural Slavery and Serfdom nth- 1 4th Centuries 4- Handicraft Town Economy Money Economy Free Labor governed by Custom i3th-i8th Centuries 5- Industrial National Economy Credit Economy Individual Contract Group Contract 1 8th Century to the Pres- ent Time These various classifications are not contradictory ; on the contrary, they supplement each other. Still other divisions are possible. In the preceding table these various points of view are roughly correlated and applied to the history of England. These divisions of time are in no sense accurate, and are intended merely to be suggestive. 4.6 OUTLINES OF ECONOMICS QUESTIONS AND EXERCISES 1 . Write a description of the economic life of a tribe in one of the first two stages. 2. What is the diiierence between slavery and serfdom? 3. Give an account of the East India Company. 4. Sketch the development of the woolen industry in England to 1 760. 5. Give an account of the origin of the Bank of England. 6. Summarize the history of poor relief in England. 7. It has been held that because economic progress has been continuous, it is incorrect to divide it into "stages. " Discuss this view. REFERENCES Ashley, W. J. English Economic History, Vol. i; and The Economic Or- ganization of England, Chaps, i-v. BiJCHER, Karl. Industrial Evolution (trans, by S. M. Wickett). Cheyney, E. p. Industrial and Social History of England, Chaps, i to vii. Cunningham, William. Growth of English Industry and Commerce, Vol. i. (Middle Ages) and Vol. ii (Mercantile System). Ely, R. T. Evolution of Industrial Society, Part i, Chap. iii. Conner, E. C. K. Common Land and Inclosure. Hone, N. J. The Manor and Manorial Records. LiPSON, Ephraim. An Introduction to the Economic History of Englattd, Vol. i. Meredith, H. O. Outlines of the Economic History of England. Morgan, L. H. Ancient Society, Chap. i. Prothero, R. E. English Farming, Past and Present, Chaps, iii, iv,'vii, xi. Ratzel, Friedrich. History of Mankind (trans, by A. J. Butler), 3 vols. Salzmann, L. F. English Industries of the Middle Ages. ScHMOLLER, GusT.AV. The Mercantile System (Economic Classics, edited by W. J. Ashley). Seebohm, Frederic. The English Village Community. Stanley, H. M. In Darkest Africa, Vol. i, Chap, xxiii. Unwin, George. The Guilds and Companies of London. Vinogradoff, Paul. The Growth of the Manor. Wallace, A. R. Russia (edition of 1905), Chap. viii. 771.: CHAPTER IV THE EVOLUTION OF ECONOMIC SOCIETY {Continued) The Industrial Revolution. — The passage from the handi- craft to the industrial stage in England is generally known as the Industrial Revolution. It has been objected that this term is misleading because the introduction of the modern fac- tory system required many years and was but the working out of conditions that had been long maturing. It is true that the growth in the division of labor, the expansion of commerce, and the technical progress of f ermer ages were necessary preliminaries to the industrial revolution, but there is little danger of over- emphasizing the importance or the rapidity of the change. The period from 1770 to 1840, the span of a single life, is, after all, a short period from the standpoint of the historian. Yet the changes of this period swept away the inefficient methods that had been used for centuries, and caused profound modifi- cations in social structure. To understand the nature of this movement, we must review the condition of things before it began. England in 1760. — England was at this time largely self- sufficing in its economic life, producing for itself its food and other articles of ordinary consumption, although compared with medi- eval days there had been a marked expansion of international and colonial trade. Woolen goods were the most important ex- port. The imports consisted largely of wines, spirits, rice, sugar, coffee, oil, and furs, and some wool, hemp, silk, and linen yarn. Within the nation, too, there was not such a degree of specialization of industry in particular localities as is found at the present day, although the beginning of such localization had clearly been made in the textile and iron industries. On the whole, however, the commerce between the different sections 47 48 OUTLINES OF ECONOMICS of the country was slight. The means of transportation were exceedingly poor, notwithstanding the growth of turnpike roads. The roads were described by a traveler as " most execrably vile." Such was their condition that pack horses were still a common means of getting goods to market. Rivers were im- portant highways, canal building having barely begun. The system of hand manufacture was still in general opera- tion. Although the workmen under the domestic system were no longer owners of the material upon which they worked, yet the tools they used were their property. The beginnings of certain features of the factory system, however, are to be seen long before the use of power machinery, for in some cases work- men were employed in large numbers in buildings owned by the employer, who also furnished the mechanical equipment. But to a large extent manufacturing was combined with agri- culture, not only in the textile trad^, but in other branches also. " At West Bromwich, a chief center of the metal trade, agriculture was still carried on as a subsidiary pursuit by the metal workers." The medieval system of common field tillage was extensively used, a large part of the land being still uninclosed. The culti- vation was exceedingly poor, but important experiments tend- ing toward a '' new agriculture " were being made in the second quarter of the eighteenth century by Jethro Tull and " Turnip " Townshend. Of the whole number of farms, approximately one half " were owned and occupied by the various classes of freeholders and copyholders; that is, by land-owning farmers." The medieval notion of the relation of government to in- dustry was still nominally in force. Detailed and special legislation was supposed to be the means of securing a well- ordered trade, as explained in the preceding chapter. But a tremendous revolt had begun against this whole system. This revolt had its religious and political as well as its economic aspect. The same year that Thomas Jefferson wrote the Dec- laration of Independence, asserting that all men are by nature equal, Adam Smith published the Wealth of Nations, the most influential book ever written on economics. THE EVOLUTION OF ECONOMIC SOCIETY 49 "Every individual," said Smith, "is continually exerting himself to find out the most advantageous employment for whatever capital he can com- mand. It is his own advantage, indeed, and not that of the society, which he has in view. But the study of his own advantage, naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to society. . . . What is the species of domestic industry which his capital can employ, and of which the produce is likely to be of the greatest value, every individual, it is evident, can, in his local situation, judge much better than any statesman or lawgiver can for him." ^ The Mechanical Inventions. — During the last half of the eighteenth century the progress of invention was exceptionally rapid. Kay's flying shuttle (1738) had facilitated the weaving process to such an extent that it became difficult to secure enough yarn from the spinners. Hand spinning was improved by Hargreave's "jenny" about 1767; Arkwright, in 1771, made a practical success of roller spinning (a method patented long before) , using horse power, and later, water power. Cromp- ton combined these two processes in 1779. After 1785 steam power was applied to cotton spinning, and then it was the weav- ing process that was felt to be too slow. Cartwright began his experiments in 1784, but the power loom did not come into general use until early in the nineteenth century. The improvement in the steam engine also made possible great advances in the iron industry, of fundamental importance in an age of machinery. The production of English iron was over seventy -five times as great in 1840 as it had been in 1740. The need for better transportation was met by improved roads, by the building of canals (especially 1790 to 1805), and by the development of steam locomotion. The germ of the modern railway is seen in the tramways used in the coal mines. Cast iron rails were used as early as 1738. The first tramway to be used for public purposes was chartered in 1801, the cars to be drawn by horse power. Trevithick made a locomotive in '1803 that was of practical use. In 1814 Stephenson con- structed a locomotive that could draw a load of thirty tons at the rate of three miles an hour. The Stockton and Darlington road was opened in 1825 with a Stephenson locomotive that 1 A. Smith, Wealth of Nations, Book iv, Chap. ii. E 50 OUTLINES OF ECONOMICS made fifteen miles an hour, but two years later the directors of the road considered the advisability of abandoning the use of locomotives. In 1829 the directors of the Liverpool and Man- chester Railroad arranged a prize contest to determine the practicability of steam locomotion. The success of Stephenson's " Rocket " in meeting the requirements of the contest demon- strated that the new method of locomotion had come to stay. "A general survey of the growth of new industrial methods in the textile and iron industries marks out three periods of abnormal activity in the evolu- tion of modern industry. The first is 1 780-1 795, when the fruits of early inventions were ripened by the effective application of steam to the machine industries. The second is 1830 to 1845, when industry, reviving after the European strife, utilized more widely the new inventions, and expanded under the stimulus of steam locomotion. The third is 1856-1866 (circa), when the construction of machinery by machinery became the settled rule of industry." ^ Agricultural Changes. — During the Industrial Revolution there were also important changes in agriculture. Bakewell, in the second half of the eighteenth century, improved the breeds of sheep and cattle. The inclosing of the common fields pro- ceeded with great rapidity, not, as in the sixteenth century, for the purpose of sheep raising, but to permit of more efficient tillage of the soil. Between 1760 and 1850 over seven million acres were inclosed in England. The small land-owning farmer was crowded out, partly because more investment per acre was needed with the new agriculture, partly because " gentlemen farmers " (men who had made money in other pursuits and took up agriculture because it was fashionable) bought them out, and because the price of land was greatly increased by the desire of wealthy men to build up family estates. Today practically all English farmers are tenants. The small farmer, who under the domestic system was also frequently a handicraftsman, was thus crushed between the new agriculture and the new industry. "Hitherto the rude implements required for the cultivation of the soil, or the household utensils needed for the comfort of daily life, had been made at home. The farmer, his sons, and Iiis servants in the long winter evenings ' Hobson, Evolution of Modern Capitalism, cililion of 1907, p. 89. THE EVOLUTION OF ECONOMIC SOCIETY 51 carved the wooden spoons, the platters, and the beechen bowls, plaited wicker baskets, fitted handles to the tools, cut willow teeth for rakes and harrows and hardened them in the fire, fashioned ox yokes and forks, twisted willows into the traces of other harness gear. Traveling carpenters visited farm- houses at rare intervals to perform those parts of work which needed their professional skill. The women plaited the straw for the neck collars, stitched and stuffed sheepskin bags for the cart saddle, wove the straw and hempen stirrups and halters, peeled the rushes for and made the candles. The spinning wheel, the distaff, and the needle were never idle ; coarse hand-made cloth and linen supplied all wants ; every farmhouse had its brass brewery kettle. . . . All the domestic industries by which cultivators of the soil increased their incomes, or escaped the necessity of selling their produce, were now supplanted by manufactures." ^ Effects of the Industrial Revolution. — As has already been indicated, the Industrial Revolution introduces one of the great stages in the development of man's power over nature. But along with the new opportunities came also new dangers and perplexing problems. I. The Factory System. — The use of expensive machinery and steam power made it impossible for men to carry on their work in their own homes. The factory supplanted the home as the typical center of production. Instead of working by them- selves or with a few assistants, men now to a much greater extent than before had to congregate in cities, and submit to a new discipline in large groups organized for purposes of pro- duction. This brought with it a new division of society into classes. The machine and the workshop, as well as the raw material and the product, are at no stage in the productive process owned by the men who do the manual work. The masses become wage earners. Now, in some industries not one in a hundred can by exceptional ability become an independent employer, and the workman knows that he is a workman for life. So we have now two industrial classes, laborers and capitalists, with a great gulf between them which comparatively few men can cross, and with interests which often seem irrec- oncilable. What the ultimate effects of the new system of ' Prothero, quoted by Curtningham, Growth of English Industry and Commerce, Modern Times, Part ii, p. 722. 52 OUTLINES OF ECONOMICS production will be cannot be stated, but it has been suggested that these changes in external relations are affecting also men's habits of thought. Can we expect the institution of private property to seem as natural and sacred to those who have nothing to do with the buying and selling of products as to those who engage much in pecuniary transactions? It has been suggested that the feeling that we have a right to the product of our own labor is merely a survival of the era of small-scale hand manufacture. 2. The Expansion of Markets and Industrial Specialization. — Along with the new methods of production there has been a change from restricted local markets to national and even world markets. Improved methods of transportation make it possible for different branches of production to be localized in regions where there are special facilities for raw material or power. This implies greater economic interdependence and greater liability to trade fluctuations and disturbances. One great advantage of the old slow-going system of manufacture and trade was its regularity. As the area of the market increases, manufacturers find it more difficult to decide what and how much to produce. Trade fluctuations have increased in severity with the growth of large-scale production. This is due not merely to the chang- ing and enlarging demand which cannot be calculated, but also to the fact that manufacture itself is constantly being disturbed by improvements which cannot be foreseen. It is possible that a still larger scale of manufacture hereafter will bring steadi- ness in industry, but whatever the cause of these fluctuations, the effect upon the wage earner is demoralizing. If he were wise enough to save his earnings during good times, and so have something for hard times, he would not suffer so much. But very few people who live in abundance can do this ; how much less those whose condition even in good times is one of meager comfort ! Evils of the Transitional Period. — The condition of the English working classes in the latter part of the eighteenth and early nineteenth centuries was undoubtedly worse than in any other period in the history of the country. It is difficult to THE EVOLUTION OF ECONOMIC SOCIETY 53 say to what extent this was due to the introduction of the fac- tory system. In addition to the new methods of manufacture there were wars, peculiar conditions in land ownership, duties, and taxes. There is some evidence that the condition of child workers under the domestic system was often worse than in the factories, their parents proving the hardest taskmasters. "The evils and horrors of the industrial revolution are often vaguely- ascribed to the ' transition stage ' brought about by the development of ma- chinery and the consequent 'upheaval.' But the more we look into the matter, the more convinced we become that the factory system and machin- ery merely took what they found, and that the lines on which the industrial revolution actually worked itself out cannot be explained by the progress of material civiKzation alone ; rather, the disregard of child-life, the greed of child-labour, and the maladministration of the poor law had, during the eighteenth century, and probably much farther back still, been preparing the human material that was to be so mercilessly exploited." ^ But whatever the causes, the facts that have been revealed re- garding the conditions in English mines and factories of this period are amazing. The picture includes cruelty to appren- tice children, excessive hours, and unhealthful conditions of work. The evils were worst in the smaller factories, the owners of which were hard pressed by relentless competition. Outside of the factories, also, those who attempted to continue to work in their homes in the old way suffered from irregular employment and low earnings. The distress of the hand-loom weavers affords an illustration. Competition and Laissez-faire. -;— We have seen that Adam Smith advocated liberty. He asserted that every man, if allowed to do as he pleased, would sooner or later do that for which he was best fitted, and would consequently work where he could get the most wages. Every man would buy what suited him best, and, after some experiments, manufacturers would make what was called for. If one line of work was more profitable than another, more men would go into it and by their competition would bring prices down. If men cheated their customers, the customers would go elsewhere, and cheating * Hutchins and Harrison, A History of Factory Legislation, p. 13. J 54 OUTLINES OF ECONOMICS would not pay. Everywhere men would look out for their own interests and would make the bargain that was most ad- vantageous to themselves. This system of balanced self- interests resulting from competition was the best regulator possible, infinitely better, he claimed, than the old-time laws, which only incumbered the development of industry. If the policy of industrial freedom were adopted, there would be, he prophesied, a great increase in the production of wealth. This view gained favor during the Industrial Revolution. Not that a wholesale repeal of the old laws occurred — such things never happen in England, and are difficult anywhere — but there is a quiet and effective way of changing laws by changing men's ideas regarding them and leaving them unenforced. A law that has been long observed has often to be long dead before people gain the courage to repeal it. So the law requiring seven years' apprenticeship before one could enter certain trades quietly died during the eighteenth century, and when, finally, in the labor troubles early in the nineteenth century some workmen discovered the old law and prosecuted employers for violating it, it was first suspended and then repealed, as being plainly ill adapted to the new condition of industry. So, little by little, the old laws were repealed or forgotten, and men were left free to bargain and manufacture as they pleased. This policy of laissez-faire, or letting things drift, was very generally accepted by the economic writers who followed Adam Smith, and was clearly reflected in the parliamentary debates. The universal free play of -competition came to be the pre- vailing ideal in this first phase of the industrial stage. It was in keeping with this spirit that England became a free-trade nation in this period, the last step being taken when the " corn laws " were repealed in 1846, the act going into effect in 1849. The Reaction against the Passive Policy. — It may be said that by 1850 the abandonment of mercantilistic ideas was com- plete in England, but long before this date a new system of legislation for the purpose of controlling industry had been begun. The government could not ignore the actual condi- tions that resulted from competition and the introduction of THE EVOLUTION OF ECONOMIC SOCIETY 55 machinery. We have now to consider some of the main lines of development of this modern industrial regulation. 1. The Quality of Goods. — In repealing the laws for the in- spection of wares it was urged that cheating would not pay and would cure itself. Indeed, it was said that the very in- spection of wares by the government was the cause of fraud ; for, the government brand being often put on carelessly, men bought poor goods, because of the brand, which they would have rejected if they had examined them. The abolition of the laws would result in each examining goods for himself, it was asserted. It is hardly necessary to say that these hopes were not realized. Men might be trusted to attend to their own interests if they knew enough to do so, but they do not. Who can tell the quality of baking powder, or ground spices, or patent medicines, or many other things that are misrepresented when offered for sale? For these the ordinary buyer's knowl- edge is worthless ; an expert must be employed. Such has bepn the experience of the English people and also, more re- cently, of the people of the United States, and the law now pro- vides for the inspection by government experts of many articles of food. The notion that men will always ruin their business prospects if they cheat, and so will be deterred from cheating, has been utterly exploded by this English experiment. The rep- utation for honesty is undoubtedly a source of strength to many business houses; but many a man has perpetrated an audacious fraud upon a country for a few years and retired with a fortune when his cheating began to be known. The inspection of goods by the State is a principle now fully rec- ognized, the only question being how far it should be applied. 2. The Protection of Labor. — As a result of a series of epi- demics of infectious fevers, public attention was called to the condition of the apprenticed children in cotton factories. In 1796 the Manchester Board of Health reported upon the un- healthful conditions under which the children worked, pointing out that " the untimely labour of the night, and the protracted labour of the day, with respect to children, not only tends to diminish future expectations as to the general sum of life and 56 OUTLINES OF ECONOMICS industry by impairing the strength and destroying the vital stamina of the rising generation, but it too often gives encourage- ment to idleness, extravagance, and profligacy in the parents, who, contrary to the order of nature, subsist by the oppression of their offspring." In 1802 the first factory act was passed to protect the health and morals of pauper children in cotton factories. The apprentices were not to work more than twelve hours by day, and after 1804 not at all by night, but the law was not effectively administered. After much agitation, in which Robert Owen took a prominent part, a second step was taken in 181 9. The act prohibited children under nine years from working in cotton mills, and no person under sixteen was to be employed more than twelve hours per day. As with the act of 1802, the enforcement of the law was left to the justices of the peace. In 1833 regulations as to conditions of work for children and young persons were made for all textile factories, and special inspectors were provided to enforce the law. In the following years the controversy concerning labor legislation was violent and bitter. After a report by a committee revealing shameful conditions in the mines, an act was passed in 1842 prohibiting the employment of women and children under- ground. In 1844 women were included in the protective fac- tory legislation and the half-time system for children was enacted. The Ten Hours' Act of 1847 limited the working day to ten hours. Subsequently protective legislation was made to cover industrial establishments generally. These various laws were consolidated in 1878, and again in 1901. Another important line of legislation that has been made necessary by the extensive use of machinery deals with the liability of employers in cases of accidents to their workmen. Under the common law a workman was entitled to receive dam- ages when injured as a result of the negligence of his employers, but he was supposed to assume the ordinary risks of the busi- ness. When the injury was caused by the workman's own negli- gence or by the negligence of a fellow-workman the employer was not responsible. The Employers' Liability Act of 1880 gave the workman the right to compensation in certain cases THE EVOLUTION OF ECONOMIC SOCIETY 57 where the injury was caused by the negligence of other em- ployees, and in 1897, by the Workmen's Com'pensation Act, a radical departure was made from previous legislation. The employer is now liable to pay damages even when there has been no negligence on his own part, and even when the accident has been due to the neglect of the injured workman himself, except only in cases of " serious and willful misconduct." This principle now applies also to agriculture, shipping, and mer- cantile and domestic employments, and certain trade diseases have been made to count as accidents. The transition from "employers' liability" to "workmen's compensation" was thus a change in more than mere name. The law of employers' liability aimed merely at doing justice as between the workman and his employer. Workmen's compensation statutes are based upon a broader social principle, involving the recognition of the facts that industrial accidents are part of the price that has to be paid for the use of modern methods of production; that the worker and his family are ill-equipped to bear the burden of the loss of earning-power that results from such accidents ; and that the duty of making adequate compensation falls upon society at large, which may very properly use the employer as its responsible agent for this purpose. A newer and larger development of the principle of compensa- tion is found in social insurance, which recognizes and extends the principle of social responsibility, but combines with it an insistence upon the equal importance of the development of habits of individual thrift and self-help. The National In- surance Act of 191 1 provided for compulsory insurance against sickness, and (in certain industries) against unemployment. 3. Labor Organizations. — Modifications in the working of free competition have also been effected by the voluntary organiza- tions of the workers, not only by their influence upon legislation, but also by direct dealings with employers. We have noticed the gilds, which played a large part in the history of the Middle Ages. These, however, were not like modern trades unions. They were unions of men who worked, but not exclusively of wage earners, nor even chiefly in the interests of wage earners. 58 OUTLINES OF ECONOMICS They were formed of masters. But combinations of the wage- earning classes are found long before the Industrial Revolution. They do not become prominent, however, until the nineteenth' century. Laws prohibiting the combination of laborers had been passed at intervals since the Middle Ages, and in 1800 Parliament, finding that unions were increasing, passed a most comprehensive law to suppress them, declaring illegal " all agreements between journeymen and workmen for obtaining advances of wages, reductions of hours of labor, or any other changes in the conditions of work." Under this law many workmen were prosecuted and severely punished, but in vain. In 1824 Parliament confessed the law a mistake, and repealed it along with previous laws relating to combinations of work- men. Trades unions, thus tolerated, grew at an astonishing rate, but they were still subject to legal persecution. Judicial decisions, especially, were adverse to them, as the courts re- garded them as agreements in restraint of trade. But in 1871 a law was passed which declared that the purposes and actions of trades unions were not to be deemed unlawful as being in the restraint of trade, and in 1875 the legality of trades unions was still further recognized by the provision that acts which were not punishable as crimes when done by one person should not be indictable as conspiracy when done by two or more in further- ance of trade disputes, and finally, in igo6, the courts were forbidden to entertain actions for damages against trades unions. In this same year peaceful picketing was legalized. 4. The Extension of Government Enterprise. — The reaction against a laissez-faire policy is further shown by a growth in the sphere of industry directly managed by the government. We find municipalities operating street railways and furnishing water, gas, and electric light. Municipal enterprise includes also in various places markets, docks, dwellings, baths, race courses, oyster fisheries, slaughterhouses, milk depots, employ- ment bureaus, sewage farms, theaters, and many other lines of activity. The national government conducts the postal sav- ings banks, the parcels post, and the telegraph and telephone systems. THE EVOLUTION OF ECONOMIC SOCIETY 59 Summary. — In this chapter a brief sketch has been given of England's attempt to deal with a new set of forces. An im- mense increase in production has taken place, due in part to competition, more to machinery. But the distribution of this wealth, growing directly out of the principles of competition so long as they were unrestrictedly applied, was such that poverty grew rapidly, and some said even faster than wealth, and the laboring population of the realm sank into deeper distress and degradation. The partial benevolence of employers, which would fain have mitigated this disaster, was, as a rule, neither welcome nor tolerated by the competition which had made itself law. Not until this benevolence was formulated, generalized, and enforced by disinterested legislation was the horror of the sit,uation diminished. When we hear the principle of " a fair field and no favor " and " no State intervention " advocated by a man strong in the consciousness of personal advantages, we must remember that he is a century behind his time, and that he has not read or has not profited by one of the most dolorous chapters in human history. The English nation, after a trial of free competition and no interference, as thorough as could well be made, has undeniably returned to the principle of govern- mental activity which she had abandoned, — a principle which recognizes as the function of the State the protection of the citizens, and the furtherance of their material and social well- being, by every law and every activity which offers a reasonable guarantee of contributing to that end. It is to be noticed fur- thermore that, as a matter of fact all this activity of the State contributing to material and social well-being has also increased freedom as a positive, constructive force. It has promoted the growth of individual powers and enlarged the scope of activity of the average citizen. It has not tended to slavery, as Herbert Spencer long ago maintained, but its tendency has been in the direction of the sort of liberty that is really worth while ; namely, liberty as a power of development and of contributing (in the words of the philosopher T. H. Green) to the " common good." The older legislation restricted the individual ; the newer legis- lation enlarges and equalizes opportunities. 6o OUTLINES OF ECONOMICS QUESTIONS AND EXERCISES 1. What is the origin of the term "laissez-faire"? 2. What laws are in force in your state regarding the inspection of food and other articles offered for sale? 3. Give a detailed account of the development of one of the great inven- tions. 4. Give a sketch of the enactment and repeal of the "corn laws." 5. Give an account of the development of monopolies and trusts in England. REFERENCES Ashley, W. J. Economic Organization of England, Chaps, vii and viii. Beard, C. A. The Industrial Revolution. Cheyney, E. p. Industrial and Social History of England, Chaps, viii and ix. Cunningham, William. Growth of English Industry and Coinmerce, Mod- ern Times, Part ii, Laissez-Faire. Day, Clive. History of Commerce, Part iii. HoBSON, J. A. Evolution of Modern Capitalism, Chaps, iii and iv. HuTCHiNs, B. L., and Harrison, A. A History of Factory Legislation, Chap. ii. Perris, G. H. The Industrial History of Modern England. Slater, Gilbert. The Making of Modern England; The English Peasantry and the Enclosure of Common Fields. Toynbee, Arnold. The Industrial Revolution. Veblen, Thorstein. The Instinct of Workmanship, Chaps, vi and vii. Warner, G. T. Landmarks in English Industrial History. CHAPTER V THE ECONOMIC DEVELOPMENT OF THE UNITED STATES Economic Stages in American Industrial History. — The transit of civilization from Europe to America, as an American historian ^ has finely phrased it, thrust the European laws, customs, and industrial technique of the seventeenth century into the primitive environment of a wilderness, and for the moment the wilderness dominated. Industry was forced to begin at the beginning and retrace — as the child is said to retrace the mental development of mankind — the industrial evolution of the race. The American people have thus, during the comparatively brief historical period which has elapsed since the settlement of this country, run the whole gamut of industrial evolution, passing with striking rapidity through all the stages differen- tiated in the preceding chapters. There was slaughter of cap- tives in the Indian wars, enslavement of Indians, particularly — but not only — in the Spanish colonies, later the introduction of negro slavery and modified serfdom in the indentured servants, then the individual wage contract, still supreme among agri- cultural laborers, and finally, collective bargaining through the great trades unions of the present. In a similar way, practically all the stages differentiated in the table given on page 45 may be traced in the industrial evolution of the United States. Naturally it is not to be supposed that American industrial society worked its own way unaided through all those economic stages which the race, with " painful steps and slow," has labori- ously traversed in its upward march. Stimulated by European • Edward Eggleston, Transit of CiviUzalion. 6i 62 OUTLINES OF ECONOMICS culture, we hurried through the earher stages, for the most part, retracing them merely as an incident of frontier conditions, and skipping some — such as the pastoral stage — in many sections of the country. On the other hand, it must not be inferred that we have everywhere passed beyond the so-called primitive stages. Barter may still be found in some parts of the country, and there are comparatively few rural districts in which credit transactions have in the main taken the pilace of money transactions. It is interesting to observe that, owing to the progressive western movement of the population of the country, the stages in the history of man's productive efforts appeared in regular order from west to east. Thus, a few years ago, the country of the frontier was occupied by hunters and trappers; next were great stretches of country almost entirely devoted to grazing; farther east, agriculture pre- dominated ; trade and commerce were active, especially in the country east of the Mississippi ; manufacture on a large scale was prominent in the North Atlantic and North Central groups of states ; while finally the large industrial combinations which mark the latest step in development were confined (with respect to legal residence at least) to the Atlantic seaboard. " The United States lies like a huge page in the history of society."^ Sectionalism. — This phenomenon of the contemporaneous existence of several industrial stages, side by side, under the same government, has laid upon this country some of the hardest problems which it has had to solve. The ever present but ever receding frontier has continually created a set of interests antagonistic to those of the settled industrial and commercial communities. Shays's RebeUion in 1786 was in part a protest of the more thinly settled debtor communities against the deter- mination of the commercial centers to introduce the sound currency which a developed commerce requires. The federal Constitution was adopted and the present government created in order, largely, to strengthen national credit, insure taxation, remove trade barriers, and provide a sound currency ; and the opposition to the ratification of the Constitution came largely 1 F. J. Turner, The Significance of the Frontier in American History. ECONOMIC DEVELOPMENT OF THE UNITED STATES 63 from those agricultural and thinly settled communities that wanted to keep paper money, evade debt payment, and resist the collection of taxes. During the earlier history of the coun- try wildcat banking and inflated currency regularly followed in the wake of the frontier. Tariff legislation, with its different appeal to the agricultural and industrial sections of the country, has been another prolific source of territorial conflict. After the War of 181 2, the manu- facturing centers of the North redoubled their efforts for pro- tection. This was strenuously resisted by the South, where manufactures had practically gained no hold, and the struggle of the sections over the tariff led to Nullification in South Caro- lina and the acceptance by the South of the doctrine of secession. The Civil War itself was largely a sectional quarrel growing out of ceaseless friction between a section which had reached the industrial stage and a condition of free-wage contract with a section which had been held in the agricultural stage by the retention of slavery. As a more recent illustration of sectional conflict arising from the natural clash of districts in different stages of economic development, we have the free-silver cam- paign of 1896, when the mining, agricultural, and debtor com- munities of the West and South arrayed themselves against the industrial and creditor communities of the East and North. The typical political struggles of the past have been territorial, and sectional problems will always remain. Now that the frontier has disappeared, however, the typical political struggles of the future will take the form, probably, of class against class. Characteristics of the American People. — Although the frontier has disappeared, the pioneer work of " winning a con- tinent from nature and subduing it to the uses of man " has left an indelible impress upon the American character. In the beginning the dangers and hardships of the frontier acted as a powerful selective force in determining the character of our earlier immigrants, giving us an unusually restless, mobile, and enterprising people. The process of settlement which followed merely emphasized these qualities and added others of a kindred nature. The primitive settler, following the trapper and the > 64 OUTLINES OF ECONOMICS trader into the wilderness, was forced to depend upon himself for protection and subsistence ; he expected little aid from the government, was unused to the restraints of law, and a little contemptuous of its possibilities, either for good or for evil. The process of settlement, then, merely confirmed the American in that excessive individualism which has made him independent and resourceful, to be sure, but partial to the spoils system, tolerant of lynch law and labor violence, indifferent to waste and weakness in the administration of his government. At the same time the great natural wealth of our land and the ease with which it could be secured from the government have taught our people, particularly in the West, to regard nature rather than thrift as the source of wealth, to exploit rather than create, to work and study as we farm, — extensively. As a people, we are optimistic but careless, generous but wasteful, buoyant but boastful. Industrially, we have risen to our ex- ceptional opportunities with spirit, playing the commercial game at times with excessive energy and devotion ; but we have come to emphasize quantity rather than quality, product rather than finish. We " lead the world " in the use of labor-saving machinery, but depend largely upon Europe for our skilled artisans. Growth of Population. — The mere growth of the American people has been as striking as it is familiar. In 1640 there were about 25,000 persons, excluding Indians, in British North America ; about 260,000 at the end of the seventeenth century according to Bancroft; according to the same authority the miUion mark was reached in 1743 ; and in 1790 the first federal census showed a population of 3,930,000 in the United States alone. In the next hundred years the population doubled every twenty-five years on an average, and although the rate of in- crease has fallen off somewhat since the Civil War, we are still growing at a remarkable pace, the population of continental United States being 91,970,000 in 1910. Despite this enormous increase, the population of this coun- try has not multiplied more rapidly than the means of subsistence. This does not mean that every one receives enough to live in ECONOMIC DEVELOPMENT OF THE UNITED STATES 65 comfort. On the contrary, great masses of people live in poverty. Neither does it mean that society as a whole produces enough to support every one in comfort, if the wealth produced were equitably or evenly divided. On the latter point there is deep difference of opinion. But with respect to the movement over long periods, say during the preceding century, there can be no doubt that wages and real income have risen, not without interruption, but with comparative steadiness. The dismal predictions of overpopulation which were so common in the first half of the nineteenth century have been signally discredited a.s practical propositions applicable to the American people of this epoch. The exploitation of national wealth, the improvement of business organization, and the inven- tion of labor-saving machinery have more than kept pace with the population ; and it appears that over long periods prosperity and high wages tend to depress rather than to raise the birth rate, even of the wage-earning population. We are in no danger of a " devastating torrent of children." On the contrary, the real problem of the twentieth century, or at least the problem that has evoked the greatest discussion, is found in the steady decline of the birth rate. According to some eminent authorities, the race is dying at the top, the ablest and most successful people have the smallest families ; and this constant sterilization of the ablest stock is, in the opinion of such authorities, second in importance to no problem which Western civilization is called upon to solve. It is not that we want more people. Population is still increasing with sufficient rapidity. The problem lies in the apparent failure of the most efl&cient individuals to multiply as rapidly as certain classes of the less efficient. Other authorities, it should be added, maintain that this " race suicide " has been going on for cen- turies, that it has not in the past, and will not in the future, lower the vitality or general efficiency of the race. Such writers view with complacency the ceaseless sterilization of the upper classes, maintaining that the process stimulates the ambition of the abler members of the lower classes by creating room at the top, and that so long as the habits and ideals of the upper classes F 66 OUTLINES OF ECONOMICS remain wholesome, there is no cause for regret that the individ- uals who compose these classes are not self-perpetuating. Social heredity, not personal heredity, the preservation of sound morals, wholesome customs, and habits of social helpfulness, together with the opening up of new opportunities, are accord- ing to these writers the important factors. Second only in importance to " race suicide," and intimately connected with it, is the problem created by the rush to the city. In 1790 about 33 Americans in every thousand lived in a city of 8000 inhabitants or more, in igio approximately 390 in every thousand lived in a city of this size. The mere facts in this connection are familiar to every one and need no elaboration. Their importance lies in the fact that the rush to the city is apparently universal, that it has been going on for centuries, and that it indefinitely complicates and aggravates the social, industrial, and political problems of our time. " Race suicide," for example, is more attributable to social conditions created by city life than to any physical incapacity of the women of this generation to bear children ; the evils commonly charged to the factory system are due as much to city crowding as to the factory system itself; and, speaking generally, whatever plan of reform for existing evils we devise or champion, we must reckon with this deep-rooted and persistent force which draws to the city so much of the best talent and ability which the rural districts produce. Slavery and the Negro Problem. — From the earliest period of settlement, one of our fundamental industrial problems has been to get enough labor to exploit the great national wealth of the country. The first solution attempted was by importing bondsmen or indentured servants. " Nearly all the immigrants that came (to Virginia) between 1620 and 1650 were bondsmen," and in 1680 an English official estimated that about 10,000 persons were kidnaped or " spirited away " to America every year. This class of indentured servants consisted of runaway apprentices, penniless debtors, kidnaped children, honest laborers, vagrants, and criminals of all kinds. They were some- times subject to the most inhuman treatment, but, because ECONOMIC DEVELOPMENT OF THE UNITED STATES 67 they had white skins, soon melted into the free population and never created a race problem. The first negro slave landed in Virginia in 1619. For about thirty years they did not increase very rapidly, but after that, and until the close of the eighteenth century, they multiplied with greater rapidity than the white population. In 1790 there were 750,000 negroes or persons of negro descent in this country, constituting 19 per cent of the population. Since 1790 the negro population has steadily declined in relative importance, and in 19 10, numbering 9,830,000 in all, it constituted only 11 per cent of the general population. The relative decline of the negro population is probably not due to white immigration, since the natural growth of the white population is markedly greater than that of the negroes in the South, where white immigration has been unimportant. The whites have increased faster than the negroes even in those countries in which the negroes greatly outnumber the whites.^ The negro problem to-day, so far as it is an economic problem, arises largely from the ignorance and economic weakness of the negroes and the exploitation to which their ignorance and weakness subject them ; from their concentration in certain narrow districts of the South, known as black belts; their dependence upon credit advances ; their inability readily to take up diversified farming and, outside of the farming dis- tricts, from the social pressure which confines them to a relatively few occupations, most of which — particularly as they practice them — are neither uplifting nor developmental. In 1900, for instance, 63 per cent of the male and 90 per cent of the female negro breadwinners were employed in unskilled trades. This condition of affairs is due in some degree to the economic inertia and shiftlessness of the negroes themselves. Con- sidering the circumstances attendant upon their introduc^tion into this country, it would be surprising if they were not economically backward. But present conditions are also due 1 The greater increase of the whites "holds generally, though not universally, good in even the most overwhelmingly black of the black counties of the black belt." — John C. Rose, in American Economic Review, vol. iv, p. 292. 68 OUTLINES OF ECONOMICS in part to race prejudice of their white brethren. There is a strong movement in the South today for enforced segregation of negroes, both in urban and rural communities ; and the trade unions evince a growing disinclination to receive negroes as members on the same status as white workmen. Vigorous efforts, however, are now being made in the South to provide industrial training of a systematic kind for the negroes ; and despite the asserted facts that " only 37 per cent of the negro school population of the South is in school attend- ance," that " in the rural South today not one black child in four is in school," and that " the public school system for negroes in the rural South is worse today than it was twenty years ago, with a smaller percentage of enrollment and smaller proportion of teachers," ^ the economic status of the negro in recent years, particularly that of the negro farmer, shows steady improvement. But yesterday a slave, it is inevitable that the negro should be forced to traverse in the forward path the intermediate steps of serfdom, peonage, and tenancy before becoming farm operative and owner. No class can be trans- formed in a day by legislative enactment from the status of slavery to that of free contract. In the South during the last census decade the number of negro farmers increased more rapidly than the number of white farmers ; the acreage of land operated by white farmers decreased while that operated by negro farmers increased 10 per cent ; the value of farm land and buildings owned by whites increased 117 per cent, but the value of farm land and buildings owned by negroes increased 156 per cent ; while the number of negro farm owners increased 17 per cent as contrasted with an increase of 12 per cent in the white owners of farms. The negro has been barred from the cotton mill. If the negro farmer can learn to raise some- thing other than cotton and raise it on something other than credit, he will probably have little cause to regret his exclusion from the cotton mill. Immigration. — Next in importance to the negro question is 1 W. E. B. Du Bois, Quarterly Publications of the American Statistical Association, vol. xiii, p. 83. ECONOMIC DEVELOPMENT OF THE UNITED STATES 69 the problem of immigration. We have always had an immigra- tion problem. " Governor Thomas Dongan, in 1685, made a report to the King of England full of dreadful forebodings as to the future of the ' Royal Province ' of New England unless the tendency to overcrowding were promptly checked. . . . George Washington and Thomas Jefferson are both recorded as opponents of an unrestricted policy of immigration, and it may be safely asserted that no considerable period has elapsed since their day without producing eloquent and forceful advo- cates of a rigid restrictive immigration policy." ^ Owing, how- ever, to the extraordinary increase of immigrants in recent years (the number rose from 3,840,000 in the decade ending in 1900 to 8,796,000 in the decade ending in 1910) unusual interest in the subject has been aroused, the restrictive features of our law have been repeatedly strengthened, and on three occasions bills aiming to restrict the general volume of immigration by literacy tests have passed Congress only to be vetoed by the President. Most of the alarm which has recently been expressed, however, is due to the change in character, rather than the increase in volume, of our immigration. Instructive statistics bearing upon this point are given in Table I. Until nearly the last decade of the nineteenth century most of the immigrants came from the United Kingdom, Germany, and northwestern Europe, while since that time the arrivals have been largely from south- ern Europe ; and it appears that the new immigrants are more illiterate, much less likely to bring over their families and to remain permanently in this country, display less interest in taking out naturalization papers, and show a larger proportion of unskilled, as well as a smaller proportion of skilled laborers, than the earlier immigrants. " These people," it has been said, " have no history behind them which is of a nature to give en- couragement. They have none of the inherited instincts and tendencies which made it comparatively easy to deal with the immigration of the earlier time. They are beaten men from beaten races, representing the worst failures in the struggle 1 Commissioner of Immigration, Robert Watchom, in The Outlook, vol. kxrsdi, p. 900. 70 OUTLINES OF ECONOMICS TABLE I Total Number of Immigrants (in Thousands) and Proportion coming FROM Designated Countries by Specified Periods: 1821-1910 ^ 1821 1851 I86I 1871 1881 I89I 1901 1850 i860 1870 1880 1890 1900 1910 Total Number 2456 2598 2315 2812 5247 3844 879s Per cent Germany 24.2 36.6 34-0 25.6 27.7 I4.I 3-9 Great Britain 15.0 16.3 26.2 19-5 15-4 8.9 6.0 Ireland . . 42.3 35-2 18.8 I5-S 12.S 10.5 3-8 Norway, Sweden, and Denmark 0.7 0.9 S-4 8.6 12.5 9.9 S-7 Total 82.2 89.0 84.4 69.2 68.1 43-4 19.4 Austria Hungary 0.4 2.6 6.7 15-5 24.4 Italy 0.2 0-3 0.1 0-5 0.2 2.0 5-Q 17. 1 iS-4 23-3 18.2 Russia and Poland .... 0.1 1.8 Total 0-3 0.4 I.I 6.4 17.6 48.0 65-9 All other Countries . . . 17-5 10.6 14-5 24.4 14-3 8.6 14.7 Grand Total lOO.O lOO.O 1 00.0 1 00.0 lOO.O 100. lOO.O for existence. Centuries are against them, as centuries were on the side of those who formerly came to us." ^ There can be no doubt about the real gravity of the problem. In times past charitable associations, and even certain foreign governments, " assisted " the poorest and neediest of their 1 Data from Adams and Sumner, Labor Problems, p. 73, and the Slaiistical Abstract, igi3, p. 94. These figures are not exact and not altogether comparable, owing to changes in the immigration year, the distinction of nationalities, and the immigration laws. For the eSect of these changes, see Boeckh, " The Determina- tion of Racial Stock among American Immigrants," Publications of the American Statistical Association, December, igo6; and Willcox, National Civic Federation Review, November, December, 1906, p. 7. In the year ended June 30, 1914, the number of immigrants (1,220,000) was larger than in any previous year except 1907, and Austria-Hungary, Italy, and Russia contributed 67 per cent of the total. 2 Walker, "Restriction of Immigration," Discussions in Economics and Statistics, vol. ii, p. 447. ECONOMIC DEVELOPMENT OF THE UNITED STATES 7 1 TABLE II Proportion of European Immigrants 14 Years of Age or Over Who CAN neither Read nor Write: i 899-1 909 ^ (Average proportion for all races, 26.6 per cent.) Under 15 Per Cent Over is Per Cent Race Per Cent Illiterate Race Per Cent Illiterate Bohemian and Moravian Dutch and Flemish . . English Finnish French German Irish Italian, North .... Magyar Scandinavian .... Scotch Spanish Welsh Not specified .... 1-7 4-7 I.I 1.4 S-4 S-i 2.7 11.8 11.4 0.4 0.7 14.6 2.0 6.7 Armenian Bulgarian, Servian, and Montenegrin .... Croatian and Slovenian . Dalmatian, Bosnian, and Herzegovinian . . . Greek Hebrew Itahan, South .... Lithuanian Polish Portuguese Rumanian Russian Ruthenian Slovak Syrian . Turkish 24.1 41.8 36.4 36-4 27.0 25-7 54.2 48.8 35-4 68.2 34-7 38.5 51.0 22.1 54-1 58.9 citizens to migrate to this country; famine and revolution in Europe spurred the impecunious and the radical to take refuge among us; regularly, also, the tide of immigration has ebbed and risen in close correspondence with the business prosperity of this country, artificially swelling our laboring population in times of industrial activity, encouraging our industrial managers in their spasmodic, jerky methods of production, and thus augmenting the severity of our alternating periods of industrial depression. Moreover, in certain industries the immigrant with his relatively low standard of living has driven out the native workman ; and most of the immigrants have shown an unfortunate tendency to linger in the cities of the eastern sea- 1 Data from Jcnks and Lauck, The Immigration Problem, 3d ed., p. 35. 72 OUTLINES OF ECONOMICS board, swarming in the slums and intensifying all those social evils which have their origin in urban congestion. The problem is chiefly economic, and the social or moral delinquencies of the newer immigrants have been greatly exag- gerated. Thus, the new immigrants are far less given to alco- holic excesses than the old. But the investigations of the United States Immigration Commission, to quote from its report, " show an oversupply of unskilled labor in the industries of the country as a whole," and the Commission recommends that " a sufficient number be debarred to produce a marked effect upon the present supply of unskilled labor." " As far as possible," the report continues, " the aliens excluded should be those who come to this country with no. intention to become American citizens or even to maintain a permanent residence here. ..." A majority of the Commission recommended the literacy test as the " most feasible single method " of properly restricting immigration ; realizing that it would cause occa- sional hardship — as any standard must — and that not all literate immigrants are desirable, and not all illiterate immi- grants undesirable ; but favoring it because it offers a practicable and simple means by which to reduce numbers without impairing quality or discriminating against particular nationalities. Not in individual cases, but in the net result, the literacy test would debar those classes which exploit America rather than strengthen it, and fail to rise to its real opportunities and responsibilities. Back of the demand for restriction is not the " American " snob, but the trade union. In the light of history, on the other hand, the immigration problem is far less alarming than it is in the dry light of recent statistics. In the first place, the statistics themselves, as ordi- narily published, are misleading, because they take no account of the large number of immigrants who return to Europe. The most recent census statistics (1910) indicate that about " two fifths oi the immigrants who arrived in the United States during the decade 1900-1910 either left the United States or died before the end of the decade." In the second place, the importance of the number of immigrants depends largely upon its relation ECONOMIC DEVELOPMENT OF THE UNITED STATES 73 to the population of the country ; and relatively to the popula- tion immigration seems to be declining rather than increasing. For instance, the proportion of foreign born in the population has varied very little since i860; and immigration reckoned in proportion to the population was heavier in the period 1850- 1855 than in the period 1900-1905. In the next place, it is to be noted that our immigration laws regarding the exclusion of diseased, criminal, immoral, feeble-minded, and indigent persons are constantly becoming stricter and their administration more efficient. In addition to the plainly undesirable classes just noted, Chinese laborers have been excluded since 1882, aliens under contract to take up particular work since 1885, and an- archists since 1903. Finally, and most important, perhaps, agencies for educating, distributing, and Americanizing the immigrants have multiplied with great rapidity in recent years. Social settlements, vocational and night schools have under- taken the work of educating the immigrant ; many important labor unions have learned to organize the immigrants, and so make of them allies and not enemies in the task of maintaining and improving conditions of employment ; federal and state bureaus of information assist in the proper distribution of the immigrants, and public employment bureaus in finding work for them ; while a group of powerful and philanthropic immi- grant aid societies like the Italian Immigrant Bureau and the Hebrew Sheltering and Immigrant Aid Society "^ do effective work in Americanizing the immigrant, finding employment for him at good wages, overcoming tendencies toward congestion, effecting distribution, and promoting acquisition of American standards of living and thinking." ^ Surveying the whole history of immigration, three general conclusions may be drawn which must be fully considered by those engaged in the solution of the present problem. I. We have, as a people, shown a marvelous ability to assimi- late rapidly people of diverse races, tongues, and religions, amal- gamate them and stamp them with the characteristic qualities of the American. Even at the close of the eighteenth century, ' Max J. Kohler, American Economic Review, vol. iv, p. 107. 74 OUTLINES OF ECONOMICS about one fifth of the population spoke some other language than English as their mother tongue, and probably one half of the population were of other than Anglo-Saxon blood. The heterogeneous character of the population is illustrated by the fact that nine of the men most prominent in the early history of New York represented as many different nationalities. 2. We have failed, however, to amalgamate the Negro and the Chinese ; the incidental feature of a dark skin creates espe- cially difficult problems ; and it is this fact which makes it undesirable that Japanese, Chinese, or Hindu laborers should settle here in large numbers, particularly in separate " colonies." Despite the high qualities of some of these peoples, it is con- ceivable that they might come to this country in sufficient numbers to create a problem similar in character and gravity to the negro problem ; and if investigation show that there is real probability of such a result, they should be excluded, even though the danger be attributable to race prejudice of the natives rather than the clannishness and exclusiveness of the immigrants. 3. In the main, however, the traditional policy of this country has been " to improve rather than to check immigration," and the burden of proof is upon those persons who would restrict immigration by arbitrarily lii^iting the number of immigrants; Natural Resources. — Next to the character of the people with which this continent has been stocked, the most powerful factor in shaping the economic development of the United States has been its enormous natural wealth. With a territory (ex- cluding Alaska and our insular possessions) more than three fourths as large as all Europe, indented, particularly on the eastern coast, with a large number of good harbors, intersected by internal waterways that make communication cheap and easy, endowed with water power that in the opinion of one authority is probably " more valuable than those of all other lands put together," marked by every variety of climate and soil, covered in many places, at least originally, with magnificent forests, and liberally stocked with almost every variety of mineral wealth, it is not surprising that at the present time the United States " leads the world " in the production of iron and ECONOMIC DEVELOPMENT OF THE UNITED STATES 75 Steel, cotton, coal, coffee, gold, silver, dairy products, corn, wheat, lead, lumber, tobacco, petroleum, and hogs. It would be strange, indeed, with the vast mineral and agricultural resources at our command, if we did not " lead the world " in many things. Public Lands. — Of our 2,973,000. square miles of territory about three fourths at one time or another has belonged to the central government. The possession of this vast common treasure by the United States has played an important part in dignifying and strengthening the federal government. But the lavish alienation of the public lands in endowing free schools, subsidizing railways and other internal-improvement com- panies, and in providing free homes for the landless, has been an even more potent factor in hastening our economic develop- ment ; though it has led, as has been said with some justifi- cation, " to the ravishment rather than the development of our natural resources." Even more important is the influence which " free land " has exerted upon the wages of labor and the distribution of wealth in this country. While it was not until the passage of the Homestead Act in 1862 that land could be legally acquired without cost by simple occupation and cultivation, it is practi- cally true to say that from the seventeenth century until a few years ago any enterprising citizen could, by the exercise of a minimum amount of industry and frugality, secure a homestead large enough to support himself and family. This opportunity offered to the artisan a free choice between wage service and farming, constantly depleted the ranks of mere laborers, operated to keep wages as high as the earnings of a " no-rent " homestead, and kept fresh and vigorous that feeling of independence which has been the distinguishing mark of the American workingman. Up to June 30, 1909, according to President Van Hise, the United States had sold or disposed of to corporations and individuals 571,600,000 acres; it had granted to the states for various purposes 153,500,000 acres ; 324,500,000 acres had been reserved for parks, forests, and other public purposes ; while there were 363,300,000 acres still unreserved and unappropriated, not counting 378,000,000 acres in Alaska, of which all but about 76 OUTLINES OF ECONOMICS 10,000,000 acres were unappropriated and unreserved. The lands which were sold brought less than it cost to acquire, survey, and carry them. At the date mentioned 127,000,000 acres had been given away under the Homestead and Timber Culture Acts — supposedly to actual settlers — and 142,000,000 had been given to corporations to stimulate the building of railroads and other internal improvements.^ How long the public lands will hold out it is impossible to say. Notwithstanding the fact that the national government is disposing of its lands at the rate of from fifteen to twenty million acres a year, there is still left — if we count Alaska — almost as much territory as we have alienated since the adoption of the Constitution. Most of this is worthless or unavailable ; but irrigation and dry farming are reclaiming certain districts. In the East, especially, we have almost certainly entered upon a new era, and it must be remembered that fifteen sixteenths of the population reside in the eastern half of the United States. East of the Mississippi trade and manufactures taken together have outstripped agriculture, and a large majority of the people lack the inclination and necessary training, even if they possessed the courage and energy, to avail themselves of possibly cheaper lands elsewhere. Whatever the quaUty of this cheap land, its importance has diminished as an outlet for the population upon whose economic condition it formerly exerted so salutary an influence. Considering the population as a whole, the conclu- sion seems irresistible that we have reached, if indeed we have not already passed, the parting of the ways ; and the assistance that free land has rendered in maintaining wages and restrain- ing the evil tendencies of the modern system of capitalistic production must in the future be secured from other sources. The distinctive Americanism of the past was generated, as has been said, in the performance of our national task " of winning a continent from nature and subduing it to the uses of man " ; ^ it was a product of the frontier. But the frontier has now dis- appeared. 1 Charles R. Van Hise, The Conservation of Natural Resources in the United States p. 294. ^ E. L. Bogart, Economic History of the United States, p. i. ECONOMIC DEVELOPMENT OF THE UNITED STATES 77 QUESTIONS 1. What peculiar characteristics mark the economic stages of the United States? 2. Is the pastoral stage through which the people of our Great Plains have passed essentially different from the pastoral stage through which the people of Israel passed? 3. Enumerate the great sectional struggles which have disturbed the United States. Why does radicalism accompany the frontier? 4. Has the frontier and the work of settlement left a permanent impress upon the American people? Of what kind? 4|h 5. How rapidly is the popidation increasing at the present time ? Are the richer or poorer classes multiplying more rapidly? Can you state the reason ? 6. What are the distinctively economic factors of the negro problem? 7. ■ When did the immigration problem first alarm residents of this country? Wliat charges are directed against the "newer immigrants"? 8. Have we shown an abihty to assimilate all kinds of immigrants? What has been the historical policy of this country toward immigration? 9. What part did the public domain play in bringing about and preserv- ing the Union? in maintaining wages? 10. How does the growing size of the country modify the influence exerted by free land? REFERENCES BoGART, E. L. Economic History of the United States. Contains bibli- ography. Bruce, P. A. Economic History of Virginia (2 volumes). Bureau of the Census. A Century of Popidation Growth. Callender, G. S. Selections from the Economic History of the United States. CoMAN, Katharin'j;. Industrial History of the United States. Contains bibliography. Economic Beginnings of the Far West (2 volumes). Commons, J. R. Races and Immigrants in America. Emery, H. C. "Economic Development of the United States," in The Cambridge Modern History, Vol. vii, Chap, xxiii. Fairchild, H. p. Immigration. Hart, A. B. (ed.) The American Nation {t,'j vohime's). Contains chapters on economic history. HoURWiCH, I. A. Immigration and Labor. Jenks, J. W., and Lauck, W. J. The Immigration Problem. McM ASTER, J. B. A History of the People of the United States (8 volumes). Ross, E. A. The Old World in the New. Semple, E. C. American History and its Geographical Conditions. 78 OUTLINES OF ECONOMICS SmoNS, A. M. Social Forces in American History. Turner, F. J. "The Significance of the Frontier in American History," in Bullock, C. J., Selected Readhigs in Economics. First edition in Re- port of the American Historical Association, 1893. United States Immigration Commission. Reports (39 volumes, including useful Abstracts of Reports, in 2 volumes). Van Hise, C. R. The Conservation of Natural Resources in the United Stdtes. Weeden, W. B. Economic and Social History of New England (2 volumes). Wellington, R. G. The Political and Sectional Influence of the Public Latids. CHAPTER VI THE ECONOMIC DEVELOPMENT OF THE UNITED STATES {Continued) In the preceding chapter attention was confined to certain fundamental and pecuharly American conditions which have influenced the economic development of this country. They form the background and setting of the picture. When we come to fill in the details, however, the general effect is very similar to that produced by the description of English industrial development given in Chapter IV. There are differences, of course, — differences important enough to make this separate discussion of American economic evolution necessary. But, on the whole, it is surprising how rapidly we have developed the industrial maladies and economic problems of the Old World. Mercantilism in America. — In the American colonies, as in England itself, the Industrial Revolution was preceded by a period in which trade and industry were subject to minute regu- lation by the government. Bounties were freely offered in several colonies for the manufacture of leather, iron, paper, silk, and cloth ; land grants were made and taxes remitted, particularly in the support of the iron industry ; and in order to encourage the home manufacture of shoes, for instance, -the General Court of Massachusetts in 1640 commanded that "every hide " be sent to a tannery under penalty of a £12 fine," while " leather searchers " were appointed to see that the law was obeyed. This early colonial regulation was restrictive as well as protec- tive. In the New England colonies, in the seventeenth century, laws were repeatedly passed prohibiting idleness, fixing the hours 79 K 8o OUTLINES OF ECONOMICS of labor, and prescribing rates of wages, with appropriate penal- ties for v>^orkmen who took or employers who paid more than the legal rate. In the Boston Town Records of 1635, for instance, we find this resolution : " That Mr. William Hutchinson, Mr. William Colborne and Mr. William Breton shall sett pryces upon all cattel, comodities, victuals and labourers and Work- men's Wages and that noe other prises or rates shal be given or taken." But the restrictive laws, in general, failed dismally. The abundance of cheap land and the independent spirit gener- ated by the pioneer life prevented the enforcement of obnoxious colonial laws, and eventually led the colonists into armed resist- ance against the restrictive legislation of the English govern- ment. English Colonial Policy and the Navigation Acts. — In accordance with mercantilist views of colonial relationships, English statesmen of this period looked upon a colony as a community which was to supply raw materials for the industries of the mother country, secure its manufactured goods from the mother country; and so far as trade with the rest of the world was concerned, buy and sell through the mother country. In accordance with this general policy England gave bounties for the production in America of raw materials such as flax, indigo, naval stores, barrel staves, and the like, but restricted manufacturing proper — by prohibiting, for instance, the erec- tion of mills for slitting or rolling iron, and furnaces for making steel — and fettered our commerce in a variety of ways. The English laws were not so severe as might be inferred from our brief statement of their nature and purpose ; they were laxly enforced ; and it is to be remembered that England encouraged some industries while she attempted to destroy others. English colonial policy of this period was not so much malicious as mistaken. The important points for us are these : that it did not seriously hamper the development of American industry in general, while it did strengthen and stimulate in the American people that spirit of individualism which the industrial opportunities of the New World and the frontier conditions of the time combined to create. As a consequence the new nation, ECONOMIC DEVELOPMENT OF THE UNITED STATES 8l created in 1789, was pledged to the doctrine of individual liberty, and its constitution contained specific guarantees of personal freedom not only in matters political, but in industrial and social relationships as well. American Industries in 1776. — When the Revolutionary War broke out, American industry was still in a primitive stage. The extractive industries were, relatively, the most advanced. Large quantities of lumber and timber products were exported to Europe ; the fisheries were in a prosperous condition ; and shipbuilding had reached a really remarkable stage of develop- ment, — in 1775 " nearly one third of the tonnage afloat under the British flag had been built in American dockyards." Agri- culture, however, was carried on in the most wasteful and un- scientific way, owing to the cheapness and fertility of the soil ; and manufacturing was still in the household stage. In the middle and New England Colonies spinning and weaving, the manufacture of shoes and food products, were carried on within the home; and, in fact, the typical farm household of this period constituted almost an independent economic unit, rais- ing or making what its occupants consumed, and buying little save salt and a few necessary iron implements. Of manufactur- ing for sale and export, however, there was little worth men- tion. The absence of adequate means of transport was largely responsible for this state of affairs. The roads were little more than widened Indian trails. Some years later, when con- ditions were considerably improved, the roads were still so poor that " Madison spent a week going from New York to Boston by stage, while the cost of cartage of a cord of wood for a dis- tance of twelve miles was three dollars." Agriculture, however, was the dominant industry of the country. In 1787 less than one eighth of the working population was engaged in manu- factures, fishing, navigation, and trade combined. The Industrial Revolution in America. — The Industrial Revolution was sudden, and in its consequences momentous in America as well as in England. The Revolutionary War, by interrupting trade with Europe, threw the American people upon their own resources : goods that had hitherto been im- G 82 OUTLINES OF ECONOMICS ported had now to be manufactured at home ; a large number of new industries sprang up rapidly ; and the idea became prev- alent that the new nation must make itself industrially as well as politically independent of the Old World. The state governments endeavored to foster the new industries by protec- tive tariffs, and this policy was later continued, in a moderate form, by the federal tariff act of July 4, 1789. Prizes were offered by various societies, and even by certain state govern- ments, for the introduction of the new machines and methods which were revolutionizing industry in England. Attracted by one of these offers, Samuel Slater, " the father of American manufactures," who had been apprenticed to a manufacturer of cotton machinery, and was particurarly familiar with Ark- wright's machines and processes, came to this country in 1789, and in the following year started the first cotton factory at Paw- tucket, Rhode Island. The factory system secured its first real foothold, however, between 1806 and 181 5, when the Non-Intercourse Acts, the Embargo, and the War of 181 2, by suppressing trade with Europe, forced the American people to do their own manu- facturing, and turned large amounts of capital, which had pre- viously been employed in trade and shipping, into manu- factures. The growth during this period of isolation was extraordinary. In 1804 only four cotton mills were in opera- tion. " In 1807 there were fifteen cotton mills running 8000 spindles and producing 300,000 pounds of cotton yarn annually. In 181 1 there were eighty-seven mills operating 80,000 spindles, producing 2,880,000 pounds of yarn per year and employing 4000 men, women, and children. In 181 5, 500,000 spindles gave employment to 76,000 persons, with a pay-roll of $15,000,- 000 per year." ^ When resumption of peace with Great Britain opened the new American industries to the fierce competition of the older English manufacturers, many failures and much suffering ensued, as a consequence of which increased protec- tion was granted in the tariff acts of 1816, 1824, and 1828. A little later, in the Middle Atlantic and New England states, 1 Coman, Industrial History of the United States, p. i8i. ECONOMIC DEVELOPMENT OF THE UNITED STATES 83 the period of factory production had fully arrived. A separate class of wage earners was appearing, who were especially ap- pealed to by new arguments concerning wages in the tariff discussions ; workingmen's parties were organized ; strikes and trades unions multiplied, and the latter were combined into municipal and state federations; in the thirties and forties radical reformers linked the " white slaves " of the North with the negro slaves of the South and worked for the abolition of both " wage and chattel slavery " ; the factory town and the city slum became recognized economic conditions, and the dangers of the latter were multiplied by the heavy immigration after 1845. By the middle of the nineteenth century the Industrial Revolution was in full sway, and the economic triumph of modern capitalism was assured. As might be supposed, the Industrial Revolution produced far less suffering and want in the United States than in England. The evils attributable to the Industrial Revolution in England were of two kinds. One arose from the rapidity and magnitude of the industrial change itself; the other was due, not to the change, but to the system under which the new industry was conducted — the system of capitalistic industry working in a regime of practically unregulated competition. In our country the evils resulting from transition alone were slight. Our manufacturing industries were scarcely started when the spin- ning jenny, the power loom, and the steam engine were intro- duced, and so almost from the beginning the factory system seemed the natural one. Thus, the change which in England was a revolution was in America an evolution, a process of construction with little destruction. And for a time even those evils inherent in the system itself were mitigated and disguised by the immense natural wealth of this country, the ease with which land could be obtained, and the unusual mobility of our working people which permitted them to take quick advantage of the unusual opportunities open to them. But these ameliorating agencies served only to check and delay, not to destroy, the evil possibilities of the new industrial system. As free land has become less and less abundant, the 84 OUTLINES OF ECONOMICS wage earners of the East have had forced upon them conditions of Hfe which have kept down, although they have not absolutely- lowered, their standard of life. Extremes of wealth and aliena- tion of social classes have become so great as to arouse the appre- hension of all thoughtful men. Labor riots that call for mili- tary interference testify to the fact that we have not escaped, that in the future we can hope less and less to escape, the fric- tion that accompanies all unfraternal relations among men. We have been greatly blest in that we have escaped the worst results so long. The Development of Agriculture. — The presence and power of those economic forces which softened the asperities of the new industrial system in America are revealed in a particularly strik- ing way in the history of American agriculture. In England, it will be remembered, the changes in agriculture intensified the evils of the Industrial Revolution, led to the consolidation of small farms into large landed estates, and put the actual busi- ness of farming largely into the hands of tenants. None of these things happened in the United States. The great area of unoccupied land served as an outlet for our rapidly growing population, so that between 1850 and 1900 the number, acreage, and output of our farms increased more rapidly than our popu- lation. Farms were not consolidated but broken up ; even today nearly two thirds of our farms are operated by their owners, and more persons are employed in agriciilture than in any other branch of industry. There is a constant migration from the country to the city, to be sure, but this is in no sense due to the consolidation of farms. Thus between 1880 and 1910 the proportion of all " breadwinners " (persons ten years of age and over gainfully occupied) engaged in agriculture fell from 44.4 to 32.9 per cent. But great improvement in agricultural methods and machinery made it possible for the relatively smaller farm population to satisfy the demand for agricultural produce even more completely at the end than in the middle of the nineteenth century. That is to say, the machine power introduced into farming more than took the place of those persons and their descendants who abandoned agriculture. It ECONOMIC DEVELOPMENT OF THE UNITED STATES 85 has been estimated, for instance, that in 1895 it actually re- quired only about 120,000,000 days' work to produce the nine principal farm crops of that year, whereas, had they been pro- duced by the methods and machinery of 1850, at least 570,000,- 000 days' work would have been required.^ But our free land merely served to postpone, it could not per- manently prevent, the appearance in America of some of the agricultural conditions which accompanied the Industrial Revolution in England. The twentieth century ushered in a new era in American agricultural development. Between 1900 and 1 9 10 the number and acreage of farms increased far less rapidly than the population, while farm tenaricy grew, in close relationship, apparently, with an extraordinary increase in farm values. " The increase during the last ten years (1900-1910) in the value of farm property was equal to the total increase in the value of farm property in the United States from the landing of Columbus until 1900." ^ The value of farm land increased 118 per cent between 1900 and 19 10; and the number of farms operated by tenants increased 16.3 per cent as against an increase of 8.1 per cent in the number of farms operated by owners. More important still, the average value of land, buildings and equipment per farm increased from $3560 in 1900 to $6440 in 1910. These figures reflect in part a simple change in the value of money ; but they indicate as well the increasing importance of capitalistic methods of pro- duction in agriculture, the increasing difficulty of acquiring farm ownership, and the sharp halt which has been called upon the agricultural expansion which marked the last century. " We have now reached a stage in the history of this country when farmers in average years do not produce much more of the raw materials used for food, beverage, and clothing than is needed within the country." ^ ^ H. W. Quaintance, "The Influence of Farm Machinery on Production and Labor," Publications 0/ the American Economic Association, Third Series, vol. v, No. 4, pp. 27-20. * J. L. Coulter, "Agriculture in the United States," Quarterly Journal of Econom- ics, vol. xxvii, pp. 9-13. ^ Coulter, loc. cit. 86 OUTLINES OF ECONOMICS Manufactures. — ■ In agriculture, however, the passage of time has not brought about a highly capitalized form of indus- try, the typical farm represents only a relatively small invest- ment and is tilled by its owner, there is no sharp distinction between employees, unions of wage earners are practically un- known, and passage from the wage-earning to the employing class is still common. In manufactures, practically all these conditions have been reversed since the end of the eighteenth century. And it is the tone of the manufacturing industry rather than that of agriculture which represents the keynote of the modern economic movement, because agriculture is constantly decreasing while manufacturing and allied industries are constantly increasing in relative importance. At the be- ginning of the last decade of the eighteenth century, seven eighths of the working population were employed in agriculture, and the manufactured products of the country were valued at $20,000,000. Half a century later, in 1840, 77.5 per cent were employed in agriculture, 16.5 per cent in trades and manu- factures alone, and the products of the manufacturing industries were valued at $483,000,000. Fifty years later, in 1890, 35.7 per cent were in. agriculture, 24.4 per cent in manufacturing and mechanical pursuits, and the manufactured products were valued at $9,370,000,000. In 1909, to cite the latest figures, 32.9 per cent were in agriculture and 28.3 per cent in manufacturing and mechanical pursuits, while the value of the products had reached the enormous sum of $20,700,000,000. The change in the character of the industry has been even more striking than its growth and expansion. In the first place, machinery and capital have become increasingly promi- nent. In 1850, for instance, $556 worth of capital was invested for each wage earner, while in '1909 the average amount of capital per wage earner was $2785.^ In the second place, the organization of the industry has changed, so that the individual owner and ordinary partnership are rapidly being replaced by 1 Owing to variations in the definition of " capital " and other similar changes, the statistical comparisons made in this and the preceding paragraph are not accu- rate, and are to be accepted as illustrations rather than measurements. ECONOMIC DEVELOPMENT OF THE UNITED STATES 87 the corporation. At the beginning of the nineteenth century, corporations, though not unknown in commerce and banking, were very uncommon in the manufacturing industries. In 1909, incorporated companies employed 75.6 per cent of the wage earners and manufactured 79 per cent of the goods pro- duced in all the manufacturing industries. This change in organization has been a powerful factor in de- stroying the personal relation between the owners of capital and the wage earners who man their plants, and has thus helped to widen the growing breach between capital and labor. It has also contributed greatly to the concentration of industrial ■control. Law and custom in this country have combined to make the small stockholder in the largest corporations a virtual nonentity so far as practical participation in the management of the corporation is concerned ; and the individual or clique of " insiders " who own a bare majority of the stock too fre- quently rule the business despotically. Incorporation,, then, instead of introducing a greater measure of real industrial co- operation and thus democratizing industry, has too often turned out to be an ingenious device by which energetic promoters borrow or secure the spare savings of the community on the most flexible terms and with a minimum of responsibility. The corporation thus, while it appeared to be diffusing the ownership of industry, has in reality worked toward the concentration of industrial control. Other forces, moreover, have been working toward industrial concentration, the most powerful of which, perhaps, has been competition itself. For many decades in this country the competition among rival manufacturers was bitter and practically unrestricted. Tied down to their large investments of fixed capital, they were compelled to stand and fight with- out quarter. In 'every such war the number of combatants tends to decrease. As old rivals are killed off, the successful acquire greater skill and greater power in the conflict. With the passage of time greater and greater equipment is required to give any hope of a successful struggle, and some of the contest- ants, learning prudence from the struggle, combine to increase 88 OUTLINES OF ECONOMICS their fighting power. The inevitable result, whether through simple survival of the fittest or through combination, is a marked increase in the size and importance of the industrial unit. Be- tween 1899 and 1909, for instance, the number of establishments in the factory industries increased only 29.4 per cent, but their capital increased 105,3 Pcr cent, and the value of their products 81.2 per cent. In many of our most important industries the number of establishments is actually decreasing. In the manu- facture of agricultural implements between 1880 and 1909, to take a single illustration of the many that might be cited, the number of establishments decreased from 1943 to 640, while the wage earneo-s increased from 39,580 to 50,551, and the value of the products from $68,640,000 to $146,330,000. There are industries, of course, in which no such consolida- tion has taken place, but they are unimportant in comparison with those in which it has. The extent to which the giant in- dustry and large-scale production had come to dominate our manufacturing industries in the year 1909 is shown in the follow- ing table, which will repay careful study. Establishments of the largest size, i.e. those whose annual output exceeded $1,000,- 000, constituted a little over i per cent of the number of estab- lishments, but manufactured nearly 44 per cent of all the goods. Nearly three fourths of the wage earners were employed in establishments having a capital of more than $100,000 each. In the latter part of the nineteenth century the movement toward large-scale industry took on another phase. In addition to concentration or centralization of industry, we are now having a rapidly increasing integration of industry. Large business concerns are finding it profitable to carry on under one manage- ment several closely related industries. For illustration, take the case of the United States Steel Corporation. Here we have united under one management the American Bridge Company, the American Sheet Steel Company, the American Steel Hoop Company, the American Steel and Wire Company, the American Tin Plate Company, the Federal Steel Company, the Lake Superior Consolidated Iron Mines, the National Steel Company, the National Tube Company, and the Carnegie Steel Company. ECONOMIC DEVELOPMENT OF THE UNITED STATES 89 W CO M 1 On C^^ < On CO q^ CO OS >o^ 10 CO 00 -* t^ f^j 0. > VO q^ " 10 u~, CO .A *"• w CO CO '^ 'i- CO CO q 10 ^ 0, cs q^ q^ ^ 10. CO 1 8 10 00 10 CO ^J PI c^^ q^ H 0" T^ CO 10 no" D n q ''* s < ■+ •^ CO CO ^ ^ On TO 6 tv^ On 30 r^ M r^ M ^ "* no" CO (N Tl- Cl CO -+ t^ cT On 10 2 M t^ CO ^^ #?= ^ m M „ S 8 M ON 2: t^ O; H ^ NO t^ P t-^ ro ^ 10 CNl CO M 00 0^ CN^ vo 'f ^ 1 -*-> 1) fl IH "ti c ^ c XI !U > go OUTLINES OF ECONOMICS Of the last itself, Mr. Charles M. Schwab said in his testimony, before the Industrial Commission: ^ " The Carnegie Company- were large miners of ore — mined all the ore that they re- quired themselves, to the extent of over 4,000,000 tons per year. They transported a large percentage of it in their own boats over the lakes ; they carried a large percentage of it over their own railroad to their Pittsburgh works, and manufactured it there, by the various processes, into a great variety of iron and steel articles — I think perhaps a larger general variety of steel articles than almost any other manu- facturing concern." Transportation and Railways. — The industrial concentration of which we have been speaking does not necessarily lessen competition at all. It merely gives the business into the hands of increasingly powerful rivals among whom competition may be all the more bitter because of the size of the contestants. But in the principal transportation industries time has demonstrated that another rule prevails: competition has failed to protect the consumer, and the progress of consolidation has operated to emphasize the monopolistic character of the industry. The history of transportation in this country since the estab- lishment of the Union falls into three stages. The " turnpike period " extends from 1790, the year in which the first turnpike was constructed, until 181 6, when steam navigation upon the Ohio River became fairly regular. The second stage, the " river and canal period," ends after the panic of 1837, and is marked particularly by the introduction of steam travel on the Hudson (1807), the Ohio, and Mississippi rivers (1808 to 1817), and the opening of the Erie Canal in 1825. The last stage, the " period of the railway," extends from about 1842 to the present time. In contrasting these periods, it is not meant to suggest that canals were not built before 1790, or that turnpikes are not im- portant at the present time. As a matter of fact, a canal was built in Orange County, New York, as early as 1750; and the last few years have witnessed a rapid and costly improvement of our highways. These " periods " merely indicate the kind 1 Report of the Industrial Commission, vol. xiii, p. 448. ECONOMIC DEVELOPMENT OF THE UNITED STATES 91 of transportation facilities which at different times have been most prominent in the minds of the people. In the development of the railway, certain approximately definite stages may also be distinguished. Between 1830 (when the first important railway — the Baltimore and Ohio — was opened) and 1840, the railways were short local lines used in large degree to supplement or piece out the rivers and canals. In the next period, 1840 to 1870, many new roads were built, and the process of " linear consolidation " — the linking to- gether of local companies into through trunk lines — began. By 1869 both the New York Central and the Pennsylvania had effected through connections with Chicago. In the same year, the completion of the Central and Union Pacific railways linked the Pacific Ocean with the eastern railways, and the continent was spanned. The period between 1870 and 1890 is marked by three striking developments. First, it was a period of feverish expansion : the railway mileage of the country increased from 52,000 to 160,000 miles, more than 200 per cent. Secondly, the com- pletion of several through routes from the Atlantic seaboard to Chicago brought about a period of destructive competition, which led to discrimination and rebating in through trafi&c and the overcharging of local or non-competitive trafl&c. " Wher- ever competition appeared, discrimination followed; and in the scramble for business the stronger shippers were favored at the expense of the weaker. Where there was no competition the public felt that they were being oppressed by a monopoly, to make up for sacrifice rates elsewhere — a feeling which was in- tensified by the absentee ownership of the western roads." ^ Thirdly, this condition of demoralization led to a double re- action. The railways sought to restrain competition by the creation of pools and traffic agreements, while the people sought to protect themselves through legislation and the creation of railway commissions. The Federal or Interstate Commerce Commission was established in 1887. The last period, from 1890 to the present time, has been 1 H. C. Emery in The Cambridge Modern History, vol. vii, p. 706. 92 OUTLINES OF ECONOMICS marked by an unprecedented amount of combination among competing roads, and by a growing belief that the railway indus- try is inherently monopolistic and must be subjected to public control. Thus, at the same time that the control of the magnifi- cent railway system of this country — greater in extent than all the railways of Europe combined — has fallen into the hands of a comparatively small number of groups, the people them- selves have perfected administrative machinery strong enough, it is hoped, to hold the monopoly in check. Very recently strong efforts have been made to preserve competition in the railway industry, but it is coming to be seen that in the main reliance will have to be placed upon regulation rather than competition. The amendment of the Interstate Commerce Act in 1906 is a public recognition of the fact that the old problem of private competition versus public regulation has given way to the new problem of public regulation versus public ownership ; and public operation may be given a trial in the near future on the thousand miles of railroad which Congress (in March, 1 9 14) authorized the President to construct in Alaska. It would be almost impossible to exaggerate the part which transportation agencies, and particularly the railways, have played in the economic develop- ment of this country. Ours is a country of "magnificent distances," and because of this fact, it was particularly necessary that superior means of communication and transportation should be early introduced, if the country was to be held together. After the Revolutionary War there was real danger that the settlers west of the AUeghanies would be completely alienated. Washington v^as quick to realize this fact. "The Western settlers," he wrote to the governor of Virginia, shortly after the Revolutionary War, "stand as it were upon a pivot. The touch of a feather would turn them any way. They have looked down the Mississippi until the Spaniards, very impohticly, I think, for themselves, threw difiiculties in their way ; and they looked that way for no other reason than because they could glide gently down the stream, without considering, perhaps, the difficulties of the voyage back again, and the time necessary to perform it in ; and because they have no other means of coming to us but by long land transportations and imim- proved roads." This danger was averted by the building of the Cumberland Road, the introduction of steam navigation on the Ohio, and the completion of the Erie Canal. Later it looked as if the use of the Mississippi and other natural avenues of communication would link the Middle West more closely to the ECONOMIC DEVELOPMENT OF THE UNITED STATES 93 South than the northeastern states, thus giving the South a preponderant influence in the inevitable struggle over slavery. This problem, however, was solved by the railways, which, unlike the rivers, ran east and west rather than north and south. The railway was thus a strong factor in the preser- vation of the Union. And since the Civil War, western settlement has fol- lowed the railway. It has been the great pioneering agency of the last half century, and is entitled to as much credit as the pubKc land policy for the rapid settlement of the West. In the development of our transportation facilities, however, the State has been from the very first an active partner of private enterprise. Not only has the State built roads, canals, and railways of its own, but it subsidized the private companies which engaged in similar enterprises, with prodigal liberahty. Of the total state debts — $170,800,000 in aU — contracted prior to 1838, $60,200,000 were chargeable to canals, $42,870,000 to railways, $52,600,000 to banks, $6,600,000 to roads, and $8,500,000 to miscella- neous objects. After the panic of 1837 there was little direct construction by the State of internal improvements, but national, state, and local govern- ments vied with one another in assisting private companies by exemptions from taxation and by grants of land, money, and credit. How much these subsidies amounted to we do not know, but the aggregate must have been enormous, as appears from the statistics of land grants. "During the twenty-one years between 1850 and 1871, at which time land grants were discontinued, more than 159,000,000 acres were placed at the disposal of railroad corporations by the federal government and 55,000,000 by the state governments." ^ In their origin and genesis, therefore, as well as in their essential nature, the railways are quasi-publie institutions. The Labor Movement. — In the preceding pages we have seen how capitahstic industry under a regime of free competition passed from an earUer period of cut-throat rivalry to a later period of combination amounting in many cases to monopoly. A similar phenomenon is discernible in the labor movement. At the beginning of the nineteenth century there were probably less than a dozen trade unions in the United States, and we actually know of the existence of only one. Between 1825 and the panic of 1837, however, they multiplied rapidly, and efforts were made to unite the scattered " locals " of separate trades into broader national unions, and to confederate the unions of different trades into municipal and district federations. These efforts were only partially successful, however, and it was not * Bogart, Economic History of the United States, pp. igs, 30S, passim. 94 OUTLINES OF ECONOMICS until after 1850 that permanent national unions were established, and not till the organization of the Knights of Labor in 1869 that a fairly permanent national federation was created. The Knights of Labor reached the zenith of its power about 1886, and since the panic of 1893 its place has been gradually taken by the American Federation of Labor, with which most Ameri- can unions, except those of the bricklayers and masons, the Railway Brotherhoods, and the Industrial Workers of the World, are affiliated. In 1893 the membership of the American Federation of Labor numbered about 250,000. By 1914 it had grown to 2,020,671. These figures give some idea of the strikingly rapid growth of trade unionism in the last twenty years. As the membership of the American Federation of Labor is usually understated, and as there are probably about 750,000 members in organizations not afiiliated with the Ameri- can Federation, we conclude that the aggregate membership of American labor organizations at the close of the year 19 14 amounted to about 2,750,000 persons, mostly men.^ There are at least five periods distinguishable in the history of American trade unionism: the germinal period, 1 789-1825; the revolutionary period, 1825-1850, so called because of the close connection in this period between trade unionism and more radical reforms such as socialism and cooperation; the period of nationalization, 1 850-1 865; the period oi federation 1865-1897 ; and the period of collective bargaining, 1898 to the present time. We speak of the present epoch as the period of collective bargaining because of the rapid expansion of union- ism, and the establishment of many new national or district systems of collective bargaining after the industrial depression of 1 893-1 897 ; and because it is only in recent years that em- ployers and the general public have recognized that the trade union is here to stay, and must be regarded as a permanent institution with which many employers of labor must bargain, whether they like it or not. 1 Dr. Leo Wolman, in a recent careful study (Quarterly Journal of Economics, vol. XXX, p. 4q6), estimates the total trade union membership in the United States and Canada in igio as 2,223,000. ECONOMIC DEVELOPMENT OF THE UNITED STATES 95 The avowed aim of the trade unions is a complete combination of all the workers in a given occupation or industry. The Broth- erhood of Locomotive Engineers, for instance, probably counts among its members more than go per cent of all the locomotive engineers in North America, although there are few trades which are so completely organized as this. With the passage of time, moreover, the trade unions have made increasing use of the monopolistic principle of the closed shop — the principle which leads union men to refuse to work with nonunion men, and which finds expression in the trade unionist's new command- ment: "Thou shalt not take thy neighbor's job." The development of powerful combinations in the labor world has engendered a counter movement among the employers, which expresses itself concretely in the modern employers^ association. Such organizations are not new; we have record of such an association among the master shoemakers of Philadelphia in 1789. But in recent years these associations have become per- manent, formal, and aggressive. They fight the labor organiza- tions with their own weapons, matching the lockout against the strike, the black list against the boycott, and the " labor bureau " against the " unfair list " with which the reader of trade-union journals is familiar. Most of the employers' associations, like most of the trade unions, have associated themselves for common action in a large national federation, the Citizens' Industrial Association of America, with which, in December, 1903, there were affiliated sixty national em- ployers' associations, sixty-six State and district associations, and three hundred and thirty-five local or municipal associations of employers. This fight between organized labor and organized capital return has forced the State, in the interest of industrial peace, to inaugurate " Wage Boards " and Boards of Arbitration and Conciliation. Some of these, such as the New Zealand Court of Arbitration, are empowered to enforce their awards upon em- ployers and employees; while others, like the Canadian and some of the American State Boards of Arbitration, have no power to settle disputes authoritatively, although they may 96 OUTLINES OF ECONOMICS make " compulsory investigations " and publish their finding as to the equities of the case. These and similar topics, how- ever, are reserved for more detailed discussion in a later chapter. State Regulation of Industry. — The growing interference of the State in the conflict between capital and labor brings us naturally to the general subject of the State in relation to indus- try. When the American colonies were planted, mercantilism was the dominant political philosophy; but, as we have seen, mercantilism gave way to a philosophy of individualism in the eighteenth century, under the combined influence of the reaction against the English Navigation Acts, the natural antipathy of a frontier community to legal restraint, the philosophy of Locke, and in a minor degree the teachings of the French physi- ocrats. The triumph of individualism, as a philosophical system, came at the critical period when our State and federal constitutions were in the making, and it thus became intrenched in the organic law of the nation, giving constitutional sanction to the doctrine of laissez-faire, and establishing a constitutional guarantee oi freedom of contract, in accordance with which adult men were leit " free " to work as long as they " pleased " (or were compelled), for whatever wages they were " pleased " (or forced) to accept. Under the influence of these doctrines, for instance, our courts have annulled such wholesome regulations as laws prohibiting payment of wages in store orders, and statutes limiting the hours of labor of men in bakeshops, or other ex- hausting occupations. Decades of experience have amply proved that the average wage earner is too weak to protect himself against many evils; but our constitutional law has made it exceedingly difficult for the State to protect him. For- tunately, however, the American people have a fashion of bending their constitutional law to fit the facts, not blinding themselves to the facts by worshiping the law ; and in recent years the Supreme Court of the United States has sanctioned laws requiring the semi-monthly payment of wages, prohibiting the payment of wages in goods, and requiring the wages of certain miners to be based upon the weight of the coal before screening. Many of the State courts, however, are far less enlightened. ECONOMIC DEVELOPMENT OF THE UNITED STATES 97 It is impossible to show in detail how the free trade and indi- vidualistic tendencies of the Revolutionary period gave way to a constantly growing program of State interference. The doctrine of laissez-faire was never adopted in its entirety, and year by year we have moved farther and farther away from it. State interference began with the adoption of a tariff act in 1789, " for the support of the government, for the discharge of the debts of the United States, and the encouragement and protection of manufactures " ; reached almost a maximum in the Embargo Act of 1807 ; showed itself in the policy of internal improvements and State aid to turnpike, canal, and railway - companies; brought us the great mass of labor and factory legislation which has been adopted by so many states since the Civil War ; led in turn to the Interstate Commerce Act of 1887, the Sherman Anti- trust Act of 1890, the National Meat In- spection and Pure Food Laws; and finally culminated in the Clayton Anti-trust and the Federal Trade Commission Acts of 1914. Excessive competition among laborers, which forced them to accept work under conditions destructive of physique and morals, has led to the factory acts, prohibition of child labor, and limitation of the hours of labor of women ; excessive competition leading to the adulteration of products and their manufacture under insanitary conditions has given us the meat inspection and pure food laws ; excessive competition among corporations, leading to combination and oppressive monopoly, has brought us the anti-trust acts and regulation through State and national commissions. The rapid adoption of workmen's / compensation and minimum wage laws by the State govern- ments in recent years, is striking evidence that we have entered a new era, in which State interference and control is not unlikely i to become excessive. Whether the individualistic character of industrial society endures or disappears, individualists and . sociaUsts alike are now agreed that the State must interfere.^ As a prominent English statesman expressed it, " We are all socialists now," although he merely meant by this statement that the passive theory of government has been wholly dis- credited. 98 OUTLINES OF ECONOMICS Up to the present time State interference has had as its princi- pal object the improvement and preservation of competition. The conscientious manufacturer who would not poison con- sumers for the sake of swelling his profits, the high-minded employer who would not " sweat " women and children merely to reduce the cost of production, the delicately scrupulous shipper who would not undermine a rival by forcing a common carrier to pay him rebates, — all these have suffered as much from the abuses of competition as the general public itself. Industry under the competitive regime is a rough game played for high stakes, and if it is to be played fairly, there must be intelligent rules of the game and an umpire powerful enough to enforce them upon all contestants alike. If the manufacturers of Massachusetts are prohibited from employing children under fourteen years of age while those of South Carolina are en- couraged to do so, decency is penalized, and the victory goes to the contestant guilty of the greatest number of fouls. State interference, as we have said, has had as its principal object the maintenance of competition upon a higher and more wholesome basis. But this has not been its sole object. Our re- cent regulation of public utility companies aims not to bolster up or preserve competition among such companies, but to introduce a substitute for competition ; and it is possible that in certain lines of industry regulated monopoly may prove on the whole more beneficial than regulated competition. Whether it is desirable, whether in the long run it will be possible, to main- tain a competitive as distinguished from a socialistic regime of industrial society, may be said to be the supreme economic problem of the twentieth century. QUESTIONS 1. How do you account for the failure of the early colonial restrictive legislation ? 2. What was the effect of English colonial policy and the Navigation Acts upon American manufactures? shipbuilding? American poHtical philosophy ? 3. What was the condition of American agriculture in 1776? of manu- factures? shipbuilding? transportation? ECONOMIC DEVELOPMENT OF THE UNITED STATES 99 4. Was the Industrial Revolution as important in this country as in England? Was it attended with as much suffering? Why? 5. What part has been played by war in the tariff and industrial history of the United States? 6. In what respects has the agricultural development of this country differed from that of England? from that of the manufacturing industry? 7. What changes have taken place in the organization of manufacturing industries in the last century? 8. What are the principal causes and effects of industrial concentration? 9. What is the difference between industrial concentration and integra- tion? between large-scale production and monopoly? 10. What stages are distinguishable in the history of transportation and railways in this country? 11. What part did the State play in the development of railways? Is railway consolidation a recent phenomenon? 12. What movement has the development of trade unionism elicited from employers? from the State? 13. How did the doctrine of non-interference secure such a strong foot- hold in American constitutional law? What has been the principal object of State interference up to the present time? REFERENCES (See also References for Chapter V) Beard, C. A. Contemporary American History. Beer, G. L. The Old Colonial System, 1660-1754. Bishop, J. L. History of American Manufactures. Bryn, E. W. Progress of Invention in the Nineteenth Century. Census Reports. Tenth Census, Agriculture, p. 131; Twelfth Census, Manufactures, Part i, Chap, ii, i-iv, xvii, xxxix. Cleveland, F. A., and Powell, F. W. Railroad Promotion and Capitaliza- tion in the United States. Commons, J. R. (ed.) Documentary History of American Industrial Society. (10 volumes.) Dewtey, D. R. Financial History of the United States. GiESECKE, A. A. American Commercial Legislation before ijSg. Hadley, a. T. Railroad Transportation, its History and its Laws. Johnson, E. R. American Railway Transportation. Rabbeno, Ujo. The American Commercial Policy. Taussig, F. W. Tariff History of the United States. Weber, A. F. "The Growth of Cities in the Nineteenth Century," Co- lumbia University Studies in History, Economics, and Public Law, ■ Vol. ii. Wells, D. A. Recent Economic Changes. WiCKWARE, F. G. (ed.). The American Year Book. BOOK II PRINCIPLES AND PROBLEMS PART I PRODUCTION AND CONSUMPTION CHAPTER VII ELEMENTARY CONCEPTS In political economy many of the technical terms employed are often misunderstood because the same words are used in ordinary speech with inconsistency and confusion. Frequently we have to choose between the alternatives of being inconsistent and of violating current usage. The present chapter is devoted to a preliminary survey of some of the fundamental notions in political economy. The statement is sometimes made that economics is a mere bread-and-butter science, and this charge is not without some foundation, since the science studies men in their endeavor to make a living, but it would be an error to suppose that we are concerned with only the sordid aspects of human nature. This 'is apparent if we enumerate the motives which impel men to acquire wealth. Motives in Economic Activity. — (i) There is, in the first place, the endeavor to satisfy one's strictly personal wants, giving rise to the struggle for food, shelter, comforts, amuse- ment, etc. These things are wanted for their own sake, because of the effect which they produce upon the individual acquiring them. We have here, in short, the motive of self -maintenance and self-development. (2) But every normal individual feels such a degree of affection for certain other people that he is also anxious for their maintenance and development. Striving for the welfare of others is a second motive which impels men to labor for the acquisition of material things, and in many cases is more effective as a spur to endeavor than the first. A man 103 I04 OUTLINES OF ECONOMICS will hold himself to the daily grind more persistently when he feels some one is dependent upon him than when he is standing alone. Another motive is (3) the desire to gain the esteem of one's fellows. This motive may take the form of an endeavor to do one's part and to be deserving of the companionship of the class of people whom we admire. But much of our wealth acquisition is motivated by the hope of impressing our fellows with a sense of our own importance, to show that we are success- ful, admirable, enviable. When the income permits, old coats are discarded, not because they cease to give protection, nor because they have become aesthetically objectionable, but because the wearers wish to make a favorable impression upon other people. Part of the pleasure of owning fine houses may come from the fact that most people do not have them. This motive is not always a conscious one, since our standards of beauty or propriety may themselves have been the result in part of this desire for distinction. Somewhat similar to the desire for distinction is (4) the desire for power. Men like to dominate and command their fellows, and this want may be satisfied by means of the dollar as well as with the sword; hence our " Napoleons of Finance," " Captains of Industry," and " Railway Kings." Again, (5) the desire for activity for its own sake may be men- tioned. Enforced idleness is as painful as prolonged labor, ex- cept to the degenerate. This desire may result in the production of goods, but almost always it requires the use of goods that have been produced ; as, for example, the implements of athletic exercise. Finally, (6) religion and the ethical sense may be important factors in controlling the economic activity of the individual. Observe, for instance, the dift"erence in the history of the communistic experiments in which religious feeling has been strong and those in which it has been weak. In this discussion the use of the word " motive " must not be taken to mean that all of the economic life of the individual is a consciously rational one, in which pleasures are balanced against pains in such a way as to secure the maximum surplus ELEMENTARY CONCEPTS 105 of satisfactions. Man is, it is true, a rational being, and as such pursues definite lines of action under the influence of con- scious motives ; but he is also a creature of instincts and habits, and much of the economic activity of the individual has to be interpreted as the working out of instinct and habit. We speak, for example, of such things as the " instinct of workmanship," the " habit of industry," the " habit of saving," and the like. The foregoing analysis of the motives in economic activity is, however, broad enough if we remember that " pleasure " is something that is not always consciously sought, but is often to be understood as the result of the functioning of inherited instincts and acquired habits. Utility. — As a result of these motives, human beings are striving for the possession of certain things. These we call goods. To understand the meaning of the term " utility " in economics, we must remember that economics is primarily a science of man. Goods may be of interest in chemistry and physics merely as things, but they have no significance what- ever in economics until they come into relation with man. That fact in man which imparts to things a new character and makes them goods is the fact of human wants. Anything that is capa- ble 0} satisfying a human want is a good, and possesses utility. We need here to guard against a misunderstanding which the word " utility " might suggest. Utility is the power to satisfy wants, not the power to confer benefits. Cigars are as " useful " in the economic sense as bread or books, for all three satisfy wants. Economic wants may be serious, frivolous, or even positively pernicious, but the objects of these wants all alike possess utility in the economic sense. Free Goods and Economic Goods. — But it is apparent that the wants we have mentioned are very unlike in character. Air and water, for instance, we seldom think of as things we want at all. We usually have them in abundance and without exer- tion, so that, though they satisfy wants as vital as any we know, we seldom spend any time thinking about them or our absolute dependence upon them. These are free goods, that is, goods that exist in quantities sufficient to supply all wants for lo6 OUTLINES OF ECONOMICS them. Land in a new country is frequently a free good. But the list of things that are free is quickly exhausted. Economic goods are those which exist in quantities less than sufficient to satisfy all wants for them. Hence, we must economize in the use of them, are willing to undergo sacrifice to obtain them, and usually they are obtained only by exertion. It is, however, their scarcity as compared to the human wants which they have the power to satisfy, and not the fact that they have cost labor, that makes them economic goods. Land, for example, a free gift of nature, is one of the most important of economic goods at the present time. Effort. — Fortunately, the supply of economic goods can, in most cases, be increased by human exertion applied to the ma- terials of nature ; but this exertion, if carried beyond a certain point, is irksome, and this has an important effect upon the con- duct of life. If the labor force of the community were unlimited, a great many of the goods which we now use sparingly would be as free as air. Idealists have pictured for us a condition of the future where a few hours' work per day for each individual (an enjoyable means of working off surplus energy) will be sufficient to supply us with all of the goods that we have time to consume. At present, however, most of us find that our consumption is limited by the pain of additional effort. The end of our eco- nomic activity is, therefore, not only to get the greatest amount of satisfaction, but also to minimize the amount of painful labor. "Waiting. — Another fact that persists in our economic life is the necessity for waiting. The people of the United States wished to have the Panama Canal, but they could not get it without years of waiting. They were obliged to spend millions of days of labor with no benefit in return for a long time. So in general the production of goods by modern methods, involving the investment of capital, requires waiting as well as effort. Risk. — In a society characterized by private enterprise in industry, the risk of business failure is an important fact. The uncertainties of business life are obvious : A factory may be destroyed by fire, crops may be destroyed by storm and hail, a panic may destroy credit at a critical moment, fashions may ELEMENTARY CONCEPTS 1 07 change, or competition may prove too strong. Some of these uncertainties may be eUminated by insurance, but others can- not be so eliminated. The corporation is a device by which the risk assumed by one individual is limited, although not eliminated. The trust and the monopoly tend to reduce the importance of the factor of risk, and under a system of State socialism it might possibly become a negligible factor in our daily economic life. As society is constituted at present, how- ever, the production of goods to satisfy human wants is attended by risk, and, as we shall see later, society has to compensate those who take these inevitable business risks. Services. — Goods have been commonly divided into (i) material things, such as food, clothes, and books, and (2) personal services, such as those of physicians, lawyers, musicians, teach- ers, household servants, and public oflScers. The advisability of the distinction has been denied. Actors and singers, it has been urged, sell us perishable material things, i.e. light and sound waves of a peculiar kind. A recent writer also considers the distinction con- fusing because it obscures the fact that material things render services just as human beings do. The piano yields services as does the singer. From this point of view persons are durable economic goods along with cattle and wheelbarrows. But, on whatever ground the distinction is made, it is im- portant to recognize that among the things that contribute to our well-being are some — personal services — that are so perishable that they must be used with the direct cooperation of some other human being, while in other cases the services are, as it were, stored up in some inanimate material things, and the relation between the producer and consumer becomes an impersonal one. The service of a musician, for example, is personal and must be used the moment it is rendered; the purchase of a musical instrument, on the other hand, means the purchase at one time of a long series of uses. Personal Qualities as Goods. — The central point in our science is the conception of man in his relations to his environ- ment, and hence it does not seem reasonable to include the personal qualities of men under the head of goods. Good health and technical skill make a man's services more valuable and assist him in the acquisition of wealth, but they are a part of him rather than of his possessions. It is his services that he sells, and it is these that we have placed under the head of goods. ■ lo8 OUTLINES OF ECONOMICS When we consider the importance of the priceless heritage which the present generation has received in the shape of knowl- edge and skill, we might make these a separate category as immaterial goods. On this point Professor Marshall says: "German economists often lay stress on the non-material elements of national wealth ; and it is right to do this in some problems relating to national wealth, but not in all. Scientific knowledge, indeed, wherever discovered, soon becomes the property of the whole civilized world, and may be considered as cosmopolitan rather than a specially national wealth. The same is true of mechanical inventions and of many other improvements in the arts of production; and it is true of music. But those kinds of literature which lose their force by translation may be regarded as in a special sense the wealth of those nations in whose language they are written. And the organization of a free and weU-ordered State is to be regarded for some purposes as an important element of national wealth." 1 But knowledge does not exist in a disembodied state, and we shall omit nothing and avoid some confusion if we divide all / goods into material things and personal services. Wealth and Income. — Wealth may be looked upon either as a stock of things on hand at a particular time or as a flow of things during a period of time. When we ask how much a man is worth, it is customary in America to answer in terms of the value of his possessions, while an Englishman, would answer in terms of annual income. The two ways of looking at the matter are not identical, however: What a man spends in a year may include a good deal spent in hiring other persons to do personal service for him, while an estimate of his possessions • could not include the value of those persons unless they were his slaves. What is to be considered as a man's income is not easy to say, as our law-makers have discovered in framing income tax laws. In economic discussions we have in mind net and not gross income. We may refer to the economic goods and services enjoyed during a period of time, to the satisfaction derived from these goods and services, or to their money value. Money income is commonly given a broader meaning to cover one's ^ Principles of Economics, 6th ed., p. 59. ELEMENTARY CONCEPTS 109 total net acquisition of money regardless of whether it is spent for consumption goods or is saved. Individual Wealth and Social Wealth. — The distinction between the social and the individual standpoint meets us at many points in the study of economics. That which is wealth to the individual is often not wealth to society. An individual holding a government bond finds that he can exchange it for the things he wants almost as readily as though it were gold or some other commodity. He recognizes that the paper itself cannot be used directly for any useful purpose, yet he prizes it because it represents an indisputable claim on the services or commodities of other people. If the bond should be destroyed, the holder as an individual would suffer loss, but society as a whole would be neither richer nor poorer, and society, exclusive of the bondholder, would have gained at his expense. From the social standpoint the bond is not wealth at all, but only an evidence of a legal right to a part of the social wealth. All property rights are simply claims to a part of the social wealth or income. The claims to concrete, material things, such as farms and store buildings, are included by an individual when he enumerates his wealth; and farms and store buildings are social wealth. Again, in making an inventory of his wealth, an individual would not ordinarily include such an item as the post ofi&ce, which is public and not private property; but, strictly speaking, the post office is owned by him jointly with other members of society. A successful patent is frequently looked upon as an item of wealth, but it is simply a means by which the owner gets more from other people in return for his services. If the patent is declared invalid, others gain what he loses (not counting the lessening of the inducements to inven- tion). Again, " good will " in business is frequently paid for as though it was an economic good, and is wealth from the individual point of view, but it is not social wealth. If a busi- ness man loses his established trade, his competitors are the gainers ; society as a whole is not affected. Wealth and Value. — In the preceding paragraphs wealth has been spoken of as consisting of particular things. A lead pencil no OUTLINES OF ECONOMICS and the year's crop of wheat are both wealth. How shall we measure the amount of wealth that these objects represent ? Since the items of wealth are composed of very heterogeneous objects, we cannot use such units of measure as bushels, pounds, or feet. We must select a measure that has reference to some quality common to all kinds of wealth. Such a quality is value. This is a subject which will be discussed in detail later, the valuation of goods and personal services being the central problem in economic theory. Capital and Other Forms of Wealth. — Some material things, as well as personal services, yield satisfaction to human beings directly. From clothes, dwellings, food upon the table, musi- cal instruments, and the like, we derive enjoyment directly. These are consumption goods. Other goods are of service only indirectly. A plow, we say, is useful, but we cannot eat or wear it. It simply helps to produce the things that we can enjoy. Such articles are production goods. The distinction is a matter of degree. Even the food upon the table is not quite ready to be enjoyed. It must be handled with knives and forks. This has led some writers to make no distinction between production and consumption goods. But it has been pointed out that great differences in degree are more important than many differences in kind. The distinction, it may also be noted, is not made on the ground of durability. Consump- tion goods — a painting or a book, for example — may be very durable. Production goods, again, are divided into capital goods and land. Land is a gift of nature ; capital goods — machinery, warehouses, raw material, etc. — are produced by man. Other differences between these two classes will be discussed later. Capital Goods and Capital Value. — Capital goods, as well as other forms of wealth, are of such a heterogeneous nature that we cannot measure them by such units as pounds or inches. Here, again, we must select some quality that is common to all of them, which is value, and this can be measured in terms of dollars. Very frequently the value of capital goods is confused with the concrete good itself. A typewriter is a tangible, ma- terial capital good ; its weight is measured by pounds ; its bulk by cubic inches ; its value by dollars. In this book the word ELEMENTARY CONCEPTS III " capital " is frequently used as a short expression for either of the phrases " capital goods " and " capital value," but it will always be clear from the context which is meant. Social and Individual Capital. — The individual may include items in an enumeration of his capital which are not capital from the standpoint of society. The landlord who has dwell- ings to let regards them as part of his capital, but from the social standpoint they are consumption goods. We may call such goods acquisitive capital. Again, a street railway may consider its franchise as a part of its capital, but from the social stand- point a franchise is not capital at all, nor even wealth, but is simply a right to use the streets in a certain manner. Destroy the franchise, and social capital would not be lessened, except, perhaps, in indirect ways. Figure i will help to make these various distinctions clear : Circle AB represents goods. Circle AC represents economic Circle AE represents producer's s. Circle AF represents land. Zone BC represents free goods. Zone CE represents consumer's s. Zone DE represents acquisitive Zone EF represents social capi- tal. Fig. I. The National Wealth and the National Dividend. — Attempts have been made to ascertain the total wealth of a nation. The latest estimate made for the United States by the census authori- ties is given on the following page. Such a table is useful, even though it may contain some rather arbitrary estimates, as showing the relative importance of dif- ferent classes of our material equipment. Notice the small total value of the metals used as money and the relatively large value imputed to real property. It is rather surprising that manu- 112 OUTLINES OF ECONOMICS facturing machinery, tools, and implements are worth less than our live stock. But great care should be taken in comparing the total wealth as estimated in this and in preceding census valuations and in drawing conclusions as to the significance of a growth in national wealth measured in dollars. Estimates of Wealth for 191 2 and 1900 Form of Wealth 1912 1900 Total $187,739,071,090 $88,517,306,775 Real property and improvements taxed Real property and improvements exempt Live stock 98,362,813,569 12,313,519,502 6,238,388,985 1,368,224,548 6,091,451,274 2,616,642,734 16,148,532,502 4^596,563,292 223,252,516 1,081,433,227 123,362,701 1,491,117,193 360,865,270 290,000,000 2,098,613,122 5,240,019,651 14,693,861,489 826,632,467 815,552,233 4,295,008,593 8,463,216,222 46,324,839,234 6,212,788,930 3,306,473,278 749,775,970 2,541,046,639 1,677,379,825 9,035,732,000 1,576,197,160 211,650,000 400,324,000 98,836,600 537,849,478 267,752,468 402,618,653 1,455,069,323 6,087,151,108 424,970,592 326,851,517 2,000,000,000 4,880,000,000 Farm implements and machinery . . Manufacturing machinery, tools, and implements Gold and silver coin and bullion . Railroads and their equipment . . . Street railways, etc. : Street railways Telegraph systems Telephone systems Pullman and other cars not owned by railroads Shipping and canals Irrigation enterprises Privately owned waterworks . . . Privately owned central electric light and power stations All other : Agricultural products Manufactured products Imported merchandise Mining products Clothing and personal adornments Furniture, carriages, and kindred property In addition to the difficulty of getting accurate information on these various items, there are several things to be kept in mind in making use of such an estimate. First, the returns are made in money, so that fluctuations in the value of money will show a change in the total valuation even if there is no real change in the relation between the wants of a community and its ELEMENTARY CONCEPTS 1 13 supply of goods. Again, free goods are not included in such an estimate. Also, a good deal of public property does not have a money estimate put upon it. Who would attempt to say what our rivers and harbors are worth, and yet why should not these be included in the estimate if our canals are ? It seems that much that is included in the estimate is wealth from the individual standpoint only, but not from the social, as in the case of the valuation of a business whose value consists largely of patents or monopolistic privileges. In the table above, for example, the value of railway property was obtained by capi- talizing railway earnings. Is this sum properly included in an estimate of the total amount of wealth in the United States? The inclusion is proper if we are confining ourselves to a state- ment of the sum of the values of property rights, but it is mis- leading if we wish to show the relative importance of railways and of property in a competitive industry, or if we are discussing railways in relation to the public welfare. A similar line of thought is suggested with reference to land values. Ten years ago we had about the same area and the same quality of land as we now have, so that its high value today cannot mean that we are better equipped with natural resources. We must be on our guard against attaching improper signifi- cance to estimates of total wealth. Changes in total value are not an accurate index of changes in well-being. It is possible that an increase in concrete material goods will actually decrease the total quantity of wealth measured in dollars. A hundred bushels of wheat at $1 per bushel have a higher selling value than two hundred bushels at 40 cents per bushel. If by some magical process all goods could be made free as air, there would be no value whatever. An estimate of the value of our stock of wealth also necessarily omits to take account of personal serv- ices. It is obvious also that per capita wealth has more significance for well-being than has total wealth. Individual wealth and value connote scarcity ; well-being implies abun- dance. Nevertheless, under present conditions, it is probable that an increase in per capita individual wealth, when not due to fluctuations in the value of money, also indicates an increase I 114 OUTLINES OF ECONOMICS in well-being. There is no likelihood of our being able to in- crease the quantity of economic goods to such an extent as to render them free and hence valueless ; and, on the other hand, as will be more fully explained later, new wants are constantly developing, and value springs from the power to minister to unsatisfied wants. The national income is a concept which takes account of the services rendered directly by persons as well as of the material things that are used. The national income, objectively consid- ered, is a gigantic stream of food, clothes, comforts, personal serv- ices, etc., which is used up in the direct satisfaction of wants in a specified period, such as a year, by the millions of individual acts of consumption. Some writers would include also . the additions to our industrial equipment, such as new machines; but these may be regarded as promises of an enlarged future in- come of society, not as part of its present real income. Thus we may distinguish between the annual national product and the annual national income. It has been estimated that the average income per family was about $1500 in the United States in 1910.^ The margin of error in this average may be very great, but even if it could be taken as accurately measuring the per family income of that year, it would not necessarily be an index of how well we might live under some organization of society that attempted an equal or nearly equal distribution of income. The effect upon the efficiency of management, the hours of labor, and the intensity of effort might be disastrous. On the other hand, there might be much saving from an elimination of wasteful and unnecessary expenditure without a reduction of real enjoyment, and there might be a fuller utilization of productive forces now going to waste. We refrain from entering this realm of speculation. The national income may be looked upon as the national dividend, the sum total of good things to be divided among the various families or individuals. The forces determining the size of this dividend and the manner of its division are the main topics for discussion in political economy. 1 W. I. King, The Wealth and Income of the People of the United States, Chap. ix. ELEMENTARY CONCEPTS II 5 QUESTIONS AND EXERCISES 1. Does the following statement agree with the definitions in the text? "The true basis for an estimate of a nation's wealth is to be found in the en- joyments of its members." Hadley, Economics, p. 4. 2. Are the following wealth : air? whisky? a copyright? Lake Michigan? ' skill as a carpenter ? good health ? 3. Discuss the following: "Among the motives which lead men to accumulate wealth, the primacy, both in scope and intensity, therefore, continues to belong to this motive of pecuniary emulation." Veblen, Theory of the Leisure Class, p. 34. 4. State the significance of the following : "A horse is not wealth to us if we cannot ride, nor a picture if we cannot see, nor can any noble thing be wealth except to a noble person." Ruskin, Munera Pulveris, p. 10. 5. Discuss the following statement : "In 1770 Arthur Young reckoned the income of England to be £120,000,000; in 1901 the income may be roughly set down at £1,600,000,000. Making correct allowances for population and for prices, this growth of income would signify a large increase of com- modities per head ; but would it tell us that we are working and living some- what better than our ancestors?" Hobson, The Social Problem, p. 43. 6. How does the Federal Income Tax law (as interpreted by the Treasury Department) define a person's income? REFERENCES Cannan, Edwest. Wealth, Chap. i. Clark, J. B. The Philosophy of Wealth, Chaps, i and iii. Ely, R. T. Property and Contract, Vol. i. Chap. iii. Fisher, Irving. The Nature of Capital and Income, Chaps, i and ii. Hadley, A. T. Econoinics, pp. i-io. Hobson, J. A. The Social Problem, Book i. Chap. ii. King, W. I. The Wealth and Income of the People of the United States, Chaps, ii and v. Leslie, T. E. C. Essays in Political Economy, Chap. i. Marshall, Alfred. Principles of Economics, 6th ed., Book ii. Mitchell, W. C. "Human Behavior and Economics: A Survey of Recent Literature," Quarterly Journal of Economics, Vol. xxix, pp. 1-47. PiGOU, A. C. Wealth and Welfare, Part i. Chaps, i and ii. RusKiN, John. Munera Pulveris, Chap. i. SiDGWiCK, Henry. The Principles of Political Economy, Book i. Chap. iii. Smart, William. Studies in Economics, Chap, viii ; and Distribution of Income, Book ii. Taussig, F. W. Principles of Economics, Vol. i. Chap. i. Veblen, Thorstein. The Theory of the Leisure Class, esp. pp. 24-34; and The Instinct of Workmanship, Chap. i. Special Census Reports on Wealth, Debt, and Taxation. CHAPTER VIII PRODUCTION Production Defined. — Man creates no new matter. Neither the farmer nor the merchant adds one atom to the existing material of the earth. Yet they are both properly called pro- ducers because they increase economic utility. Production, then, means the creation of economic utilities by the application of man's mental and physical powers to the materials of nature. The act of production can be reduced to the following thjree operations : (i) changing the form of things, or combining or rearranging them, (2) changing their place, and (3) keeping them until such times as they are wanted ; in other words, production adds to the materials of nature, form or composition utility, time utility, and place utility. Production thus defined includes the rendering of direct personal services. It has seemed to some that the farmer is more truly a producer than the manufacturer, and the manufacturer than the merchant; but such is not at all the case. All of these industrial classes help at some stage in the process of getting the materials of nature ready for consumption. The miner gets iron ore from the ground, the manufacturer transforms it into stoves, the railway company transports them, and the merchant acquires a stock of them and keeps them until they are wanted. One stage is as essential as another if wants for stoves are to be satisfied. It may well happen that the utilities produced by the merchant could be produced with a smaller expenditure of economic force, and that by a better organization of the factors of production saving could be effected ; but this is no justification whatever for the popular impression that he is not a productive worker. Things are not fully " produced " until they are in the form in which they are wanted, at the place at which they are wanted, and at the time when they are wanted. 116 PRODUCTION 117 In books on political economy we are likely to find that much more is said about the distribution of wealth than specifically about its production. The reason for this is partly that the problems of production are to a very considerable extent a matter of technical progress. How to increase the yield per acre is not specifically an economic problem. Nevertheless the economist is interested in the volume of production compared with the growth in population and in changes in the character of production. Misdirected production is thought to have some- thing to do with economic crises, and changes in the production of gold may explain widespread changes in prices, so that production has in reality received a good deal of attention from economists in connection with their discussion of other sub- jects. In this book, for example, the relation of population to agriculture is considered in the chapter on Wages. The close relation between production and distribution may be further illustrated by the subject of " scientific management " in industry. This means such an arrangement of work, selection of methods, and measuring of individual efficiency within a factory or elsewhere as to produce the maximum output per man. Take the simple operation of shoveling coal or cinders, where this must be done by hand. It has been found that the amount handled per day per man will depend on the weight of the shovel, its size, the amount taken at each lift, and the number of movements per hour. The largest shovelful is not likely to be the most economical. Such inquiries obviously have a rela- tion to the wages which may equitably be paid to different workmen, and representatives of trade unions have looked upon the movement toward the utilization of scientific management with considerable suspicion and hostility as a system of driv- ing men to greater exertion. It would seem that if there is cooperation between managers and trade union officials, total production may be increased and wages may be increased by scientific management without detriment to the individual workingman. On the whole, it is probably true that the subject of production has in recent years been unduly neglected by economists. The Ii8 OUTLINES OF ECONOMICS conservation movement, looking toward the less wasteful utiliza- tion of our natural resources, had its origin outside of economic circles. In recent years, however, the economists are very properly placing more emphasis upon the obvious fact that economic progress depends upon increasing the annual per capita production of wealth as well as upon improving the way in which wealth is distributed among its producers. The Production of Values. — We have said that production means the increasing of economic utility. This is precisely equivalent to saying that it means the rendering of services that lead directly or indirectly to the satisfaction of human wants. And since we are not willing to pay for things that we do not want, it follows that every service for which we are willing to pay must be classed as productive. All money-mak- ing pursuits are, therefore, productive. Except through in- heritance or gift or gambling or fraud or theft one cannot gain an income unless one gives a quid pro quo by rendering productive services or by permitting the use of some productive agent which one owns or controls. But it does not follow that money-making is a measure or gauge of the amount of productive service rendered or that production and acquisition always go hand in hand. For the amount of money that will be paid for commodities and services will depend upon their value rather than upon their utility ; and scarcity, as well as utility, is a factor in determining the value of things. Men can sometimes increase the value of things by curtailing the supply of them, although, of course, this decreases their aggregate utility. In the case of a monopoly, where the power to control the supply of a product is lodged in the hands of a single producer or group of producers, this often becomes a matter of much importance. The case of the Dutch East India Company, which is said to have destroyed half of its spice crop, because the remaining half would have a greater value than the whole would have had, has been cited by many economists. In some fishing centers part of an unusually large catch is destroyed or sold as fertilizer in order that the market price may not be unduly lowered. Most commonly, of course, PRODUCTION 119 limitation of supply is effected by merely producing less than might have been produced and sold at a price high enough to cover expenses. In competitive enterprises, however, no one producer can control the supply of the product, so that in general the only way in which a producer can increase the value of his output is by increasing its quantity and, consequently, its utility. But it should be clear that we may get very different results if we measure the results of productive effort in terms of values from what we should get if we used utility as our measure. From the point of view of social welfare, the production of utilities is, of course, what we are interested in. But we have to recognize that in our modern exchange economy the produc- tion of values is what producers are mainly interested in. In later chapters we shall have to consider more carefully the extent to which these two principles of production are in har- mony, and the ways in which they are in conflict. '^ Factors of Production. — It has been customary to speak of three factors of production — nature, labor, and capital. Under nature are included all forces external to man, as the wind, the movement of water, attraction of gravitation, cohesion, etc. Frequently these things furnished by nature are called simply land, because, of what belongs to external nature, it is with land that we have principally to do in political economy. Of the total land surface of the United States all but about 15 per cent had been appropriated or reserved in 19 13. The unappropriated and unreserved portions were largely in Nevada, Arizona, Wyoming, and New Mexico. Of the total land sur- face, 46.2 per cent was in farms in 1910, and of these farms only 54.4 per cent consisted of improved land; that is, only 25.1 per cent of the total land area was improved farm land. " Im- proved farm land includes all land regularly tilled or mowed, land pastured and cropped in rotation, land lying fallow, land in gardens, orchards, vineyards, and nurseries, and land occupied by farm buildings." If all of the improved land were equally 1 In a literal sense neither utility nor value is "produced." The things produced are commodities and ser^'ices, which have utility and value because they satisfy human wants that would otherwise be unsatisfied. I20 OUTLINES OF ECONOMICS distributed, there would be about five acres for each person in the United States. This figure has decreased slightly in the last quarter of a century, although the historical comparison is made somewhat uncertain by the fact that woodland at the census of 1900, 1890, and 1870 was included in improved land, but was not so included in 1880 and 1910. The production of the leading cereals per acre has not changed much since 1890 and on the whole the per capita production of wheat and corn measured in bushels has not increased since 1880. In other lines of production the per capita story is quite dif- ferent, as will be seen from the following table : Per Capita Production of Selected Commodities^ I 880-1 9 13 Commodity 1880 1890 1900 1910. 1913 Per Capita Wheat production — bushels 8.992 7-732 H-325 7-352 7.868 Corn production — bushels . . . 29.769 29.483 26.722 30.341 2?. 220 Number of cattle on farms . . . .66,s .824 .676 .716 •583 Coal production — long tons . . 1-378 2.257 3-I4S 4.671 Cotton production — 500 lb. bales .114 .123 .136 .144 .152 Pig iron production — long tons . .074 .129 .192 .266 •319 Ton-miles of freight 1227 1799 2626 3106 Labor, as a factor of production, includes human activities of every sort, intellectual as well as physical, which have economic significance. We might better, perhaps, substitute man for labor as the second factor. Labor is supplied by human beings and is different from material goods because it is always con- nected with a personality. Moral and intellectual qualities increase its productiveness. Temperance, trustworthiness, skill, alertness, quick perception, a comprehensive mental grasp, — all these and other qualities belonging to the soul of man are of paramount importance. Man's mere physical strength in itself is a poor thing, being surpassed by that of the lower animals, 1 Compiled from "Statistical Record of the Progress of the United States, 1800 to 1913," in Statistical Abstract of the United States, 1913. Where possible, five-year averages have been used with the census year as the center. PRODUCTION 121 but man is far more productive, and even as a slave sold for more than the lower animals. Man can get but little directly from nature with his unaided hands. The instruments which assist him, as we have seen, are called capital; in other words, capital is every product which is used or held for the purpose of producing or acquiring wealth. By this definition, land is evidently excluded from the category. The nation's capital, then, consists of tools, machinery, busi- ness buildings, transportation systems, raw material, etc.^ Capital cannot be looked upon as an independent factor of production, since it is derived from the labor of man applied to nature. This fact has led some persons to say that capital is simply stored-up labor, but this overlooks the important ele- ment of time required for production with the aid of capital. When we say that to print a book according to present-day methods requires the cooperation of labor and capital, we do not deny that the type-setting machines and printing presses which are used are themselves the product of other kinds of labor applied to nature. To substitute capital for labor may seem to be simply substituting one kind of labor for another. But a long time elapses between the digging of the iron ore and the actual using of the machines in printing, and this means waiting for results on the part of some one. Capitalistic produc- tion, as distinct from simple hand labor, is merely a different method — a roundabout method — of applying human labor to the materials of nature. It is this time element which gives rise to the problem of interest to be discussed in a later chapter. "Capital is an intermediate product of nature and labor, nothing more. Its own origin, its existence, its subsequent action, are nothing but stages in the continuous working of the true elements, nature and labor. They, and they alone, do everything from beginning to end in bringing consumption goods into existence. The only distinction is that sometimes they do it all at once, sometimes by several stages. In the latter case the completion of each stage is marked outwardly by the appearance of a fore-product or inter- mediate product, and capital has emerged. Put, let me ask, is a thing any ^ We may here again caution the reader against confusing these concrete goods with their value. A factory building might sell for $100,000, but the capital is the building itself, not its money value. 122 OUTLINES OF ECONOMICS the less the work of its author that it is not produced all at once, but in in- stallments? If today, by allying my labor with natural powers, I make bricks out of clay, and tomorrow, by allying my labor with natural gifts, I obtain lime, and the day after make mortar and so construct a wall, can it be said of any part of the wall that I and the natural powers have not made it ? Again, before a lengthy piece of work, such as the building of a house, is quite finished, it must naturally be at one time a fourth finished, then a half finished, then three quarters finished. What, now, would be said if one were to describe these inevitable stages of the work as independent requisites of house-building, and maintain that, for the building of a house, we require, besides building materials and labor, a quarter-finished house, a half- finished house, a three-quarters finished house? In form perhaps it is less striking, but in effect it is not a whit more correct, to elevate those intermediate steps in the progress of the work, which outwardly take the shape of capital, into an independent agent of production by the side of nature and labor." i For some purposes it is important to distinguish fixed capital, which lasts for a succession of operations, from circulating capital, which is used up in one act of production. Coal used in a locomotive is an example of circulating capital; the car in which the coal is hauled is fixed capital. The difference is one of degree only.^ Saving and Capital Formation. — From the individual stand- point, saving means the postponement of consumption. To lend to another, and thus secure a claim on his services for the future, is an act of individual saving, but this does not necessarily result in saving from the social standpoint. An act can be termed social saving only when the total social income in the future will be increased thereby. .It is conceivable that this might take the form of merely hoarding up finished consumption goods in anticipation of a famine, but that is not the kind of saving that is typical of modern industrial nations. It is true, 1 Bohm-Bawerk, Positive Theory of Capital (trans, by W. Smart), p. g6. 2 The difference between fixed and circulating capital has to be recognized in the accounting systems of business undertakings. Since the unit of time for which accounting attempts to state costs and profits accurately is usually a year, items of capital which are ordinarily acquired and disposed of ("turned over") within a year are called "current assets," while items of capital whose period of normal use is more than a year are called "capital assets." Both kinds of assets are, of course, capital in the economic sense, except that land is always included in "capital assets." PRODUCTION 123 however, that we frequently produce durable consumption goods which will be used for a long time in the future. The construction of a public library building thus involves real social saving. But true social saving may also take the form of bettering the industrial equipment of society. To provide more and better machines it is necessary to use some of the labor which might be used to increase our present income. If all of the labor now used in the construction of new milling machinery, ovens, etc., were employed in turning into bread all of the flour we now have on hand, we could doubtless greatly increase temporarily our present income in bread, but it would be at the expense of the future income. Thus the saving which results in the formation of social capital requires two things: (i) abstaining from the largest possible income today, and (2) using part of our labor in bettering the industrial equipment. Organization of the Productive Factors. — The three factors, land, labor, and capital, must be brought together for purposes of production. In the case of many farmers and small-scale manufacturers, all three are furnished by the same person, but under our system of private property, a marked differentiation of ownership takes place as industrial development becomes more complex. In a large-scale establishment it is the ex- ceptional case where the majority of the laborers have any share in the ownership of the capital, but generally the owners of the capital are also the owners of the land. In American agri- culture, ownership of the land and the capital by the same person is also common, but in England at the present time it is the rule that the landowner and farmer are different persons. On the other hand, factories are frequently built upon leased ground, and much land is farmed in America by tenants who furnish their own capital. Separation in the ownership of the produc- tive factors makes necessary a distinct valuation of the services of each one of the factors. The Entrepreneur, or Undertaker. — The one who manages a business for himself was formerly called an undertaker, or ad- venturer, but the first word has been appropriated by one small 124 OUTLINES OF ECONOMICS class of business men, and the latter has acquired a new mean- ing, carrying with it the implication of rashness and even dishonesty. We have consequently been obliged to resort to the French language for a word to designate the person who organizes and directs the productive factors, and we call such a one an entrepreneur. The entrepreneur also assumes a large measure of business risks and uncertainties. The function of the entrepreneur has become such an im- portant one in modern society that it is often convenient to regard him as a fourth factor in production, distinct from other classes of laborers. He has been well called a captain of in- dustry, for he commands the industrial forces, and upon him more than any one else rests the responsibility of success or failure. A business which has achieved magnificent success often becomes bankrupt when, owing to death or other causes, an unfortunate change in the entrepreneur is made. ■ The prosperity of an entire town has sometimes been observed to depend upon half a dozen shrewd captains of industry. Division of Labor. — A characteristic feature of the organiza- tion of the factors is what is commonly called a division of labor, but this term suggests a number of related ideas which must be distinguished, (i) We may mention first a separation of occupa- tions, each one being independent of the other, as is shown, for example, in the splitting up of medical work into various special- ties, and again, entirely new occupations are continually appear- ing. (2) We also find production divided into stages, each one giving rise to a commercial product, but not to a finished con- sumption good. This becomes clear if we think of the history of almost any article of daily use : the making of bread pre- supposes the flour and wheat stages. (3) We have in the third place what is most commonly referred to by the term " division of labor," where the productive process is divided into minute parts, and one part given to each laborer. The' organization of a cotton mill affords an excellent illustration : In cotton mills, as in all other textile mills, there are men of skill and ex- perience who superintend or oversee the work in various buildings and in the rooms and yards. These supervisory employees have assistants, and PRODUCTION 125 the division of superintendence is carried down to the sections of rooms, so that all sections have their supervisors, known variously as section bosses, section hands, section girls, and third hands. The following list of occupa- tions will indicate the extent to which division of labor is carried in this industry : alley boys (or girls) ; bundle boys ; filling and roving carriers ; belt makers, blacksmiths, carpenters, machinists, masons, painters, steam fitters, and other mechanics, including sometimes electricians and battery- men ; roll coverers ; helpers ; laborers (unskilled) ; bale openers ; picker hands or cotton shakers ; lap tenders ; card brushers ; first and second breaker hands; finisher pickers; card boys; card hands; waste hands; wastemen ; card clothiers ; card strippers ; card grinders ; combers ; lap- head hands ; doublers ; drawing-frame tenders ; railway-head tenders ; slub- bers ; speeders, fly-frame tenders ; jack tenders ; rovers ; spinners ; bobbin boys; yarn pourers; piecer and doffer; back boy; band boys; doublers and twisters ; winders ; yarn untanglers ; spool boys, white spoolers ; warp- ers; slasher tenders; size makers; reel hands; dye-house hands (with further subdivisions) ; beamers and splitters ; beam carriers ; warp drawers ; harness menders; harness brushers; handers-in; twisters-in; loom fiLxer; pattern makers ; putters-up of samples ; cloth weavers ; weavers of designs ; yarn carriers ; smash piecers ; spare weavers ; inspectors ; trimmers. The finishing of the cloth is a separate industry.^ This form of the divison of labor may also exist without the use of complex machinery, as in the slaughtering and meat- packing industry. "It would be difficult to find another industry where division of labor has been so ingeniously and microscopically worked out. The animal has been surveyed and laid off like a map ; and the men have been classified in over thirty specialties and twenty rates of pay from 16 cents to 50 cents an hour. The 50-cent man is restricted to using the knife on the most delicate parts of the hide (floorman) or to using the ax in splitting the backbone (splitter) ; and wherever a less skilled man can be shpped in at 18 cents, i8§ cents, 20 cents, 21 cents, 22^ cents, 24 cents, 25 cents, and so on, a place is made for him and an occupation mapped out. In working on the hide alone there are nine positions at eight different rates of pay. A 20-cent man pulls off the tail, a 2 2§ cent man pounds off^ another part where the hide separates readily, and the knife of the 40-cent man cuts a different texture and has a different 'feel' from that of the 50-cent man. Skill has become specialized to fit the anatomy." ^ 1 From the Glossary of Occupations in the volume on Employees and Wages. Twelfth Census, Special Reports, igo3. ^ Commons, Trade Unionism and Labor Problems, p. 224, in a chapter appearing originally in the Quarterly Journal of Economics, vol. xix, p. i. 126 OUTLINES OF ECONOMICS Advantages of Division of Labor. — The advantages of a division of labor have been enumerated as follows : (i) A gain of time. A change of operations costs time. Less time is also consumed in learning one's business, as the labor of each is more simple. (2) Greater skill is acquired, because each person confines himself to one operation. (3) Labor is used more advantageously. Some parts of an industrial process can be performed by a weak person, others require unusual physical strength; some require extraordinary intelligence, some can be performed by a man of very ordinary intellectual powers. Special capacities are best utilized, and work is found for all, young and old, weak and strong, stupid and intelligent. (4) Inventions are more frequent, because the industrial processes are so divided that it is easy to see just where an improvement is possible. Besides this, when a person is exclusively engaged in one simple operation, he often sees how the appliances he uses could be improved. Workmen have made many important inventions. (5) Capital is better utilized. Each workman uses one set of tools, or one part of a set, and keeps that employed all the time. When each workman does many things, he has many tools, and some are always idle. (6) Finally, where the division of labor results in the simplification of operations, it facilitates the substitution of machinery with mechanical power in place of direct human labor. It would, for example, probably be impracticable to make a machine which would directly convert leather into finished shoes. But it has been found a relatively simple matter to devise machines which will successfully accomplish each of the successive steps in shoe- making. Such a subdivision and simplification of manufacturing processes is only possible when they are conducted on a large scale. " It is the largeness of markets, the increased demand for great numbers of things of the same kind, and in some cases of things made with great accuracy, that leads to subdivision of labor; the chief effect of the improvement of machinery is to cheapen and make more accurate the work which would any- how have been subdivided." ^ 1 Marshall, Principles of Economics, 6th ed., p. 255. PRODUCTION 127 Effects upon the Worker. — The effect of the introduction of machinery upon wages will be discussed in a later chapter, but here some attention must be given to the effect of division of labor and machinery upon the life of the worker. It is fre- quently said that when labor is rendered simple it loses both its attractiveness and its educational value. A man can enjoy his work when he manufactures a whole watch, bearing the impress of care and skill, but who can like the mere routine of feeding material into some machine? A workingman becomes a mere cog in a great mechanism, driven at a certain speed, day after day, with no further interest in the result of his labor than that it is the source of his daily wage. But much may be said on the other side. To a large extent the heaviest labor is done with mechanical appliances, and those movements which are very simple and regular are precisely the ones which are likely to be taken over by machinery, leaving to human beings the work which requires intelligence and skill. "Looked at broadly, is the average work of a laborer in a machine industry less dignified, less agreeable, less humanizing than it was before the industry reached the machine stage ? From the nature of the question, it is danger- ous to dogmatize, because neither the affirmative nor the negative is capable of being demonstrated. The negative view seems to rest mainly upon the assumption that it is more dignified to be occupied with a great many purely mechanical operations than with a very few. The old-fashioned shoe- maker, for example, was largely occupied with purely mechanical opera- tions, most of them of a very elementary nature, such as a machine can do quite as well as a man. Each of these operations required great concen- tration of attention, leaving him very little opportunity for other forms of mental activity. He was the slave of each particular task as truly as a modern machine worker can be said to be the slave of his single task. But the old-fashioned shoemaker had to turn from one kind of work to another. This increased the difficulty, and, on the whole, required of him a greater amoimt of concentration than is now required of the operator of a machine. The latter, who has but one routine task to learn, learns it easily, and can carry it out without very intense concentration of mind. His mind, there- fore, would seem to be freer than that of the old hand worker, though there was more variety to the work of the latter. Whether this greater variety is to his advantage or disadvantage would be difficult to determine off- hand. It looks as though the operator of a machine in a shoe factory, being relieved of the necessity of acquiring several forms of specialized 128 OUTLINES OF ECONOMICS manual dexterity, would be in a better position for free mental activity than the old-fashioned shoemaker." ^ It seems that those who declaim against factory Kfe do not always distinguish those things which are temporary from things which are inherent in the system. Long hours, insanitary conditions of work, and frequent industrial accidents need not be inevitable accompaniments of the use of machinery. It is the efficiency of machine methods that makes leisure possible for the workingmen, and when they learn to use that leisure sanely, their condition will be far in advance of what it could be under more primitive methods of production. The charge is also brought against machine production that it is antagonistic to the development of art. Machine production means uniform production. It is possible that a growth in the desire for what is beautiful rather than cheap will limit the use of machinery in some directions {e.g. we may insist upon more hand work in the making of furniture), but an extensive use of machinery as a servant of art will always be necessary, and that in two ways : (i) For an appreciation of art there must be leisure, or at least leisurely work, and without machine methods this is not possible for the masses. (2) There is much work that is preliminary to the work of the artist, and that can be done by machinery. Will a building be less artistic because much of the heavy work of dressing the stone is done by machinery ? Taken as a whole, however, we have probably been too much inclined to view progress as something that causes tons per capita to increase by leaps and bounds, rather than as something that improves the quality of our enjoyments. Territorial Division of Labor. — The concentration of a certain industry in a particular region is often called the territorial division of labor, or the localization of industry. Illustrations are seen in the prominence of the boot and shoe industry in Massachusetts ; the collar and cuff manufacture in Troy, New York ; oyster canning in Baltimore ; the manufacture of gloves in Gloversville and Johnstown, New York ; of coke in the Con- ^T. N. Carver, "Machinery and the Laborers," Quarterly Journal of Economics, vol. xxii, p. 230. PRODUCTION 129 nellsville district, Pennsylvania; of brassware in Waterbury, Connecticut ; of carpets in Philadelphia ; of jewelry in Provi- dence, Rhode Island, and Attleboro and North Attleboro, Massa- chusetts ; slaughtering and meat packing in Chicago ; the man- ufacture of plated and britannia ware in Meriden, Connecticut ; and of silk in Paterson, New Jersey. The following causes of localization have been mentioned : (i) proximity to raw material, (2) accessibility of markets, (3) presence of water power, (4) favorable climate, (5) availability of labor, (6) availability of capital, and (7) the momentum of an early start. The explanation of how these causes have operated in particular instances is left as an exercise for the student.^ Productive Organization of the American People. — Accord- ing to the Census of 19 10 about two fifths of the total population and about one half of the population ten years of age and over are engaged in gainful occupations. In the following table the extent to which persons in each age group are gainfully em- ployed is shown for each sex : TABLE I Number and Percentage Engaged in Gainful Occupations for Spec- ified Age Groups of Males and Females : 1910 ^ Males of SpEciriED Age Females of Specified Age Age Number Engaged in Gainful Occupations Number Engaged in Gain- ful Occupations Number Per Cent Number Per Cent 10-13 years 14-15 years 16-20 years 21-44 years ^ 45 years and over . . 3,665,779 1,798,449 4,564,179 17,848,843 9,149,308 609,030 744,109 3,615,623 17,262,209 7,860,593 16.6 41.4 79.2 96.7 85-9 3,593,239 1,770,898 4,632,821 16,331,449 8,224,305 286,946 350,140 1,847,600 4,302,969 1,288,117 8.0 19.8 39-9 26.3 15-7 10 years and over . . 37,027,559 30,091,564 81.3 34,552,712 8,075,772 234 1 Consult Hall, "The Localization of Industry," Census Bulletin No. 244 (also found in Twelfth Census, Manufactures, Part i, p. cxc), and Ross, "The Locali- zation of Industry," Quarterly Journal of Economics, vol. x, p. 247. Also the Federal Census of Manufactures for 1905, vol. i, Chap. xii. 2 Thirteenth Census, vol. iv, p. 69. ^ Includes persons of unknown age. I30 OUTLINES OF ECONOMICS The following table shows the distribution of the gainful workers among the five main classes of occupations. The most striking facts are the decline in the relative importance of agri- cultural pursuits and the increase in the relative importance of trade and transportation. TABLE II Distribution by Main Classes of Persons Engaged in Gainful Occu- pations Class of Occupation 1910 1900 1890 1880 Agricultural pursuits Professional service Domestic and personal service . . Trade and transportation .... Manufacturing and mechanical pursuits 32.9 4.8 14.0 19.9 28.3 35-7 4-3 19.2 16.4 24.4 39-2 4.0 18.1 14-3 24.4 44-3 3-5 L9.6 10.8 21.8 AU occupations 100. 100. 100. . lOO.O The broad territorial division of labor is seen when these per- centages are given separately for groups of states : TABLE III Percentage Distribution of Persons 10 Years of Age and Over En- gaged IN Gainful Occupations, by Geographic Divisions: 1910^ Division New England . . Middle Atlantic East North Central West North Central South Atlantic . . East South Central West South Central Mountain . . . Pacific United States . . 25 2: ^ a H < < < w & H 1-1 -ST! « 2 " 1 fe 2; 5 a « < S H 33 (1< CM Q^ 10.4 0-3 49.1 6.5 10.6 1-7 4.8 10.7 lO.O 4.2 40.6 8.0 12.0 1.4 4.9 11.8 25.6 2.6 33-2 7.6 10.6 I.I 4.8 9.2 41.2 1.8 20.0 7.8 10.4 I.I 5-2 8..S 51-4 1.8 18.6 S-o 6.1 I.O 3-0 lo.s 63.2 1.9 12.4 4.0 5-3 o.b 2.6 8.4 60.1 0.7 12.6 5-2 7.0 0.8 3-3 8.1 32.4 9.4 I9-S 10.3 8.7 1-7 5-2 9-1 22.6 2.4 27.2 10.3 12.6 2.0 6.0 "•3 33-2 2-5 27.9 6.9 9-5 1.2 4.4 9.9 ►J o 1 Thirteenth Census, vol. iv, p. 45. PRODUCTION 131 QUESTIONS 1 . Is the employee in a planing mill in a worse position than the old-time carpenter who has to do his planing by hand ? 2. Is the keeper of a gambling establishment a producer of wealth? 3. Is an insurance agent a producer of wealth? 4. What would happen if there should be too much saving? 5. Why is Massachusetts the center of the boot and shoe industry? 6. Write a survey of national resources and production in the United States from data in the Statistical Abstract of the United States. REFERENCES Ely, R. T. Property and Contract, Vol. ii, Appendix iii. Fisher, Irving. The Nature of Capital and Income, Chaps, v and vi. HoBSON, J. A. The Social Problem, Book ii. Chap, ii ; and Work and Wealth, Chaps, iv-viii. Marshall, Alfred. Principles of Economics, 6th ed.. Book iv. National Conservation Commission, Report (1909). Thirteenth Census, Reports. Statistical Abstract of the United States (annual). Taussig, F. W. Principles of Economics, Vol. i, Chaps, ii-v. Van Hise, C. R. Conservation of Natural Resources in the United States. Veblen, Thorstein. The Theory of Business Enterprise, Chaps, ii and iii. CHAPTER IX CONSUMPTION Consumption Defined. — Consumption means, in economics, the use of goods in the satisfaction of human wants, directly or indirectly. It is the chief incentive to economic activity, but it is not the sole incentive, for such activity is to a certain extent an end in itself. Nevertheless, in economic society as it is organized to-day we are justified in looking upon the consumption of material goods in the satisfaction of human wants as the essential motive and purpose of the production of such goods. Wants are so far from satisfied that most men must work, not because of the pleasure they may derive from the exercise of their capacities, or to utilize fully their natural energies of brain or muscle, but because they need or crave the goods which their wages will buy. Regarded as an incentive to economic activity, consumption should, of course, be defined so as to include the use made of direct personal services as well as of material goods. The philosophy of the consumption of wealth falls only partly within the domain of economics, for the use of wealth is a large part of the problem of life. Passing judgment on the rational standards according to which the true importance of different wants should be measured does not directly concern us in the study of economics. Productive and Final Consumption. — When used without qualification, the word " consumption " in economics is com- monly taken to refer to the use of goods or services to satisfy wants directly. But some goods, such as machines and raw- materials, are used up in the production of other goods. This we may call productive consumption, while that consumption which results directly in the satisfaction of wants is final con- sumption. It is now less necessary than it was in the days of 132 CONSUMPTION 133 Carlyle and Ruskin to insist that food consumed by laborers is not productive consumption. It is true that some analogy lies between the consumption of fuel by an engine and the con- sumption of food by a worker, but there is the very important difference, that the engine is specifically adapted to render economic service and cannot be conceived to derive any benefit whatever from its consumption of fuel, while in the case of the worker the consumption of food is determined with primary reference to his natural appetites and individual welfare. Man is our final term. Human Wants. — In the study of human wants as a starting point in economic theory, two facts stand out prominently : the expansion in the number and variety of wants, and the satiability of any particular one of them. As man has progressed from savagery to civilization, the variety of things he desires and even considers necessary to his existence has expanded enormously. His interests become more varied, his capacity to enjoy becomes larger, and he lives a fuller and more complex existence. There are indeed those who would have us " return to nature " and live a simple life, but taking the world as it is, the expansion of human desires with passing time appears to be without limit. But when we turn to consider some specific want by itself, as it is at any particular time, the matter is different. Our nerves weary of a repeated stimulus, and any attempt to continue indefinitely the enjoyment of some sensation results in satiation. A phonograph record grows stale after a number of repetitions. An apple has differing degrees of utility for any one of us, vary- ing from the highest degree, if we are on the point of starvation, to disgust, if a considerable number have just been consumed. Law of Diminishing Utility. — The fact that the intensity of our desire for additional units of a commodity decreases as we acquire successive units is of fundamental importance in economic science. And this " law of diminishing utility," as it is called, rests upon a broader basis of human experience than the mere satiability of the appetite for a particular kind of food, or the growing weariness of the nerves under the repetition of a partic- ular stimulus. The truth is that most commodities serve a 134 OUTLINES OF ECONOMICS multitude of different needs and different purposes, and that these needs and purposes vary greatly in their importance. It is better to have two suits of clothes than to have one, but it is by no means twice as important. And a third, or a fourth, or a tenth suit, are, in order, of rapidly decreasing importance. How large shall my building lot be? How many rooms shall I have in my house? How much electric current shall I use for lighting purposes? How many motor cars shall I own? How many servants shall I employ? Questions such as these at once suggest the way in which a certain minimum amount of a given commodity or of a given service may be deemed ex- ceedingly important for our purposes, and how a diminishing importance is attached to successive additional portions or increments. So far as any one commodity is concerned it is in general less important to have more than to have some. To guard against possible misunderstanding a word of caution is necessary at this point. With passing time the use of a partic- ular commodity often cultivates a taste for it, so that an increased supply is more urgently desired than were the earlier increments. Thus familiarity with good books or good pictures or good music may increase the pleasure that we find in such things, and so may intensify our desire to have more. And bad habits, like good ones, are prone to " grow on us." Such, for example, is the case in the use of habit-forming drugs. But these facts do not contradict the law of diminishing utility. For that law relates only to the consumer as he is at any given time, with whatever possessions, habits, desires, and aversions are his at that time. Men change and their wants change, and the character of a man's consumption is, of course, a very important factor in changing his wants. But just now we are considering men as potential buyers of more goods or sellers of surplus goods in a given market at a given time, and for men so considered the law of diminishing utility expresses a fundamental truth of very great significance. A thoughtful reader may object that in view of the considerations urged in the preceding paragraph such illustrations as that of the satiety resulting from eating a number of apples are not exactly to the point, for when the CONSUMPTION 135 hungry eater of apples becomes a satiated eater of apples, he is, in that respect, a "changed person." It is true that some expositions of the prin- ciple of diminishing utiHty attach altogether too much importance to what have been called "dinner-table illustrations." But the real point in the matter is that the satiation of the appetite is a famihar fact of experience, which has an important bearing upon the character of our wants as they manifest themselves at any one time. If I am hungry, but have six apples, I will give less for another apple than if I had only one. Marginal Utility. — It must be evident, therefore, that to say that a certain thing possesses utiHty is very indefinite. That merely tells us that it is capable of satisfying some want, per- haps important, perhaps unimportant. And, furthermore, one may use some units of a commodity in the satisfaction of very important wants, and other units of the same commodity in the satisfaction of relatively unimportant wants. This amounts to saying that for any one person different units of the same commodity may possess very different degrees of utility. The utility of the final or marginal unit of a person's stock of a given commodity is called the marginal utility of that commodity to that person. If, for example, a boy has six apples, the marginal utility of apples to him is simply the utility (or want-satisfying capacity) of the sixth apple. This does not mean the utility of any particular apple, but does mean (if the apples are all alike) the utilit}^ dependent on the possession of any one apple of his stock of six. This will be less than if he had fewer apples, and more than if he had a larger number. So with a householder who has a stock of ten tons of coal for his winter's supply. The tenth ton (any one ton of the ten) is the marginal ton ; and the utility it adds is the marginal utility of coal to the householder. Marginal utility thus depends upon the intensity of the want dependent for its satisfaction upon the possession of one unit of a commodity. The larger one's supply of a commodity, the smaller in general will be the importance one attaches to the possession of any one unit of the supply. Some writers prefer to define marginal utility as the utility of an addi- tional unit of a commodity rather than as the utihty of the last unit of one's present stock. In some apphcations of economic analysis it is convenient to think of the successive units or increments in the supply of a commodity 136 OUTLINES OF ECONOMICS as indefinitely small. In this case the difference beween the "last unit" and an "additional" unit becomes negligible. But for many purposes it is more convenient to think of the size of our successive increments as being that of the ordinary units in which goods are customarily bought and sold. ' In such cases whether the "last unit" or the "additional unit" should be considered the marginal unit depends upon whether we think of the individual concerned as a possible seller or a possible buyer. If the boy with the apples is weighing the desirability of having yet another apple against that of some peanuts he would have to part with in exchange for it, the marginal utility of apples to him may properly be said to be the utility of the additional apple, for this is the basis of its subjective impor- tance for the purpose in hand. But if he is contemplating the exchange of an apple for additional peanuts the marginal utility of apples to him depends upon the importance of the sixth apple. It is always accurate to identify marginal utility with the utility of the last unit of a stock, if we remember that in some cases it is the last unit of an existing stock and in other cases the last unit of a (possibly) increased stock. Marginal Utility Illustrated. — A clearer notion of marginal utility may be given with the help of Figure i, following. We take for our illustration the consumption of water, which has numerous uses of various degrees of im- portance. We have marked off different portions of the base line representing quan- tities of water available for man's use. The first quan- tity, ah, is just enough for drinking purposes. Sup- pose this is all the water to be had. There will be no question of sprinkling lawns or even of bathing under such circumstances. What will be the utility of water? Evidently the extent of the service which it renders us, and as this is the preservation of our life we cannot estimate it. We will indicate it by the area above the line ah which runs upward indefinitely as the curved line fails to close in. What will be the importance of another portion of water at this point of supply? As this additional portion which we CONSUMPTION 137 desire is not needed for drinking but for a less important pur- pose, the marginal utility of the water will now depend upon the urgency of this less-important want. Now suppose we have three portions of water, represented by the lines ah, be, and cd. We now have enough for all our wants, down to sprinkling the lawn and the street. We are willing to pay something for more water for this purpose, but how much ? As much as when we had only water enough to drink ? By no means. The next want on our list is comparatively unimportant, and of course we appraise an increased supply accordingly. With two or three more portions of water all our wants are satisfied, and the marginal utility of water will have become zero. As the amount of water is increased, the utility falls according to the curved line hi, till finally it touches the base line, where the marginal utility of the water vanishes. Subjective Value. — As we proceed in our study we shall see that the most important problem of economics is that of as- certaining the laws which determine the prices of different goods and services. To some goods and some services more impor- tance is attached than to others, and larger quantities of the less important goods and services can be obtained in exchange for smaller quantities of the more important goods and services. This is a matter of prime significance, since it determines the way in which the different persons who contribute goods and services to the aggregate wealth-product of the community will be able to secure shares in it. We are not yet ready to attack the general problems of value, but we can take an important step forward at this point by grasping the meaning of subjective value. The subjective value of a good is not, of course, a definitely measurable objective quality of the good, like weight or exten- sion. It is, as the word " subjective " implies, purely psycholog- ical, and may be different for different persons. It is, moreover, purely relative. The subjective valuation of things always implies the choosing of some things rather than others. In other words, it involves a determination of their comparative 138 OUTLINES OF ECONOMICS importance for one's own purposes. More formally stated, the subjective value of a good to any person is that person's estimate of the importance of possessing that good as compared with the im- portance of possessing other goods. But we do not value things in the abstract, or in indefinite quantities. In buying coal or sugar or oranges we do not have to confront the alternatives of either doing entirely without such commodities or acquiring an indefinitely large supply. If we decide to buy at all, we may buy as little as we please. Our choices, in practice, resolve themselves into questions of more or less. Even in the case of an indivisible good — an auto- mobile, for example — one may choose between having more or less of certain desirable qualities, such as size, or power, or attractive finish. And it is evident that whether the importance that we attach to the possession of an additional unit of a cer- tain good is greater or less than the importance that we attach to an additional unit of some other good will depend, very largely, upon the extent to which our wants for each of the goods in question are satisfied without the possession of the additional unit. Put in other words, the question is : Which good has the higher marginal utility? Subjective value, then, involves a balancing or comparison of marginal utilities. In fact, we may say that the subjective value of a good is the expression of its relative marginal utility. In this statement the word relative is used in order to emphasize the element of comparison or choice. / The Subjective Value of a Stock of Goods. — It shouid be carefully noted that marginal utility tells us nothing about the total subjective value of one's whole stock of the commodity. It refers solely to the present value of an additional unit, or the sacrifice that would be occasioned by the loss of a unit. We cannot get the total subjective value of a stock of goods by mul- tiplying the marginal utility by the number of units, even though they be all alike. The very term " marginal " tells us that the conception implies successive additions, and the present im- portance of one unit tells us nothing definite about the im- portance of the other units. If we wish to ascertain the total CONSUMPTION 139 subjective value of a stock of a commodity, we have simply to treat it as one large unit, and ask what would be lost if it were taken away. By this test all air would be found to have an immeasurable utility, at the same time that the subjective value of an additional cubic foot would be nothing. Thus it will be seen that the cause of subjective value is utility under a condi- tion of scarcity ; that is, such a limitation of the supply that not all wants can be satisfied. The Economic Order of Consumption. — What has been said regarding the way in which our individual estimates of the im- portance of a commodity are determined will help to explain how we make our choices in attempting to obtain the largest la lb Ic Id le 2. a 21) 2c 2d 2e Fig. 2 Fig. 3 amount of satisfaction with the income at our disposal. Evi- dently we must spend each succeeding dollar for purchasing that commodity of which a dollar'^s worth will give the greatest satisfaction. Let Figures 2 and 3 show the declining impor- tance of two commodities which an individual is consuming, and suppose that each unit of each commodity costs one dollar. If the individual has ten dollars to spend upon these two commodi- ties, his order of consumption will be as follows : he would begin with 2a, but another unit of commodity 2 would give him less satisfaction than a unit of commodity i. Hence, his consump- tion will continue as follows : la, 26, 2C, ih, IC, id, 2d, 26, le. 140 OUTLINES OF ECONOMICS In this illustration it was assumed that a unit of each com- modity had the same cost. In this case, the unit consumed is always the one that has the largest utility. But where the cost of the units is different, cost must be considered also, and we commonly do so by asking ourselves whether the thing we are buying is worth as much as other things which could be obtained with the same expenditure. Thus we are constantly abstaining from the further consumption of one thing, not because our wants for it are fully satisfied, but because some- thing else of equal cost appears at that moment to be more important. Future "Wants. — Not all of the goods for which we strive are wanted for present consumption. We recognize that we shall \ la \ lb \ Ic \ Id \ le Sh 2d 2e ^ Fig. Fig. s have needs next month or next year, and we attempt to make some preparation for them. These future needs, it is true, usually appeal to us less vividly than if they were present, but we attach a present importance to them and grade them, and they enter into our calculations when we spend money, modifying the order of our consumption. This will be seen from Figures 4 and 5. Let us suppose that in Figure 4, a, b, c, d, e represent the diminishing importance of successive units of a commodity for present consumption, and that Figure 5 shows the present importance attached to the future consumption of similar units. Then an individual would consume la, i.e. in the present. But a second unit for present use would rank lower in present esteem than a unit saved for future use. The unit 2a would CONSUMPTION 141 then be saved, and then the order would be as follows : ib, 2b, ic, etc. Thus this individual has saved two out of five units, i.e. 2a and 2b, with the same sort of, mental calcula- tion as he would use in deciding to spend a nickel for a peach rather than for a pear. But if some one should ask him to spend his fifth dollar for 2c instead of for ic, he would require some extra inducement to induce him to postpone at ruHng prices. It thus appears that a certain amount of saving is done without payment, but if saving is to be carried beyond a certain point, it must be given some special premium or compensation. This, as we shall see later, has a very important bearing upon the problem of interest. The Margin of Consumption. — Either by a conscious balancing against each other of the pleasures to be obtained from two or more possible pur- chases, or oftener, by simply buying the things which we want more than we want other things, we tend to keep our unsatisfied wants in a state of ap- proximately equal intensity. We apportion our expenditures so that our money will "go as far as possible"; that is, so that it will provide those things that have the strongest present appeal to us. Every person thus has a margin of consumption, which is measured by the utility obtained in return for the final or marginal dollar expended for any one of the things that he consumes. If he unwisely expends too much for any one thing, his more important unsatisfied wants for other things press upon him urgently, and he is apt to try to restore the balance or equilibrium in his expenditures, or, in other words, to bring his margin of consumption into alignment. An individual's margin of consumption depends primarily on his income, but also on his tastes and habits, his disposition to save, and the relative emphasis which he places upon his present and his future wants. Then, too, one's desires are constantly changing under the influence of whim, fashion, satiety, sellers' advertising, education, travel, reading, and new experiences of all kinds. Expenditures of all kinds are thus called into being by the necessity of maintaining the level of the margin of consumption. The margin of consumption is different for different persons. This is partly a matter of differences in individual tastes and purposes, but it is more largely a matter of differences in incomes. The larger one's income, the lower, of course, is one's margin of consumption, in the sense that one is able to acquire goods in larger quantities and thus to satisfy wants of less urgency. And, of course, a larger variety of commodities can be con- sumed, so that as one's income increases one's margin of consumption is normally extended downward and outward, including more things, but things of less importance. 142 OUTLINES OF ECONOMICS Consumption and Saving. — It is difficult to say just where consumption should stop and saving begin, to secure the best results for society as a whole, but the principle is clear. So much, and only so much, should be saved as will conduce to a maximum total service over long periods of time. The present generation might deny itself everything except the barest neces- sities, and labor to increase the productive equipment to be used in the future ; but the next generation could not pursue the same policy, for some one must consume the products of the factories built today, otherwise the building of them is wasted effort. Alleged Present Consumption of Future Products. — We often hear of consumption in advance of production. It is said people live on the future. It is frequently argued that during the American Civil War we were consuming faster than we were producing. It is alleged that the government borrow- ings at that time represented the consumption of future earnings. But it must be apparent that it is impossible to consume faster than we produce unless we consume past savings by not replacing worn-out equipment, or by failing to maintain the customary stocks of goods, or unless we borrow from other nations. We cannot eat today the wheat or potatoes of tomorrow, nor can we wear coats before they are made. What is alleged can never be true except of the individual consumer within the nation, or of the nation as a whole when the capital or other wealth of the country is diminishing, or when its foreign debt is in- creasing. What really happened at the time of the Civil War was this : we as a nation became indebted to some extent to foreigners, and within the nation some of us gained while the rest were losing. Government borrowings do not represent a present consumption of future wealth, but a special present use of purchasing power for which a government agrees to re- munerate its owners in the future. If war can be carried on with the aid of borrowings, it can, — leaving out of considera- tion what foreigners send, — with a sufficiently perfect taxing machinery, conceivably always and practically sometimes, be carried on without borrowing. It is only a question of how to get hold of the means of producing powder and bullets and the CONSUMPTION 143 necessaries of life. War was formerly carried on without bond issues ; they are a comparatively recent contrivance. Consump- tion can never anticipate future production for the nation as a whole taken by itself ; it can only anticipate future ownership. Luxury. — Luxury is the name of a vague something which society has always viewed with a sense of mingled tolerance and condemnation. What is its meaning? In the first place, it is clear that people ordinarily consider as luxuries many things in themselves innocent and desirable, as handsome dresses, jewels, pictures, etc. No one but an ascetic will condemn as wrong in themselves things that appeal to taste and finer appre- ciations, and yet we feel that the use of such things is not always justifiable. Second, the popular idea of luxury recognizes a difference in persons. We cannot help condemning in one person what we approve in another. Third, we judge luxury differently at different times. There is a continual transfer of articles from the list of luxuries into that of comforts and necessities. This transfer is brought about by the consensus of social judgment, and is increasingly acquiesced in by all. So we see that the term " luxury " does not apply to goods of a certain character, but to certain goods in their relation of time and person. For the purpose of discussion, we shall define luxury simply as excessive personal consumption. Our definition of luxury as excessive consumption necessarily condemns it as unjustifiable, but this should not be taken as a condemnation of an enjoyment of more than the simplest kind of life. There would be little purpose in producing wealth in larger and larger volume if it did not mean a higher and better standard of life. But this meaning does not justify the squandering of immense sums on passing caprices whose satis- faction cannot be justified from the standpoint of what is a sane life. Nor does it constitute a defense of ostentatious ex- penditure. Extravagant expenditure is sometimes condoned on the ground that it gives employment to labor, but obviously just as much employment would be given to labor by an equiv- alent expenditure for laudable purposes. Expenditures for any present gratification can be made only by reducing the 144 OUTLINES OF ECONOMICS amount either of other expenditures or of savings. Rarely in these days are savings hoarded : they are used for gainful, often for socially productive, purposes. Extravagant expenditures, therefore, may divert productive agencies into employments less beneficial to society. Moreover, to look upon expenditure as desirable because it gives employment to labor, or " puts money in circulation " and " makes trade good," is to forget that, ethically viewed, production is justified only through the satisfaction of human wants, and so far as the wants satisfied are trivial or worse the necessary productive effort is virtually wasted. Harmful Consumption. — We have been careful to avoid the impression that luxury consists in the use of pernicious goods. It is a common query, " Why should I not have this if it does me no harm? " This we have tried to answer in the preceding paragraphs. A luxury may be a positive good in itself, a satis- faction which society may weU hope to make general, but it is a good which society cannot yet afford, because other and greater wants are yet unsatisfied. But there is another kind of con- sumption which is objectionable in an entirely different way, not because it is excessive or premature, but because it is harmful in itself. Aside from the fact that such consumption usually tends to diminish the sum total of the durable satisfactions that the consumer gets out of life, it ordinarily lowers his productive efficiency, and this involves a further loss to himself, to any who may be dependent upon him, and to the whole community. Statistics of Consumption. — Instructive investigations have been made as to the relative importance of the leading items in the family budget. The late Ernst Engel, the former dis- tinguished head of the Prussian Statistical Bureau, advanced the theory that it might be possible by a careful study of a suffi- cient number of family budgets for a period of years to indicate the broad changes in consumption, and thus by a sort of social signal service to predict the coming of industrial storms. Noth- ing has been so far accomplished along this line, but Engel's tables are important in other ways. From Table I (page 145) he deduces the following four propositions : . CONSUMPTION 145 1. The greater the income, the smaller the relative percen- tage of outlay for subsistence. 2. The percentage of outlay for clothing is approximately the same, whatever the income. 3. The percentage of outlay for lodging or rent, and for fuel •and light, is invariably the same, whatever the income. 4. As the income increases in amount the percentage of out- lay for sundries becomes greater. TABLE I Engel's Statistics — Saxony Per Cent of the Expenditure of the Family of Items of Expenditure A Workingman with an Income of from $225 to $300 a year A Man of the Middle Class with an Income of from $450 to $600 a year A Man in Easy Circumstances with an Income of from $750 to $1000 a year 1. Subsistence 2. Clothing 3. Lodging 4. Heat and light .... 5. Education, pubKc worship, etc 6. Legal protection .... 7. Care of health 8. Comfort, mental and bodily recreation Total .62.0 16.0 12.0 S-o 2.0 i.o I.O 9S-0 S-o SS-ol 18.0 12.0 S-o J 3-5 2.0 2.0 2.5 J 90.0 50.0 18.0 12.0 S-o S-5 3-0 3-0 3-5 J 85.0 15.0 The reader will perceive that if Engel's table, published in 1857, had been constructed in recent years, somewhat different limits would have to be set for " middle class " incomes even in Germany. Subsequent investigations in the United States have confirmed in a general way the conclusions of Engel, but the correspondence is not exact, as will be seen from Table II, from the reports of the United States Bureau of Labor, summarizing the expendi- ture of over two thousand families in 1891 and over eleven thousand in 1903. L 146 OUTLINES OF ECONOMICS Table III gives the results of a careful study of the budgets of 383 families in New York. TABLE II Expenditures of American Families Investigated by the United States Bureau of Labor (From the Seventh [1891] and Eighteenth [1903] Annual Reports) Per Cent of Total Expenditure Income Group Food Clothing Rent Fuel and Light Miscella- neous 1891 1903 1891 1903 1891 1903 1891 1903 1891 1903 Under $200 $200-300 . $300-400 . $400-500 . $500-600 . $600-700 . $700-800 . $800-900 . $900-1000 $1000-1100 $1100-1200 $1200 or over 49.6 44-3 45-6 45-1 43-8 41.2 38.9 38.1 34-3 34-7 30-7 28.6 50-9 47-3 48.1 46.9 46.2 43-5 41.4 41.4 39-9 38.8 37-7 36.5 12.8 14-3 14.1 14.4 15-3 15-9 16.3 iS-i 16.8 17-5 16.5 iS-7 8.7 8.7 lO.O 11.4 12.0 12.9 I3-S 13-6 14.4 iS-i 14.9 iS-7 15-5 14.7 15.0 iS-3 15.2 iS-S 15-6 16. 1 14.9 iS-i 12.2 12.6 16.9 18.0 18.7 18.6 18.4 I8.S 18. 1 17. 1 17.6 17-5 16.6 17.4 8.1 7.6 7.0 6.6 6.6 S-9 5-3 5-3 4-7 4-5 3-9 3-0 8.0 7.2 7-1 6.7 6.2 5-8 5-3 5-0 S-o 4.9 4-7 5-0 14.0 19.2 18.3 18:6 19.I 21.6 23-9 25-S 29.1 28.1 36.7 40.1 •iS-6 18.8 16.1 16.S 17.2 19.4 21.6 23.0 23.2 23-7 26.1 25-4 All . . 41.4 43-1 iS-3 13.0 iS-i 18.1 5-9 5-7 22.7 20.1 Consumption and Sacrifice. — Over against the enjoyment resulting from wealth consumption lies the discomfort of wealth production. Enjoyment, we have seen, grows less and less as the consumption of a partic- ular good is continued, but the irksomeness of producing it, on the contrary, grows greater and greater the longer labor is con- tinued. Let us take the case of Robinson Crusoe picking berries. We may represent the diminishing utility of the berries to him by the line ab (Fig. i) , and the increasing irksomeness of picking them by the line cd. Fig. CONSUMPTION 147 TABLE III Expenditures of Families in New York City : 1907 ^ is Expenditures Income Group Food Cloth- ing Rent Fuel and Light Insur- ance Health Carfare Sun- dries Per cent Per cent Per cent Percent Per cent Per cent Per cent Per cent $400-499 8 40.8 13.0 26.8 5-6 1.2 3-1 2.6 6.9 $500-599 17 44.4 12.4 25-9 5-9 1-3 1.9 1.8 6.4 $600-699 72 44-6 12.9 23.6 S-« 2.0 2.1 1-7 7-3 $700-799 79 45-6 13-4 21.9 5-0 2-5 1.9 1-5 8.2 $800-899 73 44-3 14.0 20.7 5-0 2.2 2.7 2.0 9.1 $900-999 63 44-7 14.6 19.0 S-i 2.6 2.6 1-5 9.9 $1000-1099 31 44-7 I5-S 18.1 4-S 2-5 i-S 1.8 11.4 $1100-1199 18 45-6 14.9 16.2 3-« 2-5 3-6 1.9 "•5 $1200-1299 8 45 -o 15.2 19.8 3-H 2.2 1-3 2.2 10.5 $1300-1399 8 43-6 13-7 16.8 3-6 4.9 I.I I.I 15.2 $1500-1599 6 36.8 16.8 16.3 4.1 2-3 7-4 1.2 15-1 He would not pick more than Ox, because the xth berry costs him just as much pain as it yields him pleasure, and any further continuance of gathering fruit would result in an excess of pain. The degree of utility represented by mx, then, repre- sents, at the moment that the rrth berry is picked and eaten, both the marginal utility and the marginal disutility, or marginal pain or sacrifice. Each of us has sometimes made such comparisons — bal- ancing the pleasure of further consumption against the pain of further production. Many persons who are working eight or ten hours a day could increase their income somewhat by work- ing twelve hours, but the • additional discomfort is greater in their estimation than the additional fruits of their labor would be worth. To be sure, much of our economic action goes on unconsciously. We accept a position, comparing its advantages and its disadvantages in a general way with those of other openings, but once we enter upon the work, we accept the daily grind as inevitable, and, in spending our income, think ' R. C. Chapin, The Standard of Living in New York City, p. 70. 148 OUTLINES OF ECONOMICS not of the sacrifices it has cost us, but simply of how we can get the maximum satisfaction from it. In discussing future wants we saw that postponing the con- sumption of goods from the present to the future came to re- quire compensation only after a certain amount had been saved. Under present methods of production, it was explained in the preceding chapter, a large amount of this postponement of consumption is required. Machines must be made, and the result of this labor cannot be enjoyed until these machines have been used up in making finished products. This means that some one must wait for the result, and in^many cases be paid to do it. Thus production may require, in addition to com- pensation for labor, a payment for waiting. This is a point which will be discussed further in the chapter on interest. Cost of Production, Expense of Production, and OT»portunity Cost. — The preceding paragraphs explain one important sense in which the term " cost of produfction " is used, i.e. (i) the subjective cost of irksome labor or reluctant waiting. But (2) the phrase is also commonly used to refer to the expense oj production, that is, the amount of money spent in producing a commodity. (3) A third meaning is also found, which has been termed opportunity cost. Let us say that a person is confronted by the alternative of engaging in either of two occupations. He may become a lawyer or he may become a merchant, but he has not the time to be both. If he chooses to be a lawyer, he sacrifices his opportunity of being a merchant. Cost in this sense is sometimes called " alternative cost," or " displace- ment cost." This is not an ultimate cost, but it probably has a more direct and more important influence upon most of our economic choices and decisions than has any other kind of cost. Moreover, in the actual conduct of life opportunity cost and direct cost are generally inextricably blended. The increasing irksomeness of Crusoe's task of picking berries, for example, may be deemed to have been caused in large measure by the pressure of other demands upon his time. We haven't time enough to do all the things we should like to do, and so we have to apportion our time according as we think that one use of CONSUMPTION 149 it or another is the more important. And, in general, we try so to apportion our time that the fruits of the last or marginal increment of time devoted to any one purpose shall have no more or no less utility than those of the marginal unit of time devoted to any other purpose. Taking " leisure " as a collective name for all of the non- economic uses of time, that is, for all uses of time for other than productive or money-making purposes, it appears clearly that a worker with free command of his time will carry his chosen line of effort up to the point (or margin) where leisure attracts him as much as the products of his exertion, or, in modern economic life, as the* things he can acquire with the money he earns. As in the expenditure of money, so in the expenditure of time and effort : we tend to bring our expenditures up to margins wtere utilities gained and utilities sacrificed or foregone are equal. QUESTIONS AND EXERCISES 1. If you had four sacks of corn all alike, could you tell which is the marginal one? 2. May one properly speak of the marginal utihty of an indivisible good,^ a house, for example? g. If an individual estimates his present wants as 10, 8, 6, 3, i, and his future wants as equivalent to the present value of 9, 7, 5, 2, o, and if he has $9, and if each want is satisfied with $1, how many dollars will he save? 4. Give as many expressions as possible that are equivalent to the term "subjective value." 5. Comment on the following: "Doubtless the best thing to do about^ them (the spendthrifts) is to do nothing — not even to worry about their waste of money. Their waste of money, in fact, is the least silly thing they do, for the money is in constant flux and serves its purpose." World's Work, June, 1906. 6. Comment on the following words of Adam Smith : "Nothing is more useful than water; but it will purchase scarce anything; scarce anything can be had in exchange for it. A diamond, on the contrary, has scarce any value in use, but a very great quantity of goods may frequently be had in exchange for it." Wealth of Nations, Book I, Chap. iv. 7. Point out the differences in the tables of consumption statistics quoted in the text. How do they modify Engel's statements ? Suggest explanations of these differences. ISO OUTLINES OF ECONOMICS REFERENCES Bohm-Bawerk, E. von. Positive Theory of Capital, Book iii, Chaps, iii and iv. Chapin, R. C. The Standard of Living in New York City. Davenport, H. J. Economics of Enterprise, Chaps, vii, viii. HOBSON, J. A. The Social Problem, Book ii, Chap. vii. Jevons, H. S. Essays in Economics, Chaps, ii, iii. Marshall, Alfred. Principles of Economics, 6th ed., Book iii. Mayo-Smith, Richmond. Statistics and Economics, Book i. Chap. ii. More, L. B. Wage-Earners' Budgets. Rowntree, B. S. Poverty, Chaps, vi-viii. Streighthoff, F. H. The Standard of Living among the Industrial People of America, Chap. ii. Urwick, E. J. Luxury and Waste of Life, Chap. iii. Veblen, Thorstein. The Theory of the Leisure Class. Watkins, G. p. Welfare as an Economic Quantity, Chaps, i, iv. WiCKSTEED, P. H. The Common Sense of Political Economy, Book i, Chaps. i, iii. Withers, H. Poverty and Waste, Chap. viii. PART II VALUE AND EXCHANGE CHAPTER X VALUE AND PRICE If every family produced all the goods needed to supply the wants of its members, most of the problems which today con- front economic science would not exist. Most of the world's workers are, however, contributing their services either directly or indirectly (through the production of goods) toward the satisfaction of the wants of others. One's economic well- being today depends primarily on two things : the money in- come which can be got from others in return for one's services or for the use of one's land or capital, and the amount of things that can be bought with this money income. The federal census of 1 910 showed that about 93 per cent of the men over twenty years old and about 18 per cent of the women of corresponding age were employed in money-making occupations ; and this number does not include those landlords and capitalists whose income was derived entirely from their investments. The work of the housewife and the services of friendship embody utilities, that is, satisfy human wants, just as do money-making activities, but they are not reported in terms of dollars and cents. The production of wealth is in these days mostly " for the market," and wants are satisfied very largely by goods obtained from the market. In the vast interlocking system of modern economic life most goods get from those who produce them to those who use them by the processes of exchange. The Meaning and Significance of Value. — It rarely happens nowadays that goods are directly exchanged for other goods. 151 152 OUTLINES OF ECONOMICS Goods are usually sold for money/ and the seller uses the money in the purchase of other goods. The amount of money for which a unit of a given commodity exchanges is the price of that commodity. Since prices vary, when we wish to name the actual price of any commodity we must specify the price in a given market at a given time. From this simple and familiar concept of price there has been developed the more general concept of exchange value. If a hat sells for two dollars, a pair of shoes for four dollars, and a pocket knife for fifty cents, we say that the exchange value of the hat is half that of the pair of shoes and four times that of the knife. It thus comes about that we attribute exchange values to goods in accordance with their relative potency in exchange, as shown by the prices at which they sell. In this way values come to be thought of as magnitudes. Just as weight and volume are physical magnitudes by which we express the rela- tive heaviness and the relative bulk of different objects, so ex- change values are economic magnitudes or, more specifically, exchange magnitudes. The exchange value of a good is thus the resultant of its exchange relations with other goods. Exchange value is a purely relative or comparative magnitude, and there is no way of expressing or measuring the exchange value of a good except in terms of its command over other goods. In such a measurement exchange value can be expressed either as a quantity or as a ratio. We can say (i) that the value of a pair of shoes is that of eight knives or (2) that the value of the shoes is to the value of a knife as eight is to one. We thus express the exchange value of any good either by stating the quantity of other goods that can be obtained for it or by stating its ratio of exchange with other goods. The exchange value of any one commodity can, of course, be expressed in terms of any other commodity. Price is a statement or expression of exchange value in terms of money. To say that the price of a pair of shoes is four dollars amounts to saying that the value of the pair of shoes is four times the value of a dollar. When the words 1 In this chapter the word " money " is used in its broadest sense, thus including credit instruments, which are, of course, merely promises to pay money. VALUE AND PRICE 1 53 " value " and " price " are used interchangeably, as will some- times be our practice in this book, there is implied the assump- tion that the value of money as expressed in terms of other things than the particular commodity we are discussing is constant, — an assumption which, of course, does not entirely correspond with the facts. Exchange values are determined by what may be called the "price process." This term is used in a narrow sense as referring to the fixing of the money values of commodities ; in a broader sense it includes also the determination of the different rewards received by those who have contributed to the production of these commodities. In this broad sense the prob- lem of prices is the problem of the distribution of wealth. Imagine the case of a mechanic employed at a particular time in the manufacture of machinery that will be used in a flour mill. The final product of the mechanic's labor — the only product directly useful in the satisfaction of human wants — is the flour, or bread made from the flour. To the making of this final prod- uct thousands besides our mechanic — farmers, agricultural la- borers, railway officers and employees, other mechanics, and so on in a practically endless list — have contributed. What deter- mines the price of the final product? What proportion of this price goes to the mechanic ? What is his share worth to him as the means of getting the necessaries of life? Of these three ques- tions, the first and third fall within the problem of the prices of commodities ; the second, relating to the wage-price of the mechanic's services, falls within the problem of the distribution of wealth. At present we are concerned only with prices in their narrower sense, although the principles to be developed apply also in the case of the prices paid for the services of the factors in production. The significance of the subject of value in economic science lies in the fact that, within the conditions set by existing institutions, and within the limits set by the total production of wealth, human welfare, so far as it is dependent upon the pos- session of economic goods, is largely determined by the process of fixing price relations. The Market. — It is conceivable that the prices of goods 154 OUTLINES OF ECONOMICS might be fixed by public authority, or that the production of the most important commodities might be monopohzed. Then, too, it is possible to imagine a condition of society in which custom should have such power that prices, when once estab- lished, would be changed very infrequently. Still another possibility is a regime of competition in which every man is left free to buy and sell as he pleased at such prices as he can get. The first three factors — public authority, monopoly, and custom — are among the things which determine the ratios at which goods are actually exchanged today ; but the dominant factor is the fourth one mentioned — the free competition of the market. In this connection we mean by the market, not a particular place for buying and selling, but the general field within which the forces determining the price of a particular commodity operate. For some commodities, especially perishable ones, like fresh milk and cream, the market is distinctly a local one. In the case of great staple commodities like wheat and cotton, the market is a world market, for it is impossible that the prices of wheat or cotton in Europe should differ for any considerable time from their prices in America by more than the expense of transport. So-called " international " securities, such as government bonds and the stocks and bonds of certain great corporations, afford even a better example of goods for which the market is a world market. Some commodities are used only in a particular locality or country, although produced in many different places. The American consular reports frequently contain advice to Ameri- can manufacturers as to special kinds and varieties of goods used in different foreign countries. The cotton mills of England, Germany, and the United States all make special grades of cotton cloth designed especially for the Oriental market. Much more numerous, however, are the goods which, although of wide and general consumption, are produced in but few localities. This is especially evident in the case of agricultural and mineral products, but it is increasingly noticeable in manufactures. Along with this localization of industry there has been a broadening of the field of consumption of many commodities. VALUE AND PRICE 155 Among the factors which have contributed to this result may be mentioned, first, the increasingly cosmopolitan character of modern life, — a result of more generally diffused facilities for higher education, as well as of the growing ease of travel and communication ; and secondly, what has been called the " standardization of taste," — a result in part of modern ad- vertising methods and of the standardization of products which is one of the fundamental features of modern machine industry. Notwithstanding the barriers which still exist in the form of protective tariffs and local prejudices, a dominant feature of modern markets is the increasing localization of production and the extension of the field of consumption. Exchange Value and Subjective Value. — Exchange value is often called market value or objective value, and is sharply to be distinguished from subjective value, which, it will be remem- bered, is the relative importance attached by an individual to a particular unit of a commodity. Exchange value is an objec- tive, ascertainable fact of the market. Subjective value is a matter of individual feelings and preferences, and is different for different individuals. An error which we must especially guard against is that of thinking that exchange values are in any accurate sense the expression of the subjective values of different goods to society at large. Exchange value is the out- come, the resultant, of the individual subjective valuations of many different persons, the poor and the rich, the wise and the foolish, but it does not correspond to '' social subjective value," or " social marginal utility," for these two last phrases are meaningless. It is true, of course, that our own valuations are largely socially determined in the sense that, lacking much real independence of judgment, we follow and imitate other people in making our own estimates of the relative desirability of different commodities, and that we are even prone to judge of the relative importance of different things for our own pur- poses by their costliness, that is, by their exchange values, rather than by an independent analysis of our own needs. But the differences in our tastes and the differences in our powers to gratify our tastes are quite as important factors in determining 156 OUTLINES OF ECONOMICS the exchange values of things as are our similarities. Just what is the point of connection between subjective values and exchange values we shall discover in the analysis of supply and demand. Supply and Demand. — The only goods which are valued in the market are economic goods ; that is, such goods as combine the characteristics of utility and scarcity. This statement is a truism, for no one will pay for things that he does not want or for things that can be obtained freely. Utility and scarcity affect the market value of goods through the operation of the forces of demand and supply. The general " common-sense " explanation of the valuation of goods takes the form of the statement that values are determined by supply and demand. When rightly interpreted, this statement cannot be criticized, but it is often used in a misleading way. Producers do not usually throw a " supply " of goods unreservedly on the market, accepting any price that can be got for them, nor do consumers generally demand definite amounts of goods, without reference to the price of them. An entirely accurate statement, and one that is less apt to be misinterpreted, is that prices are among the factors determining supply and demand. It may seem, accord- ingly, something like arguing in a circle to attempt to explain exchange value by using the formula of supply and demand; but the fact is that the explanation is to be sought in the action of mutually dependent forces, rather than in any one principle. The Nature of Demand. — Mere desire for a commodity is not demand for it. The desire of the poor man for the counter- part of his wealthy neighbor's motor car is in no sense demand. Effective demand is sometimes defined as desire coupled with the abihty to pay. But to make demand really effective there must be added to these the inclination to buy : desire must be intense enough to lead to purchase. If I purchase a certain quantity of a particular commodity, it is because I desire it at least as intensely as anything else I can purchase with the same amount of money. When I ask myself whether a certain contemplated purchase is " worth its price " to me, I am comparing the importance of the purchase in question VALUE AND PRICE 157 with the importance of other uses of the money which the price represents. It is, in other words, a matter of my subjec- tive valuations. Now my subjective valuations, it will be remembered, depend not only upon my tastes and my purposes, but also (on account of the law of diminishing utility) upon the extent to which I am already supplied with goods like that whose purchase I am considering, as compared with the extent to which I am supplied with other things. In choosing and picking among the different alternatives open to me as a pur- chaser, in buying one thing rather than another, in acquiring more of this and less of that, I merely express my subjective valuations. A certain minimum supply of one commodity — a necessity of life, perhaps — may be more important to me, may possess a higher utility, than any possible amount of some other commodity, — a luxury, for example. But I may deem it less important to have a large supply of the first commodity than to have some of. the second commodity. If I push my expenditures for any one purpose too far, I sacrifice the satis- faction of more important wants for the, satisfaction of less important wants. Think of one's purchases as being divided, not into such units as pounds, bushels, yards, and dozens, but into units defined by the quantity one can purchase for a dollar, — into "dollar's worths." Each of us, by buying the things he wants more than he wants other things, tends to keep the subjective values of the last or marginal dollar's worths of all the different kinds of goods he consumes equal, one to another. As our tastes and desires and purposes change we alter our scheme of expenditures accordingly, but always so that our marginal dollar's worths are kept, as it were, in equilibrium. But even if our desires were constant, changes in prices would in themselves effect continual alterations in the proportions of various things that make up our purchases. The various dollar's worths become larger or smaller and acquire larger or smaller subjective values. If the price of a commodity decreases to such an extent that an additional dollar's worth gains a subjec- tive value greater than that of other dollar's worths, we normally purchase it. If the price rises, we normally curtail our ex- 158 OUTLINES OF ECONOMICS penditures for this particular commodity, and may even, under some circumstances, become sellers of it (as in the case of the householder who has bought a large supply of coal at five dollars per ton, and who, when the price rises to ten dollars, is willing to sell part of it). Some of the foregoing discussion may seem to be a statement of what is obvious and commonplace, but the neglect of these seemingly obvious factors is responsible for more than one erroneous explanation of the way in which prices are determined. The Demand Curve. — The relations between price and de- mand may be shown concretely by the analysis of the condi- tions in a hypothetical market. Imagine the case of an isolated community in which wood is used as a fuel. The conditions might be such as are represented graphi- cally in Figure i. In this diagram distances meas- ured from along the horizontal line OX rep- resent different amounts of wood, while distances measured vertically from the line OX represent prices. Assum- ing that the conditions of demand were as represented in the diagram, if the price of wood were MP dollars a cord, OM cords of wood would be bought. If MP represents a relatively high price for wood, this might mean that many families would choose to go without wood, using other kinds of fuel instead. Others would be content with a scanty supply. If, however, the price were reduced to M' P' dollars per cord, some of the families who would have refused to buy at the higher price would purchase wood, while others would increase their purchases, so that OM' cords would be bought. Similarly, at the price M"P", the amount bought would be OM" cords. Other pos- sible prices might be indicated on the diagram, so that, in general, the curve DD' (which we may call the demand curve) represents the relation between price and the amount purchased. ^ p J"' \ p'' M 31 ■ M" Fig. X VALUE AND PRICE 159 x^ p P' ~~~— i)' M .¥' X Fig. 2. More definitely, the demand curve represents the amount of a given commodity which can be sold in a given market at each of all possible prices. The Elasticity of Demand. — By the elasticity X* of demand we mean the extent to which the amounts pur- chased vary with changes in price. In every family in poor or moderate circumstances the housewife carefully economizes in the use of eggs during periods when they are high in price, using them more freely when the price is lower. The demand for eggs is therefore elastic. Relatively inelastic are the demands of most families for such things as flour and salt. Other commodities, such as sugar, may occupy an inter- mediate position. Figures 2 and 3 represent, respec- tively, elastic and inelastic conditions of demand. It §Jiould be understood that the demand curves for most commodities are probably not so smooth and regular in their slope as are these diagrams. It may often happen that the elasticity of demand is different for different portions of the demand curve. The demand for bread, for example, would probably be much more elastic at very high prices than at very low l6o OUTLINES OF ECONOMICS prices. The demand for salt, on the contrary, would prob- ably be less elastic at prices so high that it would be used only as a food than at prices low enough to permit its use (as at pres- ent) for various industrial purposes. Without giving further concrete examples, the following propositions respecting elas- ticity of demand may be stated : (i) Demand for necessities is in general less elastic than demand for luxuries. (2) Demand the commodities the use of which constitutes a habit is less elastic than demand for commodities the use of which is gen- erally a matter of conscious decision. (3) The more adequate the substitutes for a particular commodity, the more elastic will be the demand for it. (4) The demand of persons of large income is less elastic than that of persons in poor or moderate circumstances. (5) A corollary of proposition four is that the higher the general level of well-being in a community, the less elastic will be the demand for most commodities. The rectangle OMPA (in any one of the three diagrams) represents the total amount buyers pay for a certain commodity when the price is MP, just as the rectangle OM'P'A' represents the total amount paid when the price is M' P' . If the demand for the commodity is distinctly inelastic, this total value will be less when the price is low than when the price is high.^ At the lower price less money will be expended for this particular commodity and more money will be available for other uses. If, on the other hand, the relations between price and demand are such that the rectangle OM'P'A' is larger than the rectangle OMPA, a drop in price from MP to M' P' will result in a curtailing of expenditures for other things. This might involve only a decreased use of direct substitutes, such as coal in place of wood ; generally, however, it would mean a diminished con- sumption of a number of other things. But this is a gain, not 1 Elasticity of demand may be represented mathematically by a fraction whose denominator is the relative (or percentage) decrease in price and whose numerator is the corresponding relative increase in the amount demanded. Following the nota- tion used in Figures 2 and 3, this is the ratio of MM'/OM to AA'/AO. When the elasticity of demand, thus expressed, is equal to MM'/OM -j- i, the rectangles OMPA and OM'P'A' are equal; that is, the same total amount is expended for the commodity when the price is MP as when the price is M'P'. VALUE AND PRICE l6l a loss. For the lower price would not be accompanied by the purchase of a larger quantity, if the additional purchases did not satisfy more intense wants than other things that might have been purchased with the money. Larger " dollar's worths " will have been substituted for smaller ones. In this way the demand for any one commodity is affected by changes in the prices of other commodities. The competition of the market thus embraces not only the buying and selling of one commodity, but also the buying and selling of all com- modities. In this sense the wood dealers compete with the grocers and the tailors, as well as with the coal dealers and with each other. Consumers^ Surplus. — Whatever the price of a competitively produced commodity may be, there are almost always some buyers who would have paid more if it had been necessary. Referring to Figure i,. if the price is M'P', those who are just willing to pay that price, who would either have bought less or bought none if the price had been higher, may be called the marginal buyers. These are relatively few in number, however, as compared with those who would have bought even if the price had been higher. The utility of the marginal purchases to the buyers is but little more than the utility of other things that could have been bought with the same amount of money : in such cases the utility of the purchase only about equals the sacri- fice involved. In the case of all other purchases, however, there is a surplus of utility over costs (whether costs are measured as money costs or as the utility of the other possible purchases which are given up) which is called consumers' surplus (or sometimes consumers' rent, or buyers' gains). It might be supposed at first thought that if the price were, for example, M'P' (Fig. i), the area included between the horizontal line A'P' and the curve DP^ would represent consumers' surplus. This is not exactly true, however, and that for two reasons : in the first place, the satisfaction of additional wants which a lower price makes possible may make the more important wants less intense. A man might be willing to give ten dollars for a cord of wood in order that at least one room in his house could be heated during the winter. He might also be willing to give seven dollars a cord for two cords, so as to heat two rooms, but the heating of the second room might render the heating of the first room less important to him. He might not be \villing, for example, to give ten dollars plus seven dollars in order to have the two rooms heated. In the second place, utility itself is to a large extent affected by price. So far as our purchases satisfy what has been called the desire for distinction, or represent what Professor Thorstein Veblen has called "conspicuous consumption," a lowering of the price of a M l62 OUTLINES OF ECONOMICS commodity would lessen its utility to us. The successful production of artificial diamonds at a low cost would lessen the desire which most people have for natural ones. If touring cars were less an indication of one's ability to spend money freely, they would be less esteemed by not a few people. On the other hand, it might occur in some cases that a certain amount of decrease in the price of a commodity, permitting a more general consumption of it, would increase the esteem in which it is held by those who are glad to follow fads. In general, we must say that even if we had absolutely complete statistics of the actual relation of prices to demand, consumers' surplus would still be an incommensurable thing. It is neverthe- less a real thing, and is especially significant as constituting one of the differ- ences between real income and money incomes. It should be noted, however, that consumers' surplus relates only to one's consumption of a particular commodity, taken by itself, for, as we have seen, the amount which we are willing to spend in the purchase of any one com- modity depends not only on the price of that commodity, but also on the prices of the other commodities that make up our purchases. The suipluses which a consumer gets in his different lines of consumption cannot be added together to form a total. I might, for example, be wiUiiig to pay as much as four dollars for a hat that I can get for two dollars. And if I pay only two dollars for the hat I might be willing to pay as much as six doUars for a pair of shoes that I can get for four doUars. But it does not follow that I should be willing to pay four doUars for the hat and six dollars for the shoes. The Nature of Supply. — The amount of goods that will be supplied in a given market at a given time depends, like the amount demanded, on the price. " Forced sales," in which goods are offered for whatever can be got for them, form about the only important exception. The effect of price on supply varies, however, according to the length of time that is taken into consideration. The work that is being done today in the extension of old factories and the building of new ones, the con- struction of railways, the taking up of new land, is based on estimates of future prices, the present prices of agricultural and manufactured products and of railway transportation being of significance only so far as they indicate what future prices will be. The merchant's stock in trade is bought on an estimate of future business conditions; the amount of land the farmer allots to wheat and corn, respectively, depends on his estimate of the relative prices the two will bring after the harvest. In a VALUE AND PRICE 163 similar way the amounts of goods that can be supplied to the market today are limited by the estimates which business men and farmers have made in the past of the prices which buyers are willing to pay today. It would be possible, though not necessary for our purposes, to analyze, the way in which the amount of the capital and labor which have thus been applied to the production of things that will satisfy present wants was partially determined by conditions which existed still farther back in the past, and so on in an indefinitely receding series. The amount of goods available for the market of today is thus determined not only by past estimates and conditions, but also by present estimates of future conditions. Every seller has the option of selling at the present price or of waiting for possibly higher future prices — an option which is limited only by the perishability of his goods and the urgency of his need for money. And the most urgent need for money does not necessarily force an immediate sale if his opinion as to the future value of his goods is a reasonable one, for in this case it is usually easy to borrow money on the strength of the marketable value of the goods. The Supply Curve. — In the analysis of the conditions of supply existing in a particular market at a particular time we do not have to take account of the limitations imposed by the forms which productive efforts have taken in the past. At any given time a certain defi- nite amount of a commodity is available for the market : this forms what may be called the potential supply. The propor- tion of this potential supply that sellers will be willing to part with at a particular time will depend primarily on the prices they can get. If the price of a unit of a commodity is M' P' (Fig. 4), the sellers will be willing to sell a certain number of units of it, which may be represented by OM' . If the price were 164 OUTLINES OF ECONOMICS as low as PM, however, some sellers would prefer to wait for higher prices, the amount thus withheld from the market being represented by MM'. At the price M"P", however, an addi- tional supply {M'M") of the commodity would be forthcoming from sellers who were not tempted by the price M'P'. In gen- eral, the supply curve SS' represents the relations between price and the amount that will be supplied in a particular market and at a particular time. The Determination of Price. — The foregoing discussion of the nature of demand and of supply makes it possible to ad- vance another step in our analysis of the de- termination of price, by asking ourselves what will be the result of the simultaneous operation of the forces of demand and supply. This con- dition is represented graphically in Figure 5, where the demand curve and supply curve are combined in one diagram. If the curve DD' represents the potential demand in a particular market at a particular time, and the curve SS' represents the potential supply, the price which would be fixed by the free working of competitive forces would be PM, located at the point where the two curves cross. At this point demand and supply are equal, both being rep- resented by OM. It is impossible that the price should be fixed at any other point, M'P', for example. For if M"Q be drawn so as to equal M'P', it will be evident that at this price OM" units will be demanded, while only OM' units will be sup- plied. Most of the buyers, however, are willing to pay more than M'P' if necessary, so that in order to secure their share they will bid the price up until an equilibrium is reached. This is what John Stuart Mill meant when he said that " value always adjusts itself in such a manner that the demand is equal VALUE AND PRICE 1 65 to the supply," — a statement which has often been misinter- preted, and consequently unjustifiably criticized. The prices for which goods are sold in a competitive market are thus the outcome or resultant of the individual valuations of all who buy and sell in the market. Each buyer or seller, taken by himself, affects only inappreciably the price at which he buys or sells. All that he can do is to buy or sell or refuse to buy or sell, or to buy or sell more or less. For each individual trader the market price is something beyond his own control. And yet each has a part in that collective supply and demand which is the controlling factor in making the price whatever it happens to be. Producers' Surplus. — Just as the area APD (Fig. 5) has sometimes been considered, not altogether accurately, to represent a "Consumers' Surplus" (of utility over costs), so the area APS has been considered to correspond to what has been called "Producers' Surplus" or "Sellers' Gains." This sur- plus should not be thought of as corresponding to the actual profits of the sellers ; that is, as being in any way a surplus of receipts over and above the expenses of production. That part of the supply which had been produced at the smallest expense is not necessarily the part which its owners would be willing to sell at the lowest price. It cannot be too strongly emphasized that the analysis of demand and supply thus far presented relates only to the conditions existing in a particular market at a particular time. All that we can say is that when OM units are sold at the price of MP per unit, the total receipts of the sellers are represented by the rectangle OMPA ; while the area OMPS represents what they would have been willing to sell the same amount of goods for, had they not been able to get a larger return. There is, as we shall see, a relation between the prices of things and the ex- pense of producing them, when a considerable period of time is taken into consideration. At any given time, however, sellers are mainly governed by the relative profitableness of selling at existing prices or waiting for higher ones. The only kind of surplus which the area APS represents is an intangible, hypothetical thing, — the difference between actual receipts and the amount which would have been received if each seller had sold each portion of his supply for the minimum price he would have been willing to take for that portion. QUESTIONS 1. Is there such a thing as "intrinsic value"? What is usually meant when the expression is used? 2. How can one buy more or less of a non-divisible good, like a house? 1 66 OUTLINES OF ECONOMICS 3. Does the tendency of each individual to maintain the equilibrium of his margin of consumption result in the maximum satisfaction of his wants ? 4. What relation is there between the amounts which a college student pays for room rent, for food, for clothing, for books, and for athletics ? 5. Which of your customary purchases would you still make if prices were doubled? Which would you curtail? Which would you omit? 6. Illustrate the propositions relating to elasticity of demand (p. 160) by concrete examples. 7. Construct an imaginary demand "schedule," showing in parallel columns (i) six or eight different possible prices of wood per cord, and (2) the number of cords which an imaginary purchaser would buy at each stated price. Construct in the same way other demand schedules for each of four other possible purchasers. Combine these five individual demand schedules into a collective demand schedule showing the total amount of wood that could be sold at each price. Construct in a similar way individual supply schedules and a collective supply schedule for four sellers of wood. Assum- ing that all the wood sold is sold at a uniform price, how much wood will be sold and at what price ? 8. "For some years the supply of Brazilian coffee was greater than the demand for it." Criticize and amend this statement. REFERENCES Bohm-Bawerk, E. von. Positive Theory of Capital, Book iv. Chaps, i-vi. Carver, T. N. Distribution of Wealth, Chap. i. CuNYGHAME, Henry. Geometrical Political Economy, Chaps, iii and iv. Davenport, H. J. Economics of Enterprise, Chaps, v-vii. Fetter, F. A. Economic Principles, Part i. Marshall, Alfred. Principles of Economics, 6th ed.. Book iii and Book V, Chaps, i and ii. Mill, J. S. Principles of Political Economy, Book iii. Chaps i and ii. Taussig, F. W. Principles of Economics, Vol. i. Chaps viii-x. Wieser, F. von. Natural Value, Book ii, Chaps i-v. CHAPTER XI VALUE AND PRICE (Continued) Some of the most important factors in the determination of exchange values are not revealed by an analysis of the conditions of supply and demand which happen to exist at a particular time. In the preceding chapter we assumed the existence of a certain potential demand and a certain potential supply^ and explained how these result in the equilibrium of actual de- mand and supply at a certain price. Our next task is to inquire into the influences which determine potential demand and potential supply. For this purpose we shall need to pass from the study of the way in which the preferences and choices of individual buyers and sellers react upon and fix the par- ticular market price which exists at any one time to an inquiry into the operation of certain slowly acting movements and tendencies. The demand side of this problem need not detain us. De- mand will change with changes in incomes, tastes, fashions, and the like. The effect of these influences is so obvious that it may be taken for granted. The supply side of the problem, however, needs further study. The potential supply of the present is limited by conditions set by past industry. The amounts of different kinds of consumption goods that are ready for present use depend upon the direction which the work of production has taken in the past. What, in the long run, is the relation between supply and exchange value? Prices and the Expenses of Production. — The dominant motive that guides farmers and business men in their invest- ments of labor and capital is the desire for money profits. (By profits we here mean the difference between the expense in- volved in producing goods and the money that is obtained for them.) If it were always an easy matter for business men to 167 1 68 OUTLINES OF ECONOMICS change their interests and their energies from one line of pro- duction to another, and if capital and labor could likewise be freely transferred from one undertaking to another, it is hard to see how profits in any one competitive industry could be for any length of time much higher than in other competitive industries. Managerial ability, labor, and capital would gravi- tate always toward those employments which promise the greatest profits. The effect would be a continual movement toward equality of advantage in different fields of industry. This does not necessarily mean an equality of profits as between individuals in any given line of business, for the amount of profits depends largely upon the ability and enterprise of the individual business man. But in a state of free competition, with alternative business opportunities as free and open as we have assumed, the profits of any business undertaking would hardly be larger, for any period of time, than the business man could get as salary by working for others, — for if working for others offered a greater return than assuming the risks of busi- ness for himself, he would naturally choose the salaried position, and vice versa. Purely competitive profits, under conditions of this absolute " fluidity " of business ability, of labor, and of capital, would thus tend to adjust themselves, according to the ability of the individual business man; that is, to equal what we shall later describe as the " wages of management." If we include the value of the business man's services, thus measured, among the expenses of production, we may, obviously, state the tendency which we have described as a tendency toward the equality of the prices received for the products of any particular industry and the expenses of producing them. The assumptions we have made do not, however, exactly cor- respond to the conditions of actual business. Managerial ability, labor, and capital are all specialized to a greater or less extent, so that they cannot be changed from one employment to another without loss of efficiency. But it is not necessary for the validity of our analysis that all managerial ability, all labor, and all capital should be fluid enough to change from industry to industry economically. There are always many VALUE AND PRICE 1 69 business men who are anxiously watching for the most inviting business opportunities; there is always a certain amount of labor awaiting the most remunerative employment, and there is always a certain amount of money awaiting investment in those forms of capital goods which promise the greatest return. These facts are enough to give substantial truth to the state- ment that in any competitive industry the price of the com- modity produced tends to equal the cost of producing it. When the price of bicycles was high, as compared with the expense of producing them, existing bicycle factories were extended and new ones were built. The supply of bicycles was thus so increased that they could not be sold except at a much lower price. On this account and because of the cessation of demand, the profits in the manufacture of bicycles became relatively low, and many former bicycle factories are now used for other purposes. If the excess of the price of wheat over the expense of producing it promises to be greater than the excess of the price of corn over the expense of producing it, farmers will raise less corn and more wheat, and the result will be higher prices for corn and lower prices for wheat. Normal Price. — Because the market price of a commodity cannot get very far away from the expense of producing it without resulting in abnormally high or abnormally low profits, and because the existence of abnormally high or abnormally low profits sets forces at work which are very sure to move the price closer to the expense of production, the name normal price is given to that price which is just equal to the expense of producing a unit of a commodity. The effectiveness of the tendency of actual competitive prices to equal normal prices depends very largely upon the length of the period of time that is taken into consideration. The longer the period of time, the larger will be the proportion of managerial ability, labor, and capital that can be shifted from the less profitable to the more profitable undertakings. To build and to eqUip new factories and to extend old ones takes time; the supply of skilled labor in any occupation can often be increased but slowly, for many trades involve an appren- lyo OUTLINES OF ECONOMICS ticeship of three or more years. In the undertakings that are becoming less profitable, although capital specialized in the form of machines may not be useful for other purposes, yet such machines need not be replaced as they wear out ; while a skilled laborer cannot take up another trade without loss of efficiency, yet an increasing proportion of the incoming supply of laborers may begin their apprenticeship in those occupations in which there is a greater demand for labor. While the conditions of long-period supply are thus such as to result in a constant movement toward the equalization of market price and normal price, it may easily happen that the two will never become identical. For market prices them- selves are constantly changing under the influence of changing demand. And the increase in the output of an especially profit- able product is often overdone. Periods of losses or of low profits may succeed periods of high profits. In short, the goal toward which business enterprise directs productive efforts is constantly shifting. Different Conditions of Supply. — A fact of prime im- portance is that the expense of production {per unit) often varies as the amount produced is larger or smaller. But this relation between the amount of goods produced and the expense of producing them is different for different industries. In partic- ular, three forms of productive undertaking may here be dis- tinguished : those in which increased production is accompanied, in the long run, with (i) increasing, (2) decreasing, or (3) con- stant expense per unit of product. I. If transportation facilities, the knowledge of agricultural methods, and other controlling conditions remain unchanged, the amount of wheat raised in the United States cannot be sub- stantially increased without resort to lands less well adapted to the production of wheat, or the more intensive cultivation of lands already in use. Either alternative requires (as will be shown in a later chapter in more detail) the use of relatively more labor and capital per bushel in producing the additional wheat than was required for the wheat produced under the for- mer conditions. This means that the production of wheat VALUE AND PRICE 171 cannot be substantially increased except at an increased ex- pense per bushel. When this condition of increasing expense is met with — and it holds true generally in agriculture — normal price increases with an increase in production. If the price of the product is not high enough to repay the cultivation of the poorest lands used, they will cease to be cultivated. If the price of the product is appreciably higher than the expenses of cultivation, farmers will find it profitable to push cultivation still farther, up to the point where the expense equals the price. 2. In some industries, however, an increase in production will often bring forces into operation that will result in smaller expenses of production per unit of product. Where this condi- tion of decreasing expense is found, a general increase in produc- tion brings, in the long run, a decrease in the normal price of the product. What is the nature of these economies that some- times attend an increase of production? We rule out of con- sideration such things as new inventions and the general prog- ress of industrial knowledge and technique, for although these things reduce the expenses of production, they are in no direct way a necessary result of an increasing output. They play a part, moreover, in agriculture (where they help to counteract the effects of the rule of increasing expenses) as well as in in- dustries of decreasing expenses. Additions to our knowledge of ways of producing things are undoubtedly stimulated by the growth of production, which gives increased scope and impor- tance to improvements in industrial technique ; but for the purposes of the present inquiry we must put these things aside and merely assume a given state of industrial knowledge. The economies that create the condition of decreasing expenses are, properly understood, only such as are brought about, in a fairly direct way, by the increase of production itself. Here we must distinguish two things : first, economies in the general organization of whole industry, and, second, economies result- ing from an increase in the size of the individual business establishments within the industry.^ 1 These are named by Professor Alfred Marshall "external economies" and " internal economies." 172 OUTLINES OF ECONOMICS The most important of the first of these two classes of econo- mies is a greater specialization or division of labor within the industry. The different processes in the operations of the in- dustry may be separated and apportioned to different specialized plants, located, perhaps, at particularly advantageous points. Opportunity is given for a more thoroughgoing and more efficient specialization of labor and for the use of highly special- ized machinery. Subordinate industries may be developed, supplying machinery and other equipment ; improved trans- portation facilities of one kind and another may be secured. It becomes, in general, more feasible for the industry to utilize what are known to be the best and most economical methods of production and to keep pace with the advance of technical knowledge. Indirect, roundabout ways of doing things, involv- ing a thoroughgoing subdivision of processes and the use of large amounts of fixed capital in the form of elaborate plants and expensive machinery are advantageous only when the industrial output is large. All these things have played an important part in the progress of most of the great manufac- turing industries, and in making their products cheaper. Unless some obstacle, some countervailing force, prevents, these economies are sufiicient to make almost any large and growing industry one of decreasing expenses. And about the only obstacle that can stand in the way is the limitation of the supply of one of the necessary factors in production. The supply of capital has (as shown by the interest rate) kept pace with industrial demands. The industrial output has increased more rapidly than has the supply of labor, but in most industries this has not been sufficient to offset the movement toward decreasing expenses. But the supply of land and of natural products of various kinds is definitely limited. This is why agriculture, despite the fact that it benefits by some of the economies of specialization, is not an industry of decreasing expenses. For the same reason the lumber industry and petro- leum industry have had to contend, in recent years, with in- creasing expenses. The second class of economies — those connected with the VALUE AND PRICE 1 73 increasing size of the individual business unit — are usually named " the economies of large-scale production." These are of interest to us at the present stage of our study only in so far as large-scale production is in itself a result of the general growth in the volume of the output of an industry. Other things, such as the invention of new and effective " large-scale " methods of production and the cheapening of transportation (broadening the market open to a particular plant), have cooperated in stimulating the growth of large establishments. Our present inquiry is merely into the relation between the increase in the total amount of goods produced and the expense of producing them ; that is, into the long-run relation between supply and normal price. And so our question is : Does a larger output for an industry at large encourage the growth of large individual establishments by increasing any advantages they may have over smaller establishments? It is clear that there is no in- variable rule here, for in agriculture and in some special fields of manufactures and trade the average size of the individual undertaking is not increasing, despite the rapid growth of the total volume of output. But in nearly all the industries in which we have any reason to suspect the presence of the rule of decreasing expenses we find that the average establishment has been growing larger. This must mean that in many industries the first class of economies, already described, can best be util- ized by relatively large establishments. Whatever the real " economies of large-scale production " may be (and they will be discussed in the following chapter), they cannot in themselves be adequate to bring about, in any competitive industry, the general condition of decreasing ex- penses. Wherever the advantages of large-scale production are increasing, the principal effect must be merely to divide the aggregate operations of the industry among a somewhat smaller number of establishments than would otherwise be found. But the growth of the size of the business establishment has no direct bearing upon the existence of the condition of decreasing ex- penses in the industry at large, except in so far as an increase in the size of the individual establishment is found to be one 174 OUTLINES OF ECONOMICS of the ways of utilizing to best advantage the various economies made possible by the increased industrial product. Large- scale production does not create the condition of decreasing expenses, but it may be an indication, a manifestation of the presence of that condition.^ 3. In many hand industries, such as tailoring and cigar making, the expense of production per unit does not vary to any great extent with the amount produced. These are, therefore, industries with constant expenses. Figures 1,2, and 3 illustrate the relation of changes in supply to changes in price under the conditions of increasing, decreas- ing, and constant expenses, re- spectively. These diagrams must be carefully distinguished from the supply curve described in the preceding chapter, which related only to the conditions of supply at a particular time. They indicate the way in which an increased output, evoked by an increase in demand, will, in the long run, be offered to the market at higher, lower, or constant prices, depending upon the conditions existing in different classes of industries. In an in- dustry of decreasing expenses (Figure 2), for example, OM units of product per year cannot be supplied to the market at a lower price per unit than PM. But, allowing time for the necessary reorganization of the industry, OM' units per annum can be supplied at a lower price, P'M' . In an industry of in- creasing expenses this relation between price and amount of output is reversed. Fixed and Variable Expenses. — There is no better illustra- 1 We have thought it worth while to emphasize the merely indirect relation be- tween the economies of large-scale production and the so-called "law" of decreasing expenses (or "increasing returns"), because there is much confusion of thought on this matter. Only when an industry is controlled by a monopoly, are the real econo- mies of a large industrial output identical with the "economies of large-scale pro- duction." VALUE AND PRICE 175 Fig. tion of the necessity of keeping definite periods of time in mind when discussing problems relating to valuation than that furnished by the problem of the apportionment of specific expenses of production to par- y ticular units of products. In almost any industrial establish- ment, any increase in product will be attended by some specific increase in expenses : more raw material and more labor will be used, possibly more power; although the increased expenses for labor and power may not be proportionate to the increase in production. Such expenses are called variable expenses, and are to be contrasted with, fixed expenses, which remain approx- imately the same, no matter what the amount produced is. The interest on the funds invested in the factory building and its equipment of machinery is a fixed expense ; the expense of management and general office expenses will not usually be increased proportionately by an increase in the annual product of an establishment. It is often assumed that wherever only a part of the expenses varies with the amount pro- duced, the establishment is ipso facto one in which large- scale production is especially economical. Whether this as- sumption holds true or not often depends on the scale of production we have in mind. Factories and other plants are built with a certain maximum capacity, and until that maxi- mum capacity is utilized, production may be increased without a proportionate increase in expenditure. But when the maxi- mum is reached, more equipment, and often more buildings, will 176 OUTLINES OF ECONOMICS be needed before there can be a further increase in product. There is often a certain most efficient size of plant ; an increase in business beyond the capacity of the most efficient size of plant necessitates either a curtailing of the business or a duplication of the plant. When business conditions are such as to warrant temporarily pushing the output of a plant beyond its normal capacity, the result usually is, as every manufacturer knows, that this increased output is produced uneconomically, that is, at relatively increased expenses of production. Many seemingly constant expenditures (like interest on the cost of the plant) are variable in the long run. Such expendi- tures increase, but only at considerable intervals of time, as ^ additional invest- ments in fixed cap- ital are made. A long-period supply curve correspond- ing to the condi- tions of production in such a business might be some- thing like Figure 4. This diagram should be inter- preted as follows: The total expense of producing a certain output, OM, is repre- sented by the area OMPS. MP (considered not as a mere line, but as an indefinitely narrow area) represents the variable ex- pense which would not be incurred if the volume of production were a little smaller than OM units. MP, then, represents the marginal expense, in this particular establishment, of producing OM units. Thus the irregular curve SS' represents the way in which the aggregate expenses of production are increased as the output (measured on the line OX) grows. When the product reaches OM' units, and again when it reaches OM" units, fresh investments of large amounts of capital are necessary. From the long-time point of view, such a business might very M' M" Fig. 4 -X VALUE AND PRICE 177 possibly be one of approximately constant expenses ; although of course some of the real economies of large-scale production might be present and might result in decreasing expenses. The Relation of Fixed and Variable Expenses to Price. — The fact that, within limits, the expenses of a business undertaking do not increase proportionately as the output increases has an important bearing upon competitive price-making. The pro- prietors of a "business establishment will feel justified in in- creasing their output, provided the additional output will sell for enough to afford some profit above the actual amount by which it increases their expenses. If the full capacity of their plant is not already utilized, they will count as profit any addi- tional income they can secure above the necessary increase in variable expenses. If they are producing some staple commod- ity for the general market, so that they cannot discriminate in the prices at which they sell to different buyers, they will find it difiicult to make much use of this possibility of cutting prices on part of their output. But if they are producing a variety of goods, if they are making highly specialized products " to order," or if they are selling in two or more widely separated markets, they may often be able to increase their output by accepting prices too low to contribute anything to the payment of their fixed expenses. This is often the explanation of the " dumping " of part of a manufacturer's product on a foreign market at a lower price than he charges at home. Railways are able to take advantage of the fact that (for the time being) only part of their expenses vary with their trafiic, for they do not have to charge a uniform rate per ton per mile, but can classify their rates according to the origin, destination, and nature of the' traffic. The rates charged by electric plants are often less for current used at certain hours of the day when the capacity of the plant is only partly utilized. The reader will probably be able to supplement these illustrations with others based upon his own observation. If a business establishment is hard pressed by competition, or if for any other cause, such as a dull season, its sales are small, its proprietors may decide to cut prices on their whole out- N 178 OUTLINES OF ECONOMICS put to a point that will cover the variable expenses and possibly contribute something toward meeting the fixed expenses. Some fixed charges, like depreciation, interest, rent, insurance, taxes, will continue even if the output is little or nothing. It will very likely be sound business policy to make the best of a bad situa- tion by getting what little income can be had over and above the variable expenses of production. Much money may have been irrevocably invested in the business, and although possibly under no conditions can it be made to yield the return that had been expected at the time when the investment was made, matters will not be bettered by letting the plant lie idle. It may be that the prices which the proprietors of the business thus reluctantly decide to accept are high enough to pay all the ex- penses of production, fixed and variable, in some competing plants, better organized or more favorably located. Or it may be that some or all of the competing plants also' find it necessary to accept prices that do not cover their fixed expenses. Sometimes the fact that it is more profitable to produce at prices which cover merely the variable expenses than not to produce at all leads some one establishment to cut prices. Other establishments have to reduce prices in order to protect them- selves, and a period of cut- throat competition may ensue. Though at any given time it may be the variable rather than the aggregate expenses of production per unit of product which fix the price at which some or all of the different establish- ments in an industry are selling their products, it should not be inferred that it is the variable expenses alone which measure the normal price of a product. For in the long run prices have to be high enough to induce the replacement of fixed capital as it wears out and (in a growing industry) to attract new perma- nent investments of capital. That is, in the long run, prices have to be high enough to cover both variable expenses and fixed expenses, — which last, as we have seen, are generally variable as seen through a sufficiently long period of time. As a matter of fact, the prices in any large competitive industry are usually high enough to more than cover the expenses of production in the most efi&cient establishments, but are rarely VALUE AND PRICE 1 79 high enough to cover all such expenses in the least efficient establishments. For the time being the weaker establishments may continue in operation, but sooner or later they are sure to be forced out. The better establishments will be enlarged, and new and possibly yet more efficient ones will be built. If, however, none of the establishments in an industry is able to cover all of its expenses, the volume of output must eventually decline to a point where prices can be secured that will cover interest, depreciation, and the other fixed expenses that must be provided for if the recurrent needs of the industry for fresh investments in fixed capital are to be met. It is in these ways that the tendency of prices to equal the expenses of production manifests itself. Joint Expenses of Production. — When the production of one commodity is inevitably accompanied by the production of one or more other commodities, it is often impossible to assign a definite part of the total expense of production to any one of the commodities. It is impossible to separate the expenses of producing tenderloin steaks from the expenses of producing soup bones, or either one of these from the expenses of producing hides. Mutton and wool, cotton and cotton seed, coal gas and coke, are familiar examples of commodities produced under conditions of joint expense. Modern methods for the utiliza- tion of industrial by-products have greatly increased the list of commodities produced under such conditions. What is the normal price of these jointly-produced commod- ities ? Take first the simplest case : that in which all the expenses of producing two commodities are joint expenses. Neither commodity can be said to have a normal price of its own, for neither commodity has specifically assignable expenses of production of its own. But the two commodities, taken together, have what may be called a collective normal price. Suppose, for example, that the production of every unit of one commodity is necessarily accompanied by the production of two units of the other commodity. It is evident that in order to induce the production of these commodities the price of a unit of the first commodity plus the price of two units of the second l8o OUTLINES OF ECONOMICS commodity must cover the joint expense of producing these three units. This joint expense, then, measures the collective normal price of the three units. Just how the market prices which, in their sum, will tend to approximate this collective normal price, will be fixed, will depend upon the conditions of demand for each of the two commodities. Sometimes one or both of the jointly produced commodities will have to compete in the market with substitute commodities produced under other conditions, and this, of course, tends to limit the possible range of price variation. When, as often happens, two commodities are produced under conditions of partially joint expenses, further processes being necessary to fit each commodity for the market, the price must in each case cover the specific or assignable expense. The joint expenses will be assigned to one or the other of the commod- ities, or apportioned between them, according to the relative demand for them. So far as the expenses are joint they are in some respects similar to the fixed expenses of any establishment producing under the ordinary conditions of fixed and variable expenses. In a sense all fixed expenses are the joint expenses of producing the different units of output, while all variable ex- penses are specifically assignable to the different units of the product. But this analogy must not be pushed too far, and that for two reasons: (i) Most establishments with fixed and va- riable expenses have to accept one uniform price for the different units of their product. Their fixed charges, unlike true joint expenses, cannot be covered by the price of one portion of the output and disregarded in the price of another portion. (2) Even if an establishment is producing two or more different commodi- ties or is able to sell one commodity in two or more different markets at different prices, its fixed expenses are not true joint expenses except in so far as its output is necessarily accompanied, without additional expense, by the production, or partial pro- duction, of another part of their output. The importance of this is that, as we have seen, an increase or decrease in the aggregate product of an industry must ultimately increase or decrease the fixed expenses of that industry. Fixed expenses VALUE AND PRICE l8l thus enter in the long run into the determination of the normal price of all portions of the industry's output. This is not true of joint expenses, for these affect only what we have termed the collective normal price of the joint products. Thus neither steaks nor hides have a separate normal price. But each standard grade or type of product in the output of the furniture industry has a normal price of its own. The Surplus of Bargaining. — Demand and supply do not always fix price at a definite point. The price of horses of any given grade, for example, is fixed only approximately by market conditions. In the sale of a horse there is room for considerable latitude of opinion as to the price that should be paid. If the lowest price that the seller will take is considerably below the highest price that the buyer will give, just where between these limits the actual price will be finally fixed will depend upon the relative skill at bargaining of the seller and buyer. In the case of a horse trade, this opportunity for the " higgling of the market " has become proverbial, and in many other kinds of exchanges the efficient bargainer has an opportunity to get for himself a surplus above his minimum selling price, or below his maximum buying price. Real estate transactions furnish a good example. In the case of the great commodities of the world market, like wheat, cotton, and iron, the price is set so accurately by market conditions that the gains of bargaining are relatively small. In general, the wider the market, the more general the use of the commodity, the greater the ease with which the commodity can he sorted into standard grades (as in the case of wheat and cotton) , the more accurately will competitive forces fix a definite price. Goods which cannot he standardized, each unit of which possesses some unique qualities, give most scope for the varia- tions in the valuations of individual huyers and sellers. In such cases supply and demand do not fix a price point, but only cer- tain limits within which the price must fall. The widening of the market, however, and the increasing standardization of commodities — an effect of machine production — are bringing a larger and larger proportion of goods into the field where uniform market valuations dominate. 182 OUTLINES OF ECONOMICS Non-reproducible Goods. — Some economic writers have made a special class of such goods as great works of art. These are absolutely unique, in that no copy can have anything like the value of the original. The price of such non-reproducible goods has an upper limit fixed by the highest subjective valua- tion set upon it by any possible buyer. The lower limit will be either the seller's own subjective valuation, or the second highest valuation set by any competing buyer, according as one or the other of these two is the higher. Between the upper and lower limit the exact fixing of the price is a matter of pure bargaining. Such cases should not be confused with monopoly price, as has been done by some writers. The products of almost all the industrial handicrafts, as well as the products of the avowedly artistic pursuits, possess a non-reproducible element of individuality, that removes them to a greater or less extent from the operations of the law of normal price. A commodity may possess this quality of uniqueness to such an extent that it is not affected at all by the forces determining the value of the general class of goods to which it belongs, and in this case its owner may be said to have a monopoly of it. But it is better to look upon the valuations of such non-reproducible goods as determined by individual valuations and the process of bargaining. The " normal " price of such goods is simply the highest price that can be got for them — a statement which does not hold true of most monopoly goods. For monopoly goods are not necessarily unique or non-reproducible. They differ from ordinary competitive goods, however, in that they cannot be reproduced except by the monopolist. Retail Prices. — The retail prices paid by the individual con- sumer do not always respond to all the variations in wholesale prices brought about by changes in supply and demand. There are sometimes tacit or explicit local price agreements between local merchants, which apply even to competitively produced goods. Some retailers consistently sell a few kinds of goods at less than cost to attract custom for the goods on which they may make a profit. Merchants who make a specialty of a high class of goods, and thus cater to a wealthy clientele, are VALUE AND PRICE 183 apt to exact higher prices for ordinary goods than do those merchants who have to deal with a poorer class of customers. Custom has more effect on retail than on wholesale prices. The prices of various articles sold as " men's furnishing goods " form a good example of the influence of custom. Retail prices are also governed by the value of the coins that are in general use, and are generally expressed in round numbers. In the long run, demand and supply govern retail prices, but they do not set a definite price point so accurately as they do in the case of wholesale prices. Public Authority and Value. — In the Middle Ages there was considerable speculation by theologians and legists about the subject of " just price " — the value at which things ought to exchange for other things. This idea denotes an important difference between the medieval and modern concept of value. Professor Ashley has put it clearly in these words : " With Aqui- nas, the greatest of the medieval schoolmen, it [value] was some- thing objective ; something outside of the will of the individual purchaser or seller; something attached to the thing itself, existing whether he liked it or not, and that he ought to rec- ognize. And as experience showed that individuals could not be trusted thus to admit the real value of things, it followed that it was the duty of the proper authorities of state, town, or gild to step in and determine it, and what the just and reasonable price really was." This " just and reasonable price " was very often thought to be that price which would afford a reasonable compensation for the labor of the producer. When in more modern times theological speculations began to yield prece- dence to inquiries into " natural laws," the idea of just price was supplanted by the idea of " natural price." Sometimes this was interpreted as determined by the value of the labor put into a commodity (this was the dominant idea during the eight- eenth century), but the growth of capitalistic production necessitated the recognition of the other elements in the expense of producing a commodity as part of its natural price. Modern economic science, as we have seen, applies the term " normal price " to the expense of producing a thing, but interprets it 1 84 OUTLINES OF ECONOMICS only as an important factor controlling the long-period fluctua- tions of market prices. The adjective " natural/' with its mis- leading implications, has been abandoned. Yet the competitive system is today so thoroughly accepted as the " natural " economic order, that there is, as we have previously noted, a deep-seated conviction that normal competitive prices (meas- ured by the expenses of production) are natural and just prices. This conviction is, however, brought face to face with the fact of the growth of a large industrial field in which monopoly, rather than competition, rules. The question of just price is again a live issue — as it was before the growth of the com- petitive system. Public authority is frequently invoked to insure that the prices fixed by holders of municipal franchises and other monopolists are just and reasonable. The chief fundamental test which our courts are able to apply to the reasonableness of any particular price is its conformity to what the price would have been under competitive conditions. Thus it is often asked if a particular monopoly charge gives a more than normal return upon the capital invested. The deter- mination of what the expense of producing a particular com- modity or service really is, is often a difficult, or even impossible, task (the distinction between constant and variable expenses being frequently a stumbling-block), but, given the general acceptance of the competitive system, it is hard to see what other standard could be used. Moreover, the general consensus of recent court decisions is that the Fifth and Fourteenth Amend- ments to the Federal Constitution, prohibiting the taking of property without due process of law, prevent federal and state governments from going farther than this in the regulation of monopoly charges. And even this power is not conceded, except in the case of businesses affected with a distinct public interest, such as those conducted by so-called public-service corporations. In fixing prices for its own services, such as postal charges, the government is controlled by other considera- tions. These will be discussed in the chapters on public finance. Imputed Value. — The only things to which market valuations actually apply are the specific units of goods that are actually VALUE AND PRICE 1 85 bought and sold. We are accustomed, however, to impute these market prices to all other existing goods of the same kinds. When wheat is sixty cents a bushel, the only bushels of wheat actually valued by the market at that price are the ones actually sold at that price. Yet we impute or ascribe the same value to all other bushels of the potential supply of wheat in the same market. Notwithstanding the hypothetical nature of this imputed value, it is often treated as though it were a real thing. Statis- tical attempts to state the wealth of a nation in terms of dollars and cents are only estimates of the sums of these imputed values. A merchant's inventory of his stock in trade is often accompanied by an estimate of its value. Whether this value will be realized or not depends upon the constancy of business conditions, the caprices of fashion, and whether it can be sold in the regular course of trade or whether it has to be disposed of at a forced sale. Many kinds of consumption goods, such as household furniture, are not customarily thought of by the owner in terms of ex- change value. It is often necessary for purposes of taxation to ascribe value to them, but this is frequently a difficult and somewhat arbitrary process. The Prices of Production Goods. — Throughout our analysis of exchange value it has been assumed that the commodities valued were wanted by consumers for the satisfaction of their wants ; that is, that they were consumption goods. It is not altogether incorrect to say that producers' goods — capital and land — have a marginal utility, which varies with the importance attached to the possession of them. While one could thus, with substantial accuracy, include producers' goods in the scope of the foregoing analysis, there is a more instructive way of ap- proaching the problem of the prices of land and of capital. Consumption goods have value because they satisfy human wants ; that is, they yield an income of satisfactions, while production goods are valued because they have the power of gaining a money income for the owner. Just as the values of consumers' goods vary with the intensity of the wants they satisfy, so the values of producers' goods vary with their power 1 86 OUTLINES OF ECONOMICS to yield a money income. The problem of the prices of pro- ducers' goods will, accordingly, be discussed in the chapters on the rent of land and the interest on capital. Other Theories of Value. — The older economists used to em- phasize the relation between the price of a thing and the amount or the expense of the labor spent in producing it, — a relation much closer under the old methods of hand production than it is at present. The development of a systematic labor theory of value was, however, the work of Karl Marx, the founder of modern " scientific " socialism. This theory is, in essence, that labor produces all value and that the interest on capital and the rent of land are deductions from the real wages of labor — de- ductions that are made possible only by the existence of the system of private property in producers' goods. It is so ob- vious that things do not exchange today in proportion to the amount of labor involved in producing them, that to point this out in detail, as some economists have done, is unnecessary. Karl Marx himself recognized that his " values " were not measured by the actual prices of the market. They seem to hive been conceived as some mysterious essence or quality in things. But the only economic values that can be recognized from the modern scientific point of view are the values that really exist — the actual values of the market. Nor can we say that things ought to exchange in proportion to their labor costs, without begging the whole question in favor of the aboli- tion of private property in land and capital. Moreover, it will be shown later that rent and interest would not be elim- inated, although they might be changed in form, by a change from private to common ownership of producers' goods. Al- though the labor theory of value is still held by many followers of Marx, its place in the creed of scientific socialism is diminish- ing in importance. The relation between price and the expenses of production has sometimes been stated in such a way as to lead to the infer- ence that cost of production is the cause of value. The expense of production theory of price, when so stated, is open to much the same objections as the labor theory. Suppose I perfect a VALUE AND PRICE 187 machine at the expense of ten thousand dollars which will blow soap bubbles at the rate of a thousand an hour. Will it be worth ten thousand dollars ? Certainly not ; but why not ? The theory of costs will not explain it. To say that the labor and materials have not been wisely used is simply to say that the machine has no value, which is just what we are trying to explain. As a fact, it is not worth ten thousand dollars simply because no one is willing to give ten thousand dollars for it. The expenses of production do not create value, but there is a sense in which price is the cause of the expenses of production. That is, men think it worth while to expend money in producing things because they think that the products will sell for enough to recompense them for the expenses of production. Many of the economists who have written in the past about the subject of price took the facts of demand for granted, and devoted most of their treatment of the subject to an examina- tion of the relation between price and the expenses of produc- tion. This was in part an expression of a general tendency to regard the production of wealth as something to be desired for its own sake ; the fact that the satisfaction of human wants is the real goal of most economic efforts being underemphasized. In more recent years economic writers have developed the analy- sis of human wants ; the fact that utility in the economic sense is not utility in general, but the utility of a particular unit of a commodity, being the most significant point in this new analysis. Some writers have even gone so far as to take the facts of supply for granted, and to assume that price is explained when mar- ginal utility is described. As a determining cause of price, utility has a logical priority over scarcity, in the sense that demand is usually the cause of supply. Yet in the analysis of the actual price-making process we have to recognize that util- ity and scarcity, demand and supply, are forces operating simul- taneously, neither of which can be neglected without obscuring the fundamental facts of the market. OUTLINES OF ECONOMICS QUESTIONS 1. Is there any relation between the price of a lead pencil and the expense of producing it? 2. What elements of a farmer's expenses are "constant"? What are "variable"? 3. What different possible standards of just price can you suggest? 4. Combine demand curves with long-period supply curves like those shown on page 175 (the general conditions of demand being assumed to be constant) and interpret the meaning of the resulting diagrams. 5. Are the passenger service and the freight service of a railway joint products? 6. What different possible meanings can be attached to the expression "natural value"? 6. Discuss the following statement : "The fact is that labor once spent has no influence on the future value of any article ; it is lost and gone forever. In commerce bygones are forever bygones ; and we are always starting clear at each moment, judging the value of things with a view to future utility." — Jevons, Theory of- Political Economy, p. 164. REFERENCES Chapman, S. J. Outlines of Political Economy, Chaps, xv-xvii. ■ Flux, A. W. Economic Principles, Chaps, iv and v. Marshall, Alfred. Principles of Economics, 6th ed.. Book v. Chaps. ii-viii, xi. Mill, J. S. Principles of Political Economy, Book iii, Chaps, iii and iv. Taussig, F. W. Principles of Economics, Vol. i, Chaps, xii-xiv, xvi. WiESER, F. VON. Natural Value, Book v, Chaps, i-vi. CHAPTER XII MONOPOLY The Idea of Monopoly. — One of the economic terms most fre- quently used nowadays is monopoly, and at the same time it is one of those terms which are peculiarly vague and ill-defined in popular discussion. Even in law and economics, contradic- tory meanings have been attached to the term, although recently there has been a marked clarification of thought both on the part of economists and jurists. While there has been confusion of thought with respect to monopoly, all have agreed that some- thing to be called monopoly has existed, and that it has been the cause of perplexing scientific and practical problems. In economics, as in life, categories shade off into each other, and at the boundaries discrimination is difficult. It is best, therefore, to find highly developed, plainly marked types to fur- nish us the subject-matter for definition and to compare one type with another. This is an especially desirable mode of procedure in the present case, because the term " monopoly " at once sug- gests the term " competition," with which it is inevitably con- trasted. When monopoly exists, competition is thought of as absent. A state of full and free competition, on the other hand, is incompatible with monopoly. Competition means a market with rival sellers and buyers, and prices determined, on the one hand, by efforts of sellers, acting independently of one another, to dispose of commodities and services, and on the other hand, by efforts of purchasers, acting independently of one another, to secure commodities and services. We have seen the forces that under competition limit producers and purchasers, and thus determine prices, and we have seen that competitive prices are beyond the control of any one buyer or seller. igo OUTLINES OF ECONOMICS Monopoly, as the term contrasted with competition, means combination and unified action, signifying restraint on the free offering of commodities and services by rival sellers and on the free purchase of these commodities and services by rivals who desire to secure them. The word " monopoly " itself means a condition in which there is a single seller or a single purchaser, and signifies unity in management of some kind of business in some essential particular. The particular in which unity is secured in the case of monop- oly may be in production, it may be in sales, it may be in pur- chases ; or it may be in any two or all three of these particulars. This use of the term " monopoly " gives us a clear scientific concept which is workable ; and on its basis we may then formu- late this definition of monopoly : Monopoly means that substan- tial unity of action on the part of one or more persons engaged in some kind of business which gives exclusive control, more particu- larly, although not solely, with respect to price. This definition of monopoly is in accordance with good English usage, and is also in harmony with the meaning given to the corresponding word in other modern languages by those who use these languages with discrimination. In legal utterances, too, though they have been contradictory and inconsistent in various particulars, we find, nevertheless, a sound tendency to emphasize unified control of business as an essential character- istic of monopoly.^ The Idea of Monopoly and Industrial Evolution. — But the meanings of economic categories change with industrial evolu- tion. Even such terms as freedom and liberty have to be newly interpreted with every new stage and even with every marked 1 Lord Coke, in the seventeenth century, said that monopoly consisted of power granted "to any person or persons, bodies politic or corporate, for the sole buying, selling, making, working, or using of anything, whereby any person or persons, bodies politic or corporate, are sought to be restrained of any freedom or hberty that they had before, or hindered in their lawful trade" (3 Instilulcs, iSi). Blackstone, in his Commentaries on the Laws of England, gave almost precisely the same definition in the following century. The Supreme Court of the United States {National Cotton Oil Co. V. Texas, 197 U. S. 129) has accepted the definition of monopoly given in the text, above. MONOPOLY 191 phase in a stage of economic life. Naturally monopoly has acquired a new significance, requiring new interpretation. The earlier legal definitions made monopoly proceed from an express grant of public authority. Lord Coke says: "A monopoly is an institution or allowance by the king, by his grant, commis- sion, or otherwise " ; and Blackstone uses similar language in defining monopoly " as a license or privilege allowed by the king." Historically, this source of monopoly power is of paramount importance. From early times, English sovereigns granted mo- nopolies either for public or private reasons, and they became a grievous burden. Queen Elizabeth, in particular, sinned in this respect, regarding the right to grant monopolies as " one of the fairest flowers " in her prerogative, and it was not long before the citizen found himself restrained and shut in on every side by a privileged class of monopolists. In 1603, it was decided, in a famous case, with respect to one of Queen Elizabeth's grants : " That it is a monopoly and against the common law. All trades as well mechanical as others which prevent idleness (the bane of the Commonwealth) and exercise men and youth in labor for the maintenance of themselves and their families, and for the increase of their substance to serve the Queen when occasion shall require are profitable for the Commonwealth, and therefore the grant to have the sole making of them is against the common law and the benefit and liberty of the subject." Parliament, in 1624, passed a statute declaring that " all monopolies are alto- gether contrary to the laws of this realm and are and shall be void and of no effect." Exceptions to this rule were sometimes made upon one ground or another, but the general principle of the illegality of special grants of monopoly became thoroughly established in English law. Our forefathers were so deeply impressed with the evils which they had suffered at the hands of the monopolists in old England that in the Bills of Rights and elsewhere in the early constitutions of our commonwealths they frequently inserted severe denun- ciations of monopolies, and prohibited them unqualifiedly ; and these declarations and prohibitions still last in several states. 192 OUTLINES OF ECONOMICS Two illustrations will suffice. We read the following utterance in Article 39 of the Declaration of Rights which forms part of the constitution of Maryland : " Monopolies are odious, contrary to the spirit of a free government and the principles of commerce, and ought not to be suffered." And the people of Texas still cherish Section 26 of Article i of their constitution, which among other things declares that " monopolies are contrary to the genius of a free government, and shall never be allowed." While the spirit of monopoly is as old as man, there was until this century comparatively little opportunity for monopoly on any large scale save as it proceeded from express grants of public authority. These grants were sometimes made for public pur- poses, and sometimes they proceeded from mere abuse of monarchical power, and were given to favorites of royalty. We cannot now stop to discuss their merits and demerits, but call attention to the fact that they became odious, and were prohibited both in England and in this country, exception being made of patents and copyrights. At the present time, however, monopolies proceed from the nature of industrial society, and are of far greater significance in our economic and political life than ever before. The really serious monopolies of our day are far more subtle, and have for the most part grown up outside of the law, and even in spite of the law. Framed with a view to only one kind of monopoly, our law was at first wholly inade- quate to cope with these new and varied manifestations of monopoly.^ Things Sometimes Confused with Monopoly. — We must dis- tinguish sharply between a condition of monopoly and other conditions, if we are to think clearly and accurately. One thing which does not yield monopoly ils mere limitation of supply, 1 Modern industrial monopolies are often quite as much akin to the offense known in the old English law as "engrossing" as they are to the old notion of a monopoly granted as a special privilege. The engrosser was one who bought large stocks of goods in a market or on their way to a market with the purpose of selhng them later at a higher price. The opposition to engrossing seems to have been based partly on hostility to unnecessary middlemen and partly on the fear of temporary monopo- lies, created by "cornering the market." Later, the terms engrossing and monop- olizing came to be generally used as synonymous in court decisions. MONOPOLY 193 and it is strange that even an economist of the ability of John Stuart Mill should have found the essential feature of monopoly in this limitation ; for this at once makes monopoly cover the entire field of economic activity, inasmuch as economic activity is for the acquisition of valuable things, and things lack value whenever their supply is adequate for the satisfaction of all wants. It is only things limited in proportion to human desires that have exchange value. Nor may we say that a valuable thing is monopolized because its supply is limited and also graded in quality. Land exists in quantities to which physical nature has assigned limits, and the supply of land exists in grades varying in fertility and desirability of situation, and as a consequence of this limitation and grada- tion we have the rent of land. Land is not, however, a monopoly, and it is misleading to speak of it as a natural monopoly. No- where do we find monopoly either in the ownership or in the cultivation of land, but everywhere competition — competition among unequals, to be sure, but still competition. Land rent is a differential gain, a gain due to the superiority of the land owned by rent receivers over that cultivated by those who are making use of land which affords nothing beyond returns to labor and to capital. We must distinguish between the broad concept of differential gains enjoyed by those in competi- tive pursuits, and the monopolistic gains which are based on the absence of competition. Just as sharply must we distinguish between competitive busi- nesses of large magnitude and monopolies. Department stores in no city in the world enjoy monopolies, but are subjected to the steady, permanent pressure of competition. There are those who call every business operating on a vast scale monopoly, and would put in the same economic category a gasworks without a competitor and a huge retail dry-goods establishment with rivals at every hand, ready to seize every opportunity for an advantage over it, and certain to ruin it if its managers relax their intense activity and watchfulness. Classification and Causes of Monopolies. — Monopoly ap- pears to-day in so many different forms and results from so many 194 OUTLINES OF ECONOMICS different causes that the classification of monopohes is a neces- sary preliminary to clear thinking in this field. In the first place, we must note that there are (i) public monopolies, owned and operated by some political unit, for the benefit of the community, and (2) private monopolies, owned by private persons, firms, or corporations, and operated primarily for their own benefit. In the second place, monopolies may be (i) local, {2) national, or (3) international. This classification is more or less arbitrary, but it suggests that the area of the operation of a monopoly is a matter of much importance. There may be only one seller of shoes on a particular street or in a particular building. We do not call this monopoly, because the area in which this shoe dealer is without competitors is much smaller than the area in which the forces which fix the retail price of shoes operate. It is not sufiicient that one should be the only seller or buyer in a certain definite area. For monopoly to exist it is necessary that the unified control of the buying or selling of a particular commodity or service should extend throughout the area of the market, whatever that area may happen to be. The supply of gas, or of street railway transportation, is in most cities a real monopoly, because the market in such cases is merely local. Two young men in Chicago some years ago cornered the market on eggs, and thereby cleared $15,000. The weather was so cold that eggs could not be shipped to the city, and thus the speculators had a temporary local monopoly. A protective tariff or other impediments to international trade may some- times enable a monopoly to exist in one country when the same article or service is not monopolized in another country. Various attempts have been made to establish international monopolies, but none of these has been entirely successful. Agreements restricting competition between the producers of different na- tions are known to have been effected in the steel trade and in the petroleum trade. We pass now to a third classification of monopolies, according to the source of monopoly power. This classification is especially important, because v\^e shall not know how to deal effectively MONOPOLY 195 with monopolies until we understand just why and how the different kinds of monopolies have come into being. A. Social Monopolies. I. General welfare monopolies. 1. Patents. 2. Copyrights. 3. Public consumption monopolies, 4. Fiscal monopolies. II. Special privilege monopolies. 1. Those based on public favoritism. 2. Those based on private favoritism. B. Natural Monopolies. I. Those arising from limitation of supply of raw ma- terial. II. Those arising from secrecy. III. Those arising from peculiar properties inherent in the business. Social Monopolies. — Businesses are social monopolies ^ when they are made monopolies not by their own inherent properties, but either by legislative enactment or by special advantages or privileges granted to them by other monopolies. Social monopolies cannot exist without the acquiescence of society. There is no reason, therefore, why social monopolies should be permitted, except in so far as particular social monop- olies are deemed to be advantageous means of achieving socially desirable ends. The exclusive privileges conferred (for limited periods) by patent and copyright laws are justified by the stimulus they have given to invention and authorship. Patents lead to several different kinds of monopolies. In some instances the monopoly is limited to the control of the supply of the patented article itself. In other cases the use of a patented machine or process in the manufacture of some other product may give advantages important enough to create a monopoly in the supply of that product. Sometimes the owner of a patent endeavors to extend the scope of his monopoly by refusing to sell his patented prod- 1 Sometimes called " artificial monopolies." 196 OUTLINES OF ECONOMICS ucts except on the condition that other commodities, used in connection with the patented product, be purchased from him and not from his competitors. Such agreements have been en- forced in the sale of mimeographs and of shoe machinery. These " tying contracts " were made illegal by the Clayton Anti- Trust Act of 1914. Again, the patent system sometimes operates so as to perpetuate a monopoly already established. Some new inventions cannot be profitably utilized except in connection with machines or processes which have previously been patented. For this and other reasons it frequently happens that an exist- ing monopoly affords the only market for the improved machines and processes adapted to some particular industry. This has been an important factor in the telegraph, telephone, and elec- trical industries. But although our patent laws need careful revision,^ the policy of granting inventors a temporary monop- oly continues to meet with general social approval. Copyrights stand upon even firmer ground. To do away with copyrights would not only lessen the incentives to authorship, but it would also prevent the publication of many good books. Trademarks, like patents, are monopolies in the strictly legal sense that no one else may use them. But, unlike patents, they do not lead to a monopoly in the economic sense of giving exclusive control of one sort of business. They are used largely in competitive business undertakings as a help in establishing and maintaining what is termed good-will. The law also forbids the fraudulent imitation of established brands, firm names, and distinctive forms of packages. In so far as a successful business man in a competitive field is able to induce people to believe that it is better to pur- chase his particular brand of goods than to take the chance of getting a possibly inferior quality by purchasing his competitor's products, he may be able to lift himself a little above the "dead level" of competition. He may even find that he can increase his net profits by putting the price of his goods somewhat higher than that at which precisely similar goods are sold in the market. By thus successfully marking off his product as something distinct from and possibly superior to his competitor's goods, he is able to obtain what might be termed a quasi-monopoly. But because his power to control the price of his product is in general much more limited than that of the true monopolist, and because competition limits and conditions his activities in other ways, his business is more properly called competitive than monopolistic. * See p. 23, above. MONOPOLY 197 Public consumption monopolies and fiscal monopolies are to be distinguished the one from the other only by the object which the government has in view in establishing them. If the govern- ment manages for itself or grants to another a monopoly of the liquor traffic with the object of regulating the consumption, the monopoly is a public consumption monopoly. If, on the other hand, the chief object is not regulation, but revenue for the government, the monopoly is a fiscal one. Often the two objects are blended. The production of salt has at one time or another been a fiscal monopoly in many different countries. The sale of tobacco is a fiscal monopoly in France. In recent years Japan has established a number of fiscal monopolies. The old monopolies established by special grant of the sovereign were in some cases fiscal monopolies, a heavy tax or royalty being paid by the monopolist. In other cases, however, they were based merely on public favoritism. A monopoly in one country, protected by a high tariff from the competition of producers in other countries, is rightly said to be based, so far as all or part of its monopoly power is concerned, on public favoritism. Mo- nopolies based on private favoritism derive their monopoly power from special advantages granted them by other monopolies, especially natural monopolies. Railroad rebates have been in the past a fruitful source of monopoly. Natural Monopolies. — ■ These depend for their existence on natural forces as distinguished from social arrangements. They grow up independently of man's will and desire and sometimes even in direct opposition to it. The words we have used to designate the first two classes of natural monopolies are self- explanatory. Natural mineral waters and certain wines made from grapes that are grown only in restricted areas are often good examples of monopolies derived from special limitations in the supply of raw materials. The Kimberley mines, of South Africa, virtually controlling the amount of annual additions the world's stock of diamonds, constitute a monopoly of this class. The limited area in which anthracite coal is produced in the United States is an important contributing cause of the monopolistic control of that industry. 198 OUTLINES OF ECONOMICS Monopolies based on secrecy are no longer of great importance, although the use of secret processes remains in some instances a source of monopoly. By far the most important of all monopolies are natural monop- olies of the third class, arising from peculiar properties inherent in the business. Among such monopolies are roads and streets, canals, docks, bridges and ferries, waterways, harbors, light- houses, railways, telegraphs, the post office, electric lighting, waterworks, gas works, and street railways of all kinds. What are the properties inherent in such businesses that make them naturally monopolistic ? In some instances it will be found that the possession of peculiarly favorable spots or lines of land may give advantages important enough to create monopoly. This may be true, for example, of harbors, docks, street railways, rights of way through mountain passes or along narrow river valleys, and railway terminals in large cities. Often these are things which cannot be duplicated at all or can be dupli- cated only at a practically prohibitive expense. Monopolies created by the presence of such conditions are similar to natural monopolies of the first class. Natural monopolies of this third class are, however, more often rooted in conditions that make competition self -destructive. These conditions are three in number, and the presence of all of them is generally necessary to create monopoly: (i) The com- modity or service rendered must be of such a nature that a small difference in price will lead buyers to purchase from one pro- ducer rather than from another. (2) The business must be of such a nature as to make the creation of a large number of com- petitive plants impossible. Either because the business is one in which special advantages attach to large-scale production or because there are actual physical difficulties in the way of the multiplication of competing plants, there must be fairly definite limits to the possible increase of the number of plants among which the business might be divided. (3) The proportion of fixed to variable expenses of production must be high. These conditions, the reader will note, are conspicuously present in the operation of railways and of the so-called local MONOPOLY 199 public utilities, as well as in other industries in which natural monopoly prevails. The principal reason why competition cannot be maintained in this field is that under the conditions we have listed competition Jails to fix a normal price remunerative enough to attract the recurrently necessary fresh investments of capital. Competition succeeds when either, first, the ex- penses of production are largely variable expenses, or, second, the total output of the industry comes from a large number of competing business units, some successful, others, very likely, operating on the narrowest possible margin of profits. When either of these two conditions is present in an industry, the aggregate amount of the ovitput will be delicately sensitive to changes in market price. If the price rises, the output will be increased ; if it falls, the total output, and with it the total expenses of production, will be diminished. In either event the change in price will be checked, and through this process, market prices will, in the long run, be kept just about high enough to induce the industry to maintain an output of whatever size may be justified by the demand for it. That is, the forces which fix a normal price will operate effectively. But if there are, at the most, only relatively few competing establishments in an industry, if fixed expenses are relatively large as compared with variable expenses, and if the market for the commodity or service produced is quick to take advantage of price cutting on the part of one or more of the establishments, it will be difficult to maintain competitive conditions. What would happen if one of the railways running between Chicago and New York should reduce its freight rates? First, it would immediately get a large share of the traffic. Second, the other railways would be forced to lower their rates, so that if the first railway desired to retain its increased traffic it would be forced to cut rates again. Third, it is clear that there is no stopping point in this process of competitive rate cutting, so long as the rates suffice to cover variable expenses. Fourth, since fixed expenses must, however, be paid, the competing railroads have to choose between (a) ultimate bankruptcy, and (6) the main- tenance of rates at a level fixed by joint agreement. This second 200 OUTLINES OF ECONOMICS alternative means unity of action, or monopoly. Where com- petition is thus self-destructive, monopoly is inevitable. The operation of this principle has been exemplified many times in the history of American railways. A new " competing" rail- road has been built, it has cut rates to attract a share of the traffic ; a rate war has ensued ; and the end has always been mo- noply in the form of a combination or rate agreement. A simi- lar situation is found in the case of local public service companies. Twenty or thirty years ago many of our cities adopted the mis- taken policy of trying to force competition into this naturally competitive field. But very often it was found that the mere threat of competition was sufficient to bring about combination and monopoly. It is believed by some that the advantages of large-scale production increase so long as the size of the business establishment increases. If this were true, it would give production on the largest possible scale advan- tages so great that monopoly would result in all parts of the industrial field. Some socialists believe that this movement is so strong that it must result in the final disappearance of competition and the triumph of monopoly everywhere. Certain other students of the problem think that it is only in certain industries that the economies of large-scale production are sufficient to lead to monopoly. But in such fields, they hold, "capitalistic monop- olies" are sure to appear. It should be remembered, however, that the very large business establish- ment has disadvantages as well as advantages ; and it seems probable that beyond a certain point the disadvantages of a further increase in size grow more rapidly than the advantages. In most industries the point of maxi- mum efficiency is reached long before the point of monopoly is reached. It is difficult, and perhaps impossible, to find a single instance of successful monopoly in which one or more of the definite and specific sources of monopoly, mentioned in the foregoing classification, are not to be found. Our conclusion, then, may be stated as follows : There is a great and grow- ing field of industry in which competition is not natural or permanently possible ; there is another field within which monopoly does not exist, and in which it cannot exist except in the form of social (or artificial) monopoHes. Monopoly Price. — The chief peculiarity of monopoly price is found in the power of the monopolist over supply. This is, what gives the monopolist the ability to secure surplus profits. In competitive industry the supply is not within the control of a MONOPOLY - 20 1 single producer, and, as a result, prices tend to be controlled or limited by the expenses of production. The competitive pro- ducer cannot increase his profits by limiting the supply, and it is on this account that the law regards competition as one of the main pillars of our present social order. The monopolist will normally endeavor to fix his output at such a point that, given the existing state of demand, he will secure the highest possible net returns. On the one hand he has to face the fact that although he can increase his gross receipts up to a certain point, by increasing his output, yet the increase in gross receipts will not be proportionate to the increase in out- put, for the simple reason that the increased output will not find buyers except at a lower price per unit. On the other hand an increase in his output will always increase his aggregate expenses of production, although here again the increase (in expense) may not be proportionate to the increase in output. In par- ticular there are likely to be some permanently fixed expenses which will be the same for a small output as a large one, and there may be other expenses which will not increase Unless the output should be made much larger than would be profitable. In fact, it may often happen that the fact that a large output would make it necessary to increase certain expenses which would otherwise be fixed (such as the cost of the plant) may lead the monopolist to choose to produce a relatively small quantity of goods. The following table shows in parallel columns the number of sales of a monopolized good at different prices, the total resultant receipts, the variable expenses, the fixed expenses, the total expenses, and, finally, the net revenue or monopoly profit. For the sake of simplicity it is assumed that all of the fixed expenses are perma- nently constant, at least for such possible increase of output as the monopolist cares to consider. Study of the table will show that, in the case assumed here, the monopoly price will stand at six cents. It would be possible for the monopolist to produce 5,500,000 units, for this would give him a net profit of $5000. But since he can control the supply, he will limit his output to 2,500,000 units, giving him the maxi- mum net return, $25,000. 202 OUTLINES OF ECONOMICS Price PER Unit Number Sales Total Earnings Variable Expenses PER Unit Total Variable Expenses Fixed Expenses Total Expenses Net Renenue $.IO 600,000 $ 60,000 $.03 f 18,000 $50,000 $ 68,000 -$8,000 .09 800,000 72,000 •03 24,000 50,000 74,000 — 2,000 .08 1,200,000 96,000 ■03 36,000 50,000 86,000 + 10,000 .07 1 ,800,000 126,000 ■03 54.000 50,000 104,000 + 22,000 .06 2,500,000 150,000 ■03 75,000 50,000 125,000 + 25,000 •OS 3,500,000 175,000 •03 105,000 50,000 155,000 + 20,000 .04 5,500,000 220,000 •03 165,000 50,000 215,000 + 5. 000 But the case assumed here is in many ways far simpler than the cases presented by real life. The monopolist may not be able easily to hit upon just the price that will yield maximum net profits. He may, by experimenting a little, approach more closely to it, but at best he can hardly hope to reach more than an approximate maximum. Or it may be that the monopoly is one in which the price is fixed by custom or convenience (as is in some measure true of street railway transportation), so that the monopolist can vary only the quality of the commodity or service he sells at the established price. Moreover, it should be noted that the price most profitable for the present may not prove the most profitable price in the long run. The monopolist may choose to forego some of his possible profits this year in order to extend the field of demand for his product and to lay the foundation of a long-continuing period of profitable produc- tion. Furthermore, in view of the possibility of the public reg- ulation or public ownership of his business, he may deem it ex- pedient not to arouse public hostility, and so may decide to sell at a price lower than what would, for the time being, be the most profitable price. The Effect of a Tax. — Our numerical illustration may be made to convey a lesson regarding the influence of taxation upon monopolies and monopoly price. Fixed expenses have no in- fluence in determining the price. If, therefore, a fixed tax, say of $5000 a year, were to be laid upon this monopoly, it would not result in an increase of price. A study of the table will show MONOPOLY 203 that with such a tax the net revenue at price .08 would be $5000 ; at price .07, $17,000 ; at price .06, $20,000; at price .05, $15,000; at price .04, nothing. Thus price .06 will still be the point of maximum net revenue, and hence the monopoly price. On the other hand, a variable tax, for instance a tax of one cent per unit, would result in this case in raising the monopoly price. In our illustration, such a tax would make the net revenue at the price .08, — $2000; at the price .07, $4000; at the price .06, nothing; at the price .05, — $15,000. Thus, though the monop- oly would find its profits greatly curtailed by such a tax, con- sumers would be compelled to pay one cent more per unit for the monopoly product. The possible advantage which society might draw from the tax would therefore be wholly or in part offset by the increased cost of the commodity. We may conclude, therefore, that fixed taxes, or taxes on the net revenue of a mo- nopoly, cannot be shifted wholly or in part by a change in price ; while taxes laid in proportion to the amount of business, since they contribute an addition to the variable expenses, may be wholly or in part shifted by a change in price. Relation of Demand to Monopoly Price. — There are certain conditions on the side of demand which have a decisive influence in determining monopoly price. The most important of these is the degree of elasticity of the demand for the monopoly prod- uct. The more inelastic the demand jor the monopolized commodity or service, the higher will he the monopoly price which will yield the greatest net returns. If a commodity is a necessity of life, and is so habitually consumed that people cling with intensity to it, monopoly will, other things being equal, be more profitable than if the commodity were one which consumers thought they could easily dispense with. This helps to explain why salt and tobacco have been chosen as fit objects for public fiscal monopo- lies. The more adequate the substitutes for a commodity, the smaller will be the opportunity for surplus profits which a monop- oly of that commodity will give. Finally, the higher the general average of economic well-being, and the more readily money is generally expended, the higher will be the monopoly price which will yield the largest net returns. 204 OUTLINES OF ECONOMICS Thus monopoly, without any effort of its own, shares in the in- creasing wealth of a country, and absorbs a considerable part of it. It is, for example, among other influences, the larger wealth per capita and the greater willingness to spend freely that makes monopoly more profitable in the United S.tates than in Germany or other European countries. Class Price. — Thus far we have assumed that the monopolist charges one uniform price and sets the price at the point which yields him the largest net returns. But it is obvious that his gains will be increased if he is able to vary his price. His gains would be highest if he could charge each individual that price which would yield the largest net returns, taking into account the number of sales and profits on each. A rich man might pay double the current rates for gas or electric light without dimin- ishing his consumption in the least. But in the case of any large modern business it is obviously impracticable to fix a price for each individual, even were there no legal difiiculties in the way, as there are in the case of the great monopolistic businesses such as gas and electric lighting and railway transportation. The next best thing for the monopolist is to divide his public into classes, and to charge to each class that price which will yield the largest net returns. In the table already given, we found that six cents was the monopoly price on the hypothesis of one uniform price, but obviously, if the eight-cent and seven-cent prices could be secured, and six cents reserved as a price for sales that could not be made at eight or seven cents, the profits would be still higher. ' This gives rise to what, in its broad, general terms, we call class price. The monopolist seeks in every pos- sible way to divide his community into classes and to secure from each the highest possible price. We observe a remarkable development of class price in the case of our railways ; and, unless legal obstacles are interposed, this development will doubtless go still farther. We have special trains with an extra charge. We have privately owned railway coaches ; our drawing-rooms and single seats in " parlor cars " ; our ordinary first-class tickets ; and our second-class tickets, the purchasers of which frequently ride in the " day coach " with the first-class passen- MONOPOLY 205 gers. Then we have single tickets, fifty-trip family tickets, monthly commutation tickets, etc., with enormous variations in price. We may go farther and say that the American rail- way rate system of "charging what the traffic will bear " is a consummate example of monopoly prices. Nor need it be supposed that in all its ramifications class price is a bad thing. It is, when ignorance and need are exploited by a special high price ; frequently it works well when an attempt is made to reach a class of limited means with a very low price, as in the case of early and late workingmen's trains, etc. Monopoly price will vary with use also ; and this is one special subhead under class price, and may be designated as use price. The typical instance is that of two prices sometimes charged for gas : a higher when it is used for illuminating purposes ; a lower when it is used for fuel. Monopoly Price High Price. — It is often said, and frequently even in judicial decisions, that the monopolist can charge any price that he pleases. We have already seen that this is not the case. The law of monopoly price shows that the price, even in the case of monopoly, is determined by economic forces. It is conceivable that there may be cases in which monopoly price will exactly coincide with competitive price, although the prob- abilities would be against a frequent coincidence of this kind. There are also cases where monopoly price may be even lower than competitive price. If a monopolist should be able to effect great savings as compared with the expense of doing business under competition, it could happen, in theory, that the price which would yield the largest net returns would be a lower price than would be possible under competition. Probably, and in fact almost certainly, under a condition of competition, letters could not be carried as cheaply as they are. Generally there are strong reasons for the position that mo- nopoly price is high price. Monopoly is formed for the sake of gain. Gain may be secured in two ways by monopoly : first, through economies of production ; and it is alleged by trust pro- moters that these economies are a chief motive in their activity. There are some gains of this kind, but what their magnitude 2o6 OUTLINES OF ECONOMICS may be in a particular case is highly uncertain. When we com- pare a monopolistic business with a competitive business organ- ized on such a scale as to secure the maximum of efficiency, the gains of competition in alertness and inventiveness, stimulated by rivalry, have recently been too little considered. The principal source of gain in monopoly is found in the ability to get a high price. In confirmation of the position that monop- oly price is high price, we may refer to history, the utterances of which seem to be clear and distinct. At any rate, there can be no doubt that, in the opinion of historians who have treated the subject, monopoly means high price. Hume, in his treatment of monopoly in his History of England, speaks of the price of monopolized articles as exorbitant, and cites the price of salt, the price of which had been raised by monopoly tenfold and even more. It is generally conceded that in most cases of a government monopoly of the production or sale of salt the price has been so extremely high as to be a real popular grievance ; and it is generally necessary to inflict severe penalties to pre- vent the people from securing the salt at a lower price from non-authorized sources. But of still greater significance are the results of the investigations of the Industrial Commission of the United States. It was there made evident that when monopoly appears in a form at all clear and well defined, the tendency is plain to increase the margin between the prices of finished products and raw materials.^ The courts of the world have made it clear in their judicial ut- terances that they regard monopoly price as high price ; and, as their opinions are based upon cases actually brought before them, we cannot do otherwise than attach great importance to their view. Wherever commissions have been formed with power to regu- late monopoly price, and these commissions have been comprised of independent and strong men, there has been a marked tend- ency to reduce monopoly price; because unregulated monop- 1 See report by Professor J. W. Jenks on "Industrial Combinations and Prices," Report of the Industrial Commission, Vol. i, pp. 39-57 ; and also the same author's work, The Trust Problem, Chap. viii. MONOPOLY 207 oly price has very often been found to be excessive and unjust. The opinions of the Railroad Rate Commission of Wisconsin afford many illustrations. This Commission has authorized a higher price in a few cases, but generally has been forced to lower prices, although in a notable case of passenger rates it did not go so far as the legislature subsequently did. The same state- ment holds true in large measure of the decisions of other state public utility commissions and of the Interstate Commerce Commission. Monopolies and the Distribution of Wealth. — We have not the precise statistical data which will enable us to state the exact influence of monopoly upon the distribution of wealth. We have, however, sufficient data to warrant the opinion that the high monopoly prices and the gains resulting from the exclusive posi- tion of the monopolist give us a large privileged class in countries of modern civilization, and especially in the United States. Even when the increment of price is comparatively small, it has large significance in the case of the sale of a vast number of units of services or commodities. The difference between a four-cent street-car fare and a five-cent street-car fare may not appear to be great, but it is a difference of 25 per cent and leads to an enormous difference in earnings. All the many investigations that have been made recently in various lines of business (especially in railways, the beef industry, the steel industry, coal mining, etc.) point to monopoly as a prime cause of the so-called swollen fortunes of this country. In this and other countries some histories of families distin- guished for wealth have been written, and probably few if any cases could be found in which some monopoly element had not entered. Various lists of rich men have been published, among them one published by the New York Sun in 1855, and one published by the New York Tribune in 1892. These lists can- not by any means be presumed to be accurate, and yet they do afford very considerable evidence of the sources of large for- tunes, and point to monopoly as a prime source of the enor- mous fortunes of today. This is a subject which in itself would require a larger book than the present one for adequate treat- 2o8 OUTLINES OF ECONOMICS ment. The student should attempt by observation and study to carry forward the lines of investigation and thought here suggested. Public Policy with Respect to Monopolies. — As many mo- nopolies have come as a result of underlying laws of industrial evolution, they cannot all be abolished. Experience, and the analysis of industries like railways, gas works, etc., falling under the head of " public utilities," so called, should be conclusive. We must have monopoly in these cases, and the only question we are concerned with is, " What kind of monopolies shall we have ? ' ' We must admit that unregulated monopolies in private hands have always been odious and are opposed to the principles of the laws of civilized nations. They are opposed to that endeavor to secure equality of opportunity which is fundaihental in modern democracy and which manifests itself as a red thread running through American history. Even George Washington, generally looked upon- as calm and self-contained, denounced monopolizers and wished they might be " hunted down as pests of society " and " hanged on a gallows five times higher than the one prepared for Haman." ^ It is not so much high price that disturbs the modern man as it is inequality of opportunity ; and this general sentiment has been very clearly and forcibly ex- pressed in court decisions. In the field in which monopoly is natural and inevitable, therefore, we cannot permit unregulated special privilege, and to this end we must choose between pub- lic monopoly — government ownership — and public control of monopolies privately owned and operated. This opens up so vast a subject for discussion that we cannot enter into it here. It should be noted, however, that the considerations which must govern our choice differ for different types of natural monopolies. Municipal waterworks and the federal post office are in most respects efficiently and successfully managed. But in the case of many other natural monopolies the problems of management are more complex and difi&cult in many ways. Just now the method of public control rather than of public ownership is be- ginning to be given a thorough test. Our policy in the future 1 C. J. Bullock, Essays on the Monetary 'History of the United States, p. 67. MONOPOLY 209 will undoubtedly be determined in large measure by the results of that test. Public control, to secure equality of opportunity, must so regulate monopolies and limit price that the gains will be no higher than those produced by equally wise investments and equally wise and prudent management in the field of com- petition.^ Sometimes it is stated that owners of railways and other monopolistic enterprises should have a competitive return upon all the money that they have invested. This would give them a position of special privilege, inasmuch as in the competi- tive field a great deal of money is lost. It is only wise invest- ment and careful management in the field of competition that can secure returns equal or superior to the current rates of in- terest. Imprudently invested capital is lost in the field of com- petition ; and when it is imprudently and unwisely invested in the field of monopoly, it cannot justly claim any return. When we turn to the field of social monopolies we find that the problems of public control are simpler, but more diverse. These monopolies exist only by the approval or tolerance of society, and each particular one can be judged on its own merits. The problem of social monopolies, therefore, resolves itself into such problems as those of the economic effects of the patent system, the best way of controlling the consumption of liquors and other harmful commodities, and the most expedient means of raising public revenues. With respect to one class of social 1 This does not mean that in the case of old enterprises price must always be so reduced that the gains shall yield a competitive return only on the physical value of a plant. The principle of vested rights or interests has to be given a certain role. These have often been created by society rather than by private persons, and faith must be kept. In the case of railways and the telegraph, the American nation and states have deliberately encouraged a wasteful policy of competition which is in large measure responsible for high capitalization. It would not be right to place upon holders of these properties all the burdens of a mistaken public poHcy in the past. What is needed is to declare a public policy for the future and to base returns for the future upon future actual investments in the case of public utilities. In any case, our federal and state governments are acting wisely in insisting upon physical valuations of railways, gas works, and other similar monopolies as a help in determining fair prices for present and future. Now and here we can do no more than to throw out these suggestions in regard to a pressing present problem of great magnitude. A further discussion of some aspects of the problem will be found in Chap. XXVII (Transportation). P 2IO OUTLINES OF ECONOMICS monopolies society has reached a very definite conclusion : There must be no needless extension of the field of monopoly through either public or private favoritism. The possibility of obtaining monopol}/ through special privilege is clearly inconsistent with the maintenance of equal opportunity in the industrial field. The problem of the public control of monopoly is sometimes confused with the " trust problem " — the problem of the public control of large industrial combination. But the trust problem is only in part a problem of monopoly. It will be discussed in the following chapter. QUESTIONS AND EXERCISES 1. Has bigness anything to do with monopoly ? Do you know any small business which is a monopoly? Do you know any very large business which is keenly competitive? Contrast a state of competition with a state of monopoly. 2. Define monopoly and discuss each point in the definition. 3. Contrast land ownership with monopoly. 4. Explain the importance of classification of monopolies, and especially of distinguishing between private and public monopolies, and social and natural monopolies. 5. State the main clashes of monopolies, and give the divisions and sub- divisions in each class. 6. A public tobacco monopoly exists in France and produces large rev- enues. The business is generally said to be well managed. Do you see any benefits that would accrue from the establishment of such a monopoly in the United States ? any evil effects ? 7. Define monopoly price and show how it is determined. 8. What does class price mean? Explain use price. 9. Why do we think of monopoly price as high price ? Do you know any monopoly price which is a low price? What do you mean by high price? by low price ? 10. What relation has monopoly to large fortunes? to small fortunes? What, if any, to poverty? 11. What is the best public policy with respect to monopolies? REFERENCES Brown, W. J. The Prevention and Control of Monopolies. Ely, R. T. Monopolies and Trusts, Chaps, i-iv. HoBSON, J. A. Evolution of Modern Capitalism, revised ed.. Chap. ix. MONOPOLY 211 Levy, Hermann. Monopoly and Competition. Marshall, Alfred. Principles of Economics, 6th ed., Book v, Chap. xiv. PiGOU, A. C. Wealth and Welfare, Chaps, ix-xiii. Price, W. H. The English Patents of Monopoly. Taussig, F. W. Principles of Economics, Vol. i, Chap. xv. United States Industrial Commission. Report, Vols, i and ii. CHAPTER XIII BUSINESS ORGANIZATION The Meaning of "Business." — The dominance of "busi- ness " in our present social economy is so familiar and common- place a thing that we are apt to forget its real significance. " Business " means profit seeking. It does not cover so broad a field as does " production," nor is it quite the same thing as " production for the market." Business is acquisitive rather than productive, and while acquisition usually involves produc- tion, this is not invariably the case. Business operations con- sist, fundamentally, in buying or hiring things and in selling them or using them for the purpose of gaining a profit. Among the things thus bought or hired are land, labor, capital goods, and business privileges or advantages, such as franchises, patents, copyrights, and " good-will." The economic world, in its busi- ness aspect, is a world of buying and selling rather than of making and using things ; it is a world in which prices, expenses, debts and credits, and contractual relations are the dominating things rather than the technical processes of production or the ultimate costs of production as measured in human effort and sacrifice. Commerce and manufactures have each in turn been brought under the dominion of business enterprise ; business methods and motives are also of the first importance in agriculture, although in this last field production for home use continues hand in hand with production for profit. The Nature of Business Units. — The business world is made up of profit-seeking units, — entrepreneurial units. We are apt to think of business units as composed of individual men or groups of men. In an ultimate sense this is not incorrect, but for present purposes we may more profitably view business units BUSINESS ORGANIZATION 213 as merely the centers ox foci of the contractual and other rela- tions that bind the business world together. These relations are recorded and stated more or less fully in the accounts of each business unit; ultimately, however, they are matters of legal fact, and, as we shall see, the legal aspect and the accounting aspect of these relations are not always identical. The Business Unit in Accounting. — The simplest general way in which a business unit can be described by its accounts is by means of the balance sheet, which is the statement of the assets or resources and the liabilities or obligations of the busi- ness unit as they exist at a particular time. The following is a simplified form of balance sheet for a small manufacturing establishment : Assets Liabilities Land and buildings . . : Machinery and fixtures Raw materials, goods in process, and finished goods on hand . . . Accounts receivable . . Cash on hand and in banks Total assets .... 1190,000 50,000 40,000 28,000 7,000 J 1 5,000 Original capital invested Income reinvested . . Accounts payable . . Profits Total liabilities f200,000 70,000 20,000 25,000 515,000 The itemized assets explain themselves, but the meaning of the various liabilities may not be so clear. In this statement all the items of the liabilities except " accounts payable " are liabil- ities of the business unit, conceived as a separate thing, to its owner or owners, — the amount which would be left if the business were sold as a whole at a price just equal to the total estimated value of the assets minus the actual outstanding obli- gations (the accounts payable).^ It will be noted that the item called " profits " is the variable by which the account is bal- anced. 1 The form of balance sheet given in the text is a simple adaptation of the kind of balance sheet used in the published statements of corporation accounting. But if the individual proprietor of a small business keeps an accurate ledger account with himself, the result is the same so far as the independence of the business as an accounting unit is concerned. 214 OUTLINES OF ECONOMICS On such a showing as this the owners might decide to take $5000 out of the business as dividends, or personal profits, as the case may be. This would reduce the "cash" to $2000 and correspondingly reduce "profits." They might decide, also, permanently to retain $10,000 of their earnings in the business. "Profits" would then be reduced to Sifi^ooo, and the "income reinvested" would be increased to $80,000. In the case of cor- porations the "original investment" item is called "capital" and repre- sents the par or nominal value of the corporation's stocks and bonds, whether or not the corporation has received this amount in return for them. Sur- plus profits in such cases can be easily converted into "capital" by means of "stock dividends." The business unit is pictured in the balance sheet as the ovi^ner of various kinds of valuable property and of valuable claims against those indebted to it. But on the other hand, as the balance sheet also shows, there are rights or claims of equal amount against the business unit on the part of its ov^^n creditors and proprietors. The liabilities side of the balance sheet shows how the ultimate rights or equities in the property and credits shown as assets are distributed among creditors and proprietors. The business unit, as a thing apart from its proprietors, has only an imaginary existence. But it is convenient to think of it as having valuable rights or assets of its own, and to think of the claims against these rights as being distributed in the form of obligations or liabilities. This explains the statement that business units are the centers or foci of business relations. In its legal aspect, however, the business does not always have so distinct a unity of its own. This varies with the form of business organization, of which there are three important types : the individual entrepreneur, the partnership, and the corporation. The Individual Entrepreneur. — Any individual may set him- self up as a business man, an entrepreneur, without any legal formality other than the payment of the license fee which most states impose on some kinds of business undertakings, such as liquor dealing, and which some states, especially in the South, impose upon many kinds of undertakings. The individual en- trepreneur still dominates the field in agriculture, in small retail trade, and in local " shop industries." BUSINESS ORGANIZATION 215 In the legal aspect the obligations of a business conducted by an individual entrepreneur are the personal obligations of the entrepreneur. All of his possessions — of whatever kind ^ — • are jeopardized by his business risks. If the entrepreneur conducts two distinct business undertakings, the assets of one may be seized, if necessary, to secure the liabilities of the other. The personal liability of the individual entrepreneur is accordingly said to be unlimited. The usefulness of this kind of business organization is limited, obviously, to small undertakings, where / the capital and credit of the individual man are adequate. ' Partnerships. — A " firm " or partnership represents a joint undertaking by individual entrepreneurs. Partnerships are most common in mercantile undertakings of moderate size, in small manufacturing establishments, and in the professions. This joining of interests makes larger undertakings possible, but relatively increases the personal liability of the individual mem- bers of the firm. For each member is personally liable for all of the obligations contracted by the firm, including those contracted in the ordinary course of business by any other one member of the firm.2 The partners may have a contract binding among themselves as to their respective contributions (of money or time), shares in profits, and liabilities. But a member released from personal liability by an agreement of this kind is still liable for all obligations incurred by the firm. The agreement only gives a basis for instituting legal proceedings to recover the amount of his personal losses from the other members of the firm. Aside from (i) the excessive personal liability involved, the partnership is open to objection from the business man's point iThe "exemption laws" of some states constitute an exception which does not affect the principle involved. 2 This refers to the status of the ordinary partnership under common law. The statutes of most of the states provide for a special form of limited partnership, in which one or more of the partners are special partners, who are not personally liable, save for their investment in the business, and who are allowed to take no active part in the management of the business. In a few states there is a special form called a limited partnership association, in which the liabihty of all the partners is limited. These are practically joint-stock companies with non-transferable shares. The partnership in commendam, which still exists in Louisiana as a heritage of the civil law, is essentially like the statutory limited partnerships of other states. 2l6 OUTLINES OF ECONOMICS of view, because : (2) It is impossible for a partner to retire from a firm without dissolving the partnership and, possibly, break- ing up the business. The death or insolvency of any partner has the same effect. (3) A new member cannot enter the firm nor can a member transfer his interests to another person without the consent of all the members of a firm, — requirements which naturally follow from the nature of a partnership. (4) The partnership form of organization is not adapted to undertakings requiring large investments of capital and hence requiring the cooperation of a large number of persons. What advantages the partnership has come from the ease with which it can be organ- ized and dissolved, and from its elasticity, — that is, the ease with which the contractual relations among the partners, bind- ing as among themselves, can be altered to suit any contingencies that may arise. The Business Corporation. — The federal census of 1909 showed that, although only about one fourth of the manufactur- ing undertakings included in that enumeration were organized as corporations, yet these produced nearly four fifths of the total manufacturing product (measured in money value). Most banks and insurance companies are corporations, while in the field of railway transportation corporations are in almost exclu- sive control. And a large and growing number of mercantile undertakings are organized as corporations. In the case of the corporation the legal view and the account- ing view of the business unit are practically identical. While the ordinary partnership is in law merely a group of individual entrepreneurs, the corporation is regarded, for some purposes, as a " person." To the incorporated business unit, — an abstract thing, as we have seen, — the law imputes some of the attributes of personality, — and of a personality distinct from that of the individual men who are the stockholders of the corporation.^ 1 Several states authorize the organization of "joint-stock companies" which are Hke corporations in many particulars. In theory they are partnerships with transferable shares and (in some cases) with limited Uability. Joint-stock com- panies are also organized mider the common law in some states. In England and the English colonies the name "joint-stock company" is applied to a statutory BUSINESS ORGANIZATION 217 Municipalities, universities, monasteries, guilds, etc., were commonly incorporated by royal charter long before business corporations of the modern kind arose, — for this did not occur until the rise of "capitalism" in the sixteenth and seventeenth centuries. The great trading and coloniz- ing companies, such as the British East India Company, the Virginia Com- pany, the Guinea Company, etc., were the prototypes of the modern business corporation. In connection with these trading companies the joint-stock principle, which had already been used in a few isolated instances of banking, was developed. This was the practice of issuing certificates to those who made contributions to the "joint stock" (or capital) of a company, which entitled the holder to a proportionate share in the profits accruing to the joint stock. The modern business corporation, like these early trading companies, is based essentially on the combination of the joint-stock prin- ciple with the legal recognition of the business unit as a distinct entity. At the beginning of the nineteenth century what few corporations there were in America were, for the most part, banks, insurance companies, or canal and turnpike companies. The introduction of railways in the third decade of the century greatly stimulated the organization of corporations, because these new undertakings required larger investments of capital than could be furnished by any individual or firm. State enterprise, it is true, promised at one time to be an important factor in canal and railway building, but such state undertakings were usually planned with the purpose of de- veloping natural resources, attracting immigration, and building up the trade of particular districts and particular cities rather than of getting money profits. Most of these state undertakings had succumbed by 1840, so that the field was left open for business enterprise. In the general expansion and reorganization of business that followed the Civil War the corporation form of organization began to be more generally used for all kinds of business undertakings. The growing importance of corporations in business life is partly an effect and partly a cause of the growing size of the business unit. The Corporation Charter. — The corporation is a creature of the state, its right to exist being dependent on a charter or on articles of incorporation, granted or approved by the state. In- corporation formerly necessitated a special act of the legislature in each case. This gave opportunity for favoritism and monop- oly and subjected corporations of all kinds to hostility and suspicion. Most corporations are now organized under general laws, whereby any group of men can secure a corporation limited-liability association, essentially like the American business corporation, while the word " corporation " is usually applied only to municipal corporations and certain long-established companies, created by special charters. 2l8 OUTLINES OF ECONOMICS charter by complying with certain prescribed conditions. In fact, all but six states now have constitutional provisions against the granting of charters to business corporations by special act. It was formerly a common practice to grant corporation char- ters in perpetuity, but the decision of Chief Justice Marshall in the Dartmouth College case (1819), whereby the corporation charter was declared to constitute a binding contract between the state and the corporation, which could not be altered or amended by the state except with the consent of the corporation, has led to the general practice of limiting the life of corporations to terms of from twenty to one hundred years, fifty years being a common period. The corporation may, of course, secure a new charter at the expiration of the old, but the limited term gives the state the opportunity to change the requirements of the charter from time to time, or to refuse reincorporation alto- gether, as may seem most desirable. Most states, moreover, now specifically reserve the right to alter or amend the corpora- tion charter at pleasure. Corporation charters, or articles of incorporation, usually con- tain details relating to such matters as the purpose or purposes for which the corporation is formed, its principal place of busi- ness, the number of its directors, and the amount of its capitali- zation. Lack of Uniformity in State Laws. — Many difl&culties in the public control of corporations have arisen from the fact that while charters are granted by individual states, the activities of many business corporations extend over the boundaries of many states. Moreover, some states are much more lenient than others in such matters as the control of capitalization, require- ments as to publicity, limitations on the scope of activity of a single corporation, taxes and fees, etc. New Jersey has become known as the " home of corporations " despite the fact that some states have had even more lenient laws than New Jersey. New Jersey has been favored, however, on account of the proximity of New York City — the real home of most of the greater cor- porate interests of the country — as well as on account of its BUSINESS ORGANIZATION 219 early start and the adaptability of its laws to great combinations of corporations.^ Other states, with stricter laws, could not prevent corporations organized under lax laws from doing business within their terri- tory so far as that business is interstate. So far, however, as a corporation organized under the laws of one state carries on any part of its business wholly within the borders of another state, the latter state has the right of refusing to recognize it as a cor- poration ; that is, the right to treat it as a mere partnership. In practice, however, one state freely recognizes the corporations of another state under the rule of " interstate comity." In fact, many corporations transact practically all of their business out- side the borders of the state which chartered them. The real standards, therefore, are the laxest standards, not the highest. More use on the part of American states of the power of exacting certain standards from " foreign corporations," as they are called, is much to be desired. Corporation Capital and Capitalization. — The business world uses the term " capital " in two ways. It speaks of the total permanent investments — the amount of money "tied up" in a business unit — as its capital. This is the better and more common usage. But it also speaks of the total selling value of the business unit as a whole as its capital. This last will depend not so much upon the amount of the investment as upon its profitableness. It is roughly measured by the " capitalized " earning capacity of the business, or by the market value of the corporation's stock and bonds. The capitalization of a corporation should not be confused with its capital. In a strictly legal sense its capitalization is the amount of its authorized capital stock. The capitalization cor- responds, in theory, to the amount of money actually invested in the business by the original stockholders. As a matter of fact, the full amount of the authorized capital is rarely paid in at the organization of a new corporation. The capitalization is apt to be, in practice, a somewhat arbitrary thing, — a nominal 'In 19 1 3 the corporations laws of New Jersey were revised so that they offer fewer advantages to large corporations than they previously did. 220 OUTLINES OF ECONOMICS money sum divided into units or shares, the relative holdings of different individuals being measured by the number of shares they own. Corporation stock is divided into two general classes, — pre- ferred stock and common stock, although many corporations issue only the latter. Preferred stock represents a prior claim on the earnings of the corporation. A corporation which has " 6 per cent preferred stock " outstanding can pay no dividends to its common stockholders until it has paid 6 per cent dividends on its preferred stock. Preferred stock may be cumulative (in which the prior claims to dividends accumulate from year to year, if unpaid) or non-cumulative. It may or may not have any claim on any part of the surplus profits remaining after a stated rate of dividend has been paid on the common stock. In the popular use of the word the capitalization of a corpora- tion includes also its funded debt. The funded debt is represented by bonds, which are interest-bearing promises to pay certain sums of money at definite times in the future. There are many differ- ent kinds of bonds, but three principal classes are : (i) ordinary mortgage bonds, (2) collateral trust mortgage bonds, (3) income and debenture bonds. The first class is based on a mortgage of all or of a specific part of the real property of a corporation. Collateral trust mortgage bonds are secured by the pledge of securities issued by other corporations, but owned by the corpo- ration issuing the bonds. They have been much used in financ- ing railway consolidations. Income and debenture bonds are usually secured only by the earning capacity of the business. Industrial corporations make less use of bonds than do railways, and confine themselves usually to the mortgage bond type, — of which, however, there are many subordinate varieties. In the case of many corporations the mortgage security behind an issue of bonds is in itself not of great importance, for the property mortgaged is apt to be worthless except as an integral part of a unified business establishment. The mere power of foreclosure, however, gives mortgage bondholders a position of strength in the reorganization of insolvent corporations. Bonds are sometimes said to represent " creditor interests," BUSINESS ORGx\NIZATION 221 and stock " proprietorship interests." This statement is sug- gestive and is not inaccurate. In a more general sense, however, stock and bonds are merely different kinds of equities in a busi- ness unit, — conveying the right to receive income, to share in the distribution of the assets in case of insolvency, and to have a voice in the management. Stockholders alone participate in the management of the corporation, although bondholders are often able to dictate policies when the affairs of a corporation are in a precarious condition. Bonds differ from stock in being terminable at a definite period of time in the future. In practice, however, the bonds of great corporations are usually replaced by new issues as rapidly as they mature. Overcapitalization. — Much has been said about the over- capitalization of corporations, — " stock watering," as it is called. Only a few states require that all the nominal capitaliza- tion of corporations organized under their laws shall represent capital actually invested. In most states, moreover, it is not difficult for a corporation to increase its capitalization from time to time so as to secure funds from the sale of securities, or (as in the case of stock dividends) in order to afford a basis for the distribution of surplus profits without employing an excessively high dividend rate. On the one hand it is urged that capitalization is a nominal thing, that it is immaterial whether a corporation pays 12 per cent dividends on $1,000,000 of capital stock or 6 per cent dividends on $2,000,000 of capital stock. On the other hand it is said that capitalization should not be a merely nominal thing, but that it should correspond to the actual amount of the invest- ment; that, without regard to the amount of capitalization, regularly recurring dividends of 12 per cent suggest excessive profits in a way that 6 per cent dividends do not. The argument in favor of a closer correspondence between capitalization and real investment is especially strong in the case of railways and other transportation corporations with quasi-public functions, municipal public service corporations, and corporations enjoying natural monopolies of all kinds. For there is a growing feeling that such corporations are in a peculiar 222 OUTLINES OF ECONOMICS sense social trustees, to whom have been committed certain public economic functions that might very properly be per- formed by the State, if that course were deemed the more advan- , tageous. That such corporations should be restricted to the payment of a reasonable dividend on reasonable capitalization would seem scarcely to be open to question.^ Yet excessive profits are what make excessive dividends possible, and whether profits are excessive or not can be determined in most cases without reference to capitalization by the compulsory use of adequate accounting methods. Even where accounting methods used in the past have been inadequate, the amount of the in- vestment entitled to a return can usually be determined with rough accuracy by means of a "valuation" or appraisal of a company's properties, coupled with an examination of the prin- cipal facts of its financial history. There is a growing use of this method on the part of both federal and state governments. There is a prevalent but entirely mistaken belief that over- capitalization is often the cause of exorbitant charges. It is thought that the desire to pay dividends on an inflated capitali- zation leads corporations to exact a higher return for their prod- ucts or their services than they otherwise would. But it can easily be seen that such cannot often be the case. For whether its capitalization be high or low the corporation will desire to fix its charges at the level which will yield the greatest possible profits. The magnitude of the corporation's capitalization will have no bearing upon the determination of the most profitable level of charges. The charges which would be most profitable under a low capitalization will also be the most profitable under a high capitalization. A weightier indictment of overcapitalization is that it has opened the door to a number of reprehensible practices in cor- poration promotion and management. Where there is no defi- nite correspondence between capitalization and investment it is difficult to make sure that some persons will not be able to acquire the securities of a given corporation on much easier 1 It is better to curtail excessive profits by public control of rates, prices, and services than by arbitrarily limiting the dividend rate. BUSINESS ORGANIZATION 223 terms than others. Overcapitalization always makes available, for example, what may be termed a surplus of stock, and this surplus, instead of being distributed equally among the differ- ent stockholders, may be used in a disproportionate and extrava- gant payment to the promoter (or organizer) of the corporation, or the bankers who have assisted in marketing its securities. Or a group of men in control of a corporation may reap an unfair advantage at the expense of other security holders by turning over to the corporation properties of which they themselves are the owners in return for an exorbitant amount of the corpora- tion's securities. Operations of this kind have only too fre- quently attended the organization of great industrial combina- tions in this country. American railway history, also, is full of examples of extravagant sums paid by operating companies to " construction companies " which had been organized for the purpose of building the roads and selling them to the operating companies. These payments were usually made in bonds or stock, and burdened the operating company with either a heavy load of fixed charges or an inflated amount of capital stock. In fact, the time is not long past when it was frequently said of representative American railroads that the whole amount of the actual investment in their properties was represented by their bonded debt, while their stock issues represented nothing but prospective surplus earnings. In the promotion of industrial combinations it was common practice to issue enough preferred stock to cover the actual expense of acquiring the various proper- ties brought into the consolidation and to issue in addition a large amount of common stock representing nothing except whatever increase in earning power might result from combina- tion. The common stock, at whatever price it could be sold, represented, in fact, the profits of promotion ; and these usually went to promotors and other " insiders." In both the railway and industrial field, however, conditions are much improved. In many cases large additional investments have been made out of earnings without a corresponding increase in capitalization; in certain other cases corporations have been reorganized, with reduced capitalization. But, nevertheless, there are recent 224 OUTLINES OF ECONOMICS instances of unfair and even fraudulent use of excessive capitali- zation as a means of securing special profits for those in control of a corporation's policies.^ The situation is clearly one that needs mending. Two very different methods of regulation have been proposed. The first of these two methods involves the definite limitation of a cor- poration's capitalization to an amount corresponding to the sum of money actually received by the corporation and invested in its business. If securities are issued in exchange for property turned over to the corporation or for services rendered it, a full account must be rendered of all of the circumstances attending such transactions, and an official appraisal of their value may even be required. Such, in general, have been since 1884 the conditions under which joint-stock companies in Germany issue their shares, and it does not appear that these requirements have hindered the organization or growth of such companies in that country. Under the second method of regulation, corporations are left free to issue their securities in such quantities as they deem best, it being required merely that publicity shall be given to the prices at which the securities are sold, to the price placed upon any property or services paid for in securities, and to the disposi- tion made of all money obtained by the issue of securities. This kind of regulation is adopted, in principle, in the British Com- panies Act, but the mechanism provided to enforce it is not very effective. At best, however, even the most thoroughgoing publicity respecting the conditions under which securities are issued cannot be a wholly adequate safeguard against the real evils of over-capitalization. Publicity might tend to curb ex- travagant allowances for personal services, but it would not al- ways prevent the overvaluation of large properties taken in exchange for securities. To think otherwise is to count too much upon the knowledge and alertness of the individual stock- holder. Certain American railroads have openly paid exorbi- tant prices for branch lines and other properties, without re- 1 See the special reports of the Interstate Commerce Commission on the St. Louis and San Francisco and the New York, New Haven, and Hartford railroads. BUSINESS ORGANIZATION 225 ceiving any protests, at the time, from stockholders and creditors injuriously affected by these transactions. We have done very little in the United States in the regulation of the capitalization, or the other conditions of promotion, of ordinary industrial corporations. Some states, however, now exercise a fairly rigid control over the new security issues of rail- ways and other public service corporations. This regulation, however, does not have as its primary motive the protection of minority stockholders. It is to be interpreted as part of a gen- eral attempt to limit the earnings of such corporations to a fair return upon a reasonable capitalization. It has been suggested ^ that in order to guard against the very prevalent misunderstanding of the real nature of corporation shares, the "dollar mark" should not appear on them, or, in other words, that they should have no "par value." They would then become, in form as in fact, merely certificates of the ownership of certain fractional equities in a corporation's business. There is much that is attractive about this proposal. If the issue of securi- ties is to be as unregulated as it has been in the past, it would be better to make it impossible for investors and the general public to attach any ficti- tious importance to the amount of a corporation's capitalization. But if we are to have the regulation of promotion and capitalization that we need, there would be nothing gained by the change suggested. And the "dollar mark" on stock certificates is convenient in many ways. Form of Capitalization. — A significant feature of recent de- velopment in corporation finance, is the multiplicity of types of corporate securities. It is no uncommon thing, for example, for the equities in a railway corporation (in addition to the floating debt, or accounts payable) to be divided among a dozen or twenty varieties of bonds and two or three varieties of stock. This multiplicity of securities is of advantage to the corporation in that it enables it to offer to investors and speculators a care- fully graded assortment of risks, and this makes the total selling value of a corporation's securities greater than it would other- wise be. This complex kind of capitalization has, however, some undesirable features. If the owners of a particular security — the common stockholders, perhaps — control the corporation, 1 Most recently by the very able federal Railroad Securities Commission of igii. The state of New York now permits the issue ^ f corporate shares without par value. Q 226 OUTLINES OF ECONOMICS they may desire to increase the value of their securities for specu- lative purposes by the payment of unearned dividends, — a pro- ceeding which would be opposed to the interests of the holders of all the other securities of the corporation. Or the holders of preferred stock may wish to put some of the earnings of the cor- poration back into improvements in its plant, so as to safeguard its future earning capacity, while the holders of common stock may prefer that all the earnings be paid out in dividends. More- over, in cases of insolvency and reorganization, it is a difficult matter to untangle and to adjust equitably the rights of the holders of the different kinds qf securities. In times of prosperity corporations often pay for extensions of their plants from the proceeds of bond sales, because it is esti- mated that the earning power of such extensions will more than suffice to pay the interest on the bonds and will afford a hand- some surplus for the stockholders. Corporations thus accumu- late in prosperous times an unwieldy load of fixed charges in the form of interest on bonds, — a fact which is apt to be a source of difficulty in less prosperous years. In periods of financial stringency these fixed charges are a common cause of insolvency, receiverships, and consequent reorganizations, from which the bondholders are apt to emerge as stockholders, and in which the stockholders are apt to lose their holdings. The legal restric- tion of the securities issued by any one corporation to one kind of stock and three or four varieties of bonds is both feasible and desirable. Nor should the bonded debt usually be allowed to exceed the amount of the paid-up capital stock. Corporation Management. — The management of business cor- porations is, as a rule, in the hands of boards of directors, elected by the stockholders from among their own number. The details of management are in the hands of officers, chosen usually by the directors. In principle this system achieves something like rep- resentative government of the affairs of the corporation. In practice, in the larger corporations, some of the directors are apt to be " dummy directors," — men exercising no real power or responsibility, made directors in order to complete the number prescribed in the charter, — or are the representatives of great BUSINESS ORGANIZATION . 227 financial interests, and often of competing interests. Directors of this latter sort are not primarily concerned with the manage- ment of a corporation in the interests of its stockholders and bondholders. They are directors for the purpose of guarding special interests, and in many cases for the purpose of preventing competition from becoming anything more active than an armed peace. In some cases the real direction of a corporation's policies is in the hands of an " executive committee " or " finance committee " of three or more directors representing the person or persons in actual control of the corporation. The proper adjustment of the rights and' duties of the various members of a corporation is a matter of general public concern. This is partly because the shares in a corporation are freely trans- ferable. A new member cannot protect himself by making special contracts with the other members, but must accept the conditions fixed by the by-laws of the corporation and by the laws of the state which chartered it. Moreover, the ordinary shareholder in a large corporation has little opportunity to par- . ticipate in any way in the conduct of the affairs of the corpora- tion, even for the purpose of protecting his own interests. The general theory upon which the law of corporations is based is that the corporation is a democracy with a representative gov- ernment. That is, the directors are supposed to represent the interests of the stockholders. For many small local corpora- tions this theory undoubtedly corresponds fairly well with the facts. But large corporations, with hundreds or thousands of stockholders, living in different parts of the country, and even in different countries, cannot accurately be pictured as rep- resentative democracies. Outside of a group of holders of large blocks of stock, the stockholders, whether a minority or a scattered majority, are likely to be not only powerless but voiceless. It is difficult and probably undesirable to change this general situation. The growth of large corporations means necessarily the growth of widespread participation in large business undertakings. But the participators, whether stockholders or bondholders, are to be regarded as investors rather than active partners. What is needed in our corporation 228 OUTLINES OF ECONOMICS statutes, therefore, is a frank recognition of this situation. In many cases directors cannot, in any real way, " represent " the stockholders. For this reason their responsibility as trustees for the stockholders should be emphasized in our laws.^ Advantages of the Corporation as a Form of Business Organ- ization. — From the point of view of the business man the cor- poration presents decided advantages over the partnership for all undertakings of considerable size. Some of its points of superiority are : (i) Stockholders usually have no personal lia- bility for the corporation's obligations except so far as the full par value of their stockholdings has not been paid up.^ (2) The relative permanence and stability of the corporation are of de- cided advantage, especially in undertakings requiring large in- vestments of capital in relatively fixed and permanent forms. (3) The concentration of executive power in the hands of direc- tors and officers leads to efiiciency in management. (4) The transferability of corporation securities makes it possible for stockholders to enter or leave the undertaking at pleasure. (5) The division of the securities into small units and into differ- ent grades and classes affords opportunities to all kinds of inves- tors, — the small and the large, the conservative and the ven- turesome. (6) All of the advantages named make it easier for the corporation to attract and to use efficiently large amounts of capital, furnished by many different investors. Social Aspects of the Growth of Corporations. — That corpora- tions do possess desirable features, from the point of view of 1 On this account the recent development of "express trusts" as business or- ganizations, especially in Massachusetts, is of particular interest. These have "trust deeds" in place of articles of incorporation, "trustees" in place of directors, and "beneficiaries" in place of stockholders. In simplicity, adaptability, and in the protection of investors and creditors, this form of business organization has some real advantages over the corporation. But it has not yet been subjected to adequate public control, and there are some minor difficulties in its working. It may prove to be, however, the germ of an important development in business or- ganization. 2 Exception should be made of banking and insurance corporations, in the case of which " double Hability " on the part of the stockholders is common. A few states impose some measure of personal liability upon the stockholders of all corporations organized under their laws. BUSINESS ORGANIZATION 229 business interests, is a fact clearly evidenced by the unprece- dented growth of this form of business organization. In the main, efhciency for business purposes, for money-making, means efficiency from the social point of view, productive efficiency also. But, nevertheless, the two points of view are not identical, and what is desirable from one point of view is not always desirable from the other. The gap between money-making and service to society (never quite identical things) is distinctly widened when those in control of a corporation's policies subordinate the profits to be obtained by the sale of its products to the profits to be obtained by specu- lation in its securities. Many of our greatest corporations are directed by men to whom fluctuations in capital values (as repre- sented in the prices of securities) are a much more important source of personal income than are the net earnings of such corporations. The payment of unearned dividends, the non- payment of earned dividends, the direction of a corporation's policy for the benefit of the holders of one kind of security among the different ones issued by the corporation, the effecting of cor- porate combinations and reorganizations that will affect the stock exchange rather than the produce market, — these are some of the more obvious results of the unfortunate relation between cor- poration management and speculation in corporation securities. It should also be noted in this connection that the growth of corporations is bringing with it a subtle but very significant change in the nature of the institution of private property. So far as a large and increasing proportion of productive wealth is concerned, we are losing that direct relation of ownership be- tween men and goods which Arthur Young had in mind when he said, " The magic of property turns sand into gold." We often have, instead, several layers of corporation securities interposed between the ultimate owners and the ultimate objects of owner- ship. The effect of this will undoubtedly be to bring about the more thorough domination of business principles in the business world. Sentiment, the honored traditions of long-established firms, the " pride of ownership," the joy of workmanship (which may be felt by the employer who turns out a good product, as 230 OUTLINES OF ECONOMICS well as by the workman) are bound to yield yet more completely to the sway of the cold logic of corporation accounts and stock market quotations. The adequacy of purely business principles as the foundation of our economic life will be tested more thor- oughly under the corporation form of organization than ever be- fore. Trusts. — A distinctive feature of the economic development of the past few decades has been the combination of individual corporations into larger concerns, or trusts. The " trust," in the technical sense, involved either giving a board of trustees the absolute control of the actual properties of the different con- cerns in the combination, or what amounted to the same thing, assigning to them the stock of each corporation, with its voting power, in exchange for " trust certificates," on which dividends were paid. The Standard Oil Trust of 1882 was the first impor- tant combination of this kind, but it was speedily followed by several others. In 1890, in a case brought by the state of New York against the sugar trust, the trust agreement was held to be illegal under common law.^ .Corporate combinations were not destroyed by this decision. They changed, however, to a more definitely coherent form, — that in which a single great corpora- tion dominates the consolidation. In most cases, this corporation, which is usually organized for the purpose, does not own the actual plants of the various concerns in the combination, but simply owns all or a majority of the stock of each. It is accordingly called a " holding company." The holding company exchanges its own securities for the securi- ties of constituent companies, or, when necessary, it buys the securities of the constituent companies with funds secured from the sale of its own securities, — sometimes by the sale of bonds secured by the pledge of the securities of constituent companies as collateral. Not only in industrial consolidations,^ but also in '^People V. North River Sugar Refining Co., 121 N. Y. 582. A similar decision was rendered two years later by the Supreme Court of Ohio in State v. Standard. Oil Co., 49 Ohio St. 137. 2 A very complete list of "trusts," prepared by Mr. Byron W. Holt for the World Almanac (igoS), contained the names of about 250 industrial combinations, most of which were holding companies. BUSINESS ORGANIZATION 231 railway and electric railway mergers has the holding company device become important. From the point of view of business organization the holding company is simply an extension of the principle of the corpora- tion. The holding company needs for purposes of control only a majority interest in the stocks of its subsidiary corporations. Various holding companies may in turn be combined by means of one larger holding company, and the process may, and does, go even further. A group of capitalists may, by an investment of $1,000,000, for example, control a holding company with a stock issue of $2,000,000, which in turn may control corpora- tions with $4,000,000 of stock outstanding,^ — ■ and some of these last may in their turn be holding companies. The result is a tremendous concentration of industrial and financial power, with the minimum of liability. The uncontrolled use of the holding company device leads to neglect of the interests of the minority stockholders in the various corporations concerned ; to difficulty in fixing the legal responsibility for corporate mis- deeds ; to an undesirable complexity in the economic and legal relations of the holders of securities in the different corporations, and to the subordination of industrial to speculative ends. The " trust problem," however, has attracted more attention as a problem of monopoly than as a problem of business organiza- tion. Combination and monopoly, it is important to note, are not identical things ; we may have either one without the other. But the movement toward combination originated in the efforts of business men to escape from the restraints imposed upon them by competition. Use has often been made of simpler forms of combination than the trust and the holding company. Agree- ments to sell only at certain prices, agreements to limit output, the employment in common of one selling agent, pooling (the distributions of orders or of profits to the parties to the agree- ment in predetermined proportions), and other devices have 1 It is assumed, for convenience, that the stock in each case is worth par and that the ownership of half of it will give substantial control. In the case of indus- trial combinations ownership of all the stock of the subsidiary companies by the holding company is not uncommon. 232 OUTLINES OF ECONOMICS been used. Such combinations are formed by contracts entered into by a number of individual firms, each of which retains its own autonomy in all other respects. These contracts are un- enforceable at common law=^ — being held to be "contracts in restraint of trade " and hence contrary to public policy — so that it was difficult to be sure that any one firm would abide by the contract any longer than it deemed it to be to its own individual advantage. Combinations of this sort still persist. Railroad rate agreements are, for example, both universal and necessary. But the movement toward combination which has played so important a part in the economic history of the past thirty years has been characterized especially by the organization of combina- tions of a more thoroughly unified type, in which each individual firm brought into the combination yields up its own autonomy and is absorbed by a corporation, usually a holding company, organized for the purpose. These unified combinations,. it was thought, would be valid at common law, and would be less vulnerable under the new anti-combination statutes that were being enacted. Their management could be made more effec- tive, and their comparative permanence and dependability made possible the adoption of business policies based on long- time considerations. Moreover, so long as there was public confidence in their success, they afforded an inviting opportunity for promoters to reap profits. The Causes of Combination. — The specific motives usually mentioned as the most important causes of corporate combina- tions are (i) the economies of large-scale business; (2) the elimination of purely competitive expenses (some kinds of ad- vertising, for example) ; (3) the power to limit output and con- trol prices. The first of these factors suggests the difficult question of the most profitable size of the business unit. The question should not be confused with that of the most economical size of the industrial plant. Many of our present-day business units are so large that they operate a number of practically duplicate plants. To that extent, at least, they are larger than is necessary to secure the maximum technical efficiency of the plant. Nor BUSINESS ORGANIZATION 233 should the question be confused with that of the factors which bring about the condition of decreasing expenses in an industry at large. Certain productive advantages sometimes attributed to great industrial combinations — such as the power of utilizing highly specialized plants, equipped with highly specialized ma- chinery and located at the most favorable points — are advan- tages which do not have to wait upon combination, but which are not only available but certain to be developed in any large and growing competitive industry. Much has been said of the com- bination's ability to buy its raw materials on the largest scale, and therefore most cheaply, and of its ability to ship its products in large quantities, and therefore most economically. But it has not been shown that the combination has a marked advantage in these particulars over large competitive establishments, unless we should take account of the unfair discriminations that railway companies have too often made in favor of the large combinations. The real problem is whether the mere fact of combination, taken by itself, brings with it any real net economies in produc- tion. It probably very often happens that combination does effect some real savings. Uniform systems of accounting and cost-keeping can be introduced ; noteworthy economies found in any one of the plants can be introduced in all the plants of the same type ; high and uniform standards can be enforced by the central administration. Especially in combinations of the " integrated " type,^ there are undoubtedly real economies in the general coordination of the different successive stages of the industrial process, in the nice adjustment of the supply of raw materials and intermediate products to the demand for finished products, and in the adaptation of transportation facilities to the needs of the industry. The Standard Oil Company un- doubtedly effected great economies in the transportation of oil by its use of pipe lines, and these could hardly have been con- structed on so large and effective a scale if the industry had re- mained competitive. On the other hand, however, great combinations have certain 1 See p. 88, above. 234 OUTLINES OF ECONOMICS disadvantages inseparable from their size. Their economies are largely those of systematization and standardization, and these are prone to degenerate into inflexible and deadening routine. The very losses of competition may sometimes be in the long run a real social advantage. For they result in part from variety of experimentation and from the free scope given to individual initiative and individual planning. In competitive industry there is a continuing natural selection of the fittest men and the fittest methods. Nor are the best results always achieved by a hierarchical organization of industry, in which corporation ofi&cials, managers, and superintendents watch only over the larger and more general aspects of an industry and depend upon an army of subordinate employees (no matter how scientifically organized and directed) to attend to all. de- tails. There is sometimes no effective substitute for intimate personal supervision on the part of those primarily responsible for the success or failure of a business undertaking. Passing to the second and third general classes of motives that are advanced as causes of corporate combinations, it is suffi- cient here to note that whether purely competitive expenses and competitive prices are eliminated by combination depends upon whether the combination has any real basis of monopoly power over and above the mere fact of combination, which, taken alone, can give at most only a temporary monopoly. For a combina- tion without some real source of monopoly power to attempt to secure monopoly profits is to invite new enterprise and new capital to come into the industry. In other words, it is to induce latent competition to become active competition. It is plain, however, that if any or all of these three classes of advantages do exist in the case of a particular combination, the earning power of the combination will be greater than the total earning power of the separate concerns before consolidation, — a difference which will be reflected in the value of the securities of the holding company. It is this increment in capital value, due to the real or expected advantages of consolidation, that has been the chief cause of such combinations. The organization of trusts has in many cases been effected by professional pro- BUSINESS ORGANIZATION 235 meters, whose connection with an undertaking does not con- tinue any longer than is necessary in order to secure the profits of consoHdation. A few great trusts like those which have figured in the oil, sugar, steel, and tobacco industries have been conspicuously successful in a business way. Many others were " made to sell " ; that is, were organized only in order that profits might be gained through the sale of their securities, and have been weighted down by a capitalization not justified by their actual earning capacity. Some of these have already fallen to pieces ; others have been reorganized, with diminished capitaliza- tion. " When judged in terms of the promises of their promoters their histories stand as striking acknowledgments of the inadequacy of mere consoHdation as a basis of economic efficiency. Two separate and distinct sets of causes can be discovered to explain why the overwhelming majority of these indus- trial combinations failed to prove as successful as their promoters had an- ticipated. One set was psychological in character and concerned with the difficulties attending the administrative management of a large business. The other was economic in character and concerned with the difficulties attending the creation of a business organization sufficiently powerful to dominate an industry in the presence of actual or potential competition." ^ It can hardly be held, then, that great industrial combinations are, what they have sometimes been called, "the natural products of economic evolution." Even where one has succeeded in so dominating a field as to establish a substantial monopoly, it has generally been found either that it possessed one or more of the specific sources of monopoly power, or that it was enabled by its size to avail itself of peculiarly destructive methods of com- petition. *-'^nti-trust Laws. — Most states have statutes and some have constitutional provisions against " combinations in restraint 1 A. S. Dewing, Corporate Promotions and Reorganizations, p. 558. Dr. Dewing's conclusion, quoted above, is based on a very careful study of the more important reorganizations of industrial combinations. He finds the following specific causes of inefficiency : (i) diffusion of responsibility; (2) lack of knowledge of individual employees ; (3) lack of loyalty of officers and directors / (4) lack of attention to the laborious parts of the business by higher officials ; (5) prejudice of customers against " trusts." 236 OUTLINES OF ECONOMICS of trade." These are aimed primarily against large combina- tions of the kind already described, although if strictly con- strued they also make illegal the whole mass of price agreements and trade restrictions, general and local, which are a much more common and characteristic feature of modern business than is generally supposed. State anti-trust statutes have accomplished but little, partly because they have often been aimed at forms rather than at facts, at symptoms rather than at fundamental causes, and partly because they have been used only sporadically. The experience of the federal government has shown that if the prosecution of illegal combinations is to be conducted success- fully, there must be thoroughgoing preliminary researches into the history and business methods of the combinations. The state governments have been poorly equipped for this kind of work. The Sherman Anti-trust Act of 1890 is a federal statute, based upon the federal power to control interstate commerce. It declares illegal " every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or com- merce among the several states, or with foreign nations." It also makes it a misdemeanor for any person to " monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or com- merce among the several states, or with foreign nations." The most important aspect of the statute is that it gave the federal courts jurisdiction in these matters. The government can proceed under the statute in either or both of two ways : (i) by bringing criminal prosecutions against persons entering into unlawful combinations ; (2) by instituting proceedings to pre- vent and restrain violations of the law. A number of criminal prosecutions have been made, but most of these have been un- successful. It has been found difficult to get a jury to convict for an offense so abstract and general and, possibly, so common, as " restraint of trade." The more important results of the law have come from proceedings for the dissolution of unlawful combinations, and it is these only that we shall discuss. There has been much discussion of the precise meaning of the BUSINESS ORGANIZATION 237 phrase " restraint of trade " as used in the Sherman Act. This phrase was taken from the common law, in which its usual appli- cation was to contracts by which a man agreed not to compete with certain others. When the restraint of trade involved in such agreements was merely incidental to some legitimate pur- pose, and necessary in order to carry out that purpose, the con- tracts have usually been deemed valid at common law. Thus, if two competitors form an ordinary partnership, or if one man sells his business to another, agreeing not to set up another business undertaking of the same kind (so as to protect the sale of the good- will of his former business), the restraint of competition involved in such contracts does not necessarily render them ille- gal. But if the direct purpose of a contract is restraint of trade it is invalid and unenforceable and under some circumstances criminal. Although the Sherman Act was intended to be primarily a weapon against great industrial combinations, it has been held by the courts to apply also to labor unions and railway combina- tions. It has never been held, however, that labor unions are illegal under the act because of any alleged restraint of competi- tion in the supply of labor. But certain activities of labor unions, particularly strikes and boycotts, have been condemned by the federal courts because such activities " interfere with the free flow of commerce from state to state." ^ This, it will be noted, is a very different thing from restraint of trade in the old com- mon-law sense. In 1897 the Supreme Court held that railroad rate agreements were in violation of the Sherman Act.^ An important point in these decisions was that neither the fact that railroad rates agreements had been defended by the Interstate Commerce Commission nor the claim that the rates agreed upon were rea- sonable was allowed to stand as a defense. If the direct purpose of such agreements, said the court, is restraint of competition, 1 United States v. Workingmen's Amalgamated Council, 55 Fed. 605 ; the Railway Strike Cases, 64 Fed. 30, 749, and 67 Fed. 70s ; Loewe v. Lawlor (the Danbury Hatters' Case), 208 U. S. 274. 2 United States v. Trans-Missouri Freight Association, 166 U. S. 290; United States V. Joint Traffic Association, 171 U. S. 505 (1898). 238 OUTLINES OF ECONOMICS they are illegal, whether reasonable or not. Railroad rate agree- ments still exist, but no more of them have been attacked by the government. An epoch-making decision was that which in 1904 ordered the dissolution of a New Jersey corporation, a holding company, organized to hold the stock of the Great Northern and Northern Pacific railroads, two " parallel and (supposedly) competing " lines.^ The importance of the decision is that for the first time the holding company, as an instrument for restrain- ing competition, was shown to be vulnerable to legal attack. But the application of the Sherman Act to railway combina- tions is in many ways unfortunate. Under the Interstate Com- merce Act we have since 1887 regulated railway rates on the as- sumption that railways are natural monopolies, and this has proved a much more effective method of dealing with unfair rates than has the attempt to force competition into the railway field. The good accomplished by the dissolution of railway com- binations lies in the inroads these dissolutions have made into the use of the holding company device, with its undue concen- tration of financial power and its opportunities for the unfair treatment of minority stockholders. But this is only an inci- dental result of these decisions, and lies quite outside the general purpose of the Sherman Act. Many large holding companies, in both the railroad and the manufacturing fields, are wholly invulnerable to prosecution as " combinations in restraint of trade." For twenty years the Sherman Act was least effective in the very field to which it had been particularly designed to apply. A few industrial pools and price agreements were declared illegal by the federal courts, but in the only case involving a trust of the modern type that came before the Supreme Court the deci- 1 United States v. Northern Securities Co., ig3 U. S. 197. A similar decision, in 191 2, involving interests of even greater magnitude, dissolved the merger of the Union Pacific and Southern Pacific railroads (226 U. S. 61). In the St. Louis Termi- nal Railroad case (224 U. S. 283), also decided in 1912, a corporation owned by fif- teen railroads, and possessing a monopoly of railroad terminal facilities in St. Louis, was not dissolved, but was merely directed so to reconstruct its organization that new companies might participate in its ownership and be given the advantages of its services on equal terms with railroads then in control of it. BUSINESS ORGANIZATION 239 sion was for the defendant corporation.^ For many years there were few prosecutions of industrial combinations. The government lacked properly equipped bureaus of research- and investigation, and the government ofhcials were apparently apathetic. But both of these conditions were changed during President Roosevelt's administration. Finally, in 1910, the government was successful in suits brought for the dissolution of two of the greatest of industrial combinations, the Standard Oil Company - and the American Tobacco Company.^ Possi- bly the most important thing in these decisions was the emphasis the Supreme Court placed on certain business practices of these companies as evidence of their monopolistic intent. Each com- pany had achieved a dominating position in its field, and the Standard Oil Company, at least, had a virtual monopoly. Helped at first by railroad rebates, it had consistently pursued a policy of monopolization, either absorbing its competitors or driving them out of business. The evidence showed that it had acquired from 85 to 97 per cent of the business of trans- porting, manufacturing, and selling petroleum and its products, and such competition as there was seems to have existed by its sufferance. It did not have a natural monopoly, for only about one ninth of the total national production of crude oil came from its own wells. It had certain advantages over its competitors, especially in its control of pipe lines and in the low railroad rates given to points at which its refineries were located. Yet it did not have a full measure of monopoly power. Ac- tive competition was always possible and was kept down only by the use of what have come to be called unfair competitive methods. Unfair competition has come to play a very important part in the trust problem. It includes the use of such devices as (i) cutting prices below cost in a locality in which competition 1 Untied States v. E. C. Knight Co., 156 U. S. The decision in this case, in- volving the American Sugar Refining Company, was to the effect that a monopoly in the manufacture of sugar could not be held to be a monopoly in interstate com- merce. ^ 221 U. S. I. 3 221 U. S. 181. 240 OUTLINES OF ECONOMICS appears ; (2) discriminating in favor of merchants who agree to refuse to handle or to discriminate against competitors' prod- ucts; (3) the use of threats and other forms of intimidation, (4) the employment of spies to ascertain the details of competi- tors' business transactions ; (5) the production of special brands of goods, sold at very low prices for the purpose of driving competitors' products out of the market ; (6) the use of sub- sidiary companies as bogus independent concerns. Most of these methods were not in themselves illegal. Some of them, including price-cutting on one or more parts of an establishment's output, are common in ordinary competitive trade. But when used by large industrial combinations such methods have come to be called " unfair," because of the purposes prompting their use and because of their effects. There is a very important difference between an effort to gain as much business as one can under competitive conditions and an effort to destroy competi- tive conditions. And methods that may be harmless when used by an enterprise of ordinary size become dangerously destructive weapons in the hands of great industrial combina- tions. The combination is able to wage a destructive competi- tive warfare because it can stand a loss at one point or on one part of its output large enough to send its smaller competitor into bankruptcy. The use of unfair methods of competition by the Standard Oil Company and the American Tobacco Company was deemed by the Supreme Court weighty evidence of the purpose of those combinations to monopolize "trade and commerce " in their respective fields. These decisions showed that the Sherman Act could be used as an efficient tool for the dissolution of great industrial com- binations organized and conducted with monopolistic intent. Since 1910 a number of successful suits have been brought for the dissolution of other trusts, while yet others have voluntarily reorganized in accordance with plans approved by the govern- ment.i It is too early to judge of the ultimate effects of these industries. There can be no doubt, however, that in a number of industries, including the oil and tobacco industries, there is 1 See the Annual Reports of the Attorney General, for igio and subsequent years. BUSINESS ORGANIZATION 24 1 a larger measure of normal competition than before the disso- lutions. The reorganization of industrial combinations in such a way as to comply with the law often presents difficult problems. Where the trust is a holding company it is impossible to distribute its stock holdings to the original owners or their heirs, for many of the holding company's own securities will have changed hands since its organization. At first the courts merely directed that the securities owned by the holding company be distributed pro rata among its own stockholders. But where a majority of the stock of the holding company was closely held by a small group of men, and where the holding company held a substantial majority of the stock of its more important subsidiary companies, this method of dissolution was unlikely to result in the prompt restoration of normal competitive conditions in the industry. More recently the dissolution plans have been more carefully worked out, so that no one group of stockholders is left in control of all the different constituent parts of the former combination. In 19 14 Congress enacted two new statutes, the Clayton Anti-trust Act and the Federal Trade Commission Act. The Clayton Act is designed to accomplish a number of different things. We can mention only its more important provisions : 1. It definitely legalizes those activities of labor unions which had been declared illegal under the Sherman Act. This topic is discussed elsewhere in this volume.^ 2. It prohibits the acquisition by one corporation of stock in another corporation when the effect may be "to substan- tially lessen competition " between such corporations, or ''to tend to create a monopoly." It also makes it illegal for a man to serve (i) as a director or officer of a bank in the Federal Reserve system and at the same time as a director or officer of any other bank or as a private banker, when one bank has liabilities of more than $5,000,000 or when both are located in a large city ; (2) as an officer or director of a common carrier and at the same time as an officer or director of a firm having large dealings with the carrier in securities, supplies, or contracts for construction or maintenance (unless under publicly super- vised competitive bidding) ; (3) as a director of two or more industrial corporations engaged in interstate commerce, if one 1 Chap. XXIII. 242 OUTLINES OF ECONOMICS has an aggregate "capital, surplus, and undivided profits "of more than $1,000,000 and if they are, "by virtue of their busi- ness and location of operation, competitors." These provi- sions against " interlocking " directors and ofl&cers, like the provision against intercorporate stockholding, have a whole- some purpose and may accomplish some good in particular cases. But so far as their effect upon industrial combinations is concerned they add little to the Sherman Act, as now inter- preted by the courts. It will be noted, however, that intercor- porate stockholdings and intercorporate directorates are pro- hibited by the Clayton Act when they may tend to lessen competition between the corporations directly concerned, even though general competitive conditions may continue in the industry in which the corporations are engaged. 3. The Clayton Act prohibits certain trade practices, in- cluding (i) unjustifiable discrimination in the prices charged to different purchasers, (2) leases or sales of goods made with the understanding that the lessee or purchaser shall not use or deal in the goods of a competitor of the lessor or seller, as well as special discounts or rebates made upon such conditions. In cases under the Sherman Act the courts, as we have seen, had already counted the use of such practices among the evi- dences of an illegal purpose to monopolize an industry. And injunctions against their further use have been included in the decrees in some of these cases. If follows that in these particu- lars, also, the Clayton Act adds little to the Sherman Act. The Federal Trade Commission, established in 1914, is com- posed of five members, appointed by the President. It suc- ceeds the Bureau of Corporations, which was established in 1903 for the primary purpose of making special investigations of particular corporations and combinations and of the condi- tions existing in particular industries. The Federal Trade Commission not only has large powers of investigation, but it has the further power to require annual or special reports from interstate corporations in such form and relating to such matters as it may prescribe. At the request of the Attorney General it is to investigate any corporation alleged to be violating the BUSINESS ORGANIZATION 243 anti-trust laws, and to make recommendations for the read- justment of its business. In suits brought under the anti- trust acts the Commission may be asked by the court to pre- pare an appropriate form of decree, which is, of course, subject to rejection or change by the court. The importance of this provision is in its bearing upon the outcome of dissolution pro- ceedings under the Sherman Act. The drafting of a wise plan of reorganization for an offending combination is often an ex- ceedingly difficult matter, requiring not only care and judg- ment, but also a large amount of technical information about the general condition of the industry affected. Furthermore, the Commission is authorized to make investigations of the manner in which decrees in suits under the anti-trust acts are carried out. The most important power of the Federal Trade Commission is undoubtedly that of issuing orders restraining the use of " unfair methods of competition in commerce." So far as such methods are used as part of a general attempt to monop- olize an industry, the new statute adds nothing to the Sherman Act except a new, prompt, and efficient method of procedure. If this power is wisely used it should be possible in many cases to put a stop to aggressive monopolizing in its early stages, before much harm has been done. But the power committed to the Federal Trade Commission has even wider aspects. It is to be hoped that the Commission may be able to build up and maintain higher standards for competitive business methods in general ; that it may fix the lines beyond which one should not go in the attempt to divert trade from one's competitors. Public Policy towards Industrial Combinations. — Our anti-trust laws express what is undoubtedly the dominant public sentiment in the United States with respect to large industrial combinations formed with the purpose of obtaining a monopoly. Our policy has been one of repression, of compul- sory disintegration. Undoubtedly we have made many blun- ders in the ways in which we have formulated and enforced this policy. We have, in some cases, attempted to force competition 244 OUTLINES OF ECONOMICS into the field of the natural monopolies ; we have often attrib- uted too large a significance to the mere fact of combination ; we have in particular attempted to cure by a sweeping prohi- bition of' " restraint of trade " and '' monopolizing " many evils that are, in their more important aspects, matters of cor- poration finance, rooted in the laxity of our statutes in respect to the organization and management of corporations. But this does not mean that our general policy has been fundamen- tally mistaken. Monopoly has yet to prove itself more efficient than competition. And, moreover, it is not entirely a ques- tion of economic efficiency. There are differences between monopoly and competition in their effects upon the distribu- tion of wealth, upon the equality of economic opportunity, and upon a host of economic and social relations ; and in most of these particulars, it is generally believed, the advantage rests with competition. At any rate, we are proceeding along sound lines in endeavoring to raise the level of competitive methods and to eliminate any advantages which large combinations may have in their power of destructive competition. This will give a fairer field for experimentation with respect to the forms of business organization really best fitted for survival. There are some who believe that our general policy has been wholly mistaken ; that we should perrnit and even encourage the formation of large combinations ; that we should place monopoly power in their hands, and that we should then subject their prices and their products to public control of the kind that now exists in the railway field. Now there is, in fact, no good reason why our notions of what constitutes a " public calling," or a " business affected with a public interest," properly subject to rigid public control, should not be extended so as cover all natural monopolies. But to regulate prices in any industrial field, not naturally monopolistic, would be an exceedingly diffi- cult and complex undertaking. It would also be difficult to define the terms on which new capital and new enterprise might come into the "regulated " industry. And there is, as yet, no proof that this proposed change in policy would, if put into effect, result in any large economic or social gains. BUSINESS ORGANIZATION 245 Federal Control of Corporations. — The unfortunate effects of the lack of uniform state requirements in such matters as purposes of incorporation, corporate powers, qualifications and responsibilities of promoters and directors, capitalization, and the like could in large measure be remedied by federal action. The Clayton Act touches only incidentally upon this field. Its provisions relating to incorporate stockholdings and interlocking directorates were framed with reference merely to the problem of the preservation of competitive con- ditions. What is needed is a federal statute dealing thoroughly and systematically with the promotion, organization, and management of corporations engaged in interstate commerce. Canal, railway, and bridge companies have in the past been chartered by the federal government, just as national banks are now. It would be legally possible and economically advisable to require at least a, federal license from all corporations engaging in interstate commerce. Moderate and just requirements as to publicity, capitalization, and other things might very well be imposed as the price of federal license. Aside from the present lack of uniformity in state laws, the mere size of modern business corporations and the interstate scope of their opera- tions make it difficult for any individual state or states to control them efficiently. Industrial Combinations in Other Countries. — A move- ment toward combination in some form has manifested itself in practically every country which has large industries of the modern type. In England, however, the movement has made much less headway than in the United States. This may be attributed in part to the fact that England's " company laws " are not so lax as are the corporation laws of many of our states, in part, possibly, to the absence of a protective tariff, and in part to the highly specialized character of English industries. During the past twenty or thirty years, however, a number of important combinations have been formed in England, but only a few of these have been successful. An English combina- tion, it may be noted, has an international monopoly of sewing cotton. England has no statute forbidding combinations. 246 OUTLINES OF ECONOMICS but the contracts by which " combinations in restraint of trade " are formed will not be enforced by the courts. In Germany and in certain other countries of continental Europe the dominant form of combination is the Kartell. This resembles a pool more than it does the thoroughly central- ized industrial combinations of the United States. The Kartell itself is, however, usually organized as a joint-stock company. The individual companies constituting its membership continue as independent producing establishments. The Kartell con- trols sales, prices, output, and the distribution of orders and of profits. Opinions in Germany with respect to the success of the Kartells is greatly divided. On the one hand it is claimed that they have eliminated many of the wastes of competition and that they have been especially active and successful in securing sales in foreign markets. On the other hand it is charged that they have discriminated against home consumers by selling abroad at lower prices than they charge at home, and that they even go so far as to sell at very different prices in different part of Germany, utilizing, as far as possible, the principle of " charg- ing what the traffic will bear." In 1906, ,when a government investigation was made, there were 384 Kartells in Germany, and many new ones have been organized in subsequent years. Note- worthy among the German Kartells have been the Rhenish- Westphalian Coal Syndicate (of which the Prussian govern- ment, as a large mine owner, was for a short time a member) and the Steel-works Association. QUESTIONS AND EXERCISES 1. What are the terms under which corporations are chartered in your own state? What anti-trust laws are in force there? 2. Explain the various items in the published balance sheet of some in- dustrial corporation. 3. What limitations should be attached to the statement that "a cor- poration is a fictitious person " ? 4. Does the word "capital" mean the same thing in accounting and in economics? 5. Report on the history of one of the following: United States Steel Corporation ; American Sugar Refining Company ; American Tobacco BUSINESS ORGANIZATION 247 Company; International Harvester Company; United States Leather Company ; Rhenish-Westphalian Coal Syndicate. 6. What advantages has a large plant? a large business unit? a monopoly ? 7. What special burdens are imposed upon corporations? Has the corporation any other disadvantages as a form of business organization ? 8. In what respects do the Clayton Anti-trust Act and the Federal Trade Commission Act cover the same ground ? REFERENCES Bureau of Corporations. Special Reports on various industries. Carter,* G. R. The Tendency towards Industrial Combinations. Clark, J. B. and J. M. The Control of Trusts. Dewing, A. S. Corporate Promotions and Reorganizations. DxjRAND, E. D. The Trust Problem. Federal Trade Commission. Annual and Special Reports. Gerstenberg, C. W. (editor). Materials of Corporation Finance. Haney, L. H. Business Organization and Combination. Jenks, J. W. The Trust Problem. Lough, W. H. Corporation Finance. Lyon, W. H. Capitalization, a Handbook of Corporation Finance. Meade, E. S. Trust Finance; Corporation Finance. Orth, S. p. (compiler). Readings on the Relation of Government to Prop- erty and Industry, Parts iv, viii, ix. Railroad Securities Commission. Report. Ripley, W. Z. Railroads : Finance and Organization; (editor) Trusts, Pools, and Corporations. Stevens, W. S. (editor): Ifidustrial Combinations and Trusts. Van Hise, C. R. Concentration and Control. Wyman, Bruce. The Control of the Market. Young, A. A. "The Sherman Act and the New Anti-trust Legislation," Journal of Political Economy, vol. xxiii, pp. 210-220, 305-326, 417-436. CHAPTER XIV MONEY The vast system of exchange, which is the most characteristic single feature of present-day economy, rests upon the use of money. We have seen that some economic writers have pic- tured an imaginary primitive state of " barter economy " ; in which, before the use of money, goods were exchanged directly for goods. But what Httle definite information there is on this point leads us to the belief that about as soon as men began to exchange things, and consequently to attribute exchange value to them, they began to use some kind ojf money — some commod- ity or commodities for which things were generally exchanged, and in terms of which the values of other things were generally stated. The earliest forms of money were crude and simple, but they sufficed to meet simple needs. As exchange economy has ad- vanced to the present complex division of labor, the monetary system has developed pari passu, the most conspicuous feature of this development in modern times being the growing impor- tance of credit as a means of effecting exchanges. Industrial and commercial progress has led to monetary progress, and has, in turn, been stimulated and made possible by it. Metallic Money. — The earliest and simplest forms of money were commodities. Particular commodities came to serve as money, not because they were arbitrarily designated as such by king or chieftain, but because they possessed some properties which made them exceptipnally exchangeable. In some cases a primitive community came to use a commodity as money be- cause it was something for which they had a dependable " for- eign market " — something, that is, which they customarily sold to other communities in exchange for their products. In other 248 MONEY 249 cases a commodity which a community did not itself produce, but which it got only in the course of trade with other com- munities, became the money commodity. Or, if for any reason a particular commodity came to be particularly esteemed as a mark of wealth or a badge of social prestige, it was likely to used as money. But whatever the original ground of the choice, a commodity which a community once began to think of as money had its exchangeability, and consequently its suitability for monetary uses, increased in a cumulative way, just as today most of us are willing to accept anything as money which we think we can use as money. A great variety of commodities have at one time or another been used as money. Some typical examples are cattle, grain, furs, oil, salt, tobacco, ivory, shells, and tea. But with the ad- vance of political and economic civilization the metals have, through the process of the survival of the fittest, proven them- selves everywhere to be preeminently and indisputably the best money commodities. Copper, silver, and gold have each in turn been chosen as the principal money metal of the civilized world, the transition from the cheaper to the dearer metals indicating the growth of exchange and of wealth and the consequent need of larger money units. Metals, and especially the precious metals, have certain quali- ties that give them a peculiar fitness to serve as money. They are durable, easily recognized and tested, and may be divided into homogeneous units of convenient form and weight. More- over, as compared with most other commodities, the precious metals are relatively stable in value. This arises in part from their durability, for any one year's output of the mines makes but a comparatively small addition to the total stock of metallic money, and in part from the nature of their non-monetary uses, for the demand for commodities that minister to our tastes for ornament and display is much more elastic than the demand for necessaries of life. Coinage. — When metals were first used as money, they passed from hand to hand simply by weight, or, in some cases, in the form of ornaments. Coinage speedily developed, however, as 250 OUTLINES OF ECONOMICS a convenient way of certifying to the weight and fineness of money units. ^ Such a guarantee is naturally of little avail unless it is generally recognized as authoritative. On this account the coinage of money has almost universally been regarded as a prerogative of the sovereign. In England, even under the divided sovereignty of the Middle Ages, the coining of gold and silver was generally a privilege belonging to the king alone. The lesser feudal lord and the chartered cities issued token coins, made of the baser metals, and intended especially for local use, but if they possessed the right of coining the precious metals, it was through a special grant of the king. The Meaning of " Money." — In modern economic life many things in addition to coined metals are included, and properly included, under the name of money. There is, how- ever, no definite line of demarcation between the things which are money and the things which are not money, consistently followed in common usage, or even in economic writings. But we may agree, to begin with, that money is what we exchange for things when purchasing them, and that sellers are willing to accept it, a.t stated prices, in exchange for their goods. Then, however, we have to take account of the fact that many ex- changes are credit transactions ; that is, that the immediate equivalent given in exchange for a thing is a promise to pay a certain amount of money. This suggests that we should dis- tinguish between " money " and " credit instruments." But when we push our analysis a little further we find that the ele- ment of credit is found in many of the things that we ordinarily call money, even, as we shall see, in some kinds of metallic money. A useful and important distinction, however, is implied in the very common practice of restricting the use of the name " money " to those instruments of general acceptability which 1 The names of many ancient coins and of some modern ones are also the names of weights, although it has generally happened that through successive debasements of the coinage these names have lost their original significance. The Greek talent, the Jewish shekel, the Roman as, the Chinese tael, the Enghsh pound, and the French livre are familiar examples. MONEY 251 pass freely from hand to hand as media of exchange. The particu- lar things thus to be counted as money vary for different periods and for different countries. In the United States this generally acceptable medium of exchange includes the metallic money coined by the federal government, the paper money issued by it, and bank notes. Checks drawn by individuals upon their bank accounts are not money, or money instruments, in this sense, because they do not pass freely from hand to hand as media of exchange. They can be used only in making payments to persons who have confidence in the honesty and solvency of the one who tenders the check for payment. Some things that are part of the generally acceptable media of exchange are them- selves promises (on the part of the government or of banks) to pay certain other forms of money on demand. But the important point is that the acceptability of such things does not depend upon the honesty or solvency of the person who tenders them in payment. So long as we have confidence in the solvency of the government and the banks, their coins and notes, issued in convenient and easily recognizable forms and denominations, are generally acceptable media of exchange, and, as such, are money. This meaning of the word has the sanction of a very common and prevalent usage ; it corresponds, moreover, to the technical definition given to the word by many economic writers, and to the official usage of the United States Treasury. In this chapter the word " money " will be employed in this restricted sense of money instruments of general acceptability. But the word is also often used in a much broader sense. We speak of " money funds," the " money market," " money ex- penditures," " investments of money," etc. And yet the " money market " is not primarily a place in which the generally acceptable media of exchange are bought and sold, nor is the fact that one's " money expenditures " amount to a given sum to be interpreted as meaning that one has actually paid out this amount in the generally acceptable media of exchange. Money, in this broad sense, includes credit in the form of rights to receive money (in the narrower sense just defined) on demand. It is these rights that are bought and sold in the money market and 252 OUTLINES OF ECONOMICS it is by transfers of these rights that a very large proportion of the aggregate annual payments for goods and services are made. A payment made by a bank check is, for example, a transfer of a right of this kind. The Media of Exchange. — Some writers have made a distinc- tion between the function which money performs as a medium of exchange, and its function as a measure of value. These are not, however, two different functions, but merely two different aspects of the same thing. By the very process of exchanging a commodity for money, we of necessity " measure " its value in terms of money, and only as a medium of exchange does money measure value. We may speak of a pound weight as an instru- ment used in weighing or as a measure of weight, but we would all recognize that these are merely two aspects of one function. In the United States the actual media of exchange in terms of which we " measure values " (or more accurately, state prices) comprise a variety of coins, made from different metals, together with several kinds of paper money of many different denomina- tions. But all these different forms of money are alike in name, — that is, they are dollars, or multiples or fractions of a dollar, — and moreover, these various kinds of dollars are not distin- guished, one from another, in the price lists. This familiar and very satisfactory condition of uniformity in the units in which we state prices does not, however, suggest to us the real nature of money in the way that a less perfect monetary system would. It would be possible to have a number of different monetary units, just as the weight or size of an object may be stated in terms of either the metric system or the English system of weights and measures. In fact, before the United States had an adequate monetary system of its own, the actual media of ex- change consisted largely of English, French, Spanish, and Portu- guese coins, and there were as many different ways of stating prices as there were varieties of money. ^ Nor does the mere 1 An instructive bit of monetary experience may be found in the eflforts of some of the colonies to reduce this foreign money, especially Spanish money, to the English system of pounds, shillings, and pence, in which accounts were generally kept. They \yere not content with a simple official statement of the actual ratios between the different value units, but sought to give an artificially enhanced value MONEY • 253 name of " dollar " give to different pieces of money a uniform purchasing power. The silver dollar of Mexico will buy only about half as much as the silver dollar of the United States, al- though it is of approximately the same size. More significant, however, is the fact that in the United States we have had at different times '' dollars " of unequal purchasing power. What is it, then, that gives uniformity to the dollar as a price- recording unit in our present monetary system? To say that various kinds of money are equal in value because they will pur- chase the same amounts of goods is, obviously, to argue in a circle. But the answer is found in the fact that they are interchangeable, and so long as any number of kinds of money, all named in dollar units, are freely exchangeable, dollar for dollar, it is impossible that domestic prices stated in terms of one kind of money should be higher or lower than domestic prices stated in terms of any other kind of money. We do not refer here to the fact that different kinds of money are exchanged for each other at par in business transactions and in banking, for this is a result, rather than a cause, of their parity. The exchangeability that underlies the parity of our different kinds of money is maintained by the federal government. All coins smaller than a dollar are by law exchangeable at the United States Treasury for " lawful money," which includes gov- ernment notes, silver dollars, and gold coins. Government notes, in turn, are simply promises to pay, which are redeemable in gold at the government treasury. While there is no definite legal mandate requiring the redemption of silver dollars in gold, yet the currency act of 1900 makes it the duty of the Secretary of the Treasury to maintain all other forms of money at a parity with gold — a requirement which means that he would have to redeem silver dollars in gold if such action should at any time be to the foreign coins by increasing the number of shillings to which they were to be considered equivalent. The result was not, however, an increase in the value of the coins, but a decrease in the value of the nominal "shilling" in which accounts were kept. This was the origin of the now rapidly vanishing use of the word "shil- ling" as equivalent to 125 cents in some localities and to i6f cents in others. The student may find an instructive parallel in this experience and the official statement of coin values by which sovereigns tried to retain their seigniorage profits. 254 ■ OUTLINES OF ECONOMICS Money in the United States: June, 30, 1915^ In Treasury, Mints, and Federal ReSEBVE BANIfS In Other Banks and in Circulation Total Gold coin and bullion . Silver dollars .... Subsidiary silver . . . $1,395,405,553 503,624,499 26,164,29s $590,133,619 64,647,156 159,265,955 $1,985,539,172 568,271,65s 185,430,250 Total metallic . . . $1,925,194,347 $814,046,730 $2,739,241,077 United States notes . . Federal reserve notes . National bank notes . $14,338,770 3,885,850 33,880,546 $332,342,246 80,374,650 785,393,047 $346,681,016 84,260,500 819,273,593 Total notes .... $52,105,166 $1,198,109,943 $1,250,215,109 Aggregate metallic and notes . . . $1,977,299,513 $2,012,156,673 $3,989,456,186 Gold certificates . . . Silver certificates . . . Treasury notes of 1890 Total certificates and $ 100,861,170 11,488,605 9,313 $1,072,847,819 481,970,395 2,244,687 — notes $112,359,088 $ 1,557,062,901 — Aggregate 2 .... — $3,569,219,574 $3,989,456,186 needed to maintain their parity. Gold certificates and silver cer- tificates are simply a mechanism for putting gold and silver money into circulation in convenient form. They are analogous to ware- house receipts, because they represent gold coins and silver dollars that are stored in the government treasury to the full amount of the certificates issued, and which may be obtained at any time in exchange for the certificates. Bank notes (including federal reserve notes and national bank notes) are redeemed by the fed- eral treasury, which for this purpose acts as an agent of the banks which have issued the notes. In practice the government is continually receiving all kinds of money, including silver dol- ^ Finance Report, igis, p. 314. ^ This aggregate does not include "minor coins," principally bronze one-cent pieces and nickel five-cent pieces, of which there were about $60,000,000 outstand- ing on June 30, 1915. MONEY 255 lars, and exchanging other kinds of money for them. The sig- nificant thing is that all other kinds of money are exchangeable, directly or indirectly, for gold coin. The Monetary Standard. — In the case of gold coin, there is a further kind of exchangeability — the unlimited and free con- vertibility of gold coin and gold bidlion. So long as any one can secure gold coin from the mints in any amount for the same weight of gold bullion of standard fineness, and so long as gold coin can be freely melted down into gold bullion, it is impossible that there should be any appreciable difference between the value of a gold coin and the value of its metallic content. We have, then, not only the interchangeability of all parts of the circulating medium, but also the positive physical identity of one part of it and the material of which this part is made. Gold coins, because their value as bullion is equal to their value as coins, constitute standard money. The gold dollar weighing 25.8 grains, and containing 23.22 grains of fine gold is by law the monetary unit, that is, the dollars in terms of which prices are stated are gold dollars or are maintained at a parity with gold dollars. The coinage of the gold dollar was discontinued in 1890, but the gold coins that are minted contain precisely this amount of gold per dollar. Gold, whether in coin or bullion, constitutes the monetary standard, for the value of any dollar must be equal to the value of the gold in a gold dollar. The recording of prices in terms of dollars through the exchange of goods and services for money of different sorts, the maintenance of the parity of dollars in all varieties of money through their exchange- ability, and the automatic equating of the value of the dollar to the value of 25.8 grains of gold bullion ; — these are the fun- damental facts of our monetary system. Seigniorage. — Sovereigns have in the past very often viewed the monopoly of coinage as an opportunity for personal profit. By calling in the stock of metallic money in the country for re- coinage, they have frequently reduced the weights of coins with- out changing their names, thus increasing the number of coins, so that a handsome profit was netted for the royal treasury. Debasement of the currency was a favorite financial expedient 256 OUTLINES OF ECONOMICS of Henry VIII, of England, and of Philip the Fair and Louis XIV, of France. Somewhat less reprehensible in theory, although amounting to about the same thing in its effects, was the common practice of making a charge for the coinage of standard money, called seigniorage. This practice was based on the idea that it was possible to maintain a difference between the value of a coin and the value of the bullion put into it.^ A great deal has been written about the possibility of seigniorage, for the subject is one that involves considerations that are fundamental in monetary theory. It has been often said, for example, that it is the " government stamp," rather than the metallic content, that gives value to a coin. Leaving aside the matter of limited or subsidiary coinage (which will be considered presently), we may dispose of this statement by saying that if it means that the use of certain metals as money creates a demand for them that would not otherwise exist and thus increases their value, it is a truism ; but if it means that in coinage we can add an arbitrary and in- tangible element of value to the value of the metallic content of standard coins, the statement is a misleading doctrine that has been disproved by the monetary experience of almost every country. There is, however, a stronger statement of the theory of seign- iorage. If the only way in which I can convert bullion into a medium of exchange is by being content with 750 ounces of money for every 1000 ounces of bullion I take to the mint, will not the coins have a value one third greater than that of the metal they contain? May not their ''metallic content" be said to be, in a figurative sense, one third more than their weight because they cost me that much more in bullion? If their bul- lion value sinks below this point, bullion will not be brought to the mint, as it will be worth more than the coins one can get for it ; just as when the value of the coins rises above this point the supply of bullion would be stimulated so that as a result the value of the coins would tend to maintain this fixed relation 1 Under Philip the Fair, the seigniorage charge went as high as 50 per cent. Charges of from 2 to 15 per cent were more common. MONEY 257 to the value of bullion. As a matter of fact, it is probable that in a completely isolated community a strong and stable govern- ment could, through wise and careful regulations, maintain a constant rate of profit on the coinage, without endangering the stability of the monetary system. The fundamental difficulty with seigniorage, however, was found in practice to be that in foreign trade coins passed current only as bullion, so that when seigniorage was charged, the prices of imported goods, expressed in money, were necessarily higher than their prices expressed in bullion, by an amount equal to the seigniorage. It was impossible that one ratio of exchange could long be maintained between coined money and bullion in domestic trade and another ratio of exchange in foreign trade. The interdependence of the prices of all kinds of goods prevented that. Money prices, in general always rose ; that is, the value of the coins sank to the level of the value of the bullion they contained. Under these conditions no one would voluntarily undergo the loss inseparable from taking bullion to the mint for coinage, and with the cessation of coinage the profits from coinage stopped. Every possible expedient, short of the abso- lute prohibition of foreign trade, was tried by sovereigns in their efforts to retain their profits.^ But market forces were found to be stronger than royal regulations, which at best only served to retard somewhat the depression in the value of the official coin- age. About the only effective way of getting profits from the coinage was for the sovereign to admit that the coins in circula- tion possessed only their bullion value, and then to call in the currency for recoinage into smaller pieces, in the manner that has already been mentioned, thus starting afresh with a new 1 The use of any other circulating medium than the official on-e was prohibited ; no one was allowed to sell imported gold or silver, whether in bullion or coin, save to the royal mint; if there were mines within the country, they were sometimes prohibited from disposing of their products except to the royal mint; goldsmiths were forbidden to melt down coin or to purchase more bullion than they needed, and this they were forbidden to buy at less than the mint price ; restrictions were placed on the export of bullion ; these and other similar methods were tried, but all to no avail. Cf. W. Lexis, article "Miinzwesen," in Handw'drterbuch der Staatswissen- schaften. S 258 OUTLINES OF ECONOMICS seigniorage charge. The result was invariably a repetition of the process of a more or less rapid depreciation in the purchasing power of the coins, leading often to further debasements of the currency. Modern nations have abandoned the attempt to secure profits from their monopoly of the coinage. Since 1666 England has made no charge whatever for coining bullion into standard money .^ Most of the countries of continental Europe make a charge just sufficient to cover the expense of coinage. This charge is sometimes called seigniorage, but it is usually, and more properly, called brassage. The United States made no coinage charge until 1853, when a charge of one half of I per cent was made for coining standard money. This was reduced in 1873 and was abandoned entirely in 1875. At pres- ent the United States exchanges gold coins, weight for weight, for bullion of standard fineness (nine tenths gold, one tenth cop- per) brought to the mint in lots of one hundred dollars or more in value. For crude bullion, or bullion not of standard fineness, gold coins are exchanged containing as much fine gold as is contained in the bullion, less a trifling charge for assaying, re- fining, and for the alloy. ^ Instead of viewing coinage as a profitable prerogative of the government, we have come to view it as a government duty, to be performed at government expense. The question of seigniorage versus gratuitous coinage is no longer a live issue. But the stu- dent who has grasped the significance of the lesson contained in 1 In practice most of the gold bullion coined in England is supplied to the mint by the Bank of England, which is required by law to purchase it at the minimum price of £3 175. gd. per ounce. An ounce of bulUon makes £3 175. io\d. in gold coin, the difference going to compensate the bank for the delay involved in getting the bullion coined at the mint. In the United States the waiting devolves upon the government, for gold coins, or, at the option of the depositor, checks upon United States subtreasuries or upon depository banks are paid to depositors as soon as their bullion can be weighed and assayed. 2 The coinage mints are at Philadelphia, San Francisco, and Denver. In addi- tion there are bullion-purchasing mints (not now operated as coinage mints) at New Orleans and Carson City, and assay ofBces at New York, Boise, Helena, St. Louis, Deadwood, Salt Lake City, and Seattle, which receive bullion on the same terms as the mints, plus an additional charge of one eighth of i per cent. MONEY 259 the history of seigniorage has taken an important step toward the understanding of monetary theory. The coinage of standard money is now in law, and always has been in fact, a device for dividing the standard money metal into convenient units of cer- tified weight and fineness. Limited Coinage. — Gold is the only metal which is made into coins by the United States government for any one who deposits bullion at the mints or assay offices. All other coins are made from metal purchased from time to time for that purpose as Con- gress may direct. In none of these coins is the bullion worth as much as the coin. In 1878, when the United States began the limited coinage of silver dollars, the value of the 3 7 if grains of pure silver in a silver dollar was about 89 cents. The value of silver declined steadily until 1902, when 371 J grains of silver were worth only 41 cents. Since that time there has been a slight upward movement, but nevertheless in 191 5 the bullion value of a silver dollar was only about one half its value as a coin. The bullion value of the smaller silver coins is still less, for they con- tain but 347.22 grains of silver to the dollar, while the bullion value of our nickel and bronze coins is yet smaller, relatively. Such coins are sometimes called " token coins," the implica- tion being that the fact that they pass from hand to hand at their full nominal value is merely a matter of habit or usage, supported by general acquiescence. More accurately, however, they are credit coins, because the excess of their coin value over their bullion value depends ultimately, as we have seen, upon the good faith and credit of the government, evidenced by their redeem- ability in gold. If, for example, a catastrophe should overthrow the present federal government, and if the new government should refuse to recognize the obligations of the old, nothing could prevent these coins from sinking to their bullion value. A very considerable profit accrues to the government from this limited coinage. The difference between the amount paid for silver bullion from 1878 to 1907, and the value of the coins made from it, amounted to $143,000,000. In the accounts of the fed- eral treasury this profit is called seigniorage, but it should be carefully distinguished from real seigniorage, — a charge ex- 26o OUTLINES OF ECONOMICS acted for the conversion of standard bullion into standard coin. If the federal government should issue a general balance sheet of the kind used in corporation accounting, the credit element in its outstanding limited coinage would properly appear as a liabil- ity, which might be greater or less than the profits that had ac- crued on such coinage, depending upon whether the present value of the bullion in the coins happened to be greater or less than the prices which the government had paid for it. Bimetallism. — A monetary system like the present one of the United States is a single standard system, because only one com- modity is used as a monetary standard. The double standard sys- tem, under which two different commodities serve concurrently as legal monetary standards, has, however, been used in the past by many governments, including our own, and its superiority over the single standard system has been alleged by many advo- cates. Practically the only commodities that civilized nations have used as monetary standards in modern times are gold and silver. The question of the double standard resolves itself, accordingly, into the question of the bimetallic standard, which means in practice the unlimited coinage of both gold and silver. Bimetallism does not mean, in theory, as might be supposed, the establishment of two different monetary units of different names, one defined as a certain amount of silver, the other de- fined as a certain amount of gold, prices being stated accord- ing to convenience in terms of either unit. On the contrary, it contemplates the establishment of one nominal unit, such as the dollar, to be defined at the same time as either a definite amount of gold or a definite amount of silver. More concretely, this means the opening of the mints to the unlimited coinage of both gold and silver into dollars, or dollar multiples, the amount of silver in a silver dollar and the amount of gold in a gold dollar being established by law. Many of the arguments that have been advanced by bimetal- lists have related to the alleged immediate advantages to be secured from the adoption of the double standard under particu- lar conditions of time and place. One argument, however, of more general significance is based on the probable greater stabil- MONEY 261 ity of prices under the double standard. Silver and gold are pro- duced under somewhat different conditions, and are used for somewhat different purposes. It has been maintained that tendencies toward fluctuations in prices stated in silver and in prices stated in gold would, therefore, be as apt to be in opposite directions as in the same direction, and that so far as they were in opposite directions they would tend to counterbalance each other. Most opponents of bimetallism, while admitting that, if feasible, it might possess some advantages, deny its possibility. The difficulty is, they maintain, that while the ratio of the weight of gold in the monetary unit to the weight of silver in the mone- tary unit has to be fixed and definite, the ratio at which gold exchanges for silver is not fixed and definite, but is subject to the fluctuations of the market. If one metal is relatively underap- praised and the other relatively overappraised by the legal ratio, the result will be that only the overappraised metal will be brought to the mint for coinage, for the underappraised metal will be worth no more than the overappraised one as coin, but will be worth more as bullion. The actual result will be, in such a case, not a bimetallic standard, but a single standard composed of the metal which, at the mint ratio, is the cheaper. Moreover, if, by a change in the market ratios of exchange of the two metals, this one in turn becomes underappraised by the mint ratio, the standard coins composed of that metal that are already in use will disappear from circulation, being hoarded, melted down, or exported, and the other metal will take its place as the actual standard of value. The opponents of bimetallism claim, in short, that it en- counters a formidable obstacle in the principle known as Gresham's law, which is usually summarized with rough accuracy in the statement that " bad money drives out good," or that " the cheaper money drives out the dearer." More definitely, this means that domestic payments will be made, as far as pos- sible, in the money which can be used to less advantage for other purposes, and that no one will exchange relatively expensive bullion for coins at the mint when coins of an equal nominal 262 OUTLINES OF ECONOMICS value and (for most purposes) of equal purchasing power can be obtained in exchange for relatively cheaper bullion. Sir Thomas .Gresham is said to have come to this conclusion as a result of his observations of the difficulties encountered by Queen Eliza- beth in her attempts to improve the condition of the debased, worn, and mutilated coinage bequeathed to her by her prede- cessors. But the operation of the principle had previously been noted by various writers. All but the most extreme bimetallists would admit the impossi- bility of establishing and maintaining a coinage ratio between the two metals that would differ by any wide margin from the initial ratio at which they exchanged in the market, but they maintain that a mint ratio established as nearly as possible to the prevail- ing market ratio will have a steadying influence upon the latter that will tend to prevent any wide divergence between the two. If the market ratio should change to such an extent that it would not pay to use one of the metals as money, more of the other metal would be used for monetary purposes, thus decreasing the supply of it available for other uses and consequently en- hancing its relative value. The net effect of this " compensa- tory action of bimetallism" would be, it is claimed, a tendency toward the equilibrium of the market ratio of exchange of the two metals at the coinage ratio. The appeal to history has been used both by bimetallists and their opponents. The claim of the monometallists that legal bi- metallism is apt to mean actual monometallism, with the rela- tively cheaper metal as the standard, has been substantiated many times in the monetary experience of different nations. The automatic change from one single standard to the other, following a change in market rates of exchange, is also a phenom- enon that has been illustrated by a large number of concrete cases. On the other hand, the bimetallists are able to point to some fairly successful bimetallic systems, such as that of France in the first half of the nineteenth century. But it is a significant fact that no real bimetallic system has been able to en- dure for any considerable time except when the annual produc- tion of gold and silver was relatively small and relatively stable. MONEY 263 and where international trade was a relatively unimportant item. There is no scientific student of monetary problems who believes that it would be possible for any nation independently to main- tain the double standard under the present conditions of a large and fluctuating annual production of the precious metals, coupled with an international commerce of vast proportions. International bimetallism, that is, the adoption by most of the leading nations of a bimetallic standard, at a ratio fixed by inter- national agreement, has had many supporters, even among those who do not believe in the practicability of national bimetallism, and representatives of different nations have assembled in several international monetary conferences for the discussion of this subject. International bimetallism would remove one difficulty experienced in the attempts made by different nations to main- tain independent bimetallic systems at even slightly differing ratios, — and that is the tendency for each metal to flow from the countries in which it is relatively underappraised in the mint ratio to the countries in which it is relatively overappraised. Other difficulties, however, would still remain, and the possi- bility of maintaining an actual bimetallic standard even under international agreement, supposing that were possible, is open to very serious doubt. The waning of public interest in the question of bimetallism in recent years is of great significance, because it indicates that the real moving forces behind the bimetallist propaganda have not been any real or assumed points of superiority of general sig- nificance that may be imputed to a double standard, but rather that certain specific results that would flow from the adoption of bimetallism at a particular time and place have been desired. More specifically, bimetallism has been supported by those who have desired " cheaper money," and these have been particu- larly active when the money in actual use has been increasing in its purchasing power, that is, when prices in general have been decreasing. The recent great increase in the world's production of gold has, temporarily at least, taken bimetallism out of the list of economic problems of general public interest. Bimetallism in the United States. — The national monetary 264 OUTLINES OF ECONOMICS system was established by act of Congress in 1792.^ The mint was opened to the free and unHmited coinage of both gold and silver, the silver coins containing 37 ij grains of fine metal per dollar, and the gold coins 24! grains per dollar, the ratio of 15 to I being thus established. It was soon found, however, that gold was worth in the market slightly more than fifteen times as much silver, and as a consequence but little gold was brought to the mint for coinage, while such gold as was coined illustrated Gresham's law by speedily disappearing from circulation. Silver dollars, too, disappeared from circulation, but for another reason. They were somewhat lighter than the Spanish dollars which were in general circulation at the time, and would, under the operations of Gresham's law, have driven the latter out of circulation, had it not been that the Spanish dollar commanded a slight premium over the American dollar in ordinary purchases. But the American dollars, on account of their new and attractive appearance, could be used as advantageously as the Spanish dollars in trade with the Spanish possessions in America. They were consequently taken from the country for that purpose, while Spanish dollars were brought back and were sometimes recoined into a larger number of American dollars. This wasteful coinage of silver dollars was stopped in 1806 by order of President Jefferson, leaving the mint open to the coinage only of gold, smaller silver coins, and minor coins. As a matter of fact American coins made up only an insignificant part of our circulating medium before 1834. Realizing the impossibility of maintaining a gold coinage under such conditions, Congress, in 1834, changed the legal ratio to 16 to I by reducing the weight of the gold dollar. By this step, however, it went too far in the other direction, for gold was not worth in the market quite sixteen times as much as silver, and while the number of gold coins increased, but little silver was brought to the mint, and silver coins quickly disappeared from circulation. In order to secure a supply of small change. Con- gress was forced, in 1853, to abandon the principle of the un- 1 The act of 1792 followed in detail the recommendations of a Report on the Establishment of a Mint, by Alexander Hamilton, then Secretary of the Treasury. Hamilton incorporated some of the recommendations contained in earlier reports by Robert Morris and Thomas Jefferson. Hamilton's Report has been frequently reprinted, but it, together with the reports of Morris and Jefferson and other perti- nent documents, may be conveniently found in the Report of the International Monetary Conference of 1S7S. MONEY 265 limited coinage of silver coins smaller than a dollar, and to order that they should be coined, as at present,, only from bullion purchased by the government at the market price. At the same time the weight of these subsidiary coins was reduced by one seventh to insure their being retained in circulation. The discovery of gold in California, in 1848, and in Australia, in 1 85 1, suddenly increased the world's supply of gold by an unprecedented amount. In fact, the careful estimates of Dr. Soetbeer indicate that as much gold was produced in the third quarter of the nineteenth century as in the preceding three cen- turies and a half following the discovery of America. The result was to increase the discrepancy between the mint ratio and the actual market ratio of exchange of gold and silver, although the production of silver had also been greatly increased. Gold was brought to the mint for coinage in enormous amounts — a con- dition that lasted even after 1861, when paper currency began to be used almost exclusively as the medium of exchange. In a general revision of the coinage laws, enacted in 1873, the silver dollar was dropped from the list of coins that could be manufactured at the mint. Although this action was almost un- noticed at the time, a fictitious significance has, in subsequent years, been attached to it. Silver was practically " demone- tized," that is, its free and unlimited coinage was actually pre- vented, by the establishment of the ratio of 16 to i in 1834. The act of 1870 gave legal recognition to an existing fact. But a sudden depreciation in the value of silver, which began at about this time, brought the question of bimetallism again into the foreground. Since the seventeenth century the market ratios of gold and silver had fluctuated only between relatively narrow margins, and in no year since the establishment of the United States mint had the average annual price of an ounce of gold been less than 15 or more than 16 j times the price of an ounce of silver. In 1875, however, the market ratio fell to 16 to I ; by 1878 it was 18 to i ; by 1886 it was 20.8 to i ; and in 1894 it was 32.6 to i.^ It is evident that if the opportunity for 1 The causes of this unprecedented decHne in the relative value of one of the precious metals were complex and intricate. The following may be mentioned. 266 OUTLINES OF ECONOMICS the free and unlimited coinage of silver at the ratio of i6 to i had still existed, there would have been another sudden change in the actual monetary standard. Gold would have been under- appraised by that ratio, and would have disappeared from cir- culation, and silver would have taken its place. It was the realization of this fact, coupled with the knowledge that the silver standard would mean a " cheaper dollar," that led to a pop- ular agitation for the free and unlimited coinage of silver which continued for more than twenty years. The first tangible result of this agitation was a compromise measure, the Bland-Allison Act, passed by Congress in 1878, which instituted the limited coinage of silver dollars by authoriz- ing the Secretary of the Treasury to purchase at market prices not less than $2,000,000 nor more than $4,000,000 worth of silver bullion per month, and to coin it into dollars. The results of this enforced coinage were satisfactory to neither party to the controversy. The amount of silver coined was in excess of the demand for that bulky kind of money, even though as much as possible was put into circulation in the form of silver certificates, and although the government tried to favor the distribution of silver by paying the expense of transporting it to the localities where it was wanted. The movement in favor of the unlimited coinage of silver continued to gain in strength, however, its ad- vocates claiming that " more silver," rather than less, was needed. A second compromise was effected in the Sherman Silver-Pur- chase Act of 1890, which provided for an increase in the amount of silver purchased to 4,500,000 ounces each month, which was to be paid for in treasury notes. These treasury notes were to be full legal tender, and were redeemable in gold or silver coin at the discretion of the Secretary of the Treasury. The silver was to be coined only so rapidly as was found necessary for the redemption of the treasury notes. The increase in the amount however, as contributing circumstances: (i) Cessation of an extraordinary de- mand for silver in India which had existed since 1850; (2) Stoppage of the unlim- ited coinage of silver in several European countries ; (3) Discovery of large silver mines in the United States; (4) Increase in the value of gold, as evidenced by a general decrease in the prices of commodities. MONEY 267 of silver purchased was a concession to the advocates of the un- limited coinage of silver ; the fact that the circulating medium based immediately on these purchases was composed of treasury- notes, which were injected into circulation in proportion to the market price of the silver purchased, was a concession to their opponents. The Roundness of the principles embodied in the Sherman Act was soon tested by a period of financial and industrial depression. Gold had to be exported to Europe in large quantities to settle an ' adverse balance of trade, and the government found difficulty in maintaining its own gold reserve, which was already seriously threatened by a decline in customs receipts, accompanied by an increase in federal expenditures. The gold reserve was at that time simply the amount of gold in the treasury that was available for the redemption of other forms of money, — especially the United States notes, or greenbacks, that had been first issued during the Civil War, but which did not become actually redeem- able in gold until 1879. During this scarcity of gold the banks were able to secure gold for their own reserves or for export by presenting United States notes at the treasury for redemption in gold. Under the law the notes had tO' be immediately reis- sued, and were used in government payments, but no sooner was this done than they were again returned by the banks for redemption in gold. The workings of this " endless chain " by which gold was pumped from the government treasury were aggravated by the fact that the treasury notes authorized by the Sherman Act were used for the same purpose. Although they were payable either in gold or silver coin, they were actually redeemed on demand in gold. This was at the urgent insistence of President Cleve- land, who believed, with good reason, that a refusal to redeem them in gold would probably have forced the silver standard upon us, by destroying the exchangeability of silver and gold and thus putting an end to their parity, and that it would cer- tainly have injured the credit of the government and put it to a disadvantage in the bond sales that were needed to replenish the gold reserve. Under the operations of the Sherman Act 268 OUTLINES OF ECONOMICS the government was virtually exchanging gold coin for silver bullion at a time when gold was sorely needed when the gold value of the purchased silver was steadily depreciating. The gold reserve sank from $190,000,000 in 1890 to $95,000,000 in 1893. In June of the latter year the closing of the mints of India to the unlimited coinage of silver gave an added impetus to the downward movement of the price of that metal. These facts led Congress, in a special session called in 1893 ^OJ" that purpose, to order, though with obvious reluctance, that the pur- chase of silver under the Sherman Act should be stopped. The agitation for the free and unlimited coinage of silver continued, however, and with increased vigor, and it was made the sole issue in the presidential campaign of 1896. It was alleged that the yet continuing indus- trial depression could be alleviated only by "more money" and "cheaper money." It was claimed by many intelligent people that the unlimited coinage of silver would not drive gold from circulation, but would increase the value of silver and decrease the value of gold until they met at a parity established by the desired legal ratio of 16 to i. The most effective argu- ment of the protagonists of silver was found, however, in the admitted fact that the value of gold, as shown by changes in the general price level, had been increasing. AU indications pointed toward a continued decrease in the annual production of gold, and a consequent further decrease in prices. This, it was argued, was a hardship to those who had borrowed money on long time obligations, such as mortgages, because they would be forced to repay in value or purchasing power more than they had borrowed.^ This agitation was, in fact, simply one of a series of cheap money move- ments that have characterized the economic development of the United States, and which have sprung from the fact that the opening up and develop- ing of new lands have called for expenditures in amounts far beyond the resources of the actual settlers. Newly settled regions have usually been debtor regions, and there is more than mere coincidence in the fact that de- mands for cheap money have always been voiced most loudly on the frontier.^ This does not mean that a cheap money movement is essentially dishonest ; that it represents the conscious attempts of debtors to escape the payment of their lawful debts. The life and vigor in this movement for the unlimited coinage of silver was put into it by men who saw the imputed value of their assets sinking and the difficulty of paying their debts increasing in a financial crisis for which they were not individually responsible. Money funds were * This argument raises the problem of the standard of deferred payments, which is to be considered in Chapter XVI. 2 Cf . C. J. Bullock, Essays in the Monetary History of the United States, Part i. MONEY 269 hard to get because personal credit, the foundation of bank credit, was lacking. This scarcity of money funds was confused, naturally, if erro- neously, with the scarcity of "money" in the sense of standard money, — gold; and the remedy was sought in an action that would give more and cheaper standard money. The defeat of the advocates of bimetallism in 1896 would probably not have stopped the agitation for the unlimited coinage of silver, had it not been for the return of prosperous conditions, coupled with an enormous increase in the world's annual production of gold, which has brought with it a general increase in prices. The single gold standard was formally and definitely recog- nized by law in 1900. All of the silver bullion purchased under the Sherman Act has been coined, and silver dollars sufficient in amount to retire the treasury notes have been set aside for that purpose. These treasury notes (which should not be confused with the United States notes, or greenbacks) are accordingly on substantially the same basis as silver certificates. Up to June 30, 1915, their amount had been reduced from $156,000,000 to $2,250,000. No silver dollars have been coined since 1904, and under the present law no more can be coined unless Congress should authorize the special purchase of bullion for that purpose. The Gold-Exchange Standard. — Within the past twenty . years gold has been accepted more generally and more definitely than ever before as the standard money metal of the world. The change from a silver standard to the gold standard is often a difficult and expensive national undertaking, but it brings the advantages of a more stable unit of value and of increased facility in making international payments. In 191 5 the silver standard prevailed only in China, Persia, Paraguay, and three Central American countries.^ In a number of places in which it is impossible, for one reason or another, to introduce gold as part of the actual medium of exchange, the silver standard has been replaced by the gold- exchange standard. Where this standard exists the currency of the country consists largely of silver coins, put into circula- tion by a system of limited coinage. These coins are maintained at a fairly definite gold value, higher than that of their bullion 1 Report of the Director of the Mint, in Finance Report, 1915, p. 456. 270 OUTLINES OF ECONOMICS content. This is not accomplished, however, by making them always and necessarily redeemable in fixed quantities of gold. Instead the government agrees to sell exchange on one or more gold-using countries at a maximum fixed price in terms of the local coins. ^ That is, while the local currency is not necessarily redeemable in gold within the home country, it is redeemable in bills of exchange or drafts payable in gold in some foreign country. It is necessary, of course, for the home government to maintain funds for this purpose in a gold-using country.- The gold-exchange standard has been adopted in India, the Philip- pines, Mexico, Panama, Siam, Indo-China, the Straits Settle- ments, and (in a modified form) in Java. Where carefully administered it has worked well, and has brought to the countries using it practically all of the advantages of the gold standard without the expense of introducing and maintaining a gold currency and sometimes without making it necessary for the people to familiarize themselves with a new kind of money. It has even been suggested by certain writers that the great nations of the world might wisely adopt the gold- exchange standard, making their local currencies redeemable at fixed rates in drafts upon some one country in which the bulk of the gold reserves of the world would be kept A change like this is impracticable so long as wars, with their interruptions of international commerce and international gold payments, re- main possible. Nor would it be particularly advantageous. The general adoption of the gold-exchange standard would, it is true, greatly decrease the amount of gold needed to carry on the world's business transactions at present prices. But the ul- timate result, there is good reason to believe, would merely be a 1 Since 1893 the mints of India have been closed to the free coinage of silver. Silver rupees, coined from bullion purchased by the government, are now main- tained at a gold value of approximately one shilling and four pence per rupee by the government's practice of selling, when necessary, bills of exchange payable in London at a price not higher than \s. 3?| d. per rupee. The peso of the Philippines, containing only about three fourths as much silver as the silver dollar of the United States, is maintained at a gold value of approximately fifty cents by the insular government's accepting it at that price (minus a small charge) in exchange for drafts payable in New York. MONEY 271 general increase in prices, so that the aggregate volume of pay- ments (measured in money units) would increase and more gold would be needed in the world's gold reserves. The world as a whole does not profit by " economizing in the use of gold," even though particular countries may be able to save by avoid- ing the expense of introducing a gold currency. Government Paper Money. — In metallic money of limited coinage, there is, as we have seen, a considerable element of credit. In paper money the element of credit is alone present. Government paper money is composed of instruments which bind the government to pay, and usually to pay on demand, equiv- alent amounts of metallic money, — usually standard money. Government paper money also differs from metallic money of limited coinage in respect to the motives which gives rise to and regulate its issue. Subsidiary coins are issued by the govern- ment in response to the demand for circulating medium for use in small transactions and in making change. The public con- venience is the first consideration ; the profit accruing to the government on such coinage is a secondary thing. In issuing government paper money, however, fiscal motives have predomi- nated. When hard pressed to swell the government income to cover an increase in expenditures, those responsible for the finan- cial policies of a government have often deemed it advisable for the government to make use of its own notes, promises to pay, in discharging its obligations. These differ from government bonds, which are often issued in similar circumstances, in that the bonds bear interest, are sold to voluntary buyers, and are usually payable at a definite time in the future, while government notes are usually non-interest bearing, represent a forced rather than a voluntary loan, and are usually, in form at least, payable on demand, or in practice, at an indefinite t-ime in the future. They are, moreover, issued in convenient form for monetary use, and are usually made legal tender, so that they pass from hand to hand as a medium of ex- change. The forced loan which they represent is therefore shifted from those who first receive the notes from the govern- ment for their goods or their services. 272 OUTLINES OF ECONOMICS Colonial and Revolutionary Bills of Credit. — Paper money issues have frequently been used in the United States as a means of meeting fiscal emergencies, especially those springing from the extraordinary expenditures occasioned by wars. The expense of sending trodps to the Indian wars was one of the things that led most of the American colonies to issue paper money. The his- tory of these colonial " bills of credit," as they were called, illus- trates two dangers that seem to be inseparable from the use of this financial and monetary device. In the first place, it was very easy to succumb to the temptation of paying ordinary as well as extraordinary expenditures in this easy way. Some of the colo- nies got entirely out of the habit of taxing themselves to meet current public expenses. The refusal to levy taxes was a prolific cause of disputes between colonial assemblies and royal gov- ernors. In the second place, because no money was raised for the pur- pose, these bills of credit were not redeemed promptly. Their purchasing power fell because people lost confidence in their redeemability. As prices rose it took continually larger issues to meet the government expenditures, and each increase in the amount in circulation led to a further fall in purchasing power. After the currency had become practically worthless, it was a common practice to repudiate it in whole or in part, and to start afresh with bills of a " new tenor." Any attempt to restrict this reckless use of public credit was met with determined resist- ance from the " cheap money " advocates of that day. There were frequent complaints of the scarcity of money, especially from the more newly settled districts. The greater the quantity of money issued, the more insistent was the demand for still further issues. In short, this colonial experience in itself gives sufficient basis for the inference that from the monetary as well as the fiscal point of view, the use of paper money easily de- generates into a bad habit. Again, in the Revolutionary War, paper-money issues were made, — this time by the Continental Congress as well as by the individual colonies. The Continental Congress was really driven to this action by its lack of the power of levying taxes. MONEY 273 Its bills became practically worthless, although every effort was made to maintain their parity with metallic money by appeals to patriotic sentiment. After the formation of the national government a few of them were redeemed at one cent on the dollar. It was our unfortunate colonial and revolutionary experience with paper money which led to the insertion of the wise provision in the federal Constitution which forbids the individual states to issue bills of credit or to made anything but gold and silver legal tender in payment of debts. The Greenbacks. — The federal government made no impor- tant issues of paper money until the Civil War.^ It was not generally foreseen that that conflict would be so long continued and intense as it was, and Congress consequently neglected to make adequate provision for taxes that would help to meet the increased expenditures and to sustain the government credit in the borrowing operations that were necessary. In 1861 the Secretary of the Treasury was authorized to issue at his discre- tion $50,000,000 in " demand notes," which, although they were not legal tender-, could be used in all payments to the government. These were redeemed promptly on demand until the end of the year, when the withdrawal of gold from the banks by depositors for hoarding, and by the government for its own uses, led first the banks and then the government to suspend specie payments, — that is, to refuse to pay their current obligations in gold. In February, 1862, moved by the absolute necessity of provid- ing some kind of money for the federal treasury. Congress authorized the issue of $150,000,000 in legal tender notes,^ or greenbacks, as they came to be called. It was hoped, moreover, that this increase in the circulating medium would improve the market for government bonds for which the greenbacks were at first made convertible at par. This action was not taken without * The federal government issued treasury notes in the war of 1812 and the Mexi- can War, and during the panics of 1837 and 1857. Most of these issues were interest bearing, however ; in no case were they legal tender, nor did they get into common use as media of exchange. 2 Including the "demand notes," which were now made legal tender. T 274 OUTLINES OF ECONOMICS strenuous opposition on the part of those who foresaw some of the disastrous consequences of large paper money issues. But as in earHer American experience with paper money, succeeding issues met with less and less resistance. All together, green- backs to the amount of $450,000,000 were issued during the war. It was the general expectation when the greenbacks were is- sued that they would lie retired as soon as possible after the con- clusion of the war. But when such action became possible, it was opposed by many who thought that the reduction of the cir- culating medium would decrease prices, impose additional bur- dens upon debtors, injure business interests, reduce the public revenues, and hamper the government in the refunding of its public debt. In 1866, however, Congress authorized the gradual retirement of the greenbacks, but repealed the act in 1868. The amount in circulation in 1874 was $282,000,000, and in that year a bill requiring the definite increase of the issue to $400,000,000 was prevented from becoming law and thus establishing a dangerous precedent only by the veto of President Grant. Some greenbacks were retired under the provisions of an act of 1875, but in May, 1878, there were $346,681,000 outstanding, and as a law then enacted provides for their constant reissue after being received or redeemed at the treasury, the amount still stands at that figure.^ The part that they played in the financial difficulties of 1 890-1 893, together with the history of the treasury notes of i8go, has been described in connection with the discussion of bimetallism. At present the greenbacks constitute a useful arid acceptable part of the stock of money. But if another financial crisis should deplete the government treasury, they would very likely prove again to be a source of difficulty. Their retirement is feasible under present conditions, but would be most difficult to accom- plish under the very financial conditions under which they would be most dangerous. The currency act of 1900 provides for a gold reserve of $150,000,000, to be held against them to insure their redeemability. If the reserve falls below $100,000,000, the Secretary of the Treasury is directed to replenish it from the * Since 1900 they have been reissued only in exchange for gold. MONEY 275 proceeds of bond sales. Although this gold reserve also con- stitutes part of the real security behind our silver dollars, it could safely be diminished in amount if the greenbacks were retired. Moreover, if a great national emergency should ever again make the issue of government paper money necessary, it would be highly advantageous to have the greenbacks out of the way.« Economic Effects of the Greenbacks. — The greenbacks are in form promises to pay, but they are not promises to pay on de- mand, nor at any specific time. During the period of the sus- pension of specie payments they were not actually redeemable in gold, nor was gold in general circulation as a medium of ex- change except on the Pacific coast. Gold was, however, in addi- tion to its industrial uses, employed as money in international trade, in the payment of interest on government bonds, and for customs duties (for which the greenbacks were not legally re- ceivable). There was thus a constant demand for gold money, which was met by its sale as a commodity in the New York mar- ket. The gold market was highly speculative, the daily and even the hourly fluctuations in the price of gold in greenbacks being considerable. Notwithstanding these speculative features the prices paid for gold indicated very accurately, in the long run, how much, in the expert judgment of market specialists, the greenbacks should be discounted as compared with gold. Everything that was thought to affect the probability of the ultimate redemption of the greenbacks in gold influenced their price. Among these factors were the quantity of greenbacks issued, the condition of the federal treasury, the military suc- cesses and reverses of the Union cause, and, in later years, the prospects for the resumption of specie payments. Greenbacks reached a parity with gold two weeks before the resumption of specie payments on January i, 1879. A fact of special sigriifi- cance is that until July, 1863, the greenbacks were convertible at par into 6 per cent gold bonds. These bonds formed an ac- tual standard of value for the greenbacks, and although them- selves depreciated, exercised for the time being a steadying influence upon their price. As the common medium of exchange consisted almost entirely 276 OUTLINES OF ECONOMICS of greenbacks ^ and of bank notes convertible only into green- backs, prices were stated in greenback " dollars " and naturally- rose as the gold value of the greenback depreciated. Reference to the table on the next page will show a rough correspondence between changes in the general level of prices, expressed in green- *backs, and changes in the price of gold, also expressed in green- backs. But the wholesale prices of commodities rose relatively higher than did the price of gold, and declined less rapidly .^ Retail prices, in turn, declined less rapidly than did wholesale prices. Wages advanced more slowly than prices; maximum wages were not paid until 1872, — seven years after retail prices and eight years after wholesale prices had reached their maxi- That there was not a closer correspondence between the movement in gen- eral prices and the changes in the gold value of the greenback was due to two sets of influences : (i) Even if greenbacks had not been issued, and if prices had been expressed in gold, there would have been marked fluctuations in prices, — not only such as continually occur in normal years, but also those due to such exceptional things as the withdrawal of a large number of men from industry and agriculture to military service, the shifting of productive effort in response to the enormous demand for military supplies, the period of extraordinary business activity, of railway building, and of agricultural and industrial expansion that followed the war, the reaction and financial crisis in 1873, and the return of prosperous conditions in the last years of the greenback period.' (2) The depreciation in the gold value of the greenback was recorded quickly and accurately in the gold market, but the movement of prices was hampered by habit, custom, existing contracts, local influences, etc. Retail prices are less sensitive to changing market conditions than are wholesale prices. Wages, in turn, are usually less mobile than retail prices. 1 Subsidiary coins did not go out of circulation until 1862, when the value of the greenback dropped below the value of the bullion in these coins. Postage stamps and notes and tokens issued by cities and by business firms were for a while used as small change. In 1862 the situation was helped by the issue of fractional paper currency in denominations as low as three cents. 2 The more detailed figures, of which the table given here is only a summary, show that the prices of commodities also advanced more slowly than did the price of gold. For an illuminating discussion of these price changes see Mitchell, Gold, Prices, and Wages under the Greenback Standard, Chap. v. ' This statement is subject to the limitation implied in the fact that general commercial conditions were themselves caused in part by the influence of the cheap and fluctuating medium of exchange. MONEY ^ 277 TABLE I Prices and Wages in the Greenback Period 1 Year Average Annual Price OF Gold in JtTLY Wholesale Average Annual Prices' Average Wages < Greenbacks Prices ^ Wholesale Retail i860 — 100 100 100 100 1861 — 95 94 107 99 1862 ^^3-3 120 109 131 104 1863 , 145.2 155 148 168 119 1864 203.3 236 225 215 142 1865 157-3 183 224 219 iSS 1866 140.9 191 203 208 164 1867 138.2 170 177 193 167 1868 139-7 165 180 190 170 1869 133-0 158 172 177 179 1870 114.9 145 156 166 179 1871 111.7 137 144 155 184 1872 112.4 139 138 151 1854/ 1873 113.8 140 143 148 183 1874 III. 2 138 144 145 17s 187s 1 14.9 129 134 140 163 1876 iii.S 118 120 ^3S 153 1877 104.8 114 117 134 143 1878 100.8 99 99 127 142 1879 100.0/ 98 93 123 139 All these things interacted. Wages, to give only one example, constitute an important part of the expenses of producing commodities, and the sluggish movement of wages kept the expenses of production from advancing, and later from falling, as rapidly as would otherwise have been the case, and must have had a corresponding effect on the prices charged for commodities. Aside from these general changes, the minor fluctuations, the short-time variations in prices, were unusually wide and numer- 1 Compiled from Gold, Prices, and Wages under the Greenback Standard, by Wesley C. Mitchell. The figures in the price columns are obtained by counting the price of each commodity in each year as a percentage of its price in i860, and then averag- ing the various relative prices thus obtained for each year. The figures in the wage column are computed in a similar way. In the "price of gold" column parity be- tween greenbacks and gold is represented by 100. 2 g2 commodities. ^ 21 commodities. ^ For 78 establishments. 278 OUTLINES OF ECONOMICS ous, — a fact which may be attributed to the uncertain future of the medium of exchange. Such fluctuations were apt to up- set all business calculations ; chance became more important and foresight less important as a factor in profits. Under such condi- tions an intense and reckless spirit of speculation was bred, with unfortunate effects on business morality as well as on economic conditions. As a fiscal expedient, the greenbacks led to results as disastrous as those which attended their use as money. The government was forced to sell bonds for depreciated greenbacks, but in order to maintain its credit it had to pay the interest and ultimately the principal of these bonds in gold. Supplies for the army were paid for in depreciated greenbacks, but these greenbacks had to be ultimately redeemed in gold. It has been estimated that the use of the greenbacks increased the expense of the Civil War by nearly $600,000,000.^ Fiat Money, — After 1873 the advocates of cheap money were not content with merely opposing any reduction in the quantity of the greenbacks. They went so far as to urge that the amount of paper should be greatly increased, and that the use of metallic money should be definitely and permanently abandoned. Bank notes were also attacked because they were issued by " privileged corporations." The question came to be an irnportant political issue, and in 1876 it brought about the organization of the Green- back party, which figured in three presidential campaigns, and which polled more than a million votes in the congressional elections of 1878. In more recent years similar demands were voiced by the Populist party. ' The theory of money which formed the basis of the contention of the members of the Greenback party is sometimes called the *' fiat money " theory. Those who held this theory of money saw no significance in the fact that the greenbacks were in form promises to pay and that they were generally regarded as only 1 This estimate applies only to the increased expense to the government, and conse- quently to its taxpayers. The real economic costs of the war were not greatly affected by the use of the greenbacks. Bondholders gained, for example, a large part of what taxpayers lost. MONEY 279 temporarily irredeemable. In their view they were simply " dollars," made such by the expressed will of the government. Nor did they see any significance in the fact that during the seventeen years of the suspension of specie payments over $500,000,000 in United States gold coins issued from the mints. As a matter of fact the fiat money advocates were misled by what some logicians have called the " jingle fallacy." That the " dollar " of the ordinary medium of exchange and the " dollar " as a standard monetary unit were different things did not occur to them. If they had succeeded in eliminating the credit element in the paper currency by ceasing to print " promises to pay "(as they actually proposed to do), and had instituted a new name for the money unit, — possibly (to reverse the spelling )" rallod," — they would perhaps have encountered difficulty in getting people to use pieces of printed paper, informing them that " This is a rallodj" as money. It is hard to see how " the supply of money as compared with the demand for it," on which the fiat money advocates counted to fix the purchasing power of their money units, would have helped matters very much. Nor would the redeemability of fiat money in interest-bearing bonds, which was suggested by some, have given us a monetary standard. For the bonds would have been merely promises to pay certain sums of fiat money, with interest at a certain rate, also in fiat money. The difficulties that would have been encountered in international trade would alone have sufficed to make fiat money impossible. This should not be taken to mean, however, that irredeemable paper money, issued in familiar denominations, may not under favorable circumstances circulate for some time among people accustomed to its use, even if there is no prospect of its ever being redeemed. The most important of the necessary " favor- able circumstances " is the absence of complications in foreign trade, such as have already been discussed in connection with" the subject of seigniorage. But, at best, there would be a host of practical difficulties in the way of getting the right amount of money, and only the right amount, into circulation. 28o OUTLINES OF ECONOMICS QUESTIONS 1. Would wheat make a satisfactory money commodity? iron? plati- num ? diamonds ? 2. Would it be possible to maintain a seigniorage of lo per cent on United States gold coinage? What would be the effect on the prices of imported commodities? of domestic commodities? 3. Report on the following questions not answered in this chapter : (i) What is the "limit of tolerance" ? (2) On whom does the loss from the wear of gold coin fall? (3) To what extent are different kinds of United States money legal tender ? 4. If the United States had adopted the free and unlimited coinage of silver in 1896, how would prices have been affected? 5. Is the actual monetary standard pure gold or gold of standard fineness ? 6. What elements of truth are there in the statement that "coins get their value from the government stamp"? 7. In the table printed on page 254, why are not gold certificates, silver certificates, and treasury notes of 1890 included in the statement of the aggregate amount of money in the United States? 8. Interpret the statement : "The value of the greenbacks depreciated." Explain in particular the meaning of the words value and depreciated as thus used. 9. Do you make a loan to the government when you receive greenbacks in payment for goods or services ? REFERENCES Bullock, C. J. Essays in the Monetary History of the United States. Commission on International Exchange (1904). Report on the Introduction of the Gold Exchange Standard. Dewey, D. R. Financial History of the United States. (See index.) Director of the Mint. Annual Report. DoDD, A. F. History of Money in Great Britain and America, Hepburn, A. B. History of American Currency. Huntington, A. T., and Mawhinney, R. J. (Compilers). Laws of the United States Concerning Money, Banking, and Loans, lyjS-igog. Jevons, W. S. Money and the Mechanism of Exchange. Johnson, J. F. Money and Currency. Kinley, David. Money. Knox, J. J. United States Notes. Laughlin, J. L. History of Bimetallism in the United States; The Principles of Money. Mitchell, W. C. History of the Greenbacks ; Gold, Prices, and Wages under the Greenback Standard. Scott, W. A. Money and Banking, Chaps, i-vi, xiv, xv. MONEY 281 Taussig, F. W. Principles of Economics, Vol. i, Chaps, xvii-xxiii. Treasurer of the United States. Annual Report. (This, together with ab- breviated forms of the reports of the Director of the Mint and the Comptroller of the Currency, is printed as an appendix to the Report of the Secretary of the Treasury in the bound edition of the annual Finance Report.) Walker, F. A. Money; Money in its Relation to Trade and Industry. Watson, D. K. History of American Coinage. White, Horace. Money and Banking. CHAPTER XV CREDIT AND BANKING Credit Transactions. — Thus far, in our discussion of money, we have failed to take account of the fact that the greater part of exchanges are credit transactions, which do not directly or immediately involve the use of money (in the sense of generally acceptable money instruments). A credit transaction is a transfer of goods, services, or money for a future equivalent. In a " cash" transaction there are only two elements,- — the goods sold and the money paid for them. But in a credit trans- action a third element — time — is added. The introduction of this third element leads to exceedingly important results. In the first place it makes possible an enormous number of ex- changes in which the buyer is either unable or disinclined to ren- der a present equivalent. In the second place it obviates, to a very large extent, the necessity of using money. Suppose, for example, that A and B are the only inhabitants of an isolated community. Three ways of making exchanges are open to them. They can use a system of direct exchange or barter, which will prevent A from getting goods from B unless he has some equivalent which he is willing to give up and which B is willing to accept. Or, they may use one commodity as money, in which case the purchasing power of either A or B at any given time will be governed by the amount of that particular commod- ity he possesses, rather than by the total amount of all his posses- sions. But by combining a system of credit with their use of money, they will be able to make transfers freely, for in an occa- sional balancing of accounts most of the payments due each other will cancel, leaving only a relatively small amount to be paid in money. 282 CREDIT AND BANKING 283 Something very much like this third process is continually going on in contemporary economic life. The process is more complex, however, because A actually sells things to one person or group of persons, and buys them from other persons. And it is very likely that these two groups, the sellers and the buyers in A's transactions, have no direct business transactions with each other in which their respective claims against A and debts to A can be canceled. If, however, we take all buyers and all sellers into account, and if we could push our analysis of the com- plex network of credit relations far enough, we would find points of contact between A's credits and his debts. That is, if A gives a promissory note in exchange for a purchased good, this promis- sory note might be passed on from hand to hand until it got into the possession of someone who is indebted to A, — if the path it should take were known. The difficulty is that the path is not known. The institution of banking, however, provides clearing centers, where credits and debts are balanced against each other and canceled. A, for example, has a " deposit " in a local bank, which means that he has the right to demand money from it at any time up to the amount of his deposit. He usually makes a payment to B, not by money or by a promissory note, but by a check, — an instrument ordering the bank to pay B the specified amount. This check will be presented for payment by B at a bank where he has a deposit, but the "payment " will usually be made by add- ing the amount of the check to B's deposit. If it is the bank where A also has his deposit, the transaction is settled by the simple process of debiting A's deposit and crediting B's. If it is another bank in the same town, and if the town is a small one, the check will enter into the daily exchange by the two banks of such claims against each other, the daily balance in favor of either bank being usually settled in money. In the larger cities a further economy in the use of money is achieved by means of the clearing house, to which a representa- tive of each bank brings daily all of the checks drawn against other local banks which it has received since the last " clearing." At the clearing house the checks are turned over to the repre- 284 OUTLINES OF ECONOMICS sentatives of the banks against which they are drawn, but bal- ances are not settled between the individual banks. Instead, a balance is struck between the total sum of each bank's claims against other banks and the total claims of other banks against it. Each bank then pays to the clearing house, usually in money, or receives from it, as the case may be, the amount of balance due to it or from it. This system achieves a great economy of both time and money.i If the banks in which A and B keep their deposits are in differ- ent towns, A's check will probably be sent by B's bank to a bank in a neighboring large city, in which B's bank has its own deposit account. If A's bank is also in the territory tributary to this same city, the check may be sent by the city bank directly to A's bank for collection, or to its own correspondent bank in the same town. If A's bank is in another part of the country, the check will be sent to a bank located in a large city in that region, which will attend to its collection.^ Thus a check drawn on a local bank in California, deposited in a local bank in Illinois, will very likely be collected via Chicago and San Francisco. The balances of credits and debits which are thus created between city and country banks are settled to a very large extent by means of crediting and debiting deposit accounts in city banks, thus obviating by that much the necessity for frequent shipments 1 Over $90,840,000,000 in checks and drafts passed through the New York Clearing House in the year ending September 30, 1915. The money balances paid amounted to $5,340,000,000, or less than 6 per cent of the total clearings. The average cash payments required during the last sixty -two years have amounted to less than 5 per cent of the clearings. In times of financial stringency clearing houses sometimes permit payment of balances in "clearing house loan certificates," issued to individual banks upon the basis of approved securities deposited with the clearing house. In some cases the banks have temporarily put such certificates into general circulation as emergency currency. 2 The London Clearing House clears for all England in a very simple and efficient way. A country bank sends its daily receipts of checks on banks in other towns to the London bank in which it keeps a deposit. In a daily "country clearing" these checks are distributed to the London banks where the banks on wliich the checks are drawn keep accounts. The mere territorial extent of the United States makes such a scheme unworkable here. The federal reserve banks, however, hope to develop a system of regional and inter-regional clearings for their member banks. CREDIT AND BANKING 285 of money. In general, we have in the United States a continuous balancing and cancellation of debts and credits, first, in each locality ; second, between each important city and its tributary territory, and, third, between the different important cities. Much the same process is characteristic of international exchange, but that is a topic which will be treated in another chapter. Personal Credit. — If a man does not hoard money on the one hand, or fail to pay his debts on the other hand, his expenditures (including investments) are bound to be, in the long run, approxi- mately equal to his income. But for a business man a continuous equality of income and expenditure is impossible. At some times his deposit account will be built up more rapidly than he checks it out ; at other times his need for means of making pay- ments will outrun his receipts. If, for example, he is a con- tractor, whose expenses of production are fairly constant, but whose product is paid for only when completed, or a merchant, who replenishes his stock of goods twice a year but whose sales are distributed throughout the year, or a farmer who must pay his harvest expenses before he sells his crops, he may find it nec- essary to utilize his credit. This he does by giving to others rights to demand money from him in the future. Now, the extent to which he can utilize his personal credit, his power of purchasing things without immediate money payment, will depend to some extent on his personal ability and integrity. But, nevertheless, the fundamental measure of his credit will be the amount of his realizable wealth. This, however, may consist in part of prop- erty that is not " for sale," — his stock of consumption goods and his income-yielding land or capital, and in part of things that he hopes to sell in the normal course of business. These things do not have to be sacrificed immediately in order \ to acquire the present means of payment. To meet a temporary V, need they may be made the basis of credit, through the process y-Nof hypothecation, a name which means the conditional transfer of property rights. The hypothecation may be definite and formal, as when a mortgage is given on specific items of property or when valuable credit instruments of various sorts (such as government or corporation bonds, bills of lading, warehouse 286 OUTLINES OF ECONOMICS receipts, etc.) are put into the actual possession of the creditor as " collateral security " ; or it may be simply implied, as in the case of an " unsecured " personal note, for practically all of the property of a borrower, over and above the items specifi- cally hypothecated for certain debts is, in legal fact, hypothe- cated for his remaining debts. It is important to note, too, that future values, rather than present values, constitute the basis of present credit. The lender's interest is in the question of the adequacy of the money value of the security at the time when payment becomes due. Present prices being equal, a borrower can secure a larger amount of credit when market conditions are improving than when they are declining. A man's probable future income and the probable future money value of his property, then, constitute the real measure and foundation of his personal credit. His personal credit, however, is of limited use to him as a means of payment. Some difficulties in the way of using personal notes as media of ex- change have already been suggested.^ There is another diffi- culty in the fact that his personal notes will not be willingly accepted by others in lieu of money payments unless they know him, the value of his property, and the extent to which it is already hypothecated. Moreover, these same difficulties stand in the way of such notes being passed from hand to hand, even j with successive indorsements. . 1 Bank Credit. — In order to acquire a readily available medium of exchange, personal credit has to be exchanged for bank credit. 1 It is true, of course, that business men often accept their customers' notes in payment of accounts, or as an equivalent for goods purchased. These notes, however, do not usually pass any farther as a medium of exchange, but are in- dorsed by the business man and presented to a bank for discount. Such notes, often known as "trade paper," constitute a large part of the securities of many commercial banks. In recent years, however, an increasing proportion of bank loans have been made upon "one-name paper." Buyers find it advantageous to secure the discounts for cash payments usually given by manufacturers, whole- salers, and jobbers, obtaining the necessary funds by borrowing from the banks on their own notes. The federal reserve banks are attempting to increase the use of paper bearing the names of both buyer and seller, and in particular to develop a larger use of bills of exchange (drafts) in place of promissory notes. The pur- pose is to make it easier to distinguish those borrowings which arise from " actual commercial transactions." CREDIT AND BANKING 287 Instead of using his own note as a medium of exchange, a business man will normally have it " discounted " by his banker. If the note is for sixty days, for example, the business man yields the right to demand a specific amount of money from him in sixty days, in exchange for a deposit credit, — the right to receive on demand the same amount of money less the discount} The business man adds the note to his liabilities and the deposit to his assets. The bank adds the note to its assets and the deposit to its liabilities. Having exchanged his personal credit for a bank deposit, the business man can now use the latter as a means of payment through the checking system that has been described. Ordinary commercial banking consists, in large part, of this purchase of personal credit and sale of banking credit. The bank builds up assets in the form of loans and discounts at the same time that it builds up its obligations in the form of deposits. The security behind the deposit liabilities of any bank consists of: (i) loans and discounts, which in turn rest back upon per- sonal credit or upon specifically hypothecated property (as in the case of loans on collateral security) ; (2) bonds, mortgages, and other securities owned by the bank, which, if necessary, may be sold for the benefit of the depositors, unless specifically pledged as security for bank note issues ; (3) the bank's own de- posits in other banks, together with the checks or similar claims against other banks that are in its possession ; (4) its other property (building, fixtures, etc.) ; (5) (in national banks and some state banks) the personal liability of the bank's stock- holders ; 2 (6) its stock of money. 1 Discount is simply one form of interest. Banker's discount differs from ordi- nary interest in that it is computed as a certain per cent of the total amount that is repaid, while ordinary interest is computed as a per cent of the amount that is lent. Discount is deducted from the principal of the loan in advance ; interest is paid at the maturity of the loan or (on long time loans) at stated intervals. On demand or "call" loans and on time loans on collateral security "interest" rather than "discount" is charged. 2 Even in case some of the bank's loans or securities prove worthless there is a margin of safety for the depositors in the fact that some of the assets of the bank represent the original investments of the bank's stockholders {^^ capital") or profits which they have put back into the business {"surplus"), and on such assets the depositors have the first claim. Moreover, in national banks and some state banks 288 OUTLINES OF ECONOMICS But that these assets should sufl&ce to cover the deposit Ka- bilities of a bank is not in itself sufficient to maintain its solvency. Much depends upon the character of the assets, — the amount of money included in them, and the ease and quickness with which other parts of the assets can be converted into money. Each deposit account is an obligation of the bank to pay in actual money if it is demanded. The depositor cannot use checks for all kinds of payments, but will often have to draw on his deposit account for money. Even when payments are made by checks, those who receive them will often prefer to cash them rather than to deposit them. Moreover, the process of the cancellation of credit obligations is, as we have seen, not alto- gether perfect. Balances arise between individual banks in the same city, between city and country, between different cities, and between different nations that very often have to be settled in money. Statement of the Condition of a National Bank in a Small Town Resources Liabilities Building and fixtures . Government bonds Other securities . . . Loans and discounts . Due from other banks Cash $4S,ooo 50,000 30,000 460,000 42,000 3S,ooo Capital stock . . Surplus .... Notes outstanding Deposits .... Due to other banks Undivided profits . $ 50,000 25,000 48,000 \ 531,000^ 3,000 ^ 5,000 --" Total resources $662,000 Total liabilities $662,000 A bank accordingly has to keep enough actual cash on hand to enable it to meet any demands that may be made upon it for money. As deposits constitute the most important cash obliga- tions of most banks, the size of this money reserve, as it is called, is normally fixed for safety's sake at a certain per cent of the amount of the deposits. This proportion varies according to the stockholders are in addition personally liable up to an amount equal to the par value of their holdings. CREDIT AND BANKING 289 the location of a bank and the nature of its business. In prac- tice it varies in different commercial banks from as low as 5 per cent to as high as 35 per cent of the deposits. If its reserve increases, a bank is at liberty to increase its de- posits by extending its loans and discounts, attracting these, possibly, by lowering the discount rate. If the reserve is de- creasing, the bank must, for safety, contract its deposits by re- stricting its loans and discounts, or by taking measures (such as the sale of securities for money) that will replenish the reserve.^ In order that the ratio of reserve to deposits may be maintained near the point where the right balance is struck between profit- ableness on the one hand and safety on the other hand, it is nec- essary that the bank's assets should be a,s fluid as possible. This is best accomplished by confining most of the loans or discounts to notes or bills of exchange that are payable in thirty, sixty, or ninety days, or, at most, in four or six months, so that a constant flow of maturing obligations makes it possible for a bank to ex- pand or contract its loans and discounts, and hence its deposits, as seems most advisable. There has been in the larger cities of the United States, es- pecially in New York, a growing use of bank loans payable on demand. This enables the banks to keep their outstanding loans much closer to the maximum allowed by the state of their reserves than would otherwise be the case, but the practice has, as we shall see presently, other effects that are not so desirable. By the " money market " is usually meant the market for freely exchangeable rights to receive money on demand ; that is, in. reality, the bank credit market. The amount of bank credit available, the freedom with which banks will make loans on cer- tain kinds of securities, and the interest and discount rates charged for bank credit are among the things that make up what is called " the state of the money market." But it should be clear to the reader that the state of the money market depends, 1 Some banks maintain a "bond reserve" of high grade securities that may be sold to enable the bank to meet an extraordinary demand for money or to enable it to extend its loans and discounts when necessary. Such investments are nor- mally made by commercial banks when the demand for loans does not absorb the fimds at the bank's disposal, that is, when money reserves are unprofitably large. U 290 OUTLINES OF ECONOMICS primarily, on two things : first, the amount and nature of the per- sonal credit that can he exchanged for hank credit, and second, the amount of money in the hank reserves. Bank Notes. — There is one way, however, in which banks can meet some of the demand for money without drawing on their re- serves and thus reducing their power of extending credit. This is by the issue of bank notes, which are simply the promises of banks to pay money on demand, issued in convenient and famil- iar form for use as paper money. These notes are paid as money to customers of a bank who want the proceeds of their borrowings in cash, and to depositors and to holders of checks who prefer money to deposit credit. Bank notes pass readily from hand to hand as money, and at the present time constitute an impor- tant part of the circulating medium in most countries. Bank notes are like deposits in that both are demand liabilities of banks. Bank notes, however, circulate among persons who have no means of informing themselves as to the solvency of the banks issuing them. The holders of bank notes are accordingly usually given special protection by laws which regulate the con- ditions of their issue and redemption. State Banks of Issue. — Before the Civil War the actual circu- lating medium of the United States consisted in very large part of notes issued by banks operating under state laws. The notes issued by some of these banks were as " good as gold " because the banks redeemed them promptly in gold, — a fact which was due in some cases to wise and rigid state regulation of banking, and in other cases, fewer in number, to conservative use of the too extensive privileges granted by lax state laws. But the notes of other banks were depreciated and in many cases were abso- lutely worthless. Public ignorance of the real nature of banking gave rise to the supposition that wealth could be mysteriously manufactured by means of a bank charter and a printing press (the fiat money theory applied to bank notes) . This and the ever recurring de- mand for cheap money were responsible for the situation. Pro- hibited by the Constitution from issuing their own bills of credit, many of the states, especially in the South and West, responded CREDIT AND BANKING 29 1 to the clamor for cheap money by making it possible for their citizens to organize " banks " and issue their own bills of credit, imposing few or no requirements as to the actual investment of capital, the accumulation of assets, or the restriction of note issue.^ In the panics of 1814, 1837, and 1857 but few banks maintained specie payments. Even so late as i860, although the hard lessons of experience had brought some improvements, especially in the older states, the bank note circulation was of decidedly varying quality. " Bank note reporters " and " counterfeit detectors " had to be issued periodically in order to give to busi- ness men the latest quotations and information relating to the depreciated currency they had to receive in the ordinary course of business. After 1861 the suspension of specie payments led to a general depreciation of bank notes as compared with gold, because most of them were thereafter redeemable only in green- backs. The National Banking System. — The successful state bank- ing system of New York was the model after which Congress, following the recommendations of Secretary Chase, patterned the national banking system which it established in 1863. The primary, although not the only, motive that led to this action was the desire to provide an artificial market for government bonds, which at the time were a drug on the market. National banks were required to use government bonds as the assets be- hind note issues, and furthermore, the national banks were, in 1866, given a monopoly of the note issue privilege by the im- position of a prohibitive tax of 10 per cent per annum upon the note issues of state banks. The details of the national banking law have been amended from time to time, but the general principles of the regulation of the note issue remained unchanged until Congress passed the Aldrich Act in igo8. As the law has stood since 1900, national banks may not be organized unless the stockholders contribute a minimum capital, varying from $25,000 for places of less than ' Some states circumvented the constitutional prohibition mentioned by estab- lishing their own banks for the manufacture of paper money. The Bank of Ken- tucky was the most famous of these. 292 OUTLINES OF ECONOMICS 3000 population to $200,000 for places of more than 50,000 popu- lation. Three limitations are put on the ordinary issue of cir- culating notes : (i) They must not exceed in amount the capital stock of the bank. (2) United States government bonds have to be purchased by the bank in amount sufficient to equal, dollar for dollar, the quantity of the notes issued, and these bonds have to be deposited with the treasurer of the United States as secur- ity for the redemption of the notes. (3) Each bank must main- tain in the United States treasury a redemption fund in " lawful money " equal to 5 per cent of its note issue. As this last re- quirement indicates, bank notes are redeemable at the federal treasury. They may also be used in all payments to the govern- ment except customs duties, although they are not legal tender. The Reserve System. — While the note holder is thus pro- tected by a special kind of security set aside for the purpose, the depositor in a national bank is protected only by its general assets. These, however, are regulated to some extent by the federal government. There are restrictions, for example, in- tended to prevent the bank from tying up its funds in long-time investments, from lending too much to one person or firm, or to directors or officers of the banks. Five times a year national banks have to furnish full statements of their . condition to the comptroller of the currency at Washington. Each bank is also examined twice a year, without notice, by federal bank examiners. But the most important requirement relates to the money re- serves that must be held by national banks. Until the Federal Reserve Act was passed in 1913, banks in " central reserve cities " (New York, Chicago, and St. Louis) were required to maintain a " lawful money reserve " ^ equal to at least 25 per cent of their deposits. Banks in other " reserve cities " (in- cluding at present about fifty cities) were also required to main- tain 25 per cent reserves, but their deposits in the national banks of the central reserve cities might be counted for one half of this amount. In all other places the banks were required to hold a 15 per cent reserve, three fifths of which might consist of de- posit accounts in banks in central reserve cities or other reserve 1 Including all kinds of United States money except minor coins and bank notes. CREDIT AND BANKING 293 cities. In all cases the funds kept by the banks with the United States treasurer for the redemption of their notes were counted as part of their legal reserves. The New York Money Market. — Under the operations of this system the cash reserves of the national banks were centered in New York. This appears clearly in Table I, which shows that on the date specified (which may be taken as fairly representa- tive of conditions in recent years) more than a third of the cash reserves of the 6544 national banks in the United States were in TABLE I Deposits and Reserves of National Banks: August 22, 1907^ No. OF Banks Deposits 2 Reserve Classification of Reserve Location 1 Lawful money in bank 2 Due from reserve agents 2 rt .2 New York . . . 38 825.7 221.3 26.8 218.8 — 2.6 Chicago .... 14 262.9 66.6 25-3 66.1 — 0-5 St. Louis .... 8 116.8 27.6 23.6 26.8 — 0.7 Other reserve cities 306 1423.4 362.3 25-5 190.3 165-7 6.3 Country banks . . 6178 2627.2 443-5 16.9 199.6 226.7 17.2 Total .... 6544 5256.1 1 1 21. 4 21.3 701.6 392-4 27-3 the vaults of thirty-eight New York banks.'* These figures do not, however, convey an adequate idea of the national impor- tance of the New York bank reserves. New York is the great wholesale market for foreign exchange, the chief center of gold movements to and from Europe, the principal importing and exporting center for commodities, — in short, the chief market place of the continent and the focus of financial operations. All state banks, private banks, and trust companies of importance find it to their advantage to maintain deposit accounts in New 1 Compiled from Report of the Comptroller of the Currency, IQ07, pp. 222-224. 2 Millions of dollars. ' Per cent. ■• The bulk of the deposits of out of town banks was in from twelve to twenty banks which have made a specialty of this kind of business. 294 OUTLINES OF ECONOMICS York, both for their own use, and in order that they may supply New York exchange to their customers. Even the deposit ac- counts of national banks in New York were in the aggregate considerably larger than the amount they were allowed to count as part of their reserves. All together the deposits of other banks have usually consti- tuted more than half of the aggregate deposits in New York national banks. Moreover, something very much like this re- serve system existed (and still exists) among other than na- tional banks, the banks in smaller places keeping deposits in national or other banks in larger cities, which in turn keep de- posits in New York. The trust companies, and some of the state banks/ keep in general very much smaller reserves in their own vaults than are required of national banks, — a fact which made the strain on the New York bank reserves all the greater. Like an inverted pyramid upon its apex, the great structure of bank credit in the United States has rested, in large measure, upon the money reserves of the New York banks. Every im- portant change in the demand for money or credit in any part of the country has had an effect on the New York money market ; similarly, every important disturbance in the New York money market has affected financial conditions throughout the country. The central reserve system effects a great economy in the use of money, and, what is more important, it mobilizes the cash resources of the country 'in such a way that variations in the local supply of bank credit in different regions resulting from differ- ences in the local supply of money available for bank reserves are minimized. It seems to be a natural and necessary feature of modern banking, for something like it is found in all the lead- ing commercial nations. But in the United States the central reserve system has worked badly. This has been attributable in part to other defects in our national banking laws and in part to some unfortunate features of the reserve system itself. Specifi- cally, the principal sources of difficulty have been the following : 1 Savings banks keep reserves that average for the United States only four fifths of one per cent of their deposits. On account of the nature of their business, which is not banking in the commercial sense, they are a negligible factor in this connection. CREDIT AND BANKING 295 (i) the dominance of speculative influences in the New York money market ; (2) the independent treasury system ; (3) the lack of elasticity in our bank note issues ; (4) the rigidity of our legal reserve requirements ; (5) the absence of any one central authority, responsible for the custody and maintenance of the central reserves. We now proceed to the discussion of these matters. Speculation and the New York Money Market. — As Table II shows, a large proportion of the loans of New York banks have not been based on " commercial paper " ; that is, on the notes and bills of exchange that arise in the ordinary course of business, but have been either time loans on collateral security or demand loans, nearly all of which are secured by collateral. Most of these collateral securities are the stocks and bonds of corpora- TABLE II Loans and Discounts of New York National Banks on Specified Dates ^ (In millions of dollars) Character of Loan 1890 1901 1906 1912 On demand 102 43 152 279 129 203 303 149 249 344 223 391 On time, with collateral security On time, without collateral security tions, and the loans, especially the demand or " call " loans, are used for the greater part in financing speculation in such securi- ties. This system has been partly responsible for the excessive and useless expansion of speculation over and above the amount that is necessary to secure the best results for the economic in- terests of the country. Here we are concerned, however, with its effects on the money market. The supply of call loans depends primarily on the amount of the surplus reserves of New York banks ; that is, the excess of the reserves over and above the legal minimum percentage of ^ Compiled from Reports of the Comptroller of the Currency. /■ 296 OUTLINES qt ECONOMICS the amount of their deposits. If the weekly statement of the clearing house banks shows a relatively large surplus reserve, this means that the banks can safely expand their loans, and the knowledge of this fact has a stimulating effect on speculation. If, however, the surplus reserve is low, the banks are bound to restrict their loans of all kinds and to " call " some of their de- mand loans. When the reserve is below the legal limit, demand loans have to be called in large quantities in order to enable the banks to meet pressing demands for credit on the part of their regular customers. The precipitate calling of demand loans by some banks simply increases the demand for credit at other banks, which in turn have to curtail their loans. Such a condition of the money market leads to a depression in the price of speculative securities, which is increased by the forced sales of securities in order to obtain the money funds that had pre- viously been lent on them ; the fall in the prices of securities leads brokers to demand more " margins " from the customers for whom they have bought securities, and it leads the banks to demand more securities as collateraf for their outstanding loans. Under such conditions the interest rate on call loans has some- times gone as high as 125 per cent, or even higher.^ If the ruling prices of speculative securities have been higher than industrial conditions would warrant, such a disturbance of the money market is apt to be long continued, and might easily develop into a general financial crisis. The call loan market is essentially speculative, and it is unfortunate that the condition of the supply of credit for the normal commercial needs of the country should have been periodically unsettled on ac- count of this fact. In no other great money center of the world 1 That is, the rate on what may be called ^marginal call loans, effected at the stock exchange by bankers' agents, or by individuals or corporations. Many banks continue to make call loans to their regular customers at such times at rates not exceeding 6 per cent. Under normal conditions the rate on call loans is lower than the rate on time loans. For the period 1901-1906 the bank rate on call loans averaged 5.;^ per cent as against an average rate of about 4.5. per cent on time loans. Excessive variability is the chief characteristic of the call loan rate. Cf. W. A. Scott, "Rates on the New York Money Market," Journal of Political Econ- omy, vol. xvi, pp. 273-29S. CREDIT AND BANKING 297 do call loans occupy the important place that they do in New- York. The Independent Treasury System. — The United States government has for many years been to a very large extent its own banker. It has kept its own money in its own strong boxes, quite after the fashion of a medieval monarch. The strong boxes in this case have been, however, the vaults of the treasury in Washington and of nine subtreasuries located in important cities. Apart from the fact that the government revenue and the government expenditures are naturally not distributed evenly throughout the year, the government has the further difficulty that a close balance of revenues and expenditures for any given year must be wholly accidental. Even if the federal budget were carefully and scientifically constructed, as it is not, the public revenues would be liable to uncertain fluctuations, — a result in part of the importance of customs receipts among them. The government, furthermore, receives a large part of its income in money, not in bank credit instruments. When a surplus accumulates in the government treasury, that much money is taken out of circulation. This reduces bank reserves, and contracts the amount of bank credit available. And it usually happens that the government revenues are largest when business is most prosperous, and when, consequently, maximum bank reserves are needed. The government is permitted, however, by the national bank act of 1863 to deposit money in selected national banks. Some secretaries of the treasury have made little use of this privilege, but in recent years such deposits have become more common. Until 1902 banks had always been required to deposit government bonds with the federal treasury as security for federal deposits, but in that year and again in 1906 Secretary Shaw offered to accept approved state and municipal bonds in lieu of a certain amount of government bonds, on condi- tion that the latter should be immediately used as security for increased note issues. Subsequently the banks have also been permitted to use "prime commercial paper," endorsed by the banks, as collateral. In 1897 only 168 banks were government depositories. In 1914 there were 1584, which held on June 30 of that year about half of the $170,000,000 constitut- ing the government's cash surplus at that date. Part of this increase is 298 OUTLINES OF ECONOMICS attributable to the effect of a law enacted in 1907 allowing customs receipts to be deposited in banks. Prior to this deposits could only be made from the proceeds of internal revenue duties and miscellaneous receipts. In recent years the banks have been required to pay 2 per cent interest on govern- ment deposits. The government has, on several occasions, come to the rescue of the banks by cash purchases of its own bonds. The dechne in the market price of government bonds in periods of financial stringency makes the purchases relatively advantageous to the government. The periodic shifting of govern- ment deposits to localities where money is most needed, the temporary de- posit of gold in New York banks equal in amount to their engagements of gold for transportation from Europe, and even the arbitrary withdrawal of government money from the banks when it was "not needed," in order that it might not be made the basis of speculative activities but kept until it "was needed," have been notable features of the recent relations of the treasury and the money market. In favor of this system it may be said that a surplus in the government treasury constitutes a real cash reserve, the wise use of which by the Secre- tary of the Treasury might avert a serious crisis. But there are dangers in intrusting so much financial power to one man. If used without discretion it is bound to do more harm than good. Moreover, these treasury operations have not always been free from the suspicion of favoritism to certain banks. Then, too, the knowledge that the government surplus will, in time of necessity, be put at their disposal tends to encourage unsound banking by relieving the banks of the proper responsibility for the maintenance of their own reserves. Finally, it should be noted, the use of the independent treasury system has prevented the government from securing for itself any large measure of the various economies and advantages that business firms find in keep- ing bank accounts. The Movement of Money. — The demand for loanable funds (rights to receive money on demand) varies locally, according to the business conditions that exist in different parts of the country. These differences make loans worth more in some lo- calities than in others, and result in some shifting of bank credit. New York banks, for example, sometimes invest in " out of town " commercial paper when this is more profitable than employing their funds at home. More frequently, interior banks place loans in New York, either through their correspond- ent banks there, or by the purchase of securities from note brokers. This shifting of credit, however, is unimportant as CREDIT AND BANKING 299 compared with the movement of money itself. Money is con- tinually flowing from New York to the interior and from the interior to New York, according as it can be more profitably em- ployed in bank reserves in one place or the other. Similar move- ments take place between the various cities of the country. This movement, it will be noted, is not one that is apt to disturb financial conditions. On the contrary, it tends to prevent ex- treme local fluctuations in money market conditions by leading to the expansion of credit where it is most needed, and similarly, to the contraction of credit where it is least needed. There is another kind of money movement, however, which is not so fortunate in its effects upon the money market. This is the movement of money out of bank reserves into general cir- culation and out of general circulation into bank reserves. The amount of money needed as an actual hand-to-hand medium of exchange varies for different seasons and for different localities. The demand for money to serve as the basis of credit in bank reserves and the demand for money as an actual medium of ex- change are different and competing demands. When more money is needed as a medium of exchange, reserves have to yield and credit has to be contracted. The most important movement of this sort is in response to the annual demand for money to be used in " moving the crops." Harvest expenses are very largely wages, and these have to be paid in cash. Many farmers, moreover, insist on receiving money payments when they sell their crops. The cotton crop of the South and the grain crop of the West annually necessitate the conversion of bank deposits in those regions into money, and the negotiation of loans on the security of the crops, the proceeds of which are also largely taken in cash. The banks in these sec- tions of the country in turn secure money from the banks in which they have deposits, and in large part this money is obtained directly and indirectly from the New York bank reserves. The movement of money from New York to the South and West usually commences in August of each year and continues through November, when the return movement sets in, continuing usu- ally till February. Despite the fact that the New York bankers 300 OUTLINES OF ECONOMICS are forewarned of this movement, it always reduces their surplus reserves and leads to stringent and sometimes precarious condi- tions in the New York money market, — conditions which are frequently reflected in difficulties in the money market through- out the country. To the arbitrary flow of money to and from the treasury, and to its movement to and from bank reserves and hand-to-hand circulation, there must be added the movement of gold between this and other countries. This will be discussed in another place; it is sufficient to note at this point that this external money movement is at the same time a cause and an effect of changing money market conditions. Inelastic Currency. — That these money movements have af- fected the supply of bank credit as they have is partly at- tributable to the inelastic character of our bond-secured bank currency. Under the provisions of the national banking law that have been described, the variations in the amount of bank notes outstanding have borne a close relation to variations in the price of government bonds, — and these variations are affected by many other things than money market conditions, and in re- cent years have been very small. As will be seen in Table III, the creation of the two per cent bonds, payable in 1930, stimulated the issue of bank notes, be- cause the federal tax is only one fourth of one per cent semi- annually on bank notes secured by two per cent bonds as against one half of one per cent on notes secured by bonds paying a higher rate of interest. The relative stability of the amount issued in recent years has been noticeable, what increase there was being a natural result of the increasing number and size of banks. Nor has the amount of note issue responded in any marked degree to the regular seasonal demands for money to move the crops or to the less regular operations of the treasury department or of the foreign exchanges. Students of banking problems have for many years thought that the national banks should have been permitted to issue part, if not all, of their notes on the security of their general assets, thus placing them on the same basis as deposits. It is CREDIT AND BANKING 301 TABLE III ' Amounts of Bank Note Circulation Secured by Specified Classes OF Bonds: 1900-1915^ Secxjrity March 13, 1900 Oct. 31, 1903 Oct. 31, 191S Loan 1908, 3's Loan 1907, 4's Loan 1925, 4's Loan 1904, s's Loan 1891, 2's Consols 1930, 2's Panama Canal, 2 's $56,164,820 130,302,250 14,697,850 21,996,350 20,490,150 $1,797,580 2,797,200 1,410,100 718,650 376,003,300 $20,377,720 32,304,800 600,678,600 81,614,420 Total . . $243,651,420 $382,726,830 $734,975,540 clear that if this had been done any sudden increase in the de- mand for money as a circulating medium might have been met by exchanging bank credit in the form of bank notes for per- sonal credit, or by the shifting of bank credit from the form of deposits to the form of note issues. " Asset banking," as this is called, is used in Canada, and enables the banks there to fur- nish money for crop moving purposes without endangering their reserves. Most of the great national banks of continental Europe also issue notes on the security of their general assets. Under such a system, it is clear, the supply of bank notes can expand automatically with an increase in the supply of personal credit in the form of discountable notes and bills of exchange, in just the way that bank deposits expand. To achieve real elasticity, however, it is necessary to provide for the ready contraction of note issues when the special demand for money is over as well as to provide for their ready expansion in time of need. Inelastic Reserves. — Under our national banking law, banks have to stop lending when their reserves fall below the legal minimum. The central reserves in New York have accordingly 1 From Reports of the Comptroller of the Currency, Finance Reports, 1907, p. 390 ; 1915, P- 571- 302 OUTLINES OF ECONOMICS been real reserves only in the sense that they have made it pos- sible for the banks to meet extraordinary demands for ready cash. So far as the extension of credit is concerned they have constituted, not a reserve, but a dead line.^ This has often had serious consequences. It is a well-tested principle of sound banking practice that about the worst thing that can happen when bank reserves are low is for the banks to stop lending. Business men, otherwise solvent, are not able to secure bank credit, and so cannot meet their own obligations or exchange their claims against their debtors for bank credit. Forced sales result ; the prices of securities and other forms of property fall ; the banks " call " their demand loans or ask for larger deposits of collateral securities ; more sales are forced, and the pressure on the banks for loans increases. In short, a general money market panic may come from suddenly curtailing loans at a time when bank reserves are relatively low. The wiser banking policy is to lend freely on good security, but at in- creased interest rates, thus automatically restricting loans to the more necessitous borrowers. The Bank of England, for example, permits its reserves to fluctuate between very wide limits, and often protects them against possible depletion by reason of withdrawals of gold to other countries by the simple process of raising its discount rate. Since the official Bank of England rate governs the general " open market rate " at which London banks discount commercial paper,^ the effect is not only that the amount of do- mestic borrowing is decreased, but also that the quantity of for- eign bills of exchange (normally bought in large quantities by London banks) sent to London for discount is decreased. Then, 1 In practice the law has not been rigidly enforced, a warning from the Comptroller of the Currency being generally the only penalty exacted for a small temporary deficit in the reserves. Nevertheless, the New York bank reserves have not often fallen more than one or two points below the legal minimum. 2 Sometimes, in order to make its increased rate "effective" in the London money market, the Bank borrows money or sells securities so as to decrease the available supply of loanable funds in the market, thus compelling the other London banks to increase their discount rate. Another device often used by the Bank in protecting its reserves is that of slightly increasing the price at which it buys gold. CREDIT AND BANKING 303 as the foreign bills already held in London mature into rights to demand money from other money markets, these offset claims of other money markets against London which would otherwise have to be paid by shipping gold. Absence of Centralized Control. — It may have occurred to the reader that some elasticity might have been given to bank reserves in the United States if the banks holding the central reserves had made it their practice normally to hold reserves considerably larger than the minimum required by law, — re- serves equal to 40 or 50 per cent of their deposits, for example. This would have given a margin sufi&cient to enable them to meet withdrawals of gold for domestic use or for export without suddenly contracting the supply of loanable funds. All this is undoubtedly true, but it must not be supposed that such a policy could voluntarily have been followed by the New York banks. The difficulty was that the banks holding the central reserves were merely large commercial banks, interested pri- marily in securing maximum profits for their own stockholders, and with no one of them individually responsible for the main- tenance of adequate surplus reserves. For any one bank to have attempted to remedy the situation would have helped but little. It would only have put itself at a disadvantage as compared with its competitors. And then there were other factors in the situation that helped to keep the reserves pared down to a minimum. It is not economical for country banks to hold a much larger amount of actual money on hand than they need to comply with the law. Moreover, the New York banks, competing with one another for the deposits of other banks, pay 2 per cent interest on such deposits. In recent years about half of the aggregate amount of lawful money in the possession of the national banks of the country has been in the vaults of New York banks. WHat surplus reserves were created from time to time by importations of gold, by the transfer of money from the subtreasuries, by the reduction in the amount of money in hand-to-hand circulation, or by a contraction in the total volume of bank deposits, speedily found their way to the New York banks. And the New York banks speedily found ways of 304 OUTLINES OF ECONOMICS utilizing the additional lending-power created by these surplus reserves. Stock exchange speculation, in particular, could generally be depended upon to absorb in the form of call loans a large part of the increased amount of available bank credit. In short, the operation of the system was such as continually to keep the ratio of reserves to deposits as close to the legal minimum as possible. Any " slack " that might appear was quickly taken up. These rigid and inelastic reserves were undoubtedly the worst features of our banking system. With more elastic reserves the evils of the independent treasury system and of inelastic cur- rency would not have been so great. Money could have flowed into reserves and out of them without often bringing conse- quences more serious than fluctuations in discount rates. Steps toward Reform. — The national banking system has in some particulars been highly successful. National, bank notes have always been thoroughly sound, and depositors, too, have been well protected, for failures of national banks have been relatively few. The high standards which the national banking system has set have had a marked influence upon the betterment of state banking laws and upon their enforce- ment. But the defects which have just been discussed made it both inadequate and, in its larger aspects, unsafe. Students of banking problems had for many years urged the need of re- form. Some advocated the establishment of a central hank, of the type that is found in almost every country of Europe. These banks hold the central banking reserves of their respec- tive countries, hold the government deposits, have (usually) a monopoly of bank note issue, and are subject to a special meas- ure of government control. But ever since the days of the Second Bank of the United States the establishment of a central bank in this country has probably been politically impossible. ^ iThe United States Bank (1791-1811) and the Second Bank of the United States (1816-1836) were large institutions, with numerous branches. But although they issued notes and held the treasury funds, they were not "central banks" in the modern sense. They did not have a monopoly of note issue, for state banks also issued notes, nor did they hold central banking reserves. In each case Congress re- fused to recharter the bank at the expiration of its original twenty-year charter. CREDIT AND BANKING 305 More interest has been aroused, however, in the matter of elastic currency, and various plans for permitting national banks to issue notes secured only by their general assets have from time to time been embodied in bills introduced in Congress. But Congress, the business men of the country, and, it must be said, , the bankers themselves, were for the most part apathetic. V***^ General interest in the matter was finally aroused by the panic of 1907, in which the worst features of our banking system stood out in clear relief. Banks throughout the country found them- selves unable to meet the large and increasing withdrawals of money by their depositors and were unable in turn to get money from the banks in New York and the other central reserve cities in which they themselves had deposits. The payment of money to depositors had to be suspended or restricted, and many banks with perfectly sound assets found themselves, for the time being, technically insolvent. Money was at a premium. Clearing-house loan certificates — virtually joint obligations of the banks associated in the clearing house, issued to individual member banks upon the deposit of adequate security — were used (as in former panics) in the payment of clearing-house balances. In many cities the clearing-house loan certificates were issued in small denominations and got into general circula- tion by being paid to depositors in lieu of money. Cashier's checks and other credit instruments were also used as money. The total amount of improvised currency issued during the panic is estimated to have been over $500,000,000.^ The whole situation was such as to impress upon thoughtful men the im- perative need of banking reform. The first tangible result was the so-called Aldrich-Vreeland Act of 1908, which made temporary provision for such emer- In each case, also, this occurred when the country was temporarily under the domi- nance of a strong democratic sentiment opposed to pohtical or financial centraliza- tion in any form. Jealousy on the part of state banks was, however, the immediate cause of the demise of the first United States Bank, while the second succumbed to the yet more potent hostiUty of Andrew Jackson. 1 A. P. Andrew, "Substitutes for Cash in the Panic of 1907," Quarterly Journal oj Economics, Vol. xxii, p. 515. For an excellent account of the general situation at the time see O. M. W. Sprague, History of Crises under the National Banking System, Chap. V. X 3o6 OUTLINES OF ECONOMICS gencies as that of 1907 by permitting national banks to issue notes, under a heavy tax, upon other security than government bonds. The methods utilized were, in part, those which had been developed by the banks themselves in issuing clearing- house certificates. Under this measure banks might increase their note issues in one or both of two ways. First, on the security of approved state, county, or mimicipal bonds deposited with the Treasurer at Washington. Second, on the security of bonds of the kinds just mentioned, of corporation bonds, or of commer- cial paper, deposited with "National Currency Associations," which last were voluntary organizations, modeled upon clearing-house associations, although provision was made for their organization in country districts. These issues were limited in amount and were to be taxed at the very heavy rate of 5 per cent for the first month and i per cent for each additional month up to a maximum of 10 per cent. The act, it is evident, did not provide for a really elastic currency, varying with business needs, but only for an emergency currency. In 1913 the rate of taxation was reduced to 3 per cent for the first month, with a maximum of 6 per cent. For several years no notes were issued under this statute, but in 1914 the outbreak of the European war led to large shipments of gold to Europe and to a small-sized panic in the money market. The issue of emergency cur- rency possibly averted a more serious panic. Altogether, emergency notes to the amount of $386,000,000 were issued by 1363 different banks. All of these had been retired before the Act expired, by limitation, on June 30, 1915- The Aldrich-Vreeland Act also created a National Monetary Commission, composed of senators and congressmen, to devise a plan for the general revision of the banking system. The plan recommended by this commission was one sponsored by Senator N. W. Aldrich of Rhode Island. It provided for a hierarchical organization of the banks of the country, with a central bank, the " National Reserve Association," at the top. Banks were to be grouped into local reserve associations, with functions not unlike those of the national currency associations of the Aldrich- Vreeland Act. The whole system was to be controlled by the banks rather than by the government. The widespread dis- cussion of the Aldrich plan undoubtedly did much to awaken interest in the problem and to. make the adoption of the federal reserve system possible. CREDIT AND BANKING 307 The Federal Reserve System. — A revolutionary change in the banking system of the United States was brought about by the Federal Reserve Act of 1913. Under the provisions of this act the country has been divided into twelve districts and a cen- tral bank, named a Federal Reserve Bank, has been established in each district.^ The system is under the general supervision and control of the government. At its head is the Federal Re- serve Board, comprising five members appointed by the Presi- dent, together with the Secretary of the Treasury and the Comp- troller of the Currency. The stock of the various federal re- serve banks is owned by local banks in the respective districts, called " member banks." National banks were required to be- come member banks, while state banks and trust companies are permitted to become member banks, provided they comply with certain standards imposed upon national banks by the na- tional banking law and with other requirements set by the Fed- eral Reserve Board. Each member bank subscribes to the stock of the federal reserve bank in an amount equal to 6 per cent of its own capital and surplus. Half of this must be paid for, and the other half remains subject to call. Any earnings of the federal reserve banks over a 6 per cent dividend to their member banks go, first, to accumulate a surplus equal to 40 per cent of the paid up capital stock, and, beyond that, to the United States Treasury. Each federal reserve bank is governed by a board of nine directors, six being elected by the member banks, and three appointed by the Federal Reserve Board. Relations of Federal Reserve Banks and Member Banks. — The federal reserve banks are " bankers' banks " ; that is, they do not accept the deposits of individuals nor do they lend directly to individuals. Their most important relations are with their member banks, and these may be summarized under the heads of (i) reserves, (2) rediscoimts, and (3) note issues. I. The federal reserve banks hold the central reserves of the 1 The twelve federal reserve banks are located at New York, Boston, Philadelphia, Richmond, Atlanta, Cleveland, Chicago, MinneapoUs, St. Louis, Kansas City, Dallas, and San Francisco. The Atlanta bank has a branch at New Orleans (with a special district assigned to it) and other branches may be estabUshed. 3o8 OUTLINES OF ECONOMICS system. Three, years are allowed for the gradual transfer of reserves from the banks which have held them in the past. After that period the requirements are as follows: A member bank may count as reserve only (i) money in its own vaults and (2) deposit credits with the federal reserve bank. Member banks in central reserve cities must maintain reserves equal to 18 per cent of their demand liabilities, of which at least one third must be money in their own vaults and at least seven eighteenths deposits in the federal reserve bank. In other re- serve cities member banks must maintain 15 per cent reserves, of which at least one third must be in their own vaults, and at least six fifteenths must be a federal reserve bank deposit. Banks in other cities or rural districts must keep 1 2 per cent reserves ; at least one third in their own vaults and at least five twelfths in the federal reserve bank. The federal banks, in turn, have to keep minimum reserves of 35 per cent of their deposits. . These provisions for minimum reserves of definite size must be interpreted as being, in part at least, a concession to American habits and prejudices. But the Federal Reserve Board is authorized to suspend temporarily any of these reserve require- ments, imposing a graduated tax upon the amounts by which the reserves fall below the stated minimum limit. It is to be expected, moreover, that the federal reserve banks will normally hold reserves much larger than those required by law. This in itself will introduce a large measure of elasticity into the situa- tion. 2. Rediscounting means the purchase by one bank of notes and bills of exchange held by another, the purchasing bank being protected by the selling bank's endorsement of the discounted paper. Rediscounting has not been a common feature of Ameri- can banking practice, and there has even been a distinct prejudice against it, although it is very common in Europe. The new law makes it an essential part of the federal reserve system. Federal reserve banks may rediscount (for their member banks) short- time notes and bills of exchange " issued or drawn for agricul- tural, industrial, or commercial purposes," and conforming to certain specifications which have been carefully formulated CREDIT AND BANKING 309 by the Federal Reserve Board. The privilege X)f rediscount is not extended to notes and bills of exchange issued " for the purpose of carrying or trading in stocks, bonds, or other invest- ment securities, except bonds and notes of the United States." The purpose of this restriction is not only to prevent the resources of the federal reserve banks from being used to finance specula- tion, but also to limit their rediscounts to so-called " self-liqui- dating paper," that is, to notes and bills of exchange held against loans which the borrowers will, in the ordinary course of business, be able to repay from the proceeds of the sales of the goods pro- duced or purchased with the aid of the borrowed funds. ' The most important general advantage of this new redis- counting system is the help it will give in the development of a thoroughly elastic supply of deposit credit, expanding and con- tracting with the number and magnitude of business transac- tions. When, for example, the reserves of certain member banks are too low to permit them to advance deposit credits to their customers in the desired quantities upon even the sound- est instruments of personal credit, they may replenish their reserves by sending part of their holdings of bills and notes to the federal reserve banks for rediscount. In order to equalize the supply of bank credit in different parts of the country the Fed- eral Reserve Board may permit and even require certain federal reserve banks to rediscount commercial paper for other federal reserve banks. The Federal Reserve Board also has general supervising power over the whole rediscounting system, includ- ing power to revise the rediscount rates of the different federal reserve banks. 3. Under the new system, national banks may still continue to issue notes, as in the past, if they wish. The existing national bank notes, constituting about one fifth of the aggregate amount of money in the country, could not be suddenly withdrawn from circulation without serious consequences. But the Federal Reserve Act provides that the national banks may gradually get rid of their note-issue liabilities by selling the government bonds they hold as security for their notes to the federal reserve banks at par. The federal reserve banks, if they wish, may 3IO OUTLINES OF ECONOMICS utilize these bonds as security for the issue of federal reserve bank notes, which in all essentials are like national bank notes. The extent to which national banks will give up their note issues will depend very largely upon the price of government bonds. More important, however, are federal reserve notes, issued by the federal reserve banks (i) in exchange for gold, thus becoming virtually gold certificates, and (2) upon the security of redis- counted paper held by them. A 100 per cent reserve is held against notes issued in exchange for gold ; a 40 per cent reserve has to be held against notes issued on the security of rediscounted paper. This last reserve requirement may, in emergency, be waived by permission of the Federal Reserve Board, a graduated tax being imposed upon deficiencies in the reserve. This makes it possible, it will be seen, for member banks to secure currency for their own borrowers and depositors by sending paper to the federal reserve banks to be rediscounted, taking the proceeds of such rediscounts in federal reserve notes. This means that when the country needs more money for hand-to-hand circula- tion it can get it by exchanging personal credit instruments for federal reserve notes. Bank credit in the form of bank notes can now be expanded quite as readily as bank credit in the form of deposits. But it is not yet certain that an adequate mecha- nism has been provided for the speedy contraction of the note issue when the special needs that called for its expansion have passed. Federal reserve notes are redeemable at the issuing banks and (out of a redemption fund maintained by the banks) at the treas- ury in Washington, and no federal reserve bank which has re- ceived the notes of another federal reserve bank is permitted to pay them out, but must return them promptly to the issuing bank " for credit or redemption." Much depends then, so far as contraction is concerned, upon the rapidity with which federal reserve notes find their way back to some federal reserve bank.. Other Functions of the Federal Reserve Banks. — In addition to being " bankers' banks," the federal reserve banks, it is expected, will be bankers for the federal government. They may, under the law, be used as depositories for all the general funds of the government and may serve as " fiscal agents " of CREDIT AND BANKING 311 the government in various treasury operations. This will make it possible for the government to use modern and economical methods in caring for its receipts and making its payments, and should also prove of advantage in its borrowing. The federal reserve banks are also empowered to buy, sell, and borrow gold coin and bullion, the securities of the federal govern- ment, and the warrants and other short-time obligations of states and municipalities. They may also buy and sell bills of exchange arising out of either foreign or domestic trade. This last power enables them, in case of need, to come to the relief of banks not members of the system. Buying bills of exchange from other banks differs from " rediscounting " only in that in the latter process the bills to be rediscounted are normally and usually exchanged for deposit credits or bank notes. Under the law, federal reserve notes cannot be issued upon the security of " pur- chased " paper, but only upon paper " rediscounted " for member banks, nor can federal reserve banks give deposit credit to banks not in the system. This means that since " purchases " will usually involve a direct drain upon the reserves of the federal banks, their power of " purchase " is much more restricted than their power of " rediscount." But there is a yet more important aspect of these authorized " open-market operations " in commercial paper. Only through the use of this power can the federal reserve banks hope to make their discount rates " effective " in the money market. Only in this way can they expect to " put on the brakes " when they think that bank credit is being expanded with dangerous rapidity or encourage free lending on the part of the banks when condi- tions are such as to make that policy seem desirable. Only in this way, moreover, can they protect their gold reserves by the use of devices similar to those which the Bank of England and other European banks have found effective. The existence of an " open market " for commercial paper means merely that commercial paper, instead of being held till maturity by the bank first discounting it, may be bought and sold freely, and may move from one city to another and even from one country to another, according to differences in prevailing discount rates. 312 OUTLINES OF ECONOMICS In the United States open market operations of this kind are not yet of sufficient magnitude to give the federal reserve banks any large opportunity for exerting their influence. They are con- sequently endeavoring to stimulate the growth of open-market operations. The federal reserve system has been very carefully devised for the purpose of getting rid of the principal evils inherent in the national banking system as it was. If given a thorough and fair test, it should accomplish that purpose. There is some danger that the new system may make possible a too easy and too rapid expansion of bank credit in periods of business pros- perity, ending perhaps in reaction and crisis. But this danger is inseparable from any really elastic system of bank credit. With a wise exercise of the powers which the Federal Reserve Board has over discount rates and reserves, the alternations of periods of business prosperity and periods of business depression should be less frequent and less violent than in the past, f' The most formidable obstacle to the success of the federal reserve system now apparent is the possible lack of cordial cooperation on the part of the banks — especially the smaller banks — of the country. Very few state banks and trust companies have become member banks, while a few member banks have given up their national bank charters and have withdrawn from the system. Despite the fact that the Federal Reserve Act modified the na- tional banking law by permitting national banks to engage in various kinds of banking operations which had previously been prohibited, some of the bankers feel that membership in the system decreases their banking profits. Member banks no longer get interest on their reserve deposits (although this is compensated for, at least in part, by the reduction in the size of the required reserves) and, if they utilize the federal reserve banks as clearing and collection agencies for checks drawn upon other banks in the system, they lose some of the profits from certain charges that had previously been made for collections and exchange. The advantages of the system to in- dividual banks will appear most clearly at time of crisis. But lessons of periods like that of igoy are soon forgotten. The greatest advantages of the system, however, are its effects upon the commercial interests of the country as a whole. A particular banker may feel that he can share in many of the general advantages of the system without membership in it. It is to be hoped that this absence of a sense of individual responsibility for the general banking situation may not develop so far as to prevent the fed- eral reserve system from attaining its maximum usefulness. CREDIT AND BANKING 3T^3 TABLE IV Combined Resources and Liabilities of the Federal Reserve Banks: July 21, 19161 (In thousands of dollars) Resources Liabilities Total reserve . . . . . 377,343 Capital paid in . . . 55,183 Five per cent redemption Government deposits . 54,277 fund against federal re- Member bank deposits . 492,000 serve bank notes . . . A 50 Federal reserve notes ^ . 10,120 Bills discounted for mem- Federal reserve bank bers 28,937 notes 1,692 Bills bought in open mar- Other liabilities . . . . . .251 ket 85,382 United States bonds . . 49,746 One-year treasury notes . 7,190 Municipal warrants . . 27,723 Federal reserve notes, net 20,014 Other resources .... 16,738 Total 613,523 Total 613,523 The Present Position of State and Private Banks. — The figures in Table V give only a partial idea of the present posi- tion of banking in the United States, for vi^hile they are com- plete as to national banks, there were, in 191 5, over 3000 other banks w^hich failed to make reports to the Comptroller of the Currency. "State banks," in the narrow sense, include only corporations chartered by the individual states to conduct a general commercial banking business. In a broader sense savings banks and trust companies incorporated under state law may be said to be state banks. 1 Compiled from statements in Federal Reserve Bulletin, Vol. ii, pp. 426, 427. 2 Federal reserve notes to the amount of $175,210,000 were outstanding at this date but a large porportion of these were covered by gold set aside for the purpose (and not included in the statement of resources) and others remained in the hands of issuing banks. The amount in circulation was $154,038,000. 314 OUTLINES OF ECONOMICS TABLE V Number of Banks and Amount of Deposits in Specified Kinds of Banks: 1915^ Number OF Banks Deposits 2 State banks Savings banks .... Private banks .... Loan and trust companies National banks . . . . Total 14,598 2,159 1,036 1,664 7,605 ?3, 277, 772,000 4,997,706,000 134,410,000 4,204,596,000 6,569,859,000 27,062 519,184,343,000 Savings banks do not usually do a commercial banking business ; that is, they are not engaged in the sale of bank credit in a form that can be used in making payments. Their deposit accounts are not usually transferable by means of checks. They receive deposits of small savings and invest them in long time securities, such as real estate mortgages and bonds of various sorts. They perform an important social service by stimulating saving and by increasing the financial power of small investors through concentrating and combining their resources. Savings banks are organized either as cor- porations or as mutual societies managed by a board of trustees acting for the depositors. The latter type is especially common in the eastern states. Trust companies were at first organized to take charge of trust funds and to act as executors and administrators of estates. They have, however, developed the functions of both savings banks and commercial banks, and have even entered such specialized banking fields as foreign exchange and the underwriting of corporation securities. They have thus the character of free lances in the banking field. Their banking functions have developed so rapidly that in many states they have been put under no such rigid control as is exercised over state and savings banks. Private banks are of two very distinct tj^es. Some are small unincor- porated banks in coimtry towns. Others are great concerns in the financial centers which deal in investment securities, buy and sell foreign exchange, finance great corporate undertakings, and, in some cases, act as brokers in the stock market. It is impossible, in fact, to draw a definite line between "banking" and 1 Compiled from Report of Comptroller of the Currency, Finance Report, 1915, pp. 533, SOS- 2 Exclusive of inter-bank deposits and postal-savings deposits. CREDIT AND BANKING 315 other financial undertakings. Building and loan associations, private money lenders, note brokers, dealers in investment securities, life insurance com- panies, etc., frequently perform fimctions which are very much Hke some kinds of "banking." But banking as the institution which converts per- sonal credit into bank credit in the form of deposit accounts and bank notes is a clearly defined thing, and has a distinct economic significance of its own. QUESTIONS 1. Explain the various items in the published "statement" of a na- tional bank. 2. Because a national bank can buy interest-bearing government bonds and use them as security for its own issues of paper money, advocates of government paper money issues have alleged that it gets "double interest on its money." Is this true? 3. How should one compare the profitableness of issuing notes with the profitableness of extending deposit credit? 4. What restrictions does your state impose on state banking corpora- tions? 5. Report on the note-issue systems of the Bank of England, the Bank of France, the Imperial Bank of Germany, and the Canadian banks. 6. Report upon the relative advantages of the promissory note and the bill of exchange as instruments of commercial credit. 7. Compare the provisions of the Aldrich plan with those of the federal reserve system. 8. Does the supply of bank credit involve the sacrifice of "waiting" on the part of anyone? Who are the real or ultimate lenders? 9. What are bank acceptances ? trade acceptances? commodity paper ? ID. Are bank notes more closely analogous to government paper money or to bank deposits? II. What points of superiority have bank notes over government paper money? REFERENCES (See also references for Chapter XIV.) Comptroller of the Currency. Annual Reports. CoNANT, C. A. History of Modern Banks of Issue. Conway, Thomas, and Patterson, E. M. The Operation of the New Bank Act. Dunbar, C. F. Chapters on the Theory and History of Banking. Federal Reserve Board. A nnual Reports ; Federal Reserve Bulletin (monthly) . HOLDSWORTH, J. T. Money and Banking. Knox, J. J. History of Banking in the United States. Laughlin, J. L. (editor). Banking Reform. 3l6 OUTLINES OF ECONOMICS National Monetary Commission. Publications. (A series of over forty mono- graphs by different authors, giving as a whole the best available history of banking in the United States and the best accounts in English of the banking institutions of other countries.) Pratt, S. S. The Work of Wall Street. Sumner, W. G. History of Banking in the United States. Willis, H. P. The Federal Reserve; American Banking. Withers, Hartley. The Meaning of Money. CHAPTER XVI OTHER PROBLEMS IN MONEY AND BANKING The Value of Money. — We have not as yet answered one very important question, and that is, " What determines the value of money? " Now by the " value of money " we mean the purchasing power of money as reported or expressed by the money prices of other things. There is no such thing in fact as " the general purchasing power of money," although we have found it convenient to use that and similar expressions. Money has, in reality, a large number of different values, ex- pressed by the different quantities of different things that it will purchase. If the price of wheat is one dollar per bushel, then one value — the wheat value — of money is a bushel per dollar. Similarly, the purchasing power of money in sirloin steaks may be four pounds per dollar. But how are we to blend sirloin steaks, wheat, and other things into one concept? The notion of the general value of money is simply a useful abstraction, based on a broad view of all its different specific values. When we fix our attention upon changes in the various pur- chasing powers of money, however, we are able to make a dis- tinction between changes that are widespread and general, and changes that affect only one or two commodities. For example, a new invention may decrease the price of a particular commodity, without affecting the prices of other things except (if the demand for the commodity is elastic) by shifting demand from other things to the commodity in question, — • an effect which would usually be slight so far as the price of any one of these other things is concerned, for the demand would very likely be shifted from many different lines of consumption. Or, if the demand for the commodity in question is relatively in- 317 3l8 OUTLINES OF ECONOMICS elastic, a diminution in its price may increase the demand for other things. But there are, on the other hand, price fluctua- tions which are widespread and which show a general trend in one direction or the other, and these we may call, with substan- tial accuracy, changes in the value of money. What are the underlying causes of these general changes in the values of money ? The Nature of the Problem. — Our first impulse, perhaps, is to suggest that there is no new problem here, that the value of money is to be determined in the way that other values are determined, and to seek to frame an explanation in terms of marginal utility and the genera.1 laws of supply and demand. But the task is not so simple as that. The analysis of marginal utility, it is true, formed the basis of our explanation of the shifting of demand from one commodity to another, but it does not help us to explain the demand for money, Marginal utility depends upon the capacity of things to satisfy human wants, and money does not directly satisfy a single human want, except the abnormal wants of the miser. We want money only as we want the things that money will buy for us. And when we turn to " supply and demand " we find at first little help. For, it will be remembered, when we were discuss- ing the relations between the prices of things and their supply and demand, we arbitrarily limited ourselves to the consider- ation of one commodity at a time. That is, we assumed that the money price of the one commodity we were considering was alone variable, and that the prices of all other things remained, for the time being, constant. The consumer whom we pictured as willing to buy a certain amount of a commodity at a certain price or a larger amount at a lower price, was, by our premises, merely comparing variable dollars' worths of the commodity in question with fixed dollars' worths of other things. All the values of money, save one, were held constant, so that the imaginary consumer simply had to equate the utility of larger and smaller marginal dollars' worths of the one commodity to their cost measured in a dollar that represented perfectly definite amounts of all other things. Now the problem of the OTHER PROBLEMS IN MONEY AND BANKING 319 value of money (understood as the problem of general changes in the different values of money) cannot be approached in that way. For the problem of the value of money is merely the obverse of the problem of the money values of all other things. If we were studying the wheat value of money we could assume the sirloin-steak value of money to be held constant. But our present problem is that of the wheat value of money and the sirloin-steak value of money and all other values of money. We can't resort to the strategy of breaking the sticks in our bundle one by one. The Quantity of Money and the Values of Money. — All this does not mean that there is no such thing as a '' demand for money." Using the word money in its broadest sense, including all " rights to receive money " that are used in mak- ing paymients, it is clear that every sale of a commodity may be viewed as a purchase of money, and every purchase of a commodity as a sale of money. Going a step farther, and remembering that one wants money only because of the things money will buy, we may say that every sale of one commodity is a purchase of the power of acquiring other things. A seller cares nothing about the quantity of money — the number of dollars — he gets in exchange for his goods, except in so far as these dollars have certain exchange relations with other things, including the things he buys as a consumer and the things he pays for under the head of " expenses of production." Simi- larly, a buyer cares not how much money he parts with in ex- change for a definite quantity of goods, except in so far as the money has alternative uses of greater or less importance. The quantity of money — the number of dollars in the aggregate supply of the instruments in which payments are made — has no significance apart from the values of the dollars. These two things — quantity and value — are in the case of money bound together in a peculiar way. They are, in a very real sense, not only interdependent but interchangeable. A small amount of money of high purchasing power per unit will meet the needs of both buyer and seller just as well as a larger amount of money of lower purchasing power per unit. 320 OUTLINES OF ECONOMICS What are the conditions under which a general change in the values of dollars is possible? Let us simplify the problem by- assuming that the change is absolutely general and uniform; that if, for example, the price of a bushel of wheat is seventy-five cents and the price of a bushel of corn is fifty cents, an increase in the price of wheat to a dollar and a half is accompanied by an increase in the price of corn to a dollar, and by a similar doubling of the money prices of all other commodities and services. Things retain, we shall assume, precisely the same exchange relations as before, except with reference to money. If prices have thus increased, all the values of money have di- minished by one half. As an intermediary, then, as a means of obtaining other things, money has only half its former potency. Sellers are demanding and receiving twice as many dollars as before for given quantities of goods ; buyers are offering and paying twice as many dollars as before per unit of goods pur- chased. Remembering now that we are using the word money in its broadest sense, including exchangeable credit instru- ments, it is evident that twice as much money as before passes from buyer to seller in exchange for every unit of everything else that passes from seller to buyer. But this means that one of two possible conditions must exist. Either (i) fewer exchanges are being made, or (2) exactly twice as much money as before is being exchanged for goods and services. So we reach the very important conclusion that there must be a definite relation between general changes in the values of money and changes in its quantity. We need not as yet con- cern ourselves with the question of which of these two related things is cause and which is effect. But that these two things are inseparably bound up, the one with the other, should now be clear. We may now state this principle in a somewhat broader form : // the number of units of goods and services of every sort annually exchanged for money remains constant, any increase or decrease in the amount of money used in making payments must he accompanied by an exactly proportionate general increase or decrease in prices. It is not necessary for the truth of this OTHER PROBLEMS IN MONEY AND BANKING 321 theorem that all prices should change in the same proportion. The general change in prices may, for example, be upward, but some prices may rise by a smaller proportion or may even fall, provided these are offset by sufSciently large increases in the prices of other things. An " exactly proportionate " general change in prices merely means such changes in specific prices as will make possible an unchanged volume of transac- tions with the increased or decreased number of dollars used in making payments. A general increase or decrease in price is of course identical with a general decrease or increase in the various specific values of money. The Equation of Exchange. — Some aspects of the general relation between prices and the quantity of money can be con- veniently represented by using algebraic symbols. Let M represent the total amount of money in circulation, and let V represent its rate of turnover, or velocity of circulation, that is, the average number of times the various dollars in circulation are exchanged for goods or services during the year. Then MV will represent total money payments, measured in money units. Let T represent the total volume of trade, or, more accurately expressed, the total number of units of commodities and services exchanged for money during the year. Finally, let P represent the average price per unit paid for these com- modities and services. The equation of exchange may now be stated in its simplest form : MV = PT. This equation, it is obvious, amounts to the statement that the quantity of money in circulation, multiplied by its average rate of turnover, is equal to the average price per unit paid for commodities and services, multiplied by the number of units sold. This, in turn, is equivalent to the yet simpler statement that the total amount of money paid for things during the year equals the sum of the prices of all the units purchased. Stated in this way, the equation of exchange is readily seen to be necessarily true. In fact, it is a truism, — an identity, almost, rather than an equation. But it is none the less significant, Y 32 2 OUTLINES OF ECONOMICS for the truism which it states is one which has very often been forgotten. Up to this point we have simphfied our problem by counting as " money " everything, including credit instruments, expressed in terms of dollars and accepted in payment for other things. But there are some important problems connected with the relation of changes in the quantity of the generally accepted media of exchange (money in the " narrower sense ") to changes in prices. So we shall now let M represent the quantity of the generally acceptable media of exchange, including metallic money, government paper money, and bank notes. The sym- bol M' will be used to represent the quantity of the trans- ferable " rights to demand money " that are used in making payments. These consist, almost entirely, of bank deposits subject to check. Then the equation of exchange becomes : MV + M'V' = PT. This is a statement in algebraic symbols of the fact that the amount of money in circulation, multiplied by its rate of turn- over, together with the amount of bank deposits subject to check, multiplied by their average rate of turnover, must be equal to average unit prices, multiplied by the number of units of things exchanged for money or for deposit credit. This equa- tion is identical with the other one, except that a distinction is now made between money and bank deposits. The principal advantage of the use of the equation of exchange, in fact, is that it enables us to discuss the relations between general changes in prices and changes in the amount of metallic and paper money without becoming involved in difficulties of analy- sis and of exposition that would otherwise be very formi- dable. The problem becomes simply that of the relations be- tween M and P in the equation of exchange. If M and M' increase in equal proportion, while V, V, and T remain fixed, P must also increase proportionally. That is, all other things being equal, an increase in the amount of money in circulation and in bank deposits must be accompanied by a proportionate increase in prices. To what extent, in fact, are OTHER PROBLEMS IN MONEY AND BANKING 323 these " other things " likely to remain equal? In the first place a sudden increase in the amount of money in circulation is very sure to increase T, the total volume of trade, by leading to increased purchases. But in the long run the increase or decrease of the total volume of trade must depend upon the natural resources of the country, the productive energies of the people, and the degree to which division of labor has been achieved. It can have no permanent dependence upon the amount of money in circulation. In the second place, a sud- den increase in the supply of money is likely to bring about a temporary decrease in V, its velocity of circulation, because a larger amount of money may, for the time being, be kept idle. But, with a given volume of transactions at given prices, V must in the long run depend very largely upon the habits of the people with respect to the amount of " pocket money " usually kept on hand. Changes in habits of this kind are slow, and may safely be neglected in studying the movement of prices through even a considerable number of years. When, in the third place, we come to consider the effect of an increase in M upon the magnitude of M', the amount of bank deposits subject to check, we find that these two things are necessarily connected. For an increase in M, the amount of money- in circulation, is very sure to be accompanied by an increase in bank reserves. Additions to the country's stock of money will distribute themselves, ultimately, between bank reserves and hand-to-hand circulation, and the proportions of the country's monetary stock allotted to these two uses usually fluctuate only between more or less definite, even if gradually changing, limits. But an increase in bank reserves normally brings with it an increase on M', the amount of bank deposits subject to check. Even in the absence of minimum reserve laws, the ratio of aggregate bank reserves to aggregate bank deposits is found, for the time being, to fluctuate around an approximately constant proportion. An increase in M, there- fore, is very sure to result in an increase in M'. It follows, then, that despite a certain amount of variability in the other factors in the equation of exchange, an increase in 324 OUTLINES OF ECONOMICS Mj carrying with it a roughly proportionate increase in M', must normally have as its most important concomitant a similar general increase in prices. This, it will be noted, is in harmony with the conclusion we had already reached without the aid of the equation of exchange. But that conclusion was stated in terms of the " amount of money (and credit instru- ments) exchanged for goods and services," the volume of trade being constant. We now see that a similar conclusion holds true when stated in terms of the quantity of money in circula- tion, the only qualifying factors being probable changes of greater or less importance in (i) the rate of turnover of money, (2) the ratio of the amount of money in bank reserves to the total amount of money in circulation, (3) the ratio of bank reserves to bank deposits, and (4) the rate of turnover of bank deposits. Allowing for the influence of these qualifying factors, an increase or decrease in the quantity of money, the volume of trade being constant, must be accompanied by a proportionate general increase or decrease in prices. This principle, known as " the quantity theory of prices," has long been one of the most important theorems of economics.^ General changes in prices must, of course, accompany changes in any of the factors in the equations of exchange, unless these happen to counteract one another. If the volume of trade increases more rapidly than the supply of money, and other things remain equal, prices must decrease. This is the apparent explanation of the general fall in prices between 1873 and 1897. The growing use of checks in making payments is substantially like an increase in the supply of money. It increases the ratio of money in bank reserves to money in hand-to-hand circulation, and thereby increases the ratio of M' to M. Unless offset by changes in other factors, this must be 1 Professor Irving Fisher, by making skillful use of such statistics as are available, has estimated the magnitude of the various items in the equation of exchange for each year since i8g6. For one factor, the total volume of trade, Professor Fisher had to be content with relative figures, showing merely the estimated percentage changes in the volume of trade from year to year. By using merely his figures for M, V, M', V', and T, Professor Fisher was able to get values showing the relative year-by-year changes in P which agreed very closely with figures derived from the statistics of actual price movements. Similar estimates, based on somewhat less complete statistics, had previously been made by Professor E. W. Kemmerer. See Fisher, The Purchasing Power of Money; and Kemmerer, Money and Credit Instruments in their Relations to General Prices. OTHER PROBLEMS IN MONEY AND BANKING 325 accompanied by rising prices. An improvement in the organization of the banking system, making possible a smaller normal ratio of aggregate bank reserves to aggregate bank deposits must also tend to increase prices. Along with a phenomenal increase in the quantity of money in the past twenty years there has been, in fact, a large increase in both the ratio of deposits to money and in the rate of turnover of deposits. The Mechanism of General Changes in Prices. — Thus far we have considered only the mathematically necessary relations between changes in the quantity of money and general changes in prices. The quantity theory of prices, even when stated in the form of the equation of exchange, tells us nothing about the process of general price changes ; nothing, that is, about the mechanism by which a change in the quantity of money oper- ates to bring about general changes in prices. No one has ever given a complete description or analysis of this process, and doubtless no one description would fit all instances of general price changes brought about by changes in the quantity of money. But some aspects of the matter are tolerably clear. Take an artificially simple case. Imagine an isolated com- munity with no foreign trade and with no banks. Suppose that a group of men find a long-forgotten hoard of gold, large even as compared with the existing stock of gold in circulation. Without increasing their own activities as producers the finders are now able to purchase larger quantities of goods. These additional purchases, it is important to note, are the direct result of the increase in the supply of money, and could not have been made without it. The merchants into whose hands the money comes in turn expend it to replenish their stocks and for other purposes. And so the money passes from hand to hand, increasing the number of exchanges — the volume of trade — just about proportionately to the increase in money. But this increase in the volume of trade cannot be the end of the process. More goods than before are passing into the possession of their ultimate consumers. The country's stock of exchangeable goods is being depleted more rapidly than it can be replenished out of the country's normal agricultural and industrial output. In short, the purchasing power of the com- 326 OUTLINES OF ECONOMICS munity, at the old level of prices, is now more than sufficient to buy the current output. Under the pressure of competing purchasers, desiring to exchange money for goods, prices will rise. And if the industrial output cannot be permanently in- creased the rise in prices will be proportionate to the increase in the money supply, so that finally the larger supply of money will have brought with it no permanent increase in the number of exchanges. The conditions under which general price changes resulting from an increase in the quantity of money occur in actual life are much more complex, and yet there is no reason to suppose that in its fundamentals the process is essentially unlike that which we have just outlined. There is, however, the difference that additions to the supply of money usually find their way at first into bank reserves, where their immediate effect is to lower the discount rate. This leads to increased bank lending and to larger bank deposits, and the immediate purchasing power of the community, in the form of its power to draw bank checks, is correspondingly increased. Increased purchases will be made, and so far as the immediate effect upon prices is con- cerned, it is immaterial that a large part of the increase may be in purchases of labor, raw materials, and supplies, i.e. in expen- ditures for " productive " rather than for " final " consump- tion. Prices must rise, and this will draw a larger amount of money into hand-to-hand circulation. With higher prices people will find it convenient to keep somewhat larger amounts of money on hand as " pocket-money." Finally, unless new disturbing factors appear, equilibrium will be reached between the amount of money in bank reserves and the amount of money in hand-to-hand circulation. It seems probable, then, that the sequence of processes by which an increase in the supply of money actually brings about a general increase in prices may often be (i) larger bank reserves, (2) lower discount rates, (3) larger bank deposits, (4) more purchases, (5) higher prices, (6) more money drawn into hand-to-hand circulation. Prices get their initial upward impetus from the larger bank re- serves, but the increase in the amount of money in hand-to- OTHER PROBLEMS IN MONEY AND BANKING 327 hand circulation helps to support and maintain the higher price-level.^ Thus far, however, we have neglected to take account of the very important facts, (i) that gold has other than monetary uses, (2) that the production of gold will itself depend in part upon its purchasing power, and (3) that international gold ship- ments are also partly dependent upon the relative purchasing power of money in one country and another. Leaving the last of these three topics for treatment in the following chapter in connection with the general subject of international trade, we pass now to the discussion of the other two. The Relation of the Industrial Uses of Gold to Prices. — From the estimates of the Director of the Mint it appears that in recent years from one fourth to one third of the world's annual production of gold finds its way into industrial uses. The United States mints and assay offices refine nearly all the crude gold bullion produced in or brought to this country, and allow the depositor to take the proceeds in money or in bars of gold for industrial use, as he prefers. But even without this convenient arrangement there would be a constant balanc- ing or comparison of the relative advantages of the industrial and monetary uses of gold. The number of dollars which can be got by selling gold for money and by actually converting gold into money must, of course, always be approximately equal. More than that, there are two things quite distinct from the direct process of selling gold bullion for money which help to fix the ratios of exchange between gold and other things. Con- sumers, on the one hand, are constantly weighing the marginal utility of objects made from gold against the marginal utility of other things. Producers, on the other hand, are weighing the relative profitableness of producing things made from gold and things made from other materials. It is clear that gold will be distributed between its industrial and monetary uses in such a way as to equalize the exchange ratios of gold and other 1 Cf. the testimony of Professor Alfred Marshall before the British Gold and Silver Commission of 1888, in Appendix to Final Report, p. 3. 328 OUTLINES OF ECONOMICS things for the two uses.^ If, for example, an increase in the stock of money (whether gold or not) results in increased prices (i.e. in decreased purchasing values of gold), a relatively larger amount of the gold annually brought to the mints will tend to flow into industrial uses, and thus to limit the increase in the amount of money and the consequent rise in prices. The Relation of the Expenses of Gold Production to Prices. — There is another way in which society makes direct compari- sons between the value of gold and the value of other things. Mining, like agriculture, is subject to the law of increasing expenses, and the tendencies of prices to equal the maximum expenses of production per unit holds true for both indus- tries. Not only are there marginal mines, mines which it just pays to operate, but in the most productive mines there are margins, — certain depths, for example, beyond which the expense of mining more than eats up the value of the product. Through the operators of mines, societ}^ is continually compar- ing the cost in labor and capital of the production of gold with the cost, similarly measured, of the things that can be bought with the produced gold. If the gold produced at the margin will purchase things which consumers deem of less importance than other things which might have been produced with the use of no more capital and labor, capital and labor will grad- ually be shifted from their marginal use in gold mining to the production of other things. Here, then, as in the case of the balancing between the monetary and industrial uses of gold, we have a direct value-comparison of gold and other things. Some years ago the Bureau of the Mint undertook an investi- gation into the relation of the expense of gold mining to the amount of gold produced. The conclusion reached is worth quoting in this connection : In every mining district there are mines producing at good profits, mines producing at small profits, mines barely paying expenses, and mines oper- ated at a loss, but with the hope that they will do better. Every increase in costs would submerge the latter more deeply, add to the list of the un- 1 The expense of transforming bullion into jewelry, etc., is left out of account, as it does not affect the principle under consideration. OTHER PROBLEMS IN MONEY AND BANKING 329 profitable, and probably close some of them. ... A higher scale of work- ing costs will bring losing experiments to an earlier conclusion, reduce profits, and make mining ventures generally less attractive, and thus diminish the output.^ To summarize : Marginal utilities and subjective values are found in the industrial uses of gold. The particular form of the law of normal price that is operative in agriculture also holds true in gold mining (although it has to be stated in a somewhat different way). An increase in the supply of gold diminishes its marginal utility in industrial uses. This is bound to decrease the values of gold as money, on account of the ease with which the supply of gold can be shifted to one use or the other. Such a rise of prices, however, cannot continue indefinitely. The increase of prices and wages brings increasing expenses in gold mining, and, unless new gold mines are found or cheaper ways of getting gold from old mines are invented, the output of gold will have to decrease. These things have a steadying influence upon prices. Tend- encies toward extreme fluctuations in prices are held in check by the resulting changes in the expense of mining gold and by the automatic changes in the proportions of the annual gold product that flow into monetary circulation and into industrial uses. It is in these ways that the significance of the fact that the monetary standard is itself a commodity appears. The Increase in the Production of Gold. — Although prob- ably more gold was produced between 1850 and 1875 than from 1492 to 1850, yet, as Table I shows, the annual production of gold since 1896 has been from two to three times as large as it was between 1850 and 1875. Most of this great output of gold, as Table II indicates, comes from relatively few countries. At present the British empire supplies over one half and the United States (including Alaska) nearly one fourth of the total product. The causes of this enormous increase were, in part, the opening up of new gold fields in South Africa, Canada, Alaska, and Colorado, and in part the improvements in methods of extracting gold from low grade and refractory ores, in which 1 Report on the Production of the Precious Metals, 1904, p. 41. 330 OUTLINES OF ECONOMICS TABLE I Production of Gold in the World since 1841 (From 1841 to 1885 the estimate is from a table of averages for certain periods, compiled by Dr. Adolph Soetbeer; for the years 1886 to 191 2 the production is the annual estimate of the Bureau of the Mint.) Annual Average for Period Period Fine Ounces Value 1841-1850 1,760,502 $ 36,393,000 1851-1855 6,410,324 132,513,000 1856-1860 6,486,262 134,083,000 1861-1865 5,949,582 122,989,000 1866-1870 6,270,086 129,614,000 1871-1875 5,591,014 ii5~,577,ooo 1876-1880 5,543,110 114,586,000 1881-1885 4,794,755 99,116,000 1886-1890 5,461,282 112,895,000 1891-1895 7,882,565 162,947,000 1896-1900 12,446,939 257,301,100 1901-1905 15,603,730 322,619,800 1906-1910 20,971,575 433,520,900 1911 22,348,313 461,939,700 1912 22,549,335 466,136,100 TABLE II Recent Production of Gold in Different Countries' Country 1897 1900 1904 Africa 88 97 86 35 9 12 II 9 26 13 III 119 31 42 14 13 8 35 129 132' 121 25 18 Australia United States and Alaska Russia Canada British India Mexico China All others 19 7 35 Total 355 385 523 * From Journal of Folitical Economy, vol. x, p. 580, and Finance Report, 1907, p. 363. The figures are given in thousands of kilograms. OTHER PROBLEMS IN MONEY AND BANKING 33 1 connection the development of the " cyanide process " has been of special importance.^ Dredging for gold in the beds of rivers which drain gold-yielding lands, is a very recent devel- opment of considerable importance. Notwithstanding the de- crease in the value of gold, the bulk of the gold produced in California today is from ore bodies that twenty-five or thirty years ago were generally considered worthless. The effects of this enormous output have been felt in both Europe and America in a general increase of both prices and wages. There are some who expect that the values of gold will continue to depreciate for a long time in the future. Account must be taken, however, of the automatic check which the increase in wages and prices is bound to put on the production of gold by increasing mining expenses. On the other hand, still further economies in productive methods are possible. Some Economic Effects of Changes in the Values of Money. — We have seen that an increase in the amount of money available for bank reserves leads to the expansion of credit, stimulates business, and increases prices. The same results are achieved, although in not the same way, by a sudden debase- ment of the standard of value, or by the introduction of irre- deemable paper money as the medium of exchange. Prices are gradually increased under such conditions, there being an unmistakable tendency to adjust them to the change in the " dollar " or other unit of the medium of exchange.^ The rising prices stimulate business by increasing profits. Profits 1 "There are many mines in operation now at a profit which could not have been worked at a profit ten years ago. There has been an important addition to the gold and silver product by the recovery of these metals from lead and copper ores by modern processes. The most important gains seem to have come, however, through economies in management, particularly by enlarging the scale of operations and by more complete extraction of the values from the ores treated." — Report on the Production of the Precious Metals, 1904, p. 41. 2 Possibly the effect upon other prices of the increased prices (measured in the depreciated money) that have to be paid for imported commodities and that are received for exported commodities is the key to this problem, just as it was undoubt- edly the chief cause of the rise of prices to fit the bulhon value of coins from which seigniorage had been taken. This is the explanation of the rise of prices under the greenbacks suggested by Professor W. C. Mitchell, the historian of that move- ment. 332 OUTLINES OF ECONOMICS are increased because most of the expenses of production are incurred before the goods are sold, so that the rise in prices increases the margin between prices and the expenses of pro- duction, and because, moreover, some of the expenses of pro- duction do not usually rise as rapidly as do prices. An expan- sion of business activity of the kind already described is apt to be the result, and this is not generally soon restrained by in- sufficient bank reserves, for depreciated money is usually, though not always, money that is coined or issued in large quantities. That periods of prosperity induced in this way are inevitably short-lived and usually end in severe crises does not make them any the less real. Nor should the fact that such artificial condi- tions of business enterprise are apt to be accompanied by exces- sive speculation and other unhealthy features blind us to the fact that they accomplish some good. The encouragement given to venturesome undertakings leads to the trial of new methods of production, to the development of new natural resources, to undertakings of vast proportion, to a general free- ing of industrial organization and methods from the restraints of habit and tradition. The foundations of modern large-scale industry in the United States were laid in the. period between the Civil War and the panic of 1873. The period of state bank note inflation preceding the panic of 1837 was a period in which the industrial map of the United States was almost wholly changed, and, in the long run, for the better. A rapid increase in the supply of standard money may have a similar effect. A tremendous expansion of international trade followed the gold discoveries in California and Australia. In the sixteenth century, increases in the supply of the money metals, historians are agreed, hastened the fall of the medieval economic system. The almost unparalleled development of industry and industrial organization in the United States since 1897 must, with its good features as well as its bad, be at- tributed in part to the increased supply of gold. Business prosperity, however, does not always coincide with the real economic welfare of the masses of the people. If OTHER PROBLEMS IN MONEY AND BANKING 2>33 prices are rising faster than money wages, real wages are ob- viously declining. A period of falling prices is very apt to be a period of increasing well-being for those whose incomes are wages or salaries, although here we have to remember that even if daily or weekly wages do not fall so rapidly as prices, an increase of unemployment may affect total yearly incomes adversely. Crises. — Crises are frequently recurring phenomena of cur- rent economic life. They are of all degrees of severity, but are generally characterized by a scarcity of bank credit, a sudden drop in prices, a subsequent period of industrial depres- sion, lack of employment for wage earners, and kindred symp- toms. Crises are frequently attributed to " over production," or, when that expression is criticized (because human wants are never fully satisfied) to " under consumption." The two ex- pressions are different ways of describing the same thing, and both are misleading because they put the emphasis in the wrong place. Production and consumption have to do with quanti- ties of things and their fitness to satisfy human wants. Crises spring from mishaps in the price process ; they relate to what might be called the dollars and cents aspect of economic life. It is difficult, even impossible, for observers to analyze all the factors entering into a particular crisis, and it is even more difficult to formulate a theory of crises that will be of general applicability. There are some important things about crises, however, that are relatively well known, and these will form the basis of our discussion. It is a significant fact that crises generally occur only as sharp interruptions of periods of business prosperity, when credit is abundant, prices relatively high, and employment plentiful. Whatever may be the cause of a period of exceptional business prosperity, it is apt to contain within itself the seeds of its own destruction. The point will appear clearly if we put together two conclusions that were reached in the preceding chapter : first, that the supply of loanable funds in the form of bank credit is a function of two variables, — the supply of personal 334 OUTLINES OF ECONOMICS credit and the supply of money available for bank reserves; second, that personal credit is based on the probable amount of future money incomes and probable future prices of property. Suppose, for example, that business conditions are pros- perous and promise to continue so, and that there is a plentiful supply of money in the bank reserves. Expected prices and expected profits are large, expected interest payments seem certain. The power to get this future income depends, how- ever, upon the possession of land, capital goods, franchises and other privileges, the established business relations that give rise to " good- will values," or upon the possession of income- yielding securities, such as mortgages, bonds, stocks, etc. Under such conditions, these things command good prices in the market and may easily be hypothecated, either formally or implicitly, in order to secure purchasing power, — bank credit. The bank credit thus created is put into further investments of capital and into the creation of further business opportunities. These things serve in turn, so long as their income-yielding power seems certain, as the basis of further extensions of bank credit, and thus the process of business expansion continues in a cumulative fashion. Overproduction, it is true, is present, but it is the overproduction of the means of production and of acquisition, — of railways, factories, and business schemes, — and it is accompanied by the overappraisal, the overcapitaliza- tion, of these things. An extensive period of increasing pros- perity of this kind is, however, scarcely possible unless the supply of money is increasing ; for bank reserves as well as the amount of expected personal incomes condition the supply of purchasing power. Very often, in fact, it may be a sudden increase in the supply of money available for bank reserves that gives the initial impetus to the rapid expansion of business. Larger reserves, lower discount rates, larger investments, an increased volume of trade, is as we have seen, the normal sequence in such cases. Periods of rising prices are periods of rising profits, for fixed charges, the rate of interest (even on new borrowings), and wages do not usually rise as rapidly as prices. These rising profits are, of course, the direct cause of OTHER PROBLEMS IN MONEY AND BANKING 335 the overinvestment in production goods and the overcapitaliza- tion of business opportunities. Aiiy one of a number of things may be sufficient to precipitate a panic under such conditions. The whole business structure may fall to pieces through sheer topheaviness. That is, so much production today is indirect, so large a share of productive effort is devoted to forwarding in indirect ways the production of goods that will be ripe for human use only in the compara- tively distant future, that the mere operations of supply and demand among business men themselves may maintain pros- perous business conditions for some time. But in the long run the maintenance of the values of producer's goods and privi- leges depends on the demand, and hence on the income, of ultimate consumers. Wages do not usually rise as rapidly as prices in periods of business expansion. This simple fact may in itself keep the average purchasing power of consumers from expanding rapidly enough to furnish a solid support for the growing structure of capital values. Crop failures may precipitate a panic by diminishing the pur- chasing power of those engaged in agriculture, and, possibly, by reducing exports and thus necessitating the taking of gold from the bank reserves to ship to Europe in payment for our imports. When the credit situation is at all strained, the failure of one im- portant bank may be enough to precipitate a panic. The bank's creditors are prevented from meeting their own obligations ; the solvency of others is in turn dependent upon them, and thus losses in expected and often already hypothecated income are transmitted from firm to firm and from industry to industry in a constantly widening circle. The reduction of bank re- serves by reason of the flow of money into hand-to-hand cir- culation in order to effect exchanges at the higher level of prices may itself be a contributing cause of a panic. In fact, whatever may be the immediate cause of a panic, it is bound to grow, in a condition of inflated capital values, with tremendous rapidity. The collapse of credit leads to forced sales of property in order that credit obligations may be met. These reduce prices, lessen the security on which credit is 336 OUTLINES OF ECONOMICS founded, and render banks less able and less willing to make loans. Moreover, the hoarding of money, which is apt to be a feature of a panic, has a destructive effect on bank reserves. In a serious panic the liquidation of obligations has to work itself out. Then the industrial process starts afresh, with lowered values imputed to capital goods and to business opportunities, and with property rights shifted, in some measure, to creditors. Crises seem to be unpreventable so long as competition and the credit system dominate in industry. Yet there are some recent developments that may make them less frequent, and possibly less serious. The " integration of industry," whereby a whole series of pro- ductive processes, from the production of the raw material to the sale of the finished product, are brought together under one management, decreases the number and complexity of credit relations between producers, and tends to prevent the Undue expansion of those parts of the productive process that are farthest removed from the consumer. The strong position of the steel industry in the United States is a case in point. The improvements in the bargaining power of wage earners result- ing from their organization have enabled them partly to pre- vent the widening of the gap between wages and prices in pros- perous times, as recent American statistics show. On the other hand, crop failures are and always will be a factor of uncertainty. The best way of softening the rigors of a panic and of restoring normal conditions promptly is through a wise use of the lending power inherent in a system of really elastic bank reserves, just as the best way of preventing panics is through a firm control of discount rates when all other condi- tions are ripe for a period of business inflation. It is in these ways, perhaps, that the new federal reserve system can best serve the country. The Standard of Deferred Payments. — The relation of changes in the purchasing power of money to long-time debts and credits has some very important aspects. If prices increase, the principal of a loan represents less purchasing power at the time of repayment than at the time the loan was made. If prices OTHER PROBLEMS IN MONEY AND BANKING 337 decrease, the reverse is, of course, true. In periods of cheap money agitations the additional burdens imposed upon debtors in a period of decreasing prices are emphasized. An important function of money, then, is found in its use as a standard of deferred payments. There is a partial, but only partial, compensation for the in- justice to debtors and creditors resulting from general changes in prices in the fact that the interest rate usually increases when prices increase and decreases when prices decrease. This is largely because rising prices increase profits, thus inducing business men to pay higher interest rates in order to secure larger supplies of funds for investment ; while falling prices decrease profits and lessen the demand for loanable funds. The result of this is that the changing purchasing power of the principal of a loan is to some extent offset or discounted by changes in the rate of interest. The decline in interest rates as prices fall makes it possible for debtors to pay off their old obligations with funds borrowed at a lower rate of interest. Creditors cannot so easily take advantage of the fact that interest rates are in- creasing when the purchasing power of the principal of their outstanding loans is decreasing. Nevertheless, more emphasis has been given to the question of the standard of deferred pay- ments in periods of declining prices, when debtors are in- juriously affected, than in periods of rising prices, when credi- tors are the losers. The United States is rapidly ceasing to be a " debtor nation," and the farmers, in particular, are becom- ing less distinctively a " debtor class." We may expect, therefore, that in a future period of declining prices we shall hear less about the injustice of our variable standard of deferred payments. Index Numbers. — General changes in prices are indicated statistically by the use of index numbers. An index number, in the most general sense, is some magnitude which varies with some other magnitude or complex of magnitudes, and whose variations can therefore be taken as representing or indicating the other variations. In studying the variations of the price of some specific thing we need no index number ; but when we 338 OUTLINES OF ECONOMICS have to deal with the variations of many different prices, we find the use of index numbers necessary. The simplest way to form an index number of general changes in prices is, first to select a list of things whose prices are to be taken into account, next to ascertain the average price per unit paid for each of these things in each successive month or year of the period being studied, and finally to take the sum of these unit prices in each of a number of successive months or years as the index numbers. Such index numbers show the variations in the total expense of a purchase consisting of one unit each of the commodities included in the list. Thus if bananas of a certain grade sell at a certain time for 15 cents a dozen, oranges at 40 cents, and peaches at 25 cents; and if a month later the prices are 20 cents for bananas, 50 cents for oranges, and 20 cents for peaches, the summed prices used as index numbers are 80 cents and 90 cents respectively." This means merely that the total money cost of a dozen each of these fruits has increased by i2|- per cent. For some purposes we get more significant results by weight- ing the specific prices in accordance with the relative impor- tance of the different commodities. If, for example, we think that twice as many bananas as peaches are ordinarily used, and three times as many oranges as peaches, we may take as our weighted sum at the earlier date, .25 plus (2 X .15) plus (3 X .40), or $1.75. For the later date the weighted sum is $2.10, indi- cating a general rise of 20 per cent in the retail prices of this small group J. R. Commons, The Distribution of Wealth, p. 252. 2 B. S. Rowntree, Poverty, p. 120. 552 OUTLINES OF ECONOMICS class whose mission it is to further culture without substantial contributions to the production of what it consumes, does not find much favor in this democratic age. The disadvantages of wide extremes in wealth have been so often pointed out by social philosophers that they need not be emphasized here. But those who believe that the competitive system roughly apportions rewards according to individual production will say that nothing can be done directly to diffuse wealth. That each individual should bear the consequences of his own con- duct, they think, is necessary as a discipline for the race. " Give the children of the shiftless, by thoughtless charity or various systems of poor relief, the right to eat the substance of the effi- cient and the prudent, and you will soon lose both the capital and the morality under which that capital has been created," ^ says one able writer. Those, on the other hand, who think that something can and should be done, question the possibility of discovering the real contributions of individual workers under modern complex in- dustrial conditions with any degree of exactness, and think there is little danger of discouraging industry and thrift. If the highest incomes were $100,000 per year, men would struggle just as hard as they do now to get into the highest class. If we take the view that something can be done to lessen the extreme inequality in wealth distribution that exists at the present time, it is necessary to formulate some program of social reform. In framing such a program it must be re- membered, on the one hand, that the right of private property is not an absolute right. No one has a vested interest in that institution, and we are at liberty to make such modification in the institution as will contribute to the social welfare. For the present the measures here advocated are not in the slightest danger of being carried so far as to discourage that wealth- getting ambition which is considered by many to be essential to progress. On the other hand, there is danger of injuring by wrong methods the very persons whom it is desirable to elevate. Indiscriminate charity may convert poverty to pauperism. ^ A. T. Hadley, Economics, p. 49. THE PERSONAL DISTRIBUTION OF WEALTH 553 "This distinction between the poor and the paupers may be seen every- where. There are, in all large cities in America and abroad, streets and courts and alleys where a class of people live who have lost all self-respect and ambition, and who rarely if ever work, who are aimless and drifting, who hke drink and who have no thought for their children, and who live aimless and contentedly on rubbish and alms. ... In our American cities,Negroes, Whites, Chinese, Mexicans, Half-breeds, Americans, Irish, and others are indiscriminately housed together in the same tenements and often in the same rooms. The blind, the crippled, the consumptive, the aged, — the ragged ends of life; the babies, the children, the half-starved, underclad beginnings in life, all huddled together, waiting, drifting. This is pauper- ism. There is no mental agony here; they do not work sore; there is no dread; they hve miserably, but they do not care. "In these same cities, and indeed everywhere, there are great districts of people who are up at dawn, who wash and dress, and eat breakfast, kiss wives and children, and hurry away to work or to seek work. The world rests upon their shoulders ; it moves by their muscle ; everything would stop if for any reason they should decide not to go into the fields and factories and mines. But the world is so organized that they gain enough to live upon only when they work ; should they cease, they are in destitution and hunger. The more fortunate of the laborers are but a few weeks from actual distress when the machines are stopped. Upon the unskilled masses want is con- stantly pressing. As soon as employment ceases, suffering stares them in the face. They are the actual producers of wealth, but they have no home nor any bit of soil which they can call their own. They are the millions who possess no tools and can work only by permission of another. In the main they live miserably, they know not why. They work sore, and yet gain noth- ing. They know the meaning of hunger and the fear of want. They love their wives and children. They try to retain their self-respect. They have some ambition. They give to neighbors in need, yet they are themselves the actual children of poverty." ^ We shall not discuss here the methods of alleviating the suf- fering that comes from poverty. The best methods of charit- able relief are necessary as palliatives, but th'ey cannot cure the evils of poverty. Two classes of reform measures should be distinguished : (i) those that aim to alter the methods of wealth acquisition in the future, and (2) those that aim to diffuse the excessive accumulations of the past. Modifying the Methods of Wealth Acquisition. — These measures again fall into two classes : (a) prevention of improper 1 R. Hunter, Poverty, pp. 3-5. 554 OUTLINES OF ECONOMICS methods of wealth accumulation ; (b) eliminating or strengthen- ing the inefificient members of society. Under the first of these falls the problem of reducing to lower terms such incomes as are individually unearned. There must be such control of monopolistic privileges as to keep them from being the means of exploiting the public. Fraud and favoritism must be elim- inated so that income shall not be wholly out of proportion to service or needs. The second class includes a large variety of methods, (i) It is possible to do something to prevent defective human beings from being born. There is a growing sentiment in favor of preventing the marriage of persons who are not fit for marriage. No individual would be deprived of any important right if a medical certificate of good health were made a condition pre- cedent to the granting of a marriage license, although here education may prove the more effective remedy. (2) Education should be made compulsory, with the endeavor of making the rising generation not only efficient producers, but also wise spenders of what they receive. (3) It is possible to provide against the misfortunes of fife by Insurance of various kinds. If men will not voluntarily make provision for themselves and for those dependent upon them in cases of sickness, accident, old age, and premature death, they should be helped to do so indirectly by some comprehensive system of workingmen's insurance and old age pensions. (4) The solution of the prob- lem of unemployment depends in part upon indirect measures, such as monetary and banking reform, which steady the prog- ress of industry, although more efficient labor exchanges and unemployment insurance are direct measures which are of some help. If business men and political leaders ever become as much interested in the problems of unemployment as in tariff reform, we may expect that productive use will be found for the unemployed so far as they are employable, and if this proves impracticable, we shall recognize that if society cannot offer a wilHng and able man an opportunity to work, it must give him a vacation with pay. (5) Opportunities for saving should be multiplied. The establishment of our postal-savings system THE PERSONAL DISTRIBUTION OF WEALTH 555 is a small step in this direction. (6) The health and vigor of the people should be improved by more efficient use of " pre- ventive medicine " and public hygiene in all its various phases, and by improvement in the conditions of work. The Diffusion of Wealth. — To some extent large fortunes dis- appear without governmental interference, but it takes com- paratively slight ability to maintain an inherited estate. It does not seem practicable or desirable to limit directly the total amount of wealth which a man may own, but there is no reason why the government should refrain from consciously encourag- ing the diffusion of wealth. The regulation and taxation of inheritances seems to be the proper remedy in this connection, even if its action is somewhat slow. QUESTIONS AND EXERCISES, 1. Can anything be said in favor of a leisure class? 2. Would Mr. Carnegie's plan of levying an inheritance tax of 50 per cent destroy the incentive to work ? 3. Explain the various systems of poor relief. 4. Describe the work of some public employment office. 5: Describe the growth of postal savings. 6. What were the causes of the development of the fortune of John Jacob Astor? 7. Discuss the following statement: "We have, then, little reason for expecting that the prevailing insecurity in the lot of the modern workman will ever be removed by the development of individual thrift." — A. S. John- son, Political Science Quarterly, Vol. xxii, p. 244. REFERENCES Adams, T. S., and Sumner, H. L. Labor Problems, Chap. v. Brooks, J. G. The Social Unrest, Chap. vii. Booth. Life and Labour of the People in London, final volume. Commons, J. R. Distribution of Wealth, pp. 252 seq. Devine, E. T. Principles of Relief. Ely, R. T. Property and Contract, Vol. i, Chap. xiii. Falkner, R. p., "Income Tax Statistics," Quarterly Publications of the American Statistical Association, Vol. xiv, p. 521. Hadley, a. T. Economics, pp. 39-63, 330-335. Hollander, J. H. The Abolition of Poverty, Chaps, ii, viii. Hunter, Robert. Poverty. 556 OUTLINES OF ECONOMICS HoBSON, J. A. The Social Problem, Chap, iv; Problems of Poverty, Chap. ix. Henderson, C. R. Modern Methods of Charity. Johnson, A. S. "Influences affecting the Development of Thrift," Political Science Quarterly, Vol. xxii. King, W. I. The Wealth and Income of the People of the United States. RowNTREE. Poverty: A Study in Town Life. Streighthoff, F. H. "The Distribution of Incomes," Columbia University Studies in History, Economics, and Public Law, Vol. iii, No. 2. Taussig, F. W. Principles of Economics, Vol. ii. Chap. liv. Warner, A. G. American Charities. Watkins, G. p. "The Growth of Large Fortunes," Publications of the American Economic Association, Third Series, Vol. vii, No. 2. Youngman, Anna. Economic Causes of Great Fortunes. PART IV SELECTED ECONOMIC PROBLEMS CHAPTER XXVII TRANSPORTATION ECONOMICS Transportation Economics Defined. — Transportation may be studied from various points of view. It presents its peculiar problems to the engineer, to the lawyer, to the financier, to the accountant, to the operating official, and finally to the economist. The economist studies the relations of transportation to other industries and to the public welfare. Leaving to the engineer the building of bridges, to the accountant the recording of the condition of the business, and to the general manager the securing of efficient operation, we turn our attention primarily to the principles that govern the determination of rates and fares, although there are many other problems to be considered in transportation economics, some of them peculiar to this field and some but special illustrations of principles underlying all industry. We make use of the technical knowledge of the engineer and of the other specialists that have been mentioned, and yet our point of view is distinct. Scope of the Term Transportation. — A complete treatment of the subject of this chapter would involve a consideration of steam railways, interurban and city railways, the common roads, water transportation, as well as the post office, the tele- graph and the telephone. Aerial transportation may bring new economic problems in the future. But it will be necessary in this chapter to confine the discussion to some of the leading principles in the economics of railroad transportation. As 557 558 OUTLINES OF ECONOMICS explained in Chapter VI, the early turnpike era was followed by one of canal building, and this in turn by the railroad era. We are now realizing that we must enter upon a new era of road building and of the improvement of waterways. Canal and river improvement, however, should be urged, not on the general ground that water transportation is cheap, but only in specific instances where it can be shown to be as advantageous as rail transportation when all of the elements of expense are taken into consideration. It is a matter of debate, for example, whether the recent construction of the New York barge canal was economically justified. The improvement of our common roads is now being vigorously forwarded by state and local activity. In 1916 the federal government made an appropria- tion to aid the states in carrying on this work. Nature of the Railway Industry. — Hardly anything can be produced without the participation of some transport agency. Modern industrial civilization would be impossible without an efficient system of commercial intercourse. The dependence is mutual, for present methods of transportation clearly would be vmeconomical without a large traffic. The influence of cheap transportation is especially important in the fact that it promotes an extensive division of labor by widening the market. It per- mits each region to devote itself to that line of production for which it is best adapted. The number of persons employed by railways in the United States in 1910 was about 1.7 millions, which was 4.45 per cent of the number of gainful workers reported by the census of that year. This percentage probably understates the relative impor- tance of transportation as compared with other economic ac- tivities, because the capital per employee is larger in the railway industry than in other lines of work. An attempt has sometimes been made to minimize the importance of the question of rail- road rates by comparing the transportation charge on such an article as a pair of shoes with the cost of the shoes and showing that it is too small appreciably to affect the retail price. This overlooks the fact that freight charges enter into the cost of the materials and of the machinery required to produce the shoes. TRANSPORTATION ECONOMICS 559 The freight charge constitutes a large percentage of the cost of such an article as coal. But, on the other hand, the importance of changes in freight rates is sometimes overemphasized by com- paring the total annual freight revenue per family with the estimated income of the average family. Thus in the year ending June 30, 1910, the freight revenue of railways in the United States was $1,925,553,036, and the number of families as reported by the census of 1910 was 20,255,555, making an average of ninety-five dollars per family. It should be obvious that this figure cannot be compared with the amount which the average family spends for food, clothing, and- other items of final consumption. If the comparison is made at all, it must be with the total annual production of the nation per family, for freight charges enter into the cost of such items as the factories, war-ships, and railway bridges con- structed each year as well as of the articles produced for final consumption. Railways differ from manufacturing industries in that they produce place utility and not form utility, and in the further fact that it is customary for manufacturers to own the materials which they change in form while railways as a rule do not own the materials which they transport. In other words, railways sell services simply, while manufacturers sell articles in which they have embodied certain services. The freight charges paid by the shipper may be compared with the toll which the farmer used to pay for having his corn ground at the mill. The fact that railways do not buy and sell the commodities to which they add utility as manufacturers do, makes the amount of their yearly income and outgo much smaller in comparison with the amount of capital employed than is the case with manufacturers. Roughly speaking, it takes railways five years to " turn over " their capital, the total operating revenues of the railways in the United States being about three billions of dollars a year, while their capitalization is about fifteen billions (excluding intercor- porate duplications). For the year 1909, the Bureau of the Census reports manufacturing establishments as having a capital of 18.4 billions of dollars and an annual value of products of 560 OUTLINES OF ECONOMICS 20.7 billions. The value of products less cost of materials pur- chased, that is, the value added by the manufacturing process, was 8.5 billions. While no accurate comparisons are possible from these data, they warrant the conclusion that capital is relatively much more important as a factor of production in the railway industry than in manufacturing enterprises taken as a whole. The fact that railway services are rendered in con- nection with a large fixed capital explains much in our railway history, especially with respect to matters relating to competi- tion, monopoly, and rate making. Railway Competition. — The early roads were short, independ- ent lines, largely for local trafi&c or to serve as feeders to canals. The first movement toward the efficiency of the present system was the welding together of separate links into through lines. The New York Central, for example, was formed in 1853 out of ten or eleven previously independent lines between Albany and Buffalo. The development of parallel through lines introduced an era of sharp competition. In the seventies the lines connect- ing Chicago and the Atlantic seaboard engaged in a series of rate wars. The experience of this decade showed clearly the tempo- rary and unstable character of competition among parallel lines. The rule seemed to be that a railway war must be followed by a rate agreement of some sort, so that instead of the maintenance of a supposedly fair level of rates by the steady pressure of com- petition, we find there was an alternation of high and low rates. The inevitable annihilation of direct competition in rates be- tween railways is clearly portrayed in a congressional report in 1874, where the following prediction was made : "But when the natural tendencies of corporate power have wrought out their in- evitable conclusions, the magnitude of our combinations will probably be in proportion to the extent of the field in which they operate." But so strongly was it felt at that time that competi- tion is the life of trade, that the committee which made this report recommended that the government build a line of its own, merely to maintain competition with the private roads, for it was thought that the government could resist the temptation to enter into a combination. TRANSPORTATION ECONOMICS 56 1 The history of Belgium affords an instructive illustration of the effect of a mixed system of public and private ownership. Belgium began in 1837 with a carefully planned system of public railways. Ten years later it was decided to grant charters to private companies. A large number of private roads was organized, some with the purpose of competing with the state system. It was thought that competition between the state and private roads would be beneficial. The Massachusetts Railroad Commission, in its report of 1871, recommended a trial of this plan in Massachusetts. But in Belgium the private lines were soon merged into four systems, which com- peted so vigorously with the state roads that the government adopted the policy of purchasing them. Pooling and Consolidation. — As a result of the intense struggle for business among the roads, there was a widespread resort to the practice of pooling, that is, a division of the earnings or ton- nage of the aggregate business. This form of combination, however, was at least nominally abandoned after it was declared illegal by the Interstate Commerce Act of 1887, but organiza- tions for the purpose of making rates continued to exist. In 1897 these were also declared illegal by the Supreme Court of the United States on the ground that they were in violation of the Anti-trust Act of 1890.^ The decision, however, did not clearly prohibit the enlargement of the various systems by the purchase and lease of other lines, or by securing indirect control by the purchase of the majority of their stock. But in 1904 the Su- preme Court again applied the Anti-trust Act of 1890 in a case against the Northern Securities Company, a corporation formed, not for the purpose of directly engaging in the railway business, but for the purpose of holding the capital stock of the Great Northern, Northern Pacific, and Burlington systems, two of which were competing systems. In 191 2 it was decided that for the Union Pacific Railroad Company to hold indirectly 46 per cent of the stock of the Southern Pacific Company was illegal, although only a small percentage of the total traffic of these roads could be regarded as competitive. The Northern Securi- ties decision did not prevent the systems involved from con- tinuing to be controlled by the same financial interests, but the Union Pacific case has apparently resulted in severing the finan- 1 See p. 237, above. •20 562 OUTLINES OF ECONOMICS cial control of the Union Pacific from that of the Southern Pacific. The present organization of any one of our large systems, like a geological record, reveals the nature of the changes that have been going on. The consolidated company controls a number of large lines, perhaps by stock ownership, and each one of these is made up of a number of subsidiary roads united as a result of purchase, partial stock ownership, or lease. Thus the Baltimore and Ohio in 191 2 operated 4455 miles of line, of which it owned 545 miles, while 3897 miles were con- trolled through partial or complete stock ownership, the re- mainder being operated under lease or trackage rights. It also controlled the Cincinnati, Hamilton, and Dayton, an independent operating company. There are numerous illustrations of the control of one large operating company by one or more other operating companies. Thus the Northern Pacific and Great Northern Companies jointly control the Burlington. Again, several operating companies may be controlled by a holding com- pany which does not itself operate any mileage. This is the case with the Louisville and Nashville and the Atlantic Coast Line Railroads, both of which are subsidiary to the Atlantic Coast Line Company. Again, two or more railroads, apparently quite independent of each other in the matter of stock ownership, may nevertheless be dominated by the same financial interests. Thus the Morgan interests control the Erie and the Southern as well as other railroads. It is safe to say that ten groups of capital- ists control over three fourths of the railway mileage of the United States. In spite of the progress of consolidation, competition has not entirely disappeared. Even where there is no active cutting of rates by parallel lines, there may be rivalry in service ; but this form of competition has also proven to be unstable and- unsatisfactory, as is seen in problems arising in connection with terminal freight services. Again, alternative routes may lead to competition among railways that are not parallel. Thus the roads serving the north Atlantic ports compete in the carriage of grain with those extending to Galveston and New TRANSPORTATION ECONOMICS 563 Orleans. The influence of water competition on railway rates has been recognized by the Interstate Commerce Commission in the adjustment of transcontinental rates and in the numerous exceptions it permits in the southern states to the rule that the charge for the shorter haul shall not exceed that for the longer. The activities of the traffic departments of railways indicates the existence of competition for business at many points. The Panama Canal will be a factor in railway competition. Much has recently been said about the influence of market competition as a force affecting rates, even when the roads have been consolidated. To illustrate, the farmers and railways of North Dakota are joint producers of wheat, and they are both desirous that it shall be sold in competition with other wheat in the London market. It would be ruinous to the roads to make such high rates that the farmers could not afford to sell their grain. The railways cannot be prosperous if the farmers, mer- chants, and manufacturers along their lines are not prosperous. This partnership, however, has its limits, for a rate which would enable the producer to continue in business might still be un- reasonably high. The Movement of Rates. — The average revenue per ton mile of traffic in the United States fell from i.ooi cents in 1888 to .729 cents in 1900, rising to .780 in 1904, and falling again to .729 in 1913. Average ton-mile receipts, however, are not an accurate index of changes in rates, for this average is affected by the changes in the nature of the traffic as well as by changes in rates charged. The average ton-mile revenue is really a weighted index number with changing weights at different peri- ods. If the proportion of low-grade freight increases, or if the length of haul increases, there will be a fall in ton-mile receipts without any change in rates. But if we also take into consider- ation rates on specific commodities, such as wheat, or stoves, between specific points, no doubt remains but that a large de- crease in freight rates took place up to the year 1900. Since that time there have been many increases in published rates, but also many decreases have been made by order of various regulating bodies. It may be that the net effect of these changes 564 OUTLINES OF ECONOMICS is fairly well represented by the ton-mile revenue, which has shown little change since 1900, although there has been some increase in the proportion of low-grade tonnage and in the aver- age length of haul between 1900 and 1913, which would seem to indicate some increase in rates since 1900. In 1910 the railway companies, both in the East and in. the West, asked the Interstate Commerce Commission to sanction a general increase in freight rates. This it refused to do. In 1 9 14, a renewed request for permission to increase rates on the part of Eastern carriers was at first denied but later granted. In 191 5 an advance in rates on a long list of commodities was proposed by carriers in the Middle West. The commission permitted certain of the advances proposed and denied others. Railway representatives assert that rates should increase when prices generally are increasing, but they have failed to demon- strate any general increase in their own ''cost of living"' except in the higher rates of wages paid and the higher rates, of interest recently prevailing. In the years following 1908, passenger rates were radically reduced in many states by two-cent fare laws. The average revenue per passenger per mile had shown little change prior to that time since the early nineties, when it was somewhat higher. Recently Eastern railways have also made general increases in passenger rates. A joint com- mittee of Congress recommended in 19 14 that the payments to railroads for carrying the mails be increased. These general changes or proposed changes in rates and fares give renewed interest to the question of how a reasonable rate may be determined.^ 1 It is left as an exercise for the student to draw charts of the movement of rev- enues per ton per mile and per passenger per mile from the Statistics of Railways published by the Interstate Commerce Commission, and to compare at different dates the average length of haul and the proportions of various kinds of commodities carried. But it must be remembered that the average revenue per ton per mile is a single figure representing the result of applying an almost infinite variety of specific rates under varying traffic conditions. This is at once the advantage and defect of an average. To emphasize this point the average receipts per ton per mile are given in the following table for eight selected commodities by geographical districts. The average length of haul as given in this table is obtained by dividing the tons per mile by the number of tons carried, as reported by each railroad, in- TRANSPORTATION ECONOMICS 565 The Level of Rates. — If, owing to the monopolistic nature of the railway business, the determination of rates can no longer be left to the automatic working of competitive forces, they must be consciously determined according to fundamental principles. Competition was supposed to do justice by limiting the aggregate earnings of an establishment approximately to the expenses of eluding both the tons originating on the line of the carrier and the tons received from connecting carriers. The average haul, therefore, is the average haul on one railroad and not the average haul for the railroads regarded as one system. For all commodities taken together in ig.13 the average haul of a ton on one rail- road was 147 miles as against 260 miles for all the railroads regarded as a system. This last figure is obtained by dividing the ton-miles by the number of tons re- ported as originating on carriers' lines, excluding the tonnage received from con- necting carriers. The same correction cannot be made for the individual com- modities. The following table, it may also be noted, does not cover all of the mileage of the country, as many railroads do not compile traffic statistics in this form. Average Receipts per Ton per Mile and Average Length of Haul for Selected Commodities in Carload Lots for Year ENDrac June 30, igi3. Covering 151,941 Miles of Road (From Statistics oj Railways in the United States, 1913, p. 44.) District and Item COVEEED < 2; u m w > w H OS Eastern District Receipts per ton-mile — cents Length of haul — miles 0.375 262 0.851 158 0.538 252 0.842 228 0.893 327 0.571 170 0.417 126 0.623 148 Southern District Receipts per ton-mile — cents Length of haul — miles 0.620 250 0.938 193 1.927 179 1.723 138 1.043 255 0-5SS 119 0.403 180 0.734 161 Western District Receipts per ton-mile — cents Length of haul — miles 0.740 236 I-IS5 162 1.792 230 1-397 2og 1. 106 327 0.630 173 0.676 117 0.713 200 Total — All Districts Receipts per ton-mile — cents Length of haul — miles 0.581 248 1. 005 166 1.693 214 1.258 209 0965 323 0.578 170 0.447 135 0.701 176 566 OUTLINES OF ECONOMICS doing the business, and it seems most natural that we should ap- ply the same standard in our railway rate making. There can be no doubt but that expense is a safe guide so far as it can be ac- curately determined. It needs but a slight analysis of railway expenditure, however, to reveal the difficulty of using expense as a criterion of a fair rate. In 1 9 1 3 the railways reported to the In- terstate Commerce Commission operating revenues and other in- come amounting to 3297 millions of dollars, and in this same year the interest on funded debt and dividends amounted to 666 mil- lions, or 20. 2 per cent of the revenues and other income. This rep- resents the amount accruing to the stock and bondholders as joint owners of the business, not counting the increase in surplus. Is this a proper payment to such owners ? That some compensa- tion of this sort is necessary under the regime of private capi- talism is clear, for if none were made, new roads would not be built nor would old ones be maintained. A common answer is that the owners should be allowed a fair return upon their investment, but it is difficult to say what is a fair return and what is the actual investment. The rate of interest to be allowed must be determined from a study of the investment market and from a consideration of what is necessary to provide a surplus for the lean years and for unproductive improvements. A more perplexing question is to decide upon a fair valua- tion upon which the return is to be calculated. Neither the amount of stocks and bonds nor the ledger value of the prop- erty is a safe guide. In some cases the actual investment may be traced historically where the records have not been destroyed, but this raises a series of difficulties. Was the investment wisely made, or does it contain a large profit paid to some con- struction company? Should investments made out of income or surplus be distinguished from the original investment or from proceeds of the sale of stock and bonds? The difficulty of as- certaining the full history of the investment has led to estimates of the cost of the production or reproduction of an enterprise by means of an engineering survey of the road and equipment. The Interstate Commerce Commission, through its Division of Valuation, has been engaged on the gigantic task of making TRANSPORTATION ECONOMICS 567 a valuation of the entire railway system of the United States. Expensive as this undertaking is, it seems to be the only hope of reaching an equitable determination of what is to be regarded as a fair valuation upon which to base rates. Should the people of the United States ever reach the conclusion that it is wise for them to own the railways, a valuation of this kind, kept up to date by appropriate accounting, will be of the greatest benefit. But the " physical " or engineering valuation itself will not answer the question of what is a fair value. Shall the "cost new" or the "depreciated value" be taken? To what extent shall an intangible or " going " value be recognized? No answer of universal application can be given to these ques- tions, but it may safely be said that when a depreciation fund has been accrued through annual charges to operating expenses, the amount of such depreciation must be deducted from the cost new. It is sometimes said that if we deduct depreciation we must also add appreciation, but this is taken into account in the method by which valuations are usually made, that is, where real estate is valued according to the selling price of neighboring lands. It is extremely doubtful whether any going or intangible value should be recognized. To do this might amount to re- warding a railroad for becoming a monopoly. The case is some- what different from that of a manufacturing establishment where its " good- will " may frequently be developed by superior skill in the face of competition. Relative Rates. — When the general level of rates has been determined we are confronted by the question of what should be charged for each particular shipment, and here we find the appli- cation of the principle of expense of still greater difiiculty and un- certainty. In attempting to say what it costs to carry a ton of coal a mile, we find that a large part of the expenditure is incurred, not for one specific kind of comm.odity, but jointly for many kinds. The roadbed, ties, and rails are maintained, not for coal cars alone, but for passenger trains as well. Even with the most careful bookkeeping it is possible to trace a direct causal connection between only a part of the expenses and specific portions of the traffic. It is possible to say that a certain traffic 5'68 OUTLINES OF ECONOMICS requires a certain amount of extra labor and fuel, and causes a certain amount of wear and tear, and clearly such traffic should normally pay enough to meet these expenses at least, if we wish to prevent waste. But what shall be done with such joint ex- penditures as fall under the head of maintenance of way ? Shall they be charged to the freight or to the passenger services ? The prevailing opinion has been that the cost of carrying a specific shipment cannot be determined with sufficient accuracy for any useful purpose because the element of " joint expense " is said to be a prominent characteristic of the production of railway serv- ices. In 1894 the National Association of Railroad Commis- sioners and the Interstate Commerce Commission indorsed the view that railroads should not be required to separate the operating expenses of their freight and passenger services. Since that time there has been a great development among manufac- turing enterprises of what is known as cost accounting, which is concerned with the apportionment of the total expenses of a factory among its several products. This has been found use- ful both in matters connected with the fixing of prices and in determining the efficiency of the various departments of an enterprise. Statistics of this kind were also developed by some railway managements, but little use was made of them in de- termining rates. In 1907 the railroad commission of Wiscon- sin gave an impetus to railway cost accounting by its opinion in the case of Buel vs. C. M. and St. P. Railway, where the reasonableness of a passenger rate of three cents a mile had been questioned. A complete apportionment was made of the expenditures of this railroad between its freight and passenger services. In 19 14 the Interstate Commerce Commission recon- sidered the whole matter, and after a public hearing decided that in the future railways must report their operating expenses sepa- rately for freight and passenger services according to bases to be prescribed by the commission.^ Is there a sound theoretical basis for this newer development ? This is a controverted point in economic theory and a full dis- cussion cannot be given here. What has been said in Chapter 1 In the AI alter of the Separation of Operating Expenses (30 1. C. C. Reports, 676). TRANSPORTATION ECONOMICS 569 XI regarding constant and variable expenses and joint expenses of production should be reviewed in this connection. Within certain limits an increase in the volume of railway traffic results in a lower average outgo per unit of product because certain items, such as maintenance of way and the interest on the in- vestment in the roadway, do not grow as rapidly as the traffic, not to mention other economies. As railways can classify their traffic by commodities and points of origin and destination, it will pay to make low rates on traffic which would not otherwise be secured. But it is superficial to stop with the analysis at this point. As traffic increases the tracks and bridges are strength- ened and additional tracks are added. In the long run the amount of the investment is markedly aflEected by the volume of traffic; that is, in the long run there is a causal connection be- tween growth in volume of traffic and growth in maintenance and interest charges, and this is the theoretical basis for attempt- ing to distribute transportation and equipment expenses and at least a part of the maintenance and interest charges to specific services. As a matter of fact, over 70 per cent of all of the operating expenses can be 'directly assigned to freight service or to passenger service without arbitrary apportionments, when the accounting is arranged for that purpose, and a considerable part of the investment can also be directly assigned to one serv- ice or to the other. The kind of expenses which can be dis- tinguished as between freight trains and passenger trains can also logically be distinguished as between different classes of freight trains, so that the cost of hauling a trainload, a carload, or even a ton of freight a mile can be approximated. If any class of freight traffic or passenger traffic cannot bear the operating expenses and interest charges attributable to that class of traffic, it is not profitable traffic. It is worth noting that the variety of railway services is not nearly so great as might be imagined from the multiplicity of rates in existence. Freight transportation consists in moving a mass of material in freight cars, and from the cost standpoint it makes little difference whether we call the material sand, cement, or iron ore. The fact that commodities vary in bulk 570 OUTLINES OF ECONOMICS as compared with their weight is not an insuperable difficulty in comparing their costs of transportation. Forty tons of coal can be loaded in one car while forty tons of bird cages might re- quire forty cars, but the train resistance caused by a car and contents in each case can be measured approximately. While greater emphasis may in the future be laid on the cost principle, rates will doubtless continue to be based to a very large degree on the principle of " charging what the traffic will bear." Whether because of past commercial developments or for reasons of public policy, some traffic will be carried at rates less than those indicated by cost considerations, and this means that other traffic will have to bear rates higher than those indicated by considerations of cost. Some of the expenses of every railroad, varying in some degree with its stage of develop- ment, may even in the long run be regarded as independent of the traffic, and such expenses should be distributed over such traffic as can best bear them. In the construction of freight classifications, the value of a commodity itself is given con- sideration as a measure of what the traffic can bear or of the " value of the service," but it is clear that this is not an exact measure. Distance. — A most perplexing factor in rate making is that of distance. In actual practice, distance has been to a very large degree ignored. For example, in group rates, the same charge is made to a common market from any point within a certain area, irrespective of the length of the haul. In the basing-point system, the rates to small towns in a certain region will not vary accord- ing to the distance from the point of shipment, but are found by adding together the rate to a railway center, called a basing point, and the local rate from this basing point to the small town, even though the town be nearer than the basing point to the original point of shipment. Again, goods brought from a for- eign country to a point in the interior may be given a rate lower than the domestic rate from the point of entry to the same point in the interior. Again, goods intended for export sent from Chi- cago to New York may pa,y less than those intended for use in New York. Goods are sent to San Francisco from New York TRANSPORTATION ECONOMICS 57 1 for less than the rate from many points west of the Mississippi River to San Francisco. '^ These conditions have largely grown out of the competition of railways among themselves and with waterways. The fact that distance is one element in the expense of carriage suggests that it should be taken account of in making rates, although there are many circumstances which necessitate a de- parture from the rule of a strict mileage rate. The fact that terminal charges, for example, are the same for a long as for a short haul justifies a decrease in the total charge per ton mile as distance grows. The great advantage of following a schedule of rates based on distance is that it affords some basis, although not an absolute guide, for settling sectional disputes concerning relative railway charges. . Government Ownership or Government Regulation ? — With the decline of competition in the railway business, the alternative lies between private operation with government supervision on the one hand, and government ownership and operation on the other. There cannot be said to be any well-defined movement for government ownership in the United States. Socialists favor it as a step in the direction of their ideals, but conservative persons also have recognized that the difficulty of regulating railroads with sufficient stringency to prevent abuses and at the same time with sufficient freedom given to railway managements to develop their properties in the most efficient manner may make governnient ownership inevitable. No convincing argument for either side of this question can be made by comparing the quality of railroad service and the rates charged in countries that have government ownership with the service and rates of railways privately owned and managed. There is little question that government ownership is feasible in this country and that good service might be expected. Greater pains might be taken to consider public convenience, and labor conditions might be improved for the lower classes of employees. 1 See City of Spokane v. Northern Pacific Railway Co., 21 I. C. C. 400 and 23 I. C. C. 454; United States v. Union Pacific Railroad Co., 234 U. S. 405 ; Commod- ity Rates to Pacific Coast Terminals and Intermediate Points, 32 I. C. C. 611. 572 OUTLINES OF ECONOMICS Personal discrimination might be expected to cease altogether. It has been suggested that rates could be reduced because, owing to the superior credit of the United States government, capital could be secured at a lower rate of interest. But it is difficult to tell to what extent the credit of the government might be adversely affected by the issue of sufficient bonds to purchase the railways of this country. There might be economies in the elimination of some of the expenses due to the efforts of railways to get traffic away from each other, to roundabout hauls, and to useless duplication of facilities. The political consequences might be unfavorable. It would be unfortunate to have sectional disputes as to rates thrown into politics. Railroad extensions might become " pork," like our river and harbor improvements. The voting power of railway employees might be sought by politicians by promises of improved conditions of work. A most serious consideration is the question of efficiency of management. A private and a public monopoly alike may be- come unprogressive. It may be that our system of regulation can be so developed that it will serve at once as a check upon abuses and as a stimulus to efiiciency. It is not always best to decide today what can as well be decided tomorrow. • Whether or not government ownership is coming, the perfection of the govern- ment control of our private railways would seem to be the wisest next step. Government regulation has already accomplished much in the United States. It has nearly eliminated rebates and personal discrimination ; it has given stability to rates ; it has strengthened railway credit ; it has promoted uniformity in accounting ; it has shown that it can raise rates as well as lower them and that it can settle sectional disputes as to rates in a com- prehensive way. There still remains the task of determining the amount of railway investment entitled to a return, of devising a proper control over capitalization, of perfecting the rate system, and of working out comparative standards of effi- ciency. We may well hope that government ownership will at least be deferred until more has been accomplished along these lines. TRANSPORTATION ECONOMICS 573 Government Regulation of Railways in the United States. — Railway corporations in the United States are almost all organ- ized under the laws of the separate states. Formerly special laws were passed when a railway company was to be formed, but at the present time there are general laws specifying what con- ditions must be complied with in order that a number of persons may organize a railway corporation. The separate states have imposed a number of regulations and restrictions not only on the. companies which they have chartered but also on others doing business within their borders. These relate to the safety and the comfort of passengers, train service, consolidations, pooling, ticket-scalping, discriminations between shippers and places, the issue of securities, and reasonableness of charges. Railway or public service commissions are found in all but a few states. That a railway corporation is subject to government regulation in the interest of the public welfare has been clearly established by a long line of judicial decisions beginning with the leading " Granger " case of Munn vs. Illinois} But the authority of the state governments has been greatly limited by two provisions in the federal Constitution. Congress having been given control over interstate commerce, the states must confine themselves in their regulations to commerce wholly within the state. And the Fourteenth Amendment declares that no state shall deprive any person of life, liberty, or property without due process of law or deny to any person within its jurisdiction the equal protec- tion of the law. The courts have interpreted this provision to mean that neither a state legislature nor a commission created by it can fix rates even on w/rastate traffic without a review by the courts. The courts have often declared rate legislation by states void on the ground that it confiscated the property of the stockholders.^ Federal regulation of railways is based on the Interstate Commerce Act of 1887, which has been repeatedly amended, most extensively in 1906 and 19 10. The following is a summary of the amended act, as in force in 1916 : 1 94 U.S. 113(1876). 2 The Fifth Amendment imposes similar limitations upon the federal government. 574 OUTLINES OF ECONOMICS The Interstate Commerce Commission consists of seven mem- bers appointed by the President with the " advice and consent " of the Senate, with terms of seven years, not more than four of the commissioners being from the same political party. The jurisdiction of the commission extends not only over steam rail- ways but also over electric railways, telegraph, telephone, and cable companies, pipe lines, express and sleeping car companies, and to some extent over water carriers. The control in these cases extends to interstate traffic merely. All charges and practices must be reasonable, but no general standards of reasonableness have been prescribed by Congress. Certain specific things are prohibited. There can be no dis- crimination between persons or places and no free passes or free transportation except to classes of persons specified in the act. The giving of rebates renders both shipper and carrier liable to punishment. Pooling is prohibited, and no railway may have any interest in any competing water carrier. When rates have been reduced to meet water competition they may not be raised again without permission. No common carrier may make any greater charge for a shorter than for a longer dis- tance in the same direction, the shorter being included within the longer, unless authorized to do so by the commission. Carriers must file with the commission copies of all their rates and fares, and no carrier may make charges different from these published rates. Changes in rates require thirty days' notice unless a shorter time is permitted by the commission. The commission may suspend rates for a period of 120 days and a further period of six months. Any person may make a complaint regarding rates or prac- tices and the commission may institute inquiries on its own mo- tion. It has power to fix maximum rates for a period of two years and may award reparation to shippers who have been overcharged. The orders of the commission may be reviewed by the courts as to questions of law but not as to findings of fact. A Commerce Court was created in 19 10 to hear appeals from the commission's orders but this court was abolished in 1913, its jurisdiction being vested in the several district courts. TRANSPORTATION ECONOMICS 575 Section 20 of the act empowers the commission to require annual and special reports from transportation companies and to prescribe the form of the accounts which may be kept. Under this provision uniform classifications of accounts have been worked out in cooperation with railway accountants. In 19 13 Congress directed the commission to ascertain the value of all the property of every common carrier subject to the act. As to every piece of property there is to be ascertained the original cost to date, the cost of reproduction new, the cost of reproduction less depreciation, and other values, if any. In 1 9 14 the commission was given authority to enforce the Clayton Anti- trust Act so far as it applies to common carriers. The main purpose of this part of the act is to prevent those inter- corporate relationships which tend to lessen competition. The commission is also charged with the enforcements of safety appliance and boile: inspection provisions and with matters relating to hours of service of employees and to railway accidents. The Interstate Commerce Commission regularly employs about 700 persons, but the work of valuation has temporarily greatly increased this number. A general survey of its work each year is given in its Annual Report to Congress. Its 30 or more volumes of decisions, published as the Inter- state Conunerce Commission Reports, contain a vast amount of descriptive material concerning the rate structures and the practices of railways in the United States. Information concerning the mileage, capitalization, reve- nues, expenses, and traffic of railways will be found in its annual volume called Statistics of Railways in the United States. QUESTIONS AND EXERCISES 1. Write a description of some railway system, giving its organization, capitalization, earnings, dividends, nature of traffic, territory covered, etc. 2. Make a digest of the opinions in the Northern Securities Case, 193 U. S. 197, and the United States vs. The Union Pacific Railroad Company, 226 U. S. 61. 3. If you have paid $200 for a share of stock in a monopolistic enter- prise, have you a right to complain if government regulation so affects its earnings that the price of the share falls to $100? 4. Discuss the conflict of authority between state and federal commis- sions (Shreveport Cases, 234 U. S. 342). 576 OUTLINES OF ECONOMICS 5. Can one ascertain what it costs the railways to carry United States mails ? 6. Can the passenger service be said to be a by-product of the freight service ? 7. Compare some of the leading railways from the standpoint of density of traffic. 8. What would be the economic effects of a "postage-stamp " railway rate system, in which rates vary with the weight and nature of the shipment, but not with distance ? REFERENCES AcwoRTH, W. M. Elements of Railway Economics. Bureau of Corporations. Report on Transportation by Water, 1909, 1910. Hammond, M. B. Railway Rate Theories of the Interstate Commerce Commis- sion. Interstate Commerce Commission. Annual Reports ; I. C. C. Reports; Statistics of Railways in the United States. Johnson, E. R. American Railway Transportation ; Ocean and Inland Water Transportation : Report on Panama Canal Traffic and Tolls. Johnson, E. R., and Huebner, G. G. Railroad Traffic and Rates (2 vols.). Joint Committee on Federal Aid in the Construction of Post Roads. Re- port (1914). McPherson, L. G. Railroad Freight Rates in Relation to Industry and Commerce. Meyer, B. H. Railway Legislation in the United States, Part ii. Morris, Ray. Railroad Administration. MouLTON, H. G. Waterways versus Railways. National Waterways Commission. Report (1909). PiGou, A. C. Wealth and Welfare, Chap. xiii. Ripley. W. Z. Railroads: Rates and Regulation; and (editor) Railway Problems. Sakolski, a. M. American Railroad Economics. Chap. iii. Smith, J. R. The Ocean Carrier. Vrooman, C. S. American Railway Problems. Webb, W. L. Economics of Railroad Construction, Part i. CHAPTER XXVIII INSURANCE Nature of Insurance. — The essential idea of the modern in- stitution of insurance is cooperation in the bearing of losses which are likely to happen to any one of a large group of persons but which will actually fall upon but few members of the group. It is thus directly opposed to gambling, although wagers have fre- quently been made in the form of the insurance contract. It may appear at first that the man who insures his house is making a wager with the insurance company that his house will burn, but this is in fact like betting on both sides of an event. If the man does not insure, he may be regarded as betting that his house will not burn, and by wagering with the insurance com- pany that it will burn, he relieves himself of risk. For this relief he is willing to incur the certain loss of his premium. Insurance does not free the policy holders from loss, but it means many small losses in place of a few unbearable ones. In well-devel- oped forms of insurance there is also no risk for the insurance company, because the amount of loss is approximately known in advance, as will be explained presently. The question is sometimes asked whether insurance is pro- ductive in the sense that other economic activities are productive. The answer is decidedly in the affirmative, for the feeling of security that it makes possible is a real satisfaction which we are willing to purchase. Then too, there is a very important eco- nomic gain in distributing among many persons the burden of losses which would otherwise fall heavily upon a few. Further- more, the relief of distress among the unfortunate without com- pelling them to accept charity is a distinct social gain, and finally, many of our business operations are facilitated by the 2 1* 577 578 OUTLINES OF ECONOMICS existence of a system of insurance. Prevention of loss is not properly a part of the idea of insurance, but nevertheless insur- ance as it exists today does have many tendencies in that direction, especially in such forms as fire and steam-boiler in- surance. On the other hand, insurance causes a certain amount of loss by provoking to some extent incendiarism, self-mutilation, or suicide, and even normal persons are likely to be less careful when they know they are insured. On the whole, however, we can scarcely overestimate the importance to society of an in- stitution which equalizes economic shocks and multiplies the incentives to thrift. The Law of Probabilities. — A special profession (that of the actuary) and a special branch of mathematics have grown up as a basis of the institution of insurance. It is a knowledge of the law of large numbers that changes insurance from a wager to a business of a routine-like nature. If a coin is tossed a large num- ber of times, heads will appear about as often as tails. This may be counted upon as practically certain, but with respect to any particular throw taken by itself, there is no way of telling in ad- vance whether heads or tails will appear. This truth has been worked out and applied most definitely to life insurance, but in other business callings also an effort is made to gather data that will make possible the formulation of statistical laws as guides in making business plans. Origin and Development. — Arrangements embodying the idea of insurance are found among the ancients, but the modern institution of insurance, although its origin is obscure, first be- comes prominent in the loans on bottomry which became com- mon during the thirteenth and fourteenth centuries. A loan on bottomry meant that money was borrowed by the owner of a ship and was to be repaid with interest at the termination of his voyage, but the principal and interest were not to be repaid if the ship was lost. Sometimes this took the form of insuring the captain's life, but no scientific system of life insurance ap- peared until the compilation of life tables. Fire insurance received an impetus from the Great Fire of London in 1666, the first company organized upon strict mer- INSURANCE 579 cantile principles being the " Fire Office," organized in 1680. It had a brigade of its own to prevent and extinguish fires. In 1693 Edmund Halley made a report to the Royal Society regard- ing the mortality at various ages upon the basis of tables of births and funerals at the city of Breslau ; but, practically, life insurance as a business dates from the organization of the " Old Equitable " in 1762. Before this, however, there were many associations for conducting in- surance upon a speculative basis, which entered into wagers of every con- ceivable description. "Even the morality of the newspapers of that day was shocked by such proceedings: we find the London Chronicle of 1768 thus declaiming, 'The introduction and amazing progress of illicit gaming at Lloyd's Coffee-house, is among others, a powerful and very melancholy proof of the degeneracy of the time. Though gaming in any degree is per- verting the original and useful design of that Coffee-house, it may in some measure he excusable to speculate on the following subjects: — Mr. Wilkes being elected member for London ; which was done from 5 to 50 guineas per cent.; — Mr. Wilkes being elected member for Middlesex, from 20 to 70 guineas per cent ; — Alderman Bond's life /or one year, now doing at 7 per cent ; — On Sir J. H. [mark the modesty] being turned out in one year, now doing at 1 2 guineas per cent ; — On John Wilkes' life for one year, now doing at five per cent. N.B. — Warranted to remain in prison during that period ; — On a declaration of war with France or Spain in one year, 8 guineas per cent. But,' continues the sensitive journalist, 'when policies come to be opened on two of the first peers in Britain losing their heads at los. 6d. per cent, or on the dissolution of the present parliament within one year at 5 guineas per cent., which are now actually doing, and under- written chiefly by Scotsmen, at the above Coffee-house, it is surely high time to interfere.'" ^ In the United States, fire insurance was fairly well begun even in pre-revolutionary days. In 1830 the New York Life and Trust Company was organized, and twelve years later ap- peared the Mutual Life Insurance Company of New York, which is the oldest of the existing American life insurance com- panies which insure more than a restricted class of individuals. In the seventies numerous failures brought the " old line " life insurance companies into discredit, and in the following years this fact, together with the desire for cheap insurance, caused 1 Walford, The Insurance Guide and Handbook, 4th ed., p. 27. 580 OUTLINES OF ECONOMICS a marked development of assessment insurance, against which there has in turn been a reaction because of its unscientific basis. Subsequently the " old line " companies again suffered a loss of prestige on account of the scandalous extravagance and corrup- tion revealed by official investigations. The evil practices had to do chiefly with the management of the surplus, which was not under legal control as was the reserve. (These terms will be ex- plained presently.) The accompanying table shows the growth in American life insurance since 1850. The check in 1880 may be noted. Between 1890 and 1910 the total amount of life in- surance in force in ordinary and industrial companies increased fourfold. The average amount in force per family was $319 in 1890 and $801 in 1910. It is perhaps needless to state that the average amount per policy is much larger than this in ordinary though not in industrial insurance. The foregoing does not 'include the insurance fraternal orders, which had 10,122,169 certificates and $9,839,909,282 of insurance in force in 1911. Forms of Insurance Organization. — Fire insurance may be written by stock companies, by mutual companies, or by associa- tions of individual insurers, known as underwriters and Lloyds. Mutual companies, again, may be either local (county or town) mutuals, state or general mutiials, or the manufacturers' mutuals. The local town mutuals have the advantage that they can be conducted with a very low cost of administration, but the stock companies seem best adapted to the business of fire insurance, since it is desirable that the risk of a conflagration should be spread over a very wide territory. Life companies are also found both in the stock and mutual form. Theoretically the management of the latter is in the hands of the policy holders themselves, but in actual practice they must be managed by a small group of financiers. Life in- surance companies are also classified according to the plans of premium payments : (i) " old line " level premium, (2) assess- ment, and (3) stipulated premium. Where risk enters in modern life, companies are often organized to offer an escape from it through insurance even before enough INSURANCE 581 data have been collected to make possible the accurate predic- tion of the amount of loss. In addition to life insurance we have indemnity in case of sickness, accident, destruction by fire, wind, hail, or explosions of boilers or fly wheels, broken windows, Ntjmber of Policies and Amount of Life Insurance in Force in Ordinary and Industrial Companies, 1850 to 1912I Ordinary Industrial Calendar Year Number of Policies Amount (Dollars) Number of Policies Amount (Dollars) 1850 29,407 68,614,189 — — i860 60,000 180,000,000 — 1870 839,226 2,262,847,000 — — 1880 685,531 1,581,841,706 236,674 20,533,469 1890 i,3i9'56i 3,620,057,439 3,882,914 4^28,789,342 1895 1,940,94s 4,917.694,131 6,952,794 820,746,562 1900 3,176,051 7,093,152,380 11,219,296 1,468,928,342 1905 5,621,417 11,054,255,524 16,872,583 2,309,754,235 1910 6,954,119 13,227,213,168 23,044,162 3,179,489,541 1912 8,159,103 15,555,901,171 26,521,655 3,684,054,893 and loss from burglary or the unfaithfulness of employees. Li- ability insurance in over a dozen different forms guards against loss from damage suits. It is impossible to take up the problems that are peculiar to each one of these branches, and attention will be confined to some of the leading features of life insurance and of what is called social insurance. Life Insurance Life Tables. — A life table or mortality table shows how many of a large group of persons of the same age will survive to each higher age. A number of these tables have been calculated, but the one generally used in this country is the American Ex- perience table, a portion of which is here reproduced : 1 Statistics from the Insurance Year Book. 582 OUTLINES OF ECONOMICS Age Living at Beginning of Year Dying during the Year lO 100,000 749 II 99,25^ 746 12 98,505 743 13 97,762 740 14 97,022 737 15 96,285 735 16 95,550 732 17 94,818 729 18 94,089 727 19 93,362 725 * * * 90 847 38s 91 462 246 92 2X6 137 93 79 S8 94 21 18 95 3 3 With such data and with an assumed rate of interest and ex- pense, it is possible to say with considerable certainty how much money must annually be collected from the policy holders in order to pay each one $1000 or other specified sum at death. Premium Plans. — It would be possible to collect from those surviving at each age enough money to pay for the deaths that would happen during the ensuing year. This step rate or natural premium plan necessitates a larger and larger assessment with advancing age ; that is, as the earning power of the insured is declining. This induces many persons who continue in good health to discontinue their insurance, thus leaving only an " ad- verse selections of risks " for the insurance company or associ- ation. It has become customary to arrange the payments on what is known as the level premium plan, the same annual pay- ment being made throughout the life of the policy. This pay- ment may be on the ordinary life plan, that is, the payments continue throughout life ; or ten, fifteen, or twenty limited pay- ments may be made, the policy continuing in force for life; INSURANCE 583 or the insurance may be for only a term of years during which the premiums are paid, the insurance ceasing entirely at the end of the term. This is the cheapest kind of insurance, for the insurance company knows that many of the insured will survive beyond the term, and to them no payment need be made, but when the insurance continues for life, the payment becomes a certainty in every case. The Reserve. — If a level premium is charged, the income of the company in the earlier years of a policy exceeds the expense of carrying the risk, as measured by the losses on account of the deaths among the policy holders of like age. The portions of the premium not currently used must be held for the credit of the policy holder until the later years, a certain rate of interest being allowed. This accumulating fund is known as the reserve. In the later years of the life of a policy, the reserve is gradually drawn upon to meet the deficit arising from the fact that in these years the level premium payments will be insufficient to meet the cost of carrying the risk, — smaller, that is, than they would have been under the step rate or natural premium plan. Surplus. — If the insured live longer than was assumed by the company in calculating its premiums, more money will be collected than is necessary to meet the obligations of the insur- ance contracts. This is one source of surplus. Again, the funds held in trust by the company may be invested at a higher rate of interest than was assumed in the calculations, and this is a second source of surplus. A third source of surplus is in keep- ing expenses below what was assumed in the calculations. (The addition which is made to the net premium to cover expenses is called "loading," and is commonly not far from a fourth of the gross premium.) The amounts paid in by those who subse- quently lapse or surrender their policies do not all go to the surplus, for it is customary now to allow "surrender values" and "paid-up insurance " ; but as these allowances are subject to a surrender charge, there is some addition to the surplus from the surrendered or lapsed policies. Out of the surplus are paid the dividends on the capital stock, if there be any,, and the dividends to each policy holder, which in some cases are 584 OUTLINES OF ECONOMICS credited or paid annually to each policy holder, but in other cases not until the expiration of a period of years. . Endowments. — What is ordinarily called an endowment policy is a combination of two distinct forms of contract. A simple life insurance contract promises to pay a certain sum upon the death of the insured ; a pure endowment contract would pay a certain sum if the holder of the policy survives after a period of years. A twenty-year endowment insurance policy combining these two features means that payment would be made at death if that occurred within the twenty years, or at the expiration of twenty years if the policy holder survives. This form of policy has been declining in popularity because in its ordinary form it is disadvantageous to the policy holder, unless he be so thriftless that he cannot be induced to save in any other way. If insurance could not be obtained in any other way, it might be wise to purchase such a policy, but the- objects of saving and insuring can be more cheaply accomplished by separating the two features. If, instead of paying $50 for an endowment policy , the holder paid part of this for term insurance and put the remainder in a savings bank at three or four per cent Compound interest, there might be more to his credit whether he lived or died. But when the loading is properly arranged, and v/ith an annual distribution of surplus, the endowment policy performs a useful function as an encouragement of thrift. In fact, a very long-term endowment maturing at, say, age sixty- five, would best meet the needs of a great many persons. Many others, feeling that they lack the necessary determination to save regularly a portion of their incomes in the ordinary way, find the endowment policy a useful form of " compulsory saving." These points will be made clearer by the following illustration of what becomes of the premium in the case of a ten-year endow- ment policy at age thirty-five with a premium of $107.70, when it is assumed that the mortality will be in accordance with the American Experience Table, that the company will earn three per cent on its funds, and that the expense charged each year to this policy will be as given in the table. ^ ^ Report of the Wisconsin Joint Legislative Investigating Committee, 1906, p. 153. INSURANCE 585 Policy Year Expense Charge Mortality Charge Deposit I $ 18.40 $7.96 $ 81.34 2 18.40 7-31 165-77 3 18.40 6.62 253-42 4 18.40 5-89 344-43 5 18.40 5.10 438.96 6 18.40 4.26 537-17 7 18.40 3-32 639.27 8 18.40 2.32 745-43 9 18.40 1. 21 855-89 10 18.40 — 970.87 Totals $ 184.00 $43-99 Industrial Insurance. — The business of insuring the lives of workingmen in this country is characterized by the small size of the average policy, the large number of lapses, and the heavy expense of solicitation. The companies say that the working- man is so thriftless that it is necessary to collect the premiums through a house-to-house canvass by agents. The hesitancy shown by workingmen to insure in these companies is considered by some persons, however, as an evidence of their thrift. Which is the correct view may be shown by the results of an experiment which is now being tried in the state of Massachusetts. Savings banks have been authorized to organize insurance departments and to sell life insurance, but without employing paid agents or solicitors. The state bears the actuarial, medical, and certain other expenses. The workingman is expected to go of his own accord to the bank or to one of the agencies at convenient places. The whole system is supervised by a state actuary and a state medical director, and the safety of the plan is assured by a guar- antee fund. Three forms of policies, limited to $500 each, are provided for : ordinary life insurance, endowment, and a com- bination of life insurance and old-age annuity. The plan has met with some success, but is still in an experimental stage. State Insurance. — Insurance is well adapted to direct man- agement by the State because the actual conduct of the business 586 OUTLINES OF ECONOMICS is of a relatively simple and routine character and because the State can offer greater security and can command greater confi- dence than is possible in the case of a private corporation. Com- petition has had the effect of causing rival companies to invent many outwardly attractive combinations of policy conditions, but on the whole it has increased rather than decreased the ex- pense of doing the business. When the State enters the field simply as an additional competitor, as in New Zealand, its full advantage is not apparent ; but if it has a monopoly of the busi- ness and compels every one to insure, it can perhaps, without any selection of risks, effect the insurance at a lower price than is asked by any existing private company.^ In 1913 the state of Wisconsin began the sale of life insurance. The main object of the law is the reduction in the cost of insurance by reducing the expense of solicitation and administration. The credit of the state is involved only to the extent of the life fund created by the insurance act. In Italy life insurance is a state monopoly. State Regulation. — Following the example of Massachusetts in 1858, other states have appointed insurance commissioners for the supervision of this business, and the insurance laws of a single one of these states are now sufficient to make a good- sized volume. Insurance companies have found this variety of control irksome and have generally advocated federal control of insurance. Although something would be gained, it cannot be said that there is any great need of federal control of life insur- ance, not to mention the constitutional difficulties, because it is not absolutely necessary, as in transport or fire insurance, that one life company do business in many states, and the people of each state should have the power to say what kind of insurance institutions they desire to have. An enumeration of the requirements in the state of New York will illustrate the nature of state regulation : A certificate of authorization must be obtained from the Superintendent of In- surance and a deposit of securities must be made. A minimum capital stock is prescribed and regulations are made concerning 1 Consult the article by M. M. Dawson in Bliss, Encyclopedia of Social Reform, new ed., p. 637. INSURANCE 587 the investment of stock and surplus. There are also provisions relating to standards of solvency, reinsurance, limitation of risks, admission of foreign companies, examination of accounts, and annual reports. The policy must contain the entire contract, and the statements are to be taken as representations and not warranties. No misleading estimates and deceptive statements are to be issued for the purpose of getting business. Life insur- ance companies are to do either a participating or non-partici- pating business, and in the former case the surplus must be an- nually apportioned and paid to each policy. There are further provisions regarding the valuation of policies, surrender values, discrimination, election of directors, limitation of the amount of new business each year, limitations as to expenses and salaries of officers, and standard forms of policies are prescribed for both life and fire insurance. Social Insurance Social Insurance Defined. — Social insurance refers to those insurance or quasi-insurance institutions which are organized by the state to alleviate the distress which is likely to fall upon the poorer classes as a result of accident, sickness, invalidity, old age, unemployment, and the premature death of the chief wage earner of the family. All insurance is obviously social in the sense that it implies cooperation on the part of many persons and is subject to extensive state regulation, but what is called social insurance implies the activity of the state far be- yond mere regulation. It is true that private activity has done much in the direction of workingmen's insurance, but it is be- cause these efforts have proved inadequate that the movement for social insurance has gathered force. It is to be distinguished from poor relief in that it recognizes that the normally thrifty wage earner cannot purchase adequate life and accident insur- ance from private commercial companies and that the respon- sibility rests on society to provide that which it is impossible for the individual to provide. It endeavors by insurance methods to provide in advance for the coming of the evil day, so that the 588 OUTLINES OF ECONOMICS benefits paid will be received, not as a matter of charity, but as a matter of right. Compensation for Industrial Accidents. — In the United States social insurance has begun its development in connection with the problem of industrial accidents. Under the common law, the employer is not responsible to an employee injured while at work if a reasonably safe place to work has been fur- nished. Even if the employer is at fault, there is no redress if there has been contributory negligence on the part of the em- ployee or one of his fellow servants or if the accident happens without negligence that can be traced to any particular person. This law of negligence has generally been modified by legis- lation designed to increase the responsibility of the employer, as, for example, by the restriction or elimination of the fellow ser- vant doctrine.^ While employees have sometimes been able to secure damages amounting to small fortunes, the general result of this legal system is that in the vast majority of cases only small damages or none at all are secured, or, if secured, they are in large part offset by the cost of litigation. The liability of the employer, however, is a serious matter to him, and an ex- pensive system of employers' liability insurance has grown up. The more severe the modifications in the law of negligence be- come, the higher are the rates imposed by the liability com- panies. Such is the expense of conducting this business that it is safe to say that less than one half of the money paid for em- ployers' liability insurance premiums ever reaches the injured employees in damages. While labor leaders were drafting bills designed to increase still further the liability of employers, attention was turned to European practice, where the view had come to prevail that it is useless to try to locate the responsibility for accidents, except for purposes of preventing them in the future, and that if a workman is injured in the course of his employment, he should be promptly assisted, even if he had been negligent. Accidents were looked upon as a trade risk against which the workingman should be adequately insured. ^ See Chapter xxiii. INSURANCE 589 The result was that in the years following 1910a wave of work- men's compensation legislation swept over our northern and western states. By the end of 1914 over one half of our states had enacted compensation for accident laws. The federal government had in 1908 established a system of compensation for industrial accidents for the majority of its industrial em- ployees. During the first five years of its operation $1,804,000 was paid out as compensation, nearly one half of which was paid to employees of the Isthmian Canal Commission. The law did not abolish the criterion of negligence, as according to its terms accidents resulting from the misconduct or negligence of the injured person are not compensated. The amount of compensation is the injured workman's wages during disability, not exceeding one year, or in fatal cases, an amount equal to one year's wages. In other respects also the law does not conform to an ideal compensation law and efforts have been made to amend it.^ The provisions of the various state laws differ greatly in de- tail, but it may be said that in general they provide for definite payments to injured workmen in hazardous employments, prac- tically regardless of negligence and almost universally at the expense of the employer. In some states the law is compul- sory, that is, the employer engaged in the industries covered must pay the compensation specified and must insure himself against the liability. In other states the law is nominally op- tional, the employer and employee being free to remain under the old law of negligence, but an inducement is given to them to choose the new compensation method by providing that if either does not accept it, he is put to certain disadvantages under the law of negligence. The purpose of this roundabout method (not always successful) of securing compliance is" to overcome the difficulty that under our constitutional guarantees of freedom a direct compulsion might not be sanctioned by our courts, while the modification of the law of negligence is well established by precedent. The following are the standards (abridged) recommended by 1 Bulletin of the Bureau of Labor Statistics, No. 155, p. 77. S90 OUTLINES OF ECONOMICS > American Association for Labor Legislation for workmen's compensation laws : ^ 1. As to the scale of compensation: Medical attendance should be furnished. No compensation should be paid for a definite period at the beginning of disability, the period being not less than three nor more than seven days. The disabled workman should receive during total disability 66f per cent of wages, not to exceed $20.00 a week and not less than $5.00, In case of partial disability the compensation is based on loss of earning power. In case of death, the employer should be required to pay funeral expenses, and the widow, if living with the decedent at the time of his death, or if dependent, should be granted 35 per cent of his wages until her death or re-marriage, with a lump sum on re-marriage equal to two years' compensa- tion. Compensation may also be given to other dependents. 2. The general argument for compensation applies to all employments, but practical considerations may justify the tem- porary exclusion of farm labor, domestic servants (except in connection with hotels and restaurants) and casual employ- ment not carried on for the profit of the employer. 3. Compensation should be provided for all personal injuries in the course of employment, and death resulting therefrom in six years, but no compensation should be allowed where the injury is occasioned by the wilful intention of the employee to bring about the injury or death of himself or another. The act should embrace occupational diseases which, when con- tracted in the course of employment, should be considered personal injuries for which compensation shall be payable. 4. Compensation should be the exclusive remedy; that is, the workman should not be given the option of bringing suit under the law of negligence. 5. Employers should be required to insure their compensation liability. Employers may maintain their own insurance fund under certain conditions, insure in a mutual association, in a state insurance fund, or in a private stock company. 6. An accident board should be maintained by the state, ^American Labor Legislation Review, vol. iv, p. 585. INSURANCE 591 the members of which should devote their entire time to the administration of the compensation law. 7. Provision should be made for the settlement of compen- sation claims either by agreement subject to the approval of the accident board, or if no agreement is reached, by arbitration, with an appeal to the accident board. Appeals from the decrees of the accident board should be allowed only on questions of law. 8. Provision should be made for full and accurate reports of all industrial accidents. Occupational diseases are not included by the compensation laws of the several states, although the Supreme Court of Massa- chusetts has construed such diseases to be injuries entitling the employee to compensation. In Michigan, however, the con- trary view has been taken. Sickness Insurance. — Compulsory sickness insurance has been introduced in about one half of the large countries of Europe and voluntary subsidized sickness insurance in others, but we have so far left practically everything in this direction to private effort, although there are state miners' hospitals in five states and the federal government conducts a hospital service for seamen. Many students of the subject believe that sickness insurance will never be made effective unless it is made compulsory. It is significant that Great Britain, where the tradi- tions, as in the United States, are against compulsion, made sickness insurance compulsory by the act of 191 1. The major- ity of workers, by virtue of being employed, are assured certain benefits in case of illness, the cost of the insurance being met partly by the government, partly by the employer, and partly by deduction from the employees' wages. In Germany, where a system of compulsory sickness insurance was established as early as 1883, one third of the cost is borne by the employers and two thirds by the employees. The sickness insurance benefits in that country cover also the care in whole or in part for the first thirteen weeks of those injured as the result of industrial acci- dents, after which time the accident benefits are paid wholly from accident insurance funds, and include maternity benefits, fu- neral benefits, and sometimes sick benefits for the members of the 592 OUTLINES OF ECONOMICS family other than the insured. Maternity benefits were added in England by an amendment in 19 13. We have need for simi- lar laws in this country and the framing of such laws may be looked upon as the next step in social insurance here. Old Age Insurance. — We are familiar in the United States with a pension system growing out of past wars and with local pensions for firemen and policemen. Other countries have provided in a much more general way by pensions, subsidized voluntary insurance, or by compulsory insurance for the relief of persons incapacitated by old age. Invalidity and old age insur- ance is one of the three great branches of the German insurance system. It covers the great majority of the wage earners of both sexes. There are contributions in equal amounts by the insured workmen and their employers and a yearly addition is made to each pension by the government. The English law of 1908, on the other hand, provides for a straight pension to per- sons 70 years of age or over whose incomes are below $153 a .year and who have not certain disqualifications mentioned in the act. The amount paid varies from 24 cents to $1.20 a week. The British system resembles poor relief more closely than insur- ance. For years an attempt has been made to induce the United States government to adopt an old age pensions system for its employees, but there has been radical difference of opinion as to whether such a system should be with or without contributions by employees. In this, as in the more general problem, a non- contributory pension may be the more advisable at the start, but a contributory old age insurance system is doubtless more desirable as permitting of more liberal incomes and as en- couraging thrift. Unemployment Insurance. — The solution of the problem of unemployment involves much more than insurance. The progress of industry should be made less irregular and men and opportunities for work should be brought together more readily. Attention is being turned at present in the United States to the establishment of a national system of labor exchanges. It is not to be expected, however, that unemployment can be elimi- nated. It is a misfortune which should be provided against by INSURANCE 593 insurance. Many European cities have made experiments in this field which have left much doubt as to the practicability of insurance as a general remedy for the evil of unemployment. But the British National Insurance Act of 191 1 has instituted a great experiment which is tending to remove this doubt. By that act persons engaged in building, construction of railroads, docks, or canals, shipbuilding, iron-founding, construction of vehicles, and saw-milling are entitled to receive unemployment benefits. About a quarter of a million of persons are covered by the act. The cost of this insurance is met by contributions from employers and employees and partly from appropriations by Parliament. Life Insurance for Workingmen. — Our private life insurance companies are selling a good many policies which are pay- able, not as lump sums, but in installments or annuities, to the survivors of the insured. Wage earners cannot often afford to purchase such policies, but the same object is to some extent attained by widows' and orphans' pensions. Beginning with 191 2 such pensions have been made a part of the German in- surance system. In the United States many state laws have recently been enacted providing for pensions to mothers in need of relief. While these American acts are to be viewed as a form of poor relief, they are significant as possible forerunners of a comprehensive system of workingmen's life insurance. Objections to Social Insurance. — Aside from questions of constitutional law, social insurance is met with the following difficulties : (i) It implies a considerable addition to the wages bill and it has been urged that it is unfair to place this burden on the employers of one state unless similar burdens are placed on employers of other states. (2) It is contrary to the eco- nomic philosophy of those who wish to see state activity reduced to a minimum. (3) It has been charged that social insurance discourages thrift and that it leads to demoralization because it encourages malingering and staying at home for trivial ailments. Cases are cited in which a maternity benefit was spent on liquor by the husband, and one man is said to have spent the maternity benefit in the purchase of a graphophone. It should be noted, 2Q 594 OUTLINES OF ECONOMICS however, that all insurance is subject to abuse. Who would question the beneficence of fire insurance because it leads in some cases to incendiarism? Fire insurance companies do a good deal in the way of fire prevention. Similarly, not the least important aspect of social insurance is its relation to the conservation of the national health. The employers' associa- tions in Germany organized for accident compensation have done much for accident prevention, and a system of sickness insurance gives timely medical and adequate care to many who now waste their money on patent medicines. QUESTIONS 1. Define insurance. 2. What is a mortality table? 3. How would you find the premium for insuring a group of persons for one year for $1000 each? 4. Distinguish between reserve and surplus. 5. What is a "pure" endowment policy? 6. What are the advantages and disadvantages of assessment insurance ? 7. What has been New Zealand's experience with State insurance? 8. What is meant by the "moral hazard"? 9. What are tontine policies? 10. Why is the " fellow-servant doctrine" not suited to modern con- ditions ? 11. Discuss the possible effects of social insurance on wages. 12. Are old-age pensions a form of insurance ? REFERENCES Alexander, William. The Life Insurance Company. American Labor Legislation Revieiv: "Social Insurance," June, 1913; " Sickness Insurance," March, 1914; "Unemployment," May, 1914. Annals of the American Academy of Political and Social Science, Vol. xxvi. Dawson, M. M. The Elements of Life Insurance; The Business of Life Insurance. Dawson, W. H. Social Insurance in Germany. FOEESTER, R. F. "The British National Insurance Act," Quarterly Jour- nal of Economics, Vol. xxvi, p. 275. Frankel, L. K. and Dawson, M. M. Social Insurance in Germany. Fricke, W. A. (compiler). Insurance — A Text-hook. Gephart, W. F. Insurance and the State; Principles of Insurance {Life). Gibbon, I. G. Unemploymejit Insurance, Chap. viii. INSURANCE 595 Gow, William. Marine Insurance. HuEBNER, Solomon. Property Insurance; Life Insurance. Jack, A. F. An Introduction to the History of Life Assurance. Kitchen, F. H. The Principles and Finance of Fire Insurance. Massachusetts Commission on Old Age Pensions, Annuities, and Insurance. Report, igio. , MoiR, Henry. Life Assurance Primer. New York Insurance Investigating Committee. Report, 1905 (6 vols.). RuBiNOW, I. M. Social Insurance. Seager, H. R. Social Insurance. The Insurance Year Book, Annual (2 vols.) United States Bureau of Labor Statistics. Bulletin, Nos. loi, 102, 103, 107, 109, 126, and 155. United States Commissioner of Labor. Twenty-fourth Annual Report. Walford, Cornelius. The Insurance Guide and Handbook. Wisconsin Insurance Investigating Committee. Report, 1906. Yale Readings on Insurance (2 vols.) Zartman, L. W. The Investments of Life Insurance Companies. CHAPTER XXIX AGRICULTURAL PROBLEMS The socialistic ideal of a highly centralized and delicately- coordinated industrial system, discussed in the following chap- ter, is confronted with a sharp contrast in the agricultural in- dustry as it exists to-day. Even in the most advanced coun- tries, agriculture is still strikingly decentralized, and furnishes at once the best illustration and the most fertile source of economic individualism. Even in this country, where the movement of industrial consolidation has proceeded with un- usual rapidity, agriculture has never been, and shows little tendency to become, a large-scale industry. The principal statistical evidence bearing upon this aspect of American agri- culture is presented in Table I, on the following page. Size of Farms. — So magnificent was the public domain of the United States that for many generations the number of farms increased more rapidly than the population and much more rapidly than the rural population. Between 1850 and 1910, for instance, the number of farms increased more rapidly than the population in four of the six decades. But such a movement could not continue indefinitely, and in recent years the relative number of farms has slightly fallen off. Even to- day, however, as shown in the last column of Table I, there is a larger acreage of improved farm land per capita than there was in 1850, and despite the rapid increase of population between 1900 and 1910, the increase in the amount of improved farm land almost kept pace. This steady increase in the number of farms and farmers could only have been maintained by a general diminution in the aver- age size of the farm. From 1850 to 1910 the average number of acres per farm decreased from 203 to 138, while the acreage 596 AGRICULTURAL PROBLEMS 597 w o <; fA 1— 1 ^ w < 1-1 g < H H y, w o ih; -u w u Average PER Capita (based on total popu- lation) Im- proved land in farms M lo r>« J>. Ch c^ On lO lO uo liO tJ- uo ■ H as d d fo i > < Imple- ments and ma- chinery « OS M 00 M M O >0 0^ CO O O O C^ O c S 00 so so ^ C) 1 1 1 1 "2 S, e S o t« M so OS "* O^ I-' 00 t^ OS O -^ OS lO LO •^00 o> lo r^ p) cs lO CM cJ~ cf ?r CO cm" « •* CO CO 00 CO ■'t 00 T^ so CM CO so O CO T)- vo uo q^ CO qs !>• scT CO CO CO CO CO cs" Average Number of. Acres PER Farm T3 si's lO < d 3 a o o o o o o o i-i O OS OO t^ so »0 OS OS 00 00 00 00 00 598 OUTLINES OF ECONOMICS of improved land per farm has remained nearly constant. Since 1880 we have had detailed statistics for farms of different sizes. Farms of all sizes have been increasing, but the in- crease has been greatest for farms under 50 acres in size, the relative importance of which has increased steadily since 1880. The relative importance of farms over 50 acres in size has decreased. Broad statements of this kind cover a multitude of different movements and tendencies. Between 1900 and 1910, for in- stance, farms under 50 acres and from 175 to 1000 acres increased more rapidly than the total; whereas farms from 50 to 175 acres, and those over 1000 acres in extent, increased less rapidly than the total. In the North, between 1900 and 1910, farms between 20 and 100 acres in size decreased both absolutely and relatively; all others, including farms over 1000 acres, gained in relative importance. In the South, farms smaller than 100 acres increased while "those over 100 acres in size diminished in relative importance. In the West the movement was substantially the same as in the South : farms under 100 acres in size increased while all those over 100 acres in size lost ground, comparatively speaking, except the class of farms containing from 175 to 449 acres, which showed a small relative gain. In the North, particu- larly in New England, there seems to be a real increase in the number and importance of the large farms, those which in cer- tain sections would be called " gentlemen's farms " ; but this is more than counterbalanced by the partition of plantations of the South and of the cattle ranges and bonanza farms in the West. Although the average farm decreased in size between 1900 and 1910, there was a striking increase in the value of the aver- age farm and its equipment. In the last half of the nineteenth century no tendency towards the increase in capital value of the farm unit had appeared. The value of the total property and equipment of the average farm was actually lower in 1900 than in i860; and the increase in the items of implements and machinery was quite in keeping with the rapid growth in wealth AGRICULTURAL PROBLEMS 599 and income in the United States, particularly among agricul- tural laborers and farm population. But between 1900 and 1910 the situation was, in appearance at least, transformed. As one commentator has aptly said, the selling price of farm property increased by a larger amount in the first decade of the twentieth century than it did in the entire period between the landing of Columbus and the close of the nineteenth century. The average value of all farm property per farm, as shown by Table I, rose frorii $3563 in 1900 to $6444 in 1910. The in- crease was greatest in the value of the land itself. In this decade the average value per farm of all farm property in- creased 80.9 per cent; that of land alone, 96.7 per cent; farm buildings, 60.3 per cent; implements and machinery, 51.9 per cent ; farm animals, including poultry and bees, 44.4 per cent. The full significance of this striking change is difficult to ascertain. In many respects is it more apparent than real and reflects merely the depreciation in the general purchasing power of the monetary unit. Thus, the average value of farm equip- ment per farm increased in a decade from $667 to $973, only 45.9 per cent, hardly more than the general increase in prices throughout the country and probably no more than the aver- age income or ability of the typical farmer. So far as equip- ment is concerned it is probably no more difficult for the aver- age farmer to secure the required amount of equipment today than it was twenty years ago. But the total value of farm land has increased more than 100 per cent, and the value of the land in the average farm has increased nearly 100 per cent. The movement is real and exceedingly significant so far as land values are concerned. Prices of farm products have in- creased more rapidly than most other prices. This has re- flected itself in a rise in the value of farm land which is far greater than the rise in the general price level. It has become in many sections far more difficult than it used to be for the young farmer to secure a farm of his own, and in those districts tenancy has increased rapidly, while in many of them the popu- lation has actually declined. Technically speaking, therefore, there appears no significant 6oo OUTLINES OF ECONOMICS increase in the size of the unit of agricultural industry. The farm unit is not growing in the physical or material sense in which the factory may be said to be growing. There is no consolidation or concentration such as we find in the manufac- turing industries. But the amount of capital represented by the farm unit has increased strikingly in the last few years and probably much more rapidly than the average wealth or in- come of the farm population.^ So much for the size of the farm as it is ; the next question concerns the size of the farm as it should be. Would the pros- perity of the agricultural classes and the general welfare be in- creased by expanding or reducing the farm unit, by m.ore or less intensive farming? Obviously no simple answer can be given to this question. The value of the land or the rent it will bring is perhaps the most important factor : high rental value indicates that the margin of cultivation has been forced to a comparatively low point, and makes it both necessary and profitable to work the land intensively, for the same reason that the owner of a very valuable manufacturing plant is inclined to run it night and day, if possible, in order to reduce that part of the cost of pro- duction which represents fixed charges or interest on the capital that is sunk in the enterprise. In addition to the factor of rent, the amount of capital that he can command, the kind of farm- ing in which he is most skilled, the character of the labor he can secure, the proximity of markets, and the adequacy of trans- portation facilities, all must be taken into account by the in- dividual farmer in determining how large a farm he will attempt to manage and how intensively he will farm it. Speaking generally, however, two powerful but counteracting forces can be detected in the agricultural industry, which pre- vent the industry from becoming either predominantly inten- sive or predominantly extensive. On the one hand, machinery can be employed most advantageously on a comparatively large 1 "In recent years the value of farm lands has been increasing at the rate of about 5 per cent a year, or approximately $2 per acre per year." Monthly Crop Report, vol. ii, No. 4 (April 15, 1916). AGRICULTURAL PROBLEMS 6oi farm, and, other things being equal, the use of labor-saving machinery is desirable. On the other hand, the importance of labor is greater, and the importance of the manager or entre- preneur is less, in agriculture than in manufactures ; and on this account the stimulus given to the individual laborer by the sense of proprietorship is a far more potent factor in agriculture than in other industries. Large factories controlled by one entrepreneur employing hundreds of dependent workmen have proved economically superior in the manufacturing industry, because of the possibility of supervising the labor, checking and measuring its efficiency automatically. In agriculture, how- ever, technical skill remains far more important relatively to those commercial or financial talents which distinguish the successful employer than in any other great division of pro- duction. This question is primarily one of private profit, which the in- dividual must decide for himself, but the legislator and the scientific student can assist the farmer by helping him to develop and use a system of sound farm accounting, and in keeping him awake to those changes in prices, wages, and transportation charges to which the farm organization must adjust itself. On the whole, however, the emphasis is wisely placed by the aver- age educator, at the present time, upon the possibilities and opportunities of more intensive farming. In the past, exten- sive farming has been, and justifiably so, the rule in this coun- tr}^, and the force of inertia is all directed that way. But the demands of the future will be in the opposite direction. As cities multiply and the market approaches the farm, intensive farming will be forced upon the people, and the readier we are to adapt ourselves to this change, the less will be the friction and loss. Moreover, the ability to earn a living by intensive farming makes it easier to acquire a farm ; and we are strongly of the opinion, as will appear hereafter, that widely diffused ownership is better than a general system of tenancy, even where land values are high. Finally, it may be noted that practically every European coun- try attempts by legislation to increase the number of small 6o2 OUTLINES OF ECONOMICS holdings ; and in a mixed problem of this kind, which is as much psychological and social as strictly economic, the instincts of the majority are likely to have a sound social basis. Even in England, where comparatively large farming has had the greatest opportunity and the most favorable environment, the consensus of opinion seems to favor the encouragement of small holdings. English authorities maintain, as a rule, that a mixed system of large and small farms is the ideal condition, but that at present the emphasis should be placed on intensive farming. In 1889 a (British) select committee on the subject recom- mended unanimously that " the extension of a system of small holdings is a matter of national importance " ; and in 1892 Par- liament passed the Small Holdings Act which empowers county councils to purchase land and sell or lease it in small holdings. Purchasers were required to pay one fifth of the price on taking possession, and the remainder in fifty years. In the beginning the act does not appear to have been a glowing success, and by 1903 only 62 small holdings, covering 248 acres, had been sold, and 166 buildings, covering 373 acres, let. In 1907, however, a new Small Holdings and Allotments Act was passed, special commissioners were authorized to ascertain the demand for small holdings in the various counties, and county councils were authorized to acquire land compulsorily. Between the passages of this act and the end of 19 12 various county councils acquired 155,000 acres of land, all of which, except two per cent, was leased to small holders. In 1912 there were 292,720 small holdings (one to fifty acres) in England and Wales, of which 9937, or about 3 per cent, had been provided by county councils. While there is a marked difference of opinion in Great Britain on the subject, the weight of testimony and balance of opinion plainly incline towards the conclusions : (i) that an. extension of small holdings is desirable not only from the standpoint of national well-being but from that of the agricultural laborer as well ; (2) that agricultural laborers who employ farming methods suited to small holdings can make a decent living without an excessive amount of toil, in proof of which there seems to be a large unsatisfied demand for these small holdings ; (3) that small AGRICULTURAL PROBLEMS 603 holdings under private land owners are likely to decline rather than increase in numbers, owing to insecurity of tenure and high rents ; (4) and that in consequence the intelligent assistance of the government is needed to achieve the desired results.^ We would not be misunderstood. A universal system of small holdings would be good for no country, as a certain number of large farmers, assisted by abundant capital, are needed to set the pace in the improvement of agricultural methods. And in the United States, it is hoped, small holdings on the British scale will not have to be considered for many generations. But this country as well as England needs to cultivate that spirit which has made Danish agriculture, in spite of great obstacles, such a marvelous success ; and it is imperative to avoid, if we can, the growth of those conditions which have drawn so much of the best blood of rural England to the cities. Both of these objects, we believe, will be measurably advanced by the encour- agement of intensive farming. Ownership and Tenancy. — The essential facts bearing upon the subject of farm ownership and tenure are summarized in Table II, printed on the following page. Section A of the table shows that share tenancy is increasing in the United States, and that the proportion of farms operated by their owners was smaller in 19 10 than in any earlier census year. Two interpretations of this phenomenon have been ad- vanced. According to the first, which is based partially upon the statistics cited in Section B of the table, the growth of tenancy is due primarily to the increasingly rapid rise of farm laborers from the position of wage earner to that of tenant. In this view, accordingly, the increase of tenancy is encourag- ing. According to the second interpretation, based partially upon the facts presented in Sections C and E, the growth of tenancy is not an encouraging sign, and indicates that it is becoming more and more difficult to acquire ownership of land in this country. The statistics of ownership under C prove that there is a steady movement from tenancy to ownership as farmers grow older. More than 70 per cent of the farmers * Cf. The Report of the Land Enquiry Committee, vol. i, Part ii, Chap. iii. 6o4 OUTLINES OF ECONOMICS TABLE II Statistics of Farm Ownership and Farm Tenure in the United States: 1880-19 io C { D{ Per cent of farms operated by owners . . Per cent of farms operated by cash tenants Per cent of farms operated by share tenants Per cent of males employed in agriculture : Who are owners Who are tenants Who are laborers and others .... Per cent of persons owning farm homes : All ages Under 25 years 25 to 34 years 35 to 44 years 45 to 54 years 55 years and over Per cent of owners of rentedfarms who own : 1 farm 2 farms 3 and under 5 farms 5 and under 10 farms 10 and under 20 farms 20 farms and over Per cent of farm homes owned : Free Encumbered Encumbered, all ages . . Encumbered, under 25 years Encumbered, 25 to 34 years Encumbered, 35 to 44 years Encumbered, 45 to 54 years Encumbered, 55 years and over 1910 63.0 13.0 24.0 66.4 33-6 1900 64.7 I3-I 22.2 42.3 23.1 34-6 64.4 27.8 45-3 64.4 70.7 81.4 80.0 11.4 5-4 2-3 0.7 0.2 69.0 31.0 31.0 29-3 35-5 36.6 31-8 24.6 1890 71.6 lO.O 18.4 42.0 16.6 41.4 65-9 32.6 49.8. 64.0 72-3 82.2 71.8 28.2 28.2 21.9 31-9 31.8 30.2 22.6 The statistics opposite B are in the nature of estimates, a small number of female owners and tenants being included under "laborers and others." The aggre- gate percentages opposite A differ from those opposite C, owing to the fact that they were collected by different departments of the census, and apply to slightly different areas. The agricultural statistics published in the reports of the Thirteenth Census are not so detailed as those published in the reports of the Twelfth Census. AGRICULTURAL PROBLEMS 605 between 45 and 54 years of age, but only 45.3 per cent of those between 25 and 34 years of age, owned the farms which they operated in 1900. This steady advance is encouraging; but the comparison of the figures for 1900 and 1890 indicates that the rate of advance is decHning. Moreover, the statistics pre- sented in Section E show that the proportion of owned farms which were burdened with indebtedness was, for every age group, larger in 1900 than in 1890, and, in the aggregate, larger in 1910 than in 1890. The statistics presented in Table II and the two interpretations of their meaning are not, in reality, inconsistent. Tenancy is more frequent in the South Central and South Atlantic states than in other sections of the country, and more prevalent among colored farmers than any other class. Here, evidently, tenancy does represent an advance. The negroes who are tenants today were farm laborers a few years ago and slaves a half century back. On the other hand, tenancy is also prevalent and grow- ing in the richest farming district of the country, a district in which farm values are high and advancing very rapidly ; and in this district — the North Central states — there is evidence of a close though not perfect correlation between farm values and tenancy.^ There is no cause for grave alarm concerning farm tenancy in this country. Although the census of 1900 revealed one land- lord who owned 704 farms worth $4,545,230, Section D of Table II shows that 80 per cent of the landlords owned only i rented farm, and 96.8 per cent less than 5 rented farms ; while the additional fact that 78.8 per cent of the landlords lived in the same county in which their farms were located proves that absentee landlordism has not developed to any extent in this country. But we cannot regard present tendencies with all the complacency exhibited by some writers.^ For not only has it been shown that the increase of tenancy in the North Central states is probably due to the increasing difficulty of acquiring 1 See H. C. Taylor, Agricultural Economics, pp. 224-250. ' See Twelfth Census, Agriculture, Part I, pp. Ixxvii-lxxxi ; and E. L. Bogart in the Journal of Political Economy, vol. xvi, pp. 201— 211. 6o6 OUTLINES OF ECONOMICS land consequent upon advancing land values ; but tenancy is almost certain to increase as land values advance, unless the American farmer learns how to get a living from smaller hold- ings. And land values are increasing with almost startling rapidity. In the four years 1911-1915 the value of improved farm land in this country increased over 25 per cent. When land goes to $200 an acre, the average young farmer can neither save enough nor command enough credit to buy a farm of 160 acres and equip it properly. We shall have either more tenancy in the older sections of the country, as time passes, or smaller farms and a different type of agriculture. As stated above, the latter change would probably do more good than harm in the end. Our only fear is that the American farmer may not adjust himself to it rapidly enough. And it is doubtful whether we ought to derive comfort from an increase in the proportion of owners — as shown in Section B of Table II — when this increase results from an exodus of the agricultural population to the cities, which must itself be regarded with grave apprehension. Some writers explain away the increase of tenancy by dividing the agricultural class into three reservoirs, — owners, tenants, and others (presumably laborers) , — and assure us that the swelling volume of the middle reservoir is due to an increasingly rapid flow from the labor reservoir to the tenant reservoir, rather than a decreasingly rapid flow from the tenant reservoir to the reservoir of owners. But what about the flow from the labor reservoir to non-agricultural occupations? And how much of the diminution of ownership in trade and manufactures should be charged to the same move- ment of population from the country to the city? It is a condition, not a theory, confronting us, and when we start to explain this condition, it is not permissible to halt midway in the explanation. Farm Labor and Earnings. — It is not difficult to understand the " exodus from the farm " when we consider the demands which farming makes on the industry and managerial skill of the farmicr, the lure of city life, and the relatively small amount of cash which the farmer has at his command. The labor and drudgery of farm life are steadily being lightened, the income of the farmer has risen rapidly in late years, and as a recent writer tells us, " it is probably true that the farming population of the United States, consisting as it does of more than thirty AGRICULTURAL PROBLEMS 607 million people, has a larger average income per family than any other equally homogeneous group of individuals of anything like the same size anywhere in the world." But when taxes and interest on indebtedness are paid the average farm family has little actual cash to spend on amusements, and a careful estimate made by the same writer for the year 1909 " shows that after all the expenses are paid the average family has $724 of net earnings, of which $322 was earned by the capital in- vested in the farm, and $402 by the labor of the farmer and his family. These $724 of net earnings were received by the family in the following manner : $303 in cash, $35 as fuel, $125 as rent, and $261 as food furnished by the farm." ^ There can be no doubt, however, about the improvement in the conditions and wages of farm labor. The movement of farm wages since the Civil War is described statistically in Table III, following. From this it appears that farm wages were higher in the last year for which statistics are available than ever before, if we properly discount the inflated currency in which wages were paid in 1866, 1869, and 1875. Moreover, the testimony is practically unanimous to the effect that the increased use of farm machinery has not only reduced the hours of labor, but has diversified and lightened the toil of the farm hand. Added to these evidences of increasing material comfort is the reassuring fact that the farm hand retains, in a large degree, his superior social position. The native white farm laborer usually eats at the same table with his employer, shares his social diversions, and in general mixes in the same social class on terms of approximate equality. There is room, however, for much improvement. The hours of labor are long in the country, — 10 in winter, 12 in summer, 13 in harvest season, according to our latest information, — and, except on a very small number of farms, there are two or three months in the year when the laborer cannot secure full work. " The able-bodied, industrious man desirous of employ- ing his full vigor continuously finds a limitation in the average 1 E. A. Goldenweiser, "The Farmer's Income," The American Economic Review, vol. vi, pp. 46, 48. 6o8 OUTLINES OF ECONOMICS TABLE III Wages of Farm Labor in the United States for Specified Years : ^ 1866-1915 (Wages expressed in paper currency for the years 1866, 1869, 1875) Year Per Month Per Day AT Harvest Per Day Other Than Harvest Without board With board Without board With board Without board With board 191S $30.15 $21.26 $1.92 $1.56 $1.47 $1.13 1914 29.88 21.05 1.91 1-55 1-45 I-I3 1911 28.77 20.18 1-85 1.49 1.42 1.09 1910 27.50 19.21 1.82 1-45 1.38 1.06 1902 22.14 16.40 1-53 1-34 I-I3 .89 1899 20.23 14.07 ^■2,7 1. 12 1. 01 ■ -77 1898 19.38 1343 1.30 1.05 .96 .72 189s 17.69 12.02 1. 14 .92 .81 .62 1894 17-74 12.16 1-13 -93 .81 -63 1893 19.10 13.29 1.24 1.03 .89 -69 1892 18.60 12.54 1.30 1.02 .92 •67 1890 18.33 12.45 1.30 1.02 .92 .68 18S8 18.24 12.36 1-31 1.02 .92 .67 188s 17.97 12.34 1.40 1. 10 .91 -67 1882 18.94 12.41 1.48 1-15 -93 ■67 1879 16.42 10.43 1.30 1. 00 .81 •59 187s 19.87 12.72 1.70 1-35 1.08 .78 1869 25.92 16.5s 2.20 1-74 1.41 1.02 1866 26.87 17-45 2.20 1-74 1-49 1.08 condition of farming. Seed time and harvest make busy their respective periods, but whenever the frost of winter or the drought of summer suspend the activity of vegetation, there will be an interval in the work of the cultivator." ^ '^See Crop Reporter, vol. xiv, No. 3, and Monthly Crop Report, vol. ii, No. 3. Broad averages are particularly unsatisfactory in dealing with the wages of farm labor, and the reader should regard this table not as an exact exhibit of money wages, but as a compendious method of describing a movement the details of which are beyond the scope of this treatise. For more adequate discussions, see Bulletin, No. 26, Miscellaneous Series, and Bureau of Statistics, Bulletin 99, U. S. Depart- ment of Agriculture. ^ J. H. Blodgett, " Wages of Farm Labor in the United States," p. 25. Bulletin, No. 26, Miscellaneous Series, U. S. Department of Agriculture, p. 25. AGRICULTURAL PROBLEMS 609 Furthermore, the best evidence obtainable supports the con- clusion that while " skilled labor, owing to its contact with ma- chinery and the influence of education, has attained increased efficiency," " unskilled and irregular labor has lost much of its former adaptability and value to the farm." ^ Worst of all, there is rapidly developing a class of migratory or casual agri- cultural laborers who drift from city to country and back again, who have no ambition to establish themselves permanently upon the land, and yet teach the farmer to rely upon their assistance, and debase the real standard of living of the laborer who adopts farming as a serious occupation, and looks forward to the acquisition some day of a farm of his own. Farm Indebtedness and Agricultural Credit. — The favorite instrument by which land ownership is achieved in this coun- try is the farm mortgage. As shown above, 33.6 per cent of the farms in this country were mortgaged in 1910, and this propor- tion had increased from 28.2 per cent in 1890. But this is not in itself alarming. The ratio of mortgage debt to farm value was only 27.3 per cent in 1910 as against 35.5 per cent in 1890, and the owner's average unencumbered equity per farm in- creased from $2200 in 1890 to $4574 in 1910. Moreover, the proportion of mortgaged farms in the latter year was higher in Iowa and Wisconsin than in any other states, although agri- culture is particularly flourishing in these states. Statistics collected in 1890 indicate that nearly 65 per cent of mortgage indebtedness of farms is contracted for the purpose of buying the farms, from 1 5 to 20 per cent for stocking, equipping, drain- ing, and improving farms, while probably not more than 5 or 6 per cent represents losses, household expenses, and " unproduc- tive consumption." The farm mortgage accordingly is not necessarily a bad thing. It is "a mere business venture " and in this country has proved a successful venture in a surprisingly large proportion of cases. If farms are operated more efficiently by their owners than by tenants or hired managers, it is obviously desirable to get the title to the farm into the hands of the farm operator as soon as ^ Final Report of the Industrial Commission, p. 92. 2R 6lO OUTLINES OF ECONOMICS possible. For this purpose some use of credit is usually neces- sary. Credit also must usually be used to secure the proper amount of farm machinery, stock, and other equipment. Agri- culture today has become a highly capitalized industry, employ- ing in this country, it is estimated, about twice as much capital as the manufacturing or factory industries. And the indications are that the average farmer at present cannot secure, or at least does not employ, enough circulating capital. Studies have been made of the earnings of farmers classified according to the amount of capital employed on each farm ; and these indicate that, after due deduction for interest upon all capital employed, the re- maining net income varies directly with the amount of capital employed, until the latter reaches $25,000 or $30,000. The New York studies indicate that farmers working with less than $5000 capital earn less than the ordinary farm hand in the same vicinity ; and that in the districts covered, the average farmer cannot earn a fair return for his labor unless he has the use of from $10,000 to $20,000 worth of capital. The figures in ques- tion are possibly affected by the probable fact that it is the better class of farmers who are enabled to obtain the larger amount of loan capital. But v/hether this be the fact or not, it is obviously desirable that the farmer should be able to secure whatever amount of capital is necessary, at the lowest practi- cable cost. At the present time credit facilities are not adequate in many rural districts. Recent statistics collected by the federal De- partment of Agriculture, for instance, show that the average rate for interest and commissions on farm mortgage loans ex- ceeds 7 per cent in twenty-five states, and rises as high as 10 per cent in New Mexico, Montana, and Wyoming. This is the average rate, and there are presumably many instances of very much higher rates. The average commission which it is neces- sary to pay to the middleman or intermediary exceeds 2 per cent a year in certain districts of North Dakota, Oklahoma, and North Carolina. The average rate for interest and other costs on loans to farmers on personal security exceeds 10 per cent in twenty states and rises to 15.6 per cent in Oklahoma, AGRICULTURAL PROBLEMS 6il 13.8 per cent in New Mexico, and to 12.4 per cent in Alabama. The average rate exceeds 12 per cent on 57.3 per cent of the loans reported in North Dakota, on 55.3 per cent in New Mex- ico, 25.5 per cent in Alabama, and 34.7 per cent in Colorado. Even in the state of Michigan 5 per cent of the loans on personal security cost the borrower more than 12 per cent a year. Recent investigations made by the Comptroller of the Currency also make it plain that in some sections of the coun- try extortionate rates of interest are being charged by banks on farm loans ; and that in some districts the farmers are really being exploited by rural " loan sharks." American farmers not only pay an unnecessarily high price for the credit which they receive, but it is not supplied in the most convenient and suitable forms. The farmer who borrows to buy a farm or to construct a barn wants a loan for more than four or five years in order to avoid the trouble of expense and renewal, with the periodic danger of foreclosure. The loan should run in many cases for twenty-five years or more ; the payment should be arranged so that the principal may be gradually extinguished as the interest is paid, and the farmer should retain the right to extinguish the entire principal when- ever it became convenient or practicable for him to do so. In the case of short-time loans on personal security, similarly, the farmer does not want a sixty-day or ninety-day loan, the kind of accommodation which commercial banks prefer to give, but needs usually a loan running from six months to a year, in order to cover the waiting period between planting and harvest time. Moreover, the banks in some sections of the country at present force farmers who borrow from them to specialize in one crop — a money crop — in order to keep the security in some easily realizable form. American banks have in this way helped to prevent the adoption of diversified farming. In Europe, agricultural credit is furnished at low cost and con- venient terms by a series of mortgage land banks and farmers' loan societies or credit unions, which vary greatly in detail and structure but rest upon certain common fundamental principles. Long-time credit is provided by mortgage land banks, the oldest 6l2 OUTLINES OF ECONOMICS form of which is perhaps the Prussian Landschaft. These banks lend to their members on real estate mortgage, and then issue bonds secured by the entire body of mortgages in such a way as to replace or reenforce each individual's credit with the credit or security of the whole group. In some of these associa- tions all the property of the members is pledged for the support of the bonds, but experience makes it plain that this is unneces- sary and that the mortgages themselves, under proper manage- ment, afford sufficient security to insure ready sale for the bonds. The associations or banks which provide short-time credit differ greatly in form. Some are stock companies, receive savings de- posits, and obtain a considerable part of the money funds which they lend from stock subscriptions and deposits. In others a group of men simply pool their credit, borrow from outside sources on their unlimited liability, and lend the proceeds of these loans to the members of the union. Machinery, organi- zation, and rules differ, but the fundamental principles and re- quirements are as follows : 1. A pooling of credit and securities so that the debt of each member is backed by the collective credit or good-wUl of the association. 2. Rigid scrutiny of the loan and the security by appraisers (usually neighbors of the borrower) who have every opportunity of knowing the circumstances of the borrower and the value of the security offered. 3. Limitation of credit to loans for productive purposes. Th^ grant of credit for speculative purposes is strictly forbidden, and many societies provide that loans may be called if the money is not properly used. 4. Management in behalf of the borrower. This represents the most essential difference between the cooperative credit associations of Europe and the credit institutions of this coun- try. Where stock is issued, each stockholder usually has only one vote, and dividends are limited, usually to the rate paid upon borrowed money. Additional earnings, if any, are turned into a surplus fund which, if the union is dissolved, goes to charity or some public purpose. AGRICULTURAL PROBLEMS 613 5. Adaptation of the period and terms of the loan to the needs of the creditor, with provision for amortization and per- mission to pay ofi the loan whenever the debtor finds it possible. Cooperative credit associations or rural banks have multi- plied rapidly all over Europe. They have greatly reduced rates of interest to farmers, and do an enormous, amount of business at low cost and with very little loss. Large central or district associations have been established which bring the rural societies in touch with city money markets, help to procure funds for the local associations, and guide their activities by constant inspection and audit. As a natural corollary, co- operative supply associations have been developed in many places, which furnish fertilizers, farm machinery, seed, and other supplies to members at the lowest possible prices. In New Zealand and Australia the State itself has, apparently with entire success, undertaken the function of lending money to farmers for the improvement and development of agricultural land. In this country a few states have adopted laws facili- tating the formation of rural credit associations, and in July, 191 6, the President approved an act of Congress the purpose of which is well indicated by its longer title : " An act to provide capital for agricultural development, to create standard forms of investment based upon farm mortgage, to equalize rates of interest upon farm loans, to furnish a mar- ket for United States bonds, to create government depositaries and financial agents for the United States, and for other purposes." This law represents an earnest attempt to give expression to the principles set forth on the preceding page. The machinery is perhaps necessarily, but unfortunately, cumbersome. The law creates a hierarchy of land banks, the control of which is cen- tralized in a Federal Farm Loan Board composed of the Secre- tary, of the Treasury and four members appointed by the Presi- dent, to serve for terms of eight years. This board is to be assisted by farm loan registrars to supervise the issues of farm loan bonds and to have custody of the mortgages and securities upon which they are based ; by land bank appraisers to deter- 6l4 OUTLINES OF ECONOMICS mine the value of properties offered as securities ; by " as many land bank examiners as it shall deem necessary " ; and by such attorneys, experts, and other employees as are required to conduct the business of the board. The country is to be divided into twelve districts, in each of which there shall be a Federal Land Bank with capital stock of not less than $750,000. The government is to supply this capital unless it is forthcoming from other sources, thus involving the government in a maximum stock subscription of $9,000,000. Government shares are to draw no dividends. It is obviously intended and hoped that these land banks shall operate through 'small National Farm Loan Associations composed of persons desiring to borrow money under the act ; but in case such loan associations are not created rapidly or widely enough, provision is also made for joint-stock land banks, with a capital of not less than $250,000, only half of which need be paid in cash before operations are begun. The larger federal land banks are also authorized to create branches and if necessary to lend money through agents scattered throughout the country. No provision is made for loans on personal property or per- sonal security. Loans must be secured by first mortgages not exceeding in amount 50 per cent of the .value of the land and 20 per cent of the value of the improvements thereon pledged as security. Interest rates are limited to 6 per cent ; proper provision is made for the amortization of the principal while the interest is being paid ; the loan may run from five to forty years and may be issued only to a person who is ''at the time, or shortly to become, engaged in the cultivation of the farm mortgaged." Such loans may be made only for the pur- pose of purchasing land for agricultural uses ; to provide for the purchase of equipment, fertilizers, and live stock ; to pro- vide for buildings and the improvement of farm lands ; or to liquidate the indebtedness of the owner of the land mortgaged. The greatest danger of such legislation, perhaps, is that the extension and multiplication of credit will increase the demand for land, raise its price, and so injure the very classes which it is designed to aid, namely, young farmers and tenants who are AGRICULTURAL PROBLEMS 615 working hard to acquire title to the farms which they operate. Moreover, there is an important connection between the interest rate and the price of land which must be considered in this connection. Land value is frequently expressed as ''so many years' purchase," i.e. so many times the annual rent or net yield, the number of years' purchase depending upon the interest rate. Roughly speaking, " twenty-five years' purchase " corresponds to a four per cent interest rate, " twenty years' purchase " to a five per cent interest rate. If we reduce the interest rate, will we not automatically increase the price of land ? While there is a real connection between land values and the interest rate, it does not follow that a reduction of, say one fifth, in the interest rate wiU be followed by an increase of one fifth in the value of land. The interest rate which largely controls in this connection is the rate on purchase-money mortgages, which do not include so large an allowance to cover risk and similar costs as do the other and smaller farm loans, interest on which it is the primary purpose of this legislation to reduce. In consequence, while it is probable that improved credit will tend to raise the price of land, it is almost certain that the in- crease will not be commensurate with the relief to the farmer afforded by the reduced cost of loans. Tenancy versus Encumbered Ownership. — At this point it is necessary to discuss briefly the question when and where — if ever — tenancy is to be preferred to land ownership. For though it may come as a surprise to some American readers, many foreign authorities of the highest rank strongly advocate tenancy in preference to ownership when land has become very valuable. In the expert evidence given before the British com- mittee of 1906 on small holdings, for instance, the balance of opinion seems to have inclined toward tenancy rather than ownership. Here again we meet one of those mixed economic and psycho- logical questions to which no simple answer can be given. In a frontier or newly settled community, there is, of course, little reason for tenancy from any standpoint. But in an old com- munity, where land values are high and are as likely to fluctuate 6l6 OUTLINES OF ECONOMICS downwards as upwards in the next score of years or so, the eco- nomic arguments in favor of tenancy are exceedingly strong if not altogether convincing, (i) Under such circumstances the farmer who insists upon holding the title to the land which he tills must either go deeply into debt, or understock his farm, or both. To underequip the farm means poor agriculture ; and a heavy debt hangs like a millstone around the neck of a farmer when land values are not on the increase. The tenant farmers of England have had a far more pleasant time since 1873 than the small landowning farmers whose holdings were encumbered with debt at that time. (2) The ownership of land throws upon the farmer all the responsibilities of the speculative entrepreneur, and other things being equal — if they can ever he regarded as equal — it is desirable for the man of small means to avoid these responsibilities. The tenant system offers a means of insurance against some of these risks. (3) Such insurance be- comes all the more advantageous and encumbered ownership all the more disadvantageous because of the well-known fact that land yields a net return, year by year, lower than almost any other form of property. Part of this is due to the social prestige of landownership and part to the fact that over very long periods the small annual profit on land is likely to be com- pensated for by an increase in the selling value of the land. Under such circumstances landownership is partly a luxury and partly a method of saving, usually for the descendants and heirs of the saver. Both factors conspire to make land a poor invest- ment for the man of small means. He cannot afford luxuries, on the one hand, and he must find a business calling, on the other hand, that yields him a quick return. (4) And finally, it must be noted that the question of tenancy is not like the labor problem which has developed in the factory industries. The tenant is not a wage earner. He may be as independent as the manufacturer who hires the land, buildings, and possibly the machinery with which he works. The problem of tenancy, therefore, has no necessary relationship to the problem created by the existence of a class of permanent wage earners. The small entrepreneur still holds the field in agriculture, all over AGRICULTURAL PROBLEMS 617 the world. The question is simply whether he shall hire his plant or own it. Notwithstanding the fact that tenant farming may go hand in hand, as it does in England, with good farming, and notwith- standing the desirability of reducing the speculative risks of an industry which is at best much too uncertain, the problem can never be settled on economic grounds alone ; and if we add to the economic virtues of ownership its social and moral advan- tages, the final verdict must be rendered against tenancy. Ownership not only spurs the zeal of the farmer, dignifies his occupation, and inculcates a love of the soil which nothing else inspires in so great a degree, but it gives the farmer a stake in the political game, steadies him, and thus improves his citizen- ship. It is perfectly plain that ownership cannot be enforced upon a people that are not prepared for it. And it is equally obvious that the virtues which go with ownership may and often do degenerate into vices : the peasant proprietor's love of the soil occasionally becomes land worship, his thrift avarice, his conservatism blind fear, and his industry cruel, — he drives himself and wife and children at a pace that would put the sweater to shame. But we are not advocating the extension of landowner ship through state aid. We simply call attention to the desirability of fostering those qualities which lead to the diffusion of owner- ship and are in turn strengthened by ownership ; and we main- tain that the American people at present are in no danger of excessive thrift or of the sordid materialism of peasant proprie- torship at its worst. The tendencies and the dangers are almost all in the opposite direction. If, in the next fifty years, the farmers of the Middle West become predominantly tenants, it will not be because tenancy is economically and socially superior to ownership, but because the farmers of that district have not had the thrift to save and the ability to adapt themselves to more intensive agriculture. And the step will be backward, not forward. The popular instinct which in this country causes an increase of tenancy to be regarded with distrust is a sound instinct. 6l8 OUTLINES OF ECONOMICS A minor disadvantage of tenancy is found in the fact that tenancy, when it becomes predominant, raises difficulties that can only be met by constant State interference. Short leases, with no indemnification to the tenant for the improvements which he has made, lead to rack-renting, exhaustion of the soil, and class hatred between landlords and tenants. Long leases, on the other hand, aiiord insufficient protection to the landlord ; because when prices are high the tenant thrives and pays his rent promptly, but when prices fall rents go unpaid and the landlord has no real redress. In Eng- land the situation has been met by a system of short-time leases together with compensation to the tenant — a legal obligation which the landlord cannot escape by "contracting out" — for any improvement made by the tenant whose value he has not exhausted. Neither party can abrogate a lease without a year's notice, although by mutual consent this maV be re- duced to six months. This system permits rentals to be adjusted frequently as prices change, rules out excessive competition, protects the landlord, and warrants the tenant in making any improvement required by good farming, since he knows that, if the landlord orders him out, he can collect on his de- parture the actual value of improvements made by him, whose benefits he has not had time to reap. In practice, the incoming tenant usually pays for the unexhausted improvements, and disputes are settled by arbitration. Under this system, " the relation between landlord and tenant is very satis- factorily arranged, the farmers are, as a rule, contented with the present system, and the fields of England prove that landownership on the part of farmers is not essential to good agriculture." ^ Marketing of Farm Products. — The work of the farmer is not finished until he has successfully sold his produce. Com- paring the price received by the farmer with the retail price of the same produce, many critics have complained that the inter- mediate distributive ^ process is wasteful and expensive. But careful investigation of the necessary costs of marketing does not indicate, on the whole, that our distributive system is so inefficient as to call for complete replacement. Improvement of present methods, and not revolution, seems to be the proper solution. On the other hand, the marketing system is manifestly defec- tive at many points. The farmer himself is responsible for some of the most costly defects. He frequently does not show suffi- cient care in producing the exact varieties of products most in 1 H. C. Taylor, The Decline of Landowning Farmers in England, p. 6i. ^ The word "distributive" is used in the popular sense in this chapter. AGRICULTURAL PROBLEMS 619 demand, or in sorting and crating them for market after they have been produced. Goods are carelessly and dishonestly packed ; there is sometimes a dearth of buyers and sometimes a monopolistic agreement among buyers at country points. There is also room for improvement in the transport of such goods from the country buying point to the wholesale markets. Many railroads do not have a sufficient supply of refrigerator cars and lack facilities for handling perishable goods. A suffi- cient number of cars is frequently not provided just when they are most needed, there are many avoidable delays in transit, and frequently great difficulties in adjusting and paying claims for damages. Generally speaking also, railway tariffs favor through traffic at the expense of local traffic and aire thus partly respon- sible for the concentration of manufactures and population in the large cities, preventing that diffusion of people throughout the country which would furnish a large number of small local markets. Among the wholesale dealers, particularly the commission houses, there is also room for improvement. Fraud and sharp practices have been common in the past. Well-organized and convenient markets have not been provided, there has not been enough inspection or publicity, and where the goods are dis- posed of at auction collusive agreements have frequently existed betv/een particular traders and the auction company itself. There is no simple or general rem^edy for these conditions. In order to secure good country markets, cooperation among farmers has proved successful and probably offers the logical and best way of disposing of farm products at country points. Cooperation has also been used successfully in the market- ing of perishable goods, and here the commission system has been partly replaced by associations of farmers or growers such as the California Fruit Growers and Shippers Association, which maintains auction rooms in eastern cities and sells its own products directly. The Southern California Fruit Exchange in a few years reduced the cost of marketing California fruits from 10 per cent to 3 per cent of the selling value. The cooperative marketing association and the intermediate 620 OUTLINES OF ECONOMICS trader who buys from the grower and sells to the retailer have in common two points of superiority over the commission sys- tem. They replace the lukewarm interest of an agent by the care and solicitude of an owner, and by shipping in large quan- tities they are in position to obtain much better rates from the railways, to say nothing of the other economies effected by handling goods on a large scale. The cooperative marketing associations have also effected great economies by carefully studying prices in the various markets and distributing their con- signments so as to get the highest prices prevailing at the time. The independent trader, however, can select the most avail- able market even more successfully than the cooperative asso- ciation, and speaking generally we do not expect to see the commission house displaced by a cooperative machinery which transfers products direct from the farmer to the retailer. An intermediate mechanism is probably necessary. It is a logical and probably an economical manifestation of the division of labor. The actual purchaser or trader, however, will probably slowly displace the commission man ; and there can be little doubt that the farmer has gained enormously by the substitu- tion of the trader for the commission house in the marketing of the great staple products. The trader comes almost to the door of the farmer with constant bids for his grain. He is an expert in railway rates, is in constant telegraphic communica- tion with the great markets of the world, and handles products in such large quantities as to reduce intermediate expenses to a minimum. Occasionally, as has sometimes been the case with the great line-elevator companies, he works in conjunction or in collusion with the railways, overbidding the small grain dealer, and forcing the railways to grant rebates on the large shipments which he commands. Even in this case, the farmer gains by the size and efficiency of the middleman (though the small dealer may suffer) because part of the economies effected — even those effected by discriminative railway rates — will come to him in the long run. Cases of monopolistic oppression are theoretically possible when there is only one buyer and one railway who are in collusion, and the farmer is deprived — because of high rail- AGRICULTURAL PROBLEMS 62 1 way rates — from shipping his products elsewhere. But the loss to the farmer through extortion of this kind has in general been much more than counterbalanced by the striking economies effected by the great trading companies ; though this, of course, affords no justification either for monopoly or railway dis- crimination. Both should be suppressed, but in such a way as to save for the farmer the distributive economies effected by large-scale handling. Finally, the government can be of great assistance, provided the laws under which it works are passed after careful investi- gation and designed to improve rather than revolutionize exist- ing marketing machinery. Laws have been passed governing the grain trade, cold-storage warehouses, future trading in cotton, and the size and character of standard packages. More important still are the state laws providing for the regulation of commission merchants and the creation of marketing com- missions. Space does not permit a discussion of the laws regulating com- mission merchants passed by Minnesota (1899), New York (1913), and other states. Speaking generally, commission dealers under these laws must obtain a license from some state com- mission or official and post a bond for the benefit of consignors conditioned upon faithful observance of the law. The laws usually require licensees to keep an exact record of the circum- stances of each sale and to make returns to shippers within a very short period after each sale. Either by the statute itself or by administrative ruling it is quite common to prohibit the commission dealer from buying consigned products for himself or from selling them to any other corporation or firm in which he has an interest. Licenses may be revoked for malpractice of the following kinds : making false charges for cartage, handling, insurance, or other services not actually rendered ; failure to make prompt settlements with consignors ; rendering false statements as to the sale or condition of the goods on receipt ; sending out false information concerning prices or other market conditions ; maintaining combinations to fix prices ; violating or neglecting other features of the law. Not 622 OUTLINES OF ECONOMICS a great many complaints have been registered under the Minne- sota law, " due partly perhaps to ignorance of the law's exist- ence, and partly to a feeling that it is hardly worth while to proceed under it. It may also be an indication that there has not been so much dissatisfaction among shippers as most people imagine." ^ According to most competent observers these laws have exercised on the whole a salutary effect and promise greatly to improve what has hitherto been one of the weakest links in the distributive chain, the ineffective commission mer- chant. In a number of states commissions or departments have been organized for the purpose of improving marketing methods. For the most part these commissions have not accomplished any very concrete results up to the present time. What is inost needed now is study and investigation rather than an attempt to introduce on a magnificent scale costly cooperative or other schemes whose practical efficiency has not been demonstrated either by practice or the most thorough advance study. Much more helpful and promising is the federal Office of Markets and Rural Organization, which by its careful investigations is gradually laying the basis for a scientific correction of the real defects and abuses which exist. Speculation. — The modern marketing or distributive mecha- nism not only relieves the producer of a large part of the specula- tive risk which attends the transmission of raw material from the farm to the consumer, and calls public attention to this specu- lative element by collecting or concentrating it, but it is respon- sible also for a large amount of unnecessary speculation which many persons believe to be particularly injurious to the farmer. We are not here concerned with the general evils of speculation but with the prevalent belief that speculative dealing in futures tends to reduce prices. " What is generally urged is that the professional short seller, by his sales of fictitious wheat or cotton, creates a fictitious oversupply in the market, which is just as instrumental in depressing prices as would be an abnormally ' L. D. H. Weld, The Marketing of Farm Products, p. 453- The discussion at this point is largely based upon Professor Weld's admirable book. ' AGRICULTURAL PROBLEMS 623 large supply of actual wheat thrown on the market by the farmer." ^ This charge is frequently supplemented by the assertion that it requires less money in margins to " sell short " — or gamble on a fall in prices — than to " sell long " in antic- ipation of a rise, and that, in consequence, the weight of the speculative dealing in farm products is exerted in the direction of lower prices. This particular charge against speculation is confirmed neither by a priori reasoning nor by inductive analysis. Every " ficti- tious " sale of wheat, to use that as an illustration, must be balanced by an equivalent " fictitious " purchase. The " bear " who sells October wheat in July, even though he may hope to depress the price of October " futures," exercises no harmful in- fluence upon the actual July or " spot " price, which is con- trolled by the demand for and supply of actual wheat; and when October comes, " the short seller of July appears now as a buyer in order to cover his contracts, and if his trading has any effect on the market at all, it is to increase the demand, not the supply." It is very plain that the fictitious market may be artificially influenced by speculative deals, but as a general thing the ficti- tious market is ruled by the actual market, not vice versa; and the only influence exerted by gambling in futures upon " spot " prices (with which alone the farmer is concerned) is a good in- fluence. This influence arises out of the effect of future trans- actions in lessening price fluctuations and in modifying present use by anticipating future necessity. And the complaint that it requires less capital to " bear " the market than to " bull " it, as well as a great number of ingenious criticisms of a similar kind, would all be negatived — if they were true — by the in- evitable consequence that any permanent factor of this kind would he quickly appreciated by speculators and fully dtscounted. In no market are influences of this kind more accurately detected or more quickly dissipated by competitive forces than on the produce and cotton exchanges. 1 N. I. Stone in the Report of the Industrial Commission, vol. vi, p. 189 ff., from which other quotations cited in this section are also taken. 624 OUTLINES OF ECONOMICS Actual investigations of prices confirm the theoretical argu- ment made above. The average prices of spot wheat in Sep- tember, October, and November — just after harvest, when the ordinary farmer is compelled to sell — have been nearer the average price for the entire year, since the speculative wheat market has become highly organized, than in the forties and fifties when wheat was sold like any other farm product. And there are reasons for the belief that speculation has not only equalized yearly fluctuations, but that the leveling has been up, not down, in the interest of the farmer who is compelled to sell after harvest, as opposed to the wealthier miller or trader who in the past carried over a supply for the lean months. " It is not un- commonly stated that in the last few years futures in the wheat market have not, in the long run, stood enough above ' spots ' to cover all the expenses of carrying. Some suggested reasons for this are : cut charges for storage ; the failure of outside speculation to maintain the market against hedging sales ; the fact that the great elevators will buy wheat and carry it for what they can get, and perform the functions of both carrier and trader for the commission of one. In any case, the tendency is to bring all prices together." ^ Not only does " speculation " tend to equalize price fluctua- tions between dift'erent points of time and between different markets, but it serves the exceedingly useful purpose of provid- ing a " body of professional risk takers " whose function is to protect the actual merchandiser from many of the speculative risks inherent in modern business. This protection against risk is secured for the most part through " hedging," which has been defined " as a purchase or sale for future delivery in- tended to offset and thereby to protect an actual transaction in merchandise." The terminal grain elevator which has accu- mulated a large amount of grain sells a corresponding amount for future delivery and thereby eliminates nearly all of the specu- lative risks involved in its business. The miller who has taken a contract to deliver flour at some time in the future hedges by 1 H. C. Emery, Speculation on the Stock and Produce Exchanges of the United States, p. 131. AGRICULTURAL PROBLEMS 625 buying future wheat sufficient to produce the flour called for in his contract. The country grain buyer who knows that an inter- val of time must elapse between the purchase of grain and its sale at the point of destination finds similar protection in a " future " which permits him to specialize in the distributive function of getting grain from the producer to the ultimate con- sumer with a minimum of speculative danger. There are simi- lar operations in the cotton market. Speculation in the narrow sense, and even more truly the highly-organized market which we associate it with, are respon- sible for a certain amount of harmful gambling which should be suppressed; but in their ultimate economic effects they are highly useful institutions designed to concentrate the uncer- tainties and risks inherent in the very nature of production for a future market. And it is important to note that hedging, the transaction by which risks are eliminated for those who prefer to specialize in the less dangerous types of profit-seeking, would be impossible without the more speculative traders who prac- tically bet on future fluctuations of prices. To steady and reduce these fluctuations, provide a certain market, and elimi- nate the exploitation of the ignorant by the expert traders, speculation and the market mechanism which it requires seem to be necessary and inevitable. QUESTIONS 1. Make a list of the economic factors which regulate the size of farms. Is the average farm likely to grow larger or smaller with the passage of time ? Is the narrow economic conclusion concerning the size of the farm, based upon maximum net profit to the individual farmer, subject to modification by reason of social or moral considerations? 2. Has the net effect of the rural exodus been favorable or unfavorable to agriculture and the agricultural classes? to society generally? 3. Does the increase of tenancy in the Southern states represent progress or retrogression? in the North Central states? 4. Under what conditions is the cash rental superior to share tenancy? Would the "corn rent" — a sHding rental varying with the price of farm products — be superior to both ? Are short leases better than long leases for the landlord? 5. Do the farmers in your locality suffer from the lack of credit facilities? 2S 626 OUTLINES OF ECONOMICS Have they any difficulty in finding safe and convenient investments for their savings ? 6. What is the advantage of speciaHzed farming over diversified farming ? Do we imply, when we advocate diversified farming, that the farmer should "buy nothing that he can raise or make for himself"? 7. Is speculation a "necessary" or an "unnecessary evil"? Is it an evil? REFERENCES Brace, H. H. The Value of Organized Speculation. Commissioner of Corporations. Report on Cotton Exchanges, Part v. BuTTERFiELD, K. L. Chapters in Rural Progress. Carver, T. N. Principles of Rural Economics. Eleventh Census. Real Estate Mortgages ; Farms and Homes; Proprietor- ship and Indebtedness. Twelfth Census. Vol. v, Agriculttire; Supplementary Analysis, "The Negro Farmer," pp. 511-579. Thirteenth Census. Vol. v. Agriculture. Coulter, J. L. Cooperation among Farmers. Emery, H. C. Speculation on the Stock and Produce Exchanges of the United States. Haggard, H. R. Rural England. Herrick, M. T., and Ingalls, R. Rural Credits: Land and Cooperative. Jebb, L. The Small Holdings of England. Marshall, Alfred. Principles of Economics, 6th ed.. Book vi. Chap. x. Mill, J. S. Principles of Political Economy, Book ii, Chaps, vi-x. MoRMAN, J. B. Principles of Rural Credits (with bibliography). Prothero, R. E. English Farming, Past and Present. U. S. Department of Agriculture. Year Book; The Crop Reporter. Industrial Commission. Report, Vols, vi, x, xi, xix. Rogers, A. S. L. The Business Side of Agriculture. RowNTREE, B. S. Land and Labour: Lessons from Belgium. Taylor, H. C. Agricultural Economics ; and "The Decline of Landowning Farmers in England," Bulletin of the University of Wisconsin, No. 96. Warren, G. F. Farm Management. Weld, L. D. H. The Marketing of Farm Products. CHAPTER XXX SOCIALISM Socialism Defined. — Socialists seek the establishment of in- dustrial democracy through the instrumentality of the State. Our political organization is to become also an economic indus- trial organization. Socialism contemplates an expansion of the business functions of government until the more important businesses are absorbed. Private property in income-yielding capital and land is to be abolished. Socialists make no war upon capital ; what they object to is the private capitalist. They desire to socialize capital and to abolish capitalists as a distinct class. Their ideal, then, is not, as is supposed by the uninformed, an equal division of existing wealth, but a change in the fundamental conditions governing the acquisition of incomes. Socialists usually say that labor creates all wealth. Land and capital, they hold, are merely passive factors of production, and their owners ought not to receive a share of the product unless they personally are useful members of the community. Labor is the active factor, and all production is carried on for the sake of man. Land and capital are simply the tools of man. Socialists admit that the owners of these tools must receive a return for them when industry is organized as it is now ; hence they desire that these tools should become public property. They wish to make of universal application the command of the Apostle Paul, " If a man will not work, neither let him eat." Distributive Justice. — Socialists, in common with a great many other people who do not accept their attitude toward the organization of industry, desire distributive justice. As to what constitutes justice they are not wholly agreed, but there is 627 628 OUTLINES OF ECONOMICS among them a tendency to accept equality of needs rather than productivity as a basis. Some, it is true, have advocated an almost mechanical equality, but most socialists today would regard the question of a precise standard for the distribution of income as not of present importance. They are simply agreed in this, that the distribution of the present day is wholly unjust. They think that men today do not have equal chances in life and that there is too much special privilege. The rewards, they think, today go to those who are shrewd and cunning, who are skillful in manipulating stocks and bonds, or who are favored by inheritance with a good start, rather than to those who render great social service. The inventors, poets, authors, scientists, skilled mechanics, and factory managers, they allege, are the large producers, but they do not get the big prizes. Varieties of Socialism. — The foregoing characterization ap- plies to most persons who have been called socialists, but the genus contains a number of species which should be distinguished. I. One group has been called " Utopian." This first group contains those who have become impressed with the evils of the present competitive system and propose the collective owner- ship of the means of production as a remedy, in much the same spirit with which a physician writes a prescription to cure his patient. There have been many attempts to picture to us how smoothly things would proceed if men could only be persuaded to adopt the collective ownership of land and capital. As a type of this class we may take Robert Owen. His life was contem- poraneous with the Industrial Revolution in England, he him- self being a successful manufacturer. He saw with his own eyes the evils of unrestricted competition, and was filled with an earnest desire to better the condition of the working classes. He is remembered as a factory reformer and promoter of volun- tary co5peration, but yet he regarded these efforts as not suffi- ciently radical. He thought human nature must be reformed by careful training from childhood in an atmosphere of associa- tion, instead of in the self-seeking, commercial atmosphere which surrounded him. He spent his large fortune in an at- tempt to carry out his ideas regarding the reconstruction of SOCIALISM 629 society. Among his projects was the founding of a colony at New Harmony, Indiana, where no private property or com- petition should exist. After a struggle of two years, the experiment ended, as most other similar enterprises have, a complete failure. In this group would also be placed Saint- Simon, Fourier, Cabet, Blanc,^ and Bellamy. 2. The " Marxian " socialists call themselves " scientific," as distinguished from the idealistic writers just mentioned. They insist that they have no cure-all for the ills of society. Socialism in their eyes is, in the main, only an explanation of what is happening. The private capitalistic system is breaking down, they say, and the logical result must be the collective ownership of the means of production as the next stage in social evolution. They say that setting aside all question of " ought " or " desirability," collective ownership is coming, and we might as well adjust ourselves to it. The four leading features of the Marxian philosophy are : (i) the view of society as an evolu- tionary product ; (2) the economic interpretation of history, according to which our whole social life, including our ideas con- cerning religion, art, marriage, etc., are but a reflex of past and present economic conditions ; (3) the doctrine of surplus value, according to which the income of the capitalist class does not represent a return for the sacrifice of " abstinence " or " wait- ing," but results from the fact that through the ownership of the means of production its members can compel the laboring class to work a longer number of hours than is necessary to pro- duce the wages which the laborers receive, what is produced in this additional number of hours being the source of capitalist income ; and (4) the doctrine of 1,he class struggle, which finds a deep antagonism between the capitalist class and the laboring class, that can only result in the overthrow of tlie former. Most socialists now believe that this victory will be won with- out bloodshed, as a result of a gradual increase in the strength of the socialist party as a political organization. 3. The Fabian Socialists, of whom the members of the 1 Louis Blanc was less " Utopian" than the others. He was transitional and in reality paved the way for the German and later "scientific" movement. 630 OUTLINES OF ECONOMICS Fabian Society of England are types, have disapproved both of the founding of Utopian settlements and of the philosophy of Marx. The aim of this society has been to spread socialistic ideas by the dissemination of knowledge on the subject, rather than by an organized political movement, advocating this or that reform as opportunity indicated. The membership has come largely from the educated middle class, and has never been very large, although the society has exercised a very great influence. Practically, the views of the more conservative socialists in France and Germany do not differ greatly from those of the Fabians. The following words of the late Jean Jaures on the method of realizing the socialist ideal are of interest in this connection : "All Socialists, indeed, some openly, others with infinite precautions, some with a mischievous Viennese good-nature, declare it to be untrue that, taken as a whole, the economic material condition of the proletariat is get- ting worse and worse. It must be conceded, after taking account of the tendency to sink and the tendency to rise, that in the immediate reality of life, the tendency to sink is not the stronger. Once this has been granted, it is no longer possible to repeat after Marx and Engels that the capitalist system will perish because it does not insure to those whom it exploits the minimum necessities of life. It follows from the same admission that it has also become puerile to expect that an economic cataclysm, menacing the proletariat in its very existence, will bring about, by the revolt of the instinct of self-preservation, the 'violent overthrow of the bourgeoisie.' "It is not by an unexpected counter-stroke of political agitation that the proletariat will gain supreme power, but by the methodical and legal organi- zation of its own forces under the law of the democracy and universal suf- frage. It is not by the collapse of the capitalistic bourgeoisie, but by the growth of the proletariat, that the Communist order will gradually install itself in our society." ^ 4. The Christian socialists. About the middle of the nine- teenth century, such men as Kingsley, Maurice, and Hughes in England were much impressed by the misery of the poor, and they attacked the competitive system as being responsible for the evils which they saw. Voluntary cooperation and the ele- vation of the workingman's character seemed to them the proper 1 Studies in Socialism (trans, by M. Minturn), pp. 167-169. SOCIALISM 631 remedies. Thus their theories do not fall under the head of socialism as we have defined the term. There is another group who believe that the ideals of Christianity can only be realized through the abolition of private capitalism. In Germany and in France socialist movements have been organized by adherents of both Protestant and Catholic churches. In the United States there has been no similar movement, although we find the term Christian socialist occasionally employed. 5. State socialism is a term frequently used in German dis- cussion to designate the views of those who favor an extension of the economic functions of government without any great change in existing class relations. 6. " Socialism of the chair " {Kathedersozialismus) refers to the views of university professors, particularly in Germany, who have advocated State interference with property rights to any extent demanded by public welfare, and have opposed the laissez-faire doctrines of the older economists. These men are not to be classed as socialists, the term being used as a reproach by their conservative opponents, and the designation has now chiefly historical significance. 7. Syndicalism may be mentioned here, although it is more akin to anarchism than to socialism, and is to be viewed as a form of labor organization. The term is derived from the French word for labor union. The syndicalists believe that the emancipation of the working classes is to be achieved, not through control of present government, but by means of the control of, first, industry and, second, government by labor unions. They advocate the use of general strikes and of other destructive tactics, such as sabotage. They are extremely pessimistic with respect to the outlook for the laboring classes. This doctrine had its highest development in France about 1908 and has had some following in England and America. The tactics of Syndicalism are condemned by the American Socialist Party. Communism. — Communism was the term employed by Karl Marx to distinguish his own philosophy from the " Utopian " schemes of such men as Owen, which he termed socialistic. But 632 OUTLINES OF ECONOMICS today the reverse has become the common usage. Communism now very generally signifies the abolition of private property not only in production goods, but also in consumption goods, whereas socialists contemplate the retention of private property in income. In this case there would be provision of private property for every one, and in this one respect socialists em- phasize and extend the idea of private property. Socialism an Extension of Existing Institutions. — Our govern- ment owns the post office ; most governments the telegraph. Nearly all own the wagon roads. Some own the canals and rail- ways. Many governments own factories. Probably every national government does at least a little manufacturing. Most governments cultivate forests, and some cultivate arable land. We have only to imagine an extension of what already exists until government enterprise dominates in manufactures, mining, transportation, commerce, and carries on, in short, most pro- ductive enterprises, and we have socialism. But saying that socialism is an extension of existing institu- tions may lead to a misconception. The elimination of private capitalism, it is supposed, would work a most radical change in many branches of our social life. The commercial spirit, social- ists think, would be abolished, and with it all that is dependent upon it. We are trained today from childhood up, it is alleged, to try to " make money," and this accentuates the selfish elements in our nature ; and it is therefore maintained that our present system does nothing to promote, and does much to hinder, the development of the brotherly spirit. The Strength of Socialism. — - Socialism makes perhaps its strongest claim in its plea, first, for a scientific organization of the productive forces of society, and second, for a just distribu- tion of the annual social income. It is said that the present production of economic goods is small in proportion to popula- tion, but the socialist replies : " Naturally enough. Competition is wasteful. Two railways are built where one would suffice. Two trains run parallel between two cities where one would serve the public equally well. Three times as many mUk wagons, horses, and drivers are required to serve the people SOCIALISM 633 with milk as would suffice if the milk business were organized like the mail distribution in cities. Look at the shops, whole- sale and retail, and see the waste of human force. Without competition, the dry goods business and the grocery business could be carried on with a third of the present expenditure of energy. Reflect on all the idle classes in modern society. Socialism would set everybody to work, and, making each one dependent on his own exertions for success, would stimulate all energies." The argument is a telling one, but it does not prove its point unless we grant that the present waste and idleness cannot be suppressed or greatly diminished without a departure from the fundamental principles of our present industrial order, or that the waste and idleness are not counterbalanced by advantages. Justice is a strong plea in the socialist philosophy. It cannot be for one moment claimed that each one's income is at present in proportion to his services to humanity. Income in proportion — to industrial merit is attractive to an ethical sentiment. But cannot we approximate justice in distribution on the basis of the existing order? There is nothing distinctively socialistic about the desire for distributive justice. It is a feeling that actuates those who work for the control of monopolies, for tax reform, for regulation of inheritances, and for labor legislation. The socialist simply differs from these people in his method of ;' attaining his ideal. The socialist criticism of the present regime is especially severe in the matter of unemployment. There are always some men able and willing to work who are seeking employment, and periodically, with the coming of crises and depressions, the lack of employment becomes widespread. Again, it is urged that today goods are made for sale, not for use, as they would be under the socialistic regime. Adulteration, deception, and " cheap and nasty " goods are the direct outcome of a system of private capitalism. In the socialistic state we are told the business of the shopkeeper is to help you find what you really need ; at the present time it is to his interest to persuade you to buy what you do not need or what will give him the greatest 634 OUTLINES OF ECONOMICS profit. The spirit of competition is to the sociahst simply war- fare. In every business establishment a good part of the most highly paid labor is devoted, not to the production of goods, but to finding a market. Ability to fight one's competitor is quite as essential in business as is the ability to turn out good products. The Weakness of Socialism. — i. Strong as may be the fore- going indictment of the existing industrial system, it is not suffi- cient to indicate that socialism is to be the necessary or the desir- able outcome. The modern machine age is little more than a century old, and some of its most important phases are very recent. The dire predictions made by Karl Marx and his fol- lowers on the strength of some of the earliest phenomena of the factory system have not been borne out, and similarly the evils of today may possibly be very largely eliminated without de- parting from our fundamental institutions. In short, the first weak point in the socialist's position is that he attempts to pre- dict the course of economic evolution too far in advance. That we shall have a juster distribution of wealth in the future, and that we shall eliminate many of the present wastes of production seems probable, but whether this will be accomplished by a socialistic organization it would be very hazardous to predict. It is desirable to have ideals to work toward, but we should not pin our faith now to a future method for attaining them, for no one can say that the collective ownership of all of the important means of production presents a question that needs to be decided now. 2. The socialist underestimates the efficiency of the present system. In particular he fails to see the significance of the great and (in many respects) smoothly-working system of economic cooperation that has resulted from giving opportunity to free individual enterprise. To-day there is a premium on energy and thrift. Much may be wasted, but much is also produced. That socialism would result in a larger sum total of goods for consumption has never been proved. But, on the other hand, we can say that the present regime is continually offering more and more to the mass of the people. Their standard of life is continually rising. Our economic world is a bettering world. SOCIALISM 635 3. The socialist is also in other respects too pessimistic with respect to the present. He sees all of the starvation, misery, luxury, and extravagance, but he passes by the millions of happ); homes scattered throughout the land. He does not see that the "] world is full of opportunity for the rising generation, that even if the chance for the ownership of an independent business for the ordinary man is smaller, the things which he can enjoy, if he is of average intelligence and energy, are much greater than ever before in the world's history. — ' 4. The socialist underestimates the importance of individual responsibility. Today a man is confronted by the stern neces- sity of making his own way, and this must have some good effect upon character. On the whole, the lazy and incompetent are sifted out. Bad heredity and a lack of proper training are the ^ cause of a good part of economic misfortune. It is well to dis- tinguish the criticism here made from the common error of supposing that socialism would necessarily crush individuality and that all would be compelled to dress and eat alike. 5. The socialist underestimates the importance of free enter- prise in industry. If a man now believes that he can develop a certain industry that will satisfy important wants of the people in the future, he does not need to secure the consent of some government official to make the experiment. The possibilities ' ^ of a free and spontaneous development should be safeguarded from governmental routine to every possible extent. 6. Perhaps the most frequently mentioned objection to social- ism is the danger to liberty. Under socialism there would be simply the public sphere of employment, and there is reason to fear that the inability to escape from the public sphere would compel the submission to onerous and tyrannical conditions imposed by the administrative heads of the business in which one might be engaged. The socialists, it is true, have a re- joinder in the fact that this objection refers to liberty in the negative sense of freedom from interference rather than in the positive sense of the power to have and to enjoy goods, and yet 1 there are many persons who fear the tyranny of the majority. Those in whose hands political and economic control centered r 636 OUTLINES OF ECONOMICS would have tremendous power, however they might be selected or appointed. As in the religious sphere in the past, so in the economic sphere in the future, we may find that compulsory cooperation is incompatible with human nature. 7. The Marxian socialists may be criticized for the impor- tance which they attach to the economic interpretation of his- tory, for the validity of that proposition does not establish the validity of the socialist contention. Even if it be true that our social life is a reflex of our economic activity, it still does not necessarily follow that our economic development is going to be such as will land us in socialism. Their doctrine of the class struggle also does not give an accurate account of existing con- ditions. We have a laboring class and a capitalist class, it is true, but there is also a considerable class, perhaps large enough to hold the balance of power between the other two, which does not sympathize exclusively with either laborers or capitalists. Moreover, we have yet other social classes, divided from one another by lines that cut across those separating the capitalists and the laborers. Race is, for example, the basis of a social classification that lessens the unity and cohesiveness of the ) laboring class. Social Reform. — There are those who recognize the strength of the socialist's criticism of the existing economic and social order, but who believe it wise^to attack the various problems confronting us one at a time. Social reform seems likely to accomplish more valuable results than socialism. We have a monopoly problem before us now. Its solution may involve a considerable extension of government enterprise. Why not con- centrate our efforts upon that problem instead of making up our minds now whether some day the greater proportion of the industrial field must be collectively owned and managed? The Socialist Movement. — In every country of importance at the present time there is an organized socialist movement. In Germany the Social-democratic party is the largest political party of the empire, having polled over one third of the total votes cast in 1812, although it has less than 28 per cent of the seats in the Reichstag. The growth in votes and representation is shown in the following table : SOCIALISM 637 Year Socialist Vote in Germany Representatives IN Reichstag! 1878 437,100 9 1881 312,000 12 1884 550,000 24 1887 763,100 II 1890 1,427,300 35 1893 1,786,700 44 1898 2,107,100 56 1903 3,010,800 81 1907 3,259,000 43 1912 4,250,400 no Although the official platform of the party adheres strictly to the orthodox Marxian faith, the party itself has worked for many reforms tending to favor the lower classes, and a large element of the party (the " revisionist " wing) is in favor of putting the doctrine of the class struggle and complete collec- tivism in the background, and laying main emphasis for the present upon social reform. In France there are a number of socialist factions of various degrees of radicalism, nominally united in one party, the factional strife being one of the promi- nent characteristics of the movement in that country. Their combined representation in the Chamber of Deputies is about one sixth of the total membership. A member of the moderate group, Millerand, was made Minister of Commerce (1899) in the Waldeck-Rousseau cabinet. Since that time other social- ists have accepted cabinet portfolios, but as individuals and not as representatives of the socialist party. In a number of French municipalities the government is almost completely socialistic in personnel. The result in these cases has been an increased public activity in behalf of workingmen, the poor, and the un- fortunate. In Belgium the success of the socialist party in promoting the cooperative movement has been striking. In England no one socialist party has attained the prominence of those in Germany ' The total number of seats in the Reichstag is 307. 638 OUTLINES OF ECONOMICS and France. Some of the socialist organizations have joined with the trade unions in forming a Labor Party, which in 1914 had 39 representatives in Parliament. In the United States there are two rival parties, the Socialist party and the Socialist Labor party (of minor importance), both having platforms based upon the Marxian philosophy. The list of socialist ofi&cials in the United States in 1913 included 21 members of State legisla- tures, 34 mayors, and 612 municipal, county, and school officers. In 191 2 a socialist was elected to Congress from Wisconsin. The elections of 19 14 also resulted in the choice of one socialist member of Congress (from New York). In 191 2 the presidential candidates of the two socialist parties polled 6.3 per cent of the total vote, the total socialist vote at four recent presidential elections being : 1900,130,336; 1904,441,776; 1908,438,509; 1912, 93i)4o6. Socialists have rendered good service by calling attention to social problems, by forcing us to reflect on the condition of the less fortunate classes, by quickening our consciences ; also by helping us to form the habit, acquired by few as yet, of looking at all questions from the standpoint of the public welfare and not merely of individual gain ; finally, by calling our attention to the nature of the industrial functions of government and helping us to separate rationally the private industrial sphere from the public industrial sphere. A number of questions hav- ing no connection with socialism have been, even by socialists, not infrequently associated with it. Atheism and free love may be mentioned. Socialists generally, however, regard religion and marriage as changing institutions. Anarchism. — In contrast with the socialist, the anarchist holds that the ideal social arrangement is that men should freely and spontaneously form cooperative groups. The anarchists attack government and deny the right of one man to exercise authority over another. Freedom, independence, self-reliance, non-compulsion, are what appeal to them. Such an ideal con- tains nothing reprehensible, but its complete attainment is im- possible. Some governmental compulsion seems necessary with human nature as it is or is ever likely to be. The anarchist is SOCIALISM 639 not opposed to the principle of association ; he simply asks that the association be voluntary. The anarchist ideal is thus por- trayed by Kropotkin : "This society will be composed of a multitude of associations federated for all the purposes which require federation ; trade federations for produc- tions of all sorts, — agricultural, industrial, intellectual, artistic ; communes for consumption, making provision for dwellings, gasworks, supplies of food, sanitary arrangements, etc. ; federations of communes, among themselves, and federations of communes with trade organizations; and finally, wider groups covering all the country, or several countries, composed of men who collaborate for the satisfaction of such economic, intellectual, artistic, and moral needs as are not limited to a given territory. All these will combine directly by means of free agreements between them, just as the railway companies or the postal departments of different countries cooperate now, without having a central railway or postal government, — even though the former are actuated b)^ merely egotistic aims, and the latter belong to differ- ent and often hostile states ; or as meteorologists, the Alpine clubs, the life- boat stations in Great Britain, the cyclists, the teachers, and so on, com- bine for all sorts of work in common, for intellectual pursuits or simply for pleasure." ^ Many persons class anarchists and socialists together as simply dangerous persons. One thing they do have in common, and that is, discontent with existing conditions. Otherwise their views are in most respects radically divergent. Anarchists differ among themselves. The " communist- anarchist " Kropotkin has advocated revolutionary tactics. Bakunine and Stirner also favored the use of violence. The " individualistic anarchists," such as Tolstoi and Tucker, have advocated a peaceful policy of non-resistance. Godwin and Proudhon may be called anarchistic reformers. QUESTIONS AND EXERCISES 1. Is the public purchase of a street-railway system socialistic? 2. What is the attitude of socialists toward the trust problem? 3. Compare the Amana Society with the New Harmony Community. 4. What is meant by the economic interpretation of history? Is it ac- cepted by thinkers who are not socialists? 5. Can the socialist be said to have a distinctive attitude towards war? * Memoirs of a Revolutionist, pp. 398-399- 640 OUTLINES OF ECONOMICS 6. What is the relation between trade-unionism and socialism in the United States? 7. How should one measure the real cost of the supply of capital in a sociahstic state? REFERENCES Barker, J. E. British Socialism. Cross, I. B. The Essentials of Socialism. Ely, R. T. Socialism and Social Reform; French and German Socialism. Eltzbacher, Paul. Anarchism. (Trans, by S. T. Bjdngton.) Ensor, R. C. K. (Editor). Modern Socialism, 2d ed. (A collection of essays by leading socialists.) HiLLQUiT, Morris. History of Socialism in the United States. Hinds, W. A. American Communities. (Descriptive.) HuGHAN, J. W. The Facts of Socialism. Jaures, Jean. Studies in Socialism. (Trans, by M. Minturn.) KiRKUP, Thomas. History of Socialisjn. Kropotkin, p. Modern Science and Anarchism. Le Rossignol, J. E. Orthodox Socialism. Morris, William. News from Nowhere. Orth, S. p. Socialism and Democracy in Europe. Rae, John. Contemporary Socialism, 2d ed. Seligman, E. R. a. The Economic Interpretation of History. SiMKHOViTCH, V. G. Marxism vs. Socialism. Skelton, O. D. Socialism: A Critical Analysis. Socialist Party Campaign Book. Spargo, John. Syndicalism, Industrial Unionism, and Socialism. Tucker, Benjamin. Instead of a Book, 2d ed. VizETELLY, E. A. The Anarchists. Walling, W. E. Socialism As It Is; The Larger Aspects of Socialism. Wells, H. G. A Modern Utopia; Socialism and the Great State. Zenker, E. V. Anarchism. BOOK III PUBLIC FINANCE CHAPTER XXXI PUBLIC EXPENDITURES Nature and Significance of Public Finance. — Public finance deals with the revenues of government, with their expenditure, and their administration. Public finance is one part of economics. Like general economics, it deals with the means for the satisfac- tion of human wants. Some of our wants we satisfy in one way, some in another. Some we satisfy individually. Some we satisfy through private associated effort, especially through the private corporation. Others we satisfy through public collective effort, that is to say, through some governmental agency. The wants which we satisfy through governmental agency are not all of them so peculiar that they could not be satisfied either through private individual activity or private associated activity. Let us take the case of watering the streets. There are places in which the streets, in so far as they are watered at all, are watered by in- dividuals in their private capacity, each man watering the street in front of his own house with his own hose. There are other places in which the householders join together and pay some one to water the streets for them, and do this privately. There are still other cities in which the city government employs persons to water the streets and pays them from the proceeds of taxation. There are, to be sure, some wants which are satisfied through governmental agency and which a civilized community will not allow us to satisfy privately. This is the case with those wants which are satisfied by means of the police and the courts. It i? a peculiar function of government in modern times to provide the inestimable blessing that we call security of person and property. This requires economic resources, just as the satisfaction of the other wants mentioned does, and public finance has to do with the provision of these resources. 643 644 OUTLINES OF ECONOMICS Public finance, then, is a part of economics because it deals with the satisfaction of wants by the use of economic resources. It is also a part of economics because it has its influence upon the production, the distribution, and the consumption of wealth. But while we have to insist that public finance belongs to eco- nomics, it is more separated from the other parts of economics than they are from each other. Inasmuch as it deals with the satisfaction of wants through governmental agency, it has its own peculiarities, and it is only an undue emphasis upon these peculiarities which leads some writers to, make it a separate science. The significance of public finance may be brought before us by examination of, first, the increasing amount of public revenues, and of, second, the enormous aggregate of these revenues at the present time. Public revenues have gone on increasing during the past hundred years by leaps and bounds. An illustration is afforded by the history of France. Ninety years ago the public expenditures of France reached one thousand million francs for the first time, or, as we generally say, a billion francs. There was universal astonishment and alarm, just as there was when, for the first time, an American Congress spent a thousand million dollars in two years. Never since the time,. however, when the public expenditures of France first amounted to a thousand mil- lion francs have they been so small. Gradually they increased until they reached two thousand millions, never to pass below that mark ; then they increased until they touched three thou- sand millions ; and now the national expenditures are nearly four thousand millions. Public expenditures at the present time, under the modern government, amount to more than a tenth part of all the wealth produced.'^ 1 This estimate (that public expenditures equal one tenth part of all the wealth annually produced) has been given, but it must be a very considerable underestimate for the modern nation. We in reality know very Httle about the amount of wealth annually produced in the modern nations of the world. But such data as we have, and familiar observation, are sufficient' to convince us that the wealth produced is not ten times the total pubHc expenditures. In the United States, according to Starke M. Grogan, chief (Census) Statistician in Charge of Wealth, Debt, and Taxa- tion, the total expenditures or "total governmental cost payments," including the PUBLIC EXPENDITURES 645 Now what does this mean ? Does it signify increasing extrav- agance or even corruption? Quite the contrary. While the modern government is far from perfect, it is throughout the civilized world probably better than it ever has been before. Taking the civilized world as a whole, there probably never was more honest government or more efhcient government than there is today. What it really means is this : We are living in a pe- riod of increasing public cooperation. We think we find it more advantageous to satisfy certain wants, growing in number and significance, through public cooperation than through individual effort or private cooperation. This is the chief significance of the increasing governmental budget throughout the civilized world. Mihtarism in its various phases is the chief phase of pub- lic expenditures that is disquieting.^ Educational expenditures afford a good illustration of the general tendency. They run up into the hundred millions in the modern nation, whereas, previously to this century, they were insignificant. Expendi- tures for police protection, for public lighting, and for sanitation are things which, so far as any expenditures of magnitude are concerned, belong to this century. Public finance has still another significance. Questions of social reform are now connected generally with financial ques- tions just as formerly they were with constitutional questions. Public finance has become the central fighting place for social reform. The question of protection has, from the earliest days in this country, been connected with public finance. Police regulation has also been connected with fiscal measures. The license charge for the privilege of selling alcoholic beverages national government, states, territories and local subdivisions amounted in 1913 to $3,284,343,266 or $33.83 per capita. Professor W. I. King {Wealth and Income of the People of the United States, p. 248) estimates the average income in the United States, for the year 1910, at $332 per capita. Public expenditures thus appear to take about 10 per cent of the income in this country. In England the per capita expenditure of the national government alone was, before the European War, over $15-5°, and in France over $17. The 10 per cent estimate, then, is clearly an underestimate for most countries. 1 This topic is adequately treated by Professor Charles J. Bullock in his article entitled "The Growth of Federal Expenditures," Political Science Quarterly, vol. xviii, pp. 97-1 1 1. 646 OUTLINES OF ECONOMICS furnishes an illustration. The scope of the police power is expanding in the United States, and this means expansion of the field of public finance. The discussion of public expenditures reveals, as few other subjects do, the nature of our civiliza- tion. Public and Private Expenditures Contrasted. — There is a difference between public and private economies with respect to the equilibrium between income and outgo. Relatively, there is an elasticity of government revenues and an inelasticity of government expenditures. This finds expression in the state- ment that public revenues are gauged acccording to expenditures ; whereas, in the private economy, the household expenditures are regulated by income. This is a regular rule for normal conditions. It is abnormal when irregularities in public income lead to irregu- larities in expenditures. It has been observed by a critic that this principle of public finance is true in a legal sense, but not in an economic sense. It is said that when public expenditure is decided upon, then we legally determine the income ; but, eco- nomically, the expenditures of the state rest upon a foundation as elastic as that of a private person.^ It is true that in public expenditures there must be a balancing of gain and sacrifice, and that in the case of a particular expenditure it must be weighed over against all other possible expenditures, not only public, but private. The rich state, undoubtedly, will incur expenditures from which a poor but prudent people will probably shrink. On the other hand, a private person is not to be thought of as neces- sarily spending all his income, even if he gauges his expendi- tures by income. Nevertheless, roughly speaking, the principle has significance because of the priority of the claims of the State. This has been well brought out by critics of Henry George, who advocated the appropriation of economic rent for public expenditures. Some of Mr. George's followers have replied to the objection that eco- nomic rent might not be sufficient for public expenditures : " Then the State must curtail its expenditures as the private person would do." When we think about it, we find that certain public * Gustav Cohn, Finanzwissenschaft, S. 184. PUBLIC EXPENDITURES 647 expenditures must be made and must take prior claim. How- ever, when, as is so often the case in cities, there is an income strictly limited by the tax rate, we have a situation like that of a man with a limited and inadequate income. This is an un- fortunate situation for cities ; but the case of a national govern- ment which did not have a prior claim upon wealth for defense would be anomalous. Closely connected with what has been said, we find various differences due to the sovereignty of the State and its perpetual life. The State orders a citizen to give up a part of his possessions, and, indeed, frequently fixes the prices to be paid for them. And a peculiarity of the prices paid by all states for property and services is that they must be determined by criteria of fairness, inasmuch as by the very hypothesis competition is wanting wholly or in part. Consequently, we find courts and legislatures much occupied with the determination of what is " fair and rea- sonable." The perpetual life of the State has to be kept in mind in a great variety of expenditures. It is the special function of the State to provide for future generations, and this is seen, for example, in forestry and in care for rivers and harbors. There is a difference between public and private economies in the means of measuring the utilities resulting from expenditures. It is at once admitted that all expenditures of states and of pri- vate persons should, in a large sense, be productive. Waste is everywhere an economic wrong, but productive expenditures mean simply useful expenditures. What the State produces is largely immaterial services, and these have no market price. How can we tell whether they are socially profitable or unprofit- able? They are not worth while if they result in a sacrifice of other expenditures which would yield larger satisfactions. It is a special function of the legislative body, in a constitutional state, to decide upon the relative advantages of various possible public expenditures, and to weigh these over against the ad- vantages of private expenditures which might have been made if the money permitting the expenditures had been left in private pockets. When a certain sum is taken from me by taxation, it results in a public expenditure instead of a private expenditure 648 OUTLINES OF ECONOMICS which might have been made. This is only another way of saying that public expenditures are largely from income which is derivative. Private individuals secure an income and then yield a part of it for public purposes. These contributions are compulsory. On the other hand, there are economists who look upon the State as a factor in production, and hold that what is paid in taxes is less than what corresponds to the cooperative activity of the State in the maintenance of law and order and in other services. The special social significance of public expendi- tures is that their aim is inclusive^ normally and regularly; whereas, normally and regularly, the aims of private expendi- tures are more or less exclusive. A public library contrasted with a scholar's private collection of books illustrates this point. All these differences are considerable, and they give us perhaps at least one reason why business men are so often a disappoint- ment in an official capacity. The public financier must be gov- erned by the public point of view.; and there are many points at which this diverges from the private point of view. The true statesman is one who has the public point of view, and yet is able to avail himself of the knowledge and experience of private business. The Proper Proportion between the Total Income of Society and Public Expenditures. — We notice actual changes in this proportion, and we discover that further changes are advocate4, running all the way from anarchism, which would abolish gov- ernment and public expenditures, to socialism, which, by making production and distribution public functions, would make public expenditures, broadly construed, nearly equal to the total wealth production. An attempt has been made by those who take a less extreme position than either of these to give an estimate of what is a large public expenditure, what a small expenditure, what is desirable, undesirable, or even intolerable. Generally these estimates are made with respect to the maximum expenditure, but we could equally well raise the question with respect to the minimum. One writer speaks of public expenditures of 16 per cent as aver- age, and 25 per cent as excessive. Another regards public ex- PUBLIC EXPENDITURES 649 penditures which consume 1 5 per cent of the total annual wealth production as the upper limit. In our American practice, we very generally attempt to fix a maximum direct tax rate. But these limits are based on the valuation of property and not on income. State constitutions very frequently also limit state expenditures, as well as the expenditures of cities and other local units. For local purposes in the United States, we have roughly a tax limit of | to 3 per cent of the value of property. Total taxation of real property frequently runs in the United States from 10 per cent to even 20 per cent of the net profits, and indeed not infrequently goes far beyond that. The truth is that it is absolutely impossible to give any general answer to the question, " What is the proper proportion between the total income of society and public expenditures? " Variations in- the wealth of a country have to be considered, and these mean much when the question of additional expenditure is raised. Variations in tax systems and the consequent distribution of the burden of taxa- tion make a wide difference. In times of distress, more can be expended than on ordinary occasions. When the national life of the State is endangered in a war, expenditures will be incurred which would be impossible at any other time, simply because for any other reason the people would not submit to the sacrifice involved. But there are other points of view which go still deeper. Why do we spend money at all through the State ? Obviously to sat- isfy needs. How much we should spend publicly depends upon what needs are satisfied publicly. We have to ask and answer the question, " What position do these needs hold among our needs in general? " " Do they belong to our necessities or superfluities? " When we consider public expenditures in the broadest terms, we must take into account the amount of pro- duction which is carried on by the State — employing this term " State " here as elsewhere in its generic sense. If the railways (as in Germany) are state railways, a larger percentage of the expenditures and revenues of the country are public in character than would be the case if they were privately owned and operated. No comparison of expenditures of various countries can have any 650 OUTLINES OF ECONOMICS value if it does not take into account considerations of this kind. Professor Adolph Wagner ^ lays down this rule, which is help- ful in answering the question as to the proper proportion between the income of society and public expenditures for any particular time and place : " The permissible amount of public expendi- tures, both absolutely and relatively considered, will vary di- rectly in proportion to (a) the direct economic value of state activi- ties ; (b) the extent to which these promote the productive power of all ; (c) the absolutely free social income ; ^ (d) the part of the net state receipts coming from the quasi-private acquisition (railways, industries in general) of the State and not from taxes." ^ Fortunately, how much we shall spend presents itself historically, that is, with respect to historical conditions, and has reference to increments or decrements of expenditure. The problem is far easier of solution than it would be otherwise. In fact, except as a concrete historical problem, it is impossible to state how great the public expenditures should be. We are now in a position to understand why it is that the nations of the world have not been ruined by expenditures which even a genera- tion ago would have been thought absolutely crushing, and one hundred years ago would have been inconceivable. We satisfy our needs to an ever increasing extent through public agencies. This finds expression in the /aw of increasing public expendi- tures, given by the writer from whom we have just quoted. " Comparisons between different countries and different periods show regularly among progressive nations an extension of public activities. This manifests itself extensively and intensively. The State and its subordinate political units continually undertake new functions, and they perform their dtities, old and new, better and bet- ter. In this way, that is, through public agency, the needs of the population, especially their common needs, are satisfied to an in- 1 Finanzwissenschaft, 2te A., Bd. i., S. 65. 2 I.e. beyond and above what is needed for subsistence. ' This means public ownership of enterprises which are so conducted as to yield profits. All the profits can and indeed must be expended for public purposes, whereas, if the industry were private, only a part of the profits could be taken for public purposes. PUBLIC EXPENDITURES 651 creasing extent; and the public services for the satisfaction of needs continually improve in quality. The clear proof of this is given statistically in the increased demands made by the State and the subordinate political units J ^ ^ We have here described what is a part of a still larger move- ment, namely, the socialization of production and the socializa- tion of consumption. It is, however, the socialization of con- sumption which especially confronts us in public expenditures. To an increasing extent what is consumed by the family is pro- duced outside the family. There has been going forward a great process of socialization, and this finds expression in part in public expenditures. The needs of the family are satisfied, in increas- ing proportion, not by the private economy, but by the public economy, and satisfied also, as Professor Wagner points out, not in accordance with the principles of private economy, which is service for service, but in accordance with the principles of the public economy, which is an adequate general return for that which is received. We have to do with what we may also call socialization of sup- ply. We do not protect ourselves against physical violence, but are protected by the State. We do not educate our own children ; they are educated by public agency. And public expenditures are also made to promote art and all the higher interests of life. The services which the federal government renders us in the post office find expression in public expenditures. Public expenditures are giving us more beautiful and more healthful cities, and are satisfying the needs which arise out of the extensive growth of the country, in its expansion geographically and in the size of the population, and also the needs which arise from an intensive growth. The significance of this lies partly in increased state activities and partly in the incidence of the cost of the services under con- sideration. The poor, who could not themselves have pleasure grounds, enjoy public parks, and these are maintained at public expense. So we may take up one service after another and find that wealth, produced in accordance with the principles of the ^ Wagner, Grundlegung der polUischen Oekonomie, 3te A., Bd. i, S. 893. 652 ' OUTLINES OF ECONOMICS private economy, is consumed in accordance with the principles of the public economy, and that is very largely in accordance with needs and capacity for use. The whole public educational system, from the country district school to the modern state university, culminating in research and investigation, admirably illustrates this principle. Extravagance, Economy, and Parsimony in Public Expendi- tures. — After a definition of economy in Webster's International Dictionary, we find the following : " Economy, Frugality, Parsi- mony. Economy avoids all waste and extravagance, and applies money to the best advantage ; frugality cuts off indulgences, and proceeds on a system of saving. The latter conveys the idea of not using or spending superfluously, and is opposed to layishness or profusion. Frugality is usually applied to matters of con- sumption, and commonly points to simplicity of manners. Parsimony is frugality carried to an extreme, involving mean- ness of spirit and a sordid mode of living. Economy is a virtue and parsimony a vice." We must have clear ideas as to which course of the three we shall follow, for it is scarcely to be taken for granted that we shall follow the course of extravagance. There is, however, danger of indifference as to the size of public expenditures, and extrava- gance may result therefrom. While scarcely any one now would deliberately advocate extravagance so far as the general princi- ple is concerned, extravagance in detail might be advocated; and, in fact, in practice we find both indifference and extrava- gance. Sometimes the idea that extravagance brings money into circulation has found favor, and especially has been used for the justification of large expenditures by royal courts. The same idea has been used as- a justification for luxury. It can, however, find no support in economic principles. There is dan- ger of extravagance because each one concerned with govern- mental expenditures feels that what he spends is a relatively small matter, and indeed it is. It is sometimes thoughtlessly overlooked that when many are spending, " small waste " be- comes significant, and may be even ruinous. This is a problem which concerns every large business, and it requires strict and PUBLIC EXPENDITURES 653 wise administration to avoid the two extremes of wasteful extravagance and red tape. Sectionalism also results in extravagance, and this shows itself badly in the United States at times. Whatever any state can se- cure from the federal treasury is often looked upon as so much clear gain. This was clearly brought out in the discussions con- cerning the repaym_ent, several years ago, of the direct tax that had been paid by the states to the federal government. This tax has now been repaid, but many states gave agents large and extravagant sums to work for the refund. Sometimes sectional- ism manifests itself even in cities. In one section of the city there may be vigorous efforts to secure money for itself without due regard for the general interest. For many years, in this country, federal taxes were laid very largely for other than revenue purposes, and there was no care- ful balancing over and against one another of probable revenues and probable expenditures, with the result that there was fre- quently a large surplus in the federal treasury. There never has been a time when it would not have been possible to have expended wisely the entire revenues of the federal government ; e.g. the telegraph might have been purchased, and educational expenditures might have been increased. But there was no demand for these expenditures strong enough to prevail, and the outlet was found along the lines of least resistance, or, perhaps it ought rather to be said, along the lines of greatest " pull." We may then lay it down as a general law that there is danger of extravagance whenever public revenues outrun felt needs. In the domain of local government it is possible to limit taxes or expenditures, and, as stated above, American statute books are full of laws prescribing maximum rates for school, highway, and other tax levies. These laws have failed in the past because they were adjusted to our prevailing underassessment of prop- erty and it was perfectly easy to evade them by raising the assessment a little closer to the true value. More recently, however, Colorado and several other states have adopted " tax limit laws " which work successfully. Instead of limiting tax rates, the total tax levy or the total expenditures are limited to a 654 OUTLINES OF ECONOMICS certain increase, say ten per cent, over the tax levy or total expenditures of the previous year ; and some authority — usually the state tax commission — is empowered to raise the normal limit in " cases of emergency or urgent necessity." Tax limit laws applied in an arbitrary way may cripple, and in some cases have crippled, municipal governments in necessary and desirable expansions of public activity ; but when adminis- tered by a wise board or commission authorized to modify the ordinary limit when necessary, they are capable of restraining harmfully rapid expansion of public expenditures.^ There is a tendency, especially wherever public spirit is not highly developed, to favor parsimony, and to regard that as the best administration which spends least, and the smallest tax as the best tax. This idea was particularly encouraged by those who looked upon government expenditures as external to the life of the people — as if they were expenditures for some outside person. This idea, indeed, may be traced back to monarchical government and to a time when royal courts consumed a large part of the public revenue. The smallest expenditure means the accomplishment of the fewest purposes. Parsimony means meanness, and can never be the rule either of public or private financiering. Frugality is the rule when it is a necessity. Econ- omy is the sound rule ; and this means a broad and liberal policy and a husbanding of resources. The wise citizen judges any particular administration either in the nation or the state, not chiefly by the amount of public expenditures, but by the results of public expenditures, appreciating full well that increasing public expenditures are a normal condition in a sound and healthy society. The Development of Public Expenditures. — It is instructive to consider the historical order in which the objects of public expenditure appear. This order throws a strong light upon the evolution of industrial society and of civilization in general. This is an almost unworked field of investigation, but it is an extremely interesting and important one. This order can be 1 See discussions of this subject in State and Local Taxation (Proceedings of the National Tax Association), Vol. viii, pp. 368-390, and Vol. ix, pp. 452-473. PUBLIC EXPENDITURES 655 presented here only in the most general terms, and in these terms it is somewhat as follows : Expenditures for (i) external security; (2) security within the community; (3) promotion of material interests ; (4) benevolence (transferred in part from the Church at the time of the Reformation) ; (5) education in its various phases ; (6) labor. In a general way the organization of the departments of the federal government corresponds with this order. In 1789, the Treasury, War, and State departments were organized, also the Department of Justice, Supreme Court, and the Navy Department ; the Post Office Department was organized as a distinct department in 1829 ; the Department of the Interior was organized in 1849 J the Department of Labor as a separate department (without representation in the Cabinet) in 1889 ; the Department of Agriculture as a separate department (with representation in the Cabinet) in 1889 ; the Department of Commerce and Labor (with representation in the Cabinet) in 1903. In 1 9 13 Commerce and Labor were divided and given separate representation in the Cabinet. The modern nation has been spending an increasing proportion of its resources for edu- cation. (We use " nation " in the general sense here, including all the subdivisions of the nation.) We find a rapidly increasing item in the budget of the modern municipality for public libraries, in which line of expenditure the United States is leading the world. Lately, in the modern budget, we find expenditures which are distinctively for the promotion of the interests of labor. Most interesting it is to observe, within the last few years, an expenditure in the national budgets for international agreements and arrangements to promote the interests of labor. In 1900, the International Association for Labor Legislation was formed, and its permanent Bureau was established at Basle, Switzerland, in 1 90 1. As the competition of labor and capital was interna- tional, it had, in the opinion of many careful observers, become necessary to safeguard the interests of labor by international agreements. Consequently, we find that this international association receives subsidies from most European governments, and a small one from the United States through our federal 656 OUTLINES OF ECONOMICS Department of Labor. And, in 1905, as we have already seen, an international treaty was entered into by Italy and France for the advancement of the interests of labor and for mutual protection of employers. Small indeed are these items, but they are significant as beginnings. We must, however, analyze the public expenditures of the various departments more carefully to understand fully the order of development in the objects of public expenditures. The whole expenditure of the Department of Agriculture is an expen- diture to promote material well-being, and this has become one of the great departments in modern government. The Depart- ment of the Interior is also largely concerned with expenditures to promote the general material welfare. We have in the De- partment of Agriculture such divisions as forestry, food adultera- tion, botany, seed tests, pomology, entomology, agricultural soils, irrigation investigations, and road inquiry. , We cannot lay down any hard and fast line between public and private expenditures, because there is a perpetual shifting from the satisfaction of v/ants privately to the satisfaction of wants publicly, and sometimes even, though less frequently, the reverse process. The railways of Prussia were once private, and their receipts and expenditures had little to do with the Prussian budget. Now the receipts are public receipts, and their expen- ditures are public expenditiires. The addition to the budget, however, does not mean necessarily an additional burden on the people. Indeed, if the people are well served and served for a lower price than formerly, with less relative cost of operation, the burdens of the people have been lightened, and this is what is generally claimed in Prussia. Let us take the case of a city in which watering the streets is a private matter paid for by private subscription. The expenditure becomes a public expenditure when the city takes upon itself this function, but if the public expenditure is no greater than the private expenditure, there is no additional burden. If the service is better performed, and the total burden more fairly distributed by taxation than by private subscription, — as sometimes, at least, happens, — there is a positive gain. The increased density of population has been PUBLIC EXPENDITURES 657 mentioned as a cause of increased public expenditures. A suburb without any municipal organization may maintain electric lights in the streets by private subscription. The expenditure appears in no public budget. This suburb secures some kind of a mu- nicipal organization, and that which was a private expenditure becomes a public expenditure. Again, however, there is no increased burden resting upon the people ; their wants are satis- fied through a different channel. When we compare modern times with ancient times, we find that an increasing proportion of the public expenditures are incurred for objects which directly benefit the people, and relatively a decreasing amount for objects in which they have comparatively little concern. This finds most striking exem- plification in a comparison of the budget of France in 1789 ^ with the budgets of 1906 and 1907, which we take merely as typical modern budgets.^ Expenses — 1789 LiVRES 2 Cost of collection and reimbursements (does not include cost of collecting taxes farmed out) Consolidated debt - — included portion made up of annuities Interest, etc., on remaining portion of debt Pensions 31,478,000 162,486,000 80,527,000 29,560,000 33,240,000 Royal family and princes Total 337,291,000 " This formed the total deduction before provision could be made for general service of the government," in which the vari- ous items are as shown in the accompanying table. It will be observed, in comparing these budgets, that the French court consumed a very large proportion of the expenditures of 1789; and that of what remained a very large proportion was consumed by the public debt, the army and navy ; and that for education 1 Necker's "Budget," May, 1789, rearranged by the author of the article in the Dictionnaire des finances. * A livre is slightly — say 2 per cent — less than a franc. 2V 658 OUTLINES OF ECONOMICS and the promotion of general welfare the expenditure was rela- tively insignificant. A study of the table on the next page re- veals one of the reasons why it is that France is able to sustain so large a public expenditure. Wants are thereby satisfied, and what is expended returns to the people in services. Expenses — 1789 {Continued) LiVRES War Marine and colonies Foreign affairs Justice Interior Financial administration Public works, agriculture, and commerce Public instruction and fine arts . Public worship Total Brought forward Grand Total 100,548,000 40,900,000 7,480,000 6,353,000 8,249,000 5,801,000 11,907,000 1,227,000 2., 188,000 184,653,000 337,291,000 521,944,000 The view here presented of public expenditures is undoubtedly one which is reassuring. The impression must not be gathered from this that there is no need for care and watchfulness. As public expenditures increase, it becomes of more and more im- portance to secure wise and prudent administration of all our resources. Wastefulness becomes more serious than ever before, and the benefits from excellence in administration increase cor- respondingly. Without pronouncing any opinion upon what is called imperialism, we may also say that the enormous increase in expenditures, in one way or another connected with war, which we have seen during the past few years, cannot be viewed with- out misgiving. Even if there is no danger of the bankruptcy of any great modern nation, the thought must at least occur to one that it is a pity that, with so many public needs unsatisfied, with such large possibilities in the way of improvement of educa- PUBLIC EXPENDITURES 659 Budget Estimates Voted for the Years 1913 and 1914 Branches of Expenditure 1913 Francs 1914 Francs Finance : public debt . . . President, Chamber, Senate Finances Justice Foreign affairs Interior War Marine Merchant marine . . . . Instruction Fine arts Commerce and industry . . Labor, etc Posts and telegraphs . . . Colonies Agricvilture Public works Total 3S8 983 467: 309 21 16 106 344 loS . 55 340 ,423,922 ,116,488 948,853 1551,727 ,668,037 961,939 ,224,376 176,109 394.631 ^139,995 ,778,491 .792,379 .669,353 .313,845 .535,393 ,002,741 ,905,255 1,306,585,021 20,006,738 389,243,907 61,017,461 22,879,749 176,949,513 1,203,659,712 513,542,521 97,368,267 347,810,375 21,839,189 17,948,374 106,718,809 362,635,135 109,724,180 74,769,222 358,944,912 4,738,603,534 5,191,643,085 tion and of our general environment, such enormous and almost incomprehensible aggregates of wealth should be annually ex- pended for warlike purposes. Development of Public Expenditures with Respect to Regu- larity and Irregularity. — Public expenditures are regular and irregular, or ordinary and extraordinary, with respect to their occurrence. Whether the expenditures are regular or not depends upon the nature of the goods and services for which they are in- curred. A large force must be employed in the army and navy and civil service ; and regular expenditures must be made for these branches of the public service. On the other hand, there are great monumental works like the construction of a capitol for which the expenditure is irregular in character. War, famine, and pestilence occasion irregular expenditures. It is to be noticed, however, that in any scientific arrangement regular expenditures increase and irregular expenditures decrease. This 66o OUTLINES OF ECONOMICS is particularly the case in a large country, and especially so when long periods of time are taken into account. It is an end to be striven for in the interest of orderly finance. In India there is a regular famine fund to make provision for the recurring famines, so that even expenditure of this kind takes on the character of regularity. The longer the period of time and the larger and richer the country, the greater the possibilities of establishing regularity, inasmuch as chance elements decrease under these circumstances. The construction of a post-office building in one city is an unusual event, but, when the United States as a whole is taken into account, it is quite possible to provide regularly for post ofiice buildings. It is further to be noticed that preventive measures rather than relief measures increase regular expenditures. This is one argument in favor of constant preparation for war. The war expenditures are smaller and less disturbing when they come. It need not be remarked that this financial advantage may be secured at a loss otherwise. 'Furthermore, there is a certain con- flict of interests between administration and legislation. Those who are administratively responsible for expenditures prefer to have budgets voted for long periods, as in this way they can accomplish most with a given sum. On the other hand, a legisla- tive branch of government desires that budgets should be voted for short periods for the sake of stricter control. It is also to be noticed that the constitutional provisions against debts in the states of the American Union promote regular expenditures. Where loans are not possible, it is fre- quently necessary to spread expenditures over long periods in order that the burden may not be too great at any one time. This may happen in the construction of public buildings and of other important public works, certain sums being appropriated each year for a series of years. Classification of Public Expenditures. — Many principles of classification have been adopted. At the bases of all of these, for countries like our own organized along federal lines, is the dis- tinction among (i) central, (2) intermediate, and (3) local units. In the United States the central would be the federal, the inter- PUBLIC EXPENDITURES 66 1 mediate would be the separate states, and the others, the local. An examination of expenditures with respect to these units throws a good deal of light upon our general political evolution. It especially helps us to determine whether or not there is a tend- ency in the direction of centralization, although expenditures are not conclusive evidence. Fear is often expressed lest the central governments should expand at the expense of local gov- ernments. It is thought by some that we are living in a period of centralization. Statistics of public expenditure do not bear this out. From the close of the Civil War until the end of the nineteenth century, local expenditures increased most rapidly and state expenditures least rapidly. Between 1903 and 191 3, however, the expenditures (" governmental cost payments ") of the states increased 106 per cent, while those of incorporated places with 8000 or more inhabitants increased only 103 per cent, and those of the federal government only 54 per cent. The increase in state expenditures seems to have been due to general expansion and multiplication of state activities, although it was particularly marked by the development of state highways and costly internal improvements such as the new canal system in New York, by more generous appropriations for education, and by the multiplication of state commissions.^ The student, and even the general reader, will find it especially instructive to study the financial reports of the federal government and of our states and cities, and arrange the items of expenditures under various general heads. ^ It is exceedingly difficult to arrange a classification that will be at once practical and scientific, i.e. that wiU show the expenditures of governmental departments as they are actually organized, observe the necessary accounting distinctions, and answer scientific inquiries of major importance. For American classifications which most nearly meet all the requirements, see the financial publications of the Bureau of the Census ; the reports of the Comptroller of the State of New York ; the Massachusetts reports entitled Statistics of Municipal Finances; and, for the federal government, the reports of the President's Commission on Economy and Efficiency, and in particular a paper by Harvey S. Chase, C.P.A., deahng with the expenditure side of the national budget, in the American Economic Review, Volume v. No. i, Supplement, pp. 186-195. A suggestive classification adapted to European condi- tions will be found in Cossa's Taxation : Its Principles and Methods, Part ii, Chapter iii. The summary census classification printed on the following page covers all governmental subdivisions in the United States, except townships and incorporated places having less than 2500 inhabitants. 662 OUTLINES OF ECONOMICS 0\| I 0^ O OO ' O O O t^oO I o^ O OC^f^O "^M Ttr^O rowvOM 0^'0 O O O r^oO -^ tJ- O ■ -^ O " O 0\ O O^ ► -^ M CO C^00 O "^ O : OO 0\ r^ ■^ ^O CO O O r^ CN ( ) -etOO t^,_^,,^ I^.—N O - -■ o ■Tj-OG O O O O O ^ ^0 O . LOCO M Lo r-~ utO w Tt On "^ O' r^ 0\ M "Tt-OO ^ M t^oO M fD CO O O ro 't >o "^ ^°9- ) ^0 >. MOO \0 c^mwoo OoO O t^00^O tN t vOCO f^ i-( roO'-<'-i 0O^O< O" ^O 00 -^ lO rO lOOO fi ■^ d^ O ONMO 00 00 00 O r-OO 00 fOO » lo -^ O 'Tjco >JO -^ LOCO OO -^ y O O too O !>. ( '^■mD -^oO CO r* m I ^ d d OMD O u-j O "O O O > O l-^OO CO to r~ ro O O lOCO i>- O . ro w to CO O C>O0 -O '^ rO 1 M Tf- o w (N o\oo OOO GO yo ^ oo O <:> -rir y to t/^ -Tl- C^ CT\ CO >" ) r^ Tj- 1^ O ^ -^ c I M lOfOCNO -& ^n O O I O \0 00 CO c-^OO 0\ M fO ' O i-T d^ d^ -^ to M a>'o" ex rt o ^ < WhSo w H 00 tv^oo O r^ VO O ^O OvOO ^ .n 22 t^ q 00 i-^^ f^ o Ti- to t-- M z m w ^ 00 CN ^ ON O VO >ovo vOOO COM fOOO " M OV !N M t^ i>- I^OO" N to t^ u ^ Tf r~ <^ lo i^O 't HOO 1/1 IMVO t^ r^vo lo M lo w VO ID »OVO O n -* lO O Ov o o a 00 lo o r-to ^ VO to w t^ Ov o C5 < ^ l-t M " ' a a • • ^i^. ■a.2 c a g-S.S.2 h '^3 ^ g e ° C C m vest deb ytr gtr rs . CO •s^S-g^ II ongovernmental For purchase of For redemption In trust and age In counterbalan By general tran z 1) PUBLIC EXPENDITURES 663 If access can be had to reports covering a considerable number of years and different countries, it will be found that an examination of them will throw an immense amount of light upon the nature of modern civilization and its direction. It is also instructive to compare expenditures on account of the head of the State in various countries, and particularly ' to contrast monarchical and republican countries. It is important to discover great historical tendencies, and to contrast different periods of time, especially as regards monarchical expenditures. It is beyond all question that relatively, in the civilized world, that is an item of declinirigSijiportance. At the presenlv^ime, the king of a great country Hke Prussia or England supports a magnificence of state which is altogether out of keeping with the ideas of a defnocracy or a repubhc. Four or five millions of dollars per annum for a modern monarch is not a large expenditure. On the other hand, in contrast, the expenditures of the President of the United States (including those connected with the executive mansion, contingent expenses of all sorts, and presidential clerks) amount roughly to $150,000. However, as regards the expenditures of a modern monarch (the German Emperor, for example), a detailed examina- tion shows that custom and tradition, as well as the will of the monarch, cause a large part of his income to go for public purposes, and that his wealth has been largely socialized. The king is no longer the typical rich man. On the other hand, the expenditures on account of the American Congress are unprecedented in amount among the expenditures incurred on account of legislative bodies. The world has never seen anything of the kind be- fore, and nothing parallel to it can be found in any other country. Among other things, this goes to indicate, as contrasted vv^ith Germany, the great importance of the legislative body which is supposed to represent the people directly and immediately and to carry out their will. In aristocratic coun- tries the legislative office is sometimes an unpaid office. This was until recently the case in British and German parHaments, the idea being to favor wealth and to counteract democratic tendencies — an aim which was not accompHshed. A democracy, however, is more likely to insist upon a legislative office being a paid office; and, in some of the German states, although the payment is small, its acceptance is compulsory. Expenditures incurred in the administration of foreign affairs are of in- creasing importance on account of growing economic internationalism. We would here have two main classes ; namely, (i) expenditures on account of diplomacy, those representing the purely political side of government, and (2) expenditures on account of the consular service, representing the business interests of the country. Expenditures connected with boundaries and surveys are expenses which would come under this general heading. With regard to the administration of foreign affairs, any one nation is Hmited in what it can do by international customs. We Americans, for example, cannot force our ideas on other nations. Certain standards of 664 OUTLINES OF ECONOMICS dignity and propriety have been established with respect to the mode of hfe for diplomats, and, if we depart from these, we do so at a loss which every diplomat in the service of the United States keenly feels. The most that we can do is to exercise pressure in what we believe to be the right direction, and that is the direction of democratic simplicity. When we examine expenses incurred in the administration of justice, we notice a large increase with the growth of democracy. In earlier times in countries like England and Germany, the administration of justice was to a greater or less extent "patrimonial," being connected with certain estates. The duty of administering justice went with the great estate or manor and involved little expense. As people take things into their own hands they must pay their own expenses. Democracy, in its progress, means large pubhc expenditures. The new humanitarianism of the age, which, in a way, is one expression of democracy, involves large expenditures, as seen in education, modern re- formatories, etc. But it is believed by the advocates of humanitarianism and democracy that these expenditures are worth while. It is when we come to expenses incurred in the promotion of the general welfare that we see the most remarkable and encouraging phenomena that greet us in the treatment of public expenditures. This has been seen in the data already given, and will become increasingly manifest as the student carries on his statistical studies in this field. QUESTIONS 1. Define public finance. Why should it be regarded as a part of eco- nomics? Can you give any reasons why it should be regarded as a sepa- rate science? 2. Can we spare money for taxes only when we have an income affording a surplus over and above necessities? If the money paid for taxes is used to provide us with necessities, is there any good ground for the doctrine that an income sufficient to afford a minimum of subsistence should be exempted from taxation in the case of an income tax ? 3. What various meanings do you ascribe to the enormous increase in public expenditures during the nineteenth century? 4. What should be the consequences if the government of the state in which you live should strive for the largest possible amount of revenue, and then govern its expenditures so as to consume the entire state income? 5. Discuss the differences between public expenditures and the expendi- tures of a private household. Would you regard it wise on your part to make any expenditures with the idea that a benefit to some one would accrue one hundred years later? fifty years later? twenty years later? 6. What considerations must govern us when we attempt to answer the question, "What is the proper proportion between public expenditures and the total income of society?" PUBLIC EXPENDITURES 665 7. Discuss Wagner's rule. Is the fact that public ownership increases the permissible proportion of social income that may be used for public purposes an argument for pubhc ownership of railways? If so, why? If not, why not ? 8. Discuss economy, parsimony, frugality, extravagance in public ex- penditures, and give as full illustrations of each as you are able (a) from your own observation, (b) from your reading and conversation and correspondence with others, public officials included. 9. Discuss the historical order in which items of expenditure appear in national, state, and local governments. Give illustrations from the state and from the local poUtical imit in which you live. Give any illustration which may occur to you of taxation which lightens the burdens of the taxpayer. 10. If you were permanent Secretary of War, would you desire to know for a long number of years in advance the yearly sums that could be expended on the army ? Could you thus make the same amount of money accomplish more than if dependent upon annual grants uncertain in amount? What would be your view as a member of Congress? Is a state university to be controlled in its expenditures by the legislature as rigidly as Congress should control the administration of the army? If so, why? If not, why not? Would you make any distinction in this respect between the army and the navy? 11. Present such statistics as you may be able to gather showing relatively and for as long a time as possible the increases in public expenditures in the federal government, in your own state, and in your own local political unit (city, county, town, etc.), and give all the evidence that you can secure show- ing the significance of the movement. REFERENCES Government publications generally. As illustrative particularly of the expansion of government expenditures and pubhc work, the Year Book of the Department of Agriculture. For growth of militarism, take publications of the Department of War and publications of similar departments in other countries. For general statistical data, the Statesman's Year Book is as reliable as any- thing in English. For our own country, see annual Finance Report of the Secretary of the Treasury, and census reports, especially the reports on Wealth, Debt, and Taxation. For making a broad survey of the federal expenditures of the United States, perhaps no single publication is more useful than the annual Letter from the Secretary of the Treasury trans- mitting Estimates of Appropriations. A striking exhibit of the growth of federal expenditures will be found in Senate Document No. 528, 60th Congress, ist Session, entitled E.xpenditures of the United States Govern- ment, 1791-1907. CHAPTER XXXII PUBLIC RECEIPTS FROM LOANS AND GOVERNMENT OWNERSHIP Public Debts. — The modern State follows a policy of deficit financiering. The great and increasing expenditures, which have been described in the preceding chapter, entail burdens too heavy to be borne, at least in the first instance, by taxation alone, and recourse must constantly be had to the public credit. Even before the European War, about one fourth of the annual revenue of England was used in the payment of debt or in- terest upon debt ; and, as is shown in the French budgets given on page 659, more than one fourth of the total expenditures of France was devoted to the same purpose. In the last half of the nineteenth century, the aggregate pub- lic debt of the civilized world increased enormously. According to the best estimates, the indebtedness of the national govern- ments of the world, which amounted to $7,627,700,000 in 1848, had risen to $27,525,000,000 in 1890, and since that time it has greatly increased. Figures showing the total and per capita debt of all governmental divisions of this country are given in Table I. From this statement it appears that between 1902 and 1 913 the aggregate public debt of this country increased by over $2,000,000,000, the greater part of the increase being ascribable to the astonishing growth of municipal and local in- debtedness, which increased by 113 per cent in the interval. It is true that the total public debt is less than it was in 1870, that the per capita debt has fallen from $82.99 ^^ 1870 to $49.97 in 1 913, and that according to Census estimates of national wealth (not very trustworthy), the public debt covered only $2.58 of each one hundred dollars of national wealth in 1912, as against $2.85 in 1902, $3.06 in 1890, $6.97 in 1880, and $10.64 in 1870. 666 PUBLIC RECEIPTS 667 But this diminution of the aggregate debt is due to the extraor- dinary progress which our tariff surpluses have enabled us to make in reducing the debt contracted during the Civil War; and the normal movement in the long run is probably toward an increase of the public debt, at least absolutely and per capita, if not in proportion to the national wealth.^ TABLE I Public Debt of the United States (Debt less sinking fund assets) Total in Millions of Dollars Per Capita 1913 1902 1890 1880 1870 1913 1902 1890 1880 1870 Total .... National gov't . States .... Minor divisions $4850 1029 346 3476 $2839 969 239 1630 $1989 852 211 926 $3043 1919 275 849 $3200 2331 353 S16 $49.97 10.59 3-57 3S-8i $35-99 12.22 3-03 20.74 $31.76 13.60 3.37 14.79 $60.66 38.27 5.48 16.91 $82.99 60.46 9.15 13.38 The great increase of public debts is due principally to two causes, wars and public works. The former are misfortunes, losses, however the result is expressed. The loss comes, not in contracting a debt, but in spending and destroying the property consumed by war. This loss cannot be postponed by a debt, although one nation may postpone part of the loss by borrow- ing goods and supplies from the people of another nation. It comes out of wealth existing or produced at the time, no matter what arrangement is made. In former times each man bore the loss as it happened to fall on him. The modern method differs . in just this, that the loss is transferred to the whole public. This, again, may be done in two ways. A tax may be levied at the time sufficient to pay all expenses, or a debt may 1 According to Census estimates, the per capita debt of the United Kingdom in 1904-1905 was 3.93, that of France 4.86, and that of Italy 2.25 times as great as the per capita debt of the United States in 1902, while that of Sweden was a trifle less than the per capita debt of the United States. 668 OUTLINES OF ECONOMICS be incurred and the necessary taxation spread over a longer period of time. In practice the latter proves far the best, for at least a part of the expenses. It gives taxpayers time to adjust themselves to the extraordinary demands. A war debt is, therefore, not a misfortune, though it stands for a previous misfortune — war. The case is clearer when we consider debts contracted for public works. Under this head we include primarily productive enterprises like railways, canals, forests, gas works. These, when purchased or constructed by the government, are the occa- sion of debts, sometimes enormous in amount. It might seem possible to pay for them by immediate and heavy taxation, since no more is taken out of the people than when the money is borrowed. But the national wealth is not like an ocean, alike in all its parts and instantly filling up where water is dipped out. It makes all the difference in the world where you dip. Here are men who have funds invested in a productive business; here are others who have funds lying idle. The State decides to make a public investment, and calls for money. If it col- lects it by an immediate and heavy tax, the first class have a part of their ordinary earnings withdrawn, and their business is crippled or ruined. The others have some of their funds with- drawn, but the most still lies idle. The best that can be done in such a case is for the first class to borrow of the second, which only makes private debts instead of public ones — a much more burdensome condition of things for the national in- dustry. The wiser modern method is for the State to borrow the unemployed funds and leave industrial operations intact, then imposing a moderate tax which can be paid out of annual income. If the expenditure in question is an investment, it pre- sumably pays for itself in time without requiring taxation. This brings us to the relation between taxes and debts. Taxes should never be so heavy that they cannot be paid easily out of annual income. If they trench upon national savings, they de- range private industries disastrously because they are imposed upon all without regard to the nature of their investments. But while taxes cannot safely exceed the national disposable PUBLIC RECEIPTS 669 surplus for each year, it does not follow that the State may not take savings as well as surplus for its undertakings ; only these savings must be taken from those who have uninvested savings. This cannot be done by any method of general contribution like taxation. It can only be done by public loans. Whether the loan is a wise thing or not depends altogether on the nature of the State's investment. If the State takes these savings ever so wisely and wastes it, the people have lost just so much capi- tal. If, on the other hand, the State takes savings which were uninvested and therefore unproductive, and invests them in a profitable undertaking, the net result to society is an additional profit. Public debts are no indication of national poverty. Whether a nation is growing poorer or richer depends not on its indebtedness, but on its production relatively to its consump- tion. Public debts are not a good thing in and of them- selves, but they have incidental advantages which offset some of their disadvantages. Having noticed the natural limits of both taxation and borrow- ing, we have now to ask. What kind of expenditures should be provided for by each? In general the answer is easy, though details are troublesome at times. Ordinary expenditures, that is, those which recur with sufficient regularity so that they can be foreseen and estimated in advance, if not provided for by receipts from d mains and industries, should be met by taxa- tion. If the State cannot do this, it is a confession that ordi- nary expenditures are in excess of the disposable surplus income of the nation, a state of things which means bankruptcy if con- tinued long enough. Extraordinary expenditures, caused by national calamities, such as floods or war, and public investments — railways, city gas works, etc. — may be met by loans. The function of loans thus becomes a double one : first, the distribution of un- avoidable losses, so that industry is as little disturbed as pos- sible ; and second, the investment of uninvested capital in productive public enterprises. In the creation and management of public debt it is pecul- iarly necessary to observe the golden mean and avoid both 670 OUTLINES OF ECONOMICS improvidence and unwise restrictions. Obviously, temporary deficits resulting from a failure of current revenue to meet cur- rent expenses, should not be allowed to accumulate and then be funded as a permanent debt. This is a vice of boss-ridden government which goes far to explain the rapid growth of Ameri- can municipal indebtedness in the last half of the nineteenth century. Similarly, in our opinion, debt should not be con- tracted in order to erect public schools or other durable improve- ments which, although capable of rendering service through a long period of years, produce no money revenue and represent from the fiscal standpoint continuing liabilities rather than durable assets. It must be admitted that authorities differ on this point ; but even among those who sanction the contracting of debt to pay for durable improvements which are financially non-productive, it is agreed that in any event the life of the debt should not exceed the life of the improvement in question. Long-time bonds, for instance, should not be employed to resur- face roads and pay for highway improvements which will last only a few years. Finally, in our opinion, restriction may be properly imposed upon public indebtedness contracted for pur- poses which are fiscally nonproductive, although such restric- tions should limit the increase of indebtedness and, for reasons which have been stated on page 653, should not be expressed as a percentage of the assessed valuation of taxable property. On the other hand, few, if any, restrictions should be placed upon borrowing for the purpose of acquiring income-yielding property. Such restrictions place states and cities at a dis- advantage as compared with private corporations. They also ope ate to throw into the hands of private corporations enter- prises which cannot be paid for out of one year's revenue, and yet might advantageously be acquired by the public. At the present time excessive limitations, unworthy of a free people, make it impossible for some cities to carry out necessary public improvements which would not impose the slightest real burden upon taxpayers. In Chicago, several years ago, after a pro- longed and exceedingly expensive campaign for the improve- ment of the street car service, the city was prevented from carry- PUBLIC RECEIPTS 6'/! ing out a carefully devised plan of reform by a court decision which held that an issue of street railway certificates would in- crease the indebtedness of the city beyond the limits prescribed by the constitution. Rigid limitations which prevent munici- palities from offsetting part of their debt by the value of water- works, lighting plants, and other assets which yield a monetary return, have no place in a scientific system of public finance. While not absolutely required by theory, it is probably desir- able as a matter of practical political psychology to make pro- vision for the extinction of all public debts within a period, say, of sixty years. It has been customary in the past to do this by means of sinking funds, but experience has shown that the sinking fund is a cumbersome, wasteful, and unscientific method of accomplishing the desired end. Bonds which automatically mature in recurring installments offer a much better device for the retirement of public debts. The serial bond, as such an obligation is called, " can usually be placed at a lower rate of interest than a sinking fund obligation. It is free from most of the possibilities of political abuse and manipulation to which sinking funds are exposed. It substitutes a plain and certain for an uncertain or complicated liability; and it compels the administration which contracted the debt to begin its retire- ment immediately." ^ The Public Domain. — By domains we usually mean agricul- tural and mineral land and forests owned by the State and man- aged in the interest of the public revenue, although we might logically subsume under the term the streets and other public property of cities, with all the valuable franchises and privileges which go with them. The direct revenue from this source in the United States is not large, and if account be taken of the cost of the public domain and the expense which it has entailed, the net earnings would possibly be a minus quantity. Until a comparatively recent date this was not the case. In early feudal times the king had large estates of his own from the produce of which the government was largely supported, 1 Report of the Committee on Increase of Public Expenditures, Proceedings oj the National Tax Association, vol. ix, p. 465. 672 OUTLINES OF ECONOMICS and although he had certain military rights over his subjects, he had very limited rights over their property. Later, the king became a public rather than a private person, and a large part of the crown estate became the property of the public ; but even then taxation was relatively unimportant, and the State relied principally in times of peace upon fines, escheats, fees, crown prerogatives (certain dues which the king was entitled to col- lect as of his own right), and upon the proceeds of the public domain. Blackstone, the great English jurist, writing in 1765, classified taxation among the " extraordinary " revenues of the sovereign ; and in some of the German principalities the govern- ment was enabled to get along without taxation in times of peace, down to the close of the eighteenth century. Real democracy not yet having been achieved, the people distrusted taxation and resented its imposition, while the sovereign wisely clung to that species of revenue which was independent of the people's caprice. " The public domains," said Bodin, the great political philosopher of France in the latter part of the sixteenth century, " should be holy, sacred, and inalienable either by grant or by prescription." But as democracy developed and the representatives of the people gained control of the finances, a new policy was every- where adopted. If State management was uneconomical and wasteful, and if the government could obtain all the revenue needed by taxation, why preserve the wasteful methods of management? Why not turn public property into private property, to be developed and multiplied through the vitaliz- ing force of individual self-interest ? The great truth was real- ized that the property of individuals, when subject to taxation and regidation, is no less part of the great patrimony of the State than those lands and forests whose title is retained by the government itself. This doctrine was generally accepted by the greater countries of the world during the eighteenth century, so that Adam Smith, in defending it in 1776, was able to write that " there is not at present, in Europe, any civilized state of any kind which derives the greater part of its public revenue from the rent of lands which are the property of the state." This PUBLIC RECEIPTS 673 philosophy was dominant when our national government was created in 1789, and has guided our national policy ever since. Land Policy of the United States. — By exploration and occu- pancy, war, and various cessions, the federal government ac- quired, after the Revolutionary War, a magnificent domain of 2,252,244 square miles. Now, while we have consistently fol- lowed the doctrine of alienation until very recent years, trying, apparently, to get rid of the public domain as rapidly as possible, one observes historically a very important change in the manner of development. In the early years of the Republic, large revenues were expected from the sale of public lands ; it was the financial side which, according to Alexander Hamilton, claimed " primary attention." ^ Until about 1800, the policy was to sell the land in large blocks, even though it went to speculators ; this was followed by an attempt to sell small hold- ings to actual 'settlers, the credit system being used with dis- astrous results; later (1830), the preemption policy was intro- duced by which bona fide home makers were given certain ad- vantages in purchase ; and finally came the Homestead Act of 1862, the Timber Culture Act of 1873 (now repealed), and the other less important laws by which actual settlers can obtain homes practically free of cost. From the very beginning we have used our public lands as bounties, to hasten the develop- ment of the country ; and this policy has been carried out by enormous grants of land for the endowment of education and the subsidization of canal, railway, and other internal improve- ment companies. Our original aim, however, was not only to develop the country as rapidly as possible, but to secure as much revenue as possible from the sale of public lands. We still aim to develop the country, but the idea of profit has been replaced by the policy of giving land to the landless. To exaggerate the evolution of policy for the sake of emphasis, it may be said that we began with a productive policy, and modified it with a dis- tributive policy; that in the beginning our object was the greatest good, while now it is the greatest good to the greatest number, or, in terms more appropriate to the exact case in hand, > Quoted by Donaldson, The Public Domain, p. ig8. 2X 674 OUTLINES OF ECONOMICS the greatest possible use of the pubHc domain consistent with widespread participation in that use. Forest Lands. — The policy of alienation, while on the whole sound, is subject to certain limitations which it is very important to note. First of these is the case of forests. The ruthless de- nudation of our timber lands, the striking advance in the price of lumber indicating that the supply has not kept pace with the demand, and the meteoric development and rapid decline of the lumber industry in many localities of the Northwest, all com- bine to demonstrate that ahenation and private ownership have failed to produce that careful industrial management which conduces to the greatest use and the greatest good in the long run. More important still, we have come to realize that the most productive use of other great natural resources has not been subserved by the private ownership of the forests. The regular flow of streams, the success of the great irrigation works which we are building, and the proper development of our mines, all depend more or less upon the permanent preservation of our forests ; but private ownership and management in the past has led to destruction, not preservation. The United States awoke very slowly to these truths. Prussia abandoned the policy of disposing of forest lands in 1831. France and Austria began to increase their forest holdings about 1870. But in the United States it was not until 1876 that an awakened interest showed itself in a congressional appropriation of two thousand dollars for the purpose of employing " a com- petent man to investigate timber conditions in the United States." In 1881 a Division of Forestry was created in the De- partment of Agriculture. This expanded into the Bureau of Forestry in 1901, and into the Forest Service in 1905. In 1891 a forward step was taken by the passage of an act authorizing the President to establish forest reserves; and in the same year the first forest reserve was established. In March, 1915, the area of the national forest reserves had increased to 184,611,596 acres (of which 21,337,533 were privately owned) ; the forest service had developed to a point where it was able to care for the management of this vast national industry, and to PUBLIC RECEIPTS 675 cooperate further with private owners in estabhshing the prin- ciples of scientific forestry, while the policy of alienation has been modified to an extent amounting almost to reversal. Instead of selling forests, the government is now permitting timber to be cut in a way to preserve the forests. The revenue from this source at the present time is nearly $2,500,000, but that is a secondary consideration. The important point is that the government has demonstrated its ability to manage the forests along lines at once scientific and commercial. In many Euro- pean countries, however, a greater revenue is secured from the forests. In France, for example, the public forests cover nearly 18 per cent of the entire land surface of the country, and yield approximately, it is reported, $2.50 per acre annually, — giving a revenue of about $59,000,000 a year. In the United States at present 35 per cent of what is received, according to law, goes to the states and territories in which the reserves are situated for public roads and schools. It is estimated that in a few years the reserves will yield not less than $5,000,000 a year. Experience seems to show that the public ownership and management of forests is more efficient than private ownership and management. This is due to the length of time required to realize upon investments in this industry, its routine character, the large area one man can supervise, and, perhaps chiefly, to the fact that the government in its management takes into ac- count the interests of the community as a whole. Although private corporations may make plans for a long period of time, they are less desirable owners and managers, especially in the last particular. The property tax, as now levied, is one of the greatest enemies of rational forestry by private owners. If an owner is forced to pay ordinary property taxes upon a stand- ing or growing forest year after year, the pressure to cut the timber is almost irresistible. The State spends millions of dol- lars to preserve the forests, and yet often enforces a tax that puts a premium upon their destruction. Mineral Lands. — Our experience with timber lands is im- portant as showing that private ownership of some kinds of land has not resulted in the greatest or wisest use of that land. 676 OUTLINES OF ECONOMICS Our experience with mineral lands demonstrates that the policy of disposing of public lands in small holdings, free of cost or at prices far below their real value, has not led to a widespread participation in the use and profit of those lands. The reason for this, broadly speaking, is that our policy of alienation in small holdings conflicts with the requirements and necessities of modern industry. In disposing of our lands we have tried to balk the corporation and the speculator in order to subsidize the settler and home builder. For instance, we have made the recip- ients of homesteads and mineral claims swear that they are not acting as agents "/or any person, corporation, or syndicate,'''' or " in collusion with any person, corporation, or syndicate, to give them the benefit of the land entered," and that the land is not being secured " for the purpose of speculation." Yet for pur- poses of grazing and in less degree for mining and lumbering, modern industrial methods require that large tracts of land shall be worked together, and that individual claims shall be consolidated. The core of the difficulty was well described by Mr. Roosevelt, when President, in these words : " It is a scandal to maintain laws which sound well but which make fraud the key without which great natural resources must re- main closed. The law should give individuals and corporations, under proper government regulation and control, the right to work bodies of coal lands large enough for protfiable develop- ment." And he thereafter recommended laws to authorize the leasing, instead of the complete alienation, of coal, oil, and gas rights, as well as grazing rights on the public domain. Already the royalty has been adopted by some of the state governments, and has been employed in a few of the permits issued by the federal departments of Agriculture and the Interior.^ In a few decades, these leases will probably yield handsome revenues in some of the western states which have adopted them. As time passes the federal government exercises more freely its powers of reserving mineral rights in lands granted to " home- 1 Cf. the conditions of the interesting permit issued in favor of the International Power and Manufacturing Company, and published as Senate Document No. 147, 63d Cong., I St Sess. PUBLIC RECEIPTS 677 steaders " or municipalities, and of withdrawing from entry valuable mineral deposits such as the potash beds of California. Year by year, therefore, the policy of complete alienation is more and more restricted. The Success of our Land Policy. — In a rough, general way, our land policy has been a success, as is shown by the unprece- dented and almost feverish development of the country in the last century, with the creation of a fund of taxable values which makes it an easy matter for the state governments to raise all the revenue which they need. But in some respects it has signally failed. In the first place it has not paid : more money has been spent for the purchase, survey, and care of the public lands than has been received from their sale and lease. In the second place, certain kinds of lands, as we have shown, should not have been alienated. And in the third place, our efforts to give land to the landless have bred an immense amount of cor- ruption, fostered speculation, endowed private monopoly with public wealth, and pauperized whole communities. One has only to recall the convictions of public officers for land frauds, and to read the report of the Public Lands Commission — to which specific reference is given at the end of the chapter — to appreciate the truth of all these charges. The desert land law and the commutation clause of the Homestead Act, they tell us, operate far too often " to bring about land monopoly rather than to multiply small holdings by actual settlers." ... "In many localities, and perhaps in general, a larger proportion of the public land is passing into the hands of speculators and cor- porations than into those of actual settlers who are making homes." ... " Nearly everywhere the large landowner has succeeded in monopohzing the best tracts, whether of timber or of agricultural land." . . . " Your commission has had inquiries made as to how a number of estates, selected haphazard, have been acquired. Almost without exception, collusion or evasion of the letter and spirit of the land laws was involved." . . . " The fundamental fact that characterizes the present situation is this : that the number of patents issued is increasing out of all proportion to the number of new homes." 678 OUTLINES OF ECONOMICS Possibly the most important lesson to be derived from the his- tory of our landed domain is the vital truth that the government cannot give away valuable lands or sell them at prices far below their real value without subsidizing the speculator, endowing monopoly, and pauperizing the people. The poorer classes de- rive no real benefit from this indiscriminate public charity. As Secretary of the Interior Hitchcock said in 1905, in discussing the Timber and Stone Act: ^ " Many transfers of land patented under this law are made immediately upon completion of title to individuals and companies. In this way a monopoly of the tim- ber supplies of the public-land states is being created by sys- tematic collusion. ... It has been urged in behalf of this act that it enables poor men to enjoy the bounty of the government by obtaining tracts of land which they can afterwards sell with advantage. A careful study seems, to show, on the contrary, that the original entrymen rarely realize more than ordinary wages for the time spent in making the entry and completing the transfer. The corporations which ultimately secure title usually absorb by far the greater part of the profit." When Uncle Sam was rich enough — or was supposed to be rich enough — to provide us all with a farm, the policy of giving away the public domain appeared to be in harmony with the principle of equality of opportunity. But when the supply is far below the demand, those who receive gifts by lot or similar methods are in receipt of special privileges. What once seemed fair has, in the course of economic evolution, become unfair and de- moralizing. Our conclusion may be formulated in the following general rule : Only those lands should be wholly alienated whose use and development under private ownership lead neither to mo- nopoly nor to exhaustion and waste. Or, in more concrete terms (remembering that the maxim applies only to those lands left to the government, and to the majority of cases, not to every specific case), the rule for agricultural lands should be private ownership and management, for forest lands State ownership and management, for mining and grazing lands State ownership 1 Report of the Secretary of the Interior, 1905, p. 331. PUBLIC RECEIPTS 679 and private management under a lease or royalty system, by which the State shall secure a share of the profits and retain a large amount of regulation and control. In disposing of its lands the government should endeavor to charge value received, as gifts of valuable land, or sales at inelastic schedules of prices which place an extreme valuation upon some tracts and an utterly inadequate valuation upon others, lead to speculation and monopoly, having most of the demoralizing features of a public lottery in which the prizes are distributed partly by chance and partly in accordance with the cunning, chicanery, and unscrupulousness of the participators. Under existing con- ditions the poorer classes of society get almost none of the valuable lands. Charge value received, and the people, the masses, get their share in the revenues flowing to the public treasury, in reduced taxes, and more generous expenditures for educational, protective, and developmental purposes. Land Nationalization and Municipalization. — In recent years both state and national legislation have shown a decided trend toward the adoption of methods which will yield both greater revenue and greater control of those varied forms of national wealth which we collectively designate " land." The object of this legislation is to prevent monopoly and give to society a share in the land values created by social growth. One of the most ingenious plans for securing this end ever proposed is the single-tax scheme defended with great eloquence and earnestness by the late Henry George. His scheme, usually called " the single tax," is stated thus in his own words, printed in his organ, The Standari: " The Standard advocates the abolition of all taxes upon industry and the products of industry, and the taking, by taxation upon land values, irrespec- tive of improvements, of the annual rental value of all those various forms of natural opportunities embraced under the general term 'land.' "We hold that to tax labor or its products is to discourage industry. We hold that to tax land values to their full amount will render it impossible for any man to exact from others a price for the privilege of using those bounties of nature in which all living men have an equal right of use ; that it will compel every individual controlling natural opportunities to utilize them by employment of labor or abandon them to others ; that it will thus 68o OUTLINES OF ECONOMICS provide opportunities of work for all men and secure to each the full reward of his labor ; and that as a result involuntary poverty will be abolished, and the greed, intemperance, and vice that spring from poverty and the dread of poverty will be swept away." Mr. George's proposition rests upon an extreme application of the doctrines of individualism and natural rights. Man, he holds, has an inalienable and equal right to live, and consequently an inalienable and equal right to those natural agents which we call land, and without which human life cannot exist. This right which attaches to the individual cannot be abrogated by law or custom, nor can it be alienated by one generation or set of law givers. Moreover, it is an equal right. A, B, and C each have a right to the soil, but A has no right to better soil than B or C ; in consequence of which that part of land values which arises from the differential qualities of land belongs to society as a whole, and not to particular individuals. But the differential value of land expresses itself in the economic rent which it yields, and consequently, if society seizes this rent by taxation, it will satisfy the demands of the doctrine of natural rights, while leaving the actual management and exploitation of land in the hands of individual occupiers, thus avoiding the perils of direct public management. Man also has an unalienable right, Mr. George held, to the fruits of his own labor. As the outcome of this right, Mr. George concluded that ordinary taxation upon property other than land, upon the product of labor as distinguished from land, the gift of God, is robbery. In his view it is as immoral to levy an ordinary tax as it is criminal to fail to tax that surplus which attaches to the better classes of lands, and which we call economic rent. The policy embodied in Mr. George's scheme differs funda- mentally from the policy which we have seen creeping into recent legislation. The latter purposes to reserve only a part of the value given to some forms of land by social development. Mr. George proposes to confiscate all of the " unearned increment." Most important of all, the former proposition applies only to the future unearned increment, and purposes only to take a part, PUBLIC RECEIPTS 68 1 and that only after fair notice is given. Mr. George proposes to take all the unearned increment, past and present, and that whether the present owners have been encouraged to believe that they might be permitted to appropriate the whole unearned increment or not. Herein lies the essential injustice of Mr. George's scheme. As a nation we have induced immigrants and settlers to take up lands, clear them, and develop them with their labor and toil, with the promise that the values thus created by themselves and their neighbors should belong to them. Their risks and their sacrifices have been great. The " unearned increment " is not always unearned. Even if we assume that the State made a mistake in pursuing this policy, the results of the mistake must be cheerfully borne by the party at fault, the State itself. This of course does not mean that the private ownership of land is socially harmful, it must never- theless be perpetuated. It does mean, however, that if the state is to divest private owners, it must in equity compensate them. Mr. George not only proposes to confiscate all economic rent without compensation, and to abolish all other forms of taxa- tion, but the assertion is made in explanation and justification of the policy that it will abolish poverty. Such a policy might, indeed, prevent landowners, who do not care to use their land, from keeping it out of the hands of those who would use it ; but how it would effect all the other predicted blessings is difficult for most people to comprehend. In the first place, it is difficult to imagine how the pure economic rent of agricultural land can be separated in practice from the annual value of separable im- provements on the land. But apart from this difficulty, the appropriation of economic rent by the public without compen- sation to the owners will probably never appeal to the conscience of the American public as a just thing to do. No abstract reasoning, based on " natural rights," will persuade a modern nation to so radical a step. This honestly and earnestly advo- cated policy is only one more illustration of the danger of basing social reasoning on any theory of " natural rights." In cities it is easier to separate the pure economic rent from the earnings of improvements, such as buildings. Moreover, it 682 OUTLINES OF ECONOMICS is in cities that the principal evils attendant on private land- holding are discoverable. Therefore the objections to land nationalization do not in the same degree apply to land munici- palization. Many who will reject the one will favor the other. Even here, however, it is well to proceed very cautiously. Con- fiscation, at any rate, should not be tolerated. If great and expensive changes along this line should approve themselves to the people, the burden of the changes should be widely diffused throughout the community by means of inheritance and other taxes. ^ Public Industries. — In the beginning, let us briefly pass in review the principal classes of industrial enterprise in which the modern State engages for the satisfaction of other than State wants ; because, obviously, we are not concerned with enter- prises like the government printing office, the government navy yards, and in general, those incidental industries whose products the government consumes but does not regularly sell. 1. First, we find states like Switzerland monopolizing the manufacture of alcohol and certain alcoholic beverages, Japan monopolizing the opium traffic in Formosa, or commonwealths like South Carolina engaging at one time in the retail distribu- tion of intoxicating beverages. The purpose of the State in engaging in such industries is primarily sumptuary ; it is desired to regulate the traffic almost to the point of suppression, per- haps. Ordinarily a good revenue would be secured, but revenue is a very secondary consideration. Prices will be placed above the level of highest net profit, and not improbably the ideal of regulating consumption will be so vigorously pursued that profits will disappear altogether. 2. Secondly, we have the group of so-called " fiscal monopo- lies." France, for instance, monopolizes the manufacture of matches, cigarettes, and tobacco in general ; Japan has recently gone farther than any other country in the creation of fiscal monopolies ; while Prussia, Austria, Italy, Spain, and other European countries maintain public lotteries — as did many of the American colonies during the eighteenth century. Tho 1 See pp. 425 and 706 for further discussion of the single tax. PUBLIC RECEIPTS 683 primary object of the State in undertaking these enterprises is public revenue, gain ; and naturally a monopoly price is charged, the price which will yield the greatest net revenue. 3. Next, we have a group of enterprises consisting principally of the so-called " natural monopolies," which the State under- takes not for suppression, not for profit, but primarily for regu- lation — to regulate the quality of the product, as in the case of water ; to maintain effectively what have been called " equi- table conditions for the prosecution of private business," as in the case of railways; to prevent monopolistic extortion and corporate abuse, as in the case of lighting companies, the post office, the telegraph, and the telephone ; or to prevent crime and preserve intact the foundations of commercial prosperity, as in the monopoly of coinage. The charges here are ordinarily ad- justed to either the " revenue " or the " cost " principle, that is to say, the State will either aim to make a fair business profit such as is secured in competitive private enterprises, or it will endeavor approximately to meet expenses by adjusting its charges to the cost of production. England, France, and Ger- many, in ordinary years, obtain handsome revenues from their respective postal departments, but in the United States the accounts of the Post Office Department usually show an annual deficit, and taking the world over, the cost principle in this group of industries is probably more common than the revenue principle, and deficits more common than net profits. In the United States the post office has always been regarded as a developmental agency rather than a business enterprise, and might more logically, perhaps, be included in the next category. 4. Finally, we have a large and heterogeneous group of in- dustries which are maintained principally for service, for their educational and developmental influence, not primarily for regu- lation, and not at all for profit, but '' for the public good." We include here not only schools and educational institutions of all kinds, but roads and canals ; the savings banks and public pawn shops maintained in several countries of continental Europe ; workingmen's insurance as developed by Germany, Austria, and several of the Australian commonwealths ; and model manu- 684 OUTLINES OF ECONOMICS facturing establishments such as France maintains for the pro- duction of tapestries and fine porcelains. In this group charges will sink to a minimum, and in some lines of enterprise, such as education, practically disappear. Revenue here is not only a minor, but is almost a negligible, consideration. A brief consideration of the incomplete list of State industries given above brings out several important truths. In the first place, it is evident that only a few of these industries, the fiscal monopolies, have been taken over by the State for the purpose of revenue, and fiscal monopolies are decreasing rather than increasing in relative importance. In the second place, it is equally as clear that, on the whole, public industries are sources of expense and not of profit. When Professor Bastable, for ex- ample, tells us that in England, in the fiscal year 1 893-1 894, only 6 per cent of the national revenue came from public indus- tries and other non-tax sources, that in the local revenues of England and Wales (1891-1892) taxation stood to other sources of revenue in the ratio of five to one, that in P^^ussia about 20 per cent of the national revenue comes from the domain and in- dustrial enterprises, and in India something less than 50 per cent from " quasi-private sources of revenue," he is careful to warn us that the statistics take no cognizaiice of interest pay- ments chargeable to the several industries, or of depreciation, or of related industries in which deficits and not profits were secured. When estimating the importance of State railway earnings in the revenue account, no cognizance is ordinarily taken of the canal deficit. In the third place, we perceive from the nature of the industries that they cannot wisely be operated for profit in many cases. Education, for instance, has been taken over by the State for the very purpose of charging less than the cost of the service. The unquestionable tendency is for the prices of goods and services supplied by a democratic State to sink below the cost of production, and this, in itself, is neither good nor bad, fortunate nor unfortunate. The public financier, in adjusting the charges, must not look to profit. His only aim is the salus populi, and this policy requires here a prohibitive price, there a cost price, and again free service. Finally, it PUBLIC RECEIPTS 685 appears, the problem of public charges can be settled only with reference to a particular time, place, and industry. England finds it expedient to raise a handsome revenue from her post office, while in most years the United States manages her post office at a loss. Waterworks are successfully conducted by most of the large American municipalities, but public lighting experi- ments in this country have not been equally successful. India raises half of her revenues from non-tax sources largely because heavy taxation of the ordinary kind would be impossible. The French tobacco monopoly succeeds because the French govern- ment can supervise and trace almost every pound of tobacco grown in France. In the United States this would be impossible. Although we cannot decide in a general way what theory of charges should be followed in particular public industries, it is possible to lay down general rules which will assist us in reach- ing a correct conclusion in specific cases. Assuming that the industry in question supplies a service rather than a commodity, merely to save words in the discussion, we must first of all in- quire : (i) Is the service helpful or harmful in its net social effect ? According as it is one or the other, we will incline in our charges toward the gratuity principle or the prohibitive principle. If harmful, however, it is plain that we must not make the charges high enough to encourage smuggling or illicit manufacture. If helpful, on the other hand, we cannot at once decide upon the gratuity principle, but must inquire further : (2) How generally is the service enjoyed ? If only a small portion of the community enjoys the service, it would usually be unjust to charge less than cost, because the deficit would be borne by general taxation falling upon the entire community ; unless, in- deed, the benefit to one restricted class is seen to be of advantage to the whole community in such a degree that the rest of the community is willing to bear the deficit, as in the case of public charity. (3) Assuming that the service benefits the whole community, this is still not sufficient to justify a charge less than the cost of production. The problem is one of comparative costs. We must inquire whether greater benefit would not be secured by 686 OUTLINES OF ECONOMICS charging enough to raise a profit and then distributing that profit through the maintenance of some other gratuitous enterprise, or, if the tax system weighs heavily on the poor, by remitting taxation to the extent of the profit (4) If all these questions are answered in favor of the gratuity principle, we still must con- sider what effect gratuitous service will have upon the cost of the service. Will it encourage wastefulness? Free city water, for example, would probably prove impracticable because of waste, but free parks or free education do not lead to inordi- nate or unnecessary consumption. The question is a vital one, but it is not always to be answered one way, as some critics of government ownership seem to believe. (5) Closely related to the above is the question of pauperization. Some things the State may safely give away, and some not. The modern city, for example, may give free band concerts, in, our view, to the undoubted edification of the community ; but in Rome the public games demoralized the populace. (6) Finally, we have to ask what effect gratuitous service will have on incomes. Henry George proposed that our cities should operate the street car lines gratuitously, and the argument in its favor is far stronger than might be expected on first thought. But what effect would this gratuitous service have upon the incomes of the laboring classes ? Take the case of the worker in New York City earning $3.00 a day. Will his wages remain at $3.00, if .street car service is offered free of charge? Will not the migra- tion to New York be increased, so that wages will fall? And may not the gain ultimately fall to owners of house property in the form of enhanced rents? All these questions must be answered before the tariff of charges can be adopted, and it is plain that the answers will be determined by the particular conditions of time, industry, and place, particularly by the character of the industry. The nearest approach to a general rule which can be formulated, may be stated as follows : In proportion as a service or commodity tends to the upbuilding of character and personality, we should, so far as fiscal conditions permit, gradually move in the direction of the principle of gratuitous service. If'the service or commodity PUBLIC RECEIPTS 687 itself is widely consumed and is as desirable as any vendible commodities which would probably be purchased from possible revenues yielded by charges for the service, particularly if large consumption is desirable and waste in consumption does not become excessive, the principle of gratuitous service may be recommended. Limitations of space prevent further treatment of the subject of public industries. The important thing to understand is that the moment an industry is taken over by the government, that moment the question of profit — which is the vital considera- tion under private management — becomes of secondary im- portance, subordinate to questions of public policy; and the interjection of public policy into the determination of prices or charges, creates a problem whose complexity and difficulty can scarcely be exaggerated. At the present time, for instance, we do not even know whether our postal rates on second class mail matter pay for the cost of carriage and delivery, to say nothing of the question whether such matter ought to be carried at less than cost. Just now the indications are that the State will take over an increasing number of industries, or at least exert a constantly increasing influence upon the rates and charges of quasi-public industries. Under these circumstances our present duty is to institute, both in public and quasi-public industries, a thoroughgoing system of cost accounting, so that we shall understand upon what footing each branch of the industry rests. Our second duty, which falls primarily upon economists and statesmen, is to develop a far more satisfactory theory of public charges, for at the present time we hardly understand the many factors that must be considered in this problem, much less the net meaning or resultant of these factors. QUESTIONS 1. Are public debts a burden when represented by paying investments? by non-revenue-bearing investments? 2. Do State debts indicate impoverishment of the people? Why? 3. What defects are found in the sinking-fund method of retiring public debts? Enumerate the advantages of the serial bond. 688 OUTLINES OF ECONOMICS 4. How was the State supported in primitive times? What connection is there between taxation and representative government? 5. What has been the principal aim of the United States in the manage- ment of public lands ? How has this aim changed ? 6. Why do the poorer classes benefit least by the homestead acts and by the sale of the public lands at prices below their real value? 7. What kinds of land should be both owned and managed by govern- . ment ? Why ? 8. What are the advantages and disadvantages of the royalty or lease system? To what kinds of land should it be applied? 9. What conflict is there between modern industrial methods and the project of giving land to the landless? 10. What connection is there between "natural right" and the single-tax scheme ? 11. Is there any absolute, inalienable right to life? to anything? Ex- plain. 12. Should State industries be managed so as to yield a profit? Is a profit inconsistent with good State management? Is any general tendency, with respect to profits, discernible in the management of particular public industries ? REFERENCES Adams, H. C. Public Debts; The Science of Finance, pp. 237-260, 261-282. Bastable, C. F. Public Finance, 3d ed., pp. 157-178, 179-218, 219-232. Bullock, C. J. Selected Readings in Public Finance, Chap, iv, "The Views of Bodin and Smith," pp. 50-60; Chap, v, "Revenues from Domains," pp. 61-72; Chap, vi, "Revenues from Public Industries," pp. 80-116. Bureau of the Census. Reports on Wealth, Debt, and Taxation, and Statistics of Cities. CoHN, GusTAV. The Science of Finance (translated by Thorstein Veblen), pp. 82-103. Daniels, W. M. The Elements of Public Finance, pp. 207-223, 285-314. Grice, J. W. National and Local Finance. Hewes, L. L, and Glover, J. W. Highway Bonds. (Bulletin of the U.S. Department of Agriculture, No. 136.) Plehn, C. C. Introduction to Public Finance, 3d ed.. Part iii. Raymond, W. L. American and Foreign Investment Bonds, Chaps, ii-v. Report of the Public Lands Commission, Senate Document No. 189, 58th Con- gress, 3d Session, pp. iii-xxiv. Scott, W. A. The Repudiation of State Debts. Seligman, E. R. a. "Classification of Public Revenues," in his Essays in Taxation, rev. ed., Chap. xiv. U.S. Department of Agriculture, Forest Service. The Use Book. Van Hise, C. R. The Conservation of National Resotirces in the United States. CHAPTER XXXIII PUBLIC RECEIPTS FROM FEES, SPECIAL ASSESS- MENTS, AND TAXES Definitions. — If the reader will run over the classification of public industries given in the preceding chapter, he will notice that the corresponding payments — which descend, it will be remembered, from prohibitive to gratuity charges — fall into two main classes : those imposed upon the consumer or pur- chaser who specially benefits by the service, and those — like the revenues devoted to the maintenance of education and pub- lic parks — imposed upon the tax-paying public generally, irre- spective of the benefits conferred by the service. Moreover, as we move from the prohibitive to the gratuity group, there is a general though not regular change in the degree and kind of compulsion exercised by the State in collecting the contribution. The State does not encourage the purchase of intoxicating liquors under the Gothenburg system in order that the revenue may be as large as possible, — it actually discourages their sale ; the use of the postal money order is mildly encouraged, but you may send your money by express if you desire ; one is not forced to marry, but if one marries one is compelled to take out a mar- riage license ; and whether one uses the public schools or not, one must help pay for their maintenance. Finally, it will be noticed that as the element of compulsion increases, the public interest in the service changes, and generally though not always increases. The wood sold from the government forests is merely a commercial by-product of an enterprise maintained by the government for other purposes ; the marriage-license fee benefits the individual, but is imposed primarily to protect the morals of the community ; while the tax to maintain the public schools is paid solely for the purpose of benefiting the general public. 2Y 689 690 OUTLINES OF ECONOMICS There are, then, three general principles of classification : (i) the assignability of the benefit of the service to an individual ; (2) the degree of compulsion exercised by the State ; (3) the degree and kind of public interest involved in the service. The more voluntary payments for the more commercial services made by persons who receive a special benefit from these services are called public prices ; the less voluntary payments for services in which the public interest is less commercial in character, made by persons who receive a special benefit from the services, are called fees. Compulsory contributions, " levied in proportion to the special benefits derived, to defray the cost of a specific improvement to property, undertaken in the public interest," are, in the United States, called special assessments ; and com- pulsory contributions, exacted by public authority according to some general rule, without reference to the special benefit conferred by the services to whose maintenance the contribu- tions are devoted, are called taxes. The student is warned that little regard 'is paid to these dis- tinctions in everyday usage. The words " fees," " taxes," " licenses," " tariffs," " rates," " charges," and the like are hopelessly confused ; and even census statisticians find it im- possible to distinguish, in public accounts as they are now kept, between prices, fees, rentals, licenses, and some kinds of taxes. The utility of the terms is in emphasizing the important truth that these great categories of public contributions must be dis- tinguished and differently treated by the legislator and student, by whatever terms the different categories are designated. Fees.^ — In the exercise of its most fundamental and general functions, the government frequently confers, in an incidental way, special benefits upon particular individuals. Thus the courts, whose function it is to administer justice in general, find that this function must be performed by deciding disputes be- tween particular litigants, one of whom usually benefits by the ' Public prices have been discussed in the preceding chapter. The small tuition charges paid by students in state universities offer a good illustration of fees ; they are non-commercial in character, semi-voluntary, and in amount fall considerably short of the cost of the service. PUBLIC RECEIPTS 69 1 decision. Now if the government is disposed to take advantage of the opportunity, it is evident that much revenue may be raised from the individuals who, in a more or less adventitious way, benefit from the government activities ; and where the nation is poor or the people averse to taxation, much dependence will be placed upon fees. As wealth increases, however, and the government becomes more democratic, there is a growing disposition to support general functions by general contributions — taxes — and the relative importance of fees is likely to de- cline. On the other hand, there is no likelihood that fees will wholly disappear, as they exercise a wholesome influence in pre- venting waste. Court fees, for instance, would probably have been abolished before this, if they did not serve to prevent litigious persons from carrying their quarrels to the courts for settlements. Because of this restrictive and economical in- fluence exercised by fees, they will undoubtedly retain a per- manent place in the public revenues of even the more advanced and democratic states ; but their fiscal importance will very likely decline. During the colonial epoch the fee system was much abused in America, many offices being wholly maintained by fees which should have been abolished or supported by taxation. At the present time, however, the evils of the system arise not from the number or amount of fees, but from their connection with the salaries of certain public officials. Many officials are allowed to keep the fees which they collect in lieu of fixed salaries, and this practice results in very serious evils. In the first place, some fee-paid offices, particularly those of sheriff and register of deeds in populous districts, have come to yield princely in- comes, and the scramble for these rich offices constitutes a pro- lific source of political corruption. In the second place, fee pay- ment of public officials often impels them to an excessive and pernicious activity, in which their own interests and those of the commonwealth are placed in direct conflict. In a few states, for instance, prosecuting attorneys are paid so much per con- viction, the fee increasing with the heinousness of the offense, whUe in many cities and villages the police force and city courts 692 OUTLINES OF ECONOMICS are supported partially by fees and fines. Under these circum- stances, officials bend their activity to the conviction of offenders, not to the prevention of crime and the reform of the criminal ; they frequently set traps for persons who are likely to break the law, creating the temptation and the opportunity in order that they may increase their emoluments. In Wisconsin, sheriffs were for many years paid so much per head for the tramps whom they fed and lodged. The system, as has been said, placed a " direct premium upon vagrancy." ^ During the existence of this system in Wisconsin, tramps were " often furnished with liquor, tobacco, and newspapers, to induce them to return." Finally, the fee system has been a constant and shameful cor- rupter of justice as dispensed by justices of the peace in " the people's courts." In most states there are several justice's courts open to the plaintiff who desires to bring suit. In con- sequence, a disgraceful competition springs up, each justice en- deavoring to swell his business and multiply his fees by con- stantly finding for the plaintiff, with the result that our judicial system is thoroughly vicious at the point where perhaps it comes in closest contact with the masses of the people. The remedy is in the substitution, wherever possible, of regu- lar salaries for fee stipends, and in the institution of methods of accounting which will hold public officials to strict accountability for every fee collected. Fortunately, the movement of legisla- tion, while slow and obstinately fought by some politicians, is in the right direction ; and in almost every state public officials are being required to turn their fees into the general treasury and accept instead a fixed compensation. Special Assessments. — Where the operations of the govern- ment confer a special benefit upon some restricted group of in- dividuals, those individuals are often led to exercise undue in- fluence upon the government to secure that service, if the latter is supported by appropriations from the general funds. Jobbery and graft are encouraged. On the other hand, if the only way the group of individuals can secure the service is by expenditure 1 T. K. Urdahl, The Fee System in the United States, p. 211. The other quotations cited in this section are taken from this work. PUBLIC RECEIPTS 693 of the common funds, the government or legislature often delays the expenditure unduly for fear of criticism or because of unwise parsimony. Thus in cities where the method of special assess- ment is not used, it often happens that the opening of a street is delayed long after the time when it would be desirable for the citizens most interested, although perhaps the latter would be willing to defray the cost from their own pockets, were this permitted. A recognition of these facts has led in recent years to a strik- ing development, in the United States, of the benefit principle as exemplified in the method of special assessments. The special assessment has been used sporadically in many countries for several centuries, but it was first regularly used on a wide scale in the United States, in the latter half of the nineteenth century. Its place and importance among the revenues is shown in the table on page 695, from which it appears that special assess- ments aggregating over $113,000,000 were collected in 1902. This amount constituted a little more than 4 per cent of the revenue receipts; but as the national and state governments (except Massachusetts) make practically no use of the special assessment, its real importance appears more clearly from an examination of its place among municipal revenues. In the incorporated places having 2500 inhabitants or over in 1913, special assessments yielded nearly 9 per cent of the revenues and more than one eighth as much revenue as all kinds of taxes. The special assessment has been approved by the American courts because it places at least a part of the cost of the service upon the beneficiaries of the service, a rule which can sometimes, but not often, be violated without subjecting the government to 'excessive and corrupting private influence. The special assess- ment has appealed to the people, however, because it permits public improvements to go ahead at a pace which would be im- possible if taxation were the only fund for defraying the cost of the improvements. Needless to say, the special assessment has occasionally stimulated extravagance and premature develop- ment. Thus, in New Jersey, in the last quarter of the nineteenth century, several large cities were practically thrown into bank- 694 OUTLINES OF ECONOMICS ruptcy by undertaking ambitious public works, in which the special assessment played an important part. And in New York, under the Tweed regime, the system of special assessments fur- nished an excuse for undertaking public works in which corrup- tion flourished, and which probably would never have been under- taken, had it been known in the beginning that their cost would have to be partially defrayed by taxation. " The works had been carried on upon a scale of audacious extravagance, and in portions of the city where they were not at the time justified. Great avenues were laid out and improved largely for the pur- pose of giving fat jobs to favorite contractors, and to provide fine drives for the pleasure and convenience of others than the abutting property owners." ^ On the whole, however, the special assessment has been an unusual success as a fiscal expedient, and has proved an im- portant, if not an indispensable, factor in the development of American cities. Where its use has been followed by extrava- gance, speculation, or jobbery, these evils are to be attributed almost wholly to political corruption of the government, and only in a very small measure to the special assessment itself. Most of the evils, moreover, have arisen where the city govern- ment, or some department of the city government like that of public works, has been given the power to order the improve- ments against the will of the property owners involved or where, ^s was the case in the example cited above, assessments upon particular lots were permitted to exceed the value of the prop- erty. Special assessments should not be levied against the will of a majority of the property holders subject to assessment, except by a two thirds or three fourths vote of the city council, and in no case should the assessment exceed a small fraction of the value of the property against which the assessment is laid. Where these rules are observed, the special assessment is un- likely to lead either to premature development or hardship upon the property holder. Taxes. — In this country more than 70 per cent of all the public revenues are obtained from taxes, so the problems of 1 Victor Rosewater, Special Assessments. PUBLIC RECEIPTS 69s < M z a o z vO rO 00 CO ^ r^OOoO ^00 c^ 00 0\t^(Nvo'^OOo"o,,7 "too CO w CO cT O CO "2 ? a ^ as en D, d V « 2 ^^ Q ° a. 3 OJ -^OO 00 CO Os CO so M O ■'t Sod' ■53 .S "o t3 Si! 2 "o O ni u "d d ii 3 3 3 C g S.a ' " S S S V o o g ££ s g s O O o 1-1 M t-i th b (24 696 OUTLINES OF ECONOMICS taxation are the most important with which the public financier has to deal. These problems are of two varieties ; those deal- ing with the nature of taxation in general, and those dealing with specific taxes. The remainder of this chapter will be de- voted to the general questions. The following chapter will be given over to the more specific problems of American taxation. Justice in Taxation. — By far the most important lesson which the student of fiscal questions has to learn is the supreme neces- sity for tolerance and breadth of view. The factors which con- dition justice or make for equity in taxation are exceedingly numerous ; and the mistake most commonly made by superficial thinkers is to seize upon some one element of justice, build a philosophy upon that alone, and vigorously condemn every- thing that does not harmonize with their petty and bigoted little system. No rule less sweeping than that of the general wel- fare can serve as a safe guide in public finance. 1. Some writers go so far as wholly to deny the right of the State to take private property by taxation. These writers for- get that there is no such thing as absolutely private property. As the State determines what shall be private property, so also it determines the conditions of its existence, and the most funda- mental condition of private property is the obligation to con- tribute to the support of the State. The rights of private in- dividuals have always been of a more or less limited nature, and among the rights reserved by the people in their organic capacity will be found, in every civilized state, the right to take a portion of the wealth produced for such purposes as the lawmaking power may deem fit. 2. However, the State must exercise this power over private property in an equitable manner, or as this maxim is ordinarily expressed in the terminology of constitutional law, taxation must he equal and uniform. Thus, for example, the constitu- tion of West Virginia provides that: " Taxation shall be equal and uniform throughout this state, and all property, real and personal, shall be taxed in proportion to its value, to be ascer- tained as directed by law." Now, if we examine the way in which these requirements of equality and uniformity have been PUBLIC RECEIPTS 697 interpreted in the administration of practical justice, we find that equahty and uniformity have come to mean b'ttle more than this, that taxation shall not be arbitrary, capricious, or plainly unreasonable and that within each class of persons or objects the burden shall be equal, (i) Everywhere the legisla- ture is given a wide latitude in exempting property, so that in- stitutions and industries which are regarded as of peculiar value to the people may be encouraged by freedom from taxation. Almost everywhere, poll taxes which impose an unequal burden upon the poor, liquor licenses which impose unequal obligations upon those who pay them, inheritance and corporation taxes which single out particular classes of society for unusual taxa- tion, are sustained by the courts. Justice in taxation, then, does not require rigid equality or narrow uniformity of treatment. (2) Institutions which are socially harmful may be subject to peculiarly drastic and oppressive taxation ; that is to say, jus- tice may take into account sumptuary considerations. (3) Old taxes, which would not be used if they were not already in- trenched in the fiscal and social system, are permitted to endure ; justice takes cognizance of the fact that, other things being equal, an old tax is a good tax by very reason of its age. (4) Indirect taxes which weigh more heavily upon the poor than the rich show no signs of disappearing ; that is to say, justice gives due weight to the productivity of a tax, its cheapness of collection, and convenience of payment, and balances these considerations against factors which we are accustomed to regard as more fundamentally ethical. (5) Taxes may be employed to suppress state banks of issue, protect home manufactures, and in general to accomplish political and social ends other than the mere raising of revenue. Taxation is seldom the best agent of social or political reform. If there is an evil which needs eradication, the best way is to suppress it directly, if possible, rather than discourage it a little by general taxation. But this does not affect the general proposi- tion that where taxation is an effi,cient remedy, or the only remedy, justice sanctions its employment. (6) Finally, it is plain that, however we strive, nothing better than approximate justice can ever be secured in taxation. A system that frankly recognizes 698 OUTLINES OF ECONOMICS this truth and makes for rough justice, by the imposition of taxes which are simple, stable, convenient, inexpensive, and produc- tive, is far better than one which attempts to secure exact jus- tice through complex and delicate schemes of taxation which cannot be definitely or efficiently administered. 3. The theory of justice most widely accepted by American courts at the present time is expressed in the maxim that taxes should be proportioned to benefits derived. Like other rules of justice, this maxim contains elements of truth and elements of error. It is a fairly helpful guide, for instance, in dealing with public revenues other than taxes. Public prices, fees, and special assessments should, as we have seen, be proportioned to benefits, unless there is strong reason for departing from the rule. And in the apportionment of taxation among districts or govern- mental sections, the rule still retains, and probably always will retain, a large measure of validity. Taxation, we say, must per- tain to the district taxed, meaning by this that under ordinary circumstances it is not wise to tax District A for the benefit of District B ; although there are important exceptions to this rule. But in the apportionment of taxes among the individuals of a given district, the rule has little or no place. This conclu- sion follows, if for no other reason, from our definition of the word " taxes," which we confine to contributions levied with- out reference to special benefits received, either because no special benefit can be assigned, or because (as in the case of free schools) we specifically desire to lift the cost of the service from the shoulders of some of those who specially benefit by the service. Moreover, in general, it is impracticable to determine what proportion of the general benefits of government accrue to particular individuals. 4. At the present time a great majority of economists agree that taxes should be apportioned according to " faculty " or ability to pay. It must be confessed that the rule is not very satisfactory. No simple measure of ability exists, and many taxes, which under a superficial examination seem to conform to the rule, such as the general property or income tax, are found upon closer examination to violate the rule in many ways. PUBLIC RECEIPTS 699 Despite all these defects, however, the ability principle has ele- ments of great strength. It satisfies our sense of justice, in the first place, when explicit reasons cannot be given for departing from a general rule; and it expresses the ideal towards which we strive in voluntary contributions to the church or other voluntary joint enterprises of a social nature. In the second place, we can frequently ascertain with certainty that the rule is being violated, when we cannot define its meaning positively, and hence it is capable of practical application in a negative way. We may therefore accept the rule in this sense, that un- less other treatment is justified by the considerations cited in paragraph 2, above, or by analogous reasons, no tax which is plainly disproportional to the ability of the contributors should be employed. 5. Accepting the ability principle as the best rule for general taxes as distinguished from the specific taxes noted in para- graph 2, we at once encounter the difficult question, how is ability to be measured? Different writers have recommended as the basis or measure of ability, income, outgo or consumption, and property. A little cons'deration will convince the reader that each of these measures is marked by minor defects. The con- sumption of the poor, for instance, is out of all proportion to their ability to bear the burdens of the state. Property, on the other hand, differs widely in its productiveness, and, moreover, many persons with a little property have large incomxcs, and therefore great ability to bear taxation. Incomes, similarly, differ in per- manence and security, and equal incomes are called upon to support very unequal numbers of persons. Fortunately, it is not imperative in practice to make a decision between these measures of ability. The necessities of fiscal administration make it imperative in actual practice to employ all three bases of taxation. Property, consumption, and income are all em- ployed in the United States at the present time and will un- questionably continue to be employed for many generations. Progressive Taxation. — After we adopt any concrete measure of ability, we soon realize that it is only approximately correct, because we are immediately confronted with the question : 700 OUTUNES OF ECONOMICS Does ability increase in direct proportion or more rapidly than our measure of ability ; in other words, shall taxes be laid in direct proportion to income, property, etc, or shall the rate be increased as the amount of income or property increases ? The first method is called proportional taxation, the second progres- sive . or graduated. If the rate diminishes as the income or property increases, we speak of it as regressive taxation; and if the rate increases faster than the income or property, but toward a fixed limit which it can never exceed, it is referred to as degressive taxation. The last kind of rating is of course a special variety of progressive taxation, and usually results from the combination of a nominally proportional rate with the exemp- tion of a fixed sum from all incomes or assessed wealth. The American property tax is in principle a degressive tax, though it is regressive in practical effect. From the theoretical standpoint our real knowledge upon this subject is exceedingly unsatisfactory. On the whole, the argu- ments of those who approve progressive taxation are more con- vincing than those of its opponents, and a majority of economists at the present time agree in asserting that ability increases faster than income, property, or any common measure of ability. If we construe ability as ability to bear sacrifice (as John Stuart Mill and some other authorities do) and confine our attention solely to the consumer, there can be no doubt that progressive taxation is the means by which the least sacrifice will be visited upon the community as a whole.^ This is a strong argument, because one of the chief immediate effects of taxation is to de- prive persons of the necessaries, conveniences, and luxuries of life, while the maxim of the greatest good to the greatest number — or as it works out in taxation, the least sacrifixe to the least number — is one of the most widely accepted rules of social conduct. Surveying the ability theory from the positive stand- point of ability to acquire or produce property, we find the testi- mony almost universal, that as the fortune or income increases, the ability to earn or produce more increases at an accelerating pace. " It is the first thousand that counts," in the language 1 See T. N. Carver, Essays in Social Justice, pp. 401-406. PUBLIC RECEIPTS 701 of the successful man who is teUing the younger generation how he succeeded. Coming to the more concrete and more practical arguments, we find that the balance of opinion also inclines to the side of those who favor progressive taxation. Let us briefly recapitu- late these arguments and attempt to estimate their net resultant. Those who oppose progressive taxation charge that the proposal is socialistic, that it would discourage the accumulation of wealth, that it would not be particularly productive, — mean- ing by this that the element of progressivity adds little to what would be produced by a proportional rate, — that it would stimulate fraud and evasion, that it would interfere with the device known as " collection at the source," and that finally the whole principle is arbitrary and capricious in the sense that there is no natural limit to the increase of the rate. To these charges the defendants of progressive taxation pre- sent plans ^ by which collection at the source and progressive rating may be successfully combined in the same system ; and reply, further, that terms are immaterial and questions cannot be settled by bandying epithets such as " socialistic," " an- archistic," and the like ; that every tax discourages the accu- mulation of wealth ; that whether the tax will be productive or not, it will relieve the poorer classes to the extent that the pro- gressive rates do actually fall upon the rich ; that persons ca- pable of evading their obligations to the government will attempt to evade proportional taxes as well as progressive taxes ; and that all taxation is more or less arbitrary, resting upon the judg- ment and common sense of the legislature. The exemptions made in every tax law, the size of a license fee of any kind, the rates of excise and customs duties, are all " arbitrary " and un- limited in the sense that progressive taxation is arbitrary and unlimited. Finally, the defendant of progressive taxation points out that, owing to the great prominence of indirect taxes in our revenue system and the tendency of assessors to assess large properties at a lower proportion of real value than smaller 1 Report from the Select [British] Committee on Income Tax, igo6, pp. iii-vii. Com- pare also the provisions of the federal income tax. 702 . OUTLINES OF ECONOMICS properties, American taxation today is in practice regressive, and some progressivity is needed, if only to balance the ad- mitted regressivity of existing taxes. While general considerations thus seem to warrant persistent effort to introduce a moderate measure of progressivity into our direct taxes, the student is warned that this should not be done in any doctrinaire or offhand fashion. A thousand con- siderations of practical expediency must be taken into account in the shaping of a revenue system, and in the end we are more likely to attain the goal which the advocates of progressive taxa- tion seek by careful exemptions from taxation, by special taxes upon corporations, monopolies, inheritances, and certain forms of income, and by directing expenditures to the succor of the weak and the equalization of opportunity, than by exclusive depend- ence upon any one far-reaching tax such as a progressive in- come or property tax. ' . ' No tax system, then, can be fairly judged without reference to the character of expenditures. Where the expenditures are wasteful, corrupt, and unwise, heavy taxation is a curse, — al- though even here the rational method of reform is rather to root out the corruption and improve the administration, than to reduce taxation, even if temporarily it may be wise to do the latter. But where the expenditures are on the whole wisely and beneficently made, heavy taxation is not an evil. No country was ever yet ruined by large expenditures of money by the public and for the public. The true principle to be ob- served in levying taxes was tersely expressed in the 41st section of the constitution adopted by Pennsylvania in 1776 : '' No public tax, custom, or contribution shall be imposed upon, or paid by, the people of this state, except by a law for that purpose ; and before any law be made for raising it, the purpose for which any tax is to be raised ought to appear clearly to the legislature to be of more service to the community than the money would be if not collected, which being well observed, taxes can never be burthens." Direct and Indirect Taxes. — The considerations just adduced have an important bearing upon a problem which will probably PUBLIC RECEIPTS 703 become acute in the near future : the question of raising addi- tional revenue by indirect taxation. Indirect taxes have been strongly condemned by many authorities in the past, largely because they weigh more heavily upon the poor than the rich. But if we are to finance successfully a double program of mili- tary preparedness and social insurance in the future, it will probably be necessary not only to keep most of the indirect taxes which we now have, but to adopt others. There are prac- tical limits to direct taxation in every country. Pushed be- yond a certain point, direct taxes discourage both saving and business enterprise. Many of them — although the income tax is a marked exception — fall upon the taxpayer in lean years as well as in prosperous years, and must be paid even though the money to pay them has to be borrowed by the taxpayer. In- direct taxes, on the other hand, are usually paid in small driblets and there is, in their payment, a voluntary element which makes them easier to bear. The person who elects to drink beer may pay proportionally a large indirect tax, but he is not compelled to drink beer. Moreover, indirect taxes may be levied upon articles of luxury and other commodities consumed predomi- nantly by the wealthier classes, so as to operate as progressive rather than regressive taxes, when considered from a broad social standpoint. Finally, even regressive taxes may be helpful to the poorer classes if public expenditures are directed in sufficient volume to the support of education, social insurance, and the equalization of opportunity. It is more important that expend- itures should be progressive in their social incidence than it is to collect taxes in accordance with schedules of progressive rates. The Shifting of Taxes. — Up to this point we have been speak- ing as if a tax must remain where it is originally placed. This we know is not always the case. Excise taxes, for instance, are usually levied with the expectation that they will be passed or shifted from the business man, who first pays them, to the con- sumer or some other person. The conditions which control the shifting of taxes must evidently be considered — at least in a very general way — before we discuss the practical working of the American system of taxations. 704 OUTLINES OF ECONOMICS The word " shifting " usually refers to the increase of price by which the original payer of the tax attempts to recoup him- self. This increase of price is usually accompanied by collateral economic disturbances or dislocations — suggested by the phrase " repercussion of taxes " which is frequently employed in this connection — that are quite as important as the mere change in price. For instance, an excise tax (per unit of product) upon a monopoly may raise the price by as much or even more than the tax itself. But the monopolist nevertheless feels the burden of the tax in reduced profits. When we say that a tax is shifted, then, we do not imply that the original payer evades all the evil effects of the tax. Mobility is the chief factor which controls shifting ; and this in turn is largely dependent upon the inclusiveness or scope of the tax, and upon the existence of monopoly or differential ad- vantages. Place a tax upon a person or thing which can easily move to a jurisdiction where such taxes are not imposed, and the tax is very likely to be shifted. Local taxes upon mortgage loans offer a good example. Such taxes are very likely to raise the interest rate by as much or a little more than the tax rate, the " little more " being explained by the trouble imposed upon the lender in looking after the tax and the risk that the tax rate will be increased. On the other hand, if mortgage lenders are constrained by ignorance or custom or the existence of particu- larly high rates in this district to keep on supplying the old amounts of loans, the tax will not be shifted. Unless the supply can be or is reduced by the tax, shifting will not ordinarily take place. Naturally, theirefore, the particiilar nature of the supply is of prime importance. We may illustrate by an excise tax per unit of product upon competitive industries of various kinds. In industries subject to the law of constant expense, a fixed tax per unit of product will raise the price by just the amount of the tax, in theory. In industries subject to the law of increasing expense, however, the reduction of the supply caused by the tax some- what reduces the expenses of production per unit exclusive of the tax, and on this account prices in such industries will in- PUBLIC RECEIPTS 705 crease by an amount less than the tax. In industries subject to the law of diminishing expense, on the other hand, the price will be raised by an amount equal to the tax, plus an amount equal to the increased expense of production caused by the limitation of supply. Mobility, as has been said, is the most important factor in this connection, and it may be restricted or destroyed in a variety of ways. Monopoly limits mobility, and, as we have already seen,^ the monopolist cannot shift a fixed tax or a proportional tax on net profits unless the tax is so high as to reduce monopoly profits below the amount that could be earned on the same in- vestment in a competitive industry. For somewhat similar, but not exactly the same reasons, differential gains from durable property are peculiarly susceptible to taxation. Thus, econo- mists generally indorse the proposition that a tax on economic rent falls upon the landlord and cannot be shifted. The validity of this depends both upon the durability of land and the fact that the tax is levied upon a differential element. If land wore out and had to be replenished, the tax would reduce the future supply of land and hence raise its price and its rent in the future. Similarly, if the tax were levied upon the product of marginal or no-rent land, it would elevate the margin, reduce the supply of those products or services which land affords, and in this way again raise prices and partially reimburse the landlord. But, by hypothesis, neither of these suppositions is true. Land, as we define it, does not wear out ; and at the margin land yields no economic rent. The proposition that a tax on economic rent cannot be shifted is true, moreover, only of a proportional tax. A tax of so much per bushel or pound upon agricultural prbduce would mo'^^e the margin of cultivation and thus affect prices. Indeed, the exact form of a tax — whether fixed, proportional, or progressive, upon net or gross returns, upon product or upon profit — is of funda- mental importance always. Generally speaking, proportional taxes upon net income are less easily shifted than other forms of taxes. 1 Pp. 202, 203. 7o6 OUTLINES OF ECONOMICS If the object of taxation be durable and the tax a special or exclusive one, the price of the object is likely to be reduced by an amount equal to the capitalized value of the tax. Prospec- tive purchasers of land take into account the taxes that are likely to be levied upon it, capitalize these, and subtract their capital- ized value from the amount which they would pay for the property if it were not liable to taxation. The apparent result of this capitalization or amortization of taxes, as the process is called, is to place the burden of an endless succession of taxes upon the original owner, and relieve subsequent purchasers of any real burden. Many present-day followers of Henry George find in this prin- ciple of amortization at once a justification and a method of securing for society all economic rent. Under present condi- tions, they say, a man who buys land wholly escapes taxation upon it. Consequently, in order to make landowners pay as much as other people we should have to increase the tax upon land by a rate equal to that paid by the average tax-payer as often — say every thirty years — as the land of the community changes holders. In this way the State could gradually and with justice absorb all economic rent.^ But this whole chain of reasoning is fallacious for three reasons : (i) What the prospective purchaser capitalizes and deducts is not the entire tax on the land, but the excess of that tax over similar taxes upon other investments open to him. A new purchaser of land does not " buy free of taxes," as is so often stated; what he does is to buy free of any excessive or abnormal tax burden. After the purchase he not only pays taxes in appearance, but in actual fact pays the average tax rate.~ (2) In so far as this program of the single taxers was anticipated and understood, it would visit the whole burden of the '' reform " upon present owners, instead of being distributed over several generations. Subsequent purchasers would dis- count these periodic increases of the tax and pay to owners for their land only the present value of the rapidly vanishing income 1 See the paper upon "The Single Tax" by C. B. Fillebrown in State and Local Taxation (Proceedings of the National Tax Association), vol. i, pp. 286-203. PUBLIC RECEIPTS 707 from land. Land would be valued as a terminable annuity. (3) This whole doctrine overlooks the inevitable consequence that, if " the selling value of land is an untaxed value " and if " the burden of a land tax cannot be made to survive a change of ownership," these facts would so increase the demand for land that the profits from its purchase and ownership would not exceed profits in other lines of investment. Given plenty of time, active competition, together with a knowledge of the facts of the situation, and such inequalities of taxation are in- evitably smoothed out by the natural movement of capital toward the taxless field or away from the field in which burdens are particularly severe. This inevitable reckoning of taxation among the disad- vantages of industry brings it to pass that many old taxes are diffused over the entire community. Such diffusion does not take place when the nature of the supply prevents it from varying in nice correspondence with the prospects of profit. A poll tax upon laborers, for instance, will in our opinion not be shifted, as it is likely to lower their standard of living, stimulate the birth rate, and in turn (other things being equal) actually reduce wages. But exclusive taxes on capital and business will be diffused ; and for this reason there is a profound practical truth in the famous dictum of Canard that " every old tax is good ; every new tax is bad," when sympathetically interpreted. Of course this doctrine assumes that industrial changes are infre- quent. The tax system must and should vary with changes in the fortunes of business enterprise. The development of a new industry making unusual and unexpected profits oft'ers a good opportunity of relieving an old industry that has unexpectedly fallen upon evil days. And for this reason it is highly desirable that state constitutions prescribing a rigidly uniform system of taxation should be amended so as to permit reasonable classifica- tion of property and business for purposes of taxation. All these qualifications of the diffusion theory are true and important. But the fact still remains that under ordinary conditions noth- ing is worse in a tax system than uncertainty, continual tinker- ing with rates, and capricious readjustment of methods. 708 OUTLINES OF ECONOMICS QUESTIONS AND EXERCISES 1. In accordance with what principles of classification do we distinguish fees, special assessments, and taxes? 2. Enumerate six fees commonly employed by state governments. 3. What accounts for the rapid development of the special assessment in the last fifty years ? Is it possible to apportion the benefits of a pubhc im- provement with any degree of accuracy? 4. Why are liquor licenses distinguished from other licenses and permits ? 5. Has the state a greater right to tax land and natural agents than produced wealth ? 6. May monopolies be equitably subjected to special taxation? Even if the monopoly rests upon superior efiiciency, or upon patent rights justly acquired ? 7. Is rigid equality of taxation a primary and fundamental desideratum? Is it possible of achievement? Is there any real distinction between the so-called ethical qualities (of equality, uniformity, etc.) and the so-called ad- ministrative qualities (convenience, elasticity, productivity, etc.) of a tax? 8. Is the benefit principle wrong or merely impossible of application? If wrong, why do we retain it in fees and special assessments ? 9. Is it easier to measure ability than benefits? 10. Is progressive taxation arbitrary? Can it be satisfactorily con- sidered apart from the effect of public expenditures ? 1 1 . Work out the effect of an excise tax on a monopoly subject to the law of increasing expense. 12. Do people buy land " free of taxes " ? If so, why does not everyone buy land in order to escape taxation ? 13. Can our state legislatures be trusted to "classify" property for taxa- tion fairly and impartially? State the arguments for and against repealing the uniformity provisions common in state constitutions. REFERENCES Bastable, C. F. Public Finance, Book iii, Chaps, iii, v, and vii. Carver, T. N. Essays in Social Justice, Chap. xvii. CooLEY, T. M. A Treatise on the Law of Taxation (3d ed.). Chaps, ii and vi. Ely, R. T. Taxation in American States and Cities, Part i. Chap. iii. FiLLEBROWN, C. B. Taxation. Gray, J. M. Limitation of Taxing Power on Public Indebtedness, pp. 25-54, 642-915. Jones, Robert. The Nature and First Principles of Taxation. JuDSON, F. N. a Treatise on the Power of Taxation. Lyon, Hastings. Principles of Taxation. National Tax Association. Proceedings of the National Conferences (formerly State and Local Taxation). PUBLIC RECEIPTS 709 Patterson, E. M. (editor), "Readjustments in Taxation," Annals of the American Academy of Political and Social Science, Vol. Iviii. Plehn, C. C. Government Finance in the United States. Post, L. F. The Taxation of Land Values. RosEWATER,ViCTOR, "Special Assessments : a Study in Municipal Finance," Columbia University Studies in History, Economics, and Public Law, Vol. ii. No. 3. Seligman, E. R. a. The Shifting and Incidence of Taxation, Part ii, Chap, i ; Progressive Taxation in Theory and Practice, Part ii. Chap, iv, and Part iii. Urdahl, T. K. "The Fee System in the United States," Transactions of the Wisconsin Academy of Science, Arts, and Letters, Vol. xii. Part i, pp. 49-67, 210-230. Weston, S. F. "Principles of Justice in Taxation," Columbia University Studies in History, Economics, and Public Law, Vol. xvii, No. 2. CHAPTER XXXIV FEDERAL, STATE, AND LOCAL TAXES Federal Taxation Constitutional Limitations. — The fundamental character of the American revenue system is determined by those clauses of the federal constitution which provide that " direct taxes shall be apportioned among the several states . . . according to their respective numbers " ; that " all duties, imposts, and excises shall be uniform throughout the United States " ; and that " no state shall, without the consent of Congress, levy any imposts or duties on imports or exports, except what may be absolutely necessary for executing its inspection laws." Just what the words duties, imposts, excises, direct and in- direct taxes signify, as used in the constitution, has been a matter of considerable discussion. Ordinarily the. word duty "means an indirect tax imposed upon the importation, exportation, or consumption of goods," being given " a broader meaning than custom, which is a duty imposed upon imports or exports," while " the term impost also signifies any tax, tribute, or duty, but it seldom applied to any but indirect taxes. An excise duty is an inland impost levied upon articles of manufacture or sale, and also upon licenses to pursue certain trades or to deal in certain commodities." All these differences turn largely upon the meaning of the words direct and indirect taxes. According to most economists direct taxes are taxes levied by the state upon those who are expected to bear their burden, while indirect taxes are supposed to be shifted to others. In the economic sense, therefore, poll taxes, property, income, and inheritance taxes are usually called direct, while customs taxes and excise taxes are called 710 FEDERAL, STATE, AND LOCAL TAXES 71 1 indirect. It is plain that the economic meaning of these words is exceedingly vague, because it is made to turn upon expecta- tions concerning the shifting of taxes, and upon few subjects is there more uncertainty than upon this. Economists have generally protested against any employment of these terms in scientific analysis, and where, because of their frequent em- ployment both in popular discussion and statute law, it has been necessary to retain them, they have tried to introduce a more consistent usage. Owing to the practical impossibility of maintaining a logical distinction between direct and indirect taxes based upon eco- nomic principles, it was commonly thought until the latter part of the nineteenth century that it was necessary to give these terms a strictly historical interpretation, based upon usage cur- rent in this country at the time the constitution was adopted. Accordingly, capitation and land taxes were generally believed to be the only forms of direct taxes. This belief was partly due to the fact that the federal Supreme Court at various times had sanctioned the use by the federal government of income, inheritance, and specific property or consumption taxes. In the famous Pollock ^ case, however, the Supreme Court rendered a decision in 1895 which was generally interpreted to hold that income taxes, so far as they include income from real estate and some other forms of property, are direct taxes. Nevertheless, what was practically an income tax upon cor- porations was adopted in 1909. It was justified by the Supreme Court as an excise tax, but the principal difference between this excise tax and an income tax proper appears to have been the fact that, instead of being levied upon or on income, it was levied and assessed " with respect to " or in accordance with income.^ ^Pollock V. Farmers^ Loan and Trust Co., 157 U. S. 420; 158 U. S. 601. * At a later date (January 24, 1916) in the case of Brushaber vs. Union Pacific Railroad Company, the Supreme Court upheld the constitutionality of the present federal income tax law and Chief Justice White took occasion to expound the tangled meaning of the famous Pollock decision. He announced that "the conclusion reached in the Pollock case did not in any degree involve holding that income taxes generically and necessarily came within the class of direct taxes on property, but, on the contrary, recognized the fact that taxation on income was in its nature an 712 OUTLINES OF ECONOMICS Finally in 191 2 the sixteenth amendment to the federal con- stitution was ratified, which provides : " The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration." The troublous history of the federal income tax has been briefly traced because it illustrates clearly the conditions under which the American people must frame and administer tax laws. Income taxes were introduced during the Civil War and millions of revenue collected under them before their repeal in the early seventies. When revived in 1894 the income tax was invali- dated by the Supreme Court in a decision which had momentous political consequences. The adverse decision was then, by a play of words, evaded in the corporation excise tax ; and later the entire principle was legitimatized by the sixteenth amend- ment. Finally, the Supreme Court decided that the income tax is not a direct tax, but under certain circumstances acts substantially like a direct tax. Nothing could illustrate more clearly the metaphysical complexities introduced into tax legis- lation by constitutional limitations whose final interpretation rests not with the legislature but the courts. Much may be said for the necessity of such constitutional restrictions under the American form of government, but none can deny the enor- mous difficulties which they throw in the way of consistent, simple, and wise tax legislation. Use of Direct Taxes by the Federal Government. — Until the twentieth century, the constitutional limitations which we have been discussing served to concentrate federal taxation almost wholly upon consumption, since direct taxes when appor- tioned according to population have shown themselves to be unjust, unproductive, and exceedingly difficult of collection. Congress has made use of direct taxes only five times during the history of the national government. Two million dollars was apportioned in 1798; $3,000,000 in 1813 ; $6,000,000 in 1815; excise . . ." and was invalid only because it acted enough like a direct tax in prac- tical effect to be subject to the requirement of apportionment according to population. FEDERAL, STATE, AND LOCAL TAXES 713 $3,000,000 in 1816; and $20,000,000 in 1861. Except in the tax of 1798, Congress has always permitted any state to assume its quota and raise the money as it saw fit, although provision was always made for its collection by federal officers, in case the quota was not assumed by the state government. It would be difficult to exaggerate the unsatisfactory character of such taxation. In no case has the federal government ever collected the full amount of the tax. The taxes levied in 1814-1816 con- tinued to be collected until 1839. The last payments on the direct tax of 1861 were not received until 1888; and in 1891 a law was passed abolishing further collections and authorizing the amounts which had been collected under the act of 1861 to be returned. Considerable scandal arose out of this refunding act, owing to the enormous commissions paid to certain lobbyists for their work at Washington in securing the passage of the law. Until the adoption of the sixteenth amendment, therefore, the federal government relied almost exclusively, in ordinary years, upon customs duties, excises, and similar taxes. Customs Duties. — Among federal revenues, customs duties held the place of first importance until very recently. From the foundation of the federal government in 1789 until the Civil War, with the exception of a few excise taxes collected between 1 79 1 and 1802, the federal government derived nearly all its permanent regular revenues from customs taxation, and since the Civil War considerably more than 50 per cent of the per- manent revenue has, on the average, been derived from this source. From the very beginning, moreover, our customs duties have been in spirit, if not always in effect, protective ; and it thus becomes necessary to consider the connection between the protective and revenue principles, in addition to the more strictly fiscal aspects of customs duties. Protective duties are imposed in the hope of diminishing im- ports and substituting in their stead the products of home manu- facturers. To the extent, therefore, that they are successful in their purpose, they reduce the customs revenues and justify the statement that there is a fundamental antagonism between the protective and revenue principles. However, the reduction of 714 OUTLINES OF ECONOMICS importation does not signify that the consumers of the article in question are not taxed. So long as the price remains higher than it would be if no duty were imposed, the people are taxed to the extent of the difference, the proceeds of the tax going to home manufacturers in the form of an unmeasured, unregulated bounty, whose burden upon the taxpayers is no less real because unperceived. It is equally evident that no protection is given unless the price is raised. The popularity of customs duties is largely explained by the belief that the foreigner can be made to bear the burden of the tax. He can in some cases, but not in the majority of cases. For the most part it is very certain that the burden must be borne by the home consumer. But whatever the extent to which the foreigner can be made to pay the tax, to that extent the tariff fails to replace foreign by home products; in short, fails to " protect." We cannot have our cake and eat it too. The more the protection or bounty to the home manufacturers, the greater the tax upon the consumers, the less the shifting of the tax to the foreigner, and the less the revenue to the home government. The protectionist is logically deprived of the time-worn argument that the foreigner foots the bill. The European War has deeply impressed .upon the people of the United States the strength of the argument for protection based upon military grounds and briefly discussed on page 370 above. It is likely, therefore, that we shall have more and not less protection in the immediately ensuing years, particu- larly for those industries whose products are believed to be in- dispensable to national security in times of war. So long as war is a real possibility there is probably no logical rejoinder to this argument for protection ; but at least we should realize that we are paying for our self-sufhciency, and that the difference between the cost of the protected products and what they would cost if imported from foreign countries, represents an additional item in the budget of " preparedness " which has already reached colossal proportions. The shifting of import duties may be best explained by noticing separately the immediate and ultimate incidence, (i) The immediate eifect of the tax FEDERAL, STATE, x\ND LOCAL TAXES 715 will be to discourage certain foreign producers from shipping their products to the newly restricted market, and prices will tend to rise because of di- minished supply. If the product is controlled by a foreign monopoly, the price may not increase ; but where the foreign production take places under competitive conditions, and in most cases where the production is monopo- lized, the price will be raised. The increase of price may be more or less than or equal to the tax according to the rea'diness with which foreign pro- ducers find a new market, but in a large majority of cases the burden of the tax will be shared by the producer and consumer, the latter, according to the majority of authorities, bearing most of the burden. That the bur- den, however, is partially borne by the foreign producer accords not only with the best theory, but with the great interest displayed by exporters every- where in the tariff legislation of foreign countries, and the sacrifices which protectionist governments are willing to make in reciprocity treaties for the purpose of obtaining advantageous terms for their own producers. (2) Eventually, however, the initial increase in price may stimulate home production, and this can only take place when the increase of price is less than the duty, because if the price rises by the whole amount of the tax, the foreigner will still possess his initial advantage. If the home producer totally ousts the foreigner, then the consumer bears all the difference between the existing price and the price that would rule if no duty were imposed — although, of course, the treasury receives nothing. If the home producer secures only a part of the home market, it is plain that, under ordinary cir- cumstances, the foreigner pays part of the tax, i.e. the amount per unit of product by which the duty exceeds the increase of price; while, as before, the home consumer pays, on every unit consumed, a tax equal to the differ- ence between the old and the new prices. When, however, we attempt to go further and take account of the indirect effects of protection, the problem becomes almost hopelessly complex. Modern ■ economists, however, are substantially agreed that the foreign producer bears a somewhat larger share of the average customs duty than the English economists of the first half of the nineteenth century were willing to admit. From the standpoint of revenue, American customs duties have the great virtues of high productivity, convenience of pay- ment, and cheapness of collection. Along with these important virtues are associated almost all the vices to which indirect taxes are subject. I. The most important defects of our customs taxes are their unreliability and imcertainty . Historically, they have shown a pernicious variability, expanding when increased revenue spelt extravagance, contracting when the country sorely needed larger revenue. In 179I; for instance, the customs revenues exceeded 7l6 OUTLINES OF ECONOMICS the total ordinary expenditures by over 41 per cent, while in the very next year they fell short of the expenditures by 58 per cent. Between 1791 and i860 inclusive, the customs receipts actually exceeded the expenditures in thirty-four years ; varied between 50 and 100 per cent of the expenditures in twenty- eight years ; and fell below 50 per cent in eight years. In i860, more than 84 per cent of the expenditures were secured from this source, but in 1863 less than 10 per cent, so inadequate is the customs revenue in a serious war when money is most needed. In 1864, Congress made desperate attempts to increase the customs revenue. In the tariif act of that year about fifteen hundred articles were enumerated, and the average rate approxi- mated 50 per cent; yet the receipts dropped from something over one hundred and two millions in 1864 to less than eighty- five millions in 1865, constituting only 6.5 per cent of the total expenditures in the latter year. During the history of the national government, the customs revenues have varied with the industrial condition of the country, the prospects of peace or war, the power of the tariff lobby, the prosperity and com- mercial policy of foreign nations, but almost never in nice accord- ance with the financial needs of the federal government. Where the tariff is controlled by revenue rather than protective pur- poses, it can be made strikingly stable and responsive to the control of the treasury. " The English revenue from this source has kept very near £20,000,000 per annum for the last thirty years. In the period 1815-1895, it has only varied be- tween £24,000,000 and £19,000,000, notwithstanding the exten- sive remissions of taxation." ^ 2. From the fiscal standpoint, our tariff system is far too complex and cumbersome. Whether we tax many imports or few, the major part of the revenue comes from comparatively few imports, so that by extending the list of dutiable articles we merely add to the cost of collection and increase the interference with commerce, without materially augmenting the yield of the tax. Before the European War, Great Britain imposed import duties on less than fifty articles, and nearly all of her revenue 1 C. F. Bastable, Public Finance, p. 517 (written in 1S95). FEDERAL, STATE, AND LOCAL TAXES 717 from import taxation came from five articles : tobacco, tea, spirits, wine, and sugar. Compared with direct taxes the cost of collecting our import duties is not excessive (4.42 per cent of the receipts in 191 5), yet it exceeds the cost of collecting the internal revenue duties (1.50 per cent in 1915) ; and in some customs districts the expenses of collection actually exceed the tax collected. "There is no better illustration of a complex and incomprehensible revenue system than the tariii legislation of the United States. It levies import duties upon goods that make up the country's exports as well as upon those that constitute the normal imports of the nation's commerce ; it taxes raw material as well as the manufactured product, and the manufactured product itself is taxed at many stages in the process of its manufacture ; the rate imposed is determined in part by considerations of revenue, in part by the desire to grant 'incidental protection,' and in part for the purpose of prohibiting the import of selected articles ; the rules of rating are numerous, overlapping each other in many cases and resulting in a confusion of instruc- tions that necessitates a board of appeal in continuous session ; the text of the law makes a book of one hundred and fifty pages, while the law and its interpretation used by the officials as a guide in the performance of their duty is a volume of several hundred pages. A law of this sort cannot be comprehended." ^ Customs duties are either specific or ad valorem. Specific duties are laid in proportion to weight or number, without regard to value, while ad valorem duties are levied in proportion to the value of the commodities imported. Ad valorem duties are open to the objection that they offer a greater temptation to fraudu- lent valuations, and hence make more difficult the work of the customs officers. Specific duties, on the other hand, while they can be more easily administered, are open to the serious objec- tion that they impose a relatively heavier burden upon less valuable goods of any class. Owing to their greater ease of col- lection, however, such specific duties now play a larger part than ever before in our tariff system. Internal Revenue Duties. — In 1915 the internal revenue taxes yielded $415,681,024, or practically twice as much as the customs receipts for that year. Of the total collections just 1 H. C. Adams, Science of Finance, pp. 409, 410. 7i8 OUTLINES OF ECONOMICS one third came from the tax on spirits ; a httle less than one fifth (19 per cent in each case) from the taxes on tobacco, fer- mented hquors, and incomes, respectively ; a little less than one tenth from stamp taxes on documents and transactions ; and the remainder from taxes on oleomargarine and playing cards, back taxes, penalties, and the like. The internal revenues now include a number of taxes other than the familiar excises on articles of consumption which for so many years constituted, with customs duties, the fiscal mainstay of the federal govern- ment ; but these newer taxes will be left for separate notice and the remainder of this section confined to the excises on articles of consumption. Such excises are usually paid by stamps placed upon the package of sale, supplemented by license taxes upon dealers, which are also paid by stamps, as a rule, publicly ex- posed by the dealer in his place of business. Excise taxes, like all taxes, have their grave defects, (i) Like import duties, they m.ust be levied upon articles of wide con- sumption to be productive ; and as they are in a large degree shifted to the consumers, they frequently weigh more heavily upon the poor than upon the rich. (2) This regressivity is in- creased by the fact that the taxes are specific, not ad valorem, so that the finer grades of domestic cigars, for instance, pay a lower rate of taxation than the cheaper goods. (3) In order to prevent evasion of the tax, the government is compelled not only to watch, but partially to direct, the process of manufacturing at every step. Producers are required to give bond for the faithful observance of the law, to register raw materials which they buy, and to keep records of the stock on hand in accord- ance with bookkeeping methods prescribed for them by the Bureau of Internal Revenue. Such interference with private in- dustry is an unfortunate but necessary part of excise taxation. (4) Large systematized businesses bear such interference with less effort than small concerns, and in consequence our internal revenue system unquestionably exerts an influence in the direc- tion of large-scale production, and possibly in the direction of monopoly. The license taxes particularly, which are adjusted only in the roughest way to the size of the business, unquestion- FEDERAL, STATE, AND LOCAL TAXES 719 ably weigh more heavily upon the small than the large dealers, (5) Finally, it seems to be the almost universal opinion of com- petent students that excise taxes exercise little influence upon the consumption of articles whose use is believed to be dele- terious. An increased tax is as often followed by adulteration as by an increase of the price per unit. The advantages of the internal revenue duties, however, far outweigh their defects, (i) Like the customs duties, they yield an enormous revenue ; but although they do fall off somewhat in times of industrial depression, they are in ordinary periods regular and dependable, while in times of war they respond readily to increased rates. The increase of old duties and the imposition of new duties during the Spanish War, for instance, raised the receipts from $170,900,641 in 1898 to $273,437,162 in 1899. Many of the taxes yield a proportional increase almost as great as the increase in the rate of the tax, a rare virtue in excise taxation. (2) From the administrative standpoint they are very inexpensive to collect, give rise to comparatively little fraud or evasion, and the few industries which they affect have now become so habituated to public inspection and control that these are occasion of little complaint. (3) Finally, it is to be noted that although excise taxes are regressive, the burden of the tax is shared by producer and consumer — not borne wholly by the latter — and the share borne by the producer varies directly with the element of monopoly or differential advantage in pro- duction. " Viewed as a whole, the internal revenue system is the most satisfactory part of our entire financial structure, state or federal. Its returns are fairly steady and reliable in times of depression. Its growth is automatic. It is imposed on articles the demand for which is tolerably inelastic. Its burden is not perceptibly felt. It is honestly and economically collected; and finally, it is abundantly capable of yielding additional revenue, should an unforeseen emergency arise." ^ Taxes on Transactions. — In times of urgent need, as in the War of 1 81 2, the Civil War, and the late war with Spain, the federal government has imposed taxes upon various sorts of 1 W. M. Daniels, Public Finance, p. 148. 720 OUTLINES OF ECONOMICS transactions. Thus, the war revenue act of 1898 imposed stamp taxes on bank checks, telegrams, freight and express receipts, transfers of stocks and bonds, bills of exchange, etc. In 1899, the year after they were imposed, the stamp taxes yielded $43,837,819. Such taxes were again introduced in a period of declining customs receipts and increasing expenditures, by the so-called " war revenue act " of 1914. In 1915 this measure yielded a revenue of a little less than $38,000,000, of which $23,500,000 came from stamp taxes on documents and trans- actions and the balance from special internal revenue duties of the ordinary type. The peculiar advantage of taxes on trans- actions is their quality of immediate productivity. As the figures just quoted show, they may be made to yield largely the very year they are imposed. Moreover, the government may make evasion almost impossible by refusing to recognize documents not properly stamped in its courts, or by otherwise obstructing the use of unstamped documents as evidence. An- other advantage is that they cost almost nothing to collect, as the taxpayer buys the stamp himself and places it upon the document. On the other hand, the general effect of such taxes is to impede business ; and they are frequently if not usually shifted to the weaker bargainer in a business transaction. Cer- tainly they bear no logical relation to the ability of the taxpayer to pay taxes. Income Taxes. — The recent adoption of effective income taxation into this country affords an interesting illustration of the triumph of a sound economic idea over formidable obstacles. The legal barriers which had to be surmounted have already been mentioned, but there were other difficulties to overcome equally formidable. Income taxes had been on the statute books of American commonwealths since the seventeenth century, and had been consistently and continuously ineffective. The tax was generally believed to be too intricate and too inquisitorial for the American people, schooled by the crudities of the general property tax to evasion of and contempt for tax law. Expert opinion had come to hold that the income tax, though " sound in theory," made too many demands upon both the taxpayer FEDERAL, STATE, AND LOCAL TAXES 721 and the tax administrator to thrive in American soil. Yet in the last five years income taxes of the European type have been put into successful operation by both state and federal govern- ments and give every promise of assuming, in the future, a place of major importance in the American fir-cal system. The mistake of the experts arose rather from an underestimate of the strength of the income tax than from an underestimate of its difficulties. The alleged weaknesses of the income tax were not imaginary. Experience has shown ^hat it is a complex and difficult tax to formulate and administer. Just what items of gross income should be included and what losses, expenses, and other deductions allowed, are questions which bristle with difficulties. Some forms of income are not expressed in money and usually escape taxation ; on the other hand, it is almost im- possible to avoid double taxation, particularly in dealing with interest and dividends. The tax has also the difficulty of being a class tax : the federal income tax touches directly less than one per cent and the Wisconsin income tax less than three per cent of the respective populations affected. The tax is predominantly a city tax and farmers generally escape, owing to the facts that they usually do not keep books and that much of their income does not find expression in terms of money ; although it must be admitted that relatively few farmers receive incomes above the exemption limit. Finally, the mixture of " withholding at source " and direct collection, in the federal tax, imposes large and unjust expenses of collection upon private taxpayers, complicates the administration of the tax, and in some cases leaves the taxpayer to become the sole judge of the taxability of certain items of income and of the deduc- tibility of certain losses and expenses. 1 Despite all these difficulties, however, the income tax has succeeded. It is reasonably productive and will become more productive as time passes: the federal income tax in 1915 yielded a revenue of over $80,000,000, and in 1916 it produced 1 A criticism of the federal income tax by a disinterested and competent com- mittee of the National Tax Association will be found in the Proceedings of that asso- ciation, vol. ix. 3A 722 OUTLINES OF ECONOMICS over $100,000,000. It is elastic, and can be made more produc- tive by simple increase of rates. Above all else, it realizes with reasonable success " taxation according to ability." Property taxes pay little attention to the ability of the owner of the property. They fall upon property as such whether it is free or encumbered by debt ; they must be paid by the unsuccessful as well as the successful ; in lean years as well as fat years. The income tax, on the other hand, does not affect the very poor at all ; it spares the unsuccessful business, the new business in its developmental stage, and the old established enterprise in times of business depression. Its appeal is thus not only to the humanitarian sentiment of the age, but to the common sense of the business man. Except when collected at source (when it acts in small part like an excise) it is subject to little or no shifting. And, unlike the property tax, it grows stronger with age and continued use. The countries which have tried the income tax keep it ; and in the last quarter of the century practically every large country in the world which did not already have the income tax has introduced it. The mistake of the critics in condemning the income tax for American use was due very largely to a misinterpretation of the failure of the personal property tax. That tax is largely evaded. The critics inferred from this that American taxpayers are liars and would similarly evade an income tax. Experience with the income tax has shown, however, that the average American tax- payer is honest and will make an honest declaration if the tax be equitable and tax officials at the same time firm, competent, and considerate. The personal property tax in this country has failed, not because the taxpayer is dishonest, but because the tax is at times barbarously severe in burden, strikingly un- equal in operation, and administered by officials who are fre- quently incompetent and out of sympathy with the tax itself. Moreover, the income tax is no more complicated than any other direct tax involving valuation and assessment. It ap- pears to be more complicated than the property tax merely because in drafting income tax laws it is customary to anticipate all problems of detail and define the proper answer in the FEDERAL, STATE, AND LOCAL TAXES 723 statute itself ; whereas, in property tax laws almost all the diffi- cult questions are avoided by laying the tax on the " fair cash " or '' market value " and leaving the meaning of this term to be decided by the judgment of the assessor. In the average case, it is easier to determine a man's income with reasonable accuracy than it is to determine with the same degree of accu- racy what his property is worth. Absentee ownership increases with industrial development, and much income is now derived from particular jurisdictions by persons who reside elsewhere. This leads in practice to double taxation, as both the jurisdiction in which the recipient lives and that in which the income originates are likely to im- pose the tax. Such double taxation is reduced as the jurisdic- tion is enlarged to which the income tax applies ; and for this reason many authorities advocate the exclusive employment of the income tax by the federal government. If the income tax cannot be employed by both state and federal governments, this conclusion is warranted. But we see no reason why the states should renounce the income tax and use substitutes which are manifestly inferior, merely because the federal government is employing the same tax. Nearly all taxes must be paid out of income. The specific tax employed is merely a device for distributing the tax. Why, then, should the state employ a poor method of distribution, such as that embodied in the personal property tax, when it might employ a tax which with substan- tial accuracy lays the burden in accordance with ability to pay ? As a matter of fact, the federal income tax is likely to encourage the adoption of state income taxes, because the federal tax fa- miliarizes the people with income tax procedure, and with simple modifications a report prepared for the federal govern- ment can be used for the state government. We should have, not hostility between state and federal administrations, but joint and cooperative use of many forms of taxation. Inheritance Taxes. — In 1893, when the first edition of this work was written, the inheritance tax was used in only five states, and so strong were the objections to its wide adoption that the author felt called upon to point out that unregulated 724 OUTLINES OF ECONOMICS collateral inheritance was an unjustifiable survival of the clan system that was being carried to ridiculous lengths at that time. Since that time, however, inheritance taxation has spread rapidly, being employed in about forty states in 191 5, and with the spread of the tax has come a most significant development of progressive rating and taxation of direct as well as collateral heirs. Today one never hears of the " inherent right " of decedents to control absolutely the disposition of their property in perpetuity, and the right of the legislature to regulate in- heritance in behalf of the general social welfare is hardly dis- puted. Mr. Andrew Carnegie, for instance, advocates a rate of 50 per cent upon the estates of millionaires. At present the inheritance tax produces substantial revenues in only a few states; in 1913, the latest year for which complete statistics are available, 35 states showed collections aggregat- ing $26,470,964, of which the six states of New York, Pennsyl- vania, Massachusetts, California, Illinois and Connecticut re- ceived 78 per cent. The important fact is that the initial in- ertia and opposition have been overcome and the ground cleared for the really efficient use of this tax as a means of reducing large fortunes and increasing public revenues. The new type of the inheritance tax is well illustrated by- the Wisconsin law, which applies to direct as well as collateral heirs, and which graduates the rates according to relationship and the amount of the individual share, and not by the size of the estate. The highest rate in the Wisconsin tax, applying to shares in excess of $500,000 given to distant relatives and strangers, is 15 per cent. Great as our progress has been in this respect, our legislation still falls short of the demands of common sense. Why should collateral inheritance, apart from a will, be permitted at all ex- cept among near relatives? Why should third cousins inherit from one another unless money is left by will ? Are third cousins nearer to one than the town or city in which one has lived and where one has been able to acquire a fortune? The extent to which intestate collateral inheritance is carried is a survival of the sentiment of the time when people lived in clans, and is illogical in our day. Right and duty should be coordinated. FEDERAL, STATE, AND LOCAL TAXES 725 Ought I to be compelled by law to support an uncle who is un- able by incapacity to earn a livelihood ? Then I should inherit from him ; otherwise it does not seem clear that I should unless he leaves me property by will. So far as practicable the circle of legal duties ought, however, to be extended so as to include the circle of vital relationship. The property should go to the State in the absence of near relatives when no will is made. The clan is dead and forgotten ; ordinarily there is neither ac- quaintance nor recognizable obligation between second cousins, not to mention twenty-second. • Inheritances thus bestowed are pure gifts, wanton disturbances of existing abilities to use property. The modern clan is society, and to it belong all claims to inheritance falling outside the circle of vital relations. The en- lightened English jurist, Jeremy Bentham, wished to restrict inheritance and extend escheat, and thus abolish taxation altogether, but this is going too far. At present the inheritance tax in this country is too light to satisfy the requirements of sound inheritance taxation. The average inheritance tax, even in the case of large estates divided into large shares, is less than 3 per cent : and it is very difficult for one state to increase the rates if neighboring states do not do the same. Moreover, state inheritance taxes give rise to multiple taxation. Land devolves at situs, and its devolution is taxed at situs. But our most valuable land is rapidly pass- ing into corporate ownership, and corporations do not die. The corporate securities which represent the land are, under the inheritance tax, normally taxed at the domicile of the de- cedent. This is likely to be in another state. Hence many states, the western states in particular, try to tax not only the transfer of securities owned by resident decedents, but also the transfer' of securities " representing " property located within their borders. This is selfish and inconsistent. Both principles cannot find an equitable and logical place in the same tax law. But it is expensive and difficult to administer an inheritance tax on the " situs principle " ; and when a holding company or series of holding companies intervenes between the security and the tangible property which that security repre- 726 OUTLINES OF ECONOMICS sents, it is almost impossible. Other states, again, tax the trans- fer of securities held in trust companies located therein ; while still others pile inconsistency upon inconsistency by giving bonds issued by their municipalities a situs within their own borders, in order that the transfer of such bonds may be taxed upon the death of their nonresident owners. The writer has known one block of securities to be taxed in three different states, and it was possibly taxed later in a fourth state. Under these circumstances, many people advocate as a remedy the collection of the tax by the federal government, with a redistribution of a part of the proceeds to the state governments. The principal argument for this change is the assertion that the federal government can, while the state governments cannot, realize the full possibilities of inheritance taxation, so that the federal government can give the states more than they are now receiving from this source and still retain a handsome revenue for federal uses. This project is, however, deeply resented by state tax officials, who point out that the probate courts, the natural machinery for administer- ing inheritance taxes, are in the hands of the state governments, and that there was considerable evasion of the inheritance tax adopted by the federal government during the Spanish War. We believe that the solution of the problem lies in cooperative and joint use by federal and state governments. Neither divi- sion of government can be prevented from using this tax, and fiscal necessity will almost certainly force the federal government to make use of it in the near future. That being the case, common sense points to the desirability of administrative co- operation, and the elimination by the larger sovereignty, if pos- sible, of double taxation arising from conflicts of jurisdiction. State and Local Taxation General Property Tax. — The key to the revenue system of our state and local governments, and by far the most important tax collected in the United States, is the general property tax, which supplied, in 1902, 82 per cent of the tax receipts of the FEDERAL, STATE, AND LOCAL TAXES 727 state and local governments and 51 per cent of all taxes col- lected in the country, (i) national, state, and local. The most important characteristic of this tax is suggested by the word " general," — the tax is levied in principle upon nearly all property, real and personal, in the hands of the people. Though the administration of the property tax differs in many details among the states, it is the usual custom for assessors in each community to prepare complete statements of all kinds of taxable property owned by the people of the community. In some states the assessors receive from all residents sworn " lists " of property owned and subject to tax. By the terms of the law the property is supposed to be rated at its true full value, though, by the acknowledged practice of assessors and courts of review, the real rates vary widely from state to state, from community to community, and from individual to individual. On the basis of the property valuations thus made the state and local governments levy direct taxes at a rate fixed from year to year according to fiscal needs. The tax is then collected by local officers, and of the whole amount the portion levied by the county and state is passed on to the designated ofiicers after each minor political division has set aside its share. As yet few economists who have written upon the subject, and few state officers who have had to do with the administration of the tax, have ever been able to speak of it except in terms of the severest condemnation. Naturally, then, there is now a strong tendency to work away from this form of taxation. Some of the many serious faults which the general property tax has everywhere shown call for comment and explanation. I. Unjust Apportionment. — The first of the defects of the tax appears in the apportionment of the state's share of the tax. Each community has a narrow, selfish interest in reducing its assessment so that it may escape its just share of the tax. The same mean struggle is especially frequent between city and country districts. To correct the evil, boards of equalization are usually appointed, but experience has shown that such boards usually do their work in a most perfunctory way. Although earnest study of assessments may and sometimes does secure a 728 OUTLINES OF ECONOMICS substantially just apportionment between county and county, this equalization does not correct the glaring inequalities within particular counties, and even within single assessment districts. 2. Inequality as between Realty and Personalty. — In the second place, the general property tax has proved grossly in- equitable in laying an undue proportion of its burden upon real property, allowing various forms of personal property to escape with a slight tax or with no tax at all. A secondary result of this inequality is that the rural districts bear a disproportionate burden, since the greater part of the tax-escaping personalty is owned by the wealthy citizens of our cities. 3. Undervaluation of Lar^e Properties. — Very similar to the preceding evils is the further injustice wrought by the tax through the disproportionate assessment of large and small properties. Thus, an investigation in Virginia covering over sixteen thousand pieces of property, showed that while the average ratio of assessed to true value was 33 per cent, parcels worth less than $500 were assessed at 47 per cent of full value, and parcels worth more than $10,000 at only 28 per cent of full value. ^ 4. Temptation to Dishonesty. — It follows from the evils already described that the general property tax leads to a shock- ing amount of dishonesty, perjury, bribery, and other forms of corruption. Indeed, as one writer has expressed it, " The general property tax has gone far toward making perjury re- spectable and even virtuous." 5. Fundamental Theoretical Defects. — But the most funda- mental defect of the general property tax is found in the fact that it is an incongruous mixture of real and personal taxes. Real estate, in a great majority of states, is taxed at its situs, irrespec- tive of ownership or the tax-paying ability of the owner. The personal obligation of the owner to support the government under which he immediately lives is met practically everywhere by that part of the tax which falls upon personal property, per- sonal property paying at the domicile of the owner. This distinction between real and personal property is artificial, ^Report of the Joint Committee on Tax Revision (Virginia), 1914, p. loi. FEDERAL, STATE, AND LOCAL TAXES 729 inequitable, and illogically applied. Personalty, as a measure of ability to pay taxes, ought to be accurately computed by offset- ting liabilities against assets, so that the taxpayer would pay only upon net assets. Yet no state, with the possible exception of New Jersey, grants full and complete exemption of debts; only three states permit a subtraction of debts from all per- sonalty ; the rest either refusing any abatement for debts what- soever or limiting the abatement to subtraction of debts from money, or money and credits, or other restricted classes of per- sonalty. Moreover, nearly all the states manipulate their defini- tions of real property in the most discreditable manner, causing many kinds of double taxation. To take a single illustration : most states tax the stock of foreign corporations held by resi- dent citizens, whether the corporation pays full taxes at its situs or not. Many of these states tax their own or domestic corpora- tions at full value, thus indorsing the theory that a corporation should be taxed as a business unit where the business is carried on. Nevertheless, they attempt to tax the stock of foreign cor- porations when the stock is the only thing they can reach. Some states, though not a majority, actually tax both the shares of stock and the business of domestic corporations, and then wonder that the stockholders attempt to evade the inequitable obligations imposed upon them by law. Reform of the Property Tax. — This brief outline of the evils connected with the general property tax furnishes us with the key to reform. By far the greatest reform that could possibly be accomplished would result from placing the work of assess- ment on a scientific basis, by appointing expert assessors under civil service protection, who would give their whole time to the business and hold their places during good behavior. In 1902 practically three fourths of the revenues collected under the general property tax came from the tax on real property. We shall undoubtedly keep the real estate tax. Scarcely any one advocates its abandonment or believes that it will be possible to get along without it ; and with trained assessors it would be possible to make a substantially fair assessment of real property. Yet even the assessment of real estate is in most places today 730 OUTLINES OF ECONOMICS markedly unequal. We spend a great deal of time thinking out ambitious fiscal reforms that will remedy the present system by revolutionizing it, overlooking the fact that the remedy for the deepest and widest evil lies within our reach, neglected and un- availing, not because we are ignorant of its potency, but because we lack the will resolutely to apply it. At the same time, no assessor, however expert and well paid, can ever be expected to assess all kinds of personal property with even approximate accuracy. To persist in the attempt to assess all the property of every person is simply to debase public morality and convince assessors that nothing short of divine wis- dom will enable them to satisfy the requirements of the law. In short, the more intangible forms of personal property, if not all personal property, must be exempted from taxation, and the loss be made up by the introduction of simpler and more work- able taxes. Probably the best substitute is an income tax, or what has been called a " presumptive ability tax " based upon house rent, rental value of business premises, salary, or all of them. In individual cases such a tax would violate the rules of exact justice, but with suitable exemptions and proper adjust- ments it might be roughly equitable. The personal property tax on business and commercial con- cerns, with its impossible requirements of stock valuations, taxation of book accounts, bills receivable, and credits generally, should be replaced by a tax on gross or net income, or by some simple form of license taxation. We should then have, in place of the general property tax, a tax on real estate, a business tax, and a personal tax measured by net income or evidences of in- come. Although the real estate tax would in appearance take no cognizance of mortgages or debts secured by the property and no account on the surface of the ability of the owner, it would not in reality wholly violate the canon of taxation accord- ing to ability. The man buying land on contract or subject to a mortgage, would take into account the fact that he would be called upon to pay taxes upon the whole value of the property, irrespective of debt or incumbrance, and the price would be adjusted accordingly. Or, if he mortgaged his land after he FEDERAL, STATE, AND LOCAL TAXES 731 had acquired ownership, he would be indemnified in most cases for paying all the taxes, by receiving a lower rate of interest on his mortgage than he would be enabled to secure if the creditor were liable for taxes upon that part of the property covered by the mortgage. Real taxes, which take no cognizance of the financial status of the owner, are not inequitable when they are consistently applied and supplemented by a separate system of personal taxation. All these taxes destined to take the place of the general property tax may possibly, in the future, be assigned to the local governments, although administered in some cases by the central government. If necessary to provide enough revenue for the state, however, a small state tax could equitably be levied upon real estate, as the equalization of real estate assess- ments among the larger governmental divisions, such as coun- ties, is a comparatively easy matter. Whether the state will be able to get along without taxes upon real estate, depends prin- cipally upon the productivity of certain corporation taxes, the proceeds of which belong logically to the state rather than to the local governments. This absorption of corporation taxes by the state is already well under way in the New England and Middle Atlantic states. In 1915, for instance. New York, New Jersey, and Pennsylvania together raised $70,078,685 from special property and business taxes (practically corporation taxes), but only $18,743,626 from the general property tax. In that year Delaware made no use of the general property tax at all for state purposes. However, the breakdown of the general property tax has by no means been accomplished yet. In all the states and territories in 191 5, 51 per cent of the total tax receipts came from the general property tax, 23 per cent from special property taxes, 22 per cent from business taxes, less than I per cent from poll taxes, and something over 4 per cent from miscellaneous licenses. These proportions are based upon state receipts. If local revenues were included, the general property tax would appear much more important. Corporation Taxes. — The exact way in which any corpora- tion should be taxed depends upon a great variety of considera- 732 OUTLINES OF ECONOMICS tions, which vary from place to place and from time to time. In general, however, the following elements may be detected in the more progressive systems of corporation taxation : (i) The incorporation fee, justified by the clerical expenses of registering corporations and the value of the privileges granted to every corporation, the most important of which is that of limited liability. This charge should be imposed on all joint-stock companies, should vary with the amount of bonds as well as the amount of stock authorized, and should be small, unless the state desires narrowly to restrict the incorporation of com- mercial enterprises. (2) The franchise tax proper, to cover especially valuable privileges, such as the right to use the public streets or highways, granted to most public utility companies. This is essentially a contractual payment, a lease or royalty rather than a tax. It should be fixed in advance for a definite period at as high a figure or rate as is just, and, when fixed, should not, in justice to the corporation, be tampered with by the state. ^ In states having public service commissions power- ful enough to control rates effectively, this tax or payment may, and perhaps should, be relinquished in favor of correspondingly lower rates and better service. (3) The general property tax or some equivalent, designed to impose upon the corporation a burden equivalent to that borne by the average taxpayer of the district. Inasmuch as good will, business organization, and similar intangible assets are property, property taxes imposed under this head should cover not only tangible but intangible values as well, including the franchise, when this does not revert to the state. Corporations which have received valuable fran- chises from the state may properly be called upon to pay for the privilege (under 2) as well as tipon the privilege (under 3). This differentiation of what may be called the bases of cor- poration taxation should not be misunderstood. Many states merge two or even three of these charges in a single tax, and 1 However, where a long or perpetual franchise is given, provision should be made for the readjustment of the rental by arbitration or in some other equitable way. An illustration is found in the terms of the franchise under which the Pennsjdvania railroad built a tunnel under the North River and erected its new station in New York City. FEDERAL, STATE, AND LOCAL TAXES 733 other states exempt savings banks, insurance companies, and other kinds of corporations from one or ail of these obhgations in order to encourage thrift or foster the industry exempted. Such exemptions are often justifiable and socially helpful. But unless these separate elements are kept plainly in mind, injus- tice is almost sure to follow. To impose, or try to impose, charge (2) upon all corporations, on the theory that all of them have received exceedingly valuable privileges, is to confuse general with special corporation privileges, and to pave the way for " corporation-baiting." Finally, although it is not neces- sary, we believe real progress will be hastened by observing these distinctions in practice as well as in theoretical analysis. Business and License Taxes. — In most Southern states there is an extensive system of business licenses, which supple- ment and partly replace the general property tax. The sig- nificance and importance of these business licenses have not hitherto been sufhciently appreciated. They are levied in theory under the regulative power of the government rather than the taxing power ; but they have by extension and multi- plication become taxes for the most part, as distinguished from sumptuary charges or payments for small privileges. The license system of the South is characterized by many defects. Here and there traces of class feeling are discerned, as in the prohibitive license taxes levied upon peddlers ; and the rates employed are often illogical, inconsistent, and in- equitable to the point of absurdity. In a few cases also, these taxes are high enough to bar certain occupations to the man with small capital. But on the whole they are among the best taxes employed by American commonwealths. They are easily and cheaply collected, very productive, cause little or no com- plaint, are not excessive as a rule, and exercise little or no in- fluence upon prices. And in so far as they discourage the excessive multiplication of small retail shops they perform the useful service of preventing almost inevitable loss and bank- ruptcy. The great significance of the business license is its expression of the truth that the general property tax in its crude form is 734 OUTLINES OF ECONOMICS unsuited to the taxation of business. Under the property tax, business in general is taxed upon its tangible assets, i.e. fixed plant and stock. One has only to think of the varying relation- ship to taxable capacity of the plant and stock of a manufac- turer, a grocer, a druggist, and a stock broker, to realize the grave injustice of this method of taxation. In countries of con- tinental Europe, and in parts of Canada, as in the southern part of the United States, a wide and generally satisfactory use is made of the business tax. Eventually we shall probably come to the same thing in all parts of this country. But the tax should be adjusted to earnings or profits in a more effective way than is now done in the South. Poll Taxes. — The poll tax is the oldest tax we have in this country, and throughout the greater part of the colonial period yielded more than any other source of revenue. It aroused bitter opposition in many commonwealths and was prohibited by the liberal constitution of Maryland at the beginning of the Revolu- tionary War; but it persisted in many of the states, and still remains the most important source of revenue, after the property tax, in a few of the Southern states. The tax still stands on the statute books of about one half of the states, and is nominally employed as a highway or local tax in a still larger number of commonwealths ; but in many places little or no effort is made to enforce it. In Wisconsin, for instance, no attempt is made to collect the poll tax in more than half of the local taxing dis- tricts. The poll tax is not only difficult to collect, but is regres- sive and, when its payment is required as a prerequisite to the exercise of the suffrage, often results in widespread political cor- ruption. " No concealment need be made of the fact that the poll tax is used in Mississippi as a means of disqualifying the negro in national elections and controlling the vote in local elections." ^ The aggregate yield of the poll tax is small, and the expense of collecting it is relatively high. It has few de- fenders among competent students of taxation. 1 C. H. Brough, in "Studies in State Taxation," Johns Hopkins University Studies ill Historical and Political Science, vol. xviii, p. 213. FEDERAL, STATE, AND LOCAL TAXES 735 A Balanced Revenue System There are, on the mainland of the United States, forty-eight separate sovereignties in addition to the federal government, and the resulting conflicts of jurisdiction gives rise to the deepest defects of our revenue system. As a remedy for this evil, many authorities recommend a division or separation of revenues, by which certain taxes would be assigned to the federal govern- ment, others to the states, and still others to the local govern- ments. This plan is usually referred to as the " segregation or separation of the sources of revenue." The benefits that might be derived from a thoroughgoing system of segregation are many and obvious. But the trend of events suggests that reform must, in the main, be sought along other lines. The boundaries between state and federal finance become more indistinct with the passage of time. Both federal and state governments have recently adopted income taxes, and the federal government may very soon deem it wise to adopt the inheritance tax. The state governments in recent years have made increasing use of stamp taxes and other forms of excise taxation theretofore used almost exclusively by the federal government. In commonwealth finance, similarly, there seems little disposition to separate clearly the sphere of state and local taxation. On the contrary, state tax commissions are being given increasing powers of regulating local taxation, and it is being recognized in increasing degree that to finance the state governments by corporation and indirect taxes which do not touch the great mass of citizens directly, stimulates ex- travagance on the part of the state legislature, and, in fact, leads tc the reintroduction by the state of direct taxes on general property. Furthermore, there are some manifest ad- vantages in the joint use of the same tax by several divisions of government. The central or larger jurisdiction not only finds it possible to employ expert aid, which the local government could not afford to hire, but it has a broader, more impartial point of view which serves to check local selfishness. Local authorities, on the other hand, frequently have a helpful knowl- 736 OUTLINES OF ECONOMICS edge of important facts and conditions which are likely to escape the agents of the central government. Joint use of the same tax also permits a wise compromise between central effi- ciency and the American demand for " local self-government." A certain amount of segregation is, however, not only expe- dient but plainly necessary. Thus, the use of import and export duties is confined by the constitution to the federal government. In the domain of commonwealth government also there are cer- tain enterprises, such as sleeping car companies, whose property or business is so difficult to localize that by common consent such companies are reserved for state taxation. For the same reasons, certain other corporations, such as telephone, telegraph, insurance, freight line and equipment companies, should be, and rapidly are being, set aside for state or central taxation ; and in the case of most " state- wide " public utilities there is obvious need for central assessment. In the past, it was common to assess separately the property of railroads and similar public utilities in every tax district (including townships and even school districts) in which they operated, and this absurd mor- cellement is still practiced in some backward states^ including New York. Many of the most important properties of such corporations cannot be intelligently valued without reference to the earnings or success of the business as a whole and this, as well as considerations of administrative simplicity, makes valuation or assessment as a unit obviously desirable. When the central valuation is once made it is possible in some cases to distribute or apportion the valuation to counties or other large local subdivisions ; but it is impossible to localize some busi- nesses satisfactorily, and minute subdivision is in all cases un- desirable. Much that has been said above about state versus local assessment applies, in the case of interstate corporations, to the question of federal versus state assessment. Without federal control each state is tempted to select that form of taxation and to adopt that method of dividing or allocating corporate prop- erty and business for purposes of taxation which is most bene- ficial to itself. Under such circumstances some interstate cor- FEDERAL, STATE, AND LOCAL TAXES 737 porations are taxed upon more than one hundred per cent of their property or business, while others take advantage of the absence of authoritative central control to assign, in their own accounting systems, excessive proportions of property and business to those jurisdictions in which taxes are lightest. While federal regulation is justified by the same logic which sanctions state regulation of local taxation, it is very doubtful how far federal regulation can or should go. If the national government should require some form of federal incorporation for companies engaged in interstate commerce, it is possible that it would have power thereafter to prescribe the methods by which such interstate companies should be taxed under state law. This has been done in the case of national banks, although the power of the federal government to control taxation of national banks is clearer and probably greater than its poten- tial power to limit the rate of taxation of ordinary business cor- porations engaged in interstate commerce. But if the proposed federal regulation were elastic enough to permit the rate of taxation to vary in each state with the average level or burden of taxation in that state, and vigorous enough to suppress selfish state aggrandizement, it would represent a great reform. No form of federal control is expedient, however, that would de- prive the states of adequate revenues from this source. The properties of interstate companies form a very large part of existing wealth. In a number of states one tenth or more of the entire taxes collected, state and local, come from railroad companies alone. Commonwealth revenue systems are ad- justed to this condition and no revolutionary change is either practical or desirable. One important reform, however, could be accomplished at once. The Interstate Commerce Commission, or some similar federal agency, should at the earliest practicable date be directed to formulate and enforce some simple plan of allocating the revenues and expenses of interstate corporations to the several states in which they operate. This is required not only for the fair assessment of state income taxes, but for the valuation of the properties of interstate corporations, as these properties can 3B 738 OUTLINES OF ECONOMICS never be satisfactorily appraised without taking their earnings into account. For reasons which appear in the preceding discussion, it would be misleading to formulate any clear-cut division of taxes among the federal, state, and local governments. A few forms of revenue will unquestionably be reserved for the use of one branch of government, but the pressure of increasing expendi- ture is likely to force a joint use of such major revenues as taxes on real estate, income and inheritance taxes, excise and stamp duties ; and for these the ideal is joint administration, in which the relative impartiality and vigor of central administration may be supplemented and perfected by the more intimate knowledge of local ofBcials. QUESTIONS 1. Why are the terms "direct" and "indirect" taxes particularly vague and equivocal ? 2. Explain why no protection is given the home producer when the im- port duty is shifted upon the foreigner. 3. What is the greatest fiscal defect of American customs taxation ? Can this defect be remedied ? 4. Are excise taxes ethically justifiable? Do they materially check con- sumption when imposed upon alcoholic beverages and tobacco? 5. Do you know of any state which levies an income tax at the present time? Is the tax successful? 6. Should income which is saved and immediately reinvested be taxed? Is it not double taxation to tax savings and the earnings from such savings as well? 7. Should corporations be taxed at the same rate as unincorporated business concerns? Should any definite relation between the two kinds of taxes be maintained? 8. Contrast the taxation of national banks in your own state with the taxation of trust companies, ordinary commercial or manufacturing corpora- tions, and unincorporated business concerns. 9. State as many reasons as possible why the separation of state and local revenues would be helpful. 10. Explain why many forms of property employed in business cannot be inteUigently assessed for taxation without reference to the earnings of the business. 11. Are assessors elected or appointed in your own state? Do they re- quire taxpayers to declare their personal property in great detail? Do the FEDERAL, STATE, AND LOCAL TAXES 739 local assessment rolls contain separate figures for real estate and improve- ments? Is the property of nonresidents specially designated? 12. Why is the general property tax particularly unsuited to the taxation of business and professional men? 13. Should the federal government, if it possesses the power, make the taxation of interstate commerce corporations uniform throughout the United States ? REFERENCES Bullock, C. J. Selected Readings in Piiblic Finance, Chaps, vii-xix; "The Taxation of Corporations in Massachusetts," Quarterly Journal of. Economics, Vol. xxi, pp. 181-246. Commissioner of Corporations. Reports on the Taxation of Corporations ; Special Report on Taxation. Ely, R. T. Property and Contract in their Relations to the Distribution of Wealth, Chap. xvii. Hollander, J. H. (ed.), "Studies in State Taxation," Johns Hopkins University Studies in Historical and Political Science, Series xviii. Industrial Commission. Report. "Taxation," Vol. xix, pp. 1031-1069; "Taxation in Various States and in Canada with Special Reference to the Taxation of Corporations," Vol. xi. Part vii; "Taxation of Transportation Companies," Vol. ix, pp. 1006-1091. Reports of State Tax Commissions. Upon the topics indicated see "The Massachusetts Tax System and its Workings," Massachusetts Com- mission of 1897, pp. 1-73; "Public Service Corporations," Wisconsin Commission, 1901, pp. 72-121; "Taxation of Credits," ibid., 1903, pp. 88-144; "Mortgage Taxation," ihid., 1907, pp. 303 et seq.; "Railway Taxation," Ontario Commission, 1905 ; Committee on Taxation of the City of New York, 191 5 ; Massachusetts Special Commission on Taxa- tion, 1915. Seligman, E. R. a. The Income Tax. West, Max. The Inheritance Tax, Chaps, vii and ix. APPENDIX A HISTORY OF ECONOMIC THOUGHT Economic Ideas in the Ancient World. — The assertion is some- times made, or at least the impression is frequently given, that there were no writings on economics before Adam Smith. This impression is erroneous, and derives its plausibility from the fact that before Adam Smith economic subjects were treated either disjointedly and in a monographic way, or else in connection with ethics and pohtical philosophy. But in treating economics in connection with ethics and politics, the older writers were merely following an instinctive method of dealing with economic truths, to which in a certain degree later writers are returning. Indeed, if we are to derive the utmost possible benefit from this brief survey of the devel- opment of economic thought, it is necessary to begin many cen- turies before Adam Smith, with the Greeks. The Greeks. — The three writers among the Greeks most inter- esting to the economist are Plato, Aristotle, and Xenophon. Both Xenophon and Aristotle (or, more probably, some unknown dis- ciple of Aristotle) have treatises upon the specific subject of (Eco- nomics, but these are devoted principally to domestic economy, or the management of the household ; and the more important eco- nomic ideas of the Greek writers are derived from their works which deal primarily with political and ethical subjects. Plato describes a Utopia in his Republic. His aim was to picture an ideal society in which the ills of society were to be corrected by a communistic State, and he included a communism even of wives and children, going farther than modern communists. The com- munism of Plato admitted, strange as it may seem, slavery, on which his social superstructure indeed rested as a base. The Laws of Plato is a more practical work. It aims to present not the best possible state, but a more practicable one, and deals to a greater extent with existing institutions. Aristotle's principal work for us is the Politics, and it is indeed one of the most remarkable books in the world's history. Its in- fluence is strongly felt today, for it was carefiilly studied by theo- logians of the Middle Ages, and through them entered into the thought and life of their time ; and the thought and life of their time can be seen by the careful student to have entered in a thousand ways into the institutions of the twentieth century. While Plato tacitly accepted slavery, Aristotle actively defended the institution of slavery, describing the slave as an " animated 741 742 OUTLINES OF ECONOMICS tool," and insisting that slave labor was necessary in order that the ruling classes might have the leisure for statecraft, art, and litera- ture. Both Plato and Aristotle, also, fully appreciated the advan- tages of the division of labor, and understood, in consequence, that a certain amount of traffic and exchange is necessary. But both writers shared the common prejudice against trade and commerce ; what one man gained in exchange, they thought, some other man lost ; and to live by trade was in their eyes despicable. Aristotle, moreover, defended the institution of private property, and formu- lated surprisingly accurate ideas about money and its functions; but he condemned interest taking because, as he expressed it, money is barren. Perhaps the most characteristic quality of Greek economic thought, speaking generally, is the thorough subordination of economic to ethical and political considerations. The object of life, in their view, was self-knowledge or self-realization, not the acquisition of riches, and they refused to regard wealth as an object of funda- mental importance to either the individual or the State. Plato, indeed, in certain parts of his writings, defends the ascetic idea that human wants are to be satisfied, not by the improvement of produc- tive processes, but by the repression of the wants themselves. The Romans. — While the economic institutions of the Romans and the manifestations of their character in their economic life will repay investigation, they were not remarkable for independent thought. Their economic ideas, like their philosophical doctrines, were borrowed fro.m the Greeks, and show the same general char- acteristics which the ideas of Plato and Aristotle do. Commerce and trade were held in contempt, particularly when carried on in a small way. Interest taking was by some thought to be " as bad as murder." Agriculture, on the other hand, was esteemed to be worthy of the noblest citizens, and a " return to the soil " in later Roman times was frequently recommended as a cure for the pre- vailing degeneracy. Pliny said the great estates, the latifundia, together with slave labor and the destruction of the small inde- pendent farmer, caused the downfall of Rome. Among other agri- cultural problems discussed by the Romans were those of intensive versus extensive culture, and slave versus free labor. The jurists are, however, the most important of all. Whatever may be its imperfections, the Roman law, the corpus juris civilis, is the most remarkable legal system the world has ever seen and for training in careful and accurate statement is unsurpassed. Prob- ably, as a training for economic studies, Roman law is among the most valuable branches of learning. It gives us also invaluable information about the economic institutions of Rome. Christianity. — To the economic thought of the time Chris- tianity brought the revolutionary ideas of the dignity of toil and the equahty of men before God. The philosophy of the Stoics had brought analogous ideas to the attention of the restricted intellectual world of the day, but Christianity popularized these ideas. The APPENDIX 743 clergy were encouraged to earn their livelihood by manual labor, and laymen were exhorted to free their slaves as soon as they had become Christians. With respect to money and trade, however, the effect of Christianity was to strengthen and impress the teachings of / , Aristotle. // The Middle Ages. — As the power of the Church increased, its economic ideas found more formal expression in the treatises of the schoolmen and medieval theologians who expounded the church or canon law. Indeed, in the corpus juris canonici we have a definite system of economic thought which, while it was largely theoretical and intended originally for the ecclesiastical courts, came in time to be widely applied in secular affairs through the power of the con- fessional, the pulpit, and the wide jurisdiction of the ecclesiastical courts. The doctrines of the canonists were derived, in part, from bib- lical injunctions against usury and the pursuit of wealth. The early Christian fathers frequently went so far as to condemn private property and set up the ideal of communism among the faithful. But this was only an ideal, and private property was early recog- nized as a necessary evil resulting from the fall of man. This ideal, however, was powerful enough to keep alive the doctrine that the maintenance of the poor was not a matter of philanthropy, but a binding obligation, in the words of Thomas Aquinas, the most dis- tinguished canonist, a debitum legale. Following the philosophers of Greece and Rome, and in sym- pathy with the scriptural attitude toward wealth, trade and com- merce were regarded as greatly inferior to agriculture and handi- work as a source of livelihood. It was still believed that what the seller made by trade the buyer necessarily lost. As commerce developed, however, trade had to be recognized by the Church. In doing so, the canon writers formulated the doctrine of justum pretiiim, that every commodity has a just price, or value, which it is sinful for the seller to exceed. The modern trade-vmion doc- trine of a fair wage, and the decisions of our courts concerning rea- sonable charges for gas, railway services, etc., illustrate the perma- nent necessity of ethical ideas of this sort. The next most important economic doctrine of the canonists was the condemnation of usury, which originally signified any loan interest, and not necessarily excessive interest. Their argument against interest was based upon scriptural strictures against usury, and upon Aristotle's argument that money is barren. Interest taking by the clergy had been prohibited as early as the fourth century; but in 1311, at the Council of Vienna, interest was pro- hibited " absolutely and universally," regardless of the civil law ; and by the middle of the fourteenth century, the prohibition of interest had, in many places, been incorporated into the civil law. Little by little, however, the Church was forced to change its atti- tude, and in the middle of the sixteenth century (1545) a statute was passed in England legalizing an annual interest rate not in 744 OUTLINES OF ECONOMICS excess of lo per cent.^ By this time the teachings of the canonists were fast giving way to the doctrines of mercantilism. Economic Ideas in Modern Times. — Before the close of the sixteenth century, the temporal power of the Church had been undermined by the development of the great modern monarchies, and in economic thought religious considerations were replaced by political necessities. The problem of the Church — the universal establishment of the Kingdom of God upon earth — gave way' to a newer problem — the maintenance and aggrandizement of rival states. The latter were in pressing need of ready money with which to build navies and support armies. How to increase public revenue and national wealth became the absorbing questions of the time. Mercantilism. — The mercantile system, also called Colbert- ism, restrictive system, and commercial system, obtained from the early part of the sixteenth century until late in the eighteenth century, and its influence is still felt. Mercantilism is not, strictly speaking, the product of a school of political economists, but rather the name given to that economic policy of statesmen and to. those detached economic views of writers which prevailed during this period. Most prominent among the statesmen who were mercantil- ists may be named Colbert, of France, Frederick the Great, of .Prussia, and Cromwell, of England. Serra, an Italian, early in the seventeenth century presented a moderate and systematic statement of their views in a work entitled A Brief Treatise on Causes which make Gold and Silver abound where there are no Mines. Thomas Mun, in England, a generation later, wrote a valuable treatise from the standpoint of the mercantilists, called England'' s Treasure by Foreign Trade: or the Balance of our Trade the Rule of our Treasure, while Sir James Steuart's Inquiries into the Principles of Political Economy, published in 1767, may be regarded as closing the development of the theory of mercantilism. The principal characteristics of mercantilism — the efforts to increase the stock of precious metals within the country, to main- tain a favorable balance of trade, to increase the population and foster manufactures, if necessary at the expense of agriculture — have been described elsewhere, and need not be repeated at this point. In attempting to apply these theories, however, the states- men of this epoch instinctively turned to that instrument — the law — with whose use they were most familiar, and statutory re- strictions were multiplied until mercantilism in one sense became practically synonymous with governmental interference. Toward the end of the eighteenth century, however, the commercial posi- tion of England, for example, became so strong that many of her industries found themselves crippled and confined by the very laws which had protected their infancy, and a reaction against mercan- tilism set in. The reaction, naturally, took the form of a movement in favor of agriculture and against governmental interference in economic and industrial affairs. In obedience to the needs of anew 1 See also p. 493, above. APPENDIX 745 epoch, political economy lent itself to a propaganda in support of the doctrine of industrial liberty. The Physiocrats. — The reaction against mercantilism found its first thorough and scientific expression at the hands of the French physiocrats. Quesnay, a physician, Gournay, a merchant, and Turgot,^ the statesman, are their three principal authors. Polit- ically, the physiocrats taught the doctrine of natural laws and rights, and as a consequence loudly proclaimed the maxim of laissez- faire, that is, .that the government should not interfere with pri- vate enterprise. Economically, they exalted the importance of agriculture, and maintained that manufactures and commerce, which merely change the form or position of raw materials, are barren and unproductive (though useful when subordinated to agriculture) ; but that agriculture yields a net surplus — produit net — over and above the expenses of production. The physio- crats must thus be credited with originating the fertile economic doctrine of surplus value — a reward or premium appearing in pro- duction for which nature rather than man is responsible, and which is not required to induce men to put forth the effort necessary to produce wealth. Many of the other doctrines of the physiocrats follow logically from the primacy which they accorded to agriculture. Since agri- culture is the sole ultimate source of wealth, they maintained that the revenue of the State should be raised by a single direct tax — the impdt unique — levied upon land. All taxes must, they thought, in the end come out of rent anyway ; and it was better that the land- lord should pay them at once instead of waiting until they had passed through five or six hands and various profits had added to their amount. Naturally the physiocrats were ardent champions of free trade. They encouraged also the consumption of agricultural products, " in order that the produit net might be increased," and were generous champions of the importance and rights of the down- trodden peasantry. Pauvres pay sans, pauvre royaume; pauvre rgyaume, pauvre roi, was the borrowed motto of Quesnay's Tableau Economique, the most important treatise of the physiocratic school. Adam Smith. — In 1776 Adam Smith published his Inquiry into the Nature and Causes of the Wealth of Nations, the most influential economic treatise ever written. " The life of almost everyone in England, perhaps of everyone," said Bagehot, " is different and better in consequence of it." His writings are found to be very similar to those of the physiocrats, but further developed and modi- fied by his Scotch training and habit of mind. We find in Adam Smith the doctrines of free trade, non-interference, and natural laws, yet all stated more guardedly. Although he does not regard agriculture as exclusively productive, he does show a partiality for agriculture, for in this branch of production, he says, nature labors 1 Turgot did not count himself a member of the economic sect or school which gave their views the name of "physiocracy," but his economic doctrines are very much like theirs. 746 OUTLINES OF ECONOMICS along with man. He emphasized the importance of permitting each individual to follow his own self-interest as a means of pro- moting national prosperity, but he was not unmindful of the exist- ence of altruistic motives in mankind. He accords full recognition to the motives of sympathy and kindness in his Theory of Moral Sentiments. But the net result of Smith's teaching was to strengthen and emphasize the laissez-faire trend of economic thought in his time. " Two conceptions," said Arnold Toynbee, " are woven into every argument of the Wealth of Nations, the belief in the su- preme value of individual liberty, and a conviction that man's self- love is God's providence, that the individual in pursuing his own interest is promoting the welfare of all." Economic Thought in the Nineteenth Century. — The Classical School. — The economic philosophy which prevailed during the first half of the nineteenth century is variously designated as the classical, Ricardian, English, or orthodox school. The earlier authors of this period were Jeremy Bentham (1738-1842), Thomas Robert Malthus (1766-1834), David Ricardo (1772-1823), James Mill (1773-1836), and John Ramsay McCulloch (1779-1864). In aU of these writers we iind the utilitarian philosophy, a deductive method, and the feeling that the outlook for the mass of the laborers was not a hopeful one. They elaborated economic principles, sup- posed to be good for aU times and places, with the positiveness that one expects to find only in the inathematical or physical sciences. Bentham's great work was the formulation and propaganda of the utilitarian ethics, with its famous first principle or goal of social action — the greatest happiness of the greatest number. Malthus 's principal contribution, contained in his celebrated work, The Theory of Population, has already been discussed. While Malthus was himself a particularly charitable and benevolent friend of the working classes, his doctrine of population contributed more than any other single thing to make the political economy of the classical school harsh and gloomy. It seemed to say that although wages were low they could be no higher, because if by some fortunate chance wages increased, population was sure to multiply until the wage was forced back to the old level. Poor relief and trade- union activities were both useless. The woe of the poor was due to their own lack of foresight, and could be removed by the poor alone. It was taught " that he who brought children into the world without adequate provision for them should be left to the punishment of nature." The responsibility of poverty was thus thrust upon the poor themselves ; the rich were soothed with the assurance that they were not primarily responsible for the condition of affairs. Mathus himself, however, did not frame his doctrine in so remorseless a way. He recognized the importance of what he called " preventive checks " to the increase of the population. Mathus brought the results of elaborate historical and statistical investigations to the support of his doctrmes. Ricardo was perhaps the first economist who adequately realized APPENDtX 747 the importance of the problem of the distribution of wealth. The backbone of his distributive system was the Malthusian law of pop- ulation. Ricardo believed that as population increased, society would be forced to resort to poorer and poorer soils in order to ob- tain food ; and as this took place an increasing share of the product of industry would go to the landlord in the shape of economic rent. The division of the remaining product between labor and capital, in Ricardo's view, was determined largely by the standard of living; that is to say, the laborer would receive enough to purchase the necessaries and conveniences required to support him and his family in their customary style of living, while the residue would go to capital in the form of interest and profits. Profits were thus the " leavings of wages." With the passage of time and the settlement of a country, then, Ricardo's theory of distribution taught that rent would absorb a larger and a larger share of the product, wages a constant or slowly increasing amount, while profits would dwindle both absolutely and relatively. Ricardo's principal work is caUed Principles of Political Economy and Taxation. It was published in 1S17, and in it Ricardo elaborates, although he did not originate, the usually received doctrine of rent, which, modified and developed, is the one presented in this book. His ideas in general have a markedly pessimistic tinge. Rent, he said, is due to the niggardliness, not to the bounty, of nature ; and his theory of distribution emphasized the natural diversity of interest between wage receivers and profit makers, and the antago- nism between the interests of landowners and all other classes of society. Personally he was a kind man, and sincerely devoted to the advancement of. humanity. Ricardo is remarkable for his power in the use of the abstract deductive method, and it is note- worthy that this distinction should attach, not to a professional scholar, but to one of the most successful bankers and brokers of his day. John Stuart Mill, who lived from 1806-1873, closed one period in the development of economic science and began another in Eng- land. He started as a thoroughgoing follower of Ricardo, pre- served the old doctrines of value, rent, and profits, and advocated laissez-faire as a general principle of political expediency. But in his later years MiU advocated the diffusion of property through the regulation and taxation of inheritances, indorsed the appro- priation by the State of the future unearned increment of land, and emphasized an important distinction between the production and distribution of wealth. " The laws and conditions of the produc- tion of wealth," he said, " partake of the nature of physical truths. There is nothing optional or arbitrary in them. ... It is not so with the distribution of wealth. That is a matter of human insti- tutions solely. The things once there, mankind, individually or coUectively, can do with them as they like. . . . The distribution of wealth, therefore, depends upon the laws and customs of society. The rules by which it is determined are what the opinions and feelings 748 OUTLINES OF ECONOMICS of the community make them, and are very different in different ages and countries; and might be still more different, if mankind so choose." The old and the new doctrines found in MUI's Principles of Polit- ical Economy do not harmonize, however, and the result is a work one of the most valuable of modern times, yet full of inconsistencies. Nevertheless, Mill will always be regarded as the culmination of the school usually known as the English deductive or classical school. Most of the work of the school was deductive ; that is, they reasoned by singKng out a few main facts of the external physical world and human nature familiar to all, and showing how men must act under the guidance of these laws. None of these economists pretended that the few laws which they considered were the whole of human nature, though they have sometimes been interpreted as if they did so ; but they thought that the great multitude of motives which influenced men were too complex to be analyzed, and only one or two (chiefly self-interest) could " be reduced to any assignable law." Despite these limitations, the largest contributions that have been made to economic science came from the Enghsh classical school. Socialism. — Mill's change of heart resulted partly from his study of the sociahst writers, who voiced the earliest and most thoroughgoing protest against the views of the classical economists. Modern socialistic doctrine may conveniently be dated from WUliam Godwin's Inquiry concerning Political Justice (1793), al- though Godwin himself was more of an anarchist than a socialist. Godwin and the early French idealists and communists, — Cabet, Saint-Simon, Fourier, etc., — began the attack on the ethical and political views of the orthodox political economy. Later the attack was continued in a somewhat more practical and realistic way by writers such as WiUiam Thompson and Robert Owen in England, Bazard and Louis Blanc in France, Rodbertus, Lasalle, and Marx in Germany. The foundation of classical political economy was laissez- faire, and its doctrinal structure was built around the system of private capitalistic enterprise. Socialism in essence was a thorough protest against laissez-faire and the private ownership of property. Pierre Le Roux used the word " sociaHsm " in 1838 ^ with the very purpose of expressing the antithesis of individuahsm. In recent times, largely under the influence of Karl Marx, social- ism has acquired a distinctive economic theory of its own. Marx, in his work on Capital, was in most ways as abstract, deductive, and pessimistic as any of the classical school, but at bottom his whole theory was directed against those fundamental institutions of our social order which the classical economists took for granted. Marx has been credited by some with the discovery of the materiaHstic or economic interpretation of history, and the whole tendency of the modern scientific sociaHsts has been to emphasize the evolutionary standpoint. The Sociologists. — Among other influences which broadened 1 It was used before this in England by the followers of Robert Owen. APPENDIX 749 Mill's conception of economic science, and induced him to temper the rigor of his early teachings, were the works of Auguste Comte (i 798-1857), the founder of modern sociology. Comte was espe- cially severe in his criticism of the methods of the classical econo- mists. He denied, in particular, that it is possible to develop a helpfid science of economics distinct from history, ethics, and poli- tics. Not only must these fields, he maintained, be cultivated in common, but the work must be done by inductive, as distinct from deductive, methods. To the classical assumption that a universal science of economics could be formulated, true for all times and places, he opposed the theory that there is in society an ordered change or evolution, and that the capitalistic stage, to which the classical economies conformed, must be studied in connection with the past and the future. Economics, he particularly insisted, cannot be divorced from history. The Historical School. — This particular line of thought was taken up in Germany about 1850 by three young Germans, Roscher, Knies, and Hildebrand, who vigorously assailed the doc- trines of the classical school. They went back to the old premises — self-interest, private property, demand and supply — and traced out the historical development of economic life, coming to the con- clusion that economic policies were not absolutely, but only rela- tively, true. They denied that economic science can discover laws which hold true for all times and all places. They emphasized the importance of the inductive method, of minute investigations into facts, and the study of legal institutions, custom, and ethics in their relation to economic life, while most members of the school entertained a strong sympathy for policies of reform. Owing to the political ferment in Germany during the infancy of the historical school and the formation of the German Empire when this reaction against the classical economists was at its height, German political economy of the last half of the nineteenth century was impregnated with a striking nationalistic spirit which sepa- rated it even further from the cosmopolitanism of the English writers. The creation of a new state is almost invariably attended by the enactment of restrictive legislation, looking to the amalgamation of the diverse elements incorporated into the new state and the protection of its industries from foreign competition. Laissez- faire, under these conditions, is particularly difficult to maintain. The new national economy of Germany seemed to voice these politi- cal necessities. Like the classical economy of England, it was a creature of its own time and its own environment. The Economic Optimists. — The classical English economists have often been called pessimists. This is too strong a term, in- asmuch as they all saw hope for improvement. What can be said is that they developed pessimistic tendencies. Take it as we will, the Malthusian doctrine of population is tinged with pessimism, and so also is the Ricardian theory of distribution. In oppo- sition to English economists, there was developed elsewhere, about 750 OUTLINES OF ECONOMICS the middle of the nineteenth century, a scheme of thoroughgoing economic optimism, and this was presented in a more unquahfied way by Frederic Bastiat (1801-1850), than by any one else. Bastiat was an ardent agitator for free trade and a popiilar pleader for the existing order against the attacks of socialists and anarchists, he was the author of numerous pamphlets, and at the time of his death was engaged on a. systematic treatise entitled Economic Harmonies, of which the first volume only was completed. According to Bastiat, there is no economic rent. The landowner does not receive an unearned income. What we call rent is simply a return for past investments of capital. The profits on capital also, accord- ing to him, are simply a return on past labor, and relatively to wages, a diminishing return. For it is a peculiarity of fabor stored up in those products which we call capital, that it continually diminishes in value as compared with present labor. In other words, wages are continually gaining relatively as compared with the profits of capital. Capital may gain absolutely on account of the increase in the amount of capital. Wages gain both absolutely and rela- tively. Value gives us the ratio of exchange between services. Economic gain is in proportion to economic service except that labor is progressively a gainer on account of the fact that man's present services (as seen in labor) increase in value as compared with man's past services as accumulated in capital. As Bastiat denied the existence of pure economic rent in the Ricardian sense, he also denied the Malthusian theory of popula- tion, holding that no proof could be adduced of a tendency of popu- lation to press upon the means of subsistence. The evils that we experience come, according to Bastiat, from man's interference with natural harmonies. Nature works things out well, and this is the best of possible worlds if we could only let nature have her way. Henry C. Carey, the American contemporary of Bastiat, held similar doctrines, and was apparently the more original man. If either one borrowed from the other, it must have been Bastiat. Probably neither one was guilty of any conscious plagiarism. The writings of the optimists had a considerable influence for a time in Germany, where they were developed and applied with uncompromising logic by men like Prince-Smith, Faucher, and a considerable number of others who were influential in the press and practical affairs rather than in academic life. In the United States these writings have had a great deal of influence upon a num- ber of early writers, among whom we may mention especially the late Arthur Latham Perry, long professor in Williams College, and Edward Atkinson, a weU-known statistician and writer of Boston. Early American Economists. — The reaction against the Eng lish economists, it is interesting to note, began earlier in the United States than in England or Germany. In the early part of the nine- teenth century, emphatic dissent from the English doctrines was voiced by a group of publicists, among whom may be mentioned APPENDIX 751 Alexander Hamilton, Daniel Raymond, Matthew Carey, Hezekiah Niles, and Frederick List. Hamilton's work and views are well known ; Niles and Matthew Carey were pamphleteers of consider- able note in the first third of the nineteenth century; and List, who, in the view of some authorities, planted the seeds of the Ger- man historical school, unquestionably obtained his distinctive na- tionalistic views about political economy in the United States, and first formulated them in his Outlines of American Political Economy, published in 1827.^ Daniel Raymond, however, of aU the American writers noted, is the least known, and yet the author of the first American treatise on political economy in which a distinctively American system of economic thought is suggested. Raymond's first book. Thoughts on Political Economy, appeared in 1820 ; a second edition, under the title Elements of Political Economy, appeared in 1823, and the latter was reprinted with slight changes in 1836 and 1840. The essence of Raymond's system is found in his conception of wealth. Wealth, he maintained, is not an aggregate of exchange values but the opportunity to acquire the material comforts of life by labor. The English political economy, in Raymond's view, was a study of private as opposed to political or national economy. Raymond emphasized the distinction between individual and social wealth, and maintained that the laws of wealth laid down by Adam Smith were untrue of a nation conceived as a unit. The interests of particular individuals, or particular classes, he argued, do not always coincide with the interests of the nation as a whole, and the latter, he concluded, wiU be best advanced by developing all the national powers to their widest possible extent. He was thus a warm advocate of protection as opposed to laissez-faire. Raymond's views had so impressed Matthew Carey that he of- fered to support a chair of political economy at the University of Maryland if the University would permit Raymond to fill it. Mat- thew Carey's son, Henry C. Carey (i 793-1879), by far the most influential of the early American economists, was in like manner probably influenced by the teachings of Raymond. Carey was not only an earnest champion of protection, but an indefatigable critic of classical economic doctrines. He denied the truth of the Malthusian principle and the law of diminishing returns ; ob- jected to the Ricardian theory of rent ; and maintained that the value of a commodity depends upon the cost of reproduction rather than the cost of production, as was, he thought, laid down in the classi- cal theory of value. Carey entertained a concept of wealth very similar to that of Raymond, and in some parts of his work adopted methods of investigation which brought him in close touch with the sociologists and the German historical economists. The key- stone of his economic system is the doctrine of association. The ^ List returned to Germany and was there a forceful writer and agitator for German unity, and is identified rather with the history of economic thought of Germany than with that of the United States. 752 OUTLINES OF ECONOMICS increasing mastery of man over nature, or the increase of wealth, Carey held to be dependent upon the increasing efi&ciency resulting from a compact, homogeneous population, in which agriculture and manufacture are conducted side by side, in which the home- market idea is carried out in the most complete way, and in which, to be brief, the association of industrial and social units is most intense and intimate. It can be readily understood why the eco- nomic philosophy of Carey was so inimical to free trade at every point. The Austrian School. — The protests against the classical econo- mists which we have been considering were directed largely against the narrow scope and deductive methods of the classical school. The Austrian economists represent a reaction not against their methods, but against the conclusions, and particularly against the theory of value of the classical school. The great contribution of the Austrian school is the marginal utility theory of value, which has been most assiduously applied in economic analysis by a group of Austrian economists, among whom may be specially mentioned Menger, Wieser, Sax, and Bohm-Bawerk. But the marginal utility theory of value was advanced almost sim\iltaneously, about 1871, by the English economist Jevons, the Austrian economist Menger, and the French economist Walras.^ The Austrians have been a leading force in producing what is not inaptly termed a renaissance in theory, although, as stated, they indorsed the deductive and abstract methods of the classical economists. The classical theory put the emphasis upon supply or the conditions of supply, maintained that cost of production determines value, and found the ultimate measure and explanation of value in the pain and sacrifice of labor. The Austrians main- tain that utility, the pleasure or satisfaction derived from con- sumption, is the ultimate cause and measure of value ; they empha- size demand as the English economists emphasized supply ; and hold that value determines cost of production and not the cost of production, value. Capital, they conclude, receives its value from the finished product instead of giving value to that product. The work of this school has tended to put the consumer in the place primarily occupied by the capitalist as the center of discussion in economic theory. The work of the Austrians has had a profound influence upon economic writing in the United States. Present Condition of Economic Thought. — The net effect of all these protests against the classical English economists has been to introduce a welcome catholicity into the methods of economic investigation. The historical school emphasized the evolutionary standpoint and the necessity of minute investigation of the facts of industrial hfe, while the work of the Austrians operated to strengthen and explain the necessary place of deduction in economic analysis. 1 In reality the marginal utility theory had been explained many years before this by a number of obscure writers whose ideas, however, never affected the main current of economic thought. APPENDIX 753 Today the ordinary economist employs either method, or both, as the subject-matter demands, and the controversy about methods has become a thing of the past. With respect to the theory of value, neither supply nor demand, neither cost nor utility, neither the capi- talist nor the consumer, is now said to exert a predominating influ- ence in the determination of values. The Austrian school, it is now understood, supplied a needed corrective without revolutionizing the earlier theory of value. The Austrians themselves are seen to have been guilty of laying exaggerated emphasis upon the consumer's influence upon value and price, and there is reason, to believe that their analysis is based in some degree upon a faulty psychology. So, similarly, with respect to the scope of economics. The at- tempt of the classical economists to isolate an " economic man " ruled entirely by an enlightened self-interest and unaffected by political, ethical, and humanitarian impulses, is recognized to have been a mistake. But economics has never given itself to a com- plete study of politics or ethics. It considers ethical and political phenomena when these cannot be dissociated from economic phe- nomena, but insists, nevertheless, upon the separation of economics from ethics, politics, and sociology. We recognize that these fields are not wholly or clearly differentiated, but we recognize just as clearly that a division of labor is necessary if accurate results are to be achieved. Furthermore, this division of labor is showing itself progressively within the limits of economics itself, as it has shown itself in all growing sciences. Indeed, the present condition of eco- nomic thought was so accurately predicted by W. S. Jevons, in 1876, that his words — written in the midst of the controversy among the adherents of the deductive, historical, mathematical, and sociological methods of investigation — may weU be employed to picture the condition of the science of economics as it exists today : " As I have previously explained, the present chaotic state of economics arises from the confusing together of several branches of knowledge. Subdivision is the remedy. We must distinguish the empirical element from the abstract theory, from the applied theory, and from the more detailed art of finance and administration. Thus will arise various sciences, such as commercial statistics, the mathematical theory of economics, systematic and descriptive economics, economic sociology, and fiscal science. There may even be a kind of cross subdivision of the sciences ; that is to say, there will be division into branches as regards the subject, and division according to the manner of treating the branch of the subject. The manner may be theoretical, empirical, historical, or practical ; the subject may be capital and labor, currency, banking, taxation, land tenure, etc., — not to speak of the more fundamental division of the science as it treats of consumption, production, exchange, and dis- tribution of wealth. In fact, the whole subject is so extensive, intricate, and diverse, that it is absurd to suppose it can be treated in any single book, or in any single manner." ^ 1 Jevons, Theory of Political Economy, 3d ed., pp. xv, xvi. 3C APPENDIX B SUGGESTIONS FOR STUDENTS AND TEACHERS Some teachers of economics rely chiefly upon classroom discussions of assignments in a textbook, supplemented, possibly, by certain other reading requirements. Others make large use of lectures and of prob- lems and brief reports assigned in connection with particular subjects discussed in the class. Some require the student to write one or more longer essays or themes on specific topics. In this boolc specific refer- ences, questions, and problems have been appended to each chapter. The aim has been to list only books and papers that have value in them- selves and that have a direct bearing upon the subject matter of the respective chapters. References to parallel discussions in other elemen- tary textbooks have for the most part been avoided, the aim being to enable the student to extend his inquiries by reading more advanced and comprehensive treatments of particular problems. There is no one " best way " of teaching economics, for the methods used must depend very largely upon the size of the classes and the maturity of the students. It has been the experience of the writers, however, that whatever the relative degree of emphasis put upon lectures, classroom discussions, and assigned problem work of different sorts, mastery by the student of one book on general economics, or at least of so much of it as treats of fundamental economic principles, is an essential part of every introductory course in the subject. When pressed for time, the teacher using this book may find it desirable to omit all of it save Book II, " Principles and Problems." When more time is available, it may be deemed wise to include discussions of certain subjects not treated in this volume. " The economic problems of munic- ipalities," "the elements of statistical method," " the problems of poor relief," " the general principles of market organization," are a few among many possible supplementary topics. Valuable suggestions on the teaching of elementary economics will be found in various papers and discussions printed in the Journal of Political Economy, Vols, xvii-xxii (1909-19 14). Some help may also be gained from papers by C. J. Bullock {Education, Vol. xi) ; F. R. Clow {Economic Studies, Vol. iv) ; R. F. Hoxie {Journal of Political Economy, Vol. ix) ; H. R. Mussey {Educational Review, Vol. xi) ; and H. W. Thurston {School Review, Vol. iv). 754 APPENDIX 755 The problem of making an adequate amount of supplementary reading available to students in large classes has been made easier to solve by the publication of volumes of excerpts, designed for this particular use. (W. tl. Hamilton, Current Economic Problems; L. C. Marshall, C. W. Wright, and J. A. Field, Materials for the Study of Elementary Economics ; C. J. Bullock, Selected Readings in Economics ; F. A. Fetter, Source Book in Economics.) Similar volumes have been made up of material on special economic problems. References to many of these will be found among the reading lists appended to the different chapters in this book. General Works on Economics. — Other American textbooks on economics, of college grade, are : C. J. Bullock, Introduction to the Study of Economics ; H. J. Davenport, Outlines of Economic Theory; F. A. Fet- ter, Principles of Economics; Irving Fisher, Elementary Principles of Economics; H. R. Seager, Introduction to Economics ; and E. R. A. Seligman, Principles of Economics. Larger in scope or more detailed in their treatment of the general principles of economics are H. J. Daven- port, Economics of Enterprise; F. A. Fetter, Economics (2 vols.)-; A. T. Hadley, Economics ; F. W. Taussig, Principles of Economics (2 vols.). F. A. Walker's Political Economy {" advanced course "), although pre- senting a somewhat antiquated view of economic principles, will be found still to possess much interest for the reader. Among English books, Alfred Marshall's Principles of Economics occupies a peculiarly authoritative position. It is characterized by an unusually intimate grasp of the facts of modern economic life and by a rare degree of ability in critical analysis. It attempts to reconcile many of the modern developments in economic analysis with the fundamental tenets of the political economy of David Ricardo and John Stuart Mill. Critics differ with respect to the degree of success with which Marshall has accompHshed this reconciliation. Marshall's Principles is difficult for any but the mature student, and his own attempt at an abridgement, his Economics of Industry, is distinctly inferior to the larger work. Two excellent books that are based in large measure on Marshall's Principles are S. J. Chapman, Outlines of Political Economy, and A. W. Flux, Economic Principles. The comprehensive English work of J. S. Nichol- son {Principles of Political Economy, 3 vols.) is even more conservative in matters of economic theory than is Marshall's. Edwin Cannan's Wealth is a small manual with an original and suggestive point of view. Distinctly the most readable and in many respects one of the best recent English works is P. H. Wicksteed's The Common Sense of Political Economy. Special mention can be made of only a few of the more important German and Austrian works on general economics. Adolf Wagner's Grundlegung der politischen Oekonomie (2 vols.) is characterized by great 756 OUTLINES OF ECONOMICS erudition and by systematic and painstaking classifications and defini- tions. It is of particular interest to American students on account of its distinctive point of view, and especially its emphasis upon the general ethical and political aspects of economic problems. The Allgemeine Volkswirtschaftslehre of Gustav Schmoller (2 vols.) is characterized by the consistent use of the historical method, and by the extent to which psychology and ethnology as well as history are drawn upon to explain modern economic institutions. Wilhelm Lexis's Allgemeine Volks- wirtschaftslehre is a smaller work, embodying a better exposition of fundamental economic principles than is found in most German works, and distinguished by a large measure of originality. The Allgemeine Volkswirtschaftslehre of Eugen von Phillipovich (2 vols.) contains a more systematic presentation of general economics than does any other work in the German language. It is distinctly catholic, or perhaps, eclectic, in its general theories. The Traite theorique et pratique d'economie politique (4 vols.) of Paul Leroy-Beaulieu may be taken as the best example of a rather dogmatic type of laissez-faire economics that still commands a large and influential following in France. Representative of a newer school of thought,, more hospitable to various projects for constructive economic betterment, is the work of Charles Gide, whose two books on general economics are available in English translation (Political Economy and Principles of Political Economy). The best modern French work is, perhaps, Adolphe Landry's Manuel d'economique. In other European countries, especially in Italy, Holland, and the Scandinavian countries, there has been much economic writing of a high order. Attention may be called to the English translation of the excel- lent Dutch work of N. G. Pierson, Principles of Econo7nics (2 vols.), and to the French translation {Manuel d'economie politique) of a book (in Italian) by Vilfredo Pareto, which is possibly the most noteworthy of various modern works in which mathematical methods are used in economic analysis. Encyclopedias. — The most comprehensive encyclopedia of economics is the great H andworterbuch der Staatswissenschaften (3d ed., 7 vols.), edited by Conrad and others. A smaller, but useful, German reference work is the Worterhuch der Volkswirtschaft (3d. ed., 2 vols.), edited by Elster. In French, the Nonveau dictionnaire d'' economic politique (2 vols., with supplements), edited by Say and Chailley, is already somewhat antiquated and represents a rather narrow point of view. For special fields there are the Dictionnaire des finances (2 vols.), edited by Say and Foyot, and the Dictionnaire du commerce, de Vindustrie, et de la banque (2 vols.), edited by Guyot and Raffalovich. The English Dictionary of Political Economy (3 vols.), edited by Palgrave, is a standard reference work. There is no American dictionary or encyclopedia covering the APPENDIX 757 whole field of economics. The Encyclopedia of Social Reform, edited by- Bliss, is useful in its special field. Although published in the early eighties, some of the articles in Lalor's Cyclopedia of Political Science, Political Economy, and United States History (3 vols.) remain of value. The newer Cyclopedia of A merican Government, edited by McLaughlin and Hart, may be consulted on topics in public finance and related fields. Periodicals. — Many of the most important contributions to eco- nomics appear in special periodicals devoted to the subject. In the United States there are the Quarterly Journal of Economics, the Journal of Political Economy (monthly), the Political Science Quarterly, and the American Economic Review (the organ of the American Economic Asso- ciation, quarterly). The Annals of the American Academy of Political and Social Science (monthly), the American Political Science Review (quarterly), and the American Journal of Sociology (bi-monthly), frequently publish papers that are of importance for the student of economics. Limited to more specialized fields are the Quarterly Publica- tions of the American Statistical Association, the American Labor Legis- lation Review, the Bulletin of the National Tax Association (monthly), and the Survey (weekly, covering the field of charities and other organized movements for social betterment). In England the principal economic periodicals are the Economic Journal (the quarterly organ of the Royal Economic Society), the Journal of the Royal Statistical Society (monthly), and the Economic Review (quarterly, largely devoted to the ethical aspects of economic problems). The economic journals of the various countries of conti- nental Europe, although of great value to the specialist, are too numerous to mention here. The " trade journals " of different special industries and in the fields of banking and insurance are often useful to the special students in these fields. In particular the periodicals dealing with the general conditions of business and the money market are often indispensable. The Com- mercial and Financial Chronicle of New York (weekly) may be specially mentioned on account of the completeness and accuracy of its statistics of money market conditions. For London the Economist and the Statist occupy a similar position. The Annual Financial Review contains con- venient compilations of the more important statistics that have appeared in the Commercial and Financial Chronicle during the preceding year. A useful annual survey of international financial conditions is given by Raffalovich's Le marche financier (Paris). Such annuals as the States- man's Year Book (London), Whitaker's Almanac (London), and the World Almanac (New York), are often useful for reference purposes. The American Year Book contains, among other things, an excellent annual review of important economic legislation. Reference to the enormous output of articles on economic subjects in 758 OUTLINES OF ECONOMICS periodicals of a more general or popular type is now easy by using the " cumulative indexes " and " readers' guides " that will be found in most colleges and public libraries. These articles are, of course, of very uneven quality and must be used discriminatingly. Most of the more important current articles on economic topics are listed, with many brief abstracts or appraisals, in the successive numbers of the American Economic Review. Books in Special Fields. — The references given in connection with the different chapters in this volume are sufficient to enable one to make a fairly thorough study of the different subjects treated in these chapters. Many of the books referred to contain more elaborate bibliographies on their special subjects. The student should, of course, be familiar with the use of the card catalogue of a modern library. In using such a cata- logue it should be remembered that the library classification of books by subjects is very rarely entirely satisfactory, so that one should exercise one's ingenuity in searching und«r different subjects. The Library of Congress has printed in pamphlet form lists of books and articles on various practical economic problems, and is often able to furnish, at a small price, shorter typewritten lists of references on other subjects. Short annotated bibliographies are issued by different state legislative libraries and municipal reference libraries. The bibliographies in the various economic encyclopedias, especially the HandwUrtcrbuch der Staatswissenschaften, will often be found helpful. ' A very complete list of new books in various fields of econonaics is published quarterly in the American Economic Review. Government Publications. — The student should early acquire some familiarity with the use of government documents as first-hand sources of information. Aside from statutes and the proceedings of legislative bodies these publications include : (i) annual reports of different admin- istrative departments and bureaus ; (2) reports of special investigations made by the permanent bureaus or by special commissions ; (3) records of the hearings before legislative committees of inquiry. A record of the enormous output of the publications of the federal government is con- tained in the Monthly Catalogue of Public Documents, published by the Superintendent of Documents, Washington. This has an annual index, and a comprehensive Document Catalogue is also published for each Congressional period. The Check List of Government Documents is convenient to use in locating regular or routine documents published before 19 10. The Annotated Tables of and Consolidated Index to the Congressional Series of United States Public Documents may also be used for the same purpose. Poore's Descriptive Catalogue of the Government Publications of the United States, 1774-1881, is useful in locating irregular or obscure publications of various sorts. In nearly every congressional district there is a public or college librarj' which is an ofiicial depository APPENDIX 759 for federal documents and 'has a nearly complete set of those published in recent years. Current documents may sometimes be obtained with- out charge from the departments or bureaus issuing them or from the Representative or Senator from one's district or state. They can always be purchased at small prices from the Superintendent of Docu- ments. The Superintendent of Documents issues small printed price lists of the publications in different special fields. The Library of Congress publishes a Monthly List of State Documents. Bowker's State Publications (three parts) give a fairly complete list up to about 1900, and a full index to the economic materials in state documents is being published by the Carnegie Institution. The volumes for a number of the larger states have already appeared. Municipal docu- ments are often published in an unsystematic way, and there is no general index or list of either current or past municipal publications. The student should find it both practicable and instructive, however, to become acquainted with the published documents of the city in which he lives, or those of some large city in his state. The British Parliamentary Papers contain a wealth of material on a wide range of economic topics. Much of this is listed in P. S. King & Son's Catalogue of Parliamentary Papers, 1801-igoo (with Supplement, igoi-igio). Lists of current publications are published by several Lon- don dealers. The more important ones are noted in the English eco- nomic Journals, and (more fully) in an occasional " Blue Book Sup- plement " to the New Statesman, a London weekly. Among the gov- ernment publications of other countries we can mention here only the valuable statistical year-books published by many nations and by a number of important cities. The student will find the statistical annuals of Australia and New Zealand especially interesting and instructive. INDEX Activity, desire for, as an economic motive, 104. Adams, H. C, on fiscal aspects of the tariff, 717. Agriculture, changes in, in England, 41, 50; history of, in United States, 84; problems of, 5g6. Agricultural credit, 609. Agricultural stage, 37. Aldrich, N. W., plan for banking reform, 306. Aldrich-Vreeland Act, 305. Altruism, as an economic force, 103. American Federation of Labor, 94, 444. American people, economic characteris- tics of, 63. Amortization of taxes, 706. Anarchism, 638. Andrew, A. P., on control of banking re- serves by Secretary of the Treasury, 354- Annual product, defined, 517. Anti-trust laws, 235. Arbitration, in labor disputes, 95, 457. Aristotle's Politics, 741. Artificers, statute of, 43. Assumption of risk, legal doctrine of, 487. Austrian school, 752. Averages, 340. Balanced revenue system, 735. Balance of trade, 345 ; meaning of a "favorable balance," 356; in the com- merce of the United States, 357. Bank acceptances, 346 n. Bank credit, 286. Bank notes, 290, 291, 306, 309. Bank of England, control of gold reserves, 302. Banking, functions of, 283. See Na- tional banking system. Federal reserve system. Bargaining, surplus in, 181. Basing-point, system, 570. Bastiat, Fr6d6ric, 750. Benefit principle, in taxation, 698. Bentham, Jeremy, 746. Bills of credit, colonial and revolution- ary, 272. Bimetallism, 260; in the United States, 264; international, 263. Birth rate, in United States, 65. Blackstone, definition of monopoly, 190 n. Bland-Allison Act, 266. Blodgett, J. H., on wages of farm labor, 607. Bonds, corporation, 220; government, as security for bank notes, 300. See Public debts. Boycotts, legahty of, 475. Brassage, 258. Brown, E. F., on factory inspection in the United States, 485. Budgets, French, old and modern con- trasted, 657 ; American, 662. Bullock, C. J., on foreign trade balances of the United States, 357. Business organization, forms of, 214.' Business taxes, 733. Business unit, in accounting, 213; in law, 214. See Large-scale production. Call loans, 289, 295. Canadian Industrial Disputes Act, 459. Canon law, economic ideas in, 743. Carey, H. C, 750, 751. Carver, T. N., on the effects of the ma- chine system upon the workers, 127. Capital, as a factor in production, 121; distinguished from capital value, no; distinguished from consumption goods, 512; distinguished from land, 507 ; social and individual, in; free and speciaHzed, 506 ; investment in, 499, 5x3; replacement of, 501; effects of varying degrees of durability of, 502; price of, how determined, 505 ; pro- ductivity of, relation to interest, 495 ; relation to advances of wages, 512 ; in business usage, 219. 761 7t)2 INDEX Capitalization, corporation, 2ig, 221, 225 ; of rent, 418. Central banks, 304, 307. Central reserve system, 2g2. Charters, corporation, 217. Child labor laws, 56, 476. Christianity, influence on economic thought, 742. Christian sociaUsm, 630. Cities, growth of, in United States, 66. Class price, 204. Classical school, 746. Clayton Anti-trust Act, 241 ; in relation to labor organizations, 473. Clearing houses, 283. Clearing-house loan certificates, 284 n., 305- Closed-shop policy, 448. Coinage, 24.Q; of standard money, 255; limited, 259. Coke, definition of monopoly, 190 n. Collective bargaining, 442, 446. Colonial policy, British, 80. Combination Act, British, 58. Combinations, industrial, 230 ; causes of, 232 ; public policy toward, 243 ; in other countries, 245; railway, 561. Commerce Court, 574. Commons, J. R. on relation of monopo- lies to the distribution of wealth, 550. Comparative costs, law of, 362 ; relation to doctrine of free trade, 375. Competition, described, 28; failure of, under certain conditions, 198; relation to maximum satisfaction of wants, 538. Competitive investment, 513- Commission merchants, 620. Communism, 631. Compulsory arbitration, 459. Comte, Auguste, 749. Concentration in industry, 88. See Large-scale production. Concentration of wealth, distinguished from large-scale production, 542 ; methods of measuring, 543 ; possibility of lessening, 55 r; suggested remedies, SS4- Conspiracy, legal status of, 472. Constant expenses, relation to normal price, 171. Constitutional limitations, to govern-" ment regulation of industry, 96 ; to railway regulation, 184, 573 ; to taxa- tion, 710. Consumers' surplus, 161. Consumption, defined, 132 ; statistics of, 144 ; harmful, 144. Consumption goods, no. Contract, as an economic institution, 25 ; in relation to distribution of wealth, 386. Contributory negligence legal doctrine of, 487. Cooperation, as an economic institution, 30 ; different forms of, 464 ; in market- ing, 465, 619; cooperative credit, 46s, 613. Copyrights, 23 ; as a source of monopoly,' 195- Corporations, as business units, 216; charters of, 217; advantages of, 228; growth of, 87; management of, 226; social aspects of, 228; lack of uni- formity in state laws, 218 ; federal con- trol needed, 245; taxation of, 731. See Capitalization, Overcapitalization, Trusts. Corpus juris civilis, 742. Cost of living, statistics of, 341', 548. Cost of production, 148. See Expenses of production. Cotton industry, growth of in early nineteenth century, 82. Credit, functions of, 2S2 ; personal credit, 285; bank credit, 286; credit trans- actions, 282. Crises, analyzed, 2>2ii ; crisis of 1873, 276 ; 1892, 267; 1907, 305. Custom, as an economic institution, 31. Customs duties, fiscal aspects of, 713. See Protection. Decreasing expenses, relation to normal price, 171. Deferred payments, standard of, 337. Demand, nature of, 156; demand curve, 158. Deposits, bank, 283 ; how safeguarded, 287. Dewing, A. S., on inefficiency of indus- trial combinations, 235. Diminishing productivity, law of, 388; of labor, 390 ; of capital and land, 392 ; actual operation of, 395 ; social aspects of, 404. See Marginal productivity. -Diminishing returns, law of, 419. Diminishing utility, law of, 133. Direct appropriation, stage of, 34. Direct taxes, 702, 710; use of, by federal government, 712. INDEX 763 Discount, bank, 287 ».; rates, relation of to price of foreign exchange and to international gold movements, 302, 311, 346, 349, SSI- Distribution of wealth, as a general eco- nomic problem, 384; among persons, _542- Distributive cooperation, 464. Distributive justice, 627. Division of labor, ig; effects upon the worker, 127; relation to condition of decreasing expenses, 172. Documentary bills, 346. Domestic system, 40. Economics, defined, 4; distinguished from economy, 13 ; concepts of, 103 ; relation to other sciences, 1 1 ; laws of, 7- Economic classes, 21. Economic goods, defined, 106. Economic society, evolution of, S3- Economic stages, 33 ; table of, 45 ; in American history, 61. Economic thought, history of, 74 1 ; present condition of, 752. Effort, necessary to production, 106. Elasticity of demand, isg. Employers' associations, 95, 454. Employers' liability, law of, 56, 486, 588. Endowments, 584. Engel, Ernst, laws of expenditure, 145. Entrepreneur, functions of, 123; as risk taker, S37- Entrepreneur's wage, 168, 526. Equation of exchange, 321. Esteem, desire for, as an economic motive, 104. Ethics and politics, relation to economics, IS- Exchange, 19. See Division of labor. Exchange value. See Value. Expenses of production, 148 ; relation to price, 167, 186. Express trusts, 228 w. Fabian socialism, 629. Factors of production, 119; ultimate, 522. Factory acts, in United States, 484. Factory system, in England, 51; in United States, 82. Faculty principle, in taxation, 698. Fair competition, 29. Farming, intensive and extensive, 600. Farms, size of, in United States, • 596 ; ownership and tenancy, 603 ; indebted- ness, 609. Favoritism, as a source of monopoly power, 191, 197. Federal Farm Loan Board, 613. Federal land banks, 614. Federal Reserve Board, 307. Federal reserve system, organization, 307; reserves, 308; rediscounting, 308; note issue, 310; other functions, 310; resources and liabihties of, in 1916, 313- Federal taxation, 710. Federal Trade ComiTiission, 142. Fees, as source of pubHc revenue, 690. Fellow-servant doctrine, 487. Fiat money, 278. Final consumption, 132. Finance bills, 350. Fiscal monopolies, 197, 682. Fisher, Irving, proposal for a "stabilized dollar," 342 ; Statistical verification of the equation of Exchange, 324 n. Fisk, G. M., on early restrictions on in- ternational trade, 358. Fixed and variable expenses, 174; rela- tion to normal price, 177 ; in railway operation, 569. Foreign exchange, 345. Forest lands, 674. Form utility, 116. Fourteenth Amendment, 184, S73- Freedom, economic, 26; relation to dis- tribution, 386 ; of contract, 472. Free goods, 105, 401. Free silver. See Bimetallism. Free trade, advantages of, 374. Future products, alleged present con- sumption of, 142. Future wants, 140. General changes in prices, relation to quantity of money, 319; mechanism of, 325 ; effects of industrial uses of gold upon, 327 ; effects of expenses of gold production upon, 328; economic effects of, 331 ; relation to international gold movements, 351; index numbers of, 337- General property tax, 726; defects of, 727 ; reform of, 729. General welfare monopolies, 195. George, Henry. See Single tax. Gilds, 39. 764 INDEX Godin Jamilistere, 466. Godwin, William, 748. Gold, as monetary standard, 255, 269; relation of industrial uses of, to prices, 327 ; relation of expenses of production to prices, 328; increase in production of, 329; international movement of, 3SO. Gold-exchange standard, 269. Gold points, 348. Goldenweiser, E. A., on farmers' incomes, 607. Goods, defined, 105. Good-will, in relation to profits, 535. Government enterprise, extension of in England in nineteenth century, 58. Government ownership, of railways, 571 ; of other industries, 682. Government paper money, 271. Greeks, economic ideas of, 741. Greenbacks, 273 ; economic effects of, ays- Greenback party, 278. Gresham's lav/, 261. Group rates, 570. Hadley, A. T., on improvident poor re- lief, SS2. Hamilton, Alexander, Report on the establishment of a mint, 264 n. Handicraft stage, 39. Hedging, 532 n., 624. Hildebrand, Bruno, classification of economic stages, 44. — „ Historical school, 749. Holding company, 231. ^\ Hours of labor, statistics of, 548. Hume, David, on Elizabethan monop- olies, 206. Hunter, Robert, on distinction between poverty and pauperism, 553. Immigration, to United States, 68 ; changing character of, 70; restriction of, 72. Imputed interest, 495. Inclosures, 41, 50. Incomes, estimates of distribution of in United States, 544; in Prussia, 546. Income taxes, 720. Increasing expenses, relation to normal price, 170. Indentured servants, in United States, 66. Independent treasury system, 297, 353. Index numbers, 337. India, monetary system of, 270 n. Indirect taxes, 702, 713. Individual entrepreneur, as business unit, 214. Individual wealth, contrasted with social wealth, 109. Industrial combinations, 230; causes of, 233; legal status, 235; public policy toward, 243; in other countries, 245. Industrial democracy, 463. Industrial insurance, 585. Industrial Revolution, 47 ; evils of transi- tional period, 52 ; in America, 81. Inelastic currency, 300. Inelastic reserves, 301. Inheritance, 24; effect on distribution, 386; taxation of, 723. Instincts and habits, in economic activity, 105. Insurance, nature of, 577 ; development of, 578; forms of organization, 580. See Life insurance, Social insurance. Integration of industry, 88. Interest, formerly condemned, 493, 743 ; inadequate explanations of, 494 ; how possible, 495 ; why necessary, 496 ; normal interest, 511 ; rate, determined by supply and demand of investment funds, 521; on farm mortgage loans, 610. See Discount. Internal improvements, state activity in, 93, 217. Internal revenues, 717. International gold movements, 302, 311, / 348, 350. See Balance of trade. International trade, restrictions of, in former times, 358 ; modern restrictions, 360; advantages of, 361. Interstate Commerce Act, 573. Interstate Commerce Commission, 574. Inventions, eighteenth century, 49. Investment, in capital goods, 499, 513; shifting of, 502 ; affected by durability of capital goods, 502 ; competitive, 513 ; cumulative nature of, 518. Investment funds, sources of, 523. Jaures, Jean, on policies of socialism, 630. Jenks, J. W., investigation of monopoly prices, 206. Jevons, W. S., on necessary subdivision of economic science, 753- Joint expenses, relation to normal price, 179. Joint-stock companies, 216 w. INDEX 765 Kartells, 246. Kelley, Florence, on child labor laws, 478 ; on minimum wage laws, 480. Kemmerer, E. W., statistical verification of the equation of exchange, 324 n. King, W. I., estimates of distribution of incomes in the United States, 54s, 64s n. Knights of Labor, 04, 444. Kropotkin, P., on anarchism, 630. Labor, as a factor in production, 120. See Wages. Labor legislation, 471 ; general principles of, 48S ; in England, 56. Labor organizations, development of, in United States, 93 ; in England, 57 ; / types of, 444; economic justification, 445 ; as monopolies, 446 ; methods and policies, 447 ; educational and fraternal activities, 451; relation to industrial democracy, 468; legal status of, 58, 237, 472. Labor-saving machinery, effect on wages, 430. Laissez-faire, 54, 745-748. Land, as a factor in production, 119; services of, 408 ; distinguished from capital, 507. See Rent, Public do- main. Land nationalization. See Single tax. Large-scale production, economies of, relation to normal price, 173; not a source of monopoly power, 200. Lexis, Wilhebn, on coinage regulations, 257- License taxes, 733. Life insurance, 581 ; premium plans, 582 ; reserve and surplus, 583 ; industrial, 585 ; State, 585 ; State regulation of, 586; for workingmen, S93- Life tables, 589. Limitation of output, by labor organiza- tions, 449; by monopolies, 201. List, Friedrich, 751. Localization of industry, 128. Luxury, 143. Malthus, T. R., 746 ; law of population, 434, 746. Manor, English, 37. Manufactures, growth of, in the United States, 86. Margin of consumption, 141. Margin of cultivation. See Rent. Marginal productivity, 390; of labor 390 ; of capital and land, 392 ; general principles of, 396 ; relation to prices of production goods, 398 ; lack of ethical significance, 403 ; relation to profits, S3 2. See Diminishing productivity. Marginal utility, defined, 135; illus- trated, 136. Markets, defined, 154; expansion of , 52. Marketing of farm products, 618. Marx, Karl, labor theory of value, 186; other doctrines, 629. Marxian socialism, 629. Medium of exchange and measure of value, 252. Mercantile system, 42, 359, 744; in America, 79. Mill, J. S., on equilibrium of supply and demand, 165. Minimum wage laws, 459, 480. Mint ratio, 260. Mitchell, W. C, statistics of prices and wages in the greenback period, 277. Monetary standard, 255. See Bimetal- lism. Money, defined, 250, 251; metallic, 249; varieties used in the United States, 254; government paper money, 271; value of, 317. Money income, 387 ; flow of, 515. Money market, defined, 289; controlling conditions, 289; New York, 293; London, 347. Monopolies, Statute of, 191 ; Case of, 191 ; classification of, 193 ; labor organizations as, 446. Monopoly, 30 ; defined, 190 ; contrasted with competition, 189; distinguished from differential advantage and from large-scale business, 193 ; relation to distribution of wealth, 207, 550; pubHc pohcy with respect to, 208. Monopoly price, 200 ; relation of demand to, 203 ; effect of taxation, 202 ; usually high, 205. Mortgage land banks, 612. ^ Motives in economic activity, 103, 538. Mun, Thomas, 744. Munn vs. Illinois, 573. National banking system, 291 ; reserves, 292, 308 ; notes, 292, 300, 309 ; defects of, 29s ; steps toward reform of, 304. See Federal reserve system. 766 INDEX National income, defined, 114. National Monetary Commission, 306, 316. National wealth, statistics of, 112. Natural laws, 8. Natural monopolies, 197. Natural resources, of United States, 74. Navigation Acts, So. Negro problem, in United States, 66. New York money market, 293 ; relation to speculation, 295. New Zealand, compulsory arbitration in, 459- Non-reproducible goods, price of, 182. Normal interest, 511. Normal price, 169. Occupational distribution of the Ameri- can people, 86. Old age pensions, 592. Open-market operations of federal reserve banks, 311. Opportunity cost, 148. Optimists, economic, 749. Overcapitalization, 221. Owen, Robert, 628. Paper money, 271. Par of exchange, 348. Partnerships, 215. Pastoral stage, 36. Patents, 23; as a source of monopoly, 195- Personal distribution of wealth, 542. Personal property tax, 726. . Personal qualities as goods, 107. Philippines, monetary system of, 270 n. Physiocrats, 745. Place utility, 116. Plato's Republic, 741. Pollock case, 711. Poll taxes, 734. Pools, 231, 56r. Population, growth of in nineteenth century, 435 ; growth of, in United States, 64. See Malthus. Poverty, causes of, 549. Power, desire for, as an economic motive, 104. Present economic system, characteristics of, 17. Price, defined, 152; fixed by equilibrium • of supply and demand, 164; normal price, 169; monopoly price, 200; of production goods, 398, 418, 505; of pubhc services, 685. See General Changes in prices. Primitive man, economy of, 35. Private banks, 314. Private property, as an economic insti- tution, 21 ; relation to distribution, 386. Probabilities, law of, 578. Producers' cooperation, 466. Producers' surplus, 165. Production, defined 117; relation to sacrifice, 146. Production goods, no, 40 r ; prices of, 185, 398, 418, 505. Production of gold, increase in, 329. Productive consumption, 132. Productive organization of the American people, 129. Productivity, meaning of, 400, 497. Profits, 525; pure profits distinguished from entrepreneur's wage, 526; non- existent under certain conditions, 527; two sources of, 528; relation to prin- ciple of diminishing productivity, 532; for the industry and for the establish- ment, 533; relation to good-will, 535; relation to risk, 540 ; often associated with other forms of income, 538; relation to defense of the competitive system, 538; of monopoly, 201. Profit sharing, 461. Protection, nationalistic argument for, 368; infant industry argument, 369, 376; military argument, 370; home market argument, 371, 376; as a de- fense against dumping, 371 ; wages ar- gument, 373, 377 ; "equalizing costs of production," 373 ; fiscal aspects of, 378, 713; Ethical aspects of, 379; relation to monopoly, 194, 380. Public authority, relation of, to prices, 183. Public consumption monopolies, 197, 682. Public debts, increase of, 666 ; relation to public works, 668 ; relation to taxes, 668 ; wise use of, 610. Public domain, as a source of revenue, 671. See PubHc lands. Public expenditures, growth of, 644 ; contrasted with private expenditures, 646 ; relation to total social income, 648; extravagance, economy, and parsimony in, distinguished, 652; changing objects of, 654; regularity of, 659 ; classification of, 660 ; statis- tics of, in United States, 662. INDEX 767 Public finance, 643. Public lands of the United States, eco- nomic importance of, 75 ; development of government's policy, 76, 673 ; forest lands, 674; mineral lands, 675. Public monopolies, 194. Public receipts from loans, 661 ; from public domain, 671; from public industries, 682 ; from fees, 690 ; from special assessments, 692 ; from taxes, 694; statistics of, for the United States, 695. Quality of goods, government regulation of in England, 55. Quantity theory of prices, 324. Quasi-rent, 509. Quesnay, 745. Race suicide, 65. Railway rates, movement of, 563 ; general level of, 565; relative, 567; distance, as a factor in, 570. Railways, history of, in United States, 91; economic importance of, 558; competition of, 91, 560; pooling and consolidation, 560 ; valuation of, 566 ; expenses of, apportionment, 568 ; government ownership, 571; govern- ment regulation, 573 ; affected by Sherman Anti-trust Act, 237. Raymond, Daniel, 751. Rediscounting, 308. Religion as an economic factor^ 104. Rent, 407 ; under uniformly intensive use of land, 410; under actual condi- tions, 413 ; relation of different uses of land to, 416; the specific product of land, 394, 416; capitalization of, 418; relation to social progress, 419. Replacement fund, 501. Reserve, insurance, 583. Reserves, bank, 288, 292, 301, 308. Retail prices, 182. Ricardo, David, 746. Risk, 107; relation to profits, 536; re- lation to insurance, 577. Romans, economic ideas of, 742. Roosevelt, Theodore, on mineral land policy, 676. Rowntree, B. S., on causes of "primary" poverty, 551. Rubinow, I. M., on recent changes in real wages, S47- Rural credit, 609. Saving, and the formation of capital, 122, 4Q7, 502, 522. Savings banks, 314. Scarcity, a necessary condition of value, 106, 156, 401; of raw materials, a source of monopoly power, 197. Second Bank of the United States, 304 n. Secrecy, as a source of monopoly power, 199. Sectionalism, in American history, 62. Seigniorage, 255 ; on limited coinage, 259- Self-maintenance, as an economic motive, 103. Serra, mercantilistic writings of, 744. Services, as economic goods, 106. Shaw, L. M., control of gold reserves by, when Secretary of the Treasury, 353. Shays's rebellion, 62. Sherman Anti-trust Act, 236. Sherman Silver-purchase Act, 266. Shifting of taxes, on monopolies, 202 ; general theory of, 703 ; of import duties, 714. Sickness insurance, 591. Single tax, 425, 679, 706 ; imp6t unique, IAS- Size of business unit, increase in, 88 ; statistics of, 89. See Large-scale pro- duction. Slater, Samuel, 82. Slavery, 37 ; in the United States, 66. Small Holdings Act, 602. Smith, Adam, 48, 53, 745 ; on wages in different employments, 441. Smith, Constance, on operation of British Trade Boards Act, 483. Social dividend, 517. Social insurance, 57 ; defined, 587 ; against industrial accidents, 487, 588; against sickness, 591 ; against old age, 592; against unemployment, 592; objections to, S93- Social laws, nature of, 11. Social monopolies, 195. Social wealth, contrasted with individual wealth, 109. Socialism, defined, 627 ; varieties of, 628 ; an extension of existing institutions, 632; strength of, 632; weakness of, 634; growth of, 636; position in eco- nomic thought, 748. Sociology, 13, 748. I Special assessments, 692. 768 INDEX Special privilege monopolies, ig7. Specialization. See Division of labor. Specie payments, suspension of, 273 ; resumption of, 275. Specific productivity. See Marginal pro- ductivity. Speculation, relation to New York money market, 295 ; as a source of profits, 534; in agricultural produce, 622. Standard of deferred payments, 336. Standard of life, 438. Standard Oil Co. Case, 230. Standard Oil Trust, 230. State activity, present scope of, 17. State banks, before Civil War, 290 ; pres- ent position, 313. State insurance, 585. State regulation of industry, develop- ment of, in United States, 96. See Anti-trust laws. Labor legislation, Railways. State socialism, 631. State and local taxation, 726. Steuart, Sir James, 744. Stock, corporation, 220. Strikes, 452. Subjective value, 137; of a stock, 138; relation to exchange value, 155. Subsistence theory of wages, 437. Supply, nature of, 162; relation to normal price, 167, 170. Supply curve, short-period, 163 ; long- period, 174. Supply and demand, 156. Supply and demand curves, 164. Surplus, bank, 287 n. ; insurance, 583 ; consumers', 161; producers', 165; of bargaining, 181, 442. Surplus value, doctrine of, 629. Syndicalism, 63 1 . Tabular standard, 342. Tariff, and sectionalism, 63 ; as source of revenue, 713. See Protection. Taxation, 694 ; justice in, 696 ; progres- sive, 699 ; direct and indirect, 702 ; shifting of, 202, 703, 714; federal, 710; state and local, 726. Taylor, H. C, on farm tenancy in England, 618. Tenancy, farm, increase of, 603 ; com- pared with encumbered ownership, 615. Time utility, 116. Trade arbitration, 457. Trademarks, 23, 196. Trade unions. See Labor organizations. Transactions, taxes on, 719. Transportation, 557. See Railways. Trust companies, 314. Trusts, 230. See Combinations. Turgot, 745. Unearned increment, 422. , Unemployment insurance, 592. Unfair competition, 29, 239, 243. United States, economic development of, 61. United States Bank, 304 n. United States Steel Corporation, 88. Urban lands, rent of, 426. Urdahl, T. K., on fee system, 692. Use price, 205. Usury, 493, 523, 743. UtiHty, defined, 105. Utopian socialism, 628. Valuation, of public-service properties, 184, 209 »., 566. Value, exchange, 152 ; subjective, 137, 155; production of, 118. See Price. Values of money, 317. See General changes in prices. Variable expenses, relation to normal prices, 177. Vested interests, 25. Victoria, wage boards in, 459, 480. Voluntary arbitration, 458. Wages, as price of labor, 427; fixed by demand and supply, 428; afi"ected by structure of the population, 432 ; aSected by growth of population, 434 ; subsistance theory of, 437 ; relation of standard of life to, 438 ; in different occupations, 439 ; statistics of, in United States, 341, 547 ; agricultural wages, 606; statistics of agricultural wages, 608; in greenback period, 277. Wages of management. See Entre- preneur's wage. Wage boards, 95, 459, 480. Wagner, Adolph, statistics of incomes in Prussia, 546 ; on public expendi- tures, 650. Waiting, 106; an ultimate agent of pro- duction, 522; relation to interest rate 499.521. Wants, nature of, 133. Wealth, distinguished from income, 108. INDEX 769 Wealth of Nations. See Smith, Adam. Weld, L. D. H., on state regulation of commission merchants, 621. Wholesale prices, statistics of, 341, 548. Willcox, W. F., on growth of population, 436. Willoughby, W. F., on philosophy of labor legislation, 4go. Women, legal regulation of labor of, 470. Workmen's compensation laws, British, 57 ; in United States, 488, 589 ; stand- ards for, sgo. Printed in the United States of America. n^HE following pages contain advertisements of books by the same author or on kindred subjects. Property and Contract in Their Relation to the Distribution of Wealth By RICHARD T. ELY, Ph.D., LL.D. Of the University of Wisconsin; Author of "Outhnes of Economics," Editor of "The Citizen's Library," etc. Cloth, 8°, 2 vols., $4.00. A special law libraiy edition, sheep, $7.^0 In this work, which is based upon legal decisions as well as upon economic principles, a leading authority in political economy considers simply and concisely one of the greatest problems now before the American people. Much has been heard and written of late about judicial readjustment and direct government, but few who have discussed the subject have seen the heart of it as clearly as does Professor Ely. 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