Class ffB/j / Book , tions differ very widely in tastes and customs, so that one Reasons for person or group of persons may prize highly geousnessof a commodity that possesses little utility for exchange. others. Under such circumstances, which are the rule rather than the exception, an exchange of com- modities will place each article where it will have the greatest utility, and increase materially the sum of human satisfactions. Again, both individuals and communities have different aptitudes for the various kinds of productive labor; and, by exchanging their products, can devote themselves to the particular callings for which they are best fitted. In this way the production of wealth will be vastly increased, and all concerned may be greatly bene- fited. Then it is usually true that persons and communi- ties have different natural environments ; arable or pasture lands, valuable mines or forests, sea fisheries, water powers, and favorable climatic conditions are not every- where available, or available in equal degree. By ex- changing cotton cloth for wheat, Massachusetts has been enriched by the bounty of the fertile prairies of the West, while Iowa and Kansas have profited by the water power and acquired skill of New England. II. Market Value § 57. In the course of trade, commodities exchange for each other in certain definite proportions. A bushel of wheat, for instance, may command two bushels of oats ; and, when this is the case, the value of wheat is said to MARKET VALUE 99 be twice that of oats. It appears, therefore, that the word "value" refers to the relations that exist between commodities in the act of exchange; and we value and may define it as the power which a commodity price - has to command other commodities in exchange. The value of every sort of merchandise is usually expressed in terms of money, for which all goods are generally sold. If wheat is worth ninety cents in money, and the price of corn is sixty cents and of oats forty- five cents, we know at once the relative value of the three grains without going to the trouble of exchanging a bushel of one for a bushel of the others. A price, in fact, may be defined as a value expressed in terms of money. § 58. Whenever we say that the price of wheat is ninety cents a bushel, we refer to the value in a certain market and at a certain time. Between different Markets. markets variations of prices may exist, and from one time to another changes are likely to occur. By a market is meant the establishment of such free inter- course between traders that a single price rules for a given commodity at a given time. Chicago, New York, and Liverpool have formed one market for the exchange of wheat ever since the electric telegraph brought these places into such close communication that the daily quo- tations must be practically the same, allowance being made, of course, for the cost of transporting grain to the Atlantic seaboard and across the ocean. In general, wholesale markets of staple commodities are now of national or international extent because modern methods of communication insure the closest intercourse between dealers in distant places, and make it possible for uniform 100 THE THEORY OF EXCHANGE prices to prevail over wide areas. In retail trade, upon the other hand, prices not only vary from one city to an- other, but are not likely to be uniform in all parts of a single city of any considerable size. This is because retail buyers, i.e., the final consumers, do not take the trouble to watch prices over wide areas of country, but purchase from local dealers at such prices as are asked. The existence of a market, it will be observed, in which the same product exchanges at a uniform price, presup- poses the condition of competition. In the Competition. . . , widest sense of the term, competition denotes any struggle of conflicting interests in which each person endeavors to accomplish his own ends in the face of similar efforts upon the part of rivals. In a market, competition may mean either one of two things. It may mean the endeavor of rival sellers to dispose of their goods or services on the best possible terms; and, on the other hand, the efforts of rival buyers to purchase goods at the best advantage. Or, in the second place, it may mean the process of bargaining between buyers and sellers for the best terms in each transaction. Where there are many buyers and many sellers, competition between rival sellers on the one hand and rival buyers on the other will usually establish a uniform price without any bargaining between buyers and sellers. In fact, much bargaining between buyers and sellers is likely to break the body of traders up into groups and to destroy uniformity of prices. § 59. We are now ready to consider the causes by Market which value is determined, and shall find it value - convenient to begin with the problem of mar- ket value. During a recent year the prices commanded MARKET VALUE 101 by a bushel of wheat in New York ranged from fifty- six to eighty-three cents, and were seldom exactly the same on any two successive days. These fluctuating daily quotations were the market prices of that commod- ity; and they measured the market value, which may be defined as the actual exchange power of a commodity in a market from day to day. Investigation of the manner in which market value is determined will demonstrate that it depends upon the forces of demand and supply. By demand, . . . Demand. as we have seen, the economist means desire coupled with the ability to purchase. It is small when buyers will take but a small amount of a commodity out of the market, and large when a greater quantity is bought. Our study of the consumption of wealth has already enabled us to formulate a general law of demand; and it was shown that demand varies 1 directly as the marginal utility of a commodity, and inversely 2 as its price. The supply of commodities in a market must be dis- tinguished clearly from the stock of goods which pro- ducers or middlemen have on hand. The Supply. stock is the entire quantity of goods under the control of the sellers, while the supply is the amount that will be offered for sale at a given price. The stock is in the hands of men who have produced or purchased it 1 Since we are now studying the value of a commodity for short periods of time, we may omit the third factor mentioned in the previous chapter, viz., changes in the resources of consumers. 2 The words " directly " and " inversely " are not employed here in their strict mathematical meaning. Demand increases as utility increases, but not necessarily in the same proportion ; it varies as price varies, but not proportionately. 102 THE THEORY OF EXCHANGE for the sole purpose of selling at a profit; these holders, in fact, could have no conceivable use for any considerable part of their stock for purposes of personal consumption. They will offer for sale from day to day so much of the stocks as they consider it desirable to sell at existing prices. High prices will induce them to throw large quantities of goods into the market ; while, if prices are low, smaller quantities will be offered for sale, and the remainder of the stock reserved until the market improves. § 60. Within a market at a given time, the price of a commodity will be fixed at a point where demand and Market value supply will be equalized. Let us suppose suppiyand tnat se U ers °f wheat have on their hands a demand. stock of 1,000,000 bushels ; that, at a price of eighty cents per bushel, they will sell the entire stock; that a price of seventy cents will induce them to place 800,000 bushels upon the market; and that a price of sixty cents would reduce their offerings to 600,000 bushels. Upon the other hand, we may assume that the buyers will purchase 1,000,000 bushels of wheat at sixty cents; 800,000 bushels at a price of seventy cents; and 600,000 at a price of eighty cents. It is evident that, under such conditions, a price of seventy cents will equalize supply and demand; and a little reflection will show that this must be the ruling price for the day, since competition of buyer with buyer and of seller with seller will make no other result possible. If the bidding by some buyers should raise the price to seventy-one cents, others would reduce their purchases or retire from the market, so that the demand would quickly fall from 800,000 bushels to some such figure as 790,000. At the same time the addi- NORMAL VALUE 103 tion of one cent to the price would increase the offerings so that the supply might rise to 810,000 bushels. Such a situation would make it impossible for dealers who are anxious to sell 20,000 bushels to find a customer for their wheat, and would lead some of them to lower the price to seventy cents. Where competition exists, the demand and the supply must be equalized. § 61. In our chapter upon the consumption of wealth it was shown that commodities differ very greatly in the sensitiveness with which the demand for them Elasticity responds to changes in price. Articles for ofdemand - which the demand is inelastic must rise in price materi- ally before consumers will reduce their purchases con- siderably; and, therefore, a shortage in the supply will increase prices very much more than would be possible if the demand were elastic. Upon the other hand, if the stock is greatly increased, the sellers must reduce their price considerably before they can dispose of materially larger quantities. We learned also that, if hard times compel the consumers to retrench in their expenditures, the prices of articles with an elastic demand will suffer much earlier and more extensively than the prices of the other class of goods. III. Normal Value § 62. Although market values are constantly changing, an underlying force controls ultimately all such fluctua- tions. Experience shows that an unusually Normal high price is not likely to be maintained for value - a long time, and that exceptionally low prices are equally unstable. Moreover, if we compare the average market I CM THE THEORY OF EXCHANGE prices for a considerable period, we shall find that the relative prices of different commodities remain tolerably constant, so long as no important changes occur in the uses to which they are put or the conditions of produc : tion. Some force, evidently, sets a limit to the fluctua- tions of the market, and restores prices continually to what the business world considers a normal level; in other words, there is a certain point around which market prices play. In this way we arrive at the concept of normal value or price, which may be defined as that value or price to which, under given conditions, market prices constantly return. § 63. Commodities are produced by capitalists and laborers who desire to secure the largest possible returns for the sacrifices incurred in the process of The force m x governing production. In so far as they have the power of choice, producers will endeavor to invest their labor and capital in those occupations which promise them the best income from their exertions; and here we discover a force that tends to increase or restrict the stock of any commodity, and thus to affect the movement of prices. If two articles that require the same amounts of sacrifice for their production happen to have different values in the market, producers will increase the supply of that article which commands the higher price, and restrict the output of the other. The increased produc- tion of the dearer article will gradually lower its market value to the level of the other one representing the same expenditure of labor and capital. In this manner the cost of production influences the supply, and therefore the price, of commodities. NORMAL VALUE 105 The competition of the market, by which prices are regulated from day to day, has been called " commercial competition" ; and to the competition of pro- industrial ducers who endeavor to regulate production com P etltlon - according to the demands of the market, the term u indus- trial competition" has been applied. It is important for us to examine the actual processes by which this indus- trial competition operates. In case any industry, on account of the high prices now received for its products, becomes exceptionally profitable, many employers already engaged in it will be stimulated to enlarge their present plants; while outside capitalists, seeing an opportunity to make large profits, will establish new enterprises. In a progressive country, in every prosperous year, there is a large mass of accumulated profits which seeks invest- ment; and, besides, it is possible to withdraw from the least profitable industries considerable capital that is not too highly specialized, and employ it where it will secure a better return. On the other hand, if the market price of any commodity has fallen to such an extent that pro- ducers are confronted with the prospect of small profits, or even loss, employers will begin to operate their factories upon half time or will close their doors and wait for con- ditions to improve. Some establishments, under such conditions, are likely to fail, and the capital invested in them is thereby removed from the field ; while a few may find it possible to transfer a part of their free, or relatively free, capital to some more profitable enterprise. The burden of "hard times" falls most heavily upon the marginal producers, who, as we learned in the last chapter, have been producing at the greatest expense; and it is 106 THE THEORY OF EXCHANGE chiefly through the failure or voluntary withdrawal of such establishments that the supply is reduced to a quan- tity that can be marketed at a profit. It appears, therefore, that, just as the marginal utility determines the demand for commodities, so the cost of cost of production regulates the supply. We must, production. then ^ un( iertake a careful analysis of the dif- ferent elements that enter into the cost of production, and must inquire : What things do individual producers, both capitalists and laborers, sacrifice in order that the work of production may be carried on? ■ § 64. In the first place, it should be observed, the natu- ral agents utilized in production are not, under ordinary circumstances, an element in determining the of cost of cost. 1 Such agents are a part of nature's contri- production. . . 1 1. 1 bution ; they do not increase, but rather lighten, the sacrifices that producers undergo. What production really costs to the persons who carry it on is the sacrifice of the labor and capital required for the creation of utilities. The first element in producers' cost is the labor devoted First eie- to production. It may be expended indirectly ment: Labor. - m ^ e manufacture of capital needed in an industry, or directly in the production of consumable 1 If the supply of any material, such as copper, is monopolized, then those who control the mines may exact a large monopoly profit over and above the cost of production. This monopoly profit becomes an element in the cost of production in all industries that use copper. We are now studying competitive, not monopoly, prices, and will not pursue this sub- ject further. In the case of land, which ordinarily commands a rent, it might seem, at first thought, that this rent must be an element in the cost of production. It is, of course, an item of expense to the producer, but we shall see that it is not one of the factors determining the normal value. This will be made clearer when we come to the discussion of rent. NORMAL VALUE IO/ commodities. The sacrifice which labor represents is in all cases the cost of supplying the required number of workmen. Laborers are divided into various classes or grades, each of which possesses its own standard of living; and, in proportion as the standard is high or low, the cost of supplying any particular sort of labor will be larger or smaller. Workmen suitably trained to undertake delicate and responsible tasks cannot be had unless the remunera- tion is high enough to cover the cost of rearing and edu- cating such persons. On the other hand, work that calls for no skill and places no responsibility upon the laborer can be done by persons whose standard of living is the lowest, and represents, as these things go, a small labor cost. So far as the element of labor is concerned, the cost of producing a commodity depends upon the standard of living of the class of workmen which the industry requires. 1 The second element in producers' cost is the expenditure of capital. In so far as capital represents mere labor devoted to the production of buildings, machines, or materials, the sacrifice occasioned element: by its use has been fully accounted for in the previous paragraph. But, as has been explained else- 1 Where there is a practicable alternative for the laborer, the cost of obtaining his services may be influenced by one or two other factors. Work that is held in low social esteem will be avoided, unless the remun- eration is somewhat more than enough to equal the standard of living of laborers of the grade required. So, too, work that involves risk of life or limb must be more highly remunerated. This is true, however, only when workmen have practical freedom of choice. Much unpleasant work, or work that is dangerous to health or to limb, is performed by men who receive the lowest wages, because there is no practicable alternative. 108 THE THEORY OF EXCHANGE where (§ 29), the formation and renewal of capital require abstinence, or waiting, as well as labor; and in this we find a second element of sacrifice, independent of labor. This is not to say that every portion of a given stock of capital represents the same amount of sacrifice because, as we have seen, millionaires can accumulate capital far more easily than persons with small incomes. But it does mean that every unit of capital represents a sacrifice of the pres- ent to the future ; and, therefore, involves something more than the mere expenditure of labor in producing it. 1 § 65. The problem of normal value is somewhat com- plicated by the fact that the cost of producing any com- modity is not the same in all establishments Different J costs of pro- (§ 52). Does the normal value of a commodity, duction. iiii r 1 then, depend upon the average cost of produc- tion, upon the lowest cost, or upon the highest? The 1 A simple illustration will make evident the reality of the sacrifice represented by waiting. Suppose that five men, each furnishing his own tools and subsistence, undertake to make a boat that cannot be completed in less than five months. When finished, the boat will be worth $2000. If all the men wait until the boat is completed and sold, they may each re- ceive $400, assuming, for convenience, that their labor has been of the same value. But now suppose that one of the men, instead of waiting five months for his share of the product, demands that the others advance $400 to him at the end of the first month. He would quickly be told that, since nothing was to be realized from the undertaking for five months, he could not expect to share equally with his companions in the distribution of the $2000 then available unless he would wait until the boat was com- pleted and sold. He would not be given at the end of one month even one fifth of the $400 that would be due him at the end of five months. For him to receive advances of $80 at the end of each of the first four months would result in an unequal distribution of the sacrifice represented by waiting. He might, however, justly receive at the end of one month the present worth of the $80 which would be due for that month's labor when the boat had been completed. NORMAL VALUE 109 answer must be that it is governed by the highest, or marginal, cost of production. If the amount of wheat normally consumed in any community is 1,000,000 bushels, the price must be high enough to cover the cost of pro- duction upon the poorest land that needs to be cultivated in order to obtain so large a supply; for otherwise such lands would go out of cultivation, the supply would fall below 1,000,000 bushels, and the price would be restored to the higher figure. The same thing is true in manu- factures, or any other industry; consequently consumers must normally pay enough to cover the cost of producing the marginal unit of the supply. Moreover, competition between producers will not permit the price to be main- tained for long above the point just indicated. If prices rise above the normal level, poorer lands and inferior factories can be brought into use, the supply will increase, and competition among producers will reduce prices to the former status. Under competition, therefore, the point around which market prices play is the marginal cost of production. Between the lowest cost of production to the most skill- ful or the best situated producer and the marginal cost, the difference will be greater in some industries m , The extent than in others. In agriculture the product of of these any given tract cannot be increased beyond a certain point except under conditions of diminishing returns; so that, if the supply of any product is to be enlarged very greatly, it will be necessary to bring into cultivation one grade of inferior land after another, with the result that the marginal cost of production is likely to rise far above the cost upon the most fertile lands. IIO THE THEORY OF EXCHANGE In manufactures and commerce, on the other hand, the product that can be obtained from any piece of land can be largely increased, and it is easier to secure economies from concentrating production in large establishments; so that there is less reason for great differences between the costs incurred by the various competitors. It has now been shown that market value depends primarily on the marginal utility of a given supply of any „ . , x commodity, and that normal value, to which Marginal cost J \ 7 the determin- the fluctuations of the market must conform, ing factor. . 111 -, r , is governed by the marginal cost of production. If the market price is the one that equalizes supply and demand at any particular time, the normal price is the one that will equalize production and consumption. "Value," says Professor Marshall, "rests like the key- stone of an arch, balanced in equilibrium between the contending pressures of its two opposing sides. The forces of demand press on the one side, those of supply on the other." * § 66. In this discussion we have assumed that buyers and sellers, consumers and producers, are conducting , their affairs with full knowledge of the demands Importance of ° theory of of the market and of the conditions of pro- normal value. . auction; and we have assumed, furthermore, that absolute freedom of competition has prevailed. It 1 The following illustration may make the theory of normal value some- what clearer. Suppose that the movements of market prices show that consumers will buy 100,000 tons of pig iron at $20 per ton, and that their purchases will increase to 300,000 as the price gradually falls to $10. Suppose that the best situated furnace can supply 50,000 tons at a price of $10, and that other furnaces can supply additional amounts at prices Vhat gradually increase until 300,000 tons would come into the market NORMAL VALUE III is needless to say that such conditions are realized only imperfectly in the actual world of business, and that prices cannot always be determined in the manner which hag been described. This fact must be taken into account before we dismiss the subject of value, and in the next part of this chapter will receive careful consideration. But when all such qualifying circumstances are given due weight, it remains true that our theory of normal value possesses the highest theoretical and practical im- portance. It is based, in fact, upon a study of underlying forces that no economist or man of business can afford to neglect. if the quotations should rise to $20. Then the following table ma y show where the pric. It is now necessary to take into account the fact that perhaps one half of the whole volume of business The influence transactions is dispatched by means of vari- the C vaiue of ous instruments of credit. This fact has money. \ e ^ some writers to the conclusion that the growth of credit has invalidated the theory that the pur- chasing power of money depends on the conditions of supply and demand. And if the use of credit could be carried to any extent whatever, so that, in case the supply of money should greatly decrease, all exchanges could continue on the old basis simply by resorting to a larger supply of credit, the criticism of the accepted theory would be well founded. Money would have no effect on prices if it were not necessary for the transaction of the existing volume of business at the present level of values. But the employment of credit cannot be increased at will in order to prevent a change of prices. Book credits, promissory notes, and bills of exchange are now used about as extensively as business men find it convenient to THE LAWS OF MONEY 135 employ them. A sudden currency famine might lead to a greater use of these and other devices for exchanging commodities without the use of money, but not The effect of to such an extent as to obviate all inconven- Jrom£iy S ' ience or prevent a sharp fall of prices. It is j^ 68 '/ 11 * not accident, but the extent to which they are exchange, found convenient, that limits the use of these instruments of credit. Bank notes and checks are employed in quantities that vary from year to year ; and it might seem, at first thought, that a deficiency of metallic money could be J J The effect of remedied easily enough by an increased em- banknotes ployment of these forms of bank credit. Un- fortunately, however, there are very definite limits beyond which bank notes and checks cannot be used without the most serious danger. The limits arise from the fact that both of these forms of bankers' obligations must be in- stantly convertible into cash if they are not to depreciate — a consideration which will require further treatment in subsequent pages. At all times bankers must maintain a reserve of ready money, which, according to circumstances, should be from five to thirty per cent of the amount of money owed to depositors and holders of notes. It ap- pears, therefore, that the employment of checks and bank notes is limited by the necessity of maintaining a specie reserve, so that there are bounds beyond which the use of these instruments cannot be carried without an increase of the supply of ready money. For this reason it is safe to conclude that there must always be a connection be- tween the amount of money in circulation and the extent to which credit can be employed. 136 MONEY AND CREDIT § 89. Full importance will be given to the part which credit plays in the exchange of commodities if we make a slight restatement of our theory. Book credits, Summary: as ° J 7 to the value bills of exchange, and promissory notes suffice of money. . - . for many exchanges m which no money is used; and we may consider that their effect is to reduce, by so much, the demand for money. Bank notes and checks, on the other hand, call for the use of some money as a specie reserve, but they enable one dollar thus held by a banker to do the work of three or four dollars in actual circulation ; thus they increase the efficiency of a given stock of coin. Bearing these considerations in mind, we can formulate the following complete theory: The value of money depends upon the demand, as decreased by certain instruments of credit; and upon the supply, as increased by the heightened efficiency of those coins which are held as a reserve for the circulation 0} checks and bank notes. Ultimately, as we have seen, the cost of producing gold affects its value ; but this fact needs no further attention. § 90. We now pass to a second principle relating to money, which is known as Gresham's law. As far back as The second the record extends, governments have continu- Gresham's a % tried experiments with debased money. By law - the side of specie they have forced paper into circulation ; they have gathered up coins of full weight and recoined them into lighter pieces ; or, when one metal had become the established medium of exchange and standard of value, they have issued money made of the other metal. In the last case the new coins have been given a certain nominal value in terms of the old, but changes in the market ratio of gold and silver have sooner or later made THE LAWS OF MONEY 1 37 the metallic contents of the one kind of money less valu- able than the contents of an equal nominal amount of the other. From centuries of such experience economists have derived a law governing the operation of debased money, which has been named after Sir Thomas Gresham, in his day "the greatest merchant of London," who in the sixteenth century called to the attention of Queen Elizabeth the fact that "bad money drives out good." With other things the worse may be displaced by the better, since it is for the interest of consumers to buy the best that the market affords. Money, how- Illustrations. ever, is in demand, not as an object of per- sonal consumption, but as a medium for paying debts; and it is obviously for the interest of the debtor to employ the cheapest sort of coins that the law will permit him to offer his creditor. In the seventeenth century, when Massachusetts made public taxes payable in cattle, the taxpayers naturally turned over to the provincial treasury the poorest cattle in their pastures, until, in 1658, the Great and General Court was obliged to enact that no man should discharge the rates "with leane cattle." In the eighteenth century when North Carolina made seven- teen different commodities legal tender for debts, public and private, the governor of the province observed that it was "a stated rule that, of so many commodities, the worst sort only were paid." Illustrations of the truth of Gresham's principle might be multiplied, but the testi- mony of reason and experience is so uniform that it is unnecessary to dwell longer upon the subject. The operation of Gresham's law does not depend, under modern conditions, upon the action of the mass of the 138 MONEY AND CREDIT people in picking over the various coins in order to elect the cheapest medium for the payment of debts. The work is done far more promptly and quietly Method in r r J . which the by bankers, money dealers, and goldsmiths, aw opera es. w k ose k us i ness CO mpels them to note the smallest differences in the bullion value of coins. A gold- smith will select only new gold eagles that have lost none of their weight through abrasion, when he places money in the melting pot ; and a banker will select the same sort of pieces when he exports gold to England, where it must pass as so much bullion. Thus lighter coins remain in domestic channels of circulation, and heavier money dis- appears. So, too, if an unlimited quantity of inferior silver coins or paper money should be forced upon the country, it would be chiefly the bankers, money changers, and goldsmiths into whose coffers our gold would dis- appear. § 91. But there are certain limits to the power of in- ferior money to drive out superior. At the present mo- ment something more than $1,7^0,000,000 of Limitations 5 . '/^ ' ' on the action gold is supposed to circulate in the United States, or to be held in bank reserves and the federal treasury. Yet by the side of this standard money circulate $350,000,000 of paper issued by the govern- ment, and silver to the nominal amount of $724,000,000 which, if put into the melting pot, would be worth only 40 cents on the dollar. How, indeed, are these facts to be reconciled with our law that cheap money drives out dearer ? The difficulty is cleared up when the law is modified so as to read * Cheaper money drives out oj circulation a sub- THE LAWS OF MONEY 1 39 stantially equivalent amount of dearer money. The reason for such a limitation of the principle is not hard to explain. The present volume of business in the The law United States could not be transacted at the restated - present level of prices without about as many dollars of all kinds as are now in circulation. If a large part of our present supply of gold should leave the country, prices would fall to a marked degree unless an equivalent amount of paper and silver were added to the currency. Such a fall in prices would cheapen commodities so greatly that gold would flow back into the country in order to purchase various products on the favorable terms that would be offered. Our present supply of gold, therefore, is in no danger of leaving the country if we see to it that no addi- tion is made to the stock of paper and debased silver now in circulation. The debased money already issued has, undoubtedly, driven out an equivalent quantity of gold, or, what is the same thing, has prevented it from coming to us. But it cannot drive out all of the gold because its supply is limited to a quantity that is not sufficient to carry on the business of the country except at abnormally low prices that would attract the yellow metal back to our markets. Bad money, then, displaces an approximately similar amount of good money, but no more. Indeed, if a country which originally had no money but gold should issue paper or debased silver up to 80 or 90 per cent of its total circulation, 10 or 20 per cent of 7 m r Additional its former gold supply would remain in its accus- considera- tomed place if all the other factors in the situa- tion were unchanged. In strict theory it might be possible to issue debased money to the extent of 99 per cent of the 140 MONEY AND CREDIT gold supply without driving the remaining fraction of the yellow metal out of circulation or raising prices. Gener- ally, however, the threat of a large issue of debased cur- rency has the effect of checking business activity and so of reducing the demand for money. If the demand de- clines by 20 per cent, then all gold would be driven out of circulation after silver or paper had been issued to the extent of 80 per cent of the former money supply. This fact, moreover, is usually overlooked whenever a country begins to revel in the delights of a plentiful supply of cheap money ; it is, indeed, one of the chief things to be appre- hended when the process of tinkering with a sound currency begins. § 92. Our third principle is the law governing the ter- ritorial distribution of the precious metals. Gold and The third silver are not produced in material quantities territorial * n au " countries; in fact, production is local- distribution j ze j j n a f ew re onons that are noted for their of precious ° metals. large output. And yet, in proportion to their needs, all countries seem to be supplied tolerably well with gold, or silver, as they prefer. Evidently there must be some process by which this uniform distribution of the annual output is carried on. The process is nothing else than international exchange. If it ever happens that the purchasing power of the metal Th in any country is materially higher than in governing the others, gold inevitably flows to that place where distribution. . 1 . ' ' . . ■, f its value is greatest. This is another way of saying that low prices attract gold away from regions where prices are higher. In countries where there is a large output of the precious metals, the purchasing power THE LAWS OF MONEY 141 of gold would be greatly reduced if none of the annual product was exported to lands that are without important mines. Differences in general levels of prices, therefore, are the motive power that forces the constant outflow of gold from the regions where the principal mines are found. § 93. The position of a gold-producing country is well illustrated by the experience of the United States. Prior to the Californian discoveries in 1848, this Position of country produced an insignificant quantity of goidproduc- gold and silver, and was obliged to depend on its foreign trade to bring in an adequate supply of the precious metals. From 182 1, when the reported statistics begin, down to 1850, when the gold production suddenly rose to enormous proportions, imports of gold and silver into the United States exceeded exports by $70,000,000. In 185 1, however, the pendulum swung in the other direc- tion, and the net exports were not less than $24,000,000. During the decade from 1851 to i860 the exports of specie exceeded imports by the enormous sum of $417,608,000, which was nearly three quarters of the total output of the mines ; and since that time the United States has been normally a specie-exporting country. 1 No other result could have been expected. § 94. Other causes sometimes influence the movements of specie, as we shall learn in a later chapter; but the principal factor is the tendency of gold to seek the market 1 From 1878 to 1883, and from 1897 to 1908, gold imports largely ex- ceeded exports. Both conditions were due to unusual developments of our foreign trade. The last gold import movement seems now to have reached its end. As long as the United States continues to produce $80,000,000 to $90,000,000 of gold, it is likely to remain, normally, a gold-exporting country. 142 MONEY AND CREDIT where prices are lowest. The gold movement is auto- matic, regulating itself according to the needs of business, unless cheaper money is issued to cause a seri- Conclusion. x J ous displacement. If gold exports are not due to the action of Gresham's law, they will cease automat- ically as soon as the flow of money from the country lowers prices to about the level that prevails elsewhere; while an inflow will not continue after it has raised prices enough to make the purchasing power of gold no higher than it is in other places. Every nation that does not meddle with inferior substitutes must receive from its mines or its trade enough gold to enable it to transact its business at a general level of prices substantially similar to that which rules in the rest of the world; while more than this amount it cannot permanently retain. FOR SUPPLEMENTARY STUDY General: Bullock, Selected Readings in Economics, 387-405; Hadley, Economics, 180-207, 232-241; Nicholson, Polit- ical Economy, II, 88-124, 131-139; Seager, Introduction to Economics, 302-310; Taussig, Principles of Economics, Bk. III. Special: Jevons, Money and the Mechanism of Exchange, 3-85, 187-191 ; Kinley, Money; White, Money and Banking, 41-59, 217-255. CHAPTER VIII PROBLEMS OF MONEY AND BANKING I. Government Paper Money § 95. Many countries have tried disastrous experi- ments with government paper money, which consists of circulating notes issued by governmental au- Government thority. These notes usually bear on their paper - face the promise of the government to redeem them, gen- erally at no specified time; they are receivable for taxes and other dues at the public treasury; and commonly are declared a legal tender for all private debts. While frequently a paper currency has been received willingly enough when first issued, the coercion of a legal tender law has usually been employed to maintain the credit of such currency; and the longer the issues continue, the more the element of forced circulation comes to the front. § 96. The advocates of government paper have usually argued that paper money is cheaper than specie since, by its use, a country saves the expense of procur- Arguments in ing and maintaining a large stock of the pre- J*® ^^1 cious metals. This is undoubtedly true, but it ness - is a matter of no consequence if experience has shown that paper currency is an unsafe medium of exchange. Then, too, in any case, specie must be employed in foreign ex- changes since one nation will not accept paper issued in another. H3 144 PROBLEMS OF MONEY AND BANKING But it is claimed that a paper currency can be employed with perfect safety and convenience, provided that meas- ures are adopted to prevent its being issued in (<5) Safety. excess of the needs of trade. This, again, is entirely true; and it would be a highly important consid- eration if it were possible to devise some perfectly safe method of restricting the issue of paper. If a community is using $1,000,000 of specie in transacting its exchanges, the government might issue about $1,000,000 of paper without inflating prices and causing depreciation, provided that this was done in such a way as to assure business men that the new currency would not be increased beyond that limit. But such assurance it is impossible to give. Advocates of paper money have exhausted their ingenuity in devising automatic methods of limiting the issue; but most of these have been tried at some time or other, and found wanting. Even if a satisfactory restriction could be invented, there would be no guarantee that the legis- lature would not repeal or amend the law if it ever desired to increase the volume of the currency. The least intelligent argument in favor of a paper medium is that any kind of money depends for its exist- ence solely on the action of government in (c) Fiatism. .... . , . . . . rT ^ T issuing it and making it a legal tender. There- fore, it is said, the government can make one thing a dollar as well as another, and should select that medium which is cheapest. Our study of the development of metallic money has already demonstrated the falsity of the belief that it depends for its value solely upon the fiat of any government. Undoubtedly the fact that gold is employed as money increases its value by opening a new GOVERNMENT PAPER MONEY 145 use for that metal, but it was a useful commodity before it ever became a medium of exchange; moreover, it was by the action of individuals, not that of governments, that gold was gradually preferred to other commodities for monetary purposes. Governments may declare that a piece of paper shall circulate as a dollar, and may force such money upon creditors who are bound by past con- tracts; but the new unit of value will be a paper dollar after all, not a gold dollar. Whether the paper currency will be as good as the gold depends on the amount of it which the government tries to place in circulation. § 97. Although we have admitted that paper might answer the purposes of money in domestic exchange, pro- vided that its supply is held within proper bounds, the concession weakens in no way the against gov- case against government issues ; for the chances pap? r e : nt are that a limitation cannot be maintained. (ganger of overissue. In the first place, if the currency is emitted in order to defray public expenses, — and this is the way in which issues generally begin, — the real or supposed needs of the treasury are likely to lead to repeated emis- sions. It is far easier to set a printing press at work than to levy taxes for the support of a government, and this consideration will weigh heavily with a legislature anxious to please its constituents. Then, too, in time of war public expenditures are almost certain to exceed estimates and to furnish plausible excuses for additional issues of paper. Our Continental Congress began by emitting $3,000,000 of bills of credit, and finally placed $241,000,000 in circulation. In time of peace it may be proposed to issue paper in order to construct useful public works, as 146 PROBLEMS OF MONEY AND BANKING roads; in fact the advocates of such money never lack reasons for setting the printing presses at work. In a popular government a second factor operates with unpleasant force and frequency in favor of enlarging a paper currency. In all countries there are of debtor large numbers of men who have borrowed 1*1 ace ac money, and will be materially benefited by any measure that lowers the value of the medium in which repayment must be made. This is particularly true of the United States, since in all the newly settled districts land is purchased, buildings are erected, and extensive improve- ments undertaken by means of money borrowed in the older and wealthier states. It has happened repeatedly that legislative bodies have been controlled by the debtor classes who have clamored for relief from the pressure of their debts. In national politics the same influences have given rise to demands for "more money" with which to pay debts, and in this way the national credit has been impaired and the stability of our monetary system threat- ened. From 1690 down to recent times, our country has been trying repeated experiments with cheap money, which, in almost every generation, have caused as much financial loss as a destructive war. Experience should incline us to extreme skepticism concerning the efficacy of any plan for limiting the issue of cheap paper. § 98. Whenever government issues are employed, the paper begins to displace specie, although gold will not inflati n * wn °lly disappear until there is enough of the the united cheaper medium to take its place. When this States. .11 1 1 r i . point has been reached, further issues will cause a rise of prices, i.e., a paper dollar will begin to com- GOVERNMENT PAPER MONEY 147 mand fewer commodities; while, the purchasing power of specie remaining unchanged, a difference will appear between the value of paper and that of gold. 1 The premium on gold will increase so long as the inflation continues; and prices will continue to rise until they finally reach enormous figures. Since the paper currency costs practically nothing, it may be issued, despite the de- preciation, until, as in our War for Independence, a bushel of money will hardly purchase a suit of clothes. When this point is reached, the currency becomes practi- cally worthless and inflation will stop ; but this is the only limit to the depreciation. Obviously, debtors can ex- tinguish a large number of debts with Very little trouble under such conditions as have been described. By 1779 and 1780 our Continental issues had rendered thousands of people penniless, and had almost destroyed the last vestige of faith between man and man. "Old debts were paid when the paper money was more than seventy for one. Brothers defrauded brothers, children parents, and parents children. Widows, orphans, and others were paid, for money lent in specie, with depreciated paper, which they were compelled to receive. " And yet this carnival of fraud took place in spite of the fact that the various colonies had, between 1690 and 1764, tried many disastrous experiments with paper T he green- money. The bitter lessons taught by the backs - Continental currency were sufficient to make all honest men abhor the very name of bills of credit; but such 1 This is called a premium on gold. During our Civil War the pre- mium on gold rose at one time to 185. This meant that $285 in papei was needed to purchase #100 in gold. 148 PROBLEMS OF MONEY AND BANKING memories had died out when, in 1862, our national government issued $150,000,000 of greenbacks, which were soon increased to $450,000,000. This time the fortunate turn of military operations, rather than any wisdom on the part of Congress, confined the issues to a volume that was not large enough to cause such enormous depreciation as occurred during the Revolution. Yet in 1864 the green- backs were worth, on the average, less than 50 per cent of their nominal value, so that the country suffered from the evils of a depreciated currency. In 1879 tne government began to redeem the notes in coin, having accumulated a reserve of $133,000,000 of specie; and since then green- backs have been instantly convertible into gold at the demand of the holder. Unfortunately, however, an un* wise law passed in 1878 prevents the treasury from destroying a note after it has been redeemed, so that, by being reissued in any payments that the government makes, the greenbacks continue to circulate. 1 § 99. The present law, enacted in 1900, provides that a gold reserve of $150,000,000 shall be maintained in our present order to insure prompt redemption of the position. greenbacks; but it does not require them to be destroyed when drawn into the treasury in this man- ner. On the contrary, it prescribes a method by which they may be reissued, with the result that the greenbacks are still looked upon as a part of our currency system. From 1890 to 1894 demands for the redemption of enor- 1 As a result of the law of 1878, the greenbacks left in circulation amount to $346,681,000. Since 1879 the government has redeemed in gold more than $735,000,000 of the notes, without reducing the quantity outstanding. BANKS AS INSTITUTIONS OF CREDIT 149 mous quantities of the greenbacks forced the government into dire straits; but various events have improved the situation so that there is little reason to apprehend serious danger in times of peace. The objection to them now is chiefly that they would serve as a precedent for new issues in case the United States should ever be involved in a serious war. It would be far better to have the greenbacks retired by some gradual method, in order that we may not countenance even the limited employment of such a dan- gerous agency as government paper money. II. Banks as Institutions of Credit § 100. It is now in order to study with some care the part played by banks in facilitating the commerce of the world. After considering the various func- The deposit tions exercised by the banker, we shall exam- functlon - ine briefly the manner in which this important business is organized in the United States. A bank has been defined tersely as "a manufactory of credit and a machine of exchange." In fulfilling its functions it endeavors, first of all, to establish its credit upon such a sound basis as to attract deposits of the surplus cash of the community which individuals do not care to carry in their pockets and business concerns wish to place elsewhere than in the money drawer. The large corporations of modern times have to keep millions of dollars in bank in order to insure prompt payment of running expenses, while even the pro- prietor of a small store prefers to deposit in a bank all of each day's receipts that are not needed in "making change." Competition between banks frequently leads to the offer of interest, generally at the rate of two per cent, upon de- 150 PROBLEMS OF MONEY AND BANKING posits of considerable size ; but even when interest is not paid, the convenience of the check system is sufficient to attract a large body of depositors. § 101. Over three hundred years ago, bankers found that not more than a certain proportion of their deposits was ever The function called for at any one time ; and they perceived of discount, fa^ ft womc i b e perfectly safe to lend at interest a considerable part of the money intrusted to their keeping. To this depositors would not object, provided that a suffi- cient reserve of cash was kept on hand to meet all their demands from day to day; because, by investing the funds, bankers could afford to receive deposits without making any charge for keeping them in a place of safety. In this manner banks now gather up the surplus cash of a community, and lend it out to persons who desire to borrow. Usually the borrowers are men who are en- gaged in successful business enterprises, and who desire to obtain capital with which to extend them. They offer to the banker their notes of hand, secured by responsible indorsers or by the deposit of collateral ; 1 or else they present bills of exchange representing commercial trans- actions from which the returns are not yet available. 2 Such notes and bills are bought by the banker at a stipu- lated rate of discount, and thus become his property. By studying their customers carefully and watching the course of business, banks can make commercial paper an ex- tremely safe sort of investment. 1 Stocks and bonds of corporations are the usual collateral, the banker accepting them as security for a loan to the amount of from 60 to 90 per cent of their market quotations, according to the stability of their value. 2 Thus a merchant who sells goods upon thirty days' credit can draw apon his customer and discount the bill at his bank. BANKS AS INSTITUTIONS OF CREDIT 151 § 102. Deposit and discount are the essential functions that an institution must exercise in order to be a bank, but other functions may be added. Of these, the The issue one that has received the most attention is that of notes - of issuing circulating notes payable on demand. Since bank notes circulate readily from hand to hand, they are of considerable use to the business of a community in which few persons keep deposits at a bank and use checks in making payments; in large cities, however, the check is the more convenient medium of exchange. In all countries it has been found necessary to regulate by law the issue of circulating notes by banking institutions. § 103. The operations of a bank will be most easily described by means of a simple illustration. Suppose that a banking corporation begins business with a capital of $so,ooo, and that it immediately re- operations . i . , P ^ rm illustrated. ceives deposits to the amount of $100,000. I he capital, it should be observed, serves as a guarantee for the safety of the depositors' money ; for if bad investments are made, resulting in a loss, the creditors of a company can lose nothing until the entire capital is wiped out. At this stage of its operations, the balance sheet of the bank would stand as follows : — Liabilities Capital stock ... $ 50,000 Deposits 100,000 $150,000 Resources Office fixtures . . . $ 5,000 * Cash 145,000 $150,000 We will now suppose that the company lends to various persons $100,000 for ninety days at six per cent interest. 1 We will assume that the company rents its offices, and invests $5000 '« furniture, fixtures, and supplies. 152 PROBLEMS OF MONEY AND BANKING These borrowers have accounts at the bank, and wish to have the funds which they borrow available for with- drawal by the usual method — by check. Accordingly the company will deduct $1500 for interest, 1 and credit the borrowers with deposits to the amount of $98,500, When this is done, the balance sheet of the bank will stand as follows : — Liabilities Capital $ 50,000 Depositors .... 198,500 Profits 2 1,500 $250,000 Resources Fixtures $ 5,000 Cash 145,000 Loans and discounts . 100,000 $250,000 By this transaction, it will be observed, the bank has increased its liabilities to depositors by $98,500; as an offset, it now owns $100,000 of promissory notes or bills of exchange, classed as loans and discounts, which at the end of three months will not only cancel such obligations, but also leave a profit of $1500. Whenever loans are made, the effect is to increase a bank's deposits, since most of the borrowers will be depositors and will desire to draw out their money more or less gradually by check. De- posits originating in this way are precisely like the $100,000 of liabilities due to persons who deposited cash in the bank, except for the fact that they are obtained by giving promis- sory notes instead of turning over cash. Let us now suppose that depositors draw checks to the amount of $50,000 in order to effect various payments. After the 1 Except with call loans, which are payable on demand, or call, banks regularly deduct interest in advance. 2 The profits must be accounted for until they are distributed to stock- holders. BANKS AS INSTITUTIONS OF CRELIT 153 checks have been paid, the accounts of the bank will show the following changes : — Resources Fixtures $ 5,000 95,000 100,000 Liabilities Capital % 50,000 Deposits 148,500 Profits i>5oo $200,000 Cash Loans and discounts $200,000 The bank now holds $95,000 of cash against $148,500 of deposits, a reserve equal to nearly sixty-four per cent of these demand liabilities. Experience has shown „ , . 1 Banking that, under ordinary conditions, a reserve of operations r r . {continued). from fifteen to twenty-five per cent is ample to provide for all demands that depositors will make at any one time. Accordingly the bank will endeavor to enlarge its loans, since the liabilities can be safely increased ; while the profits, of course, depend upon the amount of such business that can be done. It therefore lends $100,000 upon the same terms as before, its balance sheet then standing as follows : — Liabilities Capital Deposits Profits $ 50,000 247,000 3,000 $300,000 Resources Fixtures $ 5,000 Cash 95,000 Loans and discounts . 200,000 $300,000 The cash reserve being still nearly forty per cent of its liabilities, the bank invests $10,000 in the purchase of various securities, the stocks or bonds of some prosperous corporation. If, now, shortly after this, depositors with- draw $40,000, the condition of the institution will be as follows : — *54 PROBLEMS OF MONEY AND BANKING Liabilities Capital $ 50,000 Deposits 207,000 Profits 3,000 $260,000 Resources Fixtures $ 5,000 Cash 45,000 Securities .... Loans and discounts 10,000 200,000 $260,000 The cash reserve is now less than twenty-five per cent of the deposits; but $10,000 can be added to it upon short notice by merely selling the securities which the bank holds. It now remains to study one other operation, the issue of notes. Let us assume that the bank is allowed to issue circulating notes with perfect freedom, as no operations bank in the United States has been permitted to do for more than forty years ; and assume, also, that the occasion for the issue is the demand of the depositors for $40,000 of ready money. If the persons who present the checks drawn by the depositors are willing to accept $40,000 of bank notes in payment of their claims against the bank, then the balance sheet will stand : — Liabilities Capital $ 50,000 Deposits 167,000 Notes 40,000 Profits 3,000 $260,000 Resources Fixtures $ 5,000 Cash ...... 45,000 Securities 10,000 Loans and discounts . 200,000 $260,000 Obviously this transaction has not increased the aggre- gate demand liabilities of the bank, but has merely sub- stituted a liability of $40,000 to noteholders for one of $40,000 to depositors. It has, however, had one very important result. If the checks drawn by depositors had BANKS AS INSTITUTIONS OF CREDIT 155 been paid in cash, the specie held by the bank would have been drawn down to $5000, a dangerously low point. The bank could have increased its cash by selling its $10,000 of securities, but even this would have given a reserve of less than ten per cent of the $167,000 due to depositors. Under such conditions the institution could not have loaned any more money to its customary borrow- ers and would have had to curtail its operations until the gradual maturing of some of the $200,000 of discounted paper had increased its cash to safe proportions. As it is, however, by issuing notes the cash reserve is kept unchanged ; and the bank will not need to curtail its loans. § 104. In the United States only three banks were in ex- istence when the Constitution went into effect in 1789; but soon after that the various states began to grant state bank- charters to numerous banking companies, and united** 16 these institutions multiplied at a rapid rate. states - Many of the early banks were conducted with the greatest recklessness and dishonesty, and their creditors suffered enormous losses. In 1814, 1837, and 1857 there occurred general suspensions of specie payments by most of the banks in the country. Since deposit banking was less developed than it is to-day, the banks employed their credit by issu- ing huge quantities of notes, — frequently without any intention of redeeming them. Notes often circulated long after banks had gone out of existence; and every man who did not wish to lose money was obliged to consult bank-note detectors in order to ascertain whether the bills offered him were issued by institutions that would redeem their notes on demand. In the course of time some of the older and more conservative states adopted stringent 156 PROBLEMS OF MONEY AND BANKING laws to check these abuses, and gradually established sound systems of banking. Yet in i860 there were prac- tically no convertible bank notes in the Mississippi Valley north of Louisiana, while the notes of dead or doubtful banks were hawked about at a discount varying from ten to ninety per cent. § 105. The country was wedded, however, to its system of state banks; and our national banking system would not have been established when it was if it had The national banking not been for conditions created by the Civil War. Into these we need not enter; suffice it to say that in 1863 and 1864 Congress passed laws under which our national banks were established. At the present time the principal provisions of the federal laws are as follows : 1. A Comptroller of the Currency is placed in charge of the administration of the banking laws. Each bank is required to report its condition to him five times annually, and examiners are appointed to examine the affairs of each institution. 2. Each national bank must have a capital of not less than $25,000, and stockholders are liable for the debts of the bank to double the par value of their stock. 3. A certain proportion of the capital of each bank must be invested in registered interest-bearing bonds of the United States deposited in the national Treasury. 4. On the security of these bonds, a bank may issue notes to an amount not exceeding the par value of the bonds; but the Comptroller may require additional secu- rity if the bonds ever fall below par. 5. These notes are not legal tender, but are receivable BANKS AS INSTITUTIONS OF CREDIT 157 for taxes, except for duties on imports, and are receivable for payments to any national bank. Each bank must redeem its notes on demand in legal-tender money. 6. Banks must deposit in the Treasury a fund equal to five per cent of their outstanding circulation. Thus the United States undertakes to redeem notes presented at the Treasury; and would do so even if the fund proved insufficient, having adequate security in the bonds and in a first lien upon the assets of a bank. Consequently the notes are practically guaranteed by the government. 7. Each bank must keep a reserve of lawful money. In smaller cities a reserve of fifteen per cent of the deposits is required. In the "reserve cities" a reserve of twenty- five per cent is necessary. Banks in smaller cities may deposit sixty per cent of their reserves with banks in re- serve cities. Banks of reserve cities may deposit fifty per cent of their reserves with banks in " central reserve cities," that is, in New York, Chicago, and St. Louis. 8. Banks are taxed one half of one per cent on their circulation. The notes formerly issued by state banks have been put out of existence by a tax of ten per cent, which made such issues unprofitable. Under these laws an admirably sound banking system has been developed, and the losses and inconveniences suffered prior to i860 have become a thing of The present the past. In recent years state banking insti- Sltuatl0n - tutions have increased in numbers, although they are not allowed to issue notes; and trust companies, which were established originally for the purpose of acting as trustees of estates and executing similar trusts, have entered the field of deposit and discount banking. Yet the national 158 PROBLEMS OF MONEY AND BANKING banks retain a position of preponderance, and will prob- ably continue to do so, even though some of them chafe under the restrictions which the law imposes. If any change is affected in the system, it is likely to be in the conditions under which notes are issued, but a discussion of this matter would carry us too far afield. III. Bimetallism § 1 06. Prior to the nineteenth century many countries had permitted the free coinage of both gold and silver at National ratios varying from about fifteen to fifteen and bimetallism. a hal f gra i ns f s ii ver f or e2iC h grain of gold contained in their coins. The result was that, as often as the market value of one metal or the other changed, Gresham's law came into operation, and the coins that were overvalued drove the others out of circulation. In the United States, for instance, our first coinage system, established in 1792, provided for the free coinage of a sil- The experi- ver dollar containing 371.25 grains of fine metal united e an< ^ a g°ld eagle with fine contents of 247.5 states. grains. This established a proportionate valua- tion of fifteen to one, 1 which was approximately the correct market ratio at the time the law was passed; but very soon silver fell in value, so that 15.61 grains were required in the bullion market to purchase one grain of gold. The result was that gold could not circulate by the side of sil- ver coins valued at the ratio established in 1792, and the country was thrown on a silver basis. In 1834 and 1837 1 Since the eagle weighed 247.5 grains, the law rated 24.75 grains of fine gold as equivalent to 371.25 grains of silver. This gives the ratio of fifteen to one. BIMETALLISM 1 5 g Congress cut down the contents of the eagle to 232.2 grains in order to bring gold back into circulation. This action established a ratio of 15.988 to 1 — known ever since as sixteen to one — by which silver was slightly under- valued, and gold was enabled gradually to displace it. The Californian discoveries had the effect of lowering still farther the value of gold; so that, in 1853, the silver contained in a dollar was worth $1.04, and the coin had gone wholly out of use. Thus our currency was placed upon a gold basis, and remained there until the issue of greenbacks in 1862 introduced an era of depreciated paper money. § 107. In 1816 England had debased her silver coins, made them legal tender only for small payments, and established gold as the sole standard of value. G oiamono- This movement toward gold monometallism metallism - was greatly accelerated when, in 187 1 and 1873, the newl} formed German Empire established a national gold coin- age, and withdrew most of the silver coins that had for- merly circulated in the various German states. At about the same time the United States, with a view to the future resumption of specie payments, began to revise its coinage laws; and in 1873 finally dropped from its list of author- ized coins the obsolete silver dollar which was still worth more than the gold dollar. This action put an end to the free coinage of silver, and by it that metal is said to have been "demonetized." The law of 1873 was passed for the purpose, repeatedly expressed in Congress, of making gold the sole standard of value when specie payments should be resumed; yet it has been charged, wrongly, that the measure was enacted "secretly" or "inadvert- 160 PROBLEMS OF MONEY AND BANKING ently" or even "fraudulently." The fact is that no one was interested in the fate of a silver dollar that was worth $1.02 in gold, and that no interest would have been mani- fested in it subsequently if the depreciation of silver had not made it cheaper than our standard gold coins. § 108. Meanwhile France, Italy, and some smaller countries had organized the Latin Monetary Union, and _ : ;. established the free coinage of both silver and The Latin ° Monetary gold at a ratio of 15.5 to i. The large produc- tion of gold in California and Australia had long kept the value of that metal so low that it had flowed in large quantities to the French mints; but after 1870 the output of silver was enormously increased, and its value in turn declined. The result was that silver began to flow in excessive quantities to the mints of the Latin Union, so that it became necessary to restrict the coinage of that metal; in 1876, indeed, when the ratio had become 17.75 to 1, the French mints were closed to silver. § 109. Since 1876 all changes in the monetary situation have tended toward the general adoption of a single gold standard and the relegation of silver to a place Supremacy ° r of the gold as subsidiary currency. Austria and Russia have endeavored to free themselves from de- preciated paper currencies, and to place their systems on a gold basis ; and the coinage of silver has been restricted in many countries. The peoples of Asia and South Amer- ica had from time immemorial employed silver as their principal money metal, but in 1893 India was compelled to discontinue free coinage of the silver rupee. After that the movement away from silver extended to Japan and various other countries* The result has been that BIMETALLISM l6l the opening of the twentieth century finds silver, which prior to the nineteenth century had been the more com- mon medium of exchange, relegated to the position of an inferior currency, subsidiary to gold. § no. This change has not come about without pro- test, especially in the United States. In 1876, with the resumption of specie payments approaching The silver at the end of 1878, it was seen that the silver n the United dollar, then worth but ninety cents, would be states - able to displace gold if the famous law of 1873 had not stricken it from the list of authorized coins. Immediately there began a demand for the free coinage of silver, and the "silver issue" made its appearance in national politics. In 1878 the Bland-Allison Act was passed, which required the government to purchase a certain quantity of silver at the market price each year, and coin it into dollars con- taining 371.25 grains of fine metal. Under this act, $378,166,723 of silver had been injected into circulation by 1890, when Congress passed the Sherman Act, provid- ing for increased purchases of silver against which legal- tender notes were issued. 1 The act of 1878 had effected a gradual substitution of silver for gold, and the increased inflation of cheap money authorized by the Sherman Act led to a more rapid exportation of the yellow metal. There is no question that a few more years would have placed the country upon the silver basis, by causing the complete displacement of gold. In 1893, however, a disastrous panic intervened, which was thought to be due in some 1 Of these notes about $156,000,000 were issued. They were called Sherman notes, or notes of 1890. Only about $3,246,000 remained in existence at the end of 1911, the rest having been retired. The silver purchased by the notes has been coined into standard dollars. 1 62 PROBLEMS OF MONEY AND BANKING degree to the operation of the law of 1890; and, after a protracted struggle in Congress, the Sherman Act was repealed. This action fanned the agitation into a fiercer blaze than ever before, and the presidential election of 1896 turned almost solely upon the issue of establishing the free and unlimited coinage of the silver dollar, then worth only fifty-two cents. The defeat of the silver party finally disposed of this troublesome question which had vexed the country for twenty years. There is no reason to doubt that if free coinage of silver had been permitted, the operation of Gresham's law would have placed the nation on a silver basis, and would have decreased ulti- mately by almost fifty per cent the purchasing power of "•Jie medium in which debts are paid. § in. For a single nation to attempt free coinage of silver at any such ratio as sixteen to one is now generally international conceded to be the height of folly. But for bimetallism, ftfitfy or forty years international bimetallism — another and very different proposition — has occa- sioned much discussion. The displacement of silver as standard money and the increased use of gold assumed large proportions at the very time when the world's gold production began to show signs of decrease. Simulta- neously there commenced a downward movement of prices, by which the purchasing power of the gold dollar stead- ily rose from 1873 to 1897. This, naturally enough, occa- sioned much discontent and lent great interest to schemes for the establishment of international bimetallism, by which, it was hoped, an increased use of silver would be made possible and the fall of prices would be checked. § 112. Bimetallists urged that the continual fall of BIMETALLISM 1 63 prices increased the burden of all debts growing out of contracts that ran for a term of years, and their conten- tion has never been successfully refuted. If it Arguments in is unjust to permit debtors to pay creditors in ltsfavor - money of inferior purchasing power, it must be equally so to require them to pay their debts in a medium of which the purchasing power has increased; debased currency is no more iniquitous than a currency that steadily appre- ciates. Moreover, it was argued that falling prices have an injurious effect upon industry, since they steadily diminish the amount of money that producers can get in exchange for their commodities. Bimetallists contended that the fall of prices, depressing enterprise and injuring debtors, was due to the fact that silver had been partially "demonetized," and gold had been made the sole standard of value; they urged, therefore, that the leading nations should enter into an agreement to permit both gold and silver to be employed as money at some proper ratio. Debate between the bimetallists and the advocates of monometallism turned upon the questions of the evils caused by falling prices, the cause of the fall, The fan of and the efficacy and practicability of the pro- pnces - posed remedy. The arguments advanced by some mono- metallists to prove that falling prices do not wrong debtors and are a good thing for business do not present an im- pressive appearance. 1 Turning to the causes for the fall of prices after 1873, it seems tolerably clear that the mono- metallists were not successful in their contention that an increased demand for gold money had nothing to do with 1 For instance, if the falling prices prior to 1897 were a good thing for business, have the rising prices since that date been a bad thing ? 164 PROBLEMS OF MONEY AND BANKING the change in the price level. Doubtless bimetallists exaggerated the influence of the changes in the relative demands for gold and silver for monetary purposes; yet it seems reasonable to suppose that, as one nation after another began to use gold in preference to silver, the growing demand for the former metal and the narrowing demand for the latter tended to raise the value of the one and to depress that of the other. The fall in silver was, of course, greatly accelerated by the very large increase in the production of that metal after 187O0 The serious issue between the two parties to the debate was the efficacy and practicability of the remedy. proposed Practicabn- by the bimetallists. The monometallists ar- Mmetaiiic g uec * that a ^ experience showed that the market standard. rat j between gold and silver had always fluctuated ; and that this fact demonstrated that it always would fluctuate, with the result that, at the established legal ratio, one metal would always be cheaper than the other and would enjoy exclusive circulation. The bimet- allist replied that if all the principal nations entered the agreement, gold, if it should happen temporarily to be undervalued, would not be driven entirely out of use by the cheaper silver coins. They argued that Gresham's law cannot operate if there is no country where the dearer metal can go the moment that it begins to be displaced by the cheaper. At the present time something more than $7,000,000,000 of gold circulates in the principal lands of the earth ; and the bimetallists believed that such a quan- tity of metal could not be driven out of use as money 1 and 1 It is at this point that international bimetallism differs from the pro- posal to adopt free coinage of silver in a single country. Under the latter BIMETALLISM 165 thrown into the melting pot without lowering the value of gold to a point that would reestablish its parity with silver at the legal ratio. Moreover, it was said that, as gold should begin to leave the channels of circulation, there would be a proportionate increase in the demand for sil- ver money, by which the value of that metal would be given an upward turn. On this point there may be room for considerable difference of opinion, but the belief of the writer has always been that, on the assumption that a world-wide agreement is attained, the bimetallist had the best of the controversy. § 113. The strength of the argument of the monometal- lists lay in their contention that a bimetallic agreement, how- ever desirable it might be, could not be reached , „ , , .. . The strength by all the leading nations; and, if reached, of opposing would not be certain of continued maintenance. argumen s ' As a matter of fact repeated conferences were held by various countries, including the United States, which has constantly tried to "do something'' for silver; but there has never been any prospect that England, and perhaps Germany, would abandon the gold standard. The vast commerce of England has been built up since 181 6 upon the basis of the stability of the gold sovereign, and English merchants are not willing to take any chances with a system dependent on international agreement. Germany adopted the gold standard partly for political reasons; and although there has been a strong bimetallist move- ment in that country, it has never seemed probable that the government would accept an international agreement condition, gold could be exported to many other countries to be used as money. 1 66 PROBLEMS OF MONEY AND BANKING for the free coinage of silver. This, then, was the rock on which the projects of the bimetallists always shattered. § 114. If the gold production had remained as small as it was so late as 1890, and prices had continued to fall, it is probable that international bimetallism Conclusion. i-i.ni • e -r. would still be a topic of vital interest. But the enormous increase in the output of gold, which at length caused an upward movement of prices, has produced the very condition for which the bimetallists contended, — a larger volume of money that would check the decline of prices. It has also deprived their schemes of all present importance, and made bimetallism a topic of purely aca- demic interest. So long as the world's gold output con- tinues to be as large as $450,000,000 annually, the gold standard will not be replaced by a bimetallic agreement. FOR SUPPLEMENTARY STUDY General : Bullock, Selected Readings in Economics, 406-430 ; Hadley, Economics, 207-231, 241-263; Nicholson, Po- litical Economy II, 125-130, 140-205 ; Seager, Introduction to Economics, 310-360; Taussig, Principles of Economics, Bk. III. Special : Bullock, Essays on the Monetary History of the United States, 29-121 ; Dunbar, Theory and History of Banking, 1- 94, 158-190 ; Jevons, Money and the Mechanism of Exchange, 192-284 ; Kinley, Money ; White, Money and Banking, 60- 102, 130-163, 174-216, 372-384, 4I7-43I- CHAPTER IX MONOPOLIES I. Introduction § 115. Monopoly means such control over the supply 0} a commodity as conjers the power to fix the price. It may be secured either by buying up, "corner- Monopoly ing," the major part of the available stock, defined - or by acquiring the exclusive or substantially exclusive power to produce the commodity. Control secured in the first manner can be only temporary, because efforts to " corner" the supply in order to raise prices merely tempt more capital into an industry and increase the output; if, however, control is attained in the second way, there may be a prospect of permanent success. An absolute mastery of supply, and hence of prices, sel- dom or never exists, since it is generally possible to procure substitutes for a monopolized commodity, and this will be done to an increasing extent as monopoly charges are raised. Soft coal or coke may be used instead of anthracite, cotton may be employed in place of wool, electricity may be utilized instead of illuminating oil, and many similar substitutions can be effected. This consideration is not a defence or justification of the action of the monopolizer who puts consumers to the trouble of 167 1 68 MONOPOLIES devising substitutes, which are often inferior to the origi- nal article ; but it does set an ultimate limit beyond which the power of a monopoly cannot extend. Then, again, the monopolist is likely to be disturbed by the constant establishment of rival enterprises which are called into existence by the high prices that he suppressing maintains. Our most successful trusts have competition. . . never produced more than eighty to ninety-five per cent of the products which they controlled; and the higher that prices are raised, the larger becomes the num- ber of rival establishments. The fear, therefore, of possible competition may sometimes limit the power of a combina- tion over the price of a monopolized commodity. § 116. Upon the facts that substitution is possible and competition is probable if prices are raised to exorbitant Denials of the % ures ? ^ e apologists for monopoly have based existence of the claim that there are few or no monopolies monopolies. . . in the United States. Monopoly, however, does not mean absolute control; it means merely the power to raise prices somewhat above the marginal cost of produc- tion, the point at which competitive prices are fixed. The employment of substitutes does not begin until prices are raised above the competitive level, and the fact that a few independent concerns furnish ten or twenty per cent of the product does not keep prices down to the mar ginal cost of production. For most practical purposes, control over seventy, eighty, or ninety per cent of the supply confers the power to raise prices, and answers all the objects of the monopolist. In fact, it is frequently advantageous to have the appearance of competition maintained, since this makes it easier to delude the public. INTRODUCTION 1 69 § 117. If we leave out of account exceptional cases in which the possession of extremely rare artistic or business skill confers monopolistic power upon a person, C13.SSCS 01 we can divide monopolies into three classes, monopolies: First in order we may place legal monopolies, which are dependent upon an exclusive grant from a gov- ernment ; they may be either private or public in character. In the one case the government grants an exclusive privi- lege to an individual or group of persons ; in the other, it reserves to itself the sole power to conduct some enter- prise. Private legal monopolies were secured in early times through the mere favor of the sovereign; but to- day, as with patents and copyrights, they are granted for a limited term of years for the purpose of encourag- ing invention and fostering letters. In some industries patents have become an important factor in developing and maintaining large monopolies. Public legal monopo- lies may be established in order to provide for the better administration of some important service, as the postal department; or may be created as the best method of taxing the people, as the tobacco monopoly in France. In the one case prices may be kept low in order to encourage the extensive use of the service; in the other, they will be made high enough to bring in the maximum profits. Sometimes, indeed, the two purposes are more or less mingled in the same enterprise, as in the Prussian railway service, which, although originally undertaken for other purposes, has become a source of large revenue. Second in order are natural monopolies, which arise on account of peculiar properties inherent in certain lines of business. Many natural agents of production are nar- iyo MONOPOLIES rowly limited in supply, and the limitation is frequently so strict that it is possible for a group of persons to acquire (2) Natural control of them. Practically all of the anthra- monopoiies. cite coal of the Tj n i te( } States is found in a comparatively small area in Pennsylvania, and it has been possible for a group of railways, in defiance of express provisions of law, to acquire a monopoly of hard coal. So, too, petroleum fields, deposits of copper and iron ores, water powers, irrigation facilities, water fronts of large cities, and many other natural agents are so limited in extent as to fall into the control of a small number of persons or companies. Such a condition is very favor- able for the growth of a monopoly, although this result may not appear in all cases. A second group of natural monopolies originates from the fact that certain products or services can be consumed only in connection with an expensive distrib- monopoiies uting apparatus. Gas, water, and electricity {continued). .. . . can be supplied only to persons who have connected their houses or factories with the mains, pipes, or wires required for their distribution. Street or steam railways can reach their customers only by constructing tracks in certain localities, and the telegraph and telephone present the same conditions. In all these cases it is cheaper for one company to supply a given district than for two concerns to duplicate the distributing plants and compete for business. Accordingly, whenever competi- tion is attempted, capital is wasted in needless duplication of pipes, tracks, or wires; and the managers of rival concerns perceive, sooner or later, that, even apart from the possibility of raising prices, more money can be made MONOPOLY VALUE \J\ by forming a combination and eliminating unnecessary expense for the distribution of the service. For this reason monopoly may be regarded as the condition that must ultimately prevail in such an industry. The so-called capitalistic monopolies constitute a third class. They have been formed in many branches of manufacturing industry that do not seem to ? . . ., . (3) Capital- pOSSeSS the characteristics attributed to natu- isticmonop- ral monopolies; and it is alleged that they are due to the economies that result from the combination of competing enterprises. If this should turn out to be the case, it would seem that they must be considered just as natural as the monopolies in the gas, water, or electric- lighting industries; so that the distinction between our second and third classes would disappear, The belief of the writer, however, is that this is not the case, as will be set forth in a later part of this chapter. II. Monopoly Value § 1 1 8. Whenever competition prevails, it is in the in- terest of every producer to increase his output as long as the price remains high enough to yield him a profit ; The deter- since, if he should curtail production, other Monopoly * concerns would extend their sales at his ex- values - pense. The monopolist, however, possessing for the* time being an effective control over the industry, is able to restrict the output and to raise the price of the commodity to such a point as proves to be most profitable. For this reason the value of a monopoly product will not be gov- erned by the same principles that apply when competition exists. The general law of monopoly prices is that they 172 MONOPOLIES will be adjusted in such a manner as to yield the monopo- list the largest profits obtainable from the industry; or, in technical language, will be fixed at the point of high- est net returns. In determining where this point is, the intelligent monopolist will take into account the following considerations : — (i) As the price is raised above the former level estab- lished by competition, the demand will inevitably decline, and the monopolist must reduce his output. If he does not pursue this course, part of his goods will remain un- sold at the price which he desires to maintain. With articles of voluntary consumption, the demand falls off very rapidly as the price is raised, so that the power of the monopolist is quickly limited by reason of the fact that exorbitant charges decrease the sales faster than they increase the profits on each article sold. With neces- sities, the power of the monopolist is greater; and prices can be raised very materially before the sales decline enough to make further increase unprofitable. (2) Certain expenses of production increase or decrease nearly proportionately with corresponding changes in the product; 1 while others remain absolutely or approxi- mately the same however large the output may be (§69). (3) The maximum net revenue that may be obtained is determined by disregarding all the fixed expenses, and by studying with care (a) the quantity of the product which consumers will demand at various prices, and (b) the variable expenses chargeable to each unit of the supply. 1 Sometimes the variable expenses will decrease as the output is enlarged, when considerable advantages attend production on a larger scale. MONOPOLY VALUE 173 § 119. The problem will be made clearer if we consider the assumed case of a street railway company which monopolizes the traffic of a small city. Sup- The law of pose that the fixed expenses of such a company ™*e P mus- for interest on the bonded debt, salaries of trated - principal officials, and other similar items amount to $40,000 annually; and assume that the variable expenses amount to 2 cents for each passenger carried. Then suppose that a fare of 10 cents will induce 600,000 persons to patronize the company in the course of the year, and that lower fares increase the traffic until a price of 3 cents attracts 4,000,000 passengers. The elements which the company will study in determining what fare to charge are shown in the following table: — Fare Passengfrs Carried Total Earnings Variable Expenses Net Earnings Fixed Expenses Net Revenue IO 600,000 $60,000 $12,000 $48,000 $40,000 $8,000 8 800,000 64,000 l6,000 48,000 40,000 8,000 6 1 ,400,000 84,000 28,000 56,000 40,000 l6,000 5 2,000,000 100,000 40,000 60,000 40,000 20,000 4 2,500,000 100,000 50,000 50,000 40,000 10,000 3 4,000,000 120,000 80,000 40,000 40,000 Under the conditions here represented it is evident that the total receipts of the company steadily increase until a fare of 3 cents is reached; and that, if the mu . ° ' ' The lllustra- variable expenses did not affect the problem, tion further . r ^ ^ ^ i • j i_ considered. the largest profits would be obtained by establishing this low charge. But when the variable expenses are taken into account, it is seen that 5 cents 174 MONOPOLIES wiil be the most profitable fare; since from 10 cents down to 5 the traffic increases faster than the variable expenses; while below that point these expenses increase more rapidly than the traffic. It is obvious, too, that the fixed expenses never enter into the calculation. A fare that yields the largest net income above the variable expenses will also afford the largest amount of revenue that can be secured for meeting the fixed charges. If, in this case, the net earnings with a 5 -cent fare had been insufficient to defray the fixed charges, the company would only have made the situation worse by adopting a different rate; as it is, our figures show that all expenses can be met, and that $20,000 will still remain available for dividends to the stockholders. A monopoly price, there- fore, does not mean the price that the most necessitous consumer would conceivably pay, but one that yields the highest net returns; for, indeed, if the demand for a commodity is very elastic, it may happen that the monopo- list cannot raise the price far above the point at which competition would have placed it. III. Natural Monopolies § 120. It is now generally recognized that perma- nent competition cannot be expected in industries that Municipal exhibit the characteristics attributed to nat- monopoiies. ura j monopolies. When American cities first began to require extensive waterworks, lighting facili- ties, and means of transportation, it was generally supposed that the way to secure good service and low prices was to charter a number of competing companies. In this manner enormous amounts of capital were wasted, NATURAL MONOPOLIES 1 75 while the anticipated competition always proved illusory. In many cases the rival companies were consolidated; and where this was prevented or considered inexpedient, they formed secret agreements to keep out of one another's territory and to maintain high charges. The growth of the cities has served merely to increase the gains of com- panies enjoying municipal franchises, and these profits have been concealed by issuing watered stock upon which moderate rates of dividend could be paid. 1 § 121. Even more serious have been the political evils which have flowed from these conditions. Municipal franchises are so profitable that the temptation Political to secure them, on terms unfavorable to the corru P tlon - city, by corrupt means has been too strong to be resisted. Originally the franchises were bestowed without thought of their actual or prospective value ; and it is only within a short time that we have awakened to the fact that cor- rupt boards of aldermen have been bartering away the birthright of all the people to powerful corporations that use the privileges accorded them for the purpose of exact- ing extortionate gains. Gradually the poison of bribery has worked itself into all parts of our municipal govern- ments, and has extended to the state legislatures, which have the power to control local bodies. The notorious 1 A street railroad which costs $1,000,000 to build and can earn $150,000 a year must pay 15 per cent dividends in order to distribute the earnings among the stockholders. Now by issuing $2,000,000 of watered stock and increasing the capitalization to $3,000,000, the moderate rate of 5 per cent will distribute the earnings. The company will then deny that its earnings are exorbitant; and will oppose attempts to reduce fares, on the ground that if charges are reduced it will not be able to pay the very moderate rate of 5 per cent to the widows and orphans who have purchased its stock. IJ6 MONOPOLIES evils of American city governments are not due to ignorant foreign voters, or to the alliance of the police force with vice, to any such extent as they are attributable to the misdeeds of those who consider themselves respectable citizens and the leaders in financial or social circles; for back of the "boodle alderman" one always finds the respectable banker or the eminent financier. The piracy of municipal franchises, in fact, is the principal cause of the corruption and inefficiency that are so unfortunately characteristic of city governments at the present day. § 122. Happily our people are beginning to realize the nature and extent of these evils, and are seriously study- Municipai m g various remedies suggested for the un- ownership. fortunate condition of affairs. Many writers have favored municipal ownership of all natural mo- nopolies ; and this proposition, which ten or fifteen years ago was considered rank socialism, has commanded an increasing amount of support. In behalf of the plan it is argued that, since monopoly is inevitable in these industries, our only choice lies between public and private monopoly, and that the former is far preferable to the latter. Private monopolies, it is contended, cannot be allowed to go uncontrolled; and the attempt to regulate them arrays powerful corporations against the public in- terest, with results that are disastrous to the virtue of city officials and state legislatures. Corruption and extor- tion, it is said, can be remedied only by having the ac- credited agents of all the people manage these enterprises with a single view to the interests of the public. But the problem hardly admits of such a simple solu- tion. Monopoly, it must be conceded, is inevitable; NATURAL MONOPOLIES \jy and our only alternatives are, admittedly, public owner- ship or private ownership with public control. But public ownership presents serious difficulties, chiefly i ts dim- that of securing efficient and honest man- culties - agement. At the present, from the federal postal es- tablishment down to the small municipal printing office, public management is found to be frequently ineffective, and not infrequently dishonest. Laborers engaged on public works are likely to demand short hours and the highest pay, while working at a pace that must be ex- ceeded by the citizen who hopes to pay his annual tax bill ; governments must purchase materials and supplies from contractors, many of whom will stoop to such bribery as has been exposed in the postal service; and the result is that the cost of operation is often higher than it would be under a private corporation. Moreover, when a deficit appears in a public enterprise, it is likely to be viewed with extreme complacency by the large number of citizens who pay no taxes on real or personal property, but secure the service for less than cost. Evidently, public owner- ship, even if it is better than private, carries with it very grave difficulties which make it, at the best, nothing but the less of two evils. Our cities have had the most experience with municipal waterworks, which are now more often public than pri- vate, especially in the larger centers of popu- The lessons lation. The results of public management of experience, have been better in this case than they would be in the lighting or transportation industries, since waterworks are simpler in operation and most of the methods and appliances have long since passed out of the 178 MONOPOLIES experimental stage. We have had few experiments with municipal gas plants, and the teachings of experience at this point are somewhat conflicting. A larger number of cities have entered the electric-lighting industry, but the movement is too recent to permit one to form any- thing like a final conclusion. With street railways, public management is practically untried, although municipal ownership of subways which have been leased to private companies has been adopted in New York, Boston, 'and perhaps other cities. In all industries success or failure has depended on the character of the local governments; and, wherever the politicians have been allowed to rob the people, municipal ownership has proved anything but an unmixed blessing. § 123. Between the alternatives of public ownership and private management under public control, it will be wise for the student to refrain from making Conclusions. . . . any general decision; m fact, the only safe course is to decide each case that arises with reference to its particular circumstances. Municipal ownership of waterworks has, on the whole, justified itself by its results; public management of street railways at a time when all the methods and appliances have not yet passed out of the experimental stage would be far more hazardous. 1 In all cases the probability of securing honest and efficient management is the factor to be given the chief weight. A reform of the civil service by which appointments to public office can be separated from poli- 1 Since 1890 the method of propelling cars has been revolutionized by electricity, and one form of electrical equipment after another has come into use. NATURAL MONOPOLIES 1 79 tics is an absolutely indispensable condition for the fur- ther extension of municipal enterprise; and in any case the ugly problem of bribery must be grappled with, since this will not be eliminated by the adoption of public man- agement. During the past decade American cities have made encouraging efforts to improve the management of municipal affairs, and various states have established commissions with necessary power to control public ser- vice ' corporations. Enough has already been accom- plished to justify the expectation that such control will become increasingly effective. While, therefore, experi- ments in municipal ownership may be desirable, effective public control may make unnecessary the general adop- tion of public ownership. § 124. Besides the various municipal services just mentioned, the railroads, the telegraph, and the tele- phone industries possess the characteristics of other na t U rai natural monopolies. The railroad problem m ° n °P° lies - is so extremely important that it will require treatment in a separate chapter; the telegraph and telephone industries cannot receive adequate attention in the space at our command. The events of 1902 have brought into prominence the fact that the country's supply of anthra- cite coal has fallen into the hands of a few railroads which have acquired a substantial monopoly of the mines. It is probable that from one dollar to a dollar and fifty cents is added by the coal monopoly to the price of every ton of anthracite coal consumed in the United States, and some of the magnates in charge of the roads have been so destitute of humor as to inform the country that this con- dition of things has been expressly ordained by divine 180 MONOPOLIES Providence. It is possible that the extortion now prac- ticed will some day be remedied by vigorous treatment of the railway problem, but at present we find in the anthra- cite coal industry a striking illustration of the importance that natural monopolies sometimes assume. IV. Capitalistic Monopolies § 125. Not long after the Civil War various agreements were formed in the distilling and some other industries, by which producers undertook to limit the out- Agreements ■' x between put and to raise prices. These arrangements, however, were seldom of long duration, since one or more of the parties to a compact would usually break his promise and increase his sales at the expense of those who kept their word. Similar efforts to harmonize conflicting interests and establish monopoly prices have continued to the present day; but generally mutual jealousy and suspicion have prevented them from being very effective, even when they have been reenforced by the establishment of common selling agencies. Yet a "friendly agreement" between a few large beef packers in Chicago and some other cities has sufficed to build up a partial monopoly of the dressed beef industry. § 126. The weakness of the " gentlemen's agreement" led to the establishment of a more formal organization known as a pool, by which is meant an agree- Thepool. t . i 1 . , , ment to divide the territory served, or the business obtained, or the earnings of the industry. Pools have been most extensively used by the railways of the country, but such associations existed in the steel rail industry prior to 1897, and have been renewed in recent CAPITALISTIC MONOPOLIES 181 years in nearly all branches of the steel trade. They often enable producers to raise prices for a considerable period of time, 1 but may be broken up on account of the same weakness that is so fatal to the informal agreement. The courts long ago decided that pooling contracts, since they have a tendency to restrain trade and are contrary to public policy, cannot be legally enforced; and it is very difficult to devise a system of fines or other penalties that will prevent some members from breaking a pooling agree- ment when a strong inducement is offered for doing so. § 127. A more effective device was invented in 1882 when the Standard Oil Trust was established. In the trust a large number of firms and corpora- & r The trust. tions which had already been brought under a single control were united under a board of trustees. The stockholders in the various companies surrendered their stock to the trustees, and received trust certificates for the amounts at which their property was valued. This arrangement placed effective control of the different enterprises in the hands of a single board; and within a few years, the plan was adopted by combinations in several other industries. By 1887 this movement toward the formation of trusts reached such proportions as to create considerable alarm at the spread of monopoly, and to call forth a large number of repressive statutes. During the next five years many states enacted anti- trust laws; and, 1 In the spring of 1896 a pool raised the price of steel rails by degrees from $17 to $25 per ton at Pittsburg; subsequently the price was ad- vanced to $29. In 1897, wnen the pool was dissolved, the price fell to #15, and even lower. The United States government had been charged #563 per ton for armor plate ; but after the dissolution of the pool, one of the steel companies submitted an offer at a price of $240. 1 82 MONOPOLIES in 1890, Congress passed what is known as the Sherman Act, which prohibits all contracts or combinations in re- straint of interstate commerce. Little was accomplished under most of these statutes, but the courts at length decided that the trust was an unlawful form of organiza- tion. 1 Accordingly the trusts were ostentatiously dis- solved, and forthwith reorganized in another form; so that they still exist in fact, though not in name. § 128. The so-called trusts of the present day are merely large corporations which have issued their securities in The present order to purchase the companies which were com- capTtaiistic bined under one organization. For some years monopolies. after its enactment the Sherman Act was not enforced with any degree of success against industrial combinations. But under its provisions the Supreme Court in 1904 dissolved a company organized under the laws of New Jersey to hold the stock of certain railroad companies in the Northwest. Thereafter various in- dustrial and commercial combinations were successfully attacked, and a vigorous enforcement of the Sherman Act was undertaken against a long list of organizations, both large and small. In 1911 the Standard Oil Com- pany and American Tobacco Company were finally dis- solved, but were allowed to reorganize in the form of a number of separate companies which probably remain practically under single control. There is now no doubt that the Sherman Act effectually restrains formal organi- 1 This was decided in New York on the ground that when a corpora- tion surrenders its stock to trustees, it abdicates control of its business, an action which is ultra vires, that is, beyond the powers bestowed upon it by its charter. CAPITALISTIC MONOPOLIES 1 83 zation to monopolize trade between the states, but it is doubted whether it can compel producers to compete. It is certain, however, that the formation of trusts has come to an end, and that all persons who by common ownership of stock, price agreements, or otherwise, com- bine to monopolize trade do so at serious peril. § 129. Trusts have found numerous apologists or active advocates, who, for a decade or more, have argued that modern combinations are merely the latest and ~- . . . . Arguments in most efficient method of organizing capital, favor of com- and the highest product of industrial evolu- tion. The principal basis for such claims consists of certain economies which, it is alleged, can be realized by the combination of all the companies engaged in an in- dustry. The savings attributed to the formation of trusts may be divided into two classes: those supposed to be effected in the process of production, and those realized in the marketing of products. Of the first class, the alleged economies are due to the advantages of production on a large scale. At this point the advocate of the trust usually contrasts Alleged small-scale production with a combination of economies in all competing plants, and argues that decided pr ° UC 10n ' superiority lies with the latter. But this is very wide of the mark, since the real question is whether the trust is superior to the very large concerns which it unites — ■ whether, for instance, the United States Steel Corporation is a more efficient producer than the Carnegie Company, which it absorbed, or than the Lackawanna Company, which has entered the industry as a competitor with a capital of some $40,000,000. When the matter is ex- 1 84 MONOPOLIES amined in this way, and confusion of large-scale production with monopoly is avoided, the argument in favor of the trust does not appear to be very strong. Experience seems to show that in manufacturing industry there are limits beyond which an increase in the size of a company will not reduce the cost of production, and that this point is reached long before a single concern becomes large enough to monopolize the whole field. In practically every industry that has been dominated by a trust ; in- dependent concerns have continually made their appear- ance, and have competed so effectively that they have been crushed, if at all, only by foul means. When, however, we turn to the work of marketing products, the case in favor of combination is not so weak. Economi s ^ monopoly can avoid some of the outlay in marketing which competing firms incur for advertising products. 1. 1 , ., and traveling salesmen, while occasionally something can be saved in freight rates by sending every order to be filled at the mill that is nearest to the consumer. But it must not be forgotten that a large amount of adver- tising is necessary in order to stimulate the demand for certain products, and that some trusts that originally made deep cuts in their advertising expenses found that the demand declined so rapidly that a more liberal policy was necessary. Then, too, a factory that is content to supply its natural territory and not ambitious to control all markets, however distant, does not need to make such excessive expenditures in pushing its sales. And finally the freight rates saved by avoiding cross- shipments are not a large factor in the case of products which are not of a bulky character; while, with bulky goods, production CAPITALISTIC MONOPOLIES 1 85 is usually pretty well localized in the vicinity of the principal consumers before combinations are formed, so that there is generally little room for saving in cross freights. While it must be conceded that a monopoly may be able to effect some savings in marketing its prod- ucts, it is certain that the economies thus attained have been greatly exaggerated. More than twenty different economies are said to be attained by combinations, and the list is so formidable as to raise the question how, if the facts are „,, p- The persist- as alleged, an independent concern can have enceofcom- 1 r • r -vt 1 petition. the faintest prospect of success. Now the fact is that new competitors generally arise shortly after a trust is formed, and that competition with the combina- tions has steadily increased. 1 It is evident that the busi- ness world has not accepted the argument that the trust is more efficient than an independent concern of large size, but has proceeded upon the opposite theory. For the present, therefore, the student will do well to entertain a profound skepticism concerning the net advantages of the trust. A consideration that generally escapes notice is the fact that large combinations are subjected to constant 1 Advocates of the trusts usually enter a demurrer here, and say that this proves nothing, since the new companies are organized for the purpose of selling out to the trusts at high prices. The point is not well taken, however, for no intelligent corporation manager, possessing a plant that could produce a commodity more cheaply than any possible competitor, would long continue to buy out inferior establishments that could not hope to live in the face of fair competition. A new and superior agent of pro- duction, like the power loom, can be set to work without buying up all the hand looms; and this would be true of the trust if it were the most effec- tive method of organizing production. T S6 MONOPOLIES expenses from which the independent concern may L*? comparatively free. The ablest legal talent must be em- ployed at great expense to devise methods of Disadvan- x . J ... tagesofa circumventing inconvenient statutes; an expen- combination. . . . , , . , sive secret service is sometimes needed in order to spy out the affairs of competitors by methods that involve considerable wear and tear upon the self-respect of both principal and agent; large contributions must be made to the campaign funds of one or both political parties, since the politicians must be conciliated at all hazards; while enormous sums must be constantly in- vested in suppressing competitors, and giving a proper warning to prospective interlopers. It will be observed that we here assume that the company never stoops to actual bribery or makes large legislative expenditures which have to be charged up to the construction account. When, indeed, all factors are taken into consideration, it seems doubtful whether one should speak of the net savings or the net wastes that result from combination. § 130. The whole ground covered by the debate con- cerning the advantages of the trust is too large for us The alleged to examine it in all details, but it should chSactefof be remarked that the argument in favor of competition, combination usually begins with the propo- sition that competition is not only a wasteful but a destructive process. Combination is represented as the natural refuge for competing concerns that have been wasting their substance in a life- and- death struggle for survival; and, in particular, it is alleged that hard times, which destroy profits, are the real parents of the trust movement. The claim is disproved by the simple fact CAPITALISTIC MONOPOLIES 1 87 that trusts are formed, not in times when business is depressed, but in periods of prosperity. In 1893, the year of the last serious panic, new combinations were formed with a capitalization of $239,000,000. The follow- ing year, when the prostration of industry was complete, the capitalization of organized trusts was only $30,400,000 ; and the movement continued to show small proportions until 1898, when prosperity had fully returned. In that year the newly organized trusts had a capital of $708,000,000; in 1899 the figures rose to $2,243,000,000; and in 1900 stood at $831,000,000. After 1902, when conditions in the stock market became unfavorable, it proved difficult to carry through any sort of scheme for securing the "economies of combination"; not adversity, then, but prosperity seems to be the condition favorable to the growth of trusts. § 131. This brings us to a more important considera- tion. The combinations formed between 1897 and 1902 were organized not for the purpose of realizing The re economies in manufacturing commodities, but for trust move- the profits to be derived from marketing stocks, united The return of prosperity sent investors into the stock market in search for securities in which to invest the profits drawn from their business enterprises. Under this demand stocks rose to high prices and a speculative fever was induced which broke all restraint and carried prices up to still higher figures. This was the opportunity for the promoter of companies, and he was not slow to seize it. The country needed few new railroads, and the best thing to operate in was the staple branches of manu- facturing industry. Options were secured upon large 188 MONOPOLIES numbers of plants, good, bad, and indifferent; extrava- gant prices were offered, payment being made more often with securities than with money; and the stocks or bonds of the newly formed combinations were offered to investors, who greedily seized the bait. This pro- cess continued as long as the public would purchase the securities, and it came to a close when, in 1902, the in- vestor concluded that he had had enough and abandoned Wall Street. The economies of combination figured largely in the prospectuses of the new companies, but they had little or nothing to do with the entire movement. The ordinary method of capitalizing a trust was to issue preferred stock or bonds in order to pay for the overcapitaii- plants, and then to print as much common zation. stock as there was any prospect of selling to the public. Thus the common stock has almost invari- ably represented nothing but water; while the preferred stock, issued to pay for factories bought at exorbitant prices, has usually exceeded a conservative valuation of the property owned by the trust. The result has been what one might have expected; some of the trusts have not disappointed the persons who bought their bonds or preferred shares, and have even managed to pay some- thing on their common stock; but the majority have shown much less favorable results, and have caused serious losses to investors. § 132. But the profits derived from floating companies are not the only cause of the formation of in- special privi- , lege a cause dustrial combinations, and do not account for the success which some of them have attained. Patents have been a factor of some importance, the CAPITALISTIC MONOPOLIES 189 production of certain products, such as cigarettes, barbed wire, and wire fencing, having been controlled for a time by reason of the ownership of all the available patents. Discriminating railway rates have had a vast influence in fostering monopoly, 1 and it is probable that some of the largest trusts still enjoy more favorable terms than their competitors. Then, too, elements of natural mon- opoly can be discovered in many of the combinations. The Standard Oil Company has profited greatly through its control of pipe lines, 2 the United States Steel Corpora- tion owns a large part of the supplies of Bessemer ore in the United States, and in the copper industry the effort has been made to secure control of all the principal mines. It seems probable, in fact, that whatever tendency toward monopoly may have existed in manufacturing industry has been due to the causes here mentioned rather than to any economy derived from replacing large-scale produc- tion by monopoly. § 133. Some of the responsibility for the formation of trusts and particularly for the extortion which they have sometimes practiced must be laid at the The i nflU ence door of our protective tariff, which imposes ofthetanff - heavy duties upon imported goods that might other - 1 The early growth of the Standard Oil Company is attributable chiefly to this factor; and, despite denials, it seems clear that rates are still adjusted so as to favor the points where this concern's refineries are estab- lished. In most cases proof of the existence of this evil is hard to obtain, but it can be adduced in the case of the beef trust and some others. 2 By controlling the pipe lines the Standard Oil interests can oblige in- dependent companies to pay sixty cents a barrel for service which costs but ten or twelve cents to provide ; and it has here an advantage of about one cent a gallon on oil exported from the country. igo MONOPOLIES wise compete with the products of the trusts. It was the original theory of protection that, although foreign competition might be prevented by means of a high duty, competition among domestic producers would insure fair prices to consumers. The situation is radically altered, however, when foreign competition is excluded by tariff regulations of the government, and then the home manufacturers unite to raise prices under the shelter afforded by the tariff. In 1904, for instance, American railways were compelled to pay $28 per ton for steel rails delivered at Pittsburg, while they transported to Canada similar goods for which the Canadians were charged $20 per ton. This sort of thing is common in the iron and steel industry, and occurs frequently enough elsewhere. Some few of the trusts, such as the sugar combination, have been formed largely because of conditions created by the tariff; and the power which most of the others have possessed over prices has been greatly increased by reason of the tariff duty. To this it is sometimes replied that the Standard Oil Company originated in an industry that was not dependent on the tariff, and that trusts exist in England under free trade. Neither consideration is relevant, however, for no one imagines that all trusts are due to the tariff ; while it is a well-known fact that in England few combinations exist enjoying any such control as American trusts possess over their industries, and that no English trust can levy a tribute of a single penny on account of the action of the govern- ment in excluding foreign competitors. The simple fact is that the tariff called a few trusts into being, and enables most of the others to raise prices higher than CAPITALISTIC MONOPOLIES 191 would be possible if competition prevailed at home or relief could be secured through foreign sources of supply. A reform of the tariff would not settle all problems con- nected with trusts, but it would curtail their power of plundering the public. § 134. It is sometimes alleged, indeed, that the trusts do not raise the prices charged consumers, and statistics are produced in support of this contention. TrustS and The admirers of the Standard Oil Company, prices - in particular, have insisted that this concern is responsible for the reduction in the price of refined export oil, which fell from thirty cents in 1870 to about six cents in 1898; and many people are inclined to the belief that this trust has actually cheapened oil. But such statistics do not show the margin or difference between the price of crude oil, which the Standard buys from the wells, and the refined product ; and, clearly enough, it is only by observ- ing what this margin has been that one can judge of the effect of the monopoly upon prices. In 1870 the differ- ence between the price of crude oil and that of refined ranged from fifteen to twenty cents, and by the close of 1879 competition between the Standard Oil Company and various rivals had reduced it to between five and six cents. In 1882, when the trust was finally formed, the margin was seldom as high as six cents; and from that day to the present it has never fallen, except tempo- rarily, under the influence of competition; but whenever the disappearance of competitors or the necessities of the consumers would permit, the margin has increased. The decline in the margin between crude and refined oil was brought about, therefore, prior to 1882, by the 192 MONOPOLIES influence of competition; since that year monopoly has checked the movement. Moreover, the export prices do not show what domestic consumers pay for their oil. In 1 901 the Industrial Commission found that in regions where competition was met from local refiners, the Stand- ard Oil Company sold oil for as little as 5.5 cents; while in places where competition did not exist, the consumers paid as much as twenty or twenty-five cents. These discrepancies cannot be explained by differences in the cost of transportation, since the freight rates account for but a fraction of the inequalities ; the fact is that wherever local refiners can get oil and compete with the trust, prices are low, and that wherever competition is absent, extor- tionate rates are charged. Most other trusts make a similar showing, when the prices of their finished products are compared with the prices of the principal raw materials, and it is only from competition that consumers can expect relief. § 135. When discussion of remedies for the evils of trusts began, the thing most often recommended was pro osed publicity. It was argued that, if trusts were remedies: compelled to disclose the facts about their (1) Publicity. ca pitalization, earnings, and price policies, it would be possible to secure information that would enable us to devise a sovereign remedy. Publicity is greatly to be desired, but it happened to be the favorite remedy of those who believed trusts to be, upon the whole, a good thing for the country, and it was often presented as an alternative to doing something to remedy evils already known to exist. It was known, for instance, that the tariff was one of the conditions that led to the formation CAPITALISTIC MONOPOLIES 193 of certain trusts, but many persons appeared to prefer publicity to a reform of the tariff, and even argued that the tariff had nothing to do with the trust problems. In 1903 the federal government established the Bureau Df Corporations, which has undertaken a thorough study of the trusts. The result of its investigations has been to show conclusively the need of action, and that in direc- tions not approved by many of the advocates of pub- licity. The investigations of the Bureau and the court proceedings in suits brought to dissolve illegal combina- tions have merely demonstrated the existence of the evils of which complaint was originally made, and have not disclosed the benefits about which so much was said fifteen or twenty years ago. Publicity will always be necessary, but it is a poor substitute for action. More is to be expected from a serious effort to grapple with the evil of discriminating freight rates. This subject will receive further consideration in the fol- ( 2 ) Abolition lowing chapter; for the present it is enough discrimina- te say that a number of trusts probably receive tion - favors from the railroads, and are thereby given a material advantage over possible competitors. Until all persons receive the same treatment from transportation agencies, a free field for competition cannot exist. Another remedy for a part of the extortion practiced by trusts is to reduce or remove the tariff duties imposed upon monopolized products. This is a pro- (3) Re f 0rm posal which, naturally enough, has been slow ofthetanff - in gaming the support of protectionists. It is said that removal of duties would destroy not only the trust, but the industry ; yet this is no excuse for refusing to cut down 194 MONOPOLIES the duty to the lowest possible limits. In the case of most of the important trusts, it is tolerably certain that the complete removal of the duty would have no effect except to destroy their power to plunder the public. And it is certain that this is the remedy that trust magnates most fear; they are willing that people should discuss to the full the advantages of publicity, provided that nothing is done with the favors accorded by our present tariff. It has been proposed, also, to declare unlawful some of the tactics now employed by certain trusts in order to intimidate competitors. Whenever an inde- (4) Preven- > 1 tion of unfair pendent oil refinery is built, the price of oil in competition. tit- 1 i t t that locality is at once reduced by the trust to unprofitable figures; and such action frequently bank- rupts the newcomer. Other combinations have refused to sell their goods to dealers who patronized competing companies, or have sold only on terms that could leave the wholesalers or retailers no profit. In these and other ways systematic intimidation has been practiced, and any one who contemplates entering an industry controlled by a trust must expect to meet this sort of competition. The remedy proposed is to apply to the large corporations of the present day the same principles of law which have long been applied to common carriers and some other occupations, viz., to declare that such an enterprise is affected with a public interest and must sell to all upon equal terms. Such a requirement would make it impos- sible for a trust to reduce the price in one locality in order to kill competition, while maintaining it at high figures elsewhere; if enforced, it would encourage competition and make it difficult to maintain a monopoly. Some- CAPITALISTIC MONOPOLIES 195 ching of the sort may yet have to be attempted ; but until we learn how to oblige our railroads to accord equal treat- ment to all shippers, it is doubtful whether much could be accomplished by attempting to bring other industries under the laws applicable to public callings. A reform of the state corporation laws, by which specu- lative promoting should be restricted, the power of corporations more carefully limited, and responsible man- agement in the interest of stockholders assured, . . . (5) Reform of is one of the chief desiderata; it is also the state corpora- thing most difficult to attain. Some of the states are ready to impose upon corporations all needful restrictions, but others will undertake nothing of the sort, preferring rather to encourage the incorporation of all kinds of companies under their lax laws for the sake of the large fees that can be obtained in this manner. In time the evil results of having forty-five different kinds of corporation law in the United States, and the fact that a sort of Gresham's law sends corporations to the states where the standards are lowest, may lead our people to demand uniform and safe legislation; but there is no prospect of such a result being attained in the near future. In view of this fact, it has been proposed that Congress should establish a federal corporation law for companies engaged in interstate business. Generally % . , a , ° m J (6) A federal it has been recommended that incorporation corporation under this law should be voluntary; but the United States would have the power, by various indirect means, 1 to compel every concern that desired to engage 1 It might, for instance, levy a tax of ten per cent on the gross receipts of all state corporations carrying on interstate commerce. This would be similar to the tax now levied on the notes of state banks. 196 MONOPOLIES in interstate business to take out a federal charter. The principal objection to this proposal is that it would transfer to national control a large share of the whole business of the country which has been subject heretofore to state authority, so that it would be a formidable step toward centralization. But, in reply, it may be said that it would affect only business that is already national in character and cannot be controlled adequately by the laws of the several states. It is certainly an anomalous condition of things in which three or four states create, under laws that permit or even invite fraud, companies that under- take to operate over an entire continent; nothing like it is tolerated in any other country. The climax of absurd- ity is reached in the case of the " tramp" corporation, which is forbidden to operate in the commonwealth that charters it, and is given a roving commission to prey upon the people of other states. The business of the large corporations is already national in character and extent, and should be regulated by uniform and safe laws. If the states do not remedy the evils now caused by their own negligence, it is probable that the aid of the national government will ultimately be invoked. § 136. The trust problem presents many diverse fea- tures which will not allow us to reduce our analysis to a conclusions. single formula ; for man Y thin g s ha ve con- tributed to the movement toward monopoly in recent years, and no single remedy will meet all the requirements of the situation. After considerable delay and great inconvenience, some of the evils caused by the trusts seem to be settling themselves. Speculative pro- motion has been brought to an end, at least temporarily, CAPITALISTIC MONOPOLIES \<)J by the refusal of the public to buy shares of bubble com- panies; high prices have attracted large amounts of capital into several industries, notably that of iron and steel; and competition is beginning to afford some relief to consumers. The few men who imagined, only a few years ago, that it would be possible to bring all staple branches of manufactures under their control are learn- ing that it is not an easy matter to stifle competition. Except when based upon a natural monopoly of minerals and other materials, or in cases where transportation facilities can be controlled to their advantage, it is probable that the power of trusts will steadily decline, and that an increasing proportion of the growing business of the coun- try will fall to their rivals. Already one hears less about the economies or other beauties of consolidation, and more about the weaknesses of mammoth combinations or the persistent force of competition. Monopoly has never been an agreeable thing for its victims, and a free people will not permanently tolerate it. FOR SUPPLEMENTARY STUDY General: Hadley, Economics, 151-179; Marshall, Economics, 537-553; Seager, Introduction to Economics, 188-204, 434- 459, 476-509 ; Taussig, Principles of Economics, II, 397-442. Special : Clark, The Problem of Monopoly ; Ely, Monopolies and Trusts ; Jenks, The Trust Problem ; Meade, Trust Finance. CHAPTER X RAILROAD TRANSPORTATION I. Railroad Competition and Combination § 137. Railway construction began in the United States in 1828, when work was commenced on the first section of the Baltimore and Ohio Railroad. Tne construc- tion of rail- By 1840 there were 27 zz miles of road in the roads. country, practically all in the Atlantic states and consisting of short independent lines radiating from Boston, New York, Philadelphia, Baltimore, Richmond, and Charleston. 1 During the next decade railroads were extended with considerable rapidity, and the movement became even more rapid after 1850, so that by i860 the railway mileage of the country had increased to 28,010 miles and the interior of the Mississippi Valley had been connected with the Atlantic seaboard. Although checked by the Civil War, railroad building was recommenced after 1866 on a larger scale than ever before, and, with the aid of the national government, the first line was pushed through to the Pacific coast. In 1873 tne country had 68,484 miles of iron roads; but since then many additional lines have been built, so that, in 1904, no less than 209,000 miles were in operation. Of late, however, 1 See Johnson's American Railway Transportation and Scribner's Statistical Atlas for maps showing railroad construction by decades, 198 RAILROAD COMPETITION AND COMBINATION 199 the rate of growth has decreased, and the new construction has been confined very largely to piecing out existing systems, laying double tracks, or building short branches. With the present needs of the country tolerably well sup- plied, our mileage is nearly ten per cent greater than that of all Europe, and equals about two fifths of the total for the entire world. § 138. The early railways were built, much as trolley lines have been during the last decade, as local roads and chiefly by local enterprise. The scantiest character of provision was made for through traffic, and earl y roads - it was necessary for a long time to transship freight at each terminal point where it passed to another line of road; while passengers were obliged to change cars with equal frequency. Between such cities as Albany and Buffalo, for instance, there were originally as many as ten or eleven different roads, each run in its own way and handling through traffic by the most complicated and embarrassing methods. In time, connecting lines were obliged to cooperate with each other for the purpose of interchanging business, agreements were effected by which through „ . . jo Beginning trains could be run, and fast- freight lines were of railway , . , cooperation. organized to own cars, collect freight, and arrange for the convenient dispatch of long-distance traffic. Between 1850 and 1870 an increasing degree of cooperation was reached by connecting lines, and the service which railways could render the country was vastly enlarged. In this manner, during the period just mentioned, a rapidly growing business between the Mississippi Valley and the Atlantic seaboard was developed. 200 RAILROAD TRANSPORTATION § 139. Meanwhile the combination of short connect- ing roads into trunk lines had begun. In 1853 the New York Central was formed by the consolidation Trunk lines. . . of the various roads between Albany and Buffalo ; and sixteen years later the Hudson River Rail- road was added to it, securing a connection with the city of New York. A similar process went on elsewhere during the fifties and sixties until, by 1870, there were a number of railroads that operated from 200 to 1000 miles of line. Between the Atlantic seaboard and points on Lake Erie and the Ohio River, the New York Central, the Erie, the Pennsylvania, and the Baltimore and Ohio roads were reaching out for western business; while in the Mississippi Valley various trunk lines had established through service between Chicago and the terminals of the eastern roads, or had pushed out into the West and Northwest and even to the Pacific coast. § 140. The next step in railway combination was the union of eastern roads with those in the Mississippi Valley. Railway By purchase or lease, the New York Central, systems. foe Pennsylvania, and the others secured control of lines that gave them entrance into Chicago and St. Louis. Thus our first railway systems were de- veloped. These consisted of a number of different com- panies united under a single management and operating several thousand miles of road, some of it owned in fee by the parent corporation, other portions controlled by purchase of stock, others by lease, and still others con- sisting of roads built and financed by the parent company for the purpose of rounding out its system. By 1890 some of the largest systems controlled from 4000 to 5000 RAILROAD COMPETITION AND COMBINATION 201 miles of road, consisting sometimes of parallel lines, but to a larger extent representing a union of connecting railways. 1 § 141. This process not only increased the size of the railways, but it altered materially the character of their operations. The original local lines had' r .... The growth enjoyed a monopoly in their respective dis- ofcompeti- . . . : . -ill tion - tncts, competition being possible only at a few points where rival roads met or water transportation was available. But the trunk lines could compete with each other for through traffic, which had grown to very large proportions, and the sharpest rivalry soon developed. For a few years prior to i860 the eastern trunk lines were bidding for western business, and their rivalry was greatly intensified when, in 1869, the Pennsylvania and New York Central secured firm control of Chicago connec- tions. "In 1868 rates from Chicago to New York stood at $1.88 per 100 pounds for first-class goods, and $0.82 for fourth class. In the summer of 1869 they fell, under the stress of competition, to a common rate of $0.25 per 100 pounds on all classes." At that time the new charges were ruinously low, and accordingly rates advanced to a materially higher level from 1870 to 1874. But in the latter year the Baltimore and Ohio secured entrance into Chicago, and a Canadian line entered the field. Immediately a new period of cut-throat competition began, which carried first-class rates down to $0.25 per 100 1 West of Chicago and St. Louis, however, the great systems radiated from these centers, and consisted of a number of arms reaching out into the grain regions, where most of their freight was secured. Cf. Hadley, Railroad Transportation, 86. 202 RAILROAD TRANSPORTATION' pounds, and fourth-class to $0.16. This warfare was brought to an end in 1877 by the establishment of a pool, a device which had already been employed in other parts of the country in order to meet similar conditions. § 142. In the railroad pool the through, or competitive, traffic was divided between the various roads in certain proportions ; or else, without actually diverting freight from one line to another, the revenue which accrued from competitive business was apportioned in some manner that was considered equitable. By this means the inducement to cut established rates was par- tially removed, 1 and freight charges could be maintained at profitable figures. The agreement formed by the trunk lines in 1877 was maintained with more or less success until 1 88 1, when it was broken by a dispute concerning the comparative rates charged from Chicago to the various eastern seaports. The pool was subsequently renewed, and with varying fortunes continued until 1887. In other parts of the United States, also, similar arrangements were maintained with more or less success, so that the general outcome of the sharp competition which had arisen about 1870 had been to drive the railroads into that form of combination known as the pool. The great weakness of the device arose from the fact that the courts held that pooling contracts had the effect of * restraining trade and were contrary to public policy, 1 Pools did not wholly remove the inducement. They were established for definite periods of time, and at their expiration a new allotment of traffic or revenue was necessary in order to continue the arrangements. Roads dissatisfied with the amount of business or receipts allotted to them would often cut rates secretly in order to increase their traffic to a point that would force the pool to grant them a larger allotment in the future. RAILROAD COMPETITION AND COMBINATION 203 so that such agreements could have no legal standing and could not be enforced as valid contracts. It fol- lowed that pools could have no more strength Legal status than might arise from the appeal which they ofthe P° o1 - could make to the interest or good faith of the members. It usually proved difficult to satisfy all the parties to pooling agreements, and some roads, especially the weaker ones, were constantly tempted to violate their pledges. By means of extra-legal penalties, such as fines, a certain amount of discipline was maintained; and various im- provements in organization and management made some of the later pools much stronger than the earlier. Here matters hung, when, in 1887, Congress passed the Interstate Commerce Law which prohibited all pooling contracts. This action was followed by a Pooling pro- reorganization of the various railway associa- hlbited - tions, by which it was sought to eliminate the feature of pooling and yet hold the members together in such a manner as to prevent a renewal of rate cutting. Traffic associations, therefore, under various names and forms of organization, maintained their existence; and endeav- ored, with varying success, to prevent disturbances of rates. In 1897 the Supreme Court decided that the Trans- Missouri Freight Association, formed for the professed purpose of "establishing and maintaining reasonable rates, rules, and regulations," was an illegal combination to restrain interstate commerce, such as had been pro- hibited by the Anti-Trust Law of 1890. At the time, this decision was thought to be a final blow at the railroad pool; but it appears that traffic associations of one sort or another continue to exist and to exercise some control over railway rates. 204 RAILROAD TRANSPORTATION § 143. The earliest railway combinations had taken the form of unions of connecting roads, or of radiating lines that belonged naturally to one parent roadconsoii- stem. The pool, however, was an attempt to secure united action between parallel, or competing, railway systems; it was designed to regulate or do away with competition. Prior to 1870 the result of combination had been to intensify, or even to create, competition; since that date its consequence has usually been to diminish or destroy it. Whether the pool would have proved a final adjustment of the relations of com- peting lines cannot be determined with certainty, but it seems probable that in time various causes would have led to the establishment of a closer and more permanent union of parallel roads. As it was, however, the law of 1887, by prohibiting pooling, turned the attention of rail- way managers to other methods of controlling competi- tion and accelerated very greatly the process of consolida- tion. The pool was illegal; but there was nothing to prevent one road from securing control of a competing line by lease, by purchase of stock, or by new methods which were devised. In some cases the same group of capitalists secured control of competing lines, without attempting a formal ™ ^ , * consolidation ; in others, different groups of Methods of ' or consoiida- magnates effected an interchange of holdings of stock and of directors, thus securing a " com- munity of interest." Finally the device known as the holding company was resorted to, and might have been very widely employed if the courts had not decided that the famous Northern Securities Company, formed to RAILROAD COMPETITION AND COMBINATION 205 hold the stock of the Northern Pacific and Great Northern railways, was an illegal combination under the terms of the Anti-Trust Law of 1890. How this decision will affect certain other holding companies cannot be deter- mined at the present time; but it will not do more than retard slightly the unification of railway interests. The holding company would have been the most popular device, since it would have enabled a few magnates to control vast properties with the smallest investment in their securities (§ 41). Yet there is nothing to prevent capitalists from bringing competing railroads under their control, or establishing a community of interest with the owners of other great railway systems. Prior to 1890, as we have seen, 5000 miles of line were the most that had been brought under the control of a single management; since that date, the com- . to to • ,. . Results of bination of competing lines has given us great consoiida- railway systems that operate from 10,000 to 22,000 miles. In 1902 there were nineteen systems which controlled 165,000 out of the 203,000 miles of railroad in the United States; and of these, the eight largest controlled 129,000 miles, or two thirds of the total mileage of the country. 1 Then, too, more or less close relationships are known to exist between several of the nineteen great railway systems ; so that no less than 82,000 miles of road are now controlled by interests which seem to have come to an understanding with one another. It is a striking fact that, since 1890, consolidation has proceeded very 1 For descriptions and maps of the great railway systems, see Johnson, American Railway Transportation, 52-68 ; also The Wtrld's Work, February s 1902; Review of Reviews, August, 1901. 206 RAILROAD TRANSPORTATION largely upon a territorial basis, the purpose and result being generally to bring all the important roads in any region under one management. Northern New England, for instance, falls to one road and southern New England to another. The Vanderbilt and Pennsylvania systems occupy, respectively, the northern and the southern por- tions of the territory north of the Ohio or the Potomac and east of the Mississippi, although at some points their lines penetrate each other's fields; below the rivers just mentioned, we find two other systems which divide most of the traffic of the South; and in the Northwest a close combination of transcontinental lines has been effected. 1 The same result has been reached in other countries where the roads have remained under private manage- ment. This is, perhaps, indicative of what the future of railway consolidation is to be. It is very probable, indeed, that each section of the country will finally fall to the control of a single system which will either operate or dominate all the important lines of road. § 144. The general reasons for railway consolidation should already be clear to the student who has mastered our previous discussion of large-scale produc- Reasons for < L ° r consoiida- tion and monopoly. In the first place a rail- road represents a very large investment of fixed capital, and must incur many other charges that are fixed and do not vary with the amount of business trans- acted. Interest on bonded debt, a large share of the taxes paid, salaries to important officials, remain the same, whether the amount of business is larger or smaller; the 1 South and west of St. Louis the situation is not so clearly defined, and a number of different systems are yet in existence. RAILROAD COMPETITION AND COMBINATION 207 cost of maintaining the roadbed, track, and structures will be somewhat greater when the traffic is heavy, but will not be increased proportionately, by any means; while the actual expense of handling freight and moving trains is about the only element that will vary with the volume of business. 1 For this reason it is better for a road to accept traffic at any price that will more than meet the cost of handling and moving it — even though the surplus above variable expenses is far less than enough to cover the full amount of the fixed outlays fairly charge- able to it — rather than to lose the business and earn nothing whatever toward meeting the fixed charges (§ 69). Therefore, whenever the competition between parallel lines becomes intense, freight rates fall to exceedingly low figures, and the struggle that ensues is not inappropriately described as a cut-throat contest. Moreover, unlike a store or factory, a road that is bankrupted by its losses does not go out of existence; but it passes into the hands of a receiver, and continues to compete for business, often more recklessly than before. In the railway industry, therefore, competition is likely to entail severe losses, and to drive rival lines into some form of combination. In the next place, since the service which railways offer can be utilized only in connection with an expensive plant, the construction of a parallel line involves a wastes of needless duplication of facilities in many in- com P etltlon - stances and is not desirable, even from the point of view of the public. It was originally supposed that railroad 1 Even here, by loading cars to their maximum capacity, and increasing the size of a freight train, a larger volume of business can be handled at a iower average cost. 208 RAILROAD TRANSPORTATION charges could be kept at a fair level by competition; and that, if a company already in the field exacted excessive rates, relief could be secured by chartering a rival road. In this way millions of dollars have been wasted in build- ing unnecessary lines; yet the drift toward consolidation has not been checked, since ultimately the rival companies have found it advantageous to combine. Consolidation, in all such cases, enables companies to reduce expenses and improve facilities; and it may be considered the inevitable outcome of attempts to secure competition. Finally, it cannot be doubted that another motive for consolidation has been the desire to secure monopoly power. A railroad, as we shall see, can never Monopoly. possess an absolute monopoly; for, except over local business, its power to control rates is limited in various ways. But between a rate that will yield a fair return upon the capital actually invested, and a charge that will enable a company to pay the highest possible dividends, there is often a striking difference; and the monopoly profits that may be derived from combination have been one cause of the movement in that direction. For this reason every step in the growth of monopoly in the transportation industry has intensified the public demand for governmental control over the railways, a problem which was never so important as it is to-day, and one which will require careful consideration in a subsequent part of this chapter. II. Railroad Rates § 145. Although, as we have seen, it was originally supposed that the chief work of the railway would be the RAILROAD RATES 209 transportation of passengers, the event has proved that the freight service far exceeds all the other branches. In 1 910, for instance, the railroads of the United Freight States earned $1,925,500,000 from freight, service - $628,900,000 from passengers, $116,100,000 from mail and express business, and $80,100,000 from miscellaneous sources. Thus it appears that about three quarters of the total receipts of American roads come from the trans- portation of freight. Even more important than the financial aspect of this branch of traffic is the influence which the freight service exerts upon the business of the country. It is Freight desirable, of course, that people should be able rates " to travel where they will at reasonable rates ; but passenger fares are of far less economic consequence than the rates charged for carrying commodities. Freight charges are an integral part of the cost of producing all goods that are carried by railways, and are felt by every person in the community; in fact, their universality and inevitableness have led many writers to the conclusion that they resemble taxes. Passenger rates, on the other hand, enter to a much smaller extent into the cost of conducting business enter- prises, and have far less effect upon productive industry. Further still, freight rates not only affect all consumers, but go far toward determining the fortunes of producers. A difference of a quarter or an eighth of a ^ t ° The influence cent in the cost of transportation may have of freight the effect of localizing production in one region instead of another; while if railroads are permitted to discriminate between persons, freight rates may destroy the business of one man and build up that of some other. 210 RAILROAD TRANSPORTATION Localities that are fortunate enough to enjoy access to water routes are somewhat less dependent on this factor, but elsewhere the person who adjusts freight tariffs pos- sesses what may prove the power of life and death over the majority of producers. It is for these reasons that the question of freight rates has come to be regarded as the most important part of the railroad problem. §146. When the first railways were constructed, it was supposed that the charges for carrying persons or goods would be adjusted readily enough upon Rate-making. & .„ M ,.',., , ■ « ™ 1 a uniform mileage basis, like the tolls collected for the use of turnpikes or canals; and various attempts were made to enforce such simple tariffs. Here, again, original theories had to be abandoned after a brief trial, especially in the case of freight charges. In the first place, it was soon perceived that bulky products would not bear the same rates as goods which possessed great value in small bulk. If a road should undertake to charge as much for hauling lumber or grain or stone as for carrying fur- niture or dry goods, the bulky articles would never be carried at all; whereas, if it should charge no more for the latter commodities than it must concede to the former, the total earnings would little more than cover the cost of operating trains. Obviously tariffs must be adjusted in some manner to the value of the articles carried ; and the result has been, in the United States, the development of elaborate systems of freight classification, 1 by which the railways endeavor to adjust their charges to what the traffic will bear. 1 See Johnson, Railway Transportation, 113 et seq., for a description of the three systems of classification now in force in the United States. RAILROAD RATES 211 As soon as the uniform system of tolls was abandoned, the adjustment of freight rates became an exceedingly intricate problem. In the first place, it would itscompiex- be impossible, even if it were desirable, to lties ' pay much consideration to the cost of transporting each particular commodity. Railroads transport thousands of different articles in the same freight train, or even the same cars; and no one can possibly compute the share of the total expenses that is fairly chargeable to each article. It is possible to ascertain with tolerable accuracy the cost of making up and running a freight train loaded with a single commodity; but if different articles are carried, it is not practicable to determine what precise part of the total cost should be attributed to each. The situation is rendered the more peculiar by the fact that so large a part of the total expenses of a railroad is fixed and does not vary with the volume of Different J m classes of traffic that is secured. The cost of operating traffic, trains is the element of expense which comes the nearest to varying in proportion to the amount of freight carried; and even here the correspondence is not exact, since a con- siderable amount of additional business can be accommo- dated by filling cars to the limit of their capacity or by increasing the size of the freight train, without a propor- tionate increase of expense. It follows from this circum- stance that it is profitable for a road to carry cheap and bulky products for anything more than the actual cost of handling the goods and moving the cars, even though the charge does not cover all of the fixed expenses, theoreti- cally but not practically, attributable to every commodity transported. If something can be secured from low- 212 RAILROAD 1 RANSPORTATIOJV grade traffic toward meeting a part of the fixed expenses, even though it be less than the full amount fairly charge- able, just so much less will need to be obtained from commodities of a higher grade. Such an adjustment of rates constitutes a discrimination against the latter class of goods; but, if the road could not secure anything from low-grade traffic, it would be necessary to obtain still more from traffic of a higher grade. For this reason, neither the producer nor the consumer of the latter is injured by the concession made to the former; on the contrary, by reducing rates to a point that will enable bulky goods to be transported considerable distances, the services of the railway to the community are increased and all classes of persons are benefited. Not only is it impossible for a road to charge a uniform rate for all classes of freight, but it has not proved prac- Locaiais- ticable to adjust the rate for any single com- criminations. mo dity on a un if rm mileage basis. At various points along the line of any railroad, or at its terminals, competition is likely to be encountered from other railways or from water routes. Unless its rivals are restrained from offering low rates between competitive points, the road must either reduce its charges at such places or lose all its competitive traffic. And if, as it would naturally do, it makes the necessary concessions at these points, com- petitive traffic will be carried at lower rates than similar business passing between way stations served by no other line. Thus it comes about that freight will be carried from one end of a line to the other at even a lower rate than is charged for traffic which is carried to some inter- mediate point, and in this way many local discriminations RAILROAD RATES 213 arise. Shippers at the way stations who pay the higher charges not unnaturally look upon such a condition of affairs as a grievous hardship; but, if the discrimina- tions in favor of the competitive points are no larger than the rivalry of other roads makes necessary, they are both justifiable and inevitable. Through lines, at whose ter- minals competition must be encountered, could not be built if they were allowed to charge no more for local traffic than for competitive. If local rates should be re- duced to the level of those granted to competitive points, the road could not make any money; while if the rates for competitive traffic were raised to the level of those charged for local, none of this business would be secured. As a matter of fact, if something can be secured from com- petitive business, the road can afford to carry local traffic for somewhat lower rates than would have to be charged otherwise; local charges, therefore, are not higher, but may be lower, on account of the fact that competitive traffic is handled at reduced prices. It is true that the discriminations in favor of junction or terminal points tell against the business of the way stations ; but the railroad merely accepts existing inequalities of situation, and does not create them. A town enjoying access to water routes had cheaper transportation before the road was built; and will continue to have it afterward, even if the new carrier refrains from bidding for competitive traffic. So, too, the construction of more than one line between two points creates an inequality of situation, for which neither road may be responsible, and to which freight rates must be adjusted. Besides the competition of rival routes, the competition 214 RAILROAD TRANSPORTATION of markets affects railway charges in a striking manner. Products of any kind that are carried to the same market competition fr° m different places of production must sell of markets. f or aD0U t the same price. Since the producer can obtain for his goods no more than the market allows, the railway cannot charge him very much more than is exacted by roads that serve producers in other sections of country without destroying his business and losing his traffic. If Georgia peaches are to be sold in Philadelphia and New York, or Alabama iron is to be marketed in Pennsylvania, the goods brought from the South must be carried at lower mileage rates than those procured from nearer sources of supply. Even if there is only a single road or railway system in each section of the country, competition for markets will still continue; and it is for this reason that a road can never have more than a partial monopoly. Oftentimes, however, charging what the traffic will bear has passed into charging what it will not bear, and railway unjust dis- managers have adjusted rates in an arbitrary criminations. and un j ust manner . They have discriminated in favor of places in which they or their associates were personally interested, and in favor of business enterprises in which they had a personal stake. Worst of all have been personal discriminations between shippers who were, upon the principles above stated, entitled to equal or sub- stantially equal treatment. The Standard Oil Monopoly was, in its earlier days, built up almost wholly by outrageous discriminations in its favor; and to-day, it is very doubt- ful whether a competing company will not be ruined if in any way the railroads can compass its undoing. The RAILROAD RATES 21 5 monopoly of dressed beef was established in a similar manner, unfair treatment of independent miners threw the anthracite coal fields into the hands of a few railroads, and in many other cases monopolies have been built up by means of rebates and unjust discriminations between shippers. Specious arguments have been advanced in defense of the favors accorded to large producers; among other things, it is argued that it costs a railway less to handle freight when it is supplied by the train load than when it must be gathered up in small consignments. But the cost of service is rejected by railway managers them- selves as the basis for adjusting freight rates, and it can- not be appealed to in support of practices that foster monopoly. Charges cannot be adjusted upon a basis of absolute uniformity, such as is attained by a system of tolls ; but it is possible and highly desirable to elimi- nate absolutely all personal discriminations. That it costs less to handle a train load than a car load should not weigh for an instant against the desirability of allowing all producers to use the national highways upon equal terms. This is a case in which discrimination is as inad- missible as it would be in the adjustment of postal rates, even though the latter item is a much smaller factor in the cost of production than the charge for transporting freight. We cannot consider further the intricate problems con- nected with the adjustment of railway rates. It has been shown that a uniform system of tolls is impossi- Summary. ble and undesirable, and that basing rates upon the cost of each particular service is undesirable and im- possible. Freight charges must be adjusted to what the 2l6 RAILROAD TRANSPORTATION traffic will bear; it is necessary to discriminate in favor ot bulky products and competitive business; and producers cannot be made to pay more than the competition of mar- kets will permit. Against these hard facts, restrictive or regulative legislation will beat in vain; and a rational policy toward the railway must proceed in a full recogni- tion of the conditions of the rate problem. III. Public Control of Railroads § 147. Prior to 1870 the chief problem connected with railways in the United States was that of securing the con- struction of the roads needed to handle the exist- Early policy toward rail- ing volume of traffic and to provide for the future roads. . . , . o development of the country, bo necessary was it for every community or section to obtain railroad facili- ties that our various governments, local, state, and national, aided construction by grants of land or money; while everywhere the disposition of the people was most friendly to railway enterprises. The charters of some of the earlier roads and occasional statutes placed certain restrictions upon profits, or attempted to prescribe systems of tolls, for goods and passengers, such as had been arranged for turn- pikes or canal companies. In New England, moreover, some states established railroad commissions with limited powers of supervision and control. But, in general, little serious effort had been made to regulate or control the railroads of the country; and it seems to have been as- sumed that competition would oblige the companies to provide good service at reasonable prices. § 148. But a few years after the Civil War the attitude of our people toward the railways began to change, and PUBLIC CONTROL OF RAILROADS 217 about 1870 a great deal of dissatisfaction arose in the northern part of the Mississippi Valley. After con- siderable agitation of the subject, laws, called Granger laws, were enacted * in Illinois, Iowa, of a railway Minnesota, and Wisconsin, and then in other pr ° em ' states, which were intended to correct various abuses that were believed to exist. That the farmer had real griev- ances cannot be doubted ; not only were rates frequently extortionate in themselves, but, still worse, unjustifiable local and personal discriminations greatly aggravated the situation. Some of the new statutes, however, were un- wise and even unjust to the railroads; and it was found necessary to repeal them or to amend materially their provisions. The managers of the railways, when the hostile legisla- tion was enacted, went into the courts and endeavored to have it declared unconstitutional. They as- The public serted that their roads were private enterprises Jj* ranroad and that a legislature could no more regulate DUSiness - the prices charged or service offered than it could control the details of any other business. This position was contrary to the well-established principles of the common law, by which common carriers were subject to public regulation in so far as it might be needed to insure the general welfare. And it appears little short of humorous when one considers that the very companies that now claimed to be purely private enterprises had originally asked and received the power to condemn, under right of 1 These are known as the Granger laws, since they were enacted in response to the demand of the Grange, an association that was then wide' spread in these states. See Hadley, Railway Transportation, 133-136. 218 RAILROAD TRANSPORTATION eminent domain, the land needed for the construction of their lines, upon the theory that they were undertaking work of great public utility and importance. In 1877 the Supreme Court decided, once for all, that a railway per- forms a service that is of public interest; and that, although the company remains a private corporation, it is subject to legislative regulation. By subsequent deci- sions the court has reserved to itself the power of deciding what acts of a legislature are to be deemed a reasonable and necessary exercise of the supervisory power which it is declared to possess, but since that time the public char- acter of railway transportation has not been open to fur- ther debate. § 149. The most tangible outcome of the Granger movement was the establishment of various railway corn- state railroad missions in the West and South with power to commissions. regu i ate charges and otherwise control the transportation industry. Meanwhile, in the East, another type of commission had been developed, which possessed no power to issue orders to the railways, but was author- ized to collect information and make recommendations to the legislature. Although appearing to possess greater authority, most of the so-called mandatory commissions actually accomplished less than the advisory commission of Massachusetts. In that state the high character of the commission itself, the fact that the railroads were older and more stable, and the influence of an alert public opinion, resulted in the enactment of beneficial laws or the acceptance by the roads of many of the recommenda- tions that were made. Under different conditions, how- ever, the Massachusetts plan would not have produced a PUBLIC CONTROL OF RAILROADS 219 satisfactory result; and the tendency in recent years has been toward giving the state commissions mandatory as well as advisory powers. At the present time some thirty-two of the states have established commissions that exercise more or less control over railroads. § 150. The control which the states attempted to exercise by statute or through commissions extended for some years to all railroad traffic, interstate as well as intra- , ' The Inter- State; but in 1886 the Supreme Court decided state com- that a state could regulate only the latter, the former being declared to be subject exclusively to national control. This decision took away from the state commis- sions a considerable part of their power, and intensified greatly the desire for federal regulation of the railways. Accordingly, in 1887, Congress enacted the Interstate Commerce Law, upon which most later discussions of railroad control have turned. The act of 1887 applied only to interstate traffic, but contained a number of far-reaching provisions. It pro- hibited extortionate charges and also all un- Its provi . reasonable discriminations between persons, S10ns - localities, or different classes of traffic. Then, more spe- cifically, it prescribed that no common carrier subject to the act should charge more for transporting passengers or goods a shorter distance than it received for a longer, the conditions being substantially the same and the shorter distance being included in the longer. 1 It also prohibited 1 This had the effect, not of prohibiting local discriminations, but of limiting them to such a degree that the competitive point could not actu- ally receive a lower rate than the station not favored by competition. Of course a local discrimination not great enough to make the charge for a 220 RAILROAD TRANSPORTATION the pooling of freight traffic or of aggregate money earnings by railways, with the purpose of obliging the roads to com- pete with one another ; in fact, the principle that competi- tion can and should control the industry of transportation was that upon which the entire law was based. Other provisions of the act required publicity of rates and some other things which cannot be considered here. Finally an interstate commerce commission was appointed to enforce the law, and given powers that were supposed to be ample for that purpose. This body was to receive complaints from shippers or others, investigate them, and adjudicate the cases as they might arise; but the rail- roads, of course, could appeal from the decisions of the commission to the courts of law. The intention of Con- gress was that all questions of fact should be studied and decided by the commission, and that any legal problems that might be involved should be settled by the courts. § 151. The actual results of the Interstate Commerce Law fell very far short of the expectations of its framers, Results of largely on account of legal difficulties which lation. the commission encountered in its efforts to enforce the act. When the commission appealed to the courts to enforce its orders, or railroads insti- tuted suits in order to obtain a modification of them, the courts did not accept as final the facts ascertained by the commission; but reheard the cases in all details, even allowing the carriers to introduce new evidence not submitted at the original hearing. The effect of this was, on the one hand, to encourage the roads not to make long haul less than that for a short haul might be condemned by the com- mission as unreasonable under the previous provisions of the act. PUBLIC CONTROL OF RAILROADS 221 a full disclosure of their cases before the commission, whereby its authority and efficiency were impaired. And, on the other hand, the necessity of rehearing each case in all its details, first in the lower courts, then in the higher if an appeal was taken, led to much protracted litigation which resulted in what was, to all intents and purposes, a denial of-relief to shippers. Furthermore, the Supreme Court limited very nar- rowly the powers of the commission. For a number of years after the enactment of the law, the com- „ J The powers mission, when it found that existing charges ofthecom- . mission. were unreasonable, undertook in many cases to determine what rates would be reasonable. But the Court at last decided that the law of 1887 conferred no such authority upon the commission, and intrusted it with nothing more than the power of deciding whether existing rates were reasonable or not. Since the only adequate remedy for an unjust rate is the establishment of a just one, this decision stripped the commission of all real control over railway charges. The fate of the long- and short-haul clause of the act of 1887 is equally interesting. The law did not prohibit charging more for a short haul than a long haul Long an a in cases where the conditions were dissimilar ; short hauls ' and the commission soon decided that competition of water routes or intrastate railroads not subject to its author- ity might be sufficient to make the conditions so unlike as to justify a lower charge for a long haul. The Supreme Court, however, in the test case, held that competition of other roads subject to the act was enough to modify the situ- ation and justify a lower rate for a longer distance. The 222 PUBLIC CONTROL OF RAILROADS result was that in all cases where any sort of competition prevailed, railroads could adjust their charges as they pleased, so that the long- and short-haul clause was practically of no effect. But although in many important matters the Interstate Commerce Law proved a disappointment, the act pro- other duced a number of excellent results. ■ Greater details. publicity of railroad rates was secured, useful statistics were collected, the relations of the railroads to one another were improved in various ways, while the investigations and recommendations of the commis- sion tended in a number of directions to secure a better adjustment of railway charges. Then, too, the entire experiment had great educational value; and made it possible to see, more clearly than in 1887, a way out of some of the problems presented by federal railway regu- lation. § 152. In 1906 Congress enacted another important law which greatly strengthened and enlarged the govern- Theactof merit's control over railroads. This statute I9 ° 6 - placed express companies, sleeping-car com- panies, private-car lines, and pipe lines under the control of the Interstate Commerce Commission. Then it prohibited free passes and made it a misdemeanor for any road to give, and any shipper to accept, "any rebate, concession, or discrimination." It further prohibited a railroad from transporting any article, except lumber, that had been mined, manufactured, or produced by itself; with a view to preventing carriers from monopo- lizing certain industries, such as coal mining, in which certain roads had embarked. Most important of all PUBLIC CONTROL OF RAILROADS 223 was a further provision, that the Interstate Commerce Commission shall hereafter have power to "determine and prescribe" what is a "just and reasonable rate" for a carrier to charge. Finally, the commission was given enlarged powers to secure uniform and honest account- ing, as well as to enforce greater publicity and stability of rates. The law of 1906 fared much better in the courts than the act of 1887, even though the "commodities clause," which prohibited roads from transporting The working commodities produced by themselves, was ofthisact - greatly weakened by a decision that ownership of stock of a company mining coal does not give the carrier road such an interest in the coal as the law prohibits. Not- withstanding this decision the commodities clause has checked the tendency of railroads to enter various indus- tries foreign to their proper sphere as carriers. In 1910 the "Mann-Elkins Act" extended still further the powers of the Interstate Commerce Commission. It provided that changes in rates proposed by railroads may be suspended by the com- ofigioand 1913. mission, pending investigation of their rea- sonableness, and placed upon the carriers the burden of proof of the reasonableness of such changes. Under this power the commission suspended and finally dis- approved certain general advances in freight rates pro- posed in 1910. A second important provision of the act gave new vitality to the long- and short-haul clause of the law of 1887. The interpretation placed upon this clause by the courts had practically nullified it, and vari- ous Southern and Western States had long complained 224 RAILROAD TRANSPORTATION of discriminations that favored producers and shippers in the larger cities and manufacturing districts of the East, who enjoyed exceptionally low rates on long hauls. Accordingly the new law struck out of the act of 1887 the proviso that the clause should apply only to hauls made under "substantially similar circumstances and conditions," and so made the prohibition absolute. It then provided that the Interstate Commerce Commission may permit carriers to charge more for short than for long hauls, thus placing upon that body responsibility for deciding some of the most delicate questions of rate- making, which involve conflict of both sectional and in- dustrial interests. A final provision created a Commerce Court to review orders issued by the Interstate Commerce Commission, with the purpose of securing more expedi- tious and satisfactory adjudication of such matters. In 1 91 3, with a view to securing information needed for the purpose of determining the reasonableness of rates, Congress supplemented previous legislation by an act providing for an official valuation of the railroad prop- erties of the country. § 153. Federal control of private corporations engaged in interstate transportation has presented, and still offers, National so manv difficulties that national ownership ownership. an j p era ti n of railroads have been proposed. It is argued that the country has already been parceled out among a few large systems, so that the work of organ- izing the business upon a national scale has already been largely accomplished ; and it is believed that public owner- ship offers in this field all the advantages that are claimed for it in the case of municipal industries (§ 122). On the PUBLIC CONTROL OF RAILROADS 225 other hand, purchase of the railways would involve se- rious risks, since it would require an investment of some $15,000,000,000, while the pressure of the employees for high wages and of the public for low charges might make the financial results very uncertain. Then, too, it would add more than a million men to the existing body of federal employees; and, even if civil service regulations should be enforced, there would exist here a formidable army of voters for whose support the politicians would bid, as they appeal now to the holders of military pen- sions. Finally, enormous difficulties would probably arise in the adjustment of rates and the extension or improve- ment of facilities. In the matter of rates, each section has interests that conflict with those of other sections, while similar conditions arise between industry and in- dustry; and in asking for new and improved facilities, the same jobbery would appear that to-day attends con- gressional appropriations for rivers and harbors or the ex- tension of rural free delivery routes. Then, too, it is not probable that the railway service would continue to be as efficient as it is at present, or that the adjustment of rates would be elastic enough to meet the needs of business. FOR SUPPLEMENTARY STUDY General: Hadley, Economics, 153-158, 171-179, 398-400; Seager, Introduction to Economics, 460-475; Taussig, Principles of Economics, II, 363-396. Special: Hadley, Railroad Transportation, 1-124, 236-258; Hendrik, Railway Control by Commission, 92-139; John- son, American Railway Transportation, 213-304, 349-407; Report of the Industrial -Commission, XIX, 259-484; The American Railroad. CHAPTER XI INTERNATIONAL TRADE I. The Foreign Trade of the United States § 154. When ouY present government was established, the whole foreign trade of the United States amounted to ,. M something less than $40,000,000: by i860 it had Growth of ° ^ J ' ' J our foreign grown to $687,000,000 a year, and in 1892, break- trade. . .. . . . _ . . mg all previous records, it had risen to some- thing over $1,800,000,000. Since the last date our foreign commerce has continued to expand until at the present time it is valued at $3,576,500,000. Ordinarily exports from the United States exceed the goods imported from other countries, so that the balance of trade is said to be "favorable" ; and of late years the excess of exports has greatly increased, having ranged from $300,000,000 to $6oo,ooo,ooo. 1 1 The movement of our foreign trade in recent years is shown by the following table : — Foreign Trade of United States from 1899-19 n (Inclusive) Year Exports Imports Total Foreign Trade Excess of Exports 1907 . . . 1908 . . . 1909 . . . 1910 . . . 1911 . . . $1,880,851,000 1,860,773,000 1,663,011,000 1,744,984,000 2,049,320,000 $1,434,421,000 1,194,341,000 1,311,920,000 i,556,947,ooo 1,527,226,000 $3,3i5, 2 72,ooo 3,055,n5,ooo 2,974,931,000 3,301,932,000 3,576,546,000 $446,429,000 666,431,000 351,090,000 188,037,000 522,094,000 226 FOREIGN TRADE OF THE UNITED STATES 227 The principal exports from the United States have always been agricultural products, although in recent years the proportion of manufactured goods has steadily increased. In 191 1 the country exported $124,000,000 of breadstuffs, $585,000,000 of cotton, and $149,000,000 of meat and dairy products, as well as $43,000,000 of tobacco and $19,000,000 of live animals. Among the exports of manufactured goods, iron and steel products held first place, showing an aggregate value of $230,000,000 ; and mineral oils came second, with a value of $98,000,000. Copper ingots and manufactures of copper supplied $104,000,000 of the exports, cotton manufactures $40,000,000, and leather with its various products $53,000,000. From 1893 to 191 1 manufactured exports steadily rose from $158,000,000 to $907,000,000. Our imports consist mainly of food products and raw materials that we are unable either to raise at all, or to produce in sufficient quantity to meet the demand. Sugar was imported in 191 1 to the value of $96,000,000, Imports. and coffee to the amount of $90,000,000; while imports of wool and of vegetable fibers equaled $108,- 000,000, imports of raw silk stood at $75,000,000, those of chemicals and dyes at $95,000,000, and of india rubber at^ $92,000,000. Imports of manufactured goods ready for consumption amounted in 191 1 to no more than $361,000,000 out of total imports of $1,527,000,000, the largest ever known in the history of the country. § 155. It is interesting to study the distribution of our foreign trade among the various countries with which we have dealings. Of our exports, no less than 63.8 per cent went to Europe in 191 1, and about 13 per cent to 228 INTERNATIONAL TRADE Canada, leaving less than one fourth of the trade to be transacted with South America, Asia, and Africa. In Europe, moreover, 44 per cent of the sales Our trade r ' ? *tt r ,,,,., with various were made to Great Britain and Ireland ; while Germany bought about 22 per cent of our Eu- ropean exports, and France and Holland about 18 or 19 per cent. It appears that Great Britain, Germany, Canada, France, and Holland purchased in 1911 about $1,365,000,000 of the $2,049,000,000 of goods exported from the United States. In contrast to this condition, our import trade is far more widely distributed. About 50 per cent of the imports of 191 1 came, indeed, from Eu- rope ; but this is a far smaller proportion than was shown by our European exports. Twenty per cent o, c the im- ports came from Canada and Central America, 12 per cent from South America, and 14 per cent from Asia; Africa and Oceanica accounted for the remaining 4 per cent. The reason for the unequal distribution of exports and imports is not hard to discover. Europe needs enormous amounts of our breadstuff's and meat in order Reasons for its present to feed her large population, and draws heavily upon our southern states for the materials used by her cotton manufacturers ; while the United States has no such urgent need for the manufactured and other products that Europe has to offer. On the other hand, the sugai^ tea, coffee, wool, hemp, india rubber, and other- supplies which this country is obliged to procure from foreign sources must be sought chiefly in tropical lands or the less triickly inhabited parts of the globe. So far as the United States and Europe are concerned, it is clear that her necessity is greater than ours ; and that we possess, there- THE NATURE OF INTERNATIONAL TRADE 229 fore, a material advantage in trade. This fact has some- times encouraged Americans to boastful assertions of their superiority and to reckless disregard of the interests of the nations who are our best customers ; it should rather lead us, by a fair and considerate policy, to cultivate the good will of the countries which now purchase so large a part of the surplus products of our farms, workshops, and factories. II. The Nature of International Trade § 156. Merchants sell goods in foreign countries or import them from such lands whenever differences between domestic and foreign prices make it profitable Foreign trade to do so. The individual exporter or importer lsbarter - looks upon his transactions as exchanges of goods for money, or money for goods, as the case may be; and, from his point of view, international trade consists of the exchange of commodities for money. Yet the matter is not so simple as this, and the truth is that foreign commerce is a process of barter in which, for the most part, exports pay for imports. This is a hard saying for many persons, and it is desirable to present a few facts which prove its truth beyond all per- adventure. From 182 1, when figures of specie statistical exports and imports are first available, down pr00f ' to 1896, the total movement of merchandise to or from the United States aggregated more than $53,000,000,000; while the total shipments of gold and silver amounted to less than $5,000,000,000. For the last generation gold has been the money used in international payments; and therefore a considerable part of the silver included in the 230 INTERNATIONAL TRADE figures of the specie movement should be regarded as merchandise rather than as money. For the five years ending in 191 1 the aggregate shipments of merchandise and gold (exported and imported) have been as follows : — Year Merchandise Gold 1907 . . . 1908 1909 . 1910 1911 $3,315,000,000 3,055,000,000 2,974,000,000 3,301,000,000 3,576,000,000 $165,900,000 220,700,000 135,500,000 161,900,000 96,100,000 $16,221,000,000 $780,100,000 It appears that exports and imports of gold averaged no more than 4.8 per cent of the aggregate shipments of mer- chandise, and that over 95 per cent of our foreign trade occasioned no payments in money. § 157. The first explanation of this fact is that, in for- eign trade, as in domestic, it is inconvenient and expensive This fact to handle money when some instrument of explained. cre dit can be made to do the work of exchange. Bills of exchange, therefore, are used in the larger number of international payments, and money is employed only in the settlement of balances. If imports exceed exports, gold may be exported to pay for the unfavorable balance of trade, while an excess of exports may bring gold into the country; but, in the larger proportion of cases, goods shipped in one direction provide the credits used in set- tling for commodities that move in the other. But there is an underlying, and more important, reason THE NATURE OF INTERNATIONAL TRADE 23 1 for the fact that money is little used in international trade. Shipments of money, whether outward or inward, tend to affect the general level of prices and to limit themselves au- tomatically to comparatively small proportions. An outflow of money in payment of an excess of money are of imports decreases the currency in circulation, and tends to lower prices. Such a change in conditions makes the country a poor market for foreign products, while at the same time it decreases the cost of producing domestic products; and the result is that imports will tend to decrease, and exports to expand. The change in the movement of trade effected in this manner must con- tinue until the balance ceases to be unfavorable, when gold shipments will cease of their own accord, since exports now balance imports. On the other hand, an excess of exports which brings money into a country tends to raise prices, to check purchases made by foreigners, and to increase sales of foreign products. As soon as these results have been produced, exports and imports of com- modities must tend to an equilibrium, and the inflow of money will come to an end. § 158. In the foregoing discussion it has been assumed that the only financial transactions between countries are those occasioned by the purchase of merchan- T A 4 . , J r International dise and the payments made on this account, movements of . capital. The fact is, however, that many operations are constantly carried on which affect our problem. In the first place the older and richer nations of Europe have invested considerable capital in foreign countries, England, in partic- ular, having made enormous investments in all parts of the globe. When such a transaction occurs, the investor or 232 INTERNATIONAL TRADE lender must remit the amount of his investment; but thereafter the borrower must remit the interest charges. In this manner a country is at first a debtor for the capital which its citizens invest abroad, and is thereafter a cred- itor for the annual interest payments. Each year England has credits for some hundreds of millions of dollars of interest money; while the United States, a younger coun- try which has received perhaps $6,500,000,000 of foreign capital, is a debtor for interest on such capital. Particularly important in influencing the course of the foreign exchanges are the movements of the capital of inter- __ . national bankers. If the discount rates in New Movements of banking York and London are low while they happen to be high in Paris, the international banking houses will ship a part of their capital to the latter city in order to take advantage of the better terms which the money can command. Sometimes, when a country is a debtor on other transactions and would normally begin to export gold, a rise in the interest rates will induce foreign creditors to invest the amounts due them instead of calling for instant remittance. In this manner, by offering a high rate of interest, a country can frequently borrow funds which must otherwise have been sent abroad in order to satisfy a balance of indebtedness. Other international debts are incurred for ocean freights. A country must meet in some way the cost of carrying ocean its imports; and, unless its own ships perform freights. ^jg wor ]^ foreigners must be paid for the serv- ice. On the other hand, if a country's ships carry ex- ports to foreign lands, they will earn considerable sums that must be paid by foreigners. England, besides hand- THE NATURE GF INTERNATIONAL TRADE 233 ling most of her imports in her own vessels, does a large amount of carrying for other countries, with the result that she is each year a creditor for the amount of the earnings of her merchant marine. The United States, however, imports but few goods in American ships, and earns little by carrying goods for other countries; so that it is regularly a debtor for some $20,000,000 or $30,000,000. Again, persons who travel abroad make expenditures which must affect the condition of the exchanges. The United States in recent years has incurred Travelers' large debts for the sums spent by American ex P endltures - tourists in excess of what foreigners have expended in this country. At the present time, this item must amount to fully $170,000,000; while remittances by immigrants to relatives and friends in foreign countries were esti- mated at $150,000,000 in 1 910. Other factors still might be enumerated, but we have space to mention only one. London serves as a world's clearing house for the settle- ment of international debts, and the bankers of that city receive each year considerable sums for this and similar services. The net result of all these factors is that Great Britain is a creditor nation, and receives annually enormous credits for interest on her foreign investments, freights Conclusions. earned by her ships, and the services rendered by London bankers. In 191 1 her imports aggregated £680,559,000 and her exports £557,003,000, the unfavor- able balance of trade amounting to £123,556,000. The vast excess of imports represented the various debts that 234 INTERNATIONAL TRADE other countries owed her, and, in spite of it, imports of spe- cie exceeded exports by £6,000,000. On the other hand, the United States in 191 1 exported goods to an amount that exceeded by $522,094,000 the imports brought in from other lands, and imported only $32,200,000 of specie in excess of what was exported. The favorable balance of trade represented chiefly the balance of obligations in- curred for the various invisible elements x that enter into the foreign exchanges. Great Britain, Germany, France, Holland, Belgium, and Italy ordinarily have unfavorable balances of trade ; while, besides the United States, Russia, Argentine Republic, Canada, Egypt, and Mexico show an excess of exports. The former countries are creditors of the rest of the world, and receive their annual dues in the form of an excess of imported merchandise ; the latter are debtors and must send out an excess of exports in order to meet their foreign obligations. § 159. It was once thought that the object of foreign trade should be to secure a large favorable balance, which should bring money into a country; and for a the balance long time the various nations of Europe regu- of trade. , ° . , r . . . & lated commerce in a number of injurious ways, endeavoring to make their exports exceed imports. Thus arose the theory of the balance of trade which controlled the commercial policy of the world until Adam Smith and writers of less note demonstrated its absurdity. Look- ing upon commerce as an exchange of products useful to both parties, Smith showed that the restrictions enforced 1 The invisible elements are those which do not appear in tables of exports or imports of commodities. They have been enumerated in §158. THE NATURE OF INTERNATIONAL TRADE 235 by governments had the effect of preventing mutual serv- ice; and at the same time, he pointed out that money would inevitably be distributed over the world in the pro- portions required by the trade of each country, and that one nation could not hope to secure and retain more than its proper quota. Since his day economists have ceased to worry over the imaginary evils of an unfavorable bal- ance of trade. § 160. Having grasped firmly the proposition that in- ternational trade is in its essence barter, we may proceed to a second principle which relates to the direction _ ' r r International that this trade may take. Within any small area, trade bas ed upon relative capital and labor will migrate freely to the local- advantages ities that afford the best facilities for conducting any industry; and production will be localized in those districts which offer the greatest advantages for raising or manufacturing each commodity. When exchange begins, each community will sell the things that it can produce with the smallest absolute expenditure of labor and capital for the things in which other communities have the advan- tage ; while if any district is outstripped by some other in the production of every commodity, it will be deserted gradually by laborers and capitalists, and its industries will disappear. Within a small area, therefore, commerce will be based on the absolute advantages which each community possesses for the production of various commodities ; and all articles will be produced in the places that can supply them with the smallest outlay of labor and capital. But capital and labor do not move with perfect freedom from country to country; for distance, differences in language and religion, and varying customs and political institutions 236 INTERNATIONAL TRADE all stand in the way. Although modern conditions have facilitated the process of migration, it is true, neverthe- less, that only a part of the surplus labor and capital of older countries finds its way into other lands; and that the people of each nation are content to make the best of such resources as they have rather than expatriate them- selves. For this reason, it will appear -that international commerce is based upon relative, not absolute, advantages of production. By an absolute advantage is meant the ability to produce a commodity with the smallest expenditure of capital and Relative ad- labor. One country might conceivably have an (urthTcon- absolute advantage over another in every branch sidered. f productive industry. A relative, or com- parative, advantage, however, exists only in relation to or comparison with some other industry or industries in the same country. Thus the United States might have an absolute advantage of fifty per cent over England in the production of wheat, one of thirty per cent in mining iron ore, and one of twenty per cent in the manufacture of steel billets ; in such a case American wheat raisers would have a comparative advantage over American producers of iron ore and steel rails, while our iron miners would have a comparative advantage over manufacturers of steel. Now, if no other factor entered into the case, the labor and capital of both countries would be most effi- ciently employed if the United States specialized in the production of wheat, and Great Britain in that of steel; and this is the manner in which things would work them- selves out in the trade between the two nations. This can be explained most readily by assuming that THE NATURE OF INTERNATIONAL TRADE 237 two countries, say England and the United States, produce eight and only eight commodities; and that & . Illustration. when commerce begins between them, the eight articles are selling for the following prices in each country : 1 — ■ Commodities Prices in England Prices in United States One ton steel rails . $14.00 $20.00 One pound wool •15 .20 One yard carpet I.20 2.00 One yard cotton cloth .12 •15 One bushel wheat . .90 .60 One bushel corn .70 .50 One pound leather , .20 •15 One pound pork •15 .07 Conclusions. Under the conditions here represented, American mer- chants will find a profit in importing the first four commod- ities from England, and in exporting to that country the last four articles on the list. Trade may proceed for a time upon this basis until at last it appears that, at the existing scale of prices, exports and imports cannot remain equal in volume. If, then, an excess of imports develops, the United States will begin to export gold to England in order to settle an unfavorable balance of trade. The movement of specie must continue until prices fall in this country and advance in the other 1 Assuming that these are the normal prices established by competition, it would appear that England had an absolute advantage over the United States in the production of the first four articles; and that, with the last four, the absolute advantage lay with the United States. 238 INTERNATIONAL TRADE sufficiently to change the currents of trade and establish an equilibrium between exports and imports. We may suppose, for instance, that the exportation of gold to England continues until prices advance twenty per Further mus- cent in that country and fall in corresponding tration. degree in the United States.. After this occurs, the prices of the eight commodities will stand as follows in the two countries: — Commodities English Prices American Prices Steel rails .... Wool Carpet Cotton cloth • Wheat Corn Leather Pork $l6.8o .18 I.44 .144 1.08 .84 .24 .18 $16.00 .16 1.60 .12 .48 40 .12 .056 Obviously, at the new level of prices, no profit could be made on the goods which England formerly sold to the United States, with the exception of carpets; while the margin of profits on exports of American wheat, corn, leather, and pork would have increased to an enormous extent. In fact, there might now be a profit in exporting wool and cotton cloth to England, since the differences in prices would probably more than cover the cost of transpor- tation. The result would be that imports from England would fall to small proportions, while exports from the United States would be largely increased. In this case we have assumed a small number of com- THE NATURE OF INTERNATIONAL TRADE 239 modities and a much greater change of prices than could hold true of actual traffic between the two countries, but the principle is valid with 10,000 articles of 1 x ■ 1 1 Summary. commerce and with slight changes in the general level of prices. The permanent trade between England and the United States consists of the exchange of products in which each country has the greatest comparative ad- vantages ; exchange of other goods, in which the difference between domestic and foreign prices is narrowest, will be intermittent, falling to small proportions, or even disap- pearing, when slight changes in prices wipe out the margin of profits. This, then, is our second principle : in foreign trade comparative costs of production are the determining factor. § 161. The United States, of course, has commercial relations with many countries besides England, and our statement of the laws of trade needs to take Trade with this fact into account. In 191 1 our exports mustb? 1 "* to the United Kingdom were valued at considered. $576,000,000, while imports from that country did not exceed $261,300,000; with Germany our exports stood at $287,500,000 and the imports at $163,200,000. With Cuba, however, our imports exceeded exports by over $49,000,000; in the South American trade, our excess of imports aggregated $73,000,000; and with Asiatic countries the net result was a balance of imports amount- ing to over $128,000,000. In this manner an excess of im- ports from one country may be offset by an excess of exports to another; and no serious outflow of gold will be occasioned provided that, upon the whole volume of transactions, exports and imports tend to an equilibrium. 240 INTERNATIONAL TRADE Whenever the equilibrium is disturbed, shipments of money tend to change prices and to equalize exports and imports. It is necessary, however, to remember that many invisible elements enter into the determination of a country's posi- Aiso the in- tion m tne international exchanges. If on the visible ele- m G mentsintne invisible accounts a country is a debtor, the foreign ex- changes. movement of commodities must be such as to produce an excess of exports sufficient to pay the indebted- ness ; and if the country be a creditor, the excess of imports must be sufficient to enable foreigners to meet their obli- gations. Upon the whole volume of international trans- actions, visible and invisible, there will be a constant equalization of debit and credit items, which is brought about chiefly by changes in the export and import of com- modities. For this reason a favorable or unfavorable bal- ance of trade can indicate nothing more than the position which a country occupies, as debtor or creditor, on account of the invisible elements of the exchanges; it can show nothing more than that a balance of exports or of imports is required in order to establish an equilibrium of in- ternational transactions. III. The Restriction of International Trade § 162. Foreign trade has always been restricted to a greater or less degree by customs duties levied upon goods customs exchanged between different countries. The duties - earlier method was generally to impose a light tax, of from one to five per cent, upon all imports and exports; but the modern practice is to levy heavier rates upon the former and to exempt the latter, since expor duties tend to destroy the trade unless the taxed commod RESTRICTION OF INTERNATIONAL TRADE 24 1 ity enjoys a monopoly in the foreign market. Customs duties may be either specific or ad valorem according as the mere bulk or the value of the commodities is made the basis of assessment; thus the duty of forty cents per ton which the United States levies upon iron ore is specific, while the tax on diamonds is ten per cent, ad valorem. § 163. Import duties are sometimes levied solely for the purpose of obtaining revenue for the government. When this is the case, the duties are not made Revenue so high as to restrict very greatly the amount of tanffs - goods imported, because such action would result in a loss of revenue. The English tariff at the present time aims to tax, as far as possible, only commodities that do not come into competition with the products of home indus- tries; and whenever a duty is levied upon an article that is produced at home, an excise tax of similar weight is imposed upon the domestic product. The result is that the tariff gives no advantage to the domestic producer and interferes as little as possible with business conditions. A revenue duty must normally raise the price of a com- modity by about the amount of the tax, since it is an added element in the cost of placing the product on the market. English merchants who imported tea paid to the govern- ment in 1900 the sum of $31,000,000, and there is no doubt that the largest part of this tax fell on the consumers. § 164. When duties are laid upon imports without an equivalent excise tax upon similar domestic products, the effect is to give domestic producers an i nC i den tai advantage over foreign competitors. If the P rotectlon - rates are not raised above the point at which the largest revenue is received, a tariff may be described as a revenue 242 INTERNATIONAL TRADE tariff that gives incidental protection ; this was, in general, the character of the tariffs established in the United States between 1789 and 181 2. But duties are often raised above the rates that yield the largest revenue, for the purpose of cutting down Protective imports and protecting domestic producers, tariffs. Every such duty is purely protective in char- acter, and the revenue that it may yield is merely an incidental factor; indeed, duties are sometimes made so high as to be practically prohibitory, and to reduce the receipts to insignificant proportions. In the United States the tariff was doubled at the outbreak of the War of 181 2 ; and in 181 6, when a new law was enacted, many duties were placed upon a distinctly protective basis. Since that date our various tariff laws have usually been drawn with a view to extending a high degree of protection to domestic industries. The tariff law of 1913, however, has materially lowered duties, and probably marks the end of the era of high protection. § 165. The general effect of a protective duty is to increase the cost of importing a commodity and to encour- n , „ + age domestic labor and capital to undertake CrCIlCrcll CIT6C X of protective to produce it. In the United States protec- duties. . tion has been invoked chiefly for the benefit of manufacturing industries ; but in Europe, at the present time, the principal object of protection is to favor the landed interests in their competition with cheaper bread- stuffs and meats of newer countries. Concerning its ex- pediency, public opinion has always been divided; and the economic questions at issue have usually been com- plicated with political considerations. RESTRICTION OF INTERNATIONAL TRADE 243 § 166. Approaching the problem first from a purely economic point of view, and ignoring political considera- tions, we must observe that the first effect of „ 1 Economic a protective duty is not to increase the amount effects of - , , , -it 1 ^ protection. of labor and capital that obtain employment, but to divert a part of a country's productive energy from the fields that it would otherwise have entered, and to place it in industries that are favored by the law. The only exception occurs when a high duty attracts foreign capital that would not have come into the country upon other conditions. In the United States a certain amount of European capital has been attracted in this manner, 1 but most of the funds invested in American enterprises have gone into railroads and other industries that have not been affected by the tariff; in fact, foreign capital seems to seek the unprotected industries in preference to the protected. In general, therefore, a protective duty does not increase the extent of a country's industry, but merely changes its character. The principal objection to a protective duty is that a country's labor and capital, when left to themselves, find investment in those industries' which offer the Diversion of best advantages, so that protection diverts capital into productive energy from more to less profitable JjJStJJJ " in . employment. This is another hard saying du stries. which is not accepted by most friends of protection, but 1 In 1892 it was claimed that some millions of foreign capital had been invested in the tin plate and other industries that had received increased protection in 1890. But even when the figures presented were accepted at their face value, they amounted to a very small per cent of the new capital that is annually invested in American manufactures, to say nothing of other industries. 244 INTERNATIONAL TRADE its correctness is not difficult to establish. Our study of the nature of international trade shows us that foreign products can never come into a country except in exchange for some equivalent, because commerce is conducted for profit and not from motives of philanthropy. Moreover we have seen that imports cannot be bought solely by a continued exportation of money, since the outflow of gold lowers prices and destroys importers' profits. Imports must be paid for chiefly by exports of commodities, and prices at home and abroad will always tend to a level that will permit the latter to equal the former. Foreign competition, therefore, can never prevent the investment of a country's labor and capital in enough industries to furnish the commodities by which payment is made for imports. Moreover, in any case, the bulk of the work which a nation requires to supply its needs must be done at home and can, by no possibility, be performed in tries cannot another country. Domestic services must be rendered in the household, professional call- ings must be pursued in the country where the patrons live, buildings must be erfected where they are wanted, railroad and other transportation agencies require the services of local laborers, while mercantile pursuits call for an immense amount of labor that must be performed in the country. Then, such workmen as barbers, bakers, butchers, laundresses, hotel keepers, gardeners, hostlers, and the like, are engaged in occupations that cannot be affected by foreign competition. Only in the field of agriculture, mining, and manufactures is it possible, generally speaking, to utilize the products of foreign capital RESTRICTION OF INTERNATIONAL TRADE 245 and labor instead of those of domestic make; and it is only these industries that can be affected by a tariff. Even here there is a great deal of work that foreigners cannot perform, such as that of the cobbler, the village black- smith, and the wheelwright; while bulky products such as bricks, or perishable goods like milk and garden truck, cannot be procured from foreign countries except in dis- tricts adjacent to a frontier. The statistics of occupations collected by the census disclose the fact that probably more than one half of the people engaged in gainful occu- pations in the United States are doing work which could not conceivably be protected by a duty on imports. More- over, of the remainder who are engaged in agriculture or manufactures, it appears that by far the largest pro- portion is found in occupations that produce enormous quantities of goods for export. In fact, when allowance is made for callings which cannot conceivably be affected by foreign competition, and for agricultural and manu- facturing industries in which American producers have a marked advantage over foreign, it becomes evident that not more than ten per cent of the labor and capital of the country is in a position to profit by protection. Now if perfect freedom exists, the labor and capital of any country will flow first of all into occupations in which, from the very nature of the case, no foreign competition can be felt; or will be of free ex- invested in those branches of agriculture and manufactures in which the prevailing level of prices makes it profitable to produce goods both for domestic use and for export. No competition by foreigners can ever alter this fact, which assures to domestic labor and capital 246 INTERNATIONAL TRADE the amplest and most profitable employment; for the industries in which goods can be produced for export are precisely those for which the country possesses, at the time being, the greatest comparative advantage. Therefore the production of wealth will be greatest if the energy and enterprise of the people are devoted to these branches. If the labor of 200 men and capital to the amount of $200,000 will produce 500,000 bushels of wheat or 200,000 yards of cloth in the United States, while in England they will produce 300,000 bushels of wheat or 200,000 yards of cloth, the former country, while under no abso- lute disadvantage in the manufacture of cloth, will have a considerable comparative advantage in the production of wheat. If no trade is carried on between the countries, and each one divides its labor and capital equally between the two industries, England will produce 150,000 bushels of wheat and 100,000 yards of cloth; while in the United States the figures will be respectively 250,000 and 100,000. But if the United States invests all of its labor and capi- tal in raising wheat, and England devotes itself exclu- sively to the production of cloth, the total product of the two nations will be 500,000 bushels of the former commodity and 200,000 yards of the latter. Thus we see that the opening of an unrestricted trade, which would have to be based upon comparative advantages of pro- duction, would increase the aggregate production by 100,000 bushels of wheat. 1 In this way, therefore, free- 1 Sometimes it is objected that the so-called more productive industries cannot afford a sufficient field for all the labor and capital of the country. But it is evident that, when labor and capital begin to crowd into one industry in such quantities that it becomes less profitable, investment will naturally begin in the industry next in order of advantage. No tariff if RESTRICTION OF INTERNATIONAL TRADE 247 dom of exchange must set the people of each country at work upon the industries in which their resources can be most advantageously employed. § 167. So far as the present productivity of a nation's industry is concerned, there is no answer to the argument iust stated: but it may be argued that the ' ' ... Present and causes that now make certain industries less future effect profitable than others may be removed with proper encouragement, and that it is not desirable to confine a people to a few industries like cloth making or the production of grain. It may be that a few years of experience will enable entrepreneurs to learn the best methods of production, and laborers to acquire a higher degree of skill, so that the industry will become as profita- ble as any other. In such a case the initial loss occasioned by the establishment of a less productive enterprise will come to an end; and the country will have the advantage of a greater diversity of its industries, which will give larger scope for the development of the various aptitudes of its people. That such a result may follow the establish- ment of a few wisely chosen industries by means of pro- tective duties is generally conceded by economists, and seems to be open to no doubt. It should be observed, however, that any industry thus developed is necessarily one for which the country offers superior advantages provided that the people learn how to utilize them. The effect of the protective duty, therefore, is merely to hasten the establishment of enterprises which would have come into existence at some time without such aid. needed to establish a new industry if an old one becomes so crowded as to be no longer more profitable than the other. 248 INTERNATIONAL TRADE This is the " infant industry" argument upon which the earlier protectionists relied greatly in the United States. As formulated in the previous paragraph, it infant in- states what may follow the imposition of pro- tective duties upon the products of a few wisely chosen industries; but it does not describe the actual working of protection in all the cases in which it is applied in the United States and elsewhere. It is not possible to secure from Congress a tariff law which selects judi- ciously a few industries and accords them temporary protection during the time that capital and labor are over- coming the initial obstacles. Every section of country, in fact every congressional district, will demand protec- tion for its interests; and by the time that any measure emerges from the legislative mill, it is loaded down with a mass of objectionable details which have to be incor- porated in order to secure the votes necessary for its pas- sage. In this way protection has been accorded unwisely to industries that had no prospect of becoming self-sus- taining within a reasonable time, and a permanent waste of productive energy has been the result. Moreover, the new industries, when once established, have shown no disposition to give up the favors which were accorded in their infancy; but have fought to retain high duties on their products, even after they have grown into trusts and their competition has come to be dreaded in foreign markets. Temporary protection to a few wisely selected industries is a policy that bears not the remotest resem- blance to the course actually pursued by the United States. § 168. It should never be forgotten that so long as a RESTRICTION OF INTERNATIONAL TRADE 249 duty is needed to maintain an industry, protection is causing a diversion of capital from more to less produc- tive fields of investment. It must also enhance The burden of the price paid by consumers, although not P rotectlon - necessarily by the full amount of the duty. Protection, obviously, can be needed only by an industry in which the domestic cost of production is higher than the foreign ; and labor and capital would not embark in such an enter- prise if the duty did not raise the price sufficiently to cover this difference. In fact, the demand of the protectionist is usually for a duty "high enough to counterbalance the difference between the domestic and foreign cost," or to compensate for "the higher wages paid American labor." If the domestic cost is ten per cent higher than the foreign, a duty of fifty per cent will raise the price by not more than one tenth — provided that competition exists between domestic producers; very often, however, our manufacturers have combined to exact the last penny permitted by the law. Only when the domestic cost of production falls to the level of the foreign can the tax upon consumers come to an end. At that time, the duty is no longer needed to sustain the industry, and it should be promptly repealed in order to remove a powerful incen- tive for the formation of a monopoly. If this point is ever reached, the infant industry becomes able to stand upon its own feet, and the labor and capital invested in it can no longer be considered unprofitably employed; but up to this time, every industry that requires protection is supported at the expense of the community, and receives alms in the form of an addition to the price that consumers must pay. 250 INTERNATIONAL TRADE § 169. About 1840, in discussions of the tariff question, protectionists began to appeal for the support of work- The tariff ingmen by arguing that import duties are and wages. ne cessary in order to exclude the products of cheap European labor and to maintain a high rate of wages in the United States; and this contention has ever since played an important part in the debate. There is no doubt that American wages are generally higher than those which prevail in Europe, and this fact is now attri- buted to the influence of our protective tariff. In consider- ing the validity of this claim, it is important to remember that our higher rate of wages has always existed in the United States from the establishment of the first English colonies, and that, prior to 1789, ttiere was no national tariff to which this superiority could be attributed. In 1723, for instance, an English official in the province of New York wrote: "North America containing a vast Historical tract of land, every one is able to procure a data. piece of land at an inconsiderable rate, and therefore is fond to set up for himself rather than work for hire. This makes labor continue very dear, a common laborer usually earning three shillings by the day; and consequently any undertaking which requires many hands must be undertaken at a far greater expense than in Europe, and too often this charge only overbalances all the advan- tages which the country naturally affords, and is hardest to overcome to make any commodity of manufacture profitable which can be raised in Europe." And, during the early tariff controversies, the protectionists never thought of maintaining that protective duties caused high rates of wages ; rather they argued that since wages RESTRICTION OF INTERNATIONAL TRADE 25 1 were higher in the United States, a tariff was needed in order to enable manufacturers to establish new enter- prises and pay the prevailing rates. It could not be argued that the tariff was responsible for the high general rate of American wages until the men who remembered that the higher wages were older than the tariff had disappeared from the scene of action. Wages depend, as we shall learn in the next chapter, upon the productivity of labor; and that this must be the case will be evident when one asks himself . Conclusion. how, except on condition that their labor pro- duced more commodities, the laborers of one country could possibly receive more than the laborers of another. Such a high rate of wages was no obstacle to the estab- lishment of the industries in which this country had the greatest comparative advantages, since in such cases the higher rate of payment was offset by greater efficiency. It was an obstacle, however, to the growth of industries in which the advantages of the country were not so great ; and it was on this ground that protection was deemed necessary. The tariff merely enabled the employers who entered the less productive industries to pay the prevail- ing rates of wages, and it did this by imposing a tax upon the consumers. Undoubtedly, after labor has been diverted into a less productive industry, the continued employment of the persons so engaged, at the existing rate of wages, is dependent upon the duty; and it can become independent only when the enterprise has come to be self-supporting and able to produce as cheaply as for- eign competitors. The tariff, then, did not create and does not maintain the general high rate of American wages; 252 INTERNATIONAL TRADE but it merely enables a small number of laborers to find employment, at prevailing rates, in industries that are supported by taxing the rest of the community. When one considers that less than ten per cent of the labor force of the country is employed in callings that are in any way dependent upon the tariff, it becomes evident that it is absurd to suppose that any benefits accruing to such a small body of workers could possibly raise the wages of the remaining ninety per cent to a point twenty or thirty or fifty per cent above the level that prevails in the various parts of Europe. 1 § 170. In most discussions concerning the effect of the American tariff, the protectionist assumes that manu- factures could not have been established in Diversifica- tion of in- the United States without its aid; and he argues that, whatever it may have cost, pro- tection has had the effect of diversifying our industries. This is to claim more than historical facts warrant. In the eighteenth century, in spite of unrestrained English competition and in the face of Parliamentary prohibitions, our people established several important branches of manufactures. In 1791, when Alexander Hamilton made his famous argument in favor of protection, he could say, at a time when national tariff laws had not existed long enough to exert an appreciable influence: "To all the arguments which are brought to evince the impracticability of success in manufacturing establishments in the United States, it might have been a sufficient answer to have 1 That a tariff is not needed to keep wages in one country above those prevailing in neighboring lands can be seen from the fact that in England, under free trade, wages are higher than in the rest of Europe. RESTRICTION OF INTERNATIONAL TRADE 253 referred to the experience of what has been already done. It is certain that several important branches have grown up and flourished with a rapidity which surprises, affording an encouraging assurance of success in further attempts." § 171. At the present day the important question is not the influence which the tariff has exerted in the past, but the policy which the country should The present pursue in the future. In 1909 Congress revised situation - the tariff, but failed to make such a general reduction of duties as the country demanded; with the result that agitation for further reduction continued, and led to the enactment of the tariff law of 1913. This demand for lower duties was caused in part by the feeling that many of the duties were excessive, and that some of them resulted in gross favoritism to particular industries and afforded shelter to oppressive monopolies. Then, too, between 1891 and 1911, exports of the products of do- mestic manufactures had increased from $188,300,000 to $907,500,000; and it had become evident that our manu- facturers were turning their attention to foreign markets to a greater extent than ever before. Such manufacturers were learning that import duties on raw materials ob- structed the development of foreign trade, and they had at the same time developed their industries to such a point that they needed to extend the foreign markets for their products. For these reasons the law of 191 3 encountered less opposition than such a measure would have met a decade earlier. If the inevitable readjustments caused by the new tariff do not seriously disturb industry and that law can have a fair trial for eight or ten years, it will probably stimulate greatly the development of those 254 INTERNATIONAL TRADE industries in which the United States has the greatest comparative advantages and lead to marked increase of our foreign trade. FOR SUPPLEMENTARY STUDY General: Bullock, Selected Readings in Economics, 453-512; Hadley, Economics, 421-445; Nicholson, Political Econ- omy, II, 235-328; Seager, Introduction to Economics, 361- 384; Taussig, Principles of Economics, Bk. IV. Special : Bastable, The Commerce of Nations ; Roberts, Govern- ment Revenue; Shaw, The National Revenues ; Sumner, Pro- tectionism ; Taussig, Tariff History of the United States. CHAPTER XII THE DISTRIBUTION OF WEALTH I. The National Income and its Distribution § 172. The annual product of a nation's industry is obtained through the cooperation of various classes of persons, — employers, laborers, landowners, and The distribu- capitalists, — each of which claims a share of tlve P rocess - the national income. Production, therefore, must be followed by a process of distribution, in which the wealth created each year shall find its way into the hands of the different recipients. The nature and re- sults of this distributive process now demand careful study; and, in considering them, we shall have to deal with some of the most important and difficult problems of the science. At the outset it should be observed that the annual product of industry does not constitute the whole of a nation's income. Every society possesses 1 Annual prod- a larger or smaller quantity of durable con- uctandan- sumer's goods, such as dwelling houses, books, or pictures, accumulated in the past, from which it derives each year a considerable number of enjoyments. All the services that are derived from such possessions constitute a part of the social income. They accrue, obviously, to the owners of the goods; and the manner in which they are distributed requires little further consideration. 255 256 THE DISTRIBUTION OF WEALTH It may be said, however, that laws regulating inheritance exert, from one generation to another, an important influence upon the distribution of this form of social income. It is of the division of the current product of the nation's industry that the economist usually treats when he studies the distribution of wealth. This consists of Productivity limited by both material goods and personal services obtained from the employment of labor and capital; and it will be meager or copious according to the energy and intelligence with which production is conducted, and the natural resources to which the people have access. To a very considerable extent, also, the productivity of current industry depends upon the amount of capital that producers have at their command. Greater skill, a larger number of laborers, and increased zeal will enable a society at any time to increase the products at its disposal; but there are limits to such improvement of the productivity of industry, arising from the fact that modern methods are conditioned upon the employment of capital. With the steam engine, the blast furnace, and the Bessemer converter, the United States can pro- duce more than 15,000,000 tons of steel in a single year; but without the aid of capital there could be no production of this, or any other metal; and, in order to double the product, a large additional investment of capital would be required. The same thing is true, although not always to the same extent, in the production of most material commodities. It is therefore evident that the efficiency of modern industry is conditioned, to a very large degree, upon the amount of capital produced in past years and NATIONAL INCOME AND ITS DISTRIBUTION 257 available for current use. In this manner the present is limited by the past, and the amount of the social income is dependent upon past accumulations of capital. The income of a society is here conceived of as a certain amount of commodities or services; but the incomes which individuals draw from the annual prod- Value and uct of industry must be considered both as dlstnbutlon - definite quantities of economic goods and as definite quantities of value. For in the modern distributive process, the fundamental fact is that goods are produced for the market, and that it is the value of the product, not the product itself, that is divided among the various persons entitled to participate in the proceeds of an enter- prise. When a farm is cultivated upon shares, landowner and tenant may divide a certain number of bales of cotton or bushels of wheat; but usually commodities are first sent to market, and the money secured from the sale is the source from which individual shares are derived. Private incomes, therefore, are generally expressed in terms of money. This leads to a distinction which frequently is of great importance. Private incomes may be money incomes, i.e., definite sums of money; or they may be real incomes, which, of course, consist of the money in- ,. . i«i • comes. commodities and services that money incomes will command. In a single community, where the prices of articles of necessary consumption are the same for all persons considered, the amount of a man's money income is a satisfactory indication of the comfort in which he lives. But between different communities and countries prices of particular articles, and especially of such a thing 258 THE DISTRIBUTION OF WEALTH as house rent, differ so widely that mere money incomes afford no satisfactory basis for a comparison of the real incomes that people enjoy. This consideration is exceed- ingly important in dealing with statistics showing the remuneration of labor; for between one country and another, differences in nominal, or money, wages may or may not indicate corresponding differences in the real wages received. § 173. Whenever the cooperation of the factors of pro- duction is secured in the simplest manner possible, i.e., in cases where all factors are owned by a single Simplest m J & form of man, private incomes depend solely upon the distribution. . . . . , .„ . prices obtained for the commodities that the producer has to offer. A farmer, for instance, owning his land and capital, and employing no labor except his own, receives his share of the social income when he dis- poses of his produce in the market. And for a shoemaker, a tailor, or a storekeeper, similarly situated, the distribu- tion of wealth means nothing more than the establish- ment of the value of the goods or services that he sells to his customers. If all production were organized in the simple manner just described, the laws of value would be also the only principles governing the division of the social income among the various producers. But production, as we have seen, is usually organized in a far more complex fashion, so that the distribution ^. . . .. of wealth involves something more than the Distribution ° usually com- simple process of exchange. Employers, landowners, capitalists, and laborers cooperate in the establishment of all large enterprises, each class performing a separate function; and, after the value of NATIONAL INCOME AND ITS DISTRIBUTION 259 the product has been determined, it is necessary that a satisfactory division of the proceeds should be secured. Thus the money received from the sale of products is divided up into the landowner's rent, the capitalist's inter- est, the laborer's wages, and the employer's profits ; and four different kinds of income emerge as the result of the distributive process. § 174. It is worth while to examine a little further the mechanism by which distribution is accomplished, and the relations that exist between the various The em- classes of participants. The employer, or fn^tribu* 06 responsible manager of a business enterprise, tion - is the central figure in the distributive process. He may, .and usually does, own some part of the capital invested in the enterprise, but very often borrows a part. The land occupied may belong to him, or may be rented. He may perform clerical work or act as superintendent ; but most of the labor, especially that calling for a lower grade of skill, will have to be intrusted to hired workers. With landowner, capitalist, and laborer, the employer must arrange contracts which call for the payment of specified sums for rent, interest, and wages; and the obligations thus assumed must be met, whether the enterprise proves profitable or not. If a surplus remains after rent, interest, and wages have been paid, it belongs to the employer as the gross profits of the business; but everything received in this manner is a contingent income that is dependent upon his ability to market the product at remunerative prices. The employer's capital and the entire proceeds of the year's sales stand as a buffer between the other classes of participants and the chance of loss, so that upon 260 THE DISTRIBUTION OF WEALTH him the risks of the business primarily fall. Landowners, capitalists, and laborers can lose only when the enterprise proves such a complete failure that the employer's invest- ment is wiped entirely out. The laborers, in fact, through mechanics' liens and other preferences accorded by the law, are placed in the position of favored creditors and can seldom lose their wages, even though the assets of a bankrupt concern come far short of meeting the liabilities. § 175. We are now ready to examine the forces that control the bargaining between employers and the land- owners, capitalists, or laborers, with whom Our problem. 7 r ' ' they establish business relations. It will be our purpose to learn what laws govern the amount that must be paid for rent, interest, and wages, and to ascertain: under what circumstances a # net profit can accrue to a business venture. If these things can be explained, we shall understand the manner in which the proceeds of industry are divided. It will appear that distribution is really a process of valuation, and that the share received by the landowner, capitalist, laborer, or employer, depends upon the value of the contribution which his property or labor has made to the product of industry. At the outset it will be assumed that free competition exists ; so that the value of each commodity tends toward competition i ts normal level, and the division of the product assumed. proceeds upon a competitive basis. Through- out the chapter we shall find ourselves constantly returning to the great forces of supply and demand, upon which all values depend ; in fact, all the laws of distribution are but particular applications of the general principles with which Supply varies the still larger supply that will be wanted to- with rate of , . . r . . interest. morrow, cannot be secured except by offering a fair rate of interest. Moreover, it appears that the higher the rate, the larger will be the aggregate amount of capital offered ; so that the supply will vary directly as the rate of interest. 266 THE DISTRIBUTION OF WEALTH A number of writers in recent years have been inclined to doubt whether any such relation exists between the controversy amount of capital saved and the rate offered at this point. f or j ts use> They have perceived that a con- siderable number of persons would, in any event, endeavor to provide for the future, and they argue that the lower the remuneration received, the more must a man save in order to provide a comfortable income upon which he may retire. They believe that the habit of saving is now so firmly established that the process would continue on about the same scale as at present no matter what the rate of interest might be. This is a comfortable belief for one who advocates policies that are destructive of thrift and prudence ; but it overlooks the fact that, while some capi- tal undoubtedly would be accumulated without the induce- ment of a good rate of interest, a considerable part of our present supply comes from persons who will save more or save less according to the rate obtainable from invest- ments. It also fails to give sufficient weight to the fact that constant saving is needed, not only to make additions to the supply of capital, but also to keep up the present stock. For capital is maintained intact only by constant replacement ; and the inducement to replace the buildings, materials, and appliances consumed in productive indus- try, is in no way different from that required for saving additional capital. In order to maintain the present stock as well as to provide for the growing needs of indus- try, the savings of the class of marginal investors are required; and so long as this is the case our aggregate supply of capital will vary with the inducements offered to capitalists. INTEREST 267 § 1 79. The rate of interest, like the price of a commodity, must be such as will equalize the supply and the demand. A given stock of capital cannot command a " . Equalization higher rate than is offered by the marginal of demand producer, who employs such capital as he ob- tains under conditions of the least productivity. But though this rate may have to be accepted for a short time, it cannot prevail for any considerable period, unless it is adequate compensation for the sacrifices incurred by the marginal investor, to whom a considerable premium must be offered in order to induce him to exchange present goods for future, On the other hand, if a given stock commands a rate that is greater than the marginal sacri- fice required to obtain it, the supply will gradually increase until its diminishing marginal productivity lowers the price to a point that no more than satisfies the marginal investor. Thus the normal rate of interest is such as will cause an equilibrium of supply and demand, and depends, like the normal value of a commodity, upon the demand of the marginal consumer and the sacrifices of the marginal producer. § 180. So far we have considered nothing but the re- turn received for productive capital, but we must now examine briefly two other forms that interest other classes may assume. Owners of certain durable ofloans - consumer's goods, such as dwelling houses, may lease their property to tenants and obtain a stipulated annual income from the investment. In such transactions present goods are exchanged for future, just as truly as' in a loan of productive capital; and the annual income secured from property of this character will be determined in precisely 268 THE DISTRIBUTION OF WEALTH the same manner as the rate paid for capital used in pro- duction. Loans are sometimes made for personal expen- diture and not for the support of productive undertakings. These are all too numerous, but are generally for small amounts, so that their aggregate mass is comparatively unimportant when contrasted with the enormous amounts of capital employed in industry. So far as they are sub- ject to the law of competition, the rate of interest upon such loans is determined in the manner described in the last paragraph ; but in many cases the ignorance or neces- sities of the borrower enable the lender to exact extortion- ate terms. § 181. With all investments of capital, risk exercises an influence upon rates of interest. Manifestly, when there is a prospect of a loss of both principal Risk. and interest, a very large premium will be re- quired to equalize future goods with present ; and, in pro- portion as this factor can be reduced or eliminated, the amount of the premium will tend to decline. Risk, indeed, is not to be considered a factor that is independent of the principles already discussed, but it is one of the circum- stances that affect the supply of capital offered at any given rate of interest. It is important enough, however, to require express emphasis; and an unusually high rate of interest regularly points to an unusual risk. § 182. It is a familiar fact of experience that in a progres- sive country the rate of interest tends gradually to decline. m This is due in part to the increase of wealth, Tendency of m r 7 interest to which enlarges the supply of capital and reduces decline. . . ° . . . _ r its marginal productivity. In a newer coun- try, like the United States, where natural resources are INTEREST 269 not so fully exploited, many opportunities exist for the remunerative investment of capital which cannot be equaled in an older country like England or France. Then, too, as a country becomes more fully developed, industries can be established upon a basis approved by experience, and there is less necessity for taking unknown risks. This makes business less speculative, and tends to reduce the rate of interest. In the United States the rate paid for capital is always high in a newly developed sec- tion, running as high as from twelve to fifteen per cent. The growth of wealth and the inflow of foreign capital gradually reduce interest to six or eight per cent; and there it is likely to remain until the district becomes largely independent of outside capital, which can command five per cent at home and will not be invested elsewhere unless higher rates are offered. In the leading countries of Europe, the rate is materially lower than in the United States ; and it is for this reason that so much foreign cap- ital has sought investment on this side of the Atlantic. § 183. Although the two things are not different in their essential character, something should be said concerning what are known as short- and long-time loans. ^ Short- and The former are such loans as bankers make upon long-time call, or for brief periods ranging usually from one to three months; the latter may be represented, for present purposes, by such an investment as a five- or ten- year loan upon real estate, secured by a mortgage. Bank- ers' loans are sought by business men who constantly incur liabilities that must be met before returns can be secured from their investments. They represent, in a peculiar sense, a demand for money or credit needed upon 270 THE DISTRIBUTION OF WEALTH short notice to maintain the solvency of the borrower ; so the rate that they command will fluctuate according to the conditions of what is called the money market. At certain times when the cash reserves of the New York banks are very large, money may be obtained upon call for as little as one per cent; but, upon a day's notice, some unfortunate turn of affairs might easily raise the price of call money to ten, twenty, or thirty per cent. On October 29, 1896, the rate was ten per cent when business opened in the morning; by noon it had jumped to fifty per cent annual interest, and before night it stood at eighty or one hundred per cent. On the other hand, the demand for mortgage loans is in no way influenced by the vicissi- tudes of the money market; and the interest rate may, for a generation or more, remain fixed at five or six per cent. Even with short-time loans, it is only the daily fluctuations that depend upon the plenty or scarcity of ready money ; for, if yearly averages are studied, it appears that the rate commanded by prime commercial paper, like the rate upon mortgage investments, gradually declines as a country's wealth and capital increase. In 1830 the Second Bank of the United States could obtain in Philadel- phia and New York seven per cent interest upon its ordi- nary discounts, for which, to-day, a rate of five per cent would be highly satisfactory to a banker. The decline has been brought about by the same causes that have reduced interest upon mortgages from six or seven to four or five per cent in the same communities. This fact shows us that short-time and long-time loans are governed by the same underlying conditions, and that they are, at bottom, transactions of precisely similar character. WAGES 271 III. Wages § 184. Wages are the portion of the product of industry received by the persons who perform labor, skilled or unskilled, mental or physical. In some of the Wages higher occupations the remuneration of the deflned - worker is called a salary, but it does not differ in its eco- nomic characteristics from the wages of the common laborer. Persons who are without the means necessary for establishing independent enterprises must sell their services to employers and become hired wage-earners ; but wages may be received also by small independent pro- ducers who perform their own labor, and by an employer, large or small, who does any of the routine work of his establishment in order to avoid hiring an additional man. § 185. Hired laborers may receive either time or piece wages; the former being paid for each hour or day that labor is performed, the latter being adjusted T imeand to the amount of work done. With a time P iecewa e es - wage may go a tacit or express understanding that a cer- tain quantity of work shall be accomplished, and piece wages may be computed upon a basis that will enable the average worker to earn about so much per day or week, so that the difference between the two methods is not always so great as might appear at first sight. Yet, in general, the piece system gives the workman a somewhat greater stimulus to turn out a large product. It happens, very often, that both methods of remuneration coexist in the same industry ; and, in such cases, it will usually be found that the labor cost of each unit of product is about the same. Indeed, competition between employers can pro- 272 THE DISTRIBUTION OF WEALTH duce no other result, because an establishment that pro- duces at a considerably higher labor cost than rules in the rest of the trade is likely to be forced out of the field. This leads to the further consideration that labor cost is a very different thing from rates of time wages. A high daily or weekly wage indicates generally 1 a high standard of efficiency, which makes the labor cost no higher than it is in other districts or countries where lower rates are paid. In point of fact the total cost of production is likely to be lower where high-grade labor is employed; for the increased wages are made good by the greater efficiency, while the product of a given plant is increased with a corresponding reduction of the fixed charges that enter into each unit of the output. In com- paring daily or weekly wages paid in the United States with those which prevail in other lands, this consideration is of the very greatest importance. § 1 86. The rate of wages represents the value which labor possesses under the existing conditions of supply and f demand, and is determined in the same general wages de- wa y as the value of anything else. There are, pends on .... .. . . supply and even withm the same district, almost as many grades of labor as there are kinds of com- modities ; so that the laboring class is divided into vari- ous groups, each possessing a particular kind or degree of ability and receiving a different remuneration for its services. We must now investigate the forces that govern 1 If no tariff exists to draw labor into some industries where it is less productive than in the others, a high rate of wages always points to high efficiency. WAGES 273 the demand for labor and the supply of this agent of production. § 187. The demand for any particular grade of labor will depend on the value of what it can produce. An inde- pendent farmer or artisan who sells the product Dem and for of his own hands can, obviously, receive for his labor - labor no more than the value of his goods ; and the same thing is true of the hired workman, under the operation of a healthy competition, although the complexity of the distributive process makes this fact less easy to perceive. An employer can afford to pay no more than a workman adds to the productivity of the farm or factory, and, there- fore, the demand for any grade of labor must depend upon what its productivity is considered to be. A skillful super- intendent who can secure the maximum output from each man or machine in a factory is the most productive person in the employ of the establishment, and his services will be in demand at a high salary; while the workman of inferior intelligence or industry, unskilled in any trade, produces little and is wanted, if at all, only at the lowest wages. These, of course, are the two extremes; and between them there may be, in any locality, 100 or 1000 different classes of laborers representing as many grades of productivity and subject to corresponding differences in demand. Bearing in mind that different grades of labor will be de- manded only at wages that correspond to their varying degrees of productivity, we must next study a little more r JJ J Demand for closely the conditions that control the demand various grades for any single grade of workmen. It is a fact of experience that a few laborers of the same class, all of 274 THE DISTRIBUTION OF WEALTH whom may compete for the same kind of employment, will find that their services are in demand at a higher price than could be obtained if their numbers should suddenly be increased. This is because, in any market, the produc- tivity of any kind of labor gradually diminishes as the supply is enlarged. A few workmen, even though un- skilled, when employed at a few places where the natural resources are the greatest, will create a larger product than additional laborers of the same class who have to be used in industries for which the conditions are less favorable. Then, too, on each farm or in each factory only a certain number of men are needed in order to secure the maximum efficiency ; and beyond that point, additional hands will not yield a proportionate increase of the output — a con- dition due to the variation of productive forces (§§43-45). It follows, necessarily, that the wages offered the mar- ginal workman must decline as the supply of workmen increases. It is evident, moreover, that the demand for the services of each class of workmen, depending, as it does, upon the Demand value of the product, must vary according to verseiyas tne P r i ce tna ^ is asked. A few men of a certain price. grade of skill might find a few employers, enjoy- ing the greatest natural advantages, who could afford to pay the very highest wages. A larger body of workmen must turn to other occupations, or must add to the number employed in the most favored industries; and in either case the productivity of the marginal laborer will decline. The result will be that the larger supply of labor can be taken off the market only at a lower rate, by employers whose situation does not permit them to offer as much as WAGES 275 had previously been paid. Each increase of numbers, in fact, reducing the marginal product, 1 will reduce the rate still further so that the conditions of the labor market resemble those which rule in other markets. A high price attracts but few employers, while low rates steadily in- crease the demand until it becomes large enough to ab- sorb the supply. With labor, as with other things, the demand will vary inversely as the price. § 188. Turning now to the conditions that govern the supply, we must observe that labor, like capital, has a cost of production, and that an adequate The supply supply cannot be had unless the remunera- oflabor - tion of the workman is sufficient to cover the cost of his services. For any given class the cost of production means the standard of living that the laborers are deter- mined to maintain; i.e., the quantity of the necessaries, comforts, or even luxuries that must be offered in order to obtain an adequate number of workmen at a given time, and to induce them to marry and perpetuate the supply of labor. From class to class this standard shows varia- tions that sometimes are exceedingly great and produce material differences in wages. Laborers of the lowest intelligence and industry are 1 This does not mean that, as time passes and population increases, the marginal laborer produces less and less, so that the rate of wages steadily declines. Such an inference is as incorrect as the dismal conclusion some- times drawn from the law of diminishing returns to land (p. 81). While the marginal productivity of a small number of laborers must at any time be greater than that of a larger number, improvements in production may, and probably do, enable the additional workmen supplied by a growing population to produce as much as the marginal laborers of former periods. In progressive countries, at least, this is what occurred during the nine- teenth century 276 THE DISTRIBUTION OF WEALTH likely to show little forethought in assuming the responsi- bilities of marriage, with the result that an adequate supply The supply of of such services as they are able to perform cfasseTof 18 can ^ e nao ^ at a ver Y ^ ow cos t — which, if COn- laborers. ditions are unfavorable, may be no more than is necessary to keep soul and body together. If immigra- tion is practically unrestrained, as in the United States, the cost of producing this grade of labor may be not that of rearing a family in this country, but the cost in some of the poorest districts of Europe. It is in such strata of the laboring population that the struggle for existence is fiercest, and the pressure of numbers upon the available means of subsistence most intense. Above this lowest class come successive grades of laborers, possessing greater intelligence, skill, and self-control, who insist upon having something better than the bare necessities of physical exist- ence, and who will not rear large families of children un- less favorable conditions of living are reasonably assured. At the top of the pyramid are the smallest classes, con- sisting chiefly of brain workers, of whom an adequate supply cannot be obtained unless the remuneration is sufficient to enable a man to give his children the best of commercial, technical, or professional training and all the other advantages which he himself has enjoyed. The desire of each class to maintain its position and educate children to a station at least as good as that of their par- ents, is the factor that determines the cost of each grade of labor. From what has preceded, it follows that the laboring population is divided into a large number of grades, between which little direct competition can exist, because members WAGES 277 of a lower class lack either the general intelligence or the special training required for the work performed by a higher class. Labor-saving machinery of ten enables an . e . , r Competition inferior grade of workmen to compete for work between formerly done by a superior, and thus destroys the line of demarcation between the two classes. But, except in such cases, there can be little direct competition ; and this is increasingly true as we pass from the bottom to the top of the pyramid. Indirect competition, however, is much more active, since self-sacrificing parents can educate their children for the higher callings in life, pro- vided that a system of popular education affords the nec- essary opportunities. It is obvious that the children of a higher class are likely to receive a better start in life than those belonging to a lower; but ability and character are not the exclusive possession of the offspring of any one class, and a good system of public schools may enable the poorest boy to rise to the highest and most remunerative position. It must now be explained that the standard of living, and, therefore, the cost of production, is not precisely the same for all the laborers of a given class. Some supply of workmen will be satisfied with less than others ^thraterf of no greater efficiency will demand, so that a wa « es - little labor of any particular grade can be obtained foi less than must be paid for a large supply. For each class there is a minimum supply price, which must be paid if any workmen are to be obtained ; and beyond this point the supply can be enlarged only by raising the price that is offered. It is evident, therefore, that the supply of any grade of labor will vary directly with the rate of 2?8 THE DISTRIBUTION OF WEALTH wages, rising as the rate is increased and falling as it decreases. § 189. We have seen that the demand for labor depends on the value of the product of the marginal workman, and The normal varies inversely as the price. It is evident, also, wage - that the supply, depending on the cost of ob- taining the services of the marginal laborer who has the highest standard of living, will vary directly as the remu- neration offered. The normal wage fixed by the forces of demand and supply must be such a rate as will equalize the two forces, and call out a sufficient supply to meet the demand at the price which the marginal producer can pay. The value of labor, therefore, under conditions of health- ful competition, is determined in the same manner as the value of other things. It should be observed, however, that, since human lives are involved, the supply of labor does not adjust itself readily to the conditions of demand, and that Labor is a J peculiar com- it can be decreased only with the greatest hard- ships, and increased only by immigration or the gradual growth of population. These peculiarities will receive due consideration in the following chapter, but for the present it is sufficient merely to call attention to them. Freedom to migrate makes it easy to reduce the supply of labor in any market when the value falls below the standard of living of the marginal workmen, and unrestricted immi- gration renders it more difficult to adjust supply to market conditions. Public education and all influences that tend to elevate the intellectual and moral condition of the laborer or to increase his efficiency enable him to compete more effectively for a wage that will make it possible to RENT 279 maintain his standard of living. Yet, after all allowance is made, it remains true that labor differs in important respects from other commodities. The student may have noticed that our discussion of the law of wages has proceeded upon the assumption that the family is the economic unit, and that the mt M ., . J The family is remuneration of any class of laborers must be the economic adequate to insure a future as well as a present supply of workers. Whenever the wife and children are able or willing to find employment, in the hope of increasing the earnings of the family, it usually happens that, before long, the remuneration of the father decreases. This is because it costs less to secure his services and to insure a future supply of workmen like him, when he is no longer obliged to support his entire family out of his earnings. We see here, also, a reason why the wages of women are likely to be less than those of men, even when they perform the same work. 1 A woman, in a majority of cases, does not have the burden of supporting an entire family, and her services can consequently be obtained for less than men must, upon an average, receive. Considerations like these are of great importance in dealing with problems connected with the employment of women and children. IV. Rent § 190. When competition prevails, the normal value of any commodity must be high enough to compensate 1 Frequently the work is not the same, even when it appears to be so upon first examination. The most efficient woman may be lost to the employer by her marriage at any time ; and she is actually worth less than a man whom the employer can expect to retain. 280 THE DISTRIBUTION OF WEALTH the marginal producer for the labor and capital required to procure the most costly portion of the supply. Wages Differential and interest must be received by even the mar- gams, ginal producer, and more than this competition will not allow him to obtain. But other producers, who, on account of superior situation or greater ability, are able to supply the commodity for less than the marginal cost, find that a surplus is left on their hands after they have paid for all the labor and capital that have been expended. The amount of this surplus will depend, obviously, on the degree of superiority that the recipient enjoys over the marginal producer. In industries where great differences exist between the lowest and the highest costs of produc- tion (§ 53), a very considerable part of the total product may be absorbed by the superior producers; while the surplus received by the more favored establishments will be small if there is but a slight difference between the least cost of production and the greatest. The surpluses received by the more favored entrepreneurs may arise from the possession of superior natural agents of production or from the exercise of superior ability Rent and in organizing or conducting their enterprises, profits. j n ^ f ormer cas6j tn e surplus would be called rent, which may be denned as the income that ac- crues to the owner of a natural agent of production; in the latter, it would be considered profits, or the reward to the ability and enterprise 0} the successful entrepreneur. Both of these shares in the product of industry now claim our attention, and will be treated in the order indicated above. § 191. The natural agents of production from which incomes are derived may be fertile soils, well-situated city RENT 28l lots, useful water powers, rich mines, or valuable forests; but in all cases access to them depends on the control of particular tracts of land, so that we may, for r J Rent defined. the sake of convenience, speak of rent as the return received by the owner of land. To employ a defi- nition which has attained considerable currency among economists, rent is "the value of situation with its natural gifts and all the rights and privileges pertaining to the occupancy thereof." In the sense in which the word is here employed, land is sharply contrasted with the im- provements, such as buildings, fences, walks, ditches, dikes, and fertilizers, which man places in or upon it. All of these things are products of human labor, and, in so far as they aid production, are but special forms of capital, for which interest, not rent, is received by the owner. Rent, as a category in distribution, includes nothing but the return obtained from a natural agent of production. Interest and rent are sometimes confused by reason of the fact that the selling price of any tract of land is always com- puted by capitalizing at the current rate of inter- t ndin est the annual return which the owner is able to terest not to , ._,.,. , .be confused. secure from it. If a city lot is so advantageously situated that it yields a rent of $5000, while the current rate of interest is five per cent, it will command a price of $100,000. But this fact throws no light whatever upon the reasons why an annual rent of $5000 can be obtained, and it is the annual rent that needs to be explained. Ob- viously when land is bought and sold, people will compare the rent with the interest derived from investments of capital, and will adjust the purchase price accordingly. Our theory of rent, however, must explain why rent is paid 282 THE DISTRIBUTION OF WEALTH and what determines its amount, and not whether the selling value of land is sixteen, twenty, or twenty-five years' purchase. 1 § 192. Capital and labor receive their appropriate shares of the proceeds of industry not only because they add something to the product, but also because Value of land ° r depends on they must have adequate remuneration if a sufficient supply is to be obtained. Land, however, is not the product of human effort, and the pay- ment of rent is not necessary in order to insure a supply adequate for the needs of industry. The supply of land is virtually a fixed quantity 2 ; and the rent that it bears depends, therefore, on the conditions of demand rather than on those of supply. Like any other thing the supply of which is definitely fixed, the value of land depends on what people will give for it, not on the cost of producing or reproducing the supply. § 193. With land used for residential purposes the forces governing rent may be studied in their simplest Rent of build- f° rm - When the handful of Dutch colonists mgiots. w Yio bought Manhattan Island from the Indians erected their first dwellings, a house lot, even in the section adjoining the Battery, could have had almost 1 Twenty-five years' purchase would mean a purchase price equal to twenty-five times the annual rent. This would give a four per cent return upon the investment. 2 There is, of course, a certain amount of " made land " which has been reclaimed from the water ; but it is so small in comparison with the total land surface of the globe as to be practically a negligible quantity. More- over, unlike the supply of labor or of capital, land once reclaimed generally does not need to be continually reproduced by the further expenditure of human effort. RENT 283 no value, because the supply was ample and the demand insignificant. But as the population of the island grew to thousands, then scores of thousands, and finally hundreds of thousands, the supply of land could be but slightly increased by reclaiming marshes or sites along the water front, 1 and the value of building lots steadily rose. That sites on Fifth Avenue which in 1626 were worth nothing command to-day a princely rental is due to no other cause than the pressure of an increasing demand upon an inelastic supply of land. And with land used in production the case is the same. The demand for agricultural land or for lots on Broad- way comes from men who wish to establish Lan dusedin business enterprises, and the price offered P roduction - will depend on the facilities which the particular site affords. If the normal price of wheat is eighty cents per bushel, and the fertility or advantageous location of a farm enables the producer to place his grain in the market at a cost of not more than seventy cents, the landowner can obtain a rent of ten cents per bushel. 2 On the other hand, land on which wheat cannot be raised at a smaller cost than eighty cents per bushel will yield no rent, and will not be cultivated unless it can be had for nothing. Similarly the rent of a factory site will be measured by the extent to which the situation and other advantages reduce the cost of production below that of the marginal 1 The original area of Manhattan Island was about 10,000 acres; and not more than 2500 acres of " made land " have been added to this. 2 If each acre of the land produced twenty bushels, the rent would be $2 per acre; and, if the rate of interest were five per cent, the selling price of the land would be $40. 284 THE DISTRIBUTION OF WEALTH producer. With lots occupied by stores the main con- sideration is the number of customers that can be reached ; for it is evident that, by doing a large volume of business, many of the expenses are made proportionately less, and that the savings thus effected measure the rent paid. If the farm or factory site or city lot happens to be occu- pied by the owner instead of by a tenant, the savings accrue to his benefit, so that he obtains a rent just as truly as if he had leased his land to another person. When competition prevails, each tract of land will normally be used for that purpose which will enable it Land used for to yield the highest rent. Fertile land adjacent yleTdshigh- 1 t0 a va l ua ble water power cannot be cultivated est rent. jf ft j s wa nted for a factory site, and arable land on the outskirts of cities must be cut up into building lots as fast as the demand for dwelling houses increases. Within a growing city, business encroaches upon first one and then another section that has been used for residen- tial purposes; while the choicest sites pass out of the hands of manufacturers or wholesale dealers, and are used for office buildings or for department stores. In all of these cases we perceive the effects of an increasing demand which raises the rents of the most favored tracts of land. § 194. We must now take account of the fact that the prices which producers can offer for land are influenced r nt nd ky the operation of the law of diminishing diminishing returns. If the returns to labor and capital returns. . . . invested upon a given tract increased propor- tionately until the point was reached at which no addition could be made to the product, industry would be conducted RENT 285 upon a few most favored sites until this absolute limit of productivity Were reached. A little land of the next inferior quality would then be utilized, the marginal cost of production would necessarily rise on account of the inferior conditions under which the additional supply of each commodity must be obtained, and the superior lands would begin to bear a rent proportional to the advan- tages which they afforded as compared with lands of the second grade. If this were the actual case, rent would be due simply to differences in the fertility or situation or other qualities of the various tracts of land that pro- ducers were compelled to use. But from our study of the law of diminishing returns (§ 43) we know that the product obtained from a given tract cannot be increased proportionally by investing additional labor and capital after a certain point has been reached. From this it follows that rent would be paid even if all land were equally productive, provided that the demand could not be satisfied without investing labor and capital beyond the point of diminishing returns. This may be shown by an assumed case. Suppose that a certain community has supplied itself with wheat by cultivating 1000 acres of the very best land, all equally productive, from which is, 000 bushels ^ J r ' Di Illustration. were obtained at a cost of $5000 for capital and labor. The cost of production would be 33J cents per bushel, and this would be the normal price of wheat. But the growth of numbers now increases the price obtain- able for 15,000 bushels, so that additional labor and capital are invested in this branch of industry. Accord- ingly $2000 more is invested in cultivating the best lands. 286 THE DISTRIBUTION OF WEALTH already in use; and it is found that, as the investment increases from $5000 to $7000, the product rises from 15,000 to not more than 20,000 bushels. Evidently the additional 5000 bushels have been obtained at a cost of $2000, or 40 cents per bushel, on account of the operation of the law of diminishing returns ; and the price of wheat must advance to this figure, if the supply is to remain as large as 20,000 bushels. 1 At this new price, it would be possible to bring into cultivation a second grade of land upon which $2000 of capital and labor would pro- duce 5000 bushels, as much as could be secured by the additional investment upon the superior tract. Thus the operation of the law of diminishing returns would extend cultivation from the better to the poorer lands long before the absolute limit of productivity of the former had been reached. In this illustration the owners of the best grade of wheat land will receive a rent as soon as the demand for wheat illustration forces the investment of capital beyond the (continued). p [ n t of diminishing returns. Whether the additional supply is obtained by added investments upon the older land or by bringing new into cultivation, the rent arises from the facts that the marginal cost has advanced to 40 cents, and that 15,000 bushels can be produced upon the more favored tract at a cost of 33J 1 The question may be asked, why need the price advance so far as 40 cents ? The 20,000 bushels now produced cost but $7000, and a price of 35 cents will cover the average cost of production. But with wheat at 35 cents, producers would find it more profitable to produce 15,000 than 20,000 bushels. The former would cost $5000 to produce, and would sell for #5250, yielding a rent of $250 above their cost. This surplus would be thrown away if $7000 should be expended in raising 20,000 bushels which would sell for no more than $7000. RENT 287 cents. If the demand continues to rise, the marginal cost, either of added investments upon the better lands or of cultivating a still inferior grade, would once more increase, and rents would advance to a higher figure. In all cases, it is the law of diminishing returns, and not the fact that the absolute limit of productivity is reached, which forces up the marginal cost of production and en- ables those persons who cultivate superior lands to gain a surplus, or rent, over and above what they have expended for labor and capital. And this is as true of factory sites or city lots as it is of land used for agricultural purposes. It appears, then, that rent emerges as a share in distri- bution as soon as the demand for the products of the land becomes so great as to make it profitable, and therefore necessary, to invest labor and capital upon the best tracts beyond the point of dimin- ishing returns, or to resort to inferior situations. If the former course is followed, the amount of rent is measured by the difference between the product of the earlier and the later, or marginal, investments upon the same land; if the latter is adopted, rent may be measured by the difference in the productivity of investments upon better and upon poorer grades of land. In both cases it arises from the fact that the various parts of the supply are produced at varying costs, and that the earlier and more productive investments yield a surplus over the labor and capital expended. § 195. It follows from what has already been said that rent, even a high rent, is not a cause of higher prices, but is caused by them. If the demand for a commodity exceeds the supply that can be obtained under the most 288 THE DISTRIBUTION OF WEALTH favorable conditions without pushing investments beyond the point of diminishing returns, the marginal cost of pro- duction and the normal price must rise. Before Rent not a x cause of high this occurs land can command no rent, since an eligible location can be had for nothing; after it happens, the surplus earnings of the investments on superior lands fall to the landowner, but gs a result of the higher prices. This proposition has proved a stumbling block to many students, and seems to be an affront to common sense. Every business man knows that his rent figures among the expenses that must be met out of the proceeds of his enterprise, and from this fact he often infers that it is a factor in the marginal cost of production upon which the normal price of a commodity depends. It is not to be doubted that a man who hires a lot of land must recover the rent out of the price received from his goods; but the proposition is that the price which he receives is not affected by that fact. He agrees to pay the rent because he considers that the advantages of the location will enable him to do such a large business, or do the same amount at such a reduced cost, that he can afford to pay what the landowner demands. If his rent were remitted, he would not sell his goods for less, since the demand warrants the present price, and supply and demand would not be equalized at a lower. If, through a mistake, he agrees to pay more than the price of his product enables him to recover, his only remedy is to seek a less expensive location; for the competition of other producers will not allow him to raise his prices. 1 1 A manufacturer of clothing who locates his establishment in New York does not expect to charge a higher price because his rent is higher RENT 289 § 196. Unlike interest and wages, rent is not a pay- ment for sacrifices which the recipient makes in order to assist production. The landowner neither x Rent an produces his land, nor, as landowner, assists unearned in the active conduct of industry, although he may, as capitalist or laborer, be actively employed and suitably rewarded for such efforts. For this reason rent has been termed an unearned income, and the justice of allowing private individuals to receive it has been called in question. This subject will require further attention when we discuss the merits of what is known as the single tax ; for the present, we must content ourselves with point- ing out that great care should be observed in applying the proposition that rent is an unearned income. The landlord, of course, does not produce his land and does not labor in order to obtain his rent. Yet if he has been a pioneer in a new country, the A needed increased value of his land after a new and cautlon - prosperous community grows up about him, may be regarded as no more than an adequate compensation for the labors and hardships of earlier days. The capitalist who develops a suburban district and induces people to purchase house lots from him, takes consider- able risks when he invests capital in the improvements that are needed to attract customers. At present, a part of his remuneration from such ventures comes from the than it would have been in a smaller city; in fact, competition of pro- ducers in smaller cities would not enable him to charge more. He locates in New York, and agrees to pay a higher rent, because the advantages which that city affords for his industry enable him to produce his goods cheaply and to pay his rent while selling at the same price as competitors in other cities. 290 THE DISTRIBUTION OF WEALTH inciease of land values that will accrue to him if his plans are successful. It cannot be admitted, therefore, that all increase in the rental value of land is to be considered an unearned income, in the sense that it is in no way the reward for services or sacrifices of the recipient. Yet in all progressive urban communities, it cannot be questioned that the steady growth of population increases urban land tne rent al value of city lots without effort or values. appreciable risk on the part of the owners. As John Stuart Mill observed, "The ordinary progress of a society which increases in wealth, is at all times tending to augment the incomes of landlords; to give them both a greater amount and a greater proportion * of the wealth of the community, independently of any trouble or outlay incurred by themselves. They grow richer as it were in their sleep, without working, risking, or economizing." In the city of Boston, for instance, the assessors' valua- tions show that, between 1888 and 1903, the total site value of land increased from $328,000,000 to $594,000,000 on account of the steady rise in the annual rent that it would yield; and it would hardly be claimed that this enormous increment of value was offset by equivalent services rendered or risks incurred by the landlords. Finally, it should not be forgotten that the increased rent which land bears as a result of social progress can Final consid- be considered an unearned income only for erations. t h e original owner, and not for a subsequent purchaser. A man who pays $100,000, accumulated 1 In a subsequent chapter (§ 223), we shall see that it is by no means certain that landlords receive " a greater proportion " of the income or wealth of the community. PROFITS 291 out of the "past earnings of his labor and capital, for land that yields an annual income of $5000, cannot be said to enjoy an unearned income — at least in the ordinary meaning of that term. In respect of the future increase of the rent which his land will bear, his situation will be different; but any income acquired by paying its capital- ized value is not to be considered unearned. V. Profits § 197. We have already seen that in any industry the superior establishments' supply the commodity for less than the marginal cost of production; and & v ' Profits. that, for this reason, they secure a surplus return over and above the amount expended for labor and capital. When this superiority is due to the fact that the business has been organized and conducted with exceptional skill and good fortune, the surplus falls to the entrepreneur and is to be regarded as the profit that accrues to his skill and enterprise. Although it resembles rent in many respects, it can in no sense be considered an unearned income. As the term is here employed, profit means the net proceeds of an enterprise after all obligations have been met and a suitable remuneration has been Gross and received by the labor and capital invested. net P rofits - It is to be distinguished with care from the gross profits of a business which will usually include interest upon the capital or wages for the services of the manager. Profits are the reward purely for the risk and enterprise of the man who assumes the responsibility of establishing and conducting a business undertaking. Such a person 292 THE DISTRIBUTION OF WEALTH engages to pay stipulated sums for rent, interest, and wages even though his books show a loss at the end of the year; and upon him the dangers of failure primarily fall, since his creditors can lose only when the results have been so disastrous as to more than wipe out the entrepreneur^ s own capital. Unsuccessful business men fail to meet their obligations and, becoming bankrupt, are constantly being forced out of the field of industry. By this process inefficient men are eliminated, and the control of labor and capital is placed in the hands of those who can employ them to the best advantage. Risk, therefore, is a very important factor in the organization of industry, and the person who assumes this burden must be suitably rewarded. At present the reward which lures men to exchange the assured income of the hired laborer or lender of capital for the uncertainties of business management Profits the . remuneration is the profit that may be gained in case goods ren erpn . ^^ ^ e p ro(mcec i f or } ess than the price nor- mally obtained for them. Upon his ability to produce a commodity for less than it costs the marginal producer to make it, the success of the entrepreneur depends; and though nothing is guaranteed him, his gains may be enormous. To some men the mere excitement of such a venture appeals strongly, while with others the greater freedom of the entrepreneurs position or the love of mastery is the stronger consideration. But without the prospect of a substantial gain in case of success, no one would exchange the assured income of the laborer or capitalist for the hazards assumed by the active business manager. PROFITS 293 It will be observed that we have assumed that the mar- ginal producers receive no profits, and obtain merely cur- rent rates of interest and wages for such capital Marginal and labor as they themselves supply. Their in- JSSKo™" comes are often called profits ; but when this is profits- done, it is necessary to apply some qualifying adjective to the profits obtained by employers of superior ability, and to call the latter pure or net profits. In this discussion, however, we shall apply the word " profits" only to the sur- plus earnings of superior producers, and shall consider that marginal producers receive only such interest or wages as they may earn. That they can obtain nothing more is due to the fact that, although a man will not embark in an enterprise without the prospect of such rewards as superior producers obtain, he will be likely, after his investment has once been made, to continue in the busi- ness even though he receives nothing more than ordinary interest and wages. The result is that, at a price which covers the marginal cost for capital and labor, a sufficient supply will be furnished to meet the demand, so that the normal price cannot be high enough to yield a profit, in the sense in which we employ the term, to the marginal producer. The reason why marginal entrepreneurs will continue to produce goods upon terms that would never have induced them to establish their undertakings, is not Reasons for difficult to explain. Capital once invested thlsfact - cannot be withdrawn without more or less loss, and it may be better to receive a normal rate of interest than to lose part of the principal ; moreover, if a considerable amount of the capital has been borrowed, the closing of 294 THE DISTRIBUTION- OF WEALTH the doors of the factory might mean bankruptcy. But in addition to this, it should be observed that an entre- preneur who to-day is receiving nothing more than ordi- nary interest and wages hopes for better times; and it happens not infrequently that increased exertion on his part, or a favorable turn of fortune, places him in a posi- tion where he is no longer a marginal producer and begins to receive profits. Then, too, so long as he can live upon the interest and wages that he obtains, the average man seems to prefer to conduct a business of his own rather than to become a hired laborer. These reasons, with others that are less important, explain the fact that an adequate supply of goods will be forthcoming at a price that leaves no profit to the entrepreneur who is on the margin of production. § 198. Obviously the amount of profits received by the more favored establishments depends on the degree The amount of superiority which they enjoy over the mar- of profits. ginal producer. This advantage may arise from greater organizing and financial skill, which often make all the difference between a profit and a loss upon a year's transactions. The possession of superior patents may account for the ability to produce at a lower cost; for, as Mr. Mill remarks, "If the value of the product continues to be regulated by what it costs to those who are obliged to persist in the old process, the patentee will make an extra profit equal to the advantage which his process possesses over theirs." Then, too, it cannot be doubted that mere good fortune is an important factor in deter- mining the amount of profits that an entrepreneur receives in any particular year, although it cannot account for PROFITS 295 the success which many establishments achieve over long periods of time. Finally, industry and integrity count as heavily, here as elsewhere, in favor of the persons who possess these cardinal virtues; and they have a commercial value that is despised by no one who has studied the conditions of permanent business success. § 199. The profits of the entrepreneur, unlike interest and rent, are usually of a personal nature, and often of a decidedly temporary character. They fre- Profits a per- quently depend upon the life and health of s ° nalinc <>me. a single man; and even when caused by less transitory advantages, they can be preserved only at the price of eternal vigilance. Success, itself, may destroy them since it may induce a feeling of security and lead to a relax- ation of the efforts upon which its own continuance depends. Then, too, fresh talent and more youthful energy are constantly invading the field, inefficient pro- ducers are continually forced out of the business by such competition, and the marginal cost of production steadily falls. Efficiency that yields a large profit to-day, may to-morrow give an establishment but a slight advantage over the marginal producer ; and when competition prevails, nothing can be considered assured except that it is always necessary to keep abreast of the latest develop- ments in the industry. In this respect profits differ, to a marked degree, from the surplus which goes to the land- owner in the form of rent. It follows from what precedes that profits are a surplus of wealth saved by the superior managers of p r0 fitsa industry in the process of producing a commod- sur P lus - ity which would have required a larger expenditure of 2g6 THE DISTRIBUTION OF WEALTH labor and capital under less efficient leadership. The)> are obtained by selling goods at prices that do not exceed the marginal cost of production, and, like rent, do not affect the value of a commodity. Prices could be no lower, but labor and capital would be wasted, if there were no entrepreneurs of an ability superior to that of the marginal producer. For this reason, when competition exists, " anger at the great captains of industry on account of the pure profits which they acquire is not only groundless, but insane. Rather it is the stupid and unsuccessful undertakers who deserve blame, sinking capital and starving laborers." FOR SUPPLEMENTARY STUDY General: Bullock, Selected Readings in Economics, 513-588; Hadley, Economics, 264-335; Marshall, Economics; Sea- ger, Introduction to Economics ; Taussig, Principles of Eco- nomics, Bk. V. Special : Carver, The Distribution of Wealth ; Clark, The Dis- tribution of Wealth ; Taussig, Wages and Capital. CHAPTER XIII THE LABOR PROBLEM I. The Labor Contract § 200. The hired laborer sells his services to an employer for a stipulated wage. In the view of the law, his labor is his property, and the agreement by which Labor a he disposes of it is similar to any other con- commodlt y- tract. Legally, as well as economically, labor is a com- modity which the possessor has a right to sell in the best market obtainable. In the United States both the federal and the state constitutions contain various provisions that guarantee to citizens the right to make contracts for the disposal of their property, and prevent legislative bodies from enacting laws that destroy such freedom of contract. Our courts, moreover, generally insist that these consti- tutional guarantees shall be rigidly observed ; and they often set aside, as unconstitutional, laws that undertake to prevent certain contracts from being made between employers and employees. § 201. But while labor must be regarded as a com- modity, the value of which will be governed by condi- tions of supply and demand, it differs from . ._ rr \ m Labor a other commodities in certain important re- peculiar T , , . . , ,. . . c commodity. spects. Indeed, it is to the peculiarities of this commodity that we must attribute the chief respon- sibility for the existence of such a thing as a labor problem. 2Q7 298 THE LABOR PROBLEM In the first place, the laborer and his commodity are inseparable, and do not part company when an employ- The laborer ment contract is made. "It matters nothing modliyarT" to the seller of bricks whether they are to be inseparable, used in building a palace or a sewer; but it matters a great deal to the seller of labor, who under- takes to perform a task of given difficulty, whether or not the place in which it is to be done is a wholesome and a pleasant one, and whether or not his associates will be such as he cares to have." From the very nature of the case the person who sells labor is vitally interested in the conditions of employment; while, on the other hand, the buyer has to exercise some control over the seller. The employer usually determines the place of work, and sometimes even the residence of the laborer; he has more or less control over the associates of a workman; and upon him depend many things that affect vitally the wek fare of the employee, such as the hours of work, sanitary conditions, and safety of life or limb. Under such cir- cumstances there is far more opportunity for ill will and serious friction between the parties to an exchange than there can be in contracts for the sale of other commodities. In the next place, labor is more like a perishable than a durable commodity, since there is often a certain ele- compuision ment of compulsion in its sale. The hired to sen labor. i a b orer commonly has little or nothing upon which he can fall back for support, so that he must dispose of his commodity at once for whatever price can be obtained; whereas "the seller of other goods, by the very fact that he has them to sell, has some capital upon which he can live while he is trying to make a satisfactory THE LABOR CONTRACT 299 contract." Moreover, poverty and ignorance may pre- vent a man from offering his labor in the most favorable market, and compel him to sell it in one that is already glutted. When such conditions are taken into the account, it is obvious that the person who offers labor in exchange for daily wages is not infrequently in a less favorable position than the seller of other commodities. A third peculiarity is connected with the one first men- tioned: the supply of labor changes very slowly, and only through changes in the number of laborers. The supply of The supply of other commodities can be de- j^pSSSS* creased by stopping production; but it is far m ann er. less easy to decrease the number of laborers when falling prices lead to a partial suspension of productive industry and throw many men out of employment. When a de- creased demand for labor causes low wages and lack of employment, large numbers of unemployed laborers press into the market and bid for work. Thus a decreased demand may bring an increased supply of labor into the market. On the other hand, when demand begins to increase after a period of hard times and low wages, a "reserve army" of unemployed laborers, "which the poor- houses at the expense of the whole population had sup- ported ... as long as dullness in the business continued," presses into the labor market and increases the supply. § 202. When due importance is assigned to the pecul- iarities which this commodity presents, it is clear that there must often be less actual freedom in a Summary. contract for the sale of labor than in that for the sale of most other things. Legally the laborer may do as he pleases; but as a matter of fact, he often has 3oo THE LABOR PROBLEM no alternative and must accept any terms that are offered. When a woman, a child, or one of a struggling crowd of men at a factory gate, stands before the employer who represents a capital of a million dollars, there is little real equality in the terms upon which bargaining proceeds ; and, for this reason, efforts have been made to improve the conditions of employment by legislation and the formation of labor organizations. II. Labor Legislation § 203. The growth of the factory system in England, as the result of the Industrial Revolution, partly produced and partly brought to light a multitude of English fac- v J & b toryiegisia- evils that called for some effectual remedy. Early in the nineteenth century women and children were employed in factories and mines under conditions that were destructive of body and soul; for all operatives the hours of labor were prolonged beyond human endurance, and little or no care was taken to protect workmen from the most dangerous accidents. In 1802 Parliament passed the first of a series of factory acts, which, while nominally restricting the laborer's freedom of contract, have gradually effected a material improvement in his condition. As systematized and ex- tended since 1878, these laws now prohibit the employ- ment of children under a certain age, and limit the hours that women and children can be employed in various industries; moreover, they enforce suitable ventilation and the proper sanitation of factories, and require that safety appliances shall be used whenever dangerous machinery is employed. The factory acts applied at first LABOR LEGISLATION' 30 1 only to women and children, and at present interfere less with labor contracts made by adult males than with those of other classes of laborers ; yet in a number of instances restrictions have been imposed upon callings that are followed chiefly or exclusively by men. § 204. Like the English factory acts, American legislation applies chiefly to women and children, although men engaged in the same industries are affected ° ° Details of indirectly by the statutes. Our laws pro- American hibit the employment of children under certain ages, and limit the number of hours that women and children can labor in factories and workshops. They frequently require the proper ventilation and sanitation of factories, and the fencing of dangerous machinery. In some cases statutes call for weekly payments, prohibit company stores or truck payments, and even regulate the employment of adult males in certain industries that are considered especially dangerous to the health of the operatives. In many cases the letter of the law is far stricter than its enforcement, and sometimes factory acts are partly inoperative on account of the absence of a competent body of state inspectors. The least has been accomplished in the South, where the recent growth of factory industries has produced certain conditions that call loudly for effective regulation. § 205. Not infrequently the courts have declared cer- tain kinds of labor laws to be unconstitutional upon the ground that they have invaded the citizen's „ _ A . J Constitution- freedom of contract. The decisions of the aiity of labor . legislation. courts of one state sometimes conflict with those of others, and some of the problems involved seem 302 THE LABOR PROBLEM to depend largely upon latitude or longitude; so that it is not easy to say just how far an American legislature can lawfully proceed with labor legislation. Laws regu- lating the labor of minors are generally upheld, because such persons are not yet in a position to make independent contracts, and, in a sense, are wards of the state. In some states laws regulating the employment of women have been held to be unconstitutional; and, in nearly all cases, restrictions upon the hours that adult males shall work have been set aside by the courts. Yet a few years ago the Supreme Court of the United States upheld a statute of Utah by which the employment of men in mines and smelters was limited to eight hours per day. So far as any clear principle can be distinguished in the tangle of conflicting opinions, it appears to be held that an act that has the effect of interfering with contracts made by adult males or females is constitutional only when it can be deemed a valid exercise of the police power of the state, this power being that of making such wholesome ordinances as are needed for the health, safety, or morals of its citizens. Laws requiring the proper ventilation and sanitation of factories would seem, upon their very face, within the scope of the police power; but acts limiting the hours that women shall work are not so clearly included, though it is probable that most courts will uphold them. With the contracts made by adult males, legislative interfer- ence is hardest to justify. In a mine or a smelter the propriety of state regulation is, obviously, less doubtful than in such an industry as agriculture; while in the case of a railway, the safety of travelers is involved, and the enforcement of reasonable hours would seem to be jlabor legislation 303 clearly admissible. The final outcome will probably be that the courts will find ways by which they can uphold the constitutionality of such legislation as experience shows to be necessary for the public welfare. § 206. Laws that enforce proper ventilation and sanita- tion of factories, or require adequate provision for the safety of laborers, need at this date no justifi- Economic cation. Few disinterested persons will ques- JSoriegfeia- tion the propriety of such regulation of the tion - conditions of employment. The restriction of child labor also requires no defense, even though many of our states now fall far short of performing their duty to the little victims of employers' greed or parental neglect. With the hours that adults shall work, the propriety of governmental interference is not so generally conceded. Undoubtedly there is a reasonable limit for the working day; but this differs from industry to industry, accord- ing to the healthfulness of the work or the intensity of exertion that is required. For this reason it is difficult to establish a general rule. The twelve or fourteen hour day of a former generation is, beyond question, too long for the welfare of the worker; but it is not clear that nine or ten hours is an excessive number to require in the aver- age occupation, although there are some industries where eight hours, or even less, are all that should be demanded. In the past, reductions in the hours of labor from four- teen to twelve and from twelve to ten have probably increased the efficiency of the workman enough to offset the loss of working time. A further reduction to nine hours, or even to eight, may have a similar effect in some cases; but in others it probably decreases the product, 304 THE LABOR PROBLEM and ultimately lowers the wages that can be paid. A uniform eight-hour day, which is often advocated, may yet be attainable; but it can come, if it is to be reached without reduction of wages, only by repeated experiments in one industry after another, and upon condition that the efficiency of the laborer increases pari passu with the decrease of time that he works. To introduce it by legis- lation would be unwise, even if it were constitutional. III. Labor Organizations § 207. Although combinations of craftsmen existed in some English towns during the eighteenth century, the modern labor organization did not make its Growth of ° . labor organi- appearance until the Industrial Revolution had prepared the conditions that were neces- sary for its growth. The aggregation of capital into large masses, one of the most striking results of the Revolu- tion, tended to widen the distamce between employer and employee, and to develop class feeling among the laborers. In the small workshops of former times, in which the employer worked with the aid of a few journey- men, constant personal intercourse existed; while since comparatively little capital was required to establish an in- dependent enterprise, the average journeyman could look forward to the day when he should be master of his own establishment. But all this was changed by the growth of the factory system. With the hundreds or thousands of men in his vast establishment the employer could no longer have that intimate intercourse which had served so often to promote good will and to remove causes of discontent. And, at the same time, the enormous amount LABOR ORGANIZATIONS 305 of capital needed for a modern factory made it impossible for the average laborer to expect to rise above his station and become an independent producer. Such condi- tions made it inevitable that, as the distance between employer and employee widened, laborers should resort to common action in order to protect and advance the interests of their class. § 208. Organization has usually been effected through combinations of workmen in the same craft or trade, and in this manner the trade union has been devel- The trade oped. It has proved difficult to unite men union " of different trades into a single association, since there is little community of feeling and may be considerable diversity of interest among them ; while unskilled laborers are the hardest of all to organize, probably because they are usually of a lower order of intelligence and are united by fewer apparent ties of common interest. The result is that trade unions, even in seasons of greatest prosperity, have never represented more than a fraction of the whole body of laborers. At the present moment there may be 3,000,000 laborers in the various organizations that exist in the United States, but this number is not more than one twelfth of the whole body of persons engaged in gainful employments, or more than one tenth of the entire number of hired workers. But in various indus- tries, usually those in which skilled labor is required, the proportion is far larger, and it sometimes exceeds one half of all the persons in the trade. At various times efforts have been made to unite all classes of laborers, including unskilled workmen, in a single organization. In this country, the Knights of 306 THE LABOR PROBLEM Labor, organized upon this basis, secured a large mem- bership between 1883 and 1887, increasing their num- Knightsof hers from about 52,000 in the former year to Labor. nearly 1,000,000 in the latter. But then a reckless policy with respect to strikes, conflicts with trade unions, and a disposition to enter politics brought about the overthrow of the association, which, in 1893, was supposed to have but 40,000 paying members. Its fail- ure taught labor leaders the necessity of organizing along trade lines, and during the past decade the trade union has again to come to the front. The trade unions, however, have found it desirable to cooperate for certain purposes, and have established the American Federation of Labor, which, American Federation between 1 89 7 and 1903, increased its member- ship from 265,600 to 1,605,500. The federal form of organization has permitted each trade to preserve its autonomy, and yet has made it possible to cooperate for certain ends. Besides aiding the eight-hour move- ment and advocating labor legislation, the Federation now keeps a considerable force of organizers in the field, and has had, in recent years, some success in forming unions of unskilled laborers. Aiding rather than attempt- ing to rival the organizations existing in separate trades, the Federation has now gained the leadership of the American labor movement. § 209. The objects of labor organizations are various, but their chief purpose is to better the eco- Objects of x x labor organi- nomic condition of the workmen. While many of them endeavor to improve the education and the morals of their members, or to promote social LABOR ORGANIZATIONS 307 intercourse, and while valuable results are sometimes accomplished in these directions, the labor unions are interested chiefly in bettering the conditions of employ- ment, advocating favorable legislation, and providing insurance against accident, sickness, or death. Both in the United States and in England, the trade unions have exerted some influence upon legislation, but this feature of their work can be given no i nsurance further attention here. Their insurance schemes - schemes are often useful to the organizations themselves in attracting new members and providing a method of disciplining the disobedient or unruly, who, through expulsion, lose their interest in any funds that have been accumulated. But considered purely from the stand- point of the security which they afford, the arrangements of the unions are not so advantageous for the insured. Usually insurance funds are not separated from the other resources of the unions, and may be expended in aid of strikes, so that those who pay money for one purpose may see it disbursed for another. Then, too, the rate of assessment has not always been high enough to place the schemes upon a sound financial basis. In these respects there is much room for improvement, and it is to be hoped that more of the unions will follow the exam- ple of the Locomotive Engineers in effecting an absolute separation of strike and insurance funds. With respect to the conditions of employment, the unions endeavor to secure shorter hours of work, better wages, and, sometimes, the exclusion of workmen conditions of that refuse to join their organizations. In em P lQ y ment - these matters it is possible for a combination to secure 308 THE LABOR PROBLEM better terms than individual workmen would often obtain, on account of the unequal intelligence, resources, and tactical advantages of the large employer and the single laborer. It is not correct to say, as is sometimes done, that workmen unorganized would be absolutely helpless in the hands of their employers, since in times of expand- ing trade the demand for labor is so great that the advan- tage is not wholly with the capitalist. It is also true that, when business becomes less brisk and the demand for labor declines, the strongest unions cannot avert the inevitable consequences of such a condition of the labor market. But when all this is conceded, it remains true that a well- organized union can make wages rise more promptly as the prices of commodities advance, and minimize the loss that laborers suffer when the market begins to fall. Moreover, in what may be called "sweated trades," where ignorance, poverty, and an excessive supply of labor have reduced wages below the level required for a decent subsistence, it is possible for a union to infuse hope and courage into the workers, and enable them to better their condition very materially. § 210. When wisely conducted, a union may be a highly desirable means of securing the healthy operation of Possible ad- competition in the market for labor. By Tab^Saifi- ma king the strength of the parties to the con- zations. tract substantially equal, it can oblige em- ployers to pay all that the market will enable them to give ; while, by assisting its members to migrate to places where the demand is active, it can distribute the supply of labor in the manner that is most advantageous to the community. By accumulating a reserve fund upon which its members LABOR ORGANIZATIONS 309 can subsist while temporarily out of employment, it enables the workman to reserve his commodity until he finds such conditions as he deems advantageous to himself. The satisfactory working of the laws of supply and demand requires that laborers, as well as employers, shall be intel- ligent, alert, and able to seek their own advantage — a condition which the union endeavors to maintain. § 211. A few words should be said concerning two things which are now cardinal points of trade-union policy, — the standard wage and the union, or closed- The stan dard shop. In adjusting wages the unions usually wa & e - demand a standard rate for all their members, except per- haps a few older or less competent workmen who may be permitted to accept less. Theoretically this is a mini- mum wage, and there is nothing to prevent an employer from paying more; but in practice it is often a maximum rate beyond which superior workmen do not advance. This is due sometimes to the fact that the minimum is placed so high that many employees do not earn all they receive, so that it is impossible to pay more to the better workmen, who must carry the poorer upon their backs. Or, in other cases, it arises from a disinclination upon the part of unionists to allow any of their members to do more than a certain amount of work, — a matter to which we shall return in a later paragraph. It is even urged that the standard rate should be main- tained at all times, no matter what the condition of the labor market may be, and that when the demand for products declines and prices fall, an employer should be obliged to go out of business rather than be allowed to cut wages. This method disposes of 310 THE LABOR PROBLEM the employer, but it does not provide for the payment of the standard wages after he goes out of business; in fact it would merely increase, in times of depression, the army of the unemployed by whose competition ultimately the standard rate would be broken down even in those establishments that might maintain their solvency. With the progress of industry it is possible and desirable that the rate of wages should steadily advance, but its upward movement cannot be continuous, irrespective of the con- ditions of the market. So long as conditions of business fluctuate, the rate of wages cannot be unaffected by this fact. Unions can demand a higher rate in every period of rising prices, but with a falling market it is idle for them to refuse to make concessions. § 212. As labor organizations increase in strength and numbers, they often demand that shops or factories The closed snan ^ e cl° se d to all workmen who cannot shop: produce a union card. When this is done in order to combat the efforts of employers to break up the unions by constantly displacing their members in order to make room for outsiders, it would seem to be a justifiable weapon of defense. But in cases where no discrimination is practiced against unionists, the demand for a closed shop cannot be justified. It means nothing more or less than that a private association attempts to deny the right to work to all who will not join its ranks, and it can be enforced only by arousing the worst passions of human nature against the man who refuses to join a union. In defense of the closed shop it is argued that a union secures better conditions in its trade, by which all laborers LABOR ORGANIZATIONS 311 are benefited, and that these advantages should not be en- joyed by persons who have not contributed to obtain them. But, if this is true, it does not follow that the (a) i nvo ives union should oblige outsiders to contribute; "*****• as well might a church, upon the plea that its good offices benefit the entire community, attempt to tax every one for its support. If it is necessary to force contributions to unions or to churches, the authority of the govern- ment must be invoked, because private organizations cannot be allowed to undertake the one thing or the other. At present the theory upon which we proceed is that both churches and labor unions are best conducted when they appeal to the reason or the interests of their supporters; and if compulsion is to be employed in either case, this should proceed from the government and not from a private organization. While monopoly might not result from the establish- ment of the closed shop, provided that a union opened its doors to all competent persons who would enter the trade, there would be great danger listicinits . _ tendencies. of a different outcome. By imposing high initiation fees, requiring long apprenticeships, and giving unfair advantages to the children of its members, a union could easily become the master of the situation, and abuse its powers for selfish ends. Labor organizations are subject to all the infirmities that combinations of capitalists display, and there is no reason for thinking that a monopoly of labor is at all preferable to a monopoly of capital. Capi- talist and laborer alike need to be kept upon their good behavior by the pressure of competition, and the public must suffer when either of them acquires a monopoly. 312 THE LABOR PROBLEM § 213. It is often charged that trade unions restrict the amount of work which their members do. They are also Restriction believed to exercise an unfavorable influence of output. U pon industrial efficiency. In considering the matter it should be remembered that there are certain reasonable limits to the amount of labor that any one should perform. In a trade that demands severe physical exertion or exposure to more or less unhealthful condi- tions of employment, there is a pace that makes a work- man old at forty, and one that will enable him to do a man's work still at the age of sixty. If a union does no more than oppose over-driving and endeavors to insure to its members forty instead of twenty years of efficiency, its course is morally and economically justifiable. But, unfortunately, this is not always the whole of the story. In a few cases the regulations of unions have forced an unreasonable restriction of the output; and, in a some- what larger number, a tacit agreement among the members has had the same result. The precise extent of this evil is hard to determine, and sweeping statements should be avoided. Here and there in the building trades, daw- dling has sometimes been reduced to a fine art, and one can occasionally observe elsewhere that union workmen are acquiring the most leisurely habits of work. It should be remembered, however, that laziness is older than trade unionism, and that the unions can be held accountable only for cases in which their influence has tended to increase this evil. Such instances undoubtedly exist, but more evidence than has so far been adduced would be needed to justify any more positive statement than we have made. LABOR ORGANIZATIONS 313 § 214. The growth of labor organizations has led to much friction between employers and employed, the two parties resorting to such weapons as the lock- strikes and out and the strike, the blacklist and the boy- lockouts - cott. In the United States no less than 22,793 strikes occurred between 1881 and 1900, involving 117,509 estab- lishments and 6,105,694 employees, while during the same period employers in 9933 establishments locked out 504,307 men. In these contests the laborers sacrificed $306,682,000 in wages, and the employers are supposed to have lost $142,658,000, while the inconvenience occa- sioned to the public defies all computation. Fifty per cent of the strikes and a similar proportion of the lock- outs are reported to have been successful, while thirty- six per cent of the former and nearly forty-three per cent of the latter failed completely. In the remaining cases compromises of one sort or another were finally effected. In the industrial warfare represented by these statistics the laborers often endeavored to enforce their demands by the boycott, which is an organized effort industrial to persuade or intimidate other persons from warfare - having dealings with their employers; and the employers made more or less use of the blacklist, by which they attempted to boycott obnoxious members of the unions. Both of these weapons are illegal, and deserve the severest condemnation, since they constitute a direct interference with the rights of others. The mere strike, however, and the lockout are in themselves perfectly lawful acts, although they may be accompanied by objectionable features. They have often led to violence and the loss of life and property, and recently, in the state of Colorado, 314 THE LABOR PROBLEM they have produced a condition that can be described only as civil war. In most cases the interests of the public, the third party to the transaction, have been ignored by both contestants, as was made manifest in the great coal strike of 1902. The responsibility for such conditions is sometimes laid at the door of labor organizations, but not more than half ResponsiMi- of it belongs there. The workmen have often ity divided. ma( j e unreasonable demands; they have been arrogant and selfish in too many cases, and have some- times suffered from outbreaks of homicidal mania. But, on the other hand, the reasonable demands of labor have often been met with insolent refusals to treat with the representatives of any organization ; the unlawful boycott has been met with the equally unlawful blacklist; and violence to non-unionists has been met, as in Colorado, by intimidation of the members of the unions. In 1904 the labor organizations of the country were fighting against inevitable reductions of wages in the face of a falling market, while employers were forming associations for the purpose of exterminating unionism, root and branch. Neither attempt could succeed, and the net result was loss to both sides and great inconvenience to non-com- batants. § 215. The losses and disturbances occasioned by labor controversies have called forth various plans for conciliation, remedying such difficulties. One expedient S°n P t C a g U re C e- 1S ' has been the establishment of joint boards ments. f conciliation in various trades. In these schemes employers and laborers in individual establish- ments have appointed shop committees before which LABOR ORGANIZATIONS 315 complaints can be brought for calm and fair consideration before they lead to serious disputes; or employers' asso- ciations and labor organizations covering entire trades have arranged prices and conditions of employment for definite periods of time, and have agreed to submit to boards of arbitration all disputes that may arise concern- ing the interpretation of the contracts. When such methods have been tried in good faith, it has been found that many causes for disputes can be removed by a friendly conference; both employers and laborers have taken care to avoid mistakes, and have sometimes shown in- creased respect and consideration for one another. In some cases strikes and lockouts have been avoided for considerable periods of time ; and it has been demonstrated that the conflicting claims of labor and capital can be adjusted upon a basis of reason and justice without appeals to the wager of battle, and, withal, in a spirit of mutual good will. When disagreements between employers and laborers have led to an open rupture, both parties have sometimes consented to submit their cases to arbitration voluntary by some fairly constituted tribunal. A few arbitration - of our states have established boards of conciliation and arbitration, the services of which are placed at the disposal of laborers and capitalists. In Massachusetts something has been accomplished in this manner, especially in the settlement of controversies that have not yet led to an open rupture. Even here, however, the plan has not prevented the occurrence of serious strikes ; while in other states, the public boards of arbitration have often fallen into the hands of politicians for whom neither laborers 316 THE LABOR PROBLEM nor capitalists have entertained much respect. During the past decade the prestige of state boards of arbitration has declined; and the shop council and the trade agree- ment now seem to be the favorite expedients for obtaining industrial peace. In view of the facts that no other method has been entirely successful in preventing strikes, and that, in many compulsory cases, one side or the other seems reluctant arbitration. tQ adopt any measure f Te ]i e f t it has been proposed to compel laborers and capitalists to settle their disputes in courts of law. The Australasian states have established systems of compulsory arbitration, and their experiments are now being watched with considerable in- terest. But compulsory arbitration, except, perhaps, in a few industries that have a public character, would undoubtedly be unconstitutional in the United States; and it is not at present favored by either laborers or capi- talists. At best it presents very serious difficulties, the first of which is to devise practicable methods of enforcing decisions that are unfavorable to laborers. 1 In New Zealand the workmen are obliged to organize unions before they can appeal to the arbitration courts; but unless the union possesses a large amount of property, the members can drop out rather than work under conditions that they do not wish to accept. The New Zealand plan worked smoothly until, in a period of bad times, the labor courts made a number of awards unfavorable to the workmen, when several troublesome strikes occurred 1 The employer, of course, gives hostages when he establishes his enter- prise, since he places himself in a position that makes it easy to enforce an award unfavorable to him. LABOR ORGANIZATIONS 317 in spite of the law. It has not, then, prevented strikes, but has undoubtedly diminished the number of them. The other serious difficulty in compulsory arbitration arises from the fact that it is a very delicate matter for an outsider to determine what rates of wages Criticism. employers must pay and employees accept. The only motive for offering wages is the desire to make a profit, and if the prospect of obtaining this is destroyed by decree of a court, the natural result would be to decrease the demand for labor and the wages that can be paid the workmen. On the other hand, the employee, although he can be compelled to submit to conditions that he finds distasteful, cannot be obliged to render willing and effective service, even though he is forced to perform a certain amount of labor. Certain American states have recently established wage commissions having power to fix mini- mum rates of wages in occupations where women are employed, and we shall soon have valuable evidence concerning the practical working of public regulation of wages in certain industries. § 216. Disputes between labor and capital will continue so long as industry is organized on its present basis ; and the only thing that can be expected is that need- Summary. less controversy will be avoided, and that each contestant will respect the rights of the other and those of the public. Through shop councils and joint agreements much can be accomplished, and relentless punishment of unlawful tactics will remove a great part of the incon- venience which non-combatants now suffer. As labor organizations grow older and acquire property, they become more conservative; and employers are slowly 318 THE LABOR PROBLEM learning that the trade union has come to stay, and that laborers are entitled to have a voice in determining the conditions under which they work. It is useless to hope for an industrial millennium ; but occasions for controversy will be removed in proportion as labor and capital acquire respect for each other's strength, and each considers fairly the just claims of the other. IV. The Relation of Laborers to the Product of their Labor § 217. Irrespective of any influence that trade 'unions exert, experience shows that laborers receiving time wages Time and are likely to have less incentive than they piece wages. neec [ f- j- urn 0U £ a l ar g e product. Piece wages, therefore, have been introduced in many industries, in order to give the workman a greater stimulus to diligent effort. Not infrequently employers have introduced piece wages and secured a larger product from each laborer, and then have reduced the rate paid per piece, so that an em- ployee must work much harder than before in order to make as much as his former time wages. Naturally enough, such experiences have led many laborers to look with suspicion upon proposals to adopt piece wages, and to refrain from increasing their output even when the system has been introduced. Yet in many industries payment by the piece prevails, and by fair treatment the opposition of the wage earners has been overcome. § 218. Another method of adjusting the remuneration of the laborer is what is known as a progressive wage. Progressive Employees have been guaranteed a minimum wages - time wage, and then offered a premium for attaining a certain degree of efficiency; or piece rates LABORERS AND THEIR PRODUCT 319 have been adjusted upon a progressive scale, the rate per piece rising slightly as the output increases. In some cases progressive wages have increased the prod- uct by as much as fifty, eighty, or even one hundred per cent. They may be a desirable method of remunera- tion in some occupations; but, when they combine a minimum time wage with a premium for efficiency, they are less advantageous for the laborer than a simple piece wage. 1 § 219. Profit sharing is a plan which is designed to give the laborer an inducement to work more efficiently, and to secure greater harmony of interest p ron tshar- between employer and employee. It offers ing * the laborers, beside their usual wages, a share in any profits realized from the business over and above a certain minimum amount considered to be the necessary remunera- tion of the proprietor, the portion of each employee being determined upon some equitable basis. In some cases this arrangement has given laborers an inducement to increase the product, improve its quality, or economize in the use of materials, so that by the efforts of the partici- pants themselves profits have been increased and the re- muneration of the workers enlarged. But much more often it has turned out that the profits exceed but little, if at all, the minimum sum reserved for the proprietor; and, therefore, the laborers have had only the slightest interest in the working of the schemes, not hesitating to strike if there was any prospect of immediate advantage from such a source. 1 The premium paid for exceeding a certain product is usually less than a proportionate addition to the time wage. 320 THE LABOR PROBLEM As a scheme of distribution, profit sharing is open to serious objections. The profits of a business can be increased by greater diligence on the part of laborers, but they depend so largely upon the skill exercised in buying materials, organizing produc- tion, and disposing of the product, that their amount does not and cannot vary proportionately to the increased zeal and efficiency of the employees. Laborers may increase the product ten per cent, or reduce its cost in corresponding proportion, but bad business manage- ment may result in an actual loss upon the year's transac- tions. In this case the extra exertion of the employees would reduce the extent of the losses, but would bring no extra remuneration. On the other hand, if the profits distributed are not created by extra exertion upon the part of the workmen, but arise from greater skill in the management of the business, they become a mere gratuity ; and the whole scheme works unfairly to the employer. Too often profit-sharing arrangements are so contrived that they have the evident purpose of detaching laborers Further con- f rom the trade unions, and of hampering their siderations. freedom of action. When participation in profits is deferred for a period of years, or confined to operatives who have been in the employ of the firm for a considerable length of time, the effect of the plan is too obvious to need discussion. Moreover, if the prospect of sharing in profits is held forth, laborers are less likely to demand higher wages at times when workmen in other establishments are securing advances; and it has often turned out, when profit sharing has lasted for a number of years, that the stipulated wage paid each employee LABORERS AND THEIR PRODUCT 32 1 plus his share in the profits was no more than the market rate of wages. In some instances profit sharing has increased the remuneration of laborers and promoted a better understanding between employers and employ- ees, but it has more often disappointed the hopes of its advocates. As a permanent solution of the labor prob- lem, it is hardly entitled to serious consideration. § 220. Cooperation (§ 34) proposes to remove friction between employer and employee by eliminating the em- ployer. It is usually said to have two forms, distributive and productive. The former, however, is nothing more than the cooperation of con- sumers in order to get rid of the so-called middleman, and affects in no appreciable way the labor problem. In England it has resulted in the growth of a considerable number of successful stores, and in the United States has had somewhat less success. Productive cooperation, on the other hand, is a serious attempt to grapple with the problems of labor. Societies of workingmen contribut- ing some capital, and often borrowing a part, have devel- oped in England a number of prosperous enterprises, and have sometimes succeeded in the United States. In France, Belgium, and a few other countries experi- ments with cooperative production are now being tried »n a considerable scale. Whenever cooperative enterprise is practicable, it pos- sesses very obvious advantages over the wage system. Self-employed workers have shown activity itsadvan- and zeal that hired laborers seldom exhibit, tages * frugality and saving have been encouraged by the strong- est possible inducements, while the responsibility of pro- 322 THE LABOR PROBLEM prietorship and the experience in business management have had an excellent moral and intellectual influence upon the cooperators. The system, of course, eliminates strife between the employing and laboring classes. But many difficulties beset the path of cooperators The success of any enterprise depends inevitably upon itsdifficui- the ability with which it is managed, and ties- cooperators must contrive somehow to secure the most efficient leadership if they hope for success. They may appoint a shop committee to direct their affairs, or secure, from their own ranks or elsewhere, a superin- tendent or manager. With the committee system respon- sibility and power are divided; and with both systems the management may be hampered by differences of opinion among the rank and file of the association. Then, too, when able managers are found, cooperators are not always willing or able to pay enough to retain the services of such men. In many cases, also, it has been hard for managers who owe their positions to the good will of the men under their direction to enforce the best of discipline. In general, cooperation has succeeded best in industries of a less complex character, where skillful management counts for less and efficient workmanship is of more avail. Finally, it is difficult for laborers to secure, especially at critical times, the capital needed to establish and develop their enterprises. Not infrequently when conspicuous success has been attained, the very need of additional capital to extend the undertaking has resulted in the control of the establishment passing to outside capitalists, and true cooperation has thus come to an end. Up to the present time the various difficulties here enumerated LABORERS AND THEIR PRODUCTS 323 have usually circumscribed narrowly the field within which cooperative production can succeed. The system is, undoubtedly, an ideal one whenever practicable; but for a long time to come the large majority of business undertakings will be managed by the entrepreneur, who seems best able to insure to society efficient direction of its productive forces. FOR SUPPLEMENTARY STUDY General: Hadley, Economics, 336-369, 404-421; Seager, Intro- duction to Economics, 385-433; Taussig, Principles of Eco- nomics, Bk. VI. Special : Adams, Labor Problems ; Commons, Trade Unionism and Labor Problems ; Gilman, Methods of Industrial Peace ; Rae, Eight Hours for Work ; Report of the Industrial Commission, XIX, 723-956; Schloss, Methods of Industrial Remunera- tion ; Webb, Industrial Democracy. CHAPTER XIV PROJECTS FOR ECONOMIC REFORM I. The Single Tax § 221. At various times it has been proposed to alter radically the present distribution of wealth, and .at present Land nation- tw0 projects enlist more or less public interest, aiizatum. foe single tax and socialism. About 1870 a movement was started in England in favor of land nation- alization. An organization known as the Land Tenure Reform Association, of which John Stuart Mill became the president, proposed that the state should take, by taxation, the future increase of land rentals, and that present owners should be given the option of "relinquish- ing their property to the state, at the market value which it might have acquired at the time when the project should be adopted by Parliament." The Association claimed that its plan was both just and desirable because the growth of ground rent (economic rent in the strict sense) is due to the progress of society in population and wealth, and not to "any effort or outlay by the proprietors." § 222. Some years later Mr. Henry George, in a work which gained a large number of readers, urged that the The single state should not only take by taxation the future increase of land rent, but should seize gradually the present economic rent of land, or at least 324 THE SINGLE TAX 325 so much of it as should be needed to defray all public expenditures conceived upon a somewhat elaborate scale. His purpose would be accomplished by abolishing all other taxes, and imposing on land a single tax equal sub- stantially to its economic rent, or such a proportion of it as might be required. He denied, moreover, the justice or necessity of compensating landowners for the losses occasioned in the execution of the plan, so that in scope and in method of operation his proposals were far more radical than those of the Land Tenure Reform Association, which had commanded the support of such an eminent economist as Mill. Mr. George, in expounding this scheme, argued vigor- ously that all men should have absolute rights of pos- session over the products of their labor and M r. George's capital, even denying the justice of a cax that ar « uments - falls upon anything that a person has produced. He urged, however, that rent is not the product of any man's labor, but the result of social growth and activity by which the demands upon land are increased and its value enhanced. Since the community, in this view, creates rents, it should reserve them for public uses, and not allow them to be diverted into the pockets of private individuals. Mr. George attributed poverty and other social ills to the fact that landowners, contributing nothing to the product of industry, are allowed to claim, as society advances, an increased share of the proceeds. 1 He looked upon 1 Mr. George's statement of the case was as follows : " The reason why, in spite of the increase of productive power, wages constantly tend to a minimum which will give but a bare living, is that, with increase in pro* ductive power, rent tends to even greater increase, thus producing a cor* 326 PROJECTS FOR ECONOMIC REFORM the single tax as the panacea for all evils that can in any way be removed by social action, and denounced private ownership of land as robbery. Written with great power and even eloquence, his writings have gained for him a considerable number of disciples. § 223. Passing over the metaphysics of the question, it is tolerably evident, first of all, that there is a hiatus between the proposition that rent is an unearned Criticism. . i i 1 r • • income, and the proposal to confiscate existing rents. Rent is not the only unearned income; inherit- ances, gifts, and some speculative gains are obtained without exertion on the part of the recipient. The right of private property, therefore, does not depend for its justification merely upon the fact that the objects owned are the products of the owner's labor; it depends at all times upon considerations of social expediency, and upon such grounds private ownership of land has been con- sidered by most people to be justifiable. If the belief in the good effects of private ownership is a mistake, it would follow that society would do well to correct the error; but it would not follow that the whole burden of the change should be thrown upon those persons who, in entire good faith and in accordance with the will of the community as expressed in law, had invested their fortunes in land. Appropriating existing land values stant tendency to the forcing down of wages." — Progress and Poverty, Bk. V, Chap. 2. By the " forcing down of wages," Mr. George means either an actual decrease, or a failure of wages to increase as rent in- creases, i.e., a relative decrease. 1 It is not true in all senses of the term that rents are invariably un- earned incomes, as we have seen (§ 196). That there is a very large unearned increment, however, especially in cities, is conceded to Mr. George. THE SINGLE TAX 327 without compensation is not to be thought of, even though the rest of Mr. George's arguments commanded our assent. But it is clear that Mr. George exaggerated the evils that follow private ownership of land, and overlooked entirely the benefits which have resulted from Further it. If we concede, as we must, that the usual criticism - effect of progress is to increase the value of the land, it does not follow necessarily that the proportionate share of the landlord in the product of industry increases. The landlord receives a higher rent for his land, but the prod- uct obtained from it may have increased in equal, or even greater, proportion, so that the share of the total product received by the landlord may be no larger than before. Until it can be shown that rent not only increases, but increases more rapidly than the product of industry, it cannot be demonstrated that the growth of the land- owner's income is the cause qf poverty. As a mattei of fact, for a generation or more, wages have been steadily advancing in the United States and other progressive countries at the same time that rents have increased. Then, too, it should never be overlooked that, whatever evils may have resulted from it, private property in land has furnished the great stimulus for the devel- Advantages opment of the natural resources of the United i a ndowner- States. The rise in land values following ship - the establishment of each new settlement has lured hosts of people into the wilderness, and has been a not inappro- priate reward for the hardships of pioneer days. In addition to this fact, when land ownership is widely distributed, as in this country, the increment of value 328 PROJECTS FOR ECONOMIC REFORM that results from social progress is sure to be widely distributed. Moreover, the desire to secure a small farm or a site for a house has been the principal incentive to industry and thrift for millions of people ; and the acquisi- tion of a little land has not only started many families on the road to a competency, but also created a vast body of prosperous, conservative, and law-abiding citizens. § 224. From a practical point of view, great difficul- ties would be encountered in the effort to apply the single tax to agricultural land. After a farm has Agricultural ° . and urban been under cultivation for many years, it is extremely difficult to determine what part of the so-called rent which it yields is the mere value of the site, and what represents the interest on capital expended in improvements. Barns and fences can without difficulty be valued separately ; but labor sunk in clearing, ditching, removing stones, and fertilizing defies accurate computa- tion. The best that could be done would be to apply some sort of rough estimate which would, in numberless cases, do great injustice to landowners or impair seri- ously the revenue received by the government. In cities, of course, this difficulty would not arise, since it is possi- ble to place separate valuations upon building lots and improvements, as is done to-day by the assessors in Boston and New York. § 225. If the proposal to confiscate existing rents must be rejected as unjust, the same criticism cannot be directed at projects for gradually appropriating to increment of public purposes the future increment of land values. The only question involved here is the desirability and practicability of such a change in THE SINGLE TAX 329 the policy of the government. The practical difficulties in the way of separate valuation of land and improve- ments are, for the present at least, a decisive objection to the application of the scheme to agricultural holdings. With urban land this difficulty disappears; while here the amount of the future increment, and consequently the importance of the proposal, are decidedly greater. To buy out present owners, at such values as munici- palities are obliged to pay for land taken for city pur- poses, would involve communities with a stationary or slowly increasing population in a hazardous speculation, even though a city that was growing with great rapidity might safely undertake such a venture. But to adjust municipal taxation in such a manner as to intercept a considerable part * of the future unearned increment from land would be a safe and probably a desirable policy. This would place a part of the increasing burden of city taxation upon an object that derives its value from munici- pal growth, and not from individual effort; it would do no injustice to present owners; and would make it pos- sible in growing communities to reduce the pressure of taxes upon business enterprises. It would, moreover, be in line with some of the existing tendencies in municipal finance. § 226. In passing judgment upon Mr. George's pro- 1 The whole of the future increase of rentals could not be taken with- out injustice to present proprietors. The purchase price paid for land in a progressive city is somewhat greater than its capitalized present rental value, since the purchaser can and must pay more in view of the prospec- tive increase of the rent. Some part of the future increase, therefore, is reflected in present capital values, and should be left to the present owners. 330 PROJECTS FOR ECONOMIC REFORM posals, we have been unable to accept the dark picture which he has drawn of the results of private property in land, and we are obliged, under any circum- Conclusion. f ' . stances, to reject the idea of taking existing land values without compensation. It does appear, however, that both Mr. George and the English Land Tenure Reform Association have pointed to a highly eligible object for special taxation. When it is conceded that the past increment of land values is beyond the reach of any just exercise of the taxing power, the question remains : What policy should be pursued with reference to the future increase of ground rent? So far as urban lands are concerned, there can be little doubt that it is the part of wisdom for municipalities to seize upon a source of revenue that is brought into existence by urban growth and to a large extent maintained by constant public expenditure. II. Socialism § 227. More radical than the single taxer in his criti- cism of the existing distribution of wealth, the socialist socialism holds that interest and profit, as well as rent, defined. are unearnec j incomes unjustly extorted from the persons whose labor creates all the wealth that is brought into existence. Socialism, therefore, contem- plates such a reorganization of economic society as shall bring all the instruments of production, capital as well as land, under collective ownership ; replace private enter- prise by public management of all important industries; effect a just distribution of the social income; and per- mit private ownership of the consumer's goods dealt out SOCIALISM 331 to each worker. Its elements may be briefly stated as common ownership of land and productive capital; pub- lic organization and management of at least all staple industries ; the distribution of wealth by public authority, in accordance with some principle regarded as just ; and private property in the incomes allotted to individuals. § 228. Socialism is not a new but a very old theory which has appeared and reappeared in one form or another ever since the time of Plato. It has usually _ _ ^ J Its history. attracted most interest at times when a sharp separation of rich and poor has brought to general atten- tion the unequal distribution of wealth and the problem of poverty ; although ideals of social or political equality, such as appealed to so many persons in the eighteenth century, have been another source of socialistic theories. Plato's " Republic," for instance, with its proposals for the extremest subordination of individual life to the con- trol of the state, has for its background a bitter and pro- longed contest between rich and poor which had long been waged in Athens and other Greek cities. Again, in the sixteenth and seventeenth centuries, the social distress occasioned by widespread economic and political changes evoked such works as Sir Thomas More's "Utopia" and Campanella's "City of the Sun"; and in the eighteenth, the misery that existed in France made that country a fruitful field for socialistic speculations. Finally, in the nineteenth century, the increased importance of capital and the sharper separation of the employing and the laboring classes have prepared the ground, already sown with democratic political ideaK for the growth of modern socialism. 332 PROJECTS FOR ECONOMIC REFORM § 229. Socialism of the present day is a contemplated scheme of industrial organization based upon an analysis of the workings of modern industrial society. The The basis of ° .,.,.. modern so- central fact in the present industrial society is said to be capitalistic production, by which is meant production carried on with the aid of so much capital as has come into use since the Industrial Revolution. Capi- talistic production, the socialist holds, has divided society into two classes, those who own land or capital and those who do not, the latter being dependent upon the former for an opportunity to employ their labor. Between capi- talist and laborer, consequently, there has arisen a class struggle, in which the owner of capital exploits the labor of the hired workman to his own advantage ; while the workman, oppressed with long hours of toil and low wages, endeavors vainly to improve his position so long as the existing system continues. The political and industrial history of the nineteenth century, it is alleged, is nothing but a record of the various phases which the warfare between the capitalists and the laborers has assumed; while the only clew to the development of the twentieth is to be gained from a study of the probable tendencies of this class conflict. The machinery by which the capitalist succeeds in ex- ploiting the laborer is the wages system. Socialists hold that the entire product of industry is to be attrib- Alleged ex- c .,.,., pioitation of uted to labor, and that capital is nothing but a certain amount of labor embodied in a tool or machine. But under the wages system the laborer does not receive all that he produces, because the employer manages to withhold a part as compensation for the use of his SOCIALISM 333 capital. 1 The result is that, whereas a laborer by working three or four hours could produce all the wages that he actually receives, the employer keeps him at work for nine or ten hours and appropriates, under the name of rent, interest, or profits, the surplus product of the addi- tional time. Such a contract, though disadvantageous to the laborer, is forced upon him, the socialist declares, by his poverty and inability to hold out for better terms. If it ever happens that favorable circumstances enable a laborer to secure a wage that will somewhat more than cover the bare living expenses of himself and family, the growth of population speedily forces the rate down again to the minimum required for mere existence, so that in fact, by an iron law, the wages system dooms the laborer to an unsatisfactory and precarious position. The only salvation for the laborer, according to the socialist, is to acquire political power and to take posses- sion of the instruments of production by which T he remedy he is now "enslaved." Through the estab- propose r J Demoraliza- inducements to commit frauds. When each tion caused citizen is compelled to declare under oath the full value of his property, perjury is the usual result ; for an honest man, who desires to pay all that is justly due from him, knows that, if he tells the whole truth, he will have to bear two or three times his fair burden. Thus our present system punishes honesty with a double load of taxes, and allows the dishonest and unscrupulous tax dodger to escape. Our general property tax has been shown to be largely a tax upon real estate, since most personal property, except that of a tangible form, escapes the conclusions assessors. In its apportionment there are ^property the grossest inequalities between different tax - towns and counties, while between individual citizens its burdens are often distributed without the remotest approach to justice. More than this, it has become a fruitful source of demoralization, and is systematically educating our people in habits of fraud and perjury. In theory the tax is unjust as a main source of public revenue, since property is not the best measure of ability ; and in 364 GOVERNMENTAL REVENUES practice "the general property tax as actually adminis- tered is beyond all doubt one of the worst taxes known in the civilized world." It has been abandoned in most other countries as a principal form of taxation, and is condemned by practically all students of finance. - § 250. Many of our American commonwealths levy poll or capitation taxes. These are imposed at a uni- form rate, as $2 per poll, upon all males between the ages of 20 or 21 and 45 or 60. They are poorly col- lected, and are usually evaded by all persons Poll taxes. ' J j r who do not have to pay taxes upon property. The total receipts, therefore, are small. In a few states payment of a poll tax has been a condition precedent to voting, with the result that each political party paid the taxes of many of its voters, and corruption necessarily followed. The poll tax has been abandoned in most civilized countries, and must be viewed as an antiquated financial expedient. It is, moreover, unjust in its opera- tion, since it exacts equal contributions from all, regard- less of the different abilities of taxpayers. § 251. The failure of the general property tax to reach the stocks and bonds of corporations has led various corporation " states to adopt a much more successful ex- taxes, pedient, the taxation of the corporations them- selves ; and as the number of business corporations has increased, corporation taxes have become increasingly important in state finance. It is hardly necessary to add that the reason for the success of the new method of taxing corporate property is that it is far easier to deal directly with a corporation than to discover and assess its securities in the hands of individual holders. STATE AND LOCAL TAXATION 365 In its usual form the corporation tax applies to special kinds of companies, such as those engaged in banking, insurance, railway transportation, or the tele- • graph and express businesses. Banks are com- poration monly taxed upon their capital stock, the corporations being required to withhold the amount of the tax from the dividends paid to the stock holders; and, in addition, they may be taxed locally on their real estate. Railroads are taxed in a great variety of ways, as upon their gross earnings or the value of their outstand- ing securities. When a road operates lines in different states, the tax paid in any one is levied upon the amount of earnings or securities that corresponds to the proportion which the mileage operated in that state bears to the total mileage of the company. Sometimes these special taxes on corporations are in lieu of all others, state or local ; while in other cases the real estate and other tangible property may be taxed locally, and a tax upon the balance of the property may be paid into the state treasury. In some cases the whole tax is reserved for state purposes, and in others a considerable part is distributed among the local governing bodies. Pennsylvania and New York have established general corporation taxes which apply, with certain exceptions, to all companies doing business within their Thegeneral borders ; while Massachusetts and a few others corporation tax. have taxes that apply to domestic corpora- tions. The diversity of practice is so great that it is impossible to enter into a discussion of details ; and we shall have to leave the subject with the general remark that it would seem desirable to replace special taxes with 366 GOVERNMENTAL REVENUES general laws, which, while applying to all corporate enter- prises, should vary the methods of procedure so as to secure the best result in each case. If the idea of reach- ing securities in the hands of the holder is to be given up, and there is every reason why it should, all corporate enterprises should be brought within some general scheme of taxation by which they would be adequately taxed once, and once only. The proceeds could be divided between state and local authorities in such manner and proportions as seem advisable. The revenue now derived from corporations by some of the states is large ; and sufficient in some cases, in separation of addition to inheritance and certain other taxes, local 6 and t° make it unnecessary to tax property for revenues. other than local purposes. It has often been proposed to separate absolutely the sources of state and local revenues, by abolishing all direct state taxes upon property. This plan, it is said, would remove the induce- ment for local assessors to undervalue real estate in order to reduce the quota of the direct state tax. But experience has shown that it is usually unwise to abolish all direct state taxation, since when this is done a necessary check on state expenditures is lost. Some states that have tried the plan of separation have finally been obliged to reintroduce the direct state tax, and others are likely to be forced to similar action. Nor is separation necessary for removing inequality in the distribution of the state tax, because permanent tax commissions, such as have been established in some states, can secure an equalization of burdens if they are given adequate power to supervise and control local assessments. STATE AND LOCAL TAXATION 367 § 252. License taxes upon various business and pro- fessional pursuits have been often employed in the United States. In times of emergency the federal government has made extensive use of them, but it now retains only moderate licenses for dealers in malt or License spirituous liquors. Practically all of our cities, taxes ' however, and many of the states impose license taxes upon certain occupations. In the cities of the South a very extensive system of business taxes exists, which frequently tends to restrict competition from new enter- prises and bears with very unequal weight upon the smaller establishments. Elsewhere licenses are confined to a few occupations, such as those of liquor dealers, peddlers, pawnbrokers, and the like, and have other purposes often- times than the mere collection of revenue. From a finan- cial point of view, liquor licenses exceed all others in importance, being oftentimes the source of large revenues that may go to the state as well as the local treasuries. In Massachusetts and New York, for instance, the share received by the state from liquor licenses is a very impor- tant item of income. § 253. The inheritance tax, as it is popularly called, is imposed "on the devolution of property, whether real or personal, whether by will or by intestacy." Theinherit- It is extensively employed to-day in Europe ancetax - and Australia; and has been introduced, in some form, in most of our states. In many of our commonwealths only collateral inheritances are taxed, but in most cases direct inheritances are also included. The tax has met with such general success that its adoption by other states seems merely a question of time. 368 GOVERNMENTAL REVENUES In levying the inheritance tax it is customary to exempt a certain minimum amount of property from its opera- tion, or to exempt entirely bequests for educa- Methodsof ' 1 . . taxing inher- tional, charitable, or religious purposes. The itances. . , • -, . , . rate is often progressive, the progression being most marked for inheritances passing to collateral heirs or persons not related in blood. Administration is not difficult, since most estates have to pass through the pro- bate court in order to effect a just distribution of the assets, so that, with proper provision for gifts passing inter vivos, the collection of the tax is fairly certain and inexpensive. In this case the imposition of progressive rates can be defended because adequate machinery exists for enforc- ing payment of the tax. In the younger states the yield from such taxes is not very large, but they furnish a considerable revenue in the older commonwealths, and are a highly desirable form of state taxation. In com- bination with corporation and license taxes, the inherit- ance tax should be developed to a point that will make it possible for the state governments to lighten materially the taxation of property. § 254. Our various local governments should derive much more revenue than is secured at present from pub- Local lie franchises and all other public privileges, taxation. There are many indications that this will be done in the near future, because the pressure of taxation has forced upon the attention of property owners the fact that valuable franchises are now given away without ade- quate compensation. The receipts from such sources would supply a considerable portion of the revenues required by our cities. License taxes are also avail- STATE AND LOCAL TAXATION 369 able for local purposes; large receipts already accrue from those upon the sale of liquors, but others should be employed with moderation. What other local revenues may be needed car be provided by taxes upon property and, under proper conditions, upon income. For the evils of the general property tax certain reme- dies have been found during the past decade. State control of local assessments is bringing about in some commonwealths a better assessment of real estate. The taxation of intangible property has been re- Taxation of formed in four or five states by introducing, erty°and Pr ° P in place of the present tax, a tax levied at the income - flat rate of three or four mills upon each dollar of the assessed valuation. The lower flat rate has yielded more revenue than was formerly obtained, and has secured a reasonably full and equal assess- ment. Mortgages have been exempted from taxation in some states, and in others are now subject only to a registration tax payable at the time they are recorded. Finally, Wisconsin has introduced, in lieu of other taxes on intangible and some other kinds of personal property, an income tax which in 191 2 went into successful opera- tion. If strict control and supervision by a state tax commission are provided, as in Wisconsin in connection with the income tax and in Minnesota in connection with the three-mill tax on intangible property, there is no reason why any commonwealth cannot tax either incomes or personal property at a reasonable rate. The encouraging feature of the present situation is that there has been a great awakening of interest in the subject of taxation, by which the inertia of the past is being overcome. The 37o GOVERNMENTAL REVENUES next decade will probably witness marked improvement in the methods of local taxation employed in the United States. FOR SUPPLEMENTARY STUDY General : Bullock, Selected Readings in Public Finance ; Hadley, Economics, 447-484; Nicholson, Political Economy, III, 254-415 ; Adams, Science of Finance ; Daniels, Public Fi- nance; Ely, Taxation in American States and Cities; Pro- ceedings of the National Tax Association (1907-1912); Selig- man, Essays in Taxation ; Taussig, Principles of Economics, Bk. VIII. WORKS OF REFERENCE [This list includes only the books mentioned in the suggestions for supplementary study.] Adams. C. C. Commercial Geography. New York, 1901. Adams, H. C. The Science of Finance. New York, 1898. Adams, T. S. Labor Problems. New York, 1904. Bastable, C. F. The Commerce of Nations. London, 1892. Bullock, C. J. Introduction to the Study of Economics. Fourth edition. Boston, 1913. . Selected Readings in Public Finance. Boston, 1906. — — . Selected Readings in Economics. Boston, 1907. Carver, T. N. The Distribution of Wealth. New York, 1904. Cheyney, E. P. Introduction to the Industrial and Social History of England. New York, 1901. Clark, J. B. The Distribution of Wealth. New York, 1899. . The Problem of Monopoly. New York, 1904. Commons, J. R. Trade Unionism and Labor Problems. Boston, 1905. Daniels, W. B. Public Finance. New York, 1899. Darwin, L. Bimetallism. New York, 1898. Dunbar, C. F. Theory and History of Banking. Second edition. New York, 1901. Ely, R. T. Taxation in American States and Cities. New York, 1888. . Socialism and Social Reform. New York, 1894. . Monopolies and Trusts. New York, 1900. Ensor, R. C. K. Modern Socialism. London, 1904. George, H. Progress and Poverty. San Francisco, 1879. Gilman, N. P. Methods of Industrial Peace. Boston, 1904. Greene, T. L. Corporation Finance. Third edition. New York, 1897. Hadley, A. T. Railroad Transportation. New York, 1885. . Economics. New York, 1896. Hamilton, J. H. Saving and Savings Institutions. New York, 1902. Hendrik, F. Railway Control by Commission. New York, 1900. Jenks, J. W. The Trust Problem. New York, 1900. Jevons, W. S. Money and the Mechanism of Exchange. New York, 1875. 371 372 WORKS OF REFERENCE Johnson, E. R. American Railway Transportation. New York, 1903. Kinley, D. Money. New York, 1904. Malthus, T. R. Essay on the Principle of Population. London, 1798. Edited by W. J. Ashley. New York, 1895. Marshall, A. Principles of Economics. Fourth edition. London, 1898. Mayo-Smith, R. The Science of Statistics : Part I. Statistics and Sociology. Part II. Statistics and Economics. New York, 1895, 1899. Meade, E. S. Trust Finance. New York, 1903. Menger, A. The Right to the Whole Produce of Labor. London, 1899. Nicholson, J. S. Principles of Political Economy. London, 1893- 1901. Rae, J. Eight Hours for Work. London, 1894. Report of the Industrial Commission, Vol. XIX. Final Report. Washington, 1902. Roberts, E. H. Government Revenue. Boston, 1884. Schaffle, A. The Quintessence of Socialism. Third edition. Lon- don, 1 891. Schloss, D. Methods of Industrial Remuneration. Third edition. London, 1898. Seager, H. R. Introduction to Economics. New York, 1904. Seligman, E. R. A. Essays in Taxation. New York, 1900. Shaler, N. S. Nature and Man in the United States. New York, 1891. Shaw, A. (Editor). The National Revenues. Chicago, 1888. Shearman, T. G. Natural Taxation. New York, 1895. Smith, A. Inquiry into the Nature and Causes of the Wealth of Nations. London, 1776. Edited by E. Cannan, with Intro- duction and Notes. New York, 1904. Sumner, W. G. Protectionism. New York, 1885. Taussig, F. W. The Tariff History of the United States. New York, 1888. . Wages and Capital. New York, 1896. . Principles of Economics. New York, 191 1. The American Railroad. Second edition. New York, 1897. Vandervelde, E. Collectivism. Chicago, 1901. Webb, S. and B. Industrial Democracy. London, 1897. White, H. Money and Banking. Second edition. Boston, 1902. INDEX [The references are to page numbers.] Act of 1873, relating to coinage, | Boycott, 313 159; false charges concerning, 159-160; of 1906, relating to railroads, 222. Agricultural resources of the United States, 32-33. American Federation of Labor, 306. Arbitration, voluntary, 31 5-31 6; compulsory, 316-318. Assessments, special, 346-347. Balance of trade, 226 ; the theory or, 234-235. Banks and the check system, 124- 125; bank notes, 128, 151 ; de- posit banking, 149-150 ; bank discount, 150; banking opera- tions illustrated, 151-155 ; state banking in the United States, 155— 156 ; the national banks, 156-158. Barter, difficulty of, 116. Bill of exchange, 125-126. Bimetallism, in the United States, 158-159; demonetization of silver, 159-160; national vs. interna- tional bimetallism, 162; arguments for international bimetallism, 162- 165 ; opposing arguments, 165— 166. Birth and death rates, 39. Black-list, 313. Bland- Allison Act, 161. Boards of equalization, 361. Boehm-Bawerk, E. von, on socialist theory of value, 336. Book credits, 123. Brassage, 120. Bullion and money, 132-133. Bureau of Corporations, 193. Capital, a factor of production, 45 ; denned, 46 ; concrete forms of, 47-49 ; fixed and circulating, free and specialized, 49-50 ; formation of, 50-51 ; abstinence necessary for formation of, 51-53 ; facilities for saving, 53-54; capital and interest, 262-270. Cereals, production of, in United States, 33. Clearing houses, 124-125. Closed shop, the, 310-31 1. Coal, production of, in United States, 33-34- Coinage, 119; free coinage, 119; gratuitous coinage, 119 ; coins of the United States, 120. Competition, defined, 100 ; two forms of, 100 ; commercial and industrial, 105 ; failure of, 112. Competition of markets, 213-214. Comptroller of the Currency, 156. Concentration in production, 83-84 ; economies of, 84-87 ; opposing forces, 87-90 ; conclusion con- cerning, 91. Conciliation, 314-315. Consumption of wealth, defined, 1 3 ; final and productive consumption, 13-14 ; laws of consumption, 14- 21 ; statistics of, 21-27. 373 374 INDEX Continental paper money, 145, 147. Cooperative production, 60, 321-323. Corporation stocks and bonds, 62-64. Corporation taxes, 364-366. Corporations, 60; defined, 61 ; growth of, 61 ; powers of, 61-62 ; securities, 63-64 ; limited liability, 64-65 ; advantages of, 65-66 ; accounting, 67-69; promotion of, 69-70; irresponsible management of, 70-72. Cost of production, under static conditions, 92 ; under dynamic conditions, 93-95 ; analysis of, 106-108 ; varying costs of produc- tion, 1 08-1 10. Cotton, production of, in the United States, 23- Credit, defined, 123 ; book credits, 123 ; promissory notes, 123 ; the check and clearing system, 124- 125 ; the bill of exchange, 125- 126 ; foreign bills of exchange, 126-128 ; bank notes, 128; effect of, upon prices, 134-136; bank credits, 149-158. Custom, affects prices, 112. Customs duties, 240-241, 352-354. Demand, defined, 101; the law of, 18-19; elasticity of, 19, 103. Discriminating railway rates, 214- 215. Distribution of wealth, 255; the simplest form of, 258 ; complex form of, 258-259; the employer's place in, 259-260 ; the problem of, 260 ; interest, 261-270 ; wages, 271-279; rent, 279-291 ; profits, 291-296; attempts to alter the present distribution, 324-343. Division of labor, 55 ; advantages of, 56; disadvantages of, 57. Division of occupations, 55. Dollar, history of, in United States, 120, 158-161. Domains, public, 345. Economic order of consumption, 16-18. Economics, defined, 4 ; its deriva- tion, 5 ; its relation to other sci- ences, 6; its divisions, 7-8; its scope and value, 9. Engel's law, 21-22. Entrepreneur, functions of, 59 ; position of, in distribution, 259- 260. Exchange, underlies the division of labor, 58 ; advantages of, 97-98. Excise duties, 354-357. Exports from the United States, 227; distribution of, 227-228. Extractive industries, 1-2. Factors of production, 32 ; organi- zation of, 58-60. Factory system, 82-84. Federal taxation in the United States, 352-360. Fees, 346. Fiat theory, 121, 144-145. Fines, 346. Fixed and variable expenses, 1 13- 114, 172-173- Foreign exchange, 126-128; the rate of, 127. Free trade, effect of, 245-247. Freight charges and the foreign ex- changes, 232-233. " Friendly agreements," 180. General price levels, changes in, 129-130; methods of measuring, 130. General property tax, 359-364. George, Henry, advocate of the single tax, 324-326. INDEX 375 Gold and silver, production of, in the United States, 34-35 ; have dis- placed other forms of money, 1 1 7— 118; changes in world's output of, 131-132; cost of production of, 133 ; territorial distribution of, 140-142. Gold monometallism, 159-160; ar- guments for, 165-166. Government paper money, 143 ; alleged advantages of, 143-145 ; the case against, 145-146 ; in the United States, 146-149. Granger laws, 217-218. Greenbacks, 147-149. Gresham's law, 136-140. Hadley, A. T., on effect of immi- gration, 44-45. Hamilton, Alexander, on American manufactures, 252. Holding company, 72. Household and social economy, 4-5. Human needs, the starting point of economic inquiry, 10 ; the increase and diversification of, 11. Immigration, influences the move- ment of population, 41-42; eco- nomic effects of, in the United States, 42-45. Imports of the United States, 227 ; distribution of, 227-228. Income, national, 255 ; real and money income, 257-258. Income taxes, 357-360. Index numbers, 129-130. Industrial combinations, see Mo- nopoly." "Industrial Revolution," 31. Industries, public, 345-346. " Infant-industry " theory, 248. Inflation, 145-147. Inheritance taxes, 367-368. Interest, nature of, 261-262 ; rate of, depends on supply and demand, 262-263 '■> the supply of capital, 263-266 ; equalization of supply and demand, 267 ; various classes of loans, 267-268 ; tendency of interest rate to decline, 268-269 ; short-time loans, 269-270. International movements of capital, 231-232. International trade, of the United States, 226-229 ; in barter, 229- 230; this fact explained, 230-231; various kinds of international transactions, 231-233 ; balance of trade, 234-235 ; is based on rela- tive advantages of production, 235-239 ; the restriction of, 240- 253. Interstate Commerce Law, 203, 219- 224. Iron law of wages, 333, 337. Iron ore, production of, in United States, 34. Joint agreement, 314-315. Knights of Labor, 305-306. Labor, economic significance of, 36 ; causes affecting efficiency of, 37-38 ; a commodity, 297 ; a peculiar commodity, 297-300 ; labor legislation, 300-304 ; labor organization, 304-318; relation of labor to product, 318-323. Labor cost, 272. Labor legislation, in England, 300- 301 ; in the United States, 301 ; its constitutionality, 301-303 ; its economic aspects, 303-304. Labor organizations, growth of, 305; trade unions, 305 ; Knights of Labor, 306 j American Federa« 376 INDEX tion of Labor, 306 ; objects of labor organizations, 306-308 ; ad- vantages of, 308-309 ; the stand- ard wage, 309-310 ; the closed shop, 310-31 1 ; relation to out- put, 312 ; industrial warfare, 313- 318. Land nationalization, 324-330. Large fixed capitals, their effect on prices, 1 1 3-1 14. Latin Monetary Union, 160. Law of demand, 18-21. Law of diminishing returns, from land, 74-78 ; from labor and capital, 78 ; significance of, 79- 82 ; its relation to the growth of rent, 284-287. Law of economy in organization, 82-91. Law of supply, 91-92 ; under static conditions, 92-93 ; under dy- namic conditions, 93-95 ; increas- ing and decreasing marginal cost, 93-95- Law of the variation of utility, 14-16. Legal tender, 121. License taxes, 367-368. Loans, call and time, 152; various classes of, 267-270. Local taxation in the United States, 368-370. Lockouts, 313. Lotteries, public, 346. " Magic-fund " delusion, 348. Malthusian theory of population, 39-4L Man, a factor of production, 35. Mann-Elkins act, 223. Manufacturing industries in the United States, 2-3, 252. Market, defined, 99 ; extent of mar- kets, 99-100. Market value, 98-103. Marshall, A., on value, no. Mill, J. S., on profits, 294 ; on land nationalization, 324-325. Mineral resources of the United States, 33-35. Money, purchasers measure sacrifice in terms of, 18; origin of, 116; the medium of exchange, 117; the money metals, 118 ; coinage, 1 1 9-1 20 ; the fiat theory, 1 2 1-1 22 ; other functions of money, 122 ; credit substitutes for money, 123- 128; the value of money, 128- 136 ; Gresham's law, 136-140 ; the territorial distribution of, 140-142; government paper, 143-149 ; monometallism and bimetallism, 158-166. Monopoly, defined, 167; is seldom absolute, 167-168; legal monopo- lies, 169; natural monopolies, 169— 171 ; capitalistic monopolies, 171; monopoly value, 171— 174; public policy with respect to natural monopolies, 174-180; various forms of capitalistic mo- nopolies, 180-183 ; arguments in favor of combination, 183-187; these arguments critically con- sidered, 184-187 ; recent move- ments in the United States, 187- 188 ; monopoly and privilege, 188-189 ; influence of the tariff, 1 89-1 9 1 ; trusts and prices, 191- 192 ; remedies for capitalistic monopolies, 191-196. National banking system, 156-1580 National income, 255 ; limited by capital, 256 ; real and money in- come, 257-258. Natural condition affecting Ameri can industry, 32-35. Nature a factor of production, 32. INDEX 377 Non-competing groups among labor- ers, 275-277. Normal value, 103-111. Occupations, statistics of, 1-4. Ocean freight, 232. Partnership, 60. Personal and professional service, 3 Piece wages, 27 1-^72, 318. Poll taxes, 362-363. Pools, 180-181; railway, 202-203. Population, natural increase of, 39- 41. Price, defined, 99 ; changes in general level of prices, 129- 130. Production of wealth, defined, 29 ; stages in development of, 29-31; a social process, 55 ; laws of, 74-96- Products and by-products, the value of, 114-115. Profit defined, 280, 291 ; gross and net profits, 291-292 ; marginal producer receives no profit, 293- 294 ; the amount of profits, 294- 295 ; profits a personal income, 295 ; profits a surplus, 295-296. Profit sharing, 319-321. Progressive taxation, 351-3520 Progressive wages, 3 18-3 1 9. Promissory note, 123. Proportional taxation, 351-352. Prosperity, test of, 23-27. Protective tariffs, 242-253. Public ownership of natural monop- olies, its advantages, 1 76 ; its disadvantages, 177 ; the lesson of experience, 177-178; conclu- sion, 178-179 ; of railroads, 224- 225. Public revenue, 345-370. Railroads, construction of, in United States, 198-199 ; charac- ter of early roads, 199 ; railway cooperation, 199 ; trunk lines, 200; railroad systems, 200-201 ; growth of competition, 201-202 ; progress of combination, 202-208; methods of railway consolidation, 204-205 ; results of consolidation, 205—206; reasons for consolida- tion, 206-208 ; railway rates, 208- 216; freight rates, 209-210; rate making, 210; different classes of traffic, 211; discriminating rates, 212-215; public control of rail- roads, 216-225 > early policy to- ward railroads, 216; the public character of the industry, 217; state commissions, 218-219; In- terstate Commerce Law, 219—222 ; our future policy, 223-225. Rent, defined and explained, 280- 281 ; not to be confused with interest, 281-282; depends on demand for land, 282 ; various classes of rents, 282-284 '■> ren t and diminishing returns, 284-287; not a cause of high prices, 287- 289 ; as an unearned income, 289-291. Revenue tariffs, 241-242. Risk, affects rate of interest, 268. Saving and savings institutions, 53- 54- Seigniorage, 120. Sherman Anti-Trust Act, 181-182. Shop councils, 314. Silver movement in the United States, 161-162. Single tax, 324-326 ; criticism of, 326-328 ; conclusion, 328-330. Fmith, Adam, on the scope of the science of economics, 8 ; on divi- 378 INDEX sion of labor, 56, 58 ; on corpo- ration management, 89-90 ; on taxes, 349. Social sciences, enumerated, 6. Socialism, denned, 330-331 ; its his- tory, 331 ; modern basis of, 332- 333 ; alleged tendency toward, 334 ; supposed advantages of, 3 2 4-335 5 criticism of, 335"343- Sociology, 6-7. Specific and ad valorem duties, 240- 241. Stages in development of produc- tion, 29-31. Standard of living, defined, 41 ; further considered, 275-277 ; its relation to wages, 277-J79. Standard wage, the, 309-310. State taxation in the United States, 360-369. Stock exchanges, 66. Strikes, 313-316. Supply, defined, 101-102 ; the laws of, 91-96. Tariff on imports, its relation to the growth of trusts, 1 89-191; speci- fic and ad valorem duties, 240- 241 ; revenue and protective tariffs, 241-242 ; effect of, 242-245 ; present and future effect of pro- tection, 247-248 ; the burden of protective duties, 249 ; the tariff and wages, 250-252 ; the tariff and the diversification of industry, 252-253 ; our future policy, 253. Taxes, defined, 347-348 ; the just distribution of, 349-352 ; the various taxes employed in the United States, 352-370. Time wages, 271-272, 318. Trade unions, 305-306. Transaction taxes, 357. Travellers' expenditures and the foreign exchanges, 233. Trunk lines, 200. Trusts, 181-182; the trust move- ment in the United States, 181- 191. Undertaker, 59. Unearned increment, 289-291, 328- 329. Utilities, include material com- modities and personal services, 11-12. Utility, defined, 11 ; four kinds of, 12 ; marginal and total utility, 15* Value, defined, 98-99 ; the deter- mination of market value, 100- 103 ; the equalization of supply and demand, 102-103 ; normal value, 103-111 ; analysis of cost of production, 106-108 ; mar- ginal cost of production, 1 10 ; exceptions to the theory of normal value, 1 1 2-1 15 ; monopoly value, 171-174. Variation of the efficiency of pro- ductive forces, 74. Wages, in the United States, 250- 252 ; defined, 271 ; time and piece wages, 271 ; labor cost, 272; the rate of wages, 272-273 ; the demand for labor, 273-275 ; the supply of labor, 275-277 ; the nor- mal wage, 278 ; the family the economic unit, 279. Wants, existence and culture, 10 ; are satiable, 14. Waterways in the United States, 35. Wealth, defined, 12-13. 13. SFP" 8 : !9i