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I
Social Science TTert Boofts
Edited by RICHARD T. ELY
OUTLINES OF ECONOMICS
SOCIAL SCIBNCB TEXT BOOKS
OUTLINBS OF ECONOMICS
By Richard T. Ely, Ph.D., LL.D. ReviBed and
enlarged by the Author and Thomas 8. Adams,
Ph.D., Max O. Lorbkz, Ph.D., Alltti A.
YouHO, Ph.D.
HISTORY OF ECONOMIC THOUGHT
By Lbwm T. Hanbt.
BUSINESS ORGANIZATION AND COMBINATION
By Lbwm T. Havbt.
PROBLEMS OF CHILD WELFARE
By Gborob B. Mangold, Ph.D.
OUTLINES OF ECONOMICS
(REVISED EDITION)
BY
RICHARD T. ELY, Ph,D., LL.D.
FSOVOBOR OF POLITICAL BCONOICY IN THS UNIYXftSnY OF WISGONSIlf
REVISED AND ENLARGED BT
THE AUTHOR
AMD
THOMAS S. ADAMS, Ph.D.
ntOFBSSOK OF FOUnCAL BCONOMY IN THE UNIVXRSITT
OF WISCONSIN
MAX O. LORENZ, Ph.D.
ASSISTANT P&OFBSSOR OF POLITICAL BCONOMY IN THS UNIYSKSTTY
OF WISCONSIN ; DEPUTY COMMISSIONER IN THE WISCONSIN
BUREAU OF LABOR AND INDUSTRIAL STATISTICS
ALLYN A. YOUNG, Ph.D.
PROFBS80R OF ECONOMICS IN LELAND STANFORD JUMIOB
UNIVERSITY
THE MACMILLAN COMPANY
1914
K^ 3317
Copyright, 1893,
By hunt ft EATON.
COPYUCHT, X908,
By the MACMILLAN COMPANY.
Fint published elsewhere. Reprinted May, 1900; July, October,
1901; August, 1903; July, September, 1904: July, 1905; Jsnuavy,
August, 1906; July, Z907; April, x9o&i
New edition, leYised aad enluged, September, October, 190I:
JanuMy, August, 1909 ; December, 1910; August, 19x1 ; Juae, t9za ;
May, X9X3 ; Jamuuy, July, 19x4.
J. •• Ooddiv Oo. ~ Berwlek & Smtm €0^
Norwood, Mass., U.S.A.
PREFACE
Since the first edition of the Outlines of Ecommics was pub-
fished fifteen years ago, there has been considerable progress in
economic discussion. In this revision an attempt has been made
to indude so much of the new thought as seems to have established
itsdf. No chapters remain unaltered, most of them have been
entirely rewritten, and some new ones have been added. But the
{dan of the former edition has been retained. This book differs
bom the Elementary Principles of Economics^ published in 1904
by Ely and Wicker, in that it is a more advanced treatise, and in-
tended primarily for college and university use; whereas the latter ,
although used in a number of higher Institutions, is intended pri-
marily for high schools.
Four persons have taken part in this revision, but a free inter-
change of criddsm has, it is hoped, resulted in a unified product.
Numerous passages, amoundng in the aggregate to many pages,
have been printed in smaller type. Such are the passages which,
either from their greater difficulty or from their subsidiary char-
acter, may best be omitted by a teacher pressed for time. More-
over, for classes in which the time limits are too narrow to permit
careful study of the whole text, it may be found expedient to omit
Book in, on Public Finance; while, on the other hand, some
teachers may wish to take this Book up for independent study.
Considerable attention has been given to the questions at the
dose of each chapter, and an endeavor has been made to frame
these so as to require a mastery of principles to answer them.
Po-usal of the text alone will not enable one to answer them all.
In some cases it will be necessary to use the references to literature
given at the close of chapters. There are also cases in which the
correct answer must be a matter open to differences of opinion.
It is hoped and believed that the questions will give rise to fruitful
dass discussions.
Vi PREFACE
The aim of the authors has been to cover the entire field of eco-
nomics, feeling that in this way they best serve the purposes of
those students who are going to carry their studies further as well
as those whose systematic school study of economics will end with
the present treatise.
At certain points in the discussion of distribution, use has been
made of the so-called "productivity theory." In order that th^e
may be no misapprehension, it may be well to say here, what is
repeated in the text, that in our view this theory has little or no
ethical significance, and that its principal value b as an expeditious
method of approaching the supply and demand theory, with which
it is in complete harmony. When properly handle, it has the
pedagogical virtue of leading the student directly to a study of the
innumerable forces which condition supply and demand. But to
regard the productivity theory as an end, is to mistake the problem
for its solution; and to pass from this theory lightly to the imme-
diate solution of those problems which the theory of distribution
is designed to explain, is to o£Fer, in place of scientific explanation,
a mass of pretentious platitudes.
Valuable suggestions have been received from Dr. H. C. Taylor
and from Dr. W. H. Price, both of the University of Wisconsm.
In conclusion, I wbh to express my high appreciation of the
work of my friends and colleagues in the revision of this book.
RICHARD T. ELY.
Madison, Wisconsin^
July, 1908.
PUEPACB
CONTENTS
BOOK I. — INTRODUCTION
Chaftbr L— The Natuu and Soon of Eoonomigs
Divenity of eoonomic itudy, 3 ; DeBnidon of economici» 4 ; A
•odal sdence, 5 ; Studies man in process of development, 6 ; Econo-
mic laws, 7 ; Principal divisions of economics, 15.
CHAFm IL— ThB CHAJtACTERISnCS OF THB PUSSNT EOONOMIC
System
Hmnan and physical conditions of economic activity, 16 ; Private
enterprise and state activity, 16 ; Division of labor and exchange,
18 ; Mutual dependence, 19 ; Economic classes, 19 ; Private prop-
erty, 20 ; Inheritance, 21 ; Contract, 21 ; Vested interests, 22 ;
Freedom, 23; Competition and markets, 24; Cofiperation, 26;
Monopoly, 26 ; Custom, 27 ; Authority and benevolence, 27.
Craftbr IIL— The Evolution of Eoonomic Society
Basis of the economic stages, 29; Direct appropriation, 30;
Primitive man, 31 ; Pastoral stage, 32 ; Agricultural stage, 33 ;
Manorial economy in England, 34 ; Handicraft stage, 35 ; Gilds,
35 V^™^^^ system, 36 ; Agricultural changes, 37 ; The mercan-
tile system, 37 ; Patents of monopoly, 38 ; Industrial stage, 39 ;
Other classifications, 39.
Ckaftkr IV.— The Evolution of Economic Society (^Continued)
England in 1760^ 43 ; Revolt against restrictions, 43 ; Mechani-
cal inventions, 44 ; Agricultural changes, 46 ; Effects of industrial
revolution, 47 ; The factory system, 47 ; Expansion of markets and
mdnstrial specialization, 48 ; Evils of the transition, 48 ; Competi-
tioii and iaissn-faire, 49 ; Reaction against the passive policy, 50 ;
Quality of goods, 50 ; Protection of labor, 5 1 ; Labor organizations,
53 ; Extension of government enterprise, 54*
vii
Viii CONTENTS
Chapter V. — The Economic Development op the United States
Economic stages in American industrial history, 56 ; Sectional-
ism, 57 ; Characteristics of the American people, 58 ; Growth of
population. 59; Changes in the birth rate, 60; Slavery and the
negro problem, 61 ; Inmiigration, 62 ; Natural resources, 66.
Chapter VI. —The Koonomic Development of the United
States {Continued^
Mercantilism in America, 70 ; American inditstriei in 1776, 73 ;
The Industrial Revolution in America, 72; The development of
agriculture, 75 ; Manufactures, 76 ; Transportation, 80 ; The labor
movement, 83 ; State regulation of industry, 86.
BOOK II. — PRINCIPLES AND PROBLEMS
PART I. — INTRODUCTION
Chapter VII. — Elementary Concepts
Motives in economic activity, 93 ; Utility, 95 ; Free and econo-
mic goods, 95 ; Effort, 96 ; Waiting, 96 ; Services, 96 ; Personal
qualities as goods, 97 ; Wealth, 98 ; Wealth and income, 98 ; In-
dividual and society, 98 ; Wealth and value, 99 ; Capital and other
forms of wealth, 100 ; Capital goods and capital value, 100 ; Social
and individual capital, loi ; National wealth and national divi-
dend, loi.
PART II. — CONSUMPTION
Chapter VIIL — Consumfhon
Consumption defined, 106; Productive and final consumption,
106 ; Human wants, 107 ; Law of diminishing utility, 107 ; Differ-
ent uses for the same commodity, 108 ; Marginal utility, xo8 ; The
economic order of consumption, 1 10 ; Future wants, 1 1 1 ; Alleged
present consumption of future products, 1 12; Consumption and
saving, 113; Luxury, 1x3; Ideal distribution of wealth, 114;
Harmful consumption, 116; Statistics of consumption, 117.
PART III. — PRODUCTION
Chapter IX. — Production
Production defined, 121 ; Thefactorsof production, 122; Saving
and capital formation, 123 ; Production and sacrifice, 124 ; Cost of
production and expense of production, 125 ; Separation in owner-
ship and organization of factors, 126 ; The undertaker, 127 ; Kinds
CONTENTS ix
of division of labor, 127 ; Advantages of division of labor, 128;
Effect npoD the worker and the product, 129; Territorial division
of labor, 131 ; Prodactive organization of the American people, 132.
Chapter X.— Business Organization
Nature of business units, 136; The corporation charter, 141 ;
Corporation capital and securities, 143 ; Overcapitalization, 144 ;
Forms of capitalization, 146 ; Corporation management, 147 ; Ad^
vantages and social aspects of corporations, 148; Trusts, 150;
Publicity, 153 ; Federal control, 154,
PART IV.— VALUE AND EXCHANGE
Cbaftex XI.— Value and Pucb
Meaning and significance of value, 156 ; The market, 158 ; Con-
ditkms of competitive valuation, 159; Supply and demand, 160;
Nature of demand, 160; Elasticity of demand, 163; Consumer^
surplus, 164 ; Nature of supply, 165 ; The determination of prices
167; Producer's surplus, 169.
Chapter XIL— Value and Price {Continunf)
Normal value, 1 70; Different conditions of supply, 172; Con-
stant and variable expenses, 174; Joint expenses of production,
177; Surplus of bargaining, 177; Non-reproducible goods, 178;
Monopoly value, 179; Retail prices, 179; Public authority and
▼aloe, 179; Imputed value, 181 ; Valuation of production goods,
182 ; Other theories of value, 183.
Chapter XIII.— Monopoly
The idea of monopoly, 187; Partial monopoly, 191 ; Qassifica-
tion and causes, 192 ; Public and private, 193 ; Social and natural,
194 ; Local, national, and international, 196 ; monopoly price, 197 ;
Law of monopoly price, 201 ; Qass price, 202 ; Monopoly price,
high price, 206; Monopolies and distribution of wealth, 208;
Public policy toward monopolies, 209 ; Relation of monopoly to
tni2ta,2ii.
Chapter XIV. — Money
De6nitions, 214; Metallic money, 216 ; Coinage, 217 ; Seignior*
agCt 217; The standard of value, 221 ; Limited coinage, 224;
BimetaUism, 225 ; The gold standard, 234 ; Government paper
money, 234 ; Colonial and Revolutionary bills of credit, 235 ; The
greenbacks, 236 ; Fiat money, 241.
CONTENTS
Chafter XV— Credit and Banking
Credit transactions, 243 ; Personal credit, 246 ; Bank credit, 247 ;
Bank notes, 250 ; State banks of issue, 250 ; The national banking
system, 251; The reserve system, 252; The New York money
market, 253 ; Speculation and the New York money market, 255 ;
The independent treasury system, 257 ; The movement of money^
258 ; Elastic currency, 260 ; A central bank, 262 ; State and pri-
vate banks, 263.
Chaftbr XVL — Other Problems in Money and BANicma
Crises, 267 ; Effects of changes in the value of money, 270 ;
Tlie standard of deferred payments, 271 ; Index numbers, 272;
The value of money, 275 ; The production of gold, 280.
Chapter XVII. — International Trade
Nature and advantages of international trade, 284 ; Law of com-
parative costs, 285 ; Restrictions on international trade, 286 ; Bal-
ance of trade, 288 ; Foreign exchange, 292 ; Regulation of gold
supply, 296.
Chapter XVIII.— Protection and Free Trade
The case for protection, 300 ; Arguments of free-traders, 305 ;
Conclusions, 311.
PART v.— DISTRIBUTION
Chapter XIX. — Distribution as an Economic Problem
Distribution controlled by existing institutions, 317; The dis-
tributive process, 318; Distribution as valuation, 319; Law of
diminishing productivity, 319-326; Marginal productivity, 326*
331 ; Marginal productivity and valuation, 331 ; Social aspects of
diminishing productivity, 332.
Chapter XX. — The Personal Distribution of Wealth
Wealth and income, 335 ; Absolute and relative well beings 335 ;
Concentration of wealth and large scale production, 335 ; Methods
of measuring concentration of wealth and income, 336 ; Statistics
of distribution, 337 ; Causes of poverty and riches, 341 ; The diffu-
sion of wealth, 343 ; Modifying wealth acquisition, 345.
Chapter XXI. — The Rent of Land
The services of land, 349 ; Rent under uniform intensivity of cul-
tivation, 351; Rent under actual conditions, 354; The different
uses of land, 357 ; The capitalization of rent, 359 ; Rent and social
progress, 360 ; The unearned increment, 363 ; Urban lands, 365.
CONTENTS
Chapter XXII.— The Wages of Labor
Wages as the price of labor, 367 ; Demand for labor, 368 ; Laboi
saving machinery, 369 ; Supply of labor, 371 ; Growth of popula-
tion, 373 ; Subsistence theory of wages, 376 ; The standard of life
and wages, 377; Supply of labor in different occupations, 380;
The wage contract, 381 ; Wages and efficiency, 382.
Chapter XXIIL— Labor Problems
Types of labor organizations, 387 ; Jurisdiction disputes, 388 ;
Economic justificatioQ of labor organizations, 389 ; Labor organiza*
tions and monopoly, 390 ; Methods and policies of labor organiza-
tions, 391 ; Educational and fraternal activities, 394 ; The strike,
395 ; Employers* associations, 400 ; Agencies of industrial peace,
401 ; Trade arbitration, 403 ; Voluntary arbitration, 404 ; Com-
pulsory arbitration, 404 ; Profit sharing, 406 ; Industrial democracy,
408 ; CoSperation, 409.
Chapter XXIV.— Interest
Definition, 416; Inadequate explanations, 417; Why interest
can be paid, 418; The necessity of interest, 419; The investment
and replacement of capital, 420-428 ; The expense and value of
capital, 428 ; Capital and land, 431 ; Capital and consumption
goods, 434 ; The rate of interest, 435 ; Gross and net interest, 437.
Chapter XXV. — Profits
The entrepreneur's wage, 440 ; Speculative gains, 441 $ Chance
gains, 445 ; Gains of bargaining, 446 ; Non-competitive profits,
446 i The social dividend, 448.
PART VI.— THE RELATION OF THE STATE. TO INDUSTRY
Chapter XXVL— Necessity of State Activity
The state and the meaning of state activity, 458 ; State and gov-
ernment, 459 ; Purity and efficiency of the state in relation to eco-
nomic activity, 459 ; general statement of the necessity of state
activity, 460 ; The state and the fundamental institutions of society,
460 ; Property, private and public, 461 ; trade-marks, copyrights,
and patents, 463 ; Public property, 465 ; Inheritance of property,
466 ; Contract, 466 ; Ethical level of competition, 467 ; The con-
sumer, 467 ; Monopolies, government ownership, etc., 468 ; The
state as the guardian of the permanent interests of society, 468.
xii CONTENTS
Chaftbr XXVII.— Transportation
Scope and significance* 471 ; The railway system of the United
States* 472 ; Railway competition, 473 ; Pooling and consolidation*
475 ; The movement of rates* 475 ; The level of rates* 477 ; Rela-
tive rates* 478; Distance* 480; Government ownership* 479;
Regulation of railways* 481 ; The Interstate Commerce Commia-
sion, 483.
Chaftbr XXVIII. — Insurance
Nature of insurance, 485 ; Law of probabilities* 486 ; Origin and
development* 486; Forms of insurance organization* 489; Life
tables* ^490; The reserve* 491; The surplus* 491; Endowments*
492 ; Industrial insurance* 493 ; State insurance* 493 ; State regu-
lation* 494.
Chapter XXIX. ■— Economic AcnvmEs of MumaPALinEs
Importance of municipal activity* 496; Character of municipal
activities, 498 ; Protection through competition* 501 ; Methods of
public regulation* 503 ; Municipal management* 507 ; Municipal
home rule* 512.
Chapter XXX.— Sooausm
Socialism defined* 515; Distributive justice* 515; Varieties of
socialism, 516 ; Communism* 519 ; Socialism an extension of exist*
ing institutions* 519 $ The strength of socialism* 520; The weak*
ness of socialism, 521 ; Social reform* 523 ; The socialist movement*
524 ; Anarchism* 525.
Chapter XXXI.— Agricultural Problems
Size of forms* 528 ; Ownership and tenancy* 533I; Farm labor*
536 ; Farm indebtedness and agricultural credit* 538 ; Tenancy vs,
encumbered ownership, 540; Marketing of farm products* 543;
Speculation* 546 ; Education and organization* 548.
BOOK III.— PUBLIC FINANCE
Chapter XXXII. — Public Expenditures
Nature and significance of public finance, 555; Expenditures of
public and private economics contrasted, 558; The proper propor-
tion between the total income of society and public expenditures*
560; Economy vs, parsimony, 564; Historical development* 566;
Development of public expenditures with respect to regularity and
irregularity* 570 ; Terms used in public expenditures* 572 ; Cla»i*
fication of public expenditures* 573.
CONTENTS xiii
Chapter XXXin. — Public Revenues from Loans and
Government Ownership
Classificatioii, 580 ; Temporary revenues and public debts, 582 ;
Public domains, 586; Land policy of the United States, 587; Forest
lands, 589; Mineral lands, 591 ; Success of our land poUcy, 593;
Land nationalization and municipalization, public industries, 595;
Public industries, 597.
Chapter XXXIV. — Pubuc Revenues: Derivativs Rbvbnubs,
Fees, Special Assessments, and Taxes
Definitions, 605; Fees, 606; Special assessments, 608; Taxes,
610; Justice in taxation, 612; Progressive taxation, 616; The
shifting of taxes, 619.
CoAiTBR XXXV. ~ Pubuc Revenues: Federal, Static and
Local Taxes
Direct and indirect taxes, 625; Customs duties^ 627; Internal
revenue duties, 631 ; Taxes on transactions, 633; Inheritance taxes,
637; General property tax, 640; Corporation taxes, 645; Business
and license taxes, 648; Poll taxes, 649; Federal control of taxa-
tion of interstate commerce, 650; Separation of sources of state and
local revenues, 65 1.
BOOK IV. — HISTORY OF ECONOMIC
THOUGHT
Chafixr XXXVI. ■— History of Economic Thought
The development of economic thought, 657 ; Economic ideas in
the ancient world, 658 ; The Middle Ages, 661 ; Modem times,
662 ; Adam Smith, 664 ; The classical school, 665 ; Socialism,
668 ; The sociologists, 669 ; The historical school, 669 ; The eco-
nomic optimists, 670; Early American economists, 672; The
Austrian school, 673 ; Present condition of economic thought, 674.
Aftendiz A: Statistics of Public Expenditure ..... 677
Appendix B : Subjects for Eisays and Courses of Reading • • • 685
Ihdxz •• 697
BOOK I
INTRODUCTION
OUTLINES OF ECONOMICS
CHAPTER I
THE HATURE AND SCOPE OF ECONOMICS
The most striking characteristics of the great field of knowledge
the Outlines of which we attempt to sketch m the present volume
arc its rich diversity and spacious amplitude. Starting from psychol-
ogy in its analysis of the human needs which explain or condition
wealth, it traverses the entire field of social activities and institu-
tions arising from man's efforts to supply his material needs. It
loaches on one side the physical sciences — from which it borrows
some of its most fundamental principles; occupies joint terri-
tory at places with politics, ethics, and law, although their
respective jurisdictions are in the mam distinct; and forms at
once the most fertile and most thoroughly developed province of
the broad science of human society. Within its borders, if we
may continue to compare the scientific possibilities of economics
with the natural reso\u*ces of an opulent territory, opportunity Ls
offered for the exercise of every mental aptitude and every scientific
method. The historian's gift is needed to unravel the past and
trace the development of the industrial institutions whose present-
day problems, in turn, oflfer indefinite scope for the studies of the
more practical student with a taste for administration or business
management. For the legal mind there are the subtle problems
of property, inheritance, labor legislation, and corporation control;
for the mathematically inclined, insurance and modem statistics;
fw students with practical political interests, the tariff, currency
reform, and a score of important problems in which economics
and politics are inextricably interwoven; for the philanthropici
unemployment, accident insurance, and a number of social prob-
3
4 OUTLINES OF ECONOMICS
lems growing out of the maladjustments of modem industry.
Animating the entire subject, blended of course with the love of
truth for truth's sake common to all sciences, is the persistent
hope that by systematic study we may eventually abolish the ma-
terial poverty which deadens and dwarfs the lives of millions of
our fellows. Economics is a science, but something more than a
science; a science shot through with the infinite variety of human
life, calling not only for systematic, ordered thinking, but for
human sympathy, imagination, and in an unusual degree for the
saving grace of common sense.
To define such a subject adequately in a few sentences is mani-
festly impossible. It is frequently said that economics treats of
man's efforts to earn a living, and this definition is not inaccurate
if by "man" we understand "mankind," and if we fully appre-
ciate that the individual's efforts to turn an honest penny's profit
receive but little attention in comparison with the conmiunity's
efforts to feed, clothe, and shelter itself. Satisfaction of social
need, and hot individual profit, is the objective point of the science.
So, similarly, economics has been characterized as the philosophy
of human industry; and this description is illuminating provided
we interpret "industry" broadly enough. Even the old tradi-
tional definition, that economics is the science of wealth, is true
enough if we clearly understand that there can be no wealth with-
out man, and that the science which deals with wealth, so far
from being a "gospel of mammon," necessarily begins and ends
in the study of man. As we prefer to define it, however, econo-
mics is the science which treats 'oj those social phenomena that are
due to the weaUhrgeUing and wealth-using activities of man.
Economics treats of Man. — The supreme importance of man
in the study of wealth has not always been appreciated by those
who have expounded the science. Too often they have considered
man simply as a producer of wealth, the one "by whom" the
necessaries, conveniences, and luxuries of life are created, whereas
the infinitely greater truth is that man is the one "for whom"
they are all produced. Of course no one denies this truth, but
one might almost as well deny it as to leave it out of account.
The result of such neglect is that men devise with great skill
THE NATURE AND SCOPE OF ECONOMICS 5
rules by which man may be made the best possible manufactur-
ii^ machine. It sometimes quite escapes the notice of these
persons that in making man the best possible manufacturing
machine they may make him a very poor sort of a man; that in
teaching him to supply his wants very bountifully they may pre-
vent his developing and correcting those same wants. They for-
get that there are two kinds of poverty — one a lack of goods for
the higher wants, the other a lack of wants for the higher goods.
To become rich in goods while losing at the same time the power
to profit by them is imfortunately one of the commonest retro-
gressions in human experience. We do not mean that the whole
problem of human development is the subject of economics, but
simply that manhood, rounded human development, is the goal
of all social sciences, and none must consider their subject so
Darrowly as to exclude that object.
Another common mistake has been to regard as of chief im-
portance the economic activities of one particular class, especially
the employer. Other men were treated simply as "a factor m
production." An English writer speaks of dear labor as one of
the chief obstacles to England's economic prosperity. Could
anythmg be more utterly an oversight of general human well-
being? Dear labor shouki be the very goal of England's eco-
nomic effort, for that means abundant supply of the wants of the
great mass of her people ; and the fact that labor is dear, so far
torn being an obstacle to prosperity, is the very proof and sub-
stance of that prosperity. A glance at history indicates that men
have made these mistakes not only in theory but in practice.
Industries have been developed to majestic proportions while
man was sinking into deeper degradation; wealth has grown
at the expense of that human weal in whose service it won its
name.
Economics treats of Man in Society. — This is one of those
truisms which only history can make real to us. As we pass from
the savage and cannibal, up through all the stages of development,
we find an ever-increasing interdependence among men. Man is
least dependent when he wants least, cares least, has least, knows
kast, and is least. With every betterment of condition and char-
6 OUTLINES OF ECONOMICS
acter he is more dependent than before, more dependent and yet
more free. The beginnings of barter are a confession of mutual
need; the coining of money is a declaration of dependence to all
men. We look with pride upon a century of progress, but that
progress has consisted in little else than a growth of dependence,
an ever-increasing departure from that rude kind of literal self-
help in which each one does everything for himself. Our fathers
drew water, each for himself, in "the moss-covered bucket," while
our mothers dipped candles for the evening's light. If one was
negligent, the rest did not suffer. To-day a network of pipes radi-
ate from a common center to enter a thousand households. An
engineer makes a blunder at the station, and thousands are in
darkness or drought. Progress is a passage from independence
to dependence, from distrust to confidence, from hostility to amity,
from helplessness to helpfulness, while the great law of social
solidarity gains ever-increasing importance. Our science, then,
is interested primarily in man in his relations to others, and not
in man by himself. Moreover, as a science which studies the pres-
ent in order that it may predict and prepare for the future, and
discovering that interdependence is the law of progress, it must
not hesitate to shape its principles with reference to a solidarity
which shall grow more rather than less, stronger rather than
weaker.
Economics treats of Man aa in Pirocess of Development. — Few
truths are more easily admitted or more persistently ignored than
that of change in human life and condition. History makes it
real. Man now wanders about by force of necessity and age-long
habit, now starves rather than be moved from his home. Land
is now free to all, now parceled out with well-nigh absolute right
of individual possession. The seemingly eternal features of the
social structure are gone in a few generations. Nothing so invali-
dates theories, laws, general principles, institutions, and enter-
prises as this great law of change of which we seldom take full
account. Take, for instance, bequests. Nothing is commoner
than for a man to leave a legacy under specified and detailed
regulations, binding for all time. One leaves money to endow a
religious service in a language which in a few generations no one
THE NATURE AND SCOPE OP ECONOMICS J
understands; another founds a coDege to teach certain doctrines
which in a century no one believes; and so on indefinitely. These
and a thousand other laborious efiForts of statesman, warrior, or
philosopher quite lose their worth for the future because their
authors assumed that the future would be like their present Even
the wages system and the division between capital and labor which
seem rooted in the constitution of society are scarcely two centu-
ries old as a general system. One must never forget in the study
of economics that the phenomena with which it deals are per-
vaded by the spirit of life, moving forward or backward, pro-
gressing or decaying, under those influences which control the rise
and fall of social institutions. The science is biological rather
than mechanical.
The Laws with which Economics Deals. — The evolutionary
character and complexity of economic phenomena, which account
for much of the charm of the subject, endow it also with unusual
difficulties. Conclusions true for one generation are invalid in
the next Terms and definitions appropriate to one stage of in-
dustry are misleading in a succeeding st£^. Generalizations valid
for one nation and government are inapplicable to another. Even
those laws or uniformities which the science prizes as the finest
product of its research are but statements of probabilities — dec-
hiations of what is most likely to occur for the mass of men in
^be long run under certain specified circumstances.
In no department of knowledge, consequently, is there greater need of
temperate statement and of that humility d mind which is the surest safe-
guard against bigotry and dogmatism. No system of economics is appli-
caUe unchanged to all times and all places: the premises of the aigiunents
dumge ; the ingredients of nearly every problem present themselves in differ-
ent proportions; and the conditions of almost every question vary from
country to country and from generation to generation. The student must not
expect rules of thumb by which he can decide offhand the economic problems
of the particular city or country district in which he is for the moment inter-
ealBd. No general treatise on economics can authoritatively decide the
piactical problems of particular times and places; although the economist,
before all other students, is forced to deal with practical problems. What
such a treatise can do is to point out mistakes of logic common in the current
discussions of economic questions, call attention to obscure factors — some-
times of great importance — which the practical man is likely to overlook,
8 OUTLINES OF ECONOMICS
give solutions of typical problems which are likely to arise, and thus afford a
training which will assist the student in solving practical problems for himself.
The peculiar and distinctive office of the economic scientist, however, is
to emphasize the less tangible truths, the remoter consequences, the deeper
and consequenUy less obvious forces of economic society. The impulses
of the moment, the immediate demands of the hour, the present "fact" that
stares us in the face (and sometimes blinds us), are not likely to lack vigorous
champions; and to preserve the balance there is need of a craft of thinkers
far enough removed from the battie to preserve the wider outlook, mindful
of the lessons of the past, jealous for the rights of the future, insistent upon
the less obvious truths. This is why economics so frequentiy appears to
the practical man strained and academic. This impression arises from a
difference of emphasis which in the main is as salutary as it is inevitable.
The academic quality of the economist's work arises sometimes from igno-
rance, sometimes from pedantry, but more frequently from his courageous
insistence upon the importance of the less tangible truths and the distant
consequences of present action.
Is not economics, then, a science based upon natural law ? The
question is largely a verbal one. What do we mean by natural
law? In the narrowest sense natural laws are the habits of na-
ture which know absolutely no variation. Such are gravitation
and chemical affinity; and the sciences based upon such laws —
astronomy, physics, and chemistry — were the first to develop,
and have attained a maximum degree of exactitude. The term
" science " is sometimes used in a way to imply only sciences of
this character. These sciences are more properly known as
exact sciences, and they are characterized by the fact that the
relations with which they deal can usually be expressed quanti-
tatively.
When we come in contact with life, however, and especially
with its higher forms, the exactness witB which an astronomer
predicts an eclipse or a chemist anticipates a reaction becomes
impossible. Not that life is without laws; very far from it. There
is, in the first place, the basis of physical nature, with its perfect
regularity, upon which all life rests and to which it must conform.
Then, too, there are laws governing life directly and pertaining to
it. These form the subject of the group of sciences known as
biology. We must remember, however, that all we can say of
natural laws is that they are habits^ not compulsory necessUies of
THE NATURE AND SCOPE OF ECONOMICS 9
nature, and the laws of life seem to differ from those of inanimate
nature in that they are not quite invariable habits. Variability
seems to be inherent in life, increasing as life rises in the scale of
development. It is often assumed, to be sure, that these laws are
as invariable as any other, and that this seeming variability is
only a greater complexity which we do not yet imderstand. How-
ever that may be, the result is the same for the present. The sci-
ences of life are not exact in the sense we have defined. We must
further note that in so far as a science deals with facts which seem
to be governed by no invariable law, or whose law has not been
discovered, it must content itself with a description of this part
of its subject Thus we have the term " descriptive science.'* We
might better speak of the descriptive part of a science, for all
sciences are able in part to reduce their facts to law.
What has been said of the sciences dealing with life applies to
an even greater extent to those sciences which deal with man. It
is perfectly true, of course, that within certain limits man is gov-
erned by absolutely invariable laws. He is as much bound by
gravitation as anything else, and if he falls over a precipice, we
can predict the results as certainly as though a stone fell over.
But, without entering the bog of discussion as to the nature of
human freedom, we may safely assume, for practical purposes,
that man is also, within certain limits, a law unto himself. No-
where do we find an element of variability so great and so seem-
ingly ultimate as here. We must remember, therefore, that the
sciences which deal with man deal with a being who is modified
by his environment, but who has (he power of modifying that envi-
ronment by his own conscious effort.
Let us consider verV carefully what this means. It does not
mean simply that man modifies his environment because he has
been modified by it and so reacts upon it, just as things do when
they come in contact. If we accept this view, we shall come to
Herbert Spencer's theory of natural selection. The forces at work
accomplish their own results, according to this theory, whether
man will or will not, simply by natural action and reaction. This
implies that man is modified by his environment, and that he in
turn modifies that environment without conscious effort. This
to OtrrLINES OF ECONOMICS
theory is based on an assumption that man has no power of iniH-
aHng an influence, and consistently concludes that social develop-
ment, like geological development, must be left to work itself out
Mr. Spencer, however, goes farther, and stoutly maintains that
man, by conscious effort, especially by collective or state effort,
not only does not help this development, but actually hinders it.
In this the whole theory is abandoned, for it is plain that if man
by conscious effort can hinder a process, he can help that process
in the same way, if he only has enough wisdom and sense. These
it is the purpose of sdence to give him.
In opposition to the theory of natiual selection, or unconscious
development, has been urged the theory of artificial selection, or
conscious development. Ages of natural selection made of the
potato a lean, watery, unpalatable tuber; a few years of artificial
selection made it a valuable food product and a table delicacy.
Compare the development of domestic animals in the last few
years, under man's conscious guidance, with their slow and meager
development in a state of nature. Man has precisely this power
of consciously modifying the natural and artificial elements of his
environment, and this power continually enlarges.
So, when we ask if economics deals with natural laws, we really
ask whether this being, whose activity in a certain line we are
studying, is governed by such laws. It we mean by this to ask
whether his action is characterized by absolutely invariable hab-
its, like the forces of physics, we must plainly answer, no. If
man had no power of initiative, or, on the other hand, were so
perfectly radonal as to always do the wisest thing, there would be
a regularity in his action which might perhaps form the basis of
a complicated, but exact, science. As it ii, all social sciences are
approximate and partiy descriptive. There is much in man's ac-
tion which is exceedingly (though not perfectiy) regular, and hence
we have general, though apparently not invariable, laws. There
is a part of his action, however, that seems as yet to be capricious,
and we can only roake note of it till we have more knowledge.
The laws of economics are not comparable to the laws of inani-
mate nature in invariability, but they are of very general applica-
bility, and are wholly in line with the action and intent of nature,
THE NATURE AND SCOPE OF ECONOMICS II
and are, in this sense, "natural." But the laws of economics are
not natural laws in the sense in which the word is often used;
namely, laws external to man and not at all the product of man.
The laws of economics have been designated as social laws to
distinguish them from those of physical science. Social laws de*
scribe tendencies, or regularities, which appear especially in the
consideration of large masses of facts. Human mortality serves
as an illustration. When and how a certain man, as A, will die,
is proverbially uncertain; but when we speak of himdreds of thou-
sands of lives, we can predict with such an approximation of accu*
racy that a vast business-like life insurance can be built upon
the regularity of the action of death.
The foregoing discussion enables us to answer in a word the
much-mooted question, "Is economics a science ?'' It is not an
exact or mathematical science, though certain portions of the sub-
ject may possibly become so. It is an approximate and partially
descriptive science, like all sciences dealing with man, or even
with life. The inexactness of the social sciences is due to the very
thing which gives them their supreme value, the nature of man
and the greatness of their subject.
The Relation of Economics to other Sciences. — We have al-
ready referred briefly to the relations between economics and some
of the other sciences, but the topic is one which requires fuller
treatment In one sense, economics may be said to be dependent
upon practically every other science, since the discoveries in every
field of knowledge almost inevitably react upon the industrial life
of man. Modem chemistry, to take a single example, has revo-
lutionized some industries, wholly created others, and, through
the agency of the piu*e food laws, may claim most of the credit
for entirely suppressing others. From psychology economics takes
the axiomatic principles upon which the laws of value rest; from
ph3rsical science the law of diminishing returns which plays such
an important part in the theory of distribution; and from mathe-
matics the methods by which to ascertain how insurance may be
safely supplied against accidents, death, and loss by fire. But
it is to the sister sciences dealing primarily with man that eco-
nomics is most vitally related.
12 OUTLINES OF ECONOMICS
Man has been busy from the first in several lines of effort. He
has talked, worshiped, fought, studied, and each of these lines
of effort has developed its own faculties and institutions. For
convenience we may arrange these in eight groups, as follows:
language, art, education, religion, family life, society life, politi-
cal life, economic life. Each of these is the subject of a science
more or less developed. The group of society life — that is, the
life of polite society, calls, parties, balls, and the like — has been
studied but little, and we know few of its governing principles.*
Language, on the other hand, is a science which has attained to
very complete development. The rest lie scattered between these
extremes.
A peculiar feature of these activities is that they are all of them
collective activities, activities which one man cannot well carry on
alone. This is obviously true of family and political life, language,
and others, and on careful examination it proves to be true of
the rest. It is now admitted, after many experiments, that art
and even religion do not thrive in solitude. It would seem that
if a man could do anything by himself, it would be to get a living;
but oiir brief study of history impresses us with the insignificance
of all such effort and the inevitable tendency of men to drift to-
gether in their economic activity. If it were possible for men to
live in isolation, every one of the eight lines of effort we have men-
tioned would soon dwindle into insignificance or altogether cease.
So these sciences are all of them social sciences; and as the sci-
ences that deal with life are now grouped together under the name
biology (science of life), so the social sciences are grouped under
the title of sociology, or the science of society, although some
sociologists do not define the word "sociology" in this broad sense
of an all-embracing science of human association.
Economics, then, is a branch of sociology. We have already
defined it as the science which treats of those social phenomena
that are due to the wealth-getting and wealth-using activities of
man. We may speak of the wealth-getting and wealth-using
* An attempt to examine scientifically some, at least, of the phenomena of
polite society has been made by a learned jurist, the late Professor Rudolph von
Iberiog, in hU Zwuk im RecM. Qf. also Veblen, The Theory of the Leisure Class.
THE NATURE AND SCOPE OF ECONOMICS 13
activities in all their relations as economic life or economy. Ac-
cordingly, economics is the science which deals with the economy
of man. A useful distinction in language is thus made between
economy, the life itself, and economics, the science dealing with
that life. If this distinction could always be observed, much con-
fusion would be avoided.
We have economies of various sorts: the economy of an indi-
vidual, of a family, a tribe, a city, a state, or a nation, and we
have, correspondingly, many economic imits. The dominant unit
in ancient Greece, for example, was the household, which included
the family and all the slaves and other dependents. These lived
together and formed a little group by themselves. The economic
life of Greece meant, largely, a sum of the economic activities of
these households, each of which strove to be sufficient unto itself.
It is interesting to know that many a well^managed Southern
plantation before the late Civil War endeavored to produce all the
means of life on the plantation, and in this respect, as in others,
resembled a Greek household. But as time has progressed, these
old groups have been partially dissolved, and in many instances
in modem times the individual, in his economic activity, consti-
tutes a imit, although the family is still the prevalent economic
unit It is a natmul outcome of industrial progress, as already
explained, that the relations between these units have multiplied
indefinitely in number and in importance. This is simply another
way of describing the growing interdependence of men. Eco-
nomics deals especially with the mutual relations of economies of
all kinds, private and public. It is chiefly, if not exclusively, a
science of human relations, and without these relations could not
exist.
Because of the organic connection of these relations in their
common origin, man, and because economics deals with the indi-
vidual as he is, and not with an artificially simplified '^ economic
man," it is impossible wholly to dissociate the social sciences,
and particularly impossible to divorce economics completely from
ethics and politics. This does not mean that these sciences are
an one and cannot be profitably subdivided. On the contrary,
because of the limitations of the human mind, they must be
f 4 OUTLINES OF ECONOMICS
studied separately so far as is possible. Scientific progress, like
industrial progress, comes largely through specialization and the
division of labor. Man cannot profitably study things in general.
What it does mean is that there is some territory common to all
these sdencesyand that occasionally the economist is forced to
pass ethical judgment and to decide political questions. In the
consideration of railway rates, for instance, the economist is not
only compelled to pass judgment upon what is just and reasonable,
but he discovers upon investigation that by common consent what
is fair or reasonable is decided largely upon economic grounds.
The same is true of the apportionment of taxes, in which subject
ethical, legal, and economic questions are inextricably interwoven.
Conmierdal policies, restrictive regulations, and sumptuary laws
have been the very stuff and subject-matter of the science of eco-
nomics from its very beginning. In analyzing the progress of
the past or the conditions of the present, we are forced to pass
judgment upon the success or failure of many laws and policies
which are still in force or under active discussion. Many of these
must be indorsed or repudiated either solely or largely upon
economic grounds; and because of these facts, the economist cai^-
not, even if he would, refrain from passing judgment upon laws
and political policies. Nevertheless, as was stated before, eco-
nomics does not undertake the complete and systematic study of
law, ethics, and politics, and its conclusions must almost always
be supplemented by non-economic considerations which the
economist may not have taken into account.
In the preface to the first edition of his Principles of Economics^ Professor
Matshall seems to dissent from the views here expressed, maintaining that
''the laws of economics are statements of tendencies expressed in the indica-
tive mode and not ethical precepts in the imperative." But even this most
cautious and consistent of economists cannot refrain from laying down
ethical precepts in many parts of his work. On almost the very last page
he declares that : "The most imperative duty of this generation is to provide
for the young such opportunities as will both develop their higher nature, and
make them efficient producers. And an essential condition to this end is
long-continued freedom from mechanical toil; together with abundant
leisure for school and for such kinds of play as strengthen and develop the
character." *
* Marshall, Principles of Economics, 5th ed., p. 720.
THE NATURE AND SCOPE OF ECONOMICS 1 5
Principal Divisioiis of Economics. — This view of the inevitably
practical character of economic science is carried out in the treat-
ment of the subject in the following pages. The history and evo-
lution of economic society, sketched in Book I, are followed, in
Book n, by a discussion of the consumption, production, exchange
and distribution of wealth. These subjects are treated in close
connection with those illustrative economic problems of which
the so-called "economic theory," at its best, is but a more com-
prehensive and consequently more abstract analysis. Book TH
has been reserved for the subject of public finance, which, in the
opinion of the authors, constitutes as integral a part ai econcHoic
science as the subjects of money or international trade. In Book
IV is given a brief sketch of the history of economic thought.
QUBsnovs
I. What is the most essential characteristic of tayoomics? Define cco-
2. Is man or goods the more prominent thing in ecotnomic study ? Docs
fcannmirs teach the student how to get rich ?
3. What determines ultimately whether a man is poor or not? What
kinds of porertj are there?
4. Wbat is meant by "dear labor''? Is it a good tbfa^ for society m
gEsieral? for employers in general? for an individual employer ?
5. What is the difference between natural and artificial selection ? Which
^piies to human society ?
6. Are practical ethical and political judgments the chief ends and prod-
ucts of economic science ?
7. Is ecoBDmics concerned with the negro question? asset atrrency?
prohibition? anti-trust laws? race suicide? protectioii?
SBPSRBHCBS
CjKBifis^ J. £. The Characier and Logical Method nf FMicaU Economy,
CosSA, L. An ImrodncHon io the Study of FoUtical Economy.
Ikbsaii, J. K. a History of Political Economy, Chap. VII.
Eetvks, J. The Scope and Method of Political Economy,
Masshaix, Alfred. Principles of Economics, 5th ed., Appendix C.
Mni, J. S. Essays on Some Unsettled Questions of Political Economy,
S1D6WICK, Hensy. The Scope and Method of Economic Science,
WuMtM, A. '^ On the Present State ol Political IBamamy** QuaHmly
Jomnal of Economics^ VoL I.
CHAPTER n
THE CHARACTERISTICS OF THE PRESENT ECONOMIC
SYSTEM
It is the object of the present chapter to give a descriptive
survey of the fundamental institutions and forces of the existing
economic order.
Our Environment. — Lying back of all of our economic activity
b the fact that we live in an environment in which the things that
we desire are not fiunished spontaneously in unlimited quantities.
Whether it be looked upon as due to the niggardliness of nature
or to the insatiability of human wants, the fact is that, for the most
part, the material things that we use must be economized. We
must put forth effort and exercise self-denial in order to enjoy
the good things of life. Those human arrangements which help
to determine how much of efiFort, of self-denial, and of enjoyment
is to fall to the lot of each of us are the characteristics to which
we now turn our attention. There are, however, a niunber of
social institutions which do not fall within the scope of the pres-
ent chapter. We deal here only with the social conditions directly
imderlying our economic activity, which is but one aspect of our
social life. We must leave to the sociologists and other students
of society a discussion of such topics as the family, religion, mo-
rality, ceremonial institutions, and the nature of government,
although, to be sure, these also have their efiFect upon the
economic sphere and are in turn affected by it. In the present
chapter also we omit a study of the economic significance of our
physical environment, which receives independent treatment in
books on economic geography.
Private Entarpriae and State Activity. — We live in an age when
private enterprise, for the most part, is relied upon to furnish us
x6
THE PRESENT ECONOMIC SYSTEM 17
with the necessities and enjoyments of Hfe. The cultivation of
the soil, the exploitation of the mines, transportation, the various
stages of manufacture, and the distribution of the finished prod-
uct are all left mainly * to private initiative. The discovery of
new processes, invention, and experimentation are carried on
mostly by private individuals or corporations who take upon their
own shoulders the risk of failure. The State, on the other hand,
participates in this activity in a variety of ways. It maintains
order, promotes the public health and safety, provides roads, and
takes charge of some industries completely. In its educational
institutions the State, through its agents, undertakes various ex-
periments, and encourages the growth and diffusion of knowl-
edge, an indispensable condition of continuous advancement of
our economic life. The state university and the experiment farms
may be mentioned, and also the large and extremely useful De-
partment of Agriculture of the United States, with its annual
expenditure now exceeding six million dollars. Certainly in the
vast majority of the enterprises with which we are familiar, pri-
vate and public activities are combined in varying proportions.
Let us take the case of an industry which is as nearly private,
perhaps, as any we can find, — that of agriculture, — and notice
the part which public activities play in seciuing the farmer's re-
sult. First, we may say that the farmer owns the farm that he
cultivates; this is private property. But how comes it that the
farm is his? Why does not a stronger man drive him off and
take the farm himself? Plainly because the State protects him in
the possession of the farm. When he bought the farm, he took
his deed to a government official, who recorded it, and thus gave
him an additional guarantee of possession. A neighbor's dog
kills his sheep, and an appeal to the State compels the neighbor
to redress the grievance. Another, far below, dams a river and
backs the water up so that it overflows his land. Another appeal
to the State removes the dam or secures compensation. When
wheat is raised, the farmer hauls it to market by a road built, not
by private, but by public, activity. The railway lowers the price
1 This applies especially to the United States and England so far as transper-
tadoa is concerned ; it would scarcely hold true of the world as a whole.
C
l8 OUTLINES OF ECONOMICS
of his wheat by a discriminating rate, and again government in-
terferes in his behalf. But manifold and important as are the
regulations of the government, State activity seems very much
restricted when we reflect that it might extend over the entire
industrial field. To-day the distinctive characteristic of our eco-
nomic life is private, not public, enterprise.
Division of Labor and Exchange. — It is commonly taken for
granted that every man should prepare himself for some special
occupation, that one should plow while another builds or sings.
Hardly any civilization seems possible without some industrial
specialization, but our own age is peculiar on account of the ex-
tent to which this has been carried. The introduction of machin-
ery and the development of large-scale production have split up
so minutely the work of men that the products which they turn
out are not only not of immediate use to themselves m most cases,
but they are also useless to any one else until combined with the
results of other men's labor, often performed years before or after-
wards. It is a long and complicated process from the man who
mines the ore which is to reappear in a steel plow, to the man who
bakes the bread. The effects of this specialization of employ-
ment are far-reaching: —
(i) It implies the exchange of goods. If we produce things
we do not need, we must find some one else who does want them
and some one who has the things we desire. Money, banks, and
transportation agencies could largely be dispensed with if each
family produced for itself alone. There would be none of the
complex problems that center about the question of how much
each of us is to receive in exchange for his services. One of the
striking characteristics of this process of exchange is the great
extent to which it is automatic. There is no government official
whose business it is to discover how mUch of each commodity
will be needed, and to direct that that amount shall be produced.*
Men are legally allowed to engage in almost any undertaking that
attracts them, and yet we take it for granted that somehow things
will get produced m the proper proportions. A hundred men are
^ The government does help, however, in collecting and pubHshlng information,
as in the cafie of crop reports.
THE PRESENT ECONOMIC SYSTEM 19
set to work in a factory making nothing but hats, many more
than they or their friends can use, but the manager has faith that
heads will be found to wear them all. Fanners confidently pro-
ceed to raise wheat, never troubling themselves about the grind-
ing and baking. Neither workmen nor employers in general
know why wages are as they are. Men lend money or goods, now
for one price, now for another, but few know why they demand
interest or why the rate changes. These processes go on visibly
before us, but the governing laws are hidden except to the care-
ful investigator. In this respect they are like the laws of physi-
ology. We eat and digest our food, but how many people know
bow or why digestion takes place ? It is easy, however, to over-
emphasize this idea, for a great deal of our economic activity is
conscious and volitional. When we decide to make a law or levy
a tax, we do it consciously, considering argxmients, and finally
will the thing in question. Further, in the large business con-
solidations, much knowledge regarding the course of trade is
obtained directly through special agents or reports and is made
the basis of conscious action.
(2) Specialization of work and exchange of goods just referred
to, necessarily implies mutual dependence. Instead of a number
of distinct, self-sufficient units, we have a coherent society where
one individual relies upon many others to complete his own one-
sided economic activity. A strike of the street car employees, or
of the teamsters, or the destruction of an electric lighting plant,
would each send a shock of inconvenience through a community.
A prolonged railway strike would be felt as a national misfortune.
Indeed, this interdependence is international in its scope. Eng-
land relies on other nations to send her food in exchange for her
manufactured products, and many a German workman would be
in distress if there should be a sudden failure in oiu- cotton crop.
Eomomic Classes. — In part, also, the specialization of work is
responsible for the division of society into classes, but only in
part. The difference in the work of the carpenter, machinist, or
railway brakeman does not result in the formation of classes of a
higher and lower rank. On the other hand, the professional brain
worker enjoys some social esteem that docs not fall to the lot of
20 OUTLINES OF ECONOMICS
the manual worker. But doubtless the most important basis of
social classification is the possession of wealth. The power to
spend freely, while not the only test, is to-day the most widely rec-
ognized test of social status, regret it as we may.
Private Property. — We proceed now to examine the foimda-
tion stones of this system of private enterprise. Private property
is the most important of these.
The leading English writers of economic treatises have usually taken the
institution of private property as something to be assumed as a starting
point in their discussions. John Stuart Mill, indeed, made an excellent
beginning in the discussion of property and inheritance in his Principles of
Political Economy^ but other English writers have not generally followed
up his lead. It is to the merit of the German writers that they have critic-
ally examined these fundamental institutions in their economic bearings.
The work of Professor Adolph Wagner may be mentioned especially in this
connection.
For our present purpose we may define private property as the
exclusive control over valuable things by private persons. It is
to be distinguished from mere possession. The possessor has the
use of the thing for the time being, but unless he is at the same
time the owner, he is dependent upon the will of another for the
use of it. Ownership implies the right of excluding other per-
sons from the enjoyment of a thing. The exclusive right must
be recognized and guaranteed effectively by third parties. If I
defend my exclusive right of control over some valuable thing
against your claim simply by the strength of my right arm, I have
not thereby established the right of private property. My ex-
clusive right of control must be recognized by others and must
be maintained by them. Over against private property we have
public property, and there are some things, such as air, which
fall in neither of these categories. The sphere of private property
at present includes, not only food, clothes, and other things of
personal use, but it also includes the instruments of production
— land, buildings, and machinery. In the most important pro-
ductive processes the tools are in general not owned by the per-
sons who use them. Hence our present wage system.
It may be said that property is the chief seat of social authority. As
property carries with it the exclusive right to control things, others may have
THE PRESENT ECONOMIC SYSTEM 21
access to these things only on conditions named by their owners. If
we look about us, we find men organized and acting together under
direction for purposes of production. In a factory we find an organization
of men like that of an army. We discover men moving here and there and
performing arduous tasks in obedience' to command. If we examine the
natuie of the authority which some thus exercise over others, we shall find
that it resides in property. The law of the land to some extent establishes
the authority of man over man ; but where one man obeys another because
the law in so many words tells him to do so, we find a hundred men obeying
others because these others have the authority which resides in exclusive
control over valuable things. Indirectly this latter sort of authority rests
back upon the laws in so far as these are responsible for the establishment of
property. But the chief seat of authority in society is based only indirectly
upon the government; it rests immediately upon private property.
Liheritance. — Inheritance is often regarded as a necessary part
of the right of private property, and it is true that the entire abo-
lition of the right of inheritance woiild result in a great enlarge-
ment of the public sphere of property at the expense of the private
^here, unless gifts were made to accomplish the same object as
the system of inheritance. But strictly speaking, we have here to
do with two rights. Private property is an exclusive right of con-
trol, whereas inheritance is concerned with the transmission of
this right from one generation to another.
As in the case of private property itself, the right of inheritance
is not recognized to-day as an absolute one. Detailed regulations
exist on our statute books regarding the descent of property where
no will is made, and also regarding the making of wills, and there
is an increasing tendency to limit the right of inheritance by taxa-
tion. Some features of the present law of inheritance well iUus-
trate the tendency of institutions to persist after the conditions
that gave rise to them have disappeared. The recognition which
we give to the claims of very distant relatives to a share in an
estate where there are no near relatives, and where no will has
been made, had its origin at a time when blood relationship played
a much more important part in society than it does at present.
Contract. — Scarcely second to the right of private property is
the right of contract, for the maintenance of which we are equally
dependent on the State. Some sort of contract lies at the basis
of aU associated activity. To secure the condition of such activityi
aa OUTLINES OF ECONOMICS
it is necessary, first, that men should be allowed to bind them>
selves; and second, that they should be compelled to respect the
agreement thus entered into. The entrance into a valid contract
is ordinarily voluntary, but once entered into with due formality,
the State will use its superior power to enforce it To the anar-
chistic mind this seems oppressive, and it must be admitted that
a state of society is conceivable in which the element of force
would be removed from the idea of contract, but something else
would have to be substituted to make the keeping of agreements
the general rule. There are doubtless many people living to-day
with whom the feeling of honor or fear of social disapprobation
would be sufficient for the enforcement of contracts, just as these
persons might not need the threat of a jail sentence to keep them
from stealing.
The economic ties which hold men together in industrial society on their
legal side are very generally contracts. The organization of an industrial
corporation implies many contracts. Our property is acquired very laigely
through contract, and through contract we determine the conditions under
which we do our work, such as the length of the working day. The conti-
nuity of our economic life rests upon contracts, which bind together past,
present, and future. Still, all that we have by no means comes to us through
contract. " Contract'' does not exhaust the significance of parentage, home,
and education, and much wealth changes hands through gifts and inheritance.
Vested Interests.^ — A few words should be said about vested
interests. Vested interests may be defined as pecuniary interests
which are legally recognized to be such that they cannot be im-
paired by public action without indemnification. Vested inter-
ests generally arise through property and contract. Outside of
property and contract, however, there may be vested interests.
Leeds was compelled by a feudal arrangement to grind its com,
grain, and meal at the lord's mill till well on in the last cen-
tury, and finally had to pay ;Si3,ooo to terminate this obligation.
When Prussia bought the railways, the railway presidents were
indemnified for the loss of their positions by large payments; in
other words, their offices were looked upon as vested interests.
England is the classic land of vested interests.. An office in the
army was until recently looked upon as such, and so was an
*The tcnn " vested rights " is also used.
THE PRESENT ECONOMIC SYSTEM 2$
appointment in the Established Church. It is generally held that
saloon keepers in England have a vested interest in their busi-
ness, so that they must be indemnified if their licenses are taken
&om them. Workingmen have frequently claimed that they have
a vested interest in the advantages which their acquired skill gives
them, and consequently that if through industrial changes this
skill ceases to be of as great value as formerly, they ought to he
indemnified and in some way their former income continued.
This claim of the workingmen, however, unlike many other claims
put forward in the name of vested interests, has not received rec«
ognition, either by Parliament or the courts. Vested interests,
apart from property and contract, are of less significance in the
United States than in most countries, but they may become of
more significance in the future.
FAedom. — The words " liberty " and " freedom " have given rise
to some of the deepest philosophical discussions, but we may avoid
confusion if we say that the freedom to do certain things is legally
guaranteed at the present time, such as moving from one part
of the country to another, choosing one's own occupation, and
acquiring property. These, together with the absence of chattel
slavery and imprisonment for debt, are characteristic features of
the present economic order as distinguished from past conditions.
The right to manufacture and sell what and when one pleases is a
comparatively recent one. It has often been greatly limited by
despotic governments, and the right has been made a matter of
sale for the purpose of raising revenue. Most such limitations
have been of the nature of abuses, and our own time has seen the
abolition of an immense number of hampering and vexatious re-
strictions designed for plunder rather than for the promotion of
private enterprise. So far as the absence of legal restrictions on
the actions of indivlduak is concerned, the past century has been
distinctively an age of liberty.
Restrictive laws, however, are not the only limitations on our
freedom of action. The system of private property itself means
that certain individuals in the community have power to command
other people to work, and the lack of an income under our present
regime implies the lack of the real freedom to do things. The
24 OUTLINES OF ECONOMICS
cost of a railway ticket may be quite as effective as a legal bairiei
would be in preventing movement from one state to another. It
is said that we are free to acquire unlimited property. True, the
law does not expressly prohibit such acquisition, but as a matter
of fact many persons do not acquire much property. Again, we
say involuntary servitude, except as punishment for crime, has been
abolished, yet men are compelled to work by the threat of eco-
nomic distress, in most cases quite as effectively as by means of
the slave-driver's whip, for the counterpart of legal freedom is
the economic responsibility of the individual. "Sink or swim,"
says the State to the millions struggling for worldly goods. That
is the end of the matter according to the laissez-faire theory. The
modern State helps men to learn to swim. Again, the choice of an
occupation is free according to the law, but we may find that a
long and expensive course of training is necessary, or we may be
compelled to conform to trades-union regulations, and always it is
necessary to find some one who deems our services valuable. The
right to establish enterprises is granted to all alike according to
the law, but to-day it would be difl&cult and hazardous to embark
upon the refining of oil or the manufacture of steel. Practically,
the freedom to establish new enterprises has been growing less
and less in this era of large-scale production.
Competition and Markets. — As a result of the legal conditions
that have been mentioned, we find men engaged in many kinds
of rivalry. Our economic society is often called "competitive"
for this reason. But when this term is used, not all forms of
rivalry are meant, for even if private property and free contract
were abolished, some form of struggle might still persist. There
might still be conflicts between races and nations, and the men of
any single nation might still vie with one another to prove their
superiority in the eyes of womankind or to gain positions of pub-
lic honor and power. The kind of competition which is distinc-
tive of the present economic order is the all-pervading endeavor
to obtain the largest possible amount of wealth in exchange for
commodities produced or services rendered. If we except the
idlers, the parasites, and the cheaters, men are everywhere en-
deavoring to discover what other people want urgently, and then
THE PRESENT ECONOMIC SYSTEM 25
to satisfy that want in the most efficient manner possible. On the
other hand, they attempt to give as little as possible of their own
products in exchange for the things they themselves desire. Busi-
ness comp>etition thus has two sides: rivalry in rendering a serv-
ice, and alertness in exacting a return. Each individual takes
part in the competitive contest in two ways: first, as a seller of
goods or services, in which case he finds that others are anxious
to render the same service; and second, as a buyer of the things
he wants, in which case he finds that these same things are sought
after by other people.
The intensity of the competitive struggle is subject to a good
deal of variation. At times it may be characterized as cut-throat,
where the slashing of prices has for its object the elimination of
one or more of the contestants. But the rivalry is not necessarily
so fierce. In some lines of business many competitors may con-
tinue to eHst side by side indefinitely, each competitor being con-
fronted by the ever present threat that if his service becomes very
poor, some other man will outstrip him. Various as may be the
character of competition, now predatory, now a friendly rivalry,
there is no resting place in the contest unless one secures some
special privilege as a shelter. He who is energetic, and wins suc-
cess in a certain line of business, must continue to defend himself
from a host of imitators who are anxious to snatch his gains from
him. Most of the competitors are successful in getting something,
some more than others, but many fail altogether. These last, the
inefficient, whether made so by sickness, by inherited weakness,
or by lack of proper training, fall by the wayside and must be cared
for by private charity or by the State. The process is cruel in
many of its details, but there is also a beneficent aspect in the
sifting out of the incompetent and in the encouragement of the
strong.
Here, again, reference may be made to the automatic character
of the present industrial system. It is through competition and
bargaining in the market that a price is fixed, and it is to the vari-
ations in this price that business men look for indications as to
what people want rather than to the reports of some government
official, although such reports are of some assistance. Price is
36 OUTLINES OF ECONOMICS
the universal barometer that indicates changes in the demand for
goods of all kinds.
Competition has been spoken of as a struggle, a contest, ac-
companied by success and failure, elation and disappointment.
But the State sets limits to the rivalry — it makes regulations and
acts as an umpire to compel fair play. It attempts to eliminate
fraud and brute force; it trains the rising generations for an en-
trance into the struggle by a system of free education; it insists
that no person shall sacrifice the life and limb of another in the
rush for wealth; and it protects children and women when they
seem compelled to labor under unhealthf ul conditions. Those who
fail entirely in the struggle it tries to rescue from suffering. In
short, the State, as will be explained more fully in a later chap-
ter, aims to raise the plane of competition, changing it from bru-
tal warfare into a contest in which there are prizes for all, but in
which the prizes are graded according to the energy and ability
of the contestants.
Coopeiation. — The statement that our age is one of competi-
tion is misleading if it gives the impression that every individual
is continually struggling against all of his fellows. On the con-
trary, the achievements of modem industrial civilization would be
impossible without a far-reaching cooperation between individ-
uak. Employers and employees may quarrel and bargain about
the wage contract, but when they have settled their relations for a
week or a year, they become cooperators during that period in
the conduct of the business enterprise in which they are engaged.
Again, there is an unconscious cooperation between those who
work upon a commodity in the different stages of the process from
raw material to finished product. The division of labor itself
necessarily implies cooperation. Competition merely determines
the conditions on which the cooperation takes place. If these
conditions could be determined in some other manner, it would
be possible to conceive of the elimination of competition from our
industrial system, but cooperation is so vital and fundamental
that its elimination would mean a return to barbarism.
Monopoly. — Everywhere in the industrial field the tendency
toward monopoly k present. Business men endeavor so far as
THE PRESENT ECONOMIC SYSTEM 37
possible to shelter themselves from the effects of the competitive
struck by means of some privilege, but if none is to be found,
and if competition becomes very keen, they endeavor to combine
with other business men. But while this attempt to escape com-
pedtion is universal, it is only under certain conditions that it is
at all likely to succeed. The success is least in agriculture and in
the mercantile business, where new enterprises are started rather
easily because no special privileges stand in the way and because
no very large capital is required to work efficiently. It is greatest
in mining and transportation, where special privileges are present
and where large capital is required. Scarcely anywhere k it pos-
sible wholly to escape competition, and we are still warranted
in speaking of the present era as a competitive rather than 'a
monopolistic age.
Side by side with the growth of monopoly there is an increase
in government interference in industry. The desire of the busi-
ness man is to be uncontrolled, but wherever he succeeds in throw-
ing off the control exercised by his competitors, he inevitably
substitutes that of the government official.
Custom. — Custom plays an important part in our economic
activity as well as in every other department of social life, although
its sway is not so marked as in former ages or among primitive
peoples. The custom of giving gratuities, or iip^y to servants Is
in many places so strong as to have almost the force of law. Again,
to-day much of our personal expenditure is controlled by what
custom has declared to be proper rather than by any act of our
own individual reason. Any attempt to lower wages which would
make impossible the maintenance of a customary standard of liv-
ing would be stubbornly resisted. Custom is the result of habit,
and IS continually broken into by our tendency to imitate a leader
who proposes a new line of action. Recent events in the spelling
reform movement afford an illustration. While custom may have
its beneficent aspect in preventing hasty and impulsive changes,
it frequently retards progress and causes our legislation and judi-
cial decisions to lag behind industrial development.
Authority and Benevolence. — In the preceding pages frequent
reference was made to the limitations upon the rights of private
28 OUTLINES OF ECONOMICS
property, inheritance, contract, and freedom. Public authority
may be looked upon as one of the forces governing the economic
process. The conduct of private enterprises is continually being
interfered with by State authority. Legal rates of interest are
established, and "reasonable" railway charges are substituted
for actual charges. The authoritative fixation of wages is a
future possibility.
Benevolence, or the caritative principle, may be mentioned as
another force in economic society, modifying and supplementing
in many ways the work of competition.
QUESTIONS AND EXERaSBS
' I. Attempt to classify the leading occupations in your city with respect
to the social prestige attaching to them.
2. Describe the property relations existing in the Amana Society, or in
other communistic groups.
3. What regulations concerning the inheritance of property are in force
in your state ?
4. To what extent are gambling contracts valid ?
5. Compare the legal freedom of workingmen to-day with the conditions
described in the WeaUh of Nations, Book I, Chap. X, Part II.
RSFERENCB8
Baker, C. W. Monopolies and the People, Chaps. X and XI.
Buss, W. D. P. Encyclopedia of Social Reform (new ed.), article on
Amana Community. See also on same subject, Ely, R. T., in
Harper*s Monthly Magazine, October, 1902.
Ely, R. T. Evolution of Industrial Society, Part II, Chaps. I, VII, or XL
Green, T. H. Liberal Legislation and Freedom of Contract, Works, Vol.
Ill, p. 365.
Mill, J. S. On Liberty, Chap. IV.
Mill, J. S. Principles of Political Economy, Book II, Chaps. I and II.
Nicholson, J. Shield. Principles of Political Economy, Vol. I, Book II,
Chaps. II-VIII.
Patten, S. N. Development of English Thought, pp. 22-23.
Stephens, J. F. Liberty, Equality, and Fraternity.
SiDGWiCK, Henry. Principles of Political Economy, Book II, Chap. XII.
Webb, Sidney and Beatrice. Industrial Democracy, Vol. II, pp. 562-573.
CHAPTER in
THE EVOLUTION OF ECONOMIC SOCIETY
In the preceding chapter were described the fundamental insti-
tutions of the present economic order. Here a brief sketch will
be given of the origin and development of these uistitutions. Such
a study is advisable in a general survey of the field of political
economy because many of the problems and proposed reforms
which are met with raise questions as to the soundness of the
very foundations of our present economic life, and these can only
be understood when they are viewed as historical products.
The evolution of economic society is but one of many stand-
points from which the development of mankind may be consid-
ered. The history of literatiu-e, the history of government, the
history of religion, each treats of man in one line of his activities.
Many thinkers have considered the economic activities of man-
kind as the fundamental factor in social progress, determining in
the long run even our ethical and religious conceptions. Prob-
ably human life is too complex for any sucb simple explanation.
The economic factor, however, is cleariy of the most fundamental
importance in the sense that the higher things in life cannot be
cultivated if man's entire time is spent in getting a mere subsist-
ence, so that economic progress, or gaining control over the forces
of nature, must accompany general social advancement, at least
for the mass of the community. Under primitive methods of
production, only a select few can have this leisure time.
The Economic Stages. — Many attempts have been made to
divide economic history into stages through which mankind passed
in arriving at modern industrial civilization. These attempts have
been the subject of lively criticism, but it appears that the classifi-
cation which in the past has been most widely used is still, with
29
30 OUTLINES OF ECONOMICS
some modifications, the most serviceable, and in the main, this
will be followed in the present chapter.
The basis of this classification is tJte increasing power of man
over nature. This is the fundamental fact in man's economic
development, and his position in the scale of economic civilization
is higher in proportion as this power over nature increases. In-
creasing control of nature is accompanied by changes in man
himself, especially by a growth and diversification in bis wants,
so that we may say that economic civilization consists largely in
wanting many things and in learning how to make and use them.
From this standpoint economic history may be divided into the
foUowing stages:
I. Direct Appropriation.
II. The Pastoral Stage.
III. The Agricultural Stage.
IV. The Handicraft Stage.
V. The Industrial Stage.
I. DiHECT Appropkiation (
The economy of primitive man is characterized by finding things
ready to use instead of making them. It is not intended to assert
that the lowest examples of mankind that we know do absolutely
nothing in the way of transforming the materials of nature for
use. The lowest t}'pes know the use of fire and have rude tools,
but, nevertheless, the farther back we go, the more direct do we
find the reliance on nature. One cannot read descriptions of the
Negritos, Veddahs, Fuegians, or native Australians without being
impressed with the similarity between the economy of these peo-
ples and that of the lower animals. But there are many tribes
commonly regarded as savages that show a great advancement
over those that have been mentioned. Among the North Ameri-
can Indians, for example, we find a rude sort of cultivation of the
soil along with hunting and fishing. Such soil cultivation has
been termed " hoe-culture,'* and is to be distinguished from agri-
culture with the aid of domesticated animals found in a later stage
of development.
THE EVOLUTION OF ECONOMIC SOCIETY 3 1
This kind of agriculture is found in its highest state of development among
(he negroes of Africa. " The ground for cultivation/' says Ratzel, " is cleared
bj means of fire, or with the hatchet or small ax. On the east coast a broad
chopper with a spear-shaped blade and short handle is also used. The
hnce or spearhead has, in general, to serve many peaceful purposes. Larger
trees are killed by barking. Thorny branches are placed as a border to the
fields, under the shelter of which close, quick hedges gradually grow up. The
ground is broken and cleared of weeds with a wooden spade sharpened to an
edge at either end. Many peoples have hitherto not ventured to use iron
tools, since they keep away the rain. When the ground has been got ready,
somewhere about the beginning of the rainy season, the sower walks over
the field, scraping a hole with his naked foot at every step, into which he lets
some grains fall from his hand; the foot covers them up, and if the good
witch doctor makes rain enough, and the bad one does not keep it back, there
is nothing more to be done until harvest, unless to hoe the weeds once. . . .
To the present day the plow is practically strange to them." *
The following characterization of the economy of primitive man
applies with varying force to the many tribes that may be placed
ID this first stage.
Chancteristics of Primitiytt Man. — The range of wants is nar>
row, as the savage is almost completely satisfied if he obtains mere
subsistence of the rudest sort. In the satisfaction of these few
wants he is, according to our modem standards, remarkably inef-
5cient. Prom the best natural resources he manages to get a
Tery poor living, depending as he does largely on the spontaneous
products of nature. Magic and ritual are very generally relied
upon as idds to wealth production. Primitive man is improvi-
dent, for he does not feel keenly the uncertainties of the future,
and fails to make provision for them. Hence we find him sub^
jected to alternate periods of starvation and plenty. Only a scanty
peculation is possible in this stage, as a tribe must have a large
expanse of territory from which to draw its sustenance. The
place of abode is easily changed, and warfare with neighboring
tribes frequent. Cannibalism is found among many primitive
pec^les. Private property in land is absent, although the begin-
ning of the institution of ownership appears in the recognition of
the individuars right to articlj^ of personal use. There is little
division of labor. What one man can do, all can do. The soil
'Ratzel, Bistory of Mankind, trans, by A. J. Butler, Vol. TI, pp. 380-382.
32 OUTLINES OF ECONOMICS
cultivation by the women and the specialized work of the medi-
cine man are exceptions. As each tribe is economically self-suffi-
cient, the development of trade is slight. The beginning of
slavery may be observed, but this institution plays no impor-
tant part in the economy of primitive man, except among the most
advanced tribes.
II. The Pastoral Stage
In the older accounts of economic evolution, the impression is
given that hunting peoples learned to domesticate animals and
then led a pastoral life, later learning to subdue the vegetable
kingdom, and then becoming agriculturalists. This view is not
accurate. It is possible that the domestication of animals was
developed in regions where considerable progress had been made
in hoe-culture. As this knowledge spread, certain tribes became
and remained pastoral nomads in regions where agriculture was
impossible. But whatever the actual steps may have been, the
pastoral peoples represent a type of culture that k lower than that
of the agricultural stage (as distinguished from hoe-culture), and
higher than that of the hunter. Within this stage also are classed
together tribes of var)dng advancement. Illustrations of existing
pastoral life are found in the tribes of central -\sia, many of the
Arabian and African tribes, and the Todas of India. Attempts
have been made to trace the pastoral stage in the early history of
the Hebrews, Germans, Greeks, and Britons.
Chazacteristics of Pastoral Peoples. — Some marked features of
the first stage are found also among pastoral peoples. A fixed
abode is not possible, as food must be found for the herds and flocks.
Cities do not develop. Moreover, while the land will now sup-
port many more inhabitants per square mile than before, much
land is still needed for pasture, and there is frequent collision and
warfare between neighboring tribes. It follows also that there is
very little private ownership of land among these peoples. Tribes
as a whole lay claim to certain districts and try to keep other
tribes from pasturing on them. In this stage there are frequently
individual accumulations of wealth, consisting mostly of herds or
THE EVOLUTION OF ECONOMIC SOCIETY 33
flocks, and thus the contrast between rich and poor makes its ap-
pearance. Customary rules regarding the inheritance of wealth
are recognized. But this early wealth does not produce com-
merce to any considerable extent, simply because there is little
division of labor either between localities or within the tribe.
in. The Agricultural Stage
In this stage there is an enormous increase in man's power over
nature. The production of wealth is increased especially by the
use of animal power in cultivating the soil. One result is to in-
crease population. Land which under the more primitive meth-
ods of production would give a scanty support to a small tribe
for a part of the year will now maintain a whole community with
a fixed abode. It is necessary for human development that men
should live in definite places and have homes and a country.
This results in new relations between men, new duties, new arts,
and new possibilities. The beginning of the institution of private
ownership in land falls within this stage, although it is difficult to
trace the actual steps in the process.
A most important characteristic of this period is slavery. Slav-
ery begins long before improved agriculture, but it now attains
its full magnitude as an institution. There have been many dis-
cussions as to whether slavery is right or wrong. It is both.
There is a time in human development when slavery represents a
step in human progress. The slavery of the early period we are
now considering was inevitable, and is not to be judged by modern
standards. We now know that free labor is better than slave
labor, especially in the later stages of industrial development;
but, inasmuch as primitive man is induced with difficulty to work
at all, slave labor is a great improvement on free idleness.
Commercial intercourse is still comparatively slight in this stage.
Fixed residence develops village communities, and these are econom-
ically self-sufficient. They produce the things that they consume^
and as a rule have not surplus products to dispose of to others.
Hence money does not at this time perform important functions
m the life of every day. The economic condition of Europe dur-
D
34 OUTLINES OF ECONOMICS
ing the middle ages before the growth of cities illustrates the
agricultural stage.
The Manoiial Economy in England. — England was almost
wholly agricultural for three centiuies following the Norman Con-
quest. In the thirteenth century the population for the most part
lived in villages or manors, each controlled by a lord to whom
the rest of the inhabitants were bound by customary rules to ren-
der certain assistance in the cultivation of the lord's land. The
villagers were of various classes, according to the amount of land
which they held and according to the services which they were
required to perform. The land of each tenant was not a com-
pact area, but was composed of strips scattered in the three
great fields into which the arable land was divided for purposes
of crop rotation.
Some handicraftsmen were also found upon the estate, but they do not
occupy an important place in the economy of the village. For the most part,
they were probably slaves or household servants. Slaves in EngUnd con-
stituted at the time of the Conquest about nine per cent of the population,
but ''in some of the eastern and midland shires do not appear at all, or faU
to a percentage of four or five/' while they rise to as much as twenty-four
per cent in other parts of the country. "We cannot but explain this by the
supposition that in the later stages of the English conquest a greater number
of the British cultivators were spared, so that in these districts slaves came to
form a considerable part of the rural population. Absolute slavery, how-
ever, disappeared in less than a century after the Conquest, and the servi
became customary holders of small plots, like the cotters elsewhere, but on
more onerous conditions." ^
While these manors were largely self-sufficient in their economic
life, there was, to be sure, some trade. England exported raw
products to the continent and received back some of the finer
forms of manufacture. But the ordinary needs of the very frugal
life which the tenants had to live were supplied by products of
the village itself. During the centuries following the Norman
Conquest important changes took place in the manorial system:
(i) a rapid growth in the number of free tenants; (2) the com-
mutation of customary services into fixed payments in money or
kind; and (3) the appearance of a class of agricultural laborers
* See Ashley, English Economic Sistory, Vol. I, pp. 17-18.
THE EVOLUTION OF ECONOMIC SOCIETY 35
dependent on the wages which they received. In contrasting the
manorial economy with the village of the present day, Professor
W. J. Ashley has pointed out the following differences: (i) Now
fanners live in separate homesteads among the fields they rent,
but then all the cultivators lived side by side in the village street.
(2) Now each farmer follows his own judgment as to his agricul-
tural operations, but in this early period he took his share in the
common method of cultivation, which was regulated by custom
enforced by the manor courts. (3) To-day, if the landlord him-
self engages in farming, his management is independent of that
of his tenants, but under the manorial S3rstem he depended almost
exclusively upon the labor of his tenants, who contributed plows,
oxen, and men. Finally, (4) aside from the great gulf between
lord and tenants, there was then no such social separation between
the cultivators as there is to-day between large and small farmers.
The manorial economy of England was a type, though somewhat
more systematically developed, of conditions on the continent of
Europe.
IV. The Handicrapt Stage
This stage begins with the development of towns as centers of
trade and handicraft in the latter part of the middle ages, and ex-
tends to the introduction of power manufacture in the latter part of
the eighteenth century. During such a long period many changes
took place in the economic life of the people of Europe, but so
^ as the expansion and satisfaction of wants is concerned, — the
power over nature, — the whole period is in marked contrast with
the modem era of machine production.
Gilds. — The growth of trade in the town brought with it the
merchant gild, the purpose of which was to regulate the conduct
of trade and to keep a monopoly of it for the merchants of the
town. Merchant gilds appeared in all the larger towns of Eng-
land in the twelfth century. But a new class was developing in
the tovnis, — the craftsmen who were engaged in the making of
things for sale. As this handicraft grew in importance, the mer-
chant gild was superseded by the craft gild, which in England
attained its fullest development in the first half of the fourteenth
36 OUTLINES OF ECONOMICS
century. Each craft had its gild, which specified in detail how
the business should be carried on, how many should be admitted
to it, and how the trade should be learned. This growth in spe-
cialization meant also a growth in trade, but in this early part of
the handicraft period, commerce was much restricted as compared
with that of the present day. The towns made exchanges mostly
with the country surrounding them, there being as yet no national
or world market of any importance. Plainly such a general sys-
tem of exchange cannot be carried on by barter, and in this period
money became increasingly important.
The agricultural stage had in the greater part of Europe cul-
minated in the feudal system. The nobility maintained order
and attended to the fighting while the serfs tilled the soil. The
manufacturing cities became the rivals of the feudal lords, who
felt their power threatened, and hence they bitterly opposed the
cities. The cities were free, and the serfs who fled to them were
accepted and made freemen.
The Domestic System. — With the beginning of the modem
period the town system gave way to a larger economy. The
towns lost the control of trade. The gild system was succeeded
by the domestic system, which prevailed in England from the
middle of the fifteenth to the middle of the eighteenth centimes.
As in the gild system, industry was carried on by hand in a small
way, but the functions of merchant and workman were now sep-
arated. The gild master sold the goods which he produced in his
shop directly to the customers who were to use the goods, but
under the domestic system the workman came to be less inde-
pendent. He received the raw material from a middleman, to
whom he also delivered the finished product. Much of this work
was done outside of the towns, the artisans thus being enabled to
devote part of their time to agriculture. Defoe, in his torn-
through Great Britain (i 724-1 726), describes the methods em-
ployed as follows: —
The land "was divided into small inclosures from two acres to six or seven
each, seldom more ; every three or four pieces of land had an house belonging
to them, . . . hardly an house standing out of a speaking distance from
another. . . . We could see at every house a tenter, and on almost every
THE EVOLUTION OF ECONOMIC SOCIETY 37
tenter a piece of cloth or keisie or shaloon. ... At every considerable
house was a manufactury. . . . Every clothier keeps one horse, at least,
to carry his manufactures to the market, and every one generally keeps a
cow or two or more for his family. By this means the small pieces
of inclosed land about each house are occupied, for they scarce sow com
enough to feed their poultry. . . . The houses are f uU of lusty fellows, some
at the dye-vat, some at the looms, others dressing the cloths; the women or
childien carding or spinning, being all employed, from the youngest to the
oldest."
The domestic system should be distinguished from the mano-
ml economy of the agricultural period, for the production under
the domestic system was not for home consumption simply, but
for the market.
Agricttltcual Changes. — During the handicraft period there
were a]so important changes in the agricultural life of England.
The most prominent of these is the process of inclosing the com-
mon fields for the purpose of pasturage during the Tudor period.
Later, the farmers practiced what was known as ''convertible hus-
bandry"; that is, the pasture was plowed up every few years for
raising crops. This, again, has been superseded by the moderq
system of crop rotation.
The Mercantile System. — The decay of town authority did not
imply that industry and commerce were left to the free play of
competition. The supervision of the central government took
the place of that of the towns. The nadonal system of regula-
tion has been called the Mercantile System, which prevailed in
England in the sixteenth, seventeenth, and most of the eighteenth
centuries. Its essential idea is the guidance of economic affairs
in such a way as to increase the commercial and military power
of the nation as a whole. The navigation laws which the student
has met with in his study of American history were a part of this
system. An attempt was made to create a "favorable" balance
of trade and to maintain a good supply of the precious
metals. Agriculture was fostered with the aim of promoting the
growth of population. The mercantile system has often been de-
scribed as consisting chiefly of trade restrictions, but it is the con-
tention of Professor SchmoUer that in its essence the system meant
"the replacing of a local and territorial economic policy by that
38 OUTLINES OF ECONOMICS
of the national state." Within the nation it tended to make
trade free.
It was characterfctic of the mercantile system, too, to interfere
in the conduct of internal trade. Prices, wages, and the rules of
apprenticeship were fixed by public authority. ' The quality of
goods was inspected by public officials. Patents of monopoly on
the sale of certain commodities, such as gimpowder, matches, and
pla)dng cards, were extensively granted by royal authority to fa-
vored individuals or companies, ostensibly to foster new industries.
"At the Council of York, Charles was obliged to declare many of the
industrial patents void; but enough remained to call forth an indignant
declamation from Sir J. Colepepper in the Long Parliament: 'I have but
one Grievance more to offer unto you; but this one comprisetfa many; it
is a nest of wasps, or swarm of vermin, which have overciept the land,
I mean the monopoler and polers of the people. These like the frogs of
Egypt, have got possession of our dwellings, and we have scarce a room free
from them; they sip in our cup, they dip in our dish, they sit by our fire;
we find them in the dye-vat, wash-bowl, and powdery tub ; they share with
the butler in his box, they have marked us and sealed us from head to foot.
Mr. Speaker, they will not bate us a pin ; we may not buy our own cloaths
without their brokage. These are the leeches that have sucked the com-
monwealth so hard that it is almost become hectical. And some of these
are ashamed of their right names; they have a vizard to hide the brand
made by that good law in the last Parliament of King James; they shelter
themselves under the name of a corporation; they make bye-laws which
serve their turns to squeeze us and to fill their purses; unface these and they
will prove as bad curs as any in the pack. These are not petty chapmen, but
wholesale men.* " *
A full account of this stage in English history would deal with
(i) the regulation of labor, including the Statute of Artificers
passed in the reign of Elizabeth, which provided that all able-
bodied men might be compelled to serve as agricultural laborers,
and that all artificers, rural or urban, should undergo an appfen-
ticeship of at least seven years. In this same reign provision was
made for the assessment of wages by the Justices of the Peace.
Every year in each locality the justices were to assemble, and,
** calling to them such discreet and grave persons ... as they
> Cunningham, English Commerce and Industry^ Modern Times, Part I, pp^
S07-8-
THE EVOLUTION OF ECONOMIC SOCIETY 39
sbdl think meet, and conferring together respecting the plenty or
scarcity of the time," they were to fix the wages for every kind
of manual labor, skilled or unskilled, by the year, week, or day,
and with or without allowance of food. (2) The stage would deal
further with the development of systematic poor relief by civil
authority ; (3) the encouragement of shipping and of (4) the im-
migration of foreign artisans to introduce new industries; (5) the
regulation of the corn trade; (6) the establishing of plantations
in the colonies; (7) the regulation of the coinage; (8) the develop-
ment of banking, insiuance, and foreign commerce, and the decay
of the old notions regarding the sinfubess of mterest taking.
V. The Industrial Stage
In the latter part of the eighteenth century, the slow-gomg
methods of the handicraft stage were radically changed by the
Industrial Revolution. The fundamental feature of this change
is the introduction of power manufacture. The industrial revo-
lution and the chief features of the Industrial stage will be dis-
cussed in the following chapter.
Before proceeding to the consideration of the last stage, it may
be well to nodce some of the other views which have been expressed
concerning the periods of economic development. The German
economist, Hildebrand, has taken as his principle of classification
the method of exchanging goods, and from this standpoint he gets
the following three stages: (i) barter, (2) money, and (3) credit.
All three methods of exchanging, to be sure, are in use at the pres-
ent time, but the extensive use of credit is the new and character-
istic thing about present-day exchange. It has been objected that
the period before the use of money became prominent is charac-
terized not so much by the barter of goods as by the fact that
exchange itself is unimportant.
Another writer (Bucher) has divided economic history accord-
ing to the length of time which elapses betwreen the production
and the consumption of commodities, as follows: —
1. The mdependent domestic economy.
2. The town economy.
3. The national economy.
40
OUTLINES OF ECONOMICS
In the first stage the interval between the production and con-
sumption is small. Things are produced where they are consumed,
as in the village communities of the early middle ages. In the town
economy the interval is somewhat greater. The artisans in the
town produce for the consumption of other persons, for the most
part in the immediate neighborhood, so that the producer meets
the consumer without intermediaries. In the third stage, produc-
tion is for a national market, so that goods may pass through many
hands before reaching the consumer. Possibly, according to this
view, a fourth stage might be added, — that of a world economy.
Again, we might pay attention chiefly to the condition of labor.
Beginning with a condition where there is no distinct laboring
class, we pass through slavery and serfdom to free labor, regu-
lated at first by law and custom, and then the free laborer arranges
THE ECONOMIC STAGES
From the
Standpoint
OF Produc-
tion
From
BOcher's
Standpoint
From
Hildebrand's
Standpoint
From
THE T.AnOR
Standpoint
Illustrations
History
I.
Direct Ap-
propriation
Independent
Domestic
Economy
Barter
Economy
Laboring
class not dif-
ferentiated
Prehistoric
2.
Pastoral
Before Christ
3.
Agricultural
Slavery and
Serfdom
iith-i4th
Centuries
4.
Handicraft
Town
Economy
Money
Economy
Free Labor
governed
by Custom
I3th-i8th
Centuries
Industrial
National
Economy
Credit
Economy
Individual
Contract
Group
Contract
i8th Century
to the Pres-
ent Time
THE EVOLUTION OF ECONOMIC SOCIETY 4I
the conditions of work by individual contract, and finally to an
increasing extent by group contract or collective bargaining.
These various classifications are not contradictory; on the con-
trary, they supplement each other. Still other divisions are pos-
sible. In the preceding table these various points of view are
correlated and applied to the history of England.
QUEsnoirs aud bzxrcisbs
I. Write a description of the economic life of a tribe in one of the first two
sages.
3. What are the theories concerning the origin of cannibalism ?
3. What is the extent of slavery in Africa at the present time ?
4. Sketch the development of the woolen industry in England to 1760.
5. Give an account of the origin of the Bank of England.
6. Summarize the history of poor relief in England.
SEFSRElfCES
Andrews, C. M. The Old English Manor,
Ashley, W. J. English Economic History, Vol. I.
BucHCR, Karl. Industrial Evolution (trans, by S. M. Wickett).
Cheyney, E. p. Industrial and Social History of England, Chaps. I to VII.
Cunningham, W. Growth of English Industry and Commerce^ Vol. I
(Middle Ages) and Vol. II (Mercantile System).
Ely, R. T. Evolution of Industrial Society, Part I, Chap. III.
Lubbock, Sir John. Prehistoric Times, Chap. I.
Morgan, L. H. Ancient Society, Chap. I.
Puce, L. L. A Short History of English Commerce and Industry, Chaps. I
to VIII.
PtiCE, W. H. English Patents of Monopoly.
Ratzel, F. History of Mankind (trans, by A. J. Butler), 3 vols.
ScHMOLLER, G. The Mercantile System (Economic Classics, edited by W. J.
Ashley).
Seebohm, F. The English Village Community.
Staxley, H. M. In Darkest Africa, Vol. I, Chap. XXIH.
Wallace, J>. M. Russia (edition of 1905), Chap. VIIL
Warner, T. Landmarks in English Industrial History^ Chaps. I to XIV.
CHAPTER IV
THE EVOLUTION OF ECONOMIC S0CIET7 (Continued)
The Industrial Revolution. — The passage from the handicraft
to the industrial stage in England is generally known as the In-
dustrial Revolution. It has been objected that this term is mis-
leading because the introduction of the modem factory system
required many years and was but the working out of conditions
that had been long maturing. It is true that the growth in the
division of labor, the expansion of commerce, and the technical
progress of former ages were necessary preliminaries to the in-
dustrial revolution, but there is little danger of overemphasizing
the importance or the rapidity of the change. The period from
1770 to 1840, the span of a single life, is, after all, a short period
from the standpoint of the historian. Yet the changes of this
period swept away the inefficient methods that had been used for
centuries, and caused profound modifications in social structure.
To understand the nature of this movement, we must review the
condition of things before it began.
England in 1760. — England was at this time largely self-suffic-
ing in its economic life, producing for itself its food and other
articles of ordinary consumption, although compared with medi-
aeval days there had been a mariced expansion of international
and colonial trade. Woolen goods were the most important ex-
port. The imports consisted largely of wines, spirits, rice, sugar,
coffee, oil, and furs, and some wool, hemp, silk, and linen yam.
Within the nation, too, there was not such a degree of specializa-
tion of industry in particular localities as is found at the present
day, although the beginning of such localization had clearly been
made in the textile and iron industries. On the whole, however,
the commerce between the different sections of the country was
43
THE EVOLUTION OF ECONOMIC SOCIETY 43
slight. The means of transportation were exceedingly poor, not-
withstanding the growth of turnpike roads. The roads were de-
scribed by a traveler as "most execrably vile." Such was their
condition that pack horses were still a common means of getting
goods to market Rivers were important highways, canal build-
ing having barely begun.
The system of hand manufacture was still in general operation.
Although the workmen under the domestic system were no longer
owners of the material upon which they worked, yet the tools
they used were their property. The beginnings of certain fea-
tures of the factory system, however, are to be seen long before
the use of power machinery, for in some cases workmen were em*
ployed in large numbers in buildings owned by the employer, who
also furnished the mechanical equipment. But to a large extent
manufacturing was combined with agriculture, not only in the
textile trades, but in other branches also. "At West Bromwich, a
chief center of the metal trade, agriculture was still carried on
as a subsidiary pursuit by the metal workers."
The mediaeval system of conmion field tillage was extensively
used, a large part of the land being still uninclosed. The culti-
vation was exceedingly poor, but important experiments tending
toward a "new agriculture" were being made in the second quar-
ter of the eighteenth century by Jethro Tull and " Turnip " Town-
shend. Of the whole number of farms, approximately one half
"were owned and occupied by the various classes of freeholders
and copyholders; that is, by land-owning farmers."
The mediaeval notion of government was still nominally in force.
Detailed and special legislation was supposed to be the means of
securing a well-ordered trade, as explained in the preceding chap-
ter. But a tremendous revolt had begun against this whole sys-
tem of government. This revolt had its religious and political as
wdl as its economic aspect. The same year that Thomas Jeffer-
son wrote the Declaration of Independence, asserting that all
men are by nature equal, Adam Smith published the Wealth
of Nations, the most iniSuential book ever written on economics.
"Every individual/* said Smith, "is continually exerting himself to find
out the most advantageous employment for whatever capital he can command
44 OUTLINES OF ECONOMICS
It is his own advantage, indeed, and not that of the society, which he has in
view. But the study of his own advantage, naturally, or rather necessarily,
leads him to prefer that employment which is most advantageous to society.
. . . What is the species of domestic industry which his capital can employ,
and of which the produce is likely to be of the greatest value, every in-
dividual, it is evident, can, in his local situation, judge much better than any
statesman or lawgiver can for him." ^
The Mechanical Xnventioiis. — During the last half of the eight-
eenth century the progress of invention was exceptionally rapid.
Kay's flying shuttle (1738) had facilitated the weaving process to
such an extent that it became difficult to secure enough yam from
the spinners. Hand spinning was improved by Hargreave's
* * jenny " about 1 767 ; Arkwright, in 1 7 7 1 , made a practical success
of roller spinning (a method patented long before), using horse
power, and later, water power. Crompton combined these two
processes in 1779. After 1785 steam power was applied to cotton
spinning, and then it was the weaving process that was felt to be
too slow. Cartwright began his experiments in 1784, but the
power loom did not come into general use until early in the nine-
teenth century.
The improvement in the steam engine also made possible great
advances in the iron industry, of fundamental importance in an
age of machinery. The production of English iron was over sev-
enty-five times as great in 1840 as it had been in 1740.
The need for better transportation was met by improved roads,
by the building of canals (especially 1790 to 1805), ^ind by the
development of steam locomotion. The germ of the modern rail-
way is seen in the tramways used in the coal mines. Cast iron
rails were used as early as 1738. The first tramway to be used
for public purposes was chartered in 1801, the cars to be drawn
by horse power. Trevithick made a locomotive in 1803 that was
of practical use. In 181 4 Stephenson constructed a locomotive
that could draw a load of thirty tons at the rate of three miles an
hour. The Stockton and Darlington road was opened in 1825
with a Stephenson locomotive that made fifteen miles an hour,
but two years later the directors of the road considered the advisa-
bility of abandoning the use of locomotives. In 1829 the direc-
»A. Smith, Wealth of Nations, Book IV, Chap. 11.
THE EVOLUTION OF ECONOMIC SOCIETY 45
tors of the Liverpool and Manchester Raikoad arranged a prize
contest to determine the practicability of steam locomotion. The
success of Stephenson's "Rocket" in meeting the requirements of
the contest demonstrated that the new method of locomotion had
come to stay.
"A general survey of the growth of new industrial methods in the textile
and iron industries marks out three periods of abnormal activity in the evolu-
tion of modern industry. The first is 1 780-1 795, when the fruits of early
inventions were ripened by the effective application of steam to the machine
industries. The second is 1830 to 1845, when industry, reviving after the
European strife, utilized more widely the new inventions, and expanded under
the sdmulus of steam locomotion. The third is 1856-1866 (circa), when the
oonstruction of machinery by machinery became the settled rule of industry." ^
It is impossible here to review all the lines of progress in inven-
tion and discovery. This progress is not confined to mechanical
matters, and taken as a whole, undoubtedly has been much more
ra;pkl in the nineteenth than in any preceding century.
Mr. Alfred Russel Wallace says that " to get any adequate comparison with
the nineteenth century we must take, not any preceding century or group of
centuries, but rather the whole preceding epoch of human history." A
basis for his statement is given by the following comparative lists of great
inventions and discoveries. One hesitates to make such a comparison, but
rk possesses some interest : —
OF TH£ NINETEENTH CENTURY OF ALL PRECEDING AGES
I. Railways
I.
The Mariner's Compass
2. Steamships
2.
The Steam Engine
> Electric Telegraphs
3-
The Telescope
4. Tlie Telephone
4.
The Barometer and Thermometer
5- Lucifer Matches
5-
Printing
6. Gas Illumination
6.
Arabic Numerals
7. Electric Lighting
7.
Alphabetical Writing
8. Photography
8.
Modem Chemistry Founded
g. The Phonograph
9.
Electric Science Founded
10. Rdntgen Rays
10.
Gravitation Established
II. Spectrum Analysis
II.
Kepler's Laws
12. Anaesthetics
12.
The Differential Calculus
13. Antiseptic Surgery
13.
The Circulation of the Blood
14.
Light proved to have Finite
Velocity
^ Hobaon, Evolution of Modem Capitalism, new edition of 1907, p. 89.
46 OUTLINES OF ECONOMICS
OF THS NINETEENTH CENTURY OF ALL PRECEDING AGES
15. Molecular Theory of Gases 15. The Development of Geometry
16. Velocity of Light directly
measure^, and Earth's Ro-
tation experimentally shown
17. The Uses of Dust
18. Chemistry, Definite Propor-
tions
19. Meteors and the Meteoritic
Theory
20. The Glacial Epoch
21. The Antiquity of Man
22. Organic Evolution established
23. Cell Theory and Embryology
24. Germ^ Theory of Disease, and
the Function of the Leuco-
cytes.*
Agricultural Changes. — During the Industrial Revolution there
were also important changes in agriculture. Bakewell, in the sec-
ond half of the eighteenth century, improved the breeds of sheep
and cattle. The inclosing of the common fields proceeded with
great rapidity, not, as in the sixteenth century, for the purpose of
sheep raising, but to permit of more efficient tillage of the soil.
Between 1760 and 1850 over seven million acres were inclosed in
England. The small land-owning farmer w^as crowded out, partly
because more investment per acre was needed with the new agri-
culture, partly because "gentlemen farmers" (men who had made
money in other pursuits and took up agriculture because it was
fashionable) bought them out, and because the price of land was
greatly increased by the desire of wealthy men to build up family
estates. To-day practically all English farmers are tenants. The
small farmer, who under the domestic system was also frequently
a handicraftsman, was thus crushed between the new agriculture
and the new industry.
" Hitherto the rude implements required for the cultivation of the soil,
or the household utensils needed for the comfort of daily life, had been made
at home. The farmer, his sons, and his servants in the long winter evenings
carved the wooden spoons, the platters, and the becchen bowls, plaited wicker
» Wallace, The Wonderful Century, pp. 154-155.
THE EVOLUTION OF ECONOMIC SOCIETY 47
baskets, fitted handles to the tools, cut willow teeth for rakes and harrows
and hardened them in the fire, fashioned ox yokes and forks, twisted willows
into the traces of other harness gear. Traveling carpenters visited farm-
houses at rare intervals to perform those parts of work which needed their
professional skill. The women plaited the straw for the neck collars, stitched
and stuffed sheepskin bags for the cart saddle, wove the straw and hempen
sdnups and halteis, peeled the rushes for and made the candles. The
spinning wheel, the distaff, and the needle were never idle; coarse hand-made
doth and Unen supplied all wants; every farmhouse had its brass brewery
kettle. ... All the domestic industries by which cultivators of the soil
moeased their incomes, or escaped the necessity of ^selling their produce,
were now supplanted by manufactures." *
Effects of the Industrial RevolutioxL — As has already been mdi-
cated, the Industrial Revolution introduces one of the great stages
in the development of man's power over nature. But along with
the new opportunities came also new dangers and perplexing
problems.
(i) The Factory System. — The use of expensive machinery
and steam power made it impossible for men to carry on their
work in their own homes. The factory supplants the home as
the typical unit of production. Instead of working by themselves
or with a few assistants, men now to a much greater extent than
before must congregate in cities, and submit to a new discipline in
krge groups organized for purposes of production. This brought
with it a new division of society into classes. The machine and
the workshop, as well as the raw material and the product, are at
ao stage in the productive process owned by the men who do the
manual work. The masses become wage earners. Now, in some
industries not one in a hundred can by exceptional ability become
an independent employer, and the workman knows that he is a
workman for life. So we have now two industrial classes, laborers
and capitalists, with a great gulf between them which compara-
tively few men can cross, and with interests which often seem
irreconcilable. What the ultimate effects of the new system of
production will be cannot be stated, but it has been suggested
that these changes in external relations are affecting also men's
> Protliero, quoted by Cunningham, Growth of English Industry and Com-
mreet M^dsm T4m«St Part 11, p. 730.
48 OUTLINES OF ECONOMICS
habits of thought. Can we expect the institution of private prop-
erty to seem as natural arid sacred to those who have nothing to
do with the buying and selling of products as to those who engage
much in pecuniary transactions ? It has been suggested that the
feeling that we have a right to the product of our own labor is
merely a survival of the era of small-scale hand manufacture.
(2) The Expansion of Markets and Industrial Specialization. —
Along with the new methods of production there has been a change
from restricted local markets to national and even world markets.
Improved methods of transportation make it possible for different
branches of production to be localized in regions where there are
special facilities for raw material or power. This implies greater
economic interdependence and greater liability to trade fluctua-
tions and disturbances. One great advantage of the old slow-
going system of manufacture and trade was its regularity. As the
area of the market increases, manufacturers find it more difficult
to decide what and how much to produce. Trade fluctuations
have increased in severity with the growth of large-scale produc-
tion. This is due not merely to the changing and enlarging de-
mand which cannot be calculated, but also to the fact that manu-
facture itself is constantly being disturbed by improvements which
cannot be foreseen. It is possible that a still larger scale of manu-
facture hereafter will bring steadiness in industry, but whatever
the cause of these fluctuations, the effect upon the wage earner is
demoralizing. If he were wise enough to save his earnings dur-
ing good times, and so have something for hard times, he would
not suffer so much. But very few people who live in abundance
can do this; how much less those whose condition even in good
times IS one of meager comfort I
Evils of the Transitioxial Period. — The condition of the English
working classes in the latter part of the eighteenth and early nine-
teenth centuries was undoubtedly worse than in any other period
in the history of the country. It is difficult to say to what extent
this was due to the introduction of the factory system. In addi-
tion to the new methods of manufacture there were wars, peculiar
facts about land ownership, duties, and taxes. There is some
evidence that the condition of child workers under the domestic
THE EVOLUTION OF ECONOMIC SOCIETY 49
system was often worse than in the factories, their parents prov-
ing the hardest taskmasters.
"The evils and horrors of the industrial revolution are often vaguely
ascribed to the ' transition stage * brought about by the development of ma-
cfainery and the consequent ' upheaval/ But the more we look into the matter,
the more convinced we become that the factory system and machinery merely
took what they found, and that the lines on which the industrial revolution
actually worked itself out cannot be explained by the progress of material
civilization alone ; rather, the disregard of child-life, the greed of child-labour,
and the maladministration of the poor law had, during the eighteenth century, ,
and probably much farther back still, been preparing the human material
that was to be so mercilessly exploited." ^
But whatever the causes, the facts that have been revealed re-
garding the conditions in English mines and factories of this period
are amazing. The picture includes cruelty to apprenticed chil-
dren, excessive hours, and unhealthful conditions of work. The
erils were worst in the smaller factories, the owners of which were
hard pressed by relentless competition. Outside of the factories,
also, those who attempted to continue to work in their homes in
the old way suffered from irregular employment and low earn-
ings. The distress of the hand-loom weavers affords an illustra-
tion.
Competition and Laissez-faire. — We have seen that Adam
Smith advocated liberty. He asserted that every man, if allowed
to do as he pleased, would sooner or later do that for which he
was best fitted, and would consequently work where he could get
the most wages. Every man would buy what suited him best,
and, after some experiment, manufacturers would make what was
ailed for. If one line of work was more profitable than another,
more men would go into it and by their competition would bring
prices down. If men cheated their customers, the men would go
somewhere else, and cheating would not pay. Everywhere men
vould look out for their own interests and would make the bar-
gain that was most advantageous to themselves. This system of
balanced self-interests resulting from competition was the best
regulator possible, infinitely better, he claimed, than the old-time
laws, which only incumbered the development of industry. If
* Hutcfains and Harrison, A History of Factory Legislation^ p. 13.
X
50 OUTLINES OF ECONOMICS
the policy of industrial freedom were adopted, he prophesied a
great increase in the national production of wealth.
This view gained in favor during the Industrial Revolution. Not
that a wholesale repeal of the old laws occurred, — such things
never happen in England, and are difficult anywhere, — but there
is a quiet and effective way of changing laws by changing men's
ideas regarding them and leaving them unenforced. A law that
has been long observed has often to be long dead before people
gain the courage to repeal it. So the law requiring seven yeaxs'
apprenticeship before one could enter certain trades quietly died
during the eighteenth century, and when, finally, in the labor
troubles early in the nineteenth century, some workmen in desper-
ation discovered the old law and prosecuted employers for violat-
ing it, the law was first suspended and then repealed, as being
plainly ill adapted to the new condition of industry. So, little by
little, the old laws were repealed or forgotten, and men were left
free to bargain and manufacture as they pleased.
This policy of laissez-fairey or letting things drift, was very gen-
erally accepted by the economic writers who followed Adam Smith,
and was clearly reflected in the parliamentary debates. The uni-
versal free play of competition came to be the prevailing ideal in
this first phase of the industrial stage. It was in keeping with
this spirit that England became a free-trade nation in this period,
the last step being taken when the "com laws" were repealed in
1846, the act going into effect in 1849.
The Reaction against the Passive Policy. — It may be said that
by 1850 the abandonment of mercantilistic ideas was complete in
England, but long before this date a new system of legislation was
enacted for the purpose of controlling industry. The government
could not ignore the actual condition that resulted from competi-
tion and the introduction of machinery. We have now to con-
sider some of the main lines of development of industrial regula-
tion.
(i) The Quality of Goods. — In repealing the laws for the in-
spection of wares it was urged that cheating would not pay and
would cure itself. Indeed, it was said that the very inspection of
wares by the government was the cause of fraud; for, the govern-
THE EVOLUTION OF ECONOMIC SOCIETY 51
mcnt brand being often put on carelessly, men bought poor goods,
because of the brand, which they would have rejected if they had
examined them. The abolition of the laws would result in each ex-
amiiiing goods for himself, it was asserted. It is hardly necessary
to say that these hopes were not realized. Men might be trusted
to attend their own interests if they knew enough to do so, but
they do not Who can tell the quality of baking powder, or ground
spices, or patent medicines, or many other things that are misrep-
resented when offered for sale? For these the ordinary buyer's
knowledge is worthless; an expert must be employed. Such has
been the experience of the English people and also, more recently,
of the people of the United States, and the law now provides for
the inspection by government experts of many articles of food.
The theory that men will ruin their business prospects if they cheat,
and so will be deterred from cheating, has been utterly exploded
by this great English experiment. The reputation for honesty is
undoubtedly a source of strength to many business houses; but
many a man has perpetrated an audacious fraud upon a country
for a few years and retired with a fortune when his cheating began
to be known. The inspection of goods by the State is a principle
now fidly recognized, the only question being how far it should
be applied.
(2) Tke Protection of Labor. — As a result of a series of epi-
demics of infectious fevers, public attention was called to the con-
dition of the apprenticed children in cotton factories. In 1796 the
Manchester Board of Health reported upon the unhealthful con-
ditions under which the children worked, pointing out that "the
untimely labour of the night, and the protracted laboxu: of the
day, with respect to children, not only tends to diminish futiu-e
expectations as to the general sum of life and industry, by impair-
ing the strength and destroying the vital stamina of the rismg gen-
eration, but it too often gives encouragement to idleness, extrava-
gance and profligacy in the parents, who, contrary to the order
of nature, subsist by the oppression of their offspring." In 1802
the first factory act was passed to protect the health and morals of
pauper children in cotton factories. The apprentices were not to
work more than twelve hours by day, and after 1804 not at all by
52 OUTLINES OF ECONOMICS
night, but the law was not effectively administered. After much
agitation, m which Robert Owen took a prominent part, a second
step was taken in 1819. The act prohibited children under nine
years from working in cotton mills, and no person under sixteen
was to be employed more than twelve hours per day. As with the
act of 1802, the enforcement of the law was left to the justices of
the peace. In 1833 regulations as to conditions of work for chil-
dren and young persons were made for all textile factories, and
special inspectors were provided to enforce the law. In the fol-
lowing years the controversy concerning labor legislation was vio-
lent and bitter. After a report by a committee revealing shameful
conditions in the mines, an act was passed in 1842 prohibiting the
employment of women and children underground. In 1844 wo-
men were included in the protective factory legislation and the
half-time system for children was enacted. The Ten Hours' Act
of 1847 limited the working day to ten hours. Subsequently, pro-
tective legislation was made to cover industrial establishments gen-
erally. These various laws were consolidated in 1878, and again
in 1901. Laws now in force provide for (i) the fencing in of
dangerous machinery; (2) sanitation in factories; (3) a minimum
age and schooling for children at work; (4) limitation of the hours
of work for women and children. There is no direct regulation
of the hours of adult male workers, nor of the wages of any
class of workers.
Another important line of legislation that has been made neces-
sary by the extensive use of machinery deals with the liability o]
emfloyers in cases of accidents to their workmen. Under the
common law a workman was entitled to receive damages when
injured as a result of the negligence of his employers, but he was
supposed to assume the ordinary risks of the business. When
the injury was caused by the workman's own negligence or by
the negligence of a fellow-workman, the employer was not respon-
sible. The Employers' Liability Act of 1880 gave the workman a
right to compensation also in certain cases where the injury was
caused by the negligence of other employees, but in 1897, by the
Workmen's Compensation Act, a radical departure was made from
previous legislation. The employer is now liable to pay damages
THE EVOLUTION OF ECONOMIC SOCIETY 53
even when there has been no negligence on his own part, and even
when the accident has been due to the neglect of the injured work-
man himself, except only in cases of "serious and willful miscon-
duct." This principle now applies also to agriculture, shipping,
and mercantile and domestic employments, and certain trade dis-
eases have been made to count as accidents.
(3) Labor Organizations, — Modifications in the working of
free competition have also been effected by the voluntary organi-
zation of the worker, not only by their influence up)on legislation,
but also by direct dealings with employers. We have noticed the
gilds, which played a large part in the history of the middle ages.
These, however, were not like modem trades unions. They were
unions of men who worked, but not exclusively of wage earners,
nor in the interests of wage earners even chiefly. They were
formed of masters. But combinations of the wage-earning classes
are found long before the Industrial Revolution. They do not
become prominent, however, until the nineteenth centiuy. Laws
prohibiting the combination of laborers had been passed at inter-
vals since the middle ages, and in 1800 Parliament, finding that
onions were increasing, passed a most comprehensive law to sup-
press them, declaring illegal "all agreements between journeymen
and workmen for obtaining advances of wages, reductions of hours
of labor, or any other changes in the conditions of work." Under
tins law many workmen were prosecuted and severely punished,
but in vain. In 1824 Parliament confessed the law a mistake,
and repealed it along with previous laws relating to combinations
of workmen. Trades unions thus tolerated grew at an astonish-
ing rate, but they were still subject to legal persecution. Judicial
decisions, especially, were adverse to them, as the courts r^arded
them as agreements in restraint of trade. But in 1871 a law was
passed which declared that the piuposes and actions of trades
unions were not to be deemed unlawful as being in the restraint
of trade, and in 1875 ^^^ legality of trades unions was still further
recognized by the provision that acts which were not punishable
as crimes when done by one person should not be indictable as
conspiracy when done by two or more in fiu'therance of trade dis-
pute, and finally, in 1906, the courts were forbidden to entertain
54 OUTLINES OF ECONOMICS
actions for damages against trades unions. In this same year
peaceful picketing was legalized.
(4) The Extension of Government Enterprise. — The reaction
against a laissez-faire policy is further shown by a growth in the
sphere of industry directly managed by the government. We find
municipalities operating street railways and furnishing water, gas,
and electric light. Municipal enterprise includes also in various
places markets, docks, dwellings, baths, race courses, oyster fish-
eries, slaughterhouses, milk depots, employment bureaus, sewage
farms, theaters, and many other lines of activity. Again, the na-
tional government conducts the postal savings banks, the parcels
post, and the telegraph and telephone systems.
Summary, — In this chapter a brief sketch has been given of
England's attempt to deal with a new set of forces. An immense
increase in production has taken place, due in part to competition,
more to machinery. But the distribution of this wealth, growing
directiy out of the principles of competition so long as they were
unrestrictedly applied, was such that poverty grew rapidly, and
some said even faster than wealth, and the laboring population
of the realm sank into deeper distress and degradation. The par-
tial benevolence of employers, which would fain have mitigated
this disaster, was, as a rule, neither welcomed nor tolerated by the
competition which had made itself law. Not until this benevo-
lence was formulated, generalized, and enforced by disinterested
legislation was the horror of the situation diminished. When we
hear the principle of "a fair field and no favor" and "no State
intervention" advocated by a man strong in the consciousness of
personal advantages, we must remember that he is a century be-
hind his time, and that he has not read or has hot profited by one of
the most dolorous chapters in human history. The English nation,
after a trial of free competition and no interference, as thorough
as could well be made, has undeniably returned to the principle
of governmental activity which she had abandoned, — a principle
which recognizes as the function of the State the protection
of the citizens, and the furtherance of their material and social
well-being, by every law and every activity which offers a reasona-
ble guanintee of contributing to that end. It is to be noticed fur-
THE EVOLUTION OF ECONOMIC SOCIETY 55
thermore that, as a matter of fact, all this activity of the State con-
tributing to material and social well-being has also increased free-
dom as a positive, constructive force. It has promoted the growth
of mdividual powers and enlarged the scope of activity of the
average citizen. It has not tended to slavery, as Herbert Spencer
long ago maintained, but its tendency has been in the direction of
the sort of liberty that is really worth while; namely, liberty as a
power of development and of contributing (in the words of the
philosopher T. H. Green) to the "common good."
QUB8TI0V8 AHD XZBRCISB8
1. What Is the origin of the term " laisseg-finre " f
2. What laws are in force in your state regarding the inspection of food and
other articles offered for sale ?
3. Give a detailed account of the development of one of the great iaven-
tioos.
4. Give a sketch of the enactment and repeal of the "com laws."
5. Give an account of the development of monopolies and trusts in Eng*
ItDd.
REFSREHCBS
BiAKD, C. Th9 Industrial RevoliUian,
Cheyney, E. p. Industrial and Social History of England, Chaps. VIII
and IX.
Cunningham, W. GroToth of English Industry and Commerce, Modern
Times^ Part .11. Laisses-Faire.
HoBSON, J. A. Evolution of Modem Capitalism, Chaps. Ill and IV.
Howe, F. C. " Municipal Ownership in Great Britain," Bulletin of the
United States Bureau of Labor, January, 1906.
Htjtchins and Harrison, A. A History of Factory Legislation, Chap. II.
PwcE, L. L. Short History of English Commerce and Industry, Chaps. IX
andX.
Taylor, H. C. " The Decline of Land-owning Fanners in England," Bulletin
of the University of Wisconsin, Economics and Political Science Series^
No. 142.
ToTNBEE, A. The Industrial Revolution.
VcBLEN, T. B. The Theory of Business Enterprise, Chap. IV.
CHAPTER V
THE ECONOmC DEVELOPMElTr OF THE UimED STATES
The economic development of the United States has in some
respects been very unlike the economic development of England,
and yet very like it in other respects. Let us note in the first place
the points of difference, the factors and characteristics of our eco-
nomic history which are peculiarly American.
Economic Stages in American Industrial History. — The transit
of civilization from Europe to America, as an American historian ^
has finely phrased it, thrust the European laws, customs, and in-
dustrial technique of the seventeenth century into the primitive
environment of a wilderness, and for the moment the wilderness
dominated. Industry was forced to begin at the beginning and
retrace — as the child is said to retrace the mental development
of mankind — the industrial evolution of the race.
The American people have thus, during the comparatively brief
historical period which has elapsed since the setdement of this
country, run the whole gamut of industrial evolution, passing
through with striking rapidity all the stages differentiated in the
preceding chapters. There was slaughter of captives in the In-
dian wars, enslavement of Indians, particularly — but not only —
in the Spanish colonies, latet the introduction of negro slavery
and modified serfdom in the bond or indented servants, then
the individual wage contract, still supreme among agricultural
laborers, and finally, collective bargaining through the great
trades unions of the present generations. In a similar way,
practically all the stages differentiated in the table given on page
40 may be traced in the industrial evolution of the United
States.
* Edward Eggleston, Transit of Civilization^ New York, 1900.
56
ECONOMIC DEVELOPMENT OF THE UNITED STATES 57
Naturally it is not to be supposed that American industrial so-
ciety worked its own way unaided through all those economic
stages which the race, with "painful steps and slow," has labori-
ously traversed in its upward march. Stimulated by European
culture, we hurried through the earlier stages, for the most part,
retracing them merely as an incident of frontier conditions, and
skipping some — such as the pastoral stage — in many sections
of the country. On the other hand, it must not be inferred that
we have everywhere passed beyond the so-called primitive
stages. Barter is still the commonest mode of exchange in some
parts of the country, and there are comparatively few rural dis-
tricts in which credit transactions have in the main taken the
place of money transactions. It is interesting to observe that,
owing to the progressive Western movement of the population of
the country, the stages in the history of man's productive efforts
appeared in regtilar order from West to East. Thu§, a few years
^o, the country of the frontier was occupied by hunters and
trappers; next were great stretches of country almost entirely de-
voted to grazing; farther east, agriculture predominated; trade
and commerce were active, especially in the country east of the
Mississippi; manufacture on a large scale was prominent in the
North Atlantic and North Central groups of states; while finally
the large industrial combinations which mark the latest step in
development were confined (with respect to legal residence at
least) to the Atlantic seaboard.
Sectionalism. — This phenomenon of the contemporaneous ex-
istence of several industrial ^ges, side by side, under the same gov-
ernment, has laid upon this country some of the hardest problems
which it has had to solve. The ever present but ever reced-
ing frontier has continually created a set of interests antagonis-
tic to those of the settled industrial and commercial communities.
Sbays's Rebellion in 1786 was in part a protest of the more
thinly settled debtor communities against the determination of
the commercial centers to introduce the sound currency which a
developed commerce requires. The federal Constitution was
adopted and the present government created in order, largely,
to strengthen national credit, insure taxation, remove trade
58 OUTLINES OF ECONOMICS
barriers, and provide a sound currency; and the opposition to the
ratification of the Constitution came largely from those agricul-
tural and thinly settled communities that wanted to keep paper
money, evade debt payment, and resist the collection of taxes.
During the earlier history of the coimtry wildcat banking and in-
flated currency regularly followed in the wake of the frontier.
Tariff legislation, with its different appeal to the agricultural
and industrial sections of the country, has been another prolific
source of territorial conflict. After the War of 1813, the manu-
facturing centers of the North redoubled their efforts for protec-
tion. This was strenuously resisted by the South, where manu-
factures had p'ractically gained no hold, and the struggle of the
sections over the tariff led to Nullification in South Carolina and
the acceptance by the South of the doctrine of secession. The
Civil War itself was largely a sectional quarrel growing out of
ceaseless fricdon between a section which had reached the indus-
trial stage and a condition of free-wage contract with a section
which had been held in the agricultural stage by the retention of
slavery. As a late illustration of sectional conflict arising from
the natural clash of districts in different stages of economic devel-
opment, we have the free-silver campaign of 1896, when the min-
ing, agricultural, and debtor communities of the West and South
arrayed themselves against the industrial and creditor communi-
ties of the East and North. The typical political struggles of the
past have been territorial and sectional; now that the frontier
has disappeared, the typical political struggles of the future will
take the form, possibly, of class against class.
Characteristics of the American People. — Although the frontier
has dkappeared, the pioneer work of "winning a continent from
nature and subduing it to the uses of man" has left an indelible
impress upon the American character. In the beginning the dan-
gers and hardships of the frontier acted as a powerful selective
force in determining the character of our earlier immigrants, giv-
ing us an unusually restless, mobile, and enterprising people. The
process of settlement which followed merely emphasized these
qualities and added others of a kindred nature. The primitive
settler, following the trapper and the trader into the wilderness,
ECONOMIC DEVELOPMENT OF THE UNITED STATES 59
was forced to depend upon himself for protection and subsistence;
he expected little aid from the government, was unused to the
restraints of law, and a litde contemptuous of its possibilities, either
for good or for eviL The process of setdement, then, merely con-
firmed the American in that excessive individualism which has
made him independent and resourceful, to be sure, but partial to
the spoils system, tolerant of lynch law and labor violence, indif-
ferent to waste and weakness in the administration of his govern-
ment
At the same time the great natural wealth of oiu: land and the
ease with which it could be secured from the government have
taught our people, particularly in the West, to regard nature rather
than thrift as the source of wealth, to exploit rather than create,
to work and study as we farm — extensively. As a people, we are
optimistic but careless, generous but wasteful, buoyant but boast-
ful. Industrially, we have risen to our exceptional opportunities
with spirit, playing the commercial game at times with excessive
energy and devotion; but we have come to emphasize quandty
rather than quality, product rather than £mish. We 'Mead the
world" in the use of labor-saving machinery, but depend largely
upon Europe for our skilled artisans.
Growth of Population. — The mere growth of the American peo-
ple has been as striking as it is familiar. In 1640 there were about
25,000 persons, excluding Indians, in Bridsh North America;
about 260,000 at the end of the seventeenth century according to
Bancroft; according to the same authority the million mark was
reached in 1743; and in 1790 the first federal census showed a
population of 3,929,214 in the United States alone. In the next
hundred years the population doubled every twenty-five years on
an average, and although the rate of increase has fallen off some-
what since the Civil War, we are still growing at a marvelous pace,
the population of continental United States being estimated at
82,574,195 in 1905.
Despite this enormous increase, there has been at no time any
evidence that the population of this country was multiplying more
rapidly than the means of subsistence. Wages and incomes in
general have risen, not without interruption, but with compara-
6o OUTLINES OF ECONOMICS
tive steadiness, over long periods; and the dismal predictions oi
overpopulation which were so common in the first half of the nine-
teenth century have been signally discredited as practical propo-
sitions applicable to the American people of this epoch. The
exploitation of national wealth, the perfection of business organi-
zation, and the invention of labor-saving machinery have more
than kept pace with the population; and it has been discovered
that over long periods prosperity and high wages tend to depress
rather than to raise the birth rate, even of the wage-earning popu-
lation. We are in no danger of a "devastating torrent of chil-
dren."
On the contrary, the real problem of the twentieth century, or
at least the problem that has evoked the greatest discussion, is
found in the steady decline of the birth rate. According to some
of the most eminent authorities, the race is dying at the top, the
ablest and most successful people have the smallest families; and
this constant sterilization of the ablest stock of the race is, in the
opinion of such authorities, second in importance to no problem
which Western civilization is called upon to solve. It is not that
we want more people. Population is still increasing with suffi-
cient rapidity. The problem lies in the apparent failure of the
most efficient individuals to multiply as rapidly as certain classes
of the less efficient. Other authorities, it should be added, main-
tain that this "race suicide" has been going on for centuries, that
it has not in the past, and will not in the future, lower the vitality
or general efficiency of the race. Such writers view with compla-
cency the ceaseless sterilization of the upper classes, maintaining
that the process stimulates the ambition of the abler members of
the lower classes by creating room at the top, and that so long as
the habits and ideals of the upper classes remain wholesome, there
is no cause for regret that the individuals who compose these
classes are not self-perpetuating. Social heredity, not personal
heredity, the preservation of sound morals, wholesome customs,
and habits of social helpfulness, together with the opening up of
new opportunities, are the important factors.
Second only in importance to "race suicide," and intimately
connected with it, is the problem created by the rush to the city.
ECONOMIC DEVELOPMENT OF THE UNITED STATES 6l
In 1790 about 33 Americans in every thousand lived in a city of
8cxx> inhabitants or more, in 1900 more than 33 in every hundred
lived in a city of this size. The mere facts in this connection are
familiar to every one and need no elaboration. Their importance
Kes b the fact that the rush to the city is apparently universal,
that it has been going on for centuries, and that it indefinitely com-
plicates and aggravates the social, industrial, and political prob-
lems of our time. "Race suicide," for example, is more attribu-
table to social conditions created by city life than to any physical
incapacity of the women of this generation to bear children; the
evils conunonly charged to the factory system are due as much
to city crowding as to the factory system itself; and, speaking gen-
erally, whatever plan of reform for existing evils we devise or
champion, we must reckon with this deep-rooted and persistent
force which draws to the city so much of the best talent and abil-
ity which the rural districts produce.
Slavexy and the Negro Problem. — From the earliest period of
settlement, one of our fundamental industrial problems has been
to get enough labor to exploit the great national wealth of the
country. The first solution attempted was by importing bonds-
men or indentured servants. "Nearly all the immigrants that
came (to Virginia) between 1620 and 1650 were bondsmen," and
m 1680 an English official estimated that about 10,000 persons
were kidnaped or "spirited away" to America every year. This
class of indentured servants consisted of runaway apprentices,
penniless debtors, kidnaped children, honest laborers, vagrants,
and criminals of all kinds. They were sometimes subject to the
most inhuman treatment, but, because they had white skins, soon
melted into the free population and never created a race problem.
The first negro slave landed in Virginia in 161 9. For about
thirty years they did not increase very rapidly, but after that, and
until the close of the eighteenth century, they multiplied with
greater rapidity than the white population. In 1790 there were
750,208 negroes or persons of negro descent in this country, con-
stituting 19.3 percent of the population. Since 1790 the negro
population has steadily declined in relative importance, and in
1900, numbering 8,840,789 in all, it constituted only 11. 6 per cent
6a OUTLINES OF ECONOMICS
of the general population. The relative decline of the n^ro popu-
lation is probably not due to white immigration, since the natural
growth of the white population is markedly greater than that of
the negroes in the South, where white immigration has been im-
important.
The negro problem to-day, in so far as it is an economic as dis>
tinguished from a political or social problem, arises from the tend-
ency of the negroes to concentrate in the cities and in a narrow
district of the cotton-growing states known as the black belt;
from their shiftlessness, their ignorance, their dependence upon
credit advances in the farming districts, and their alarming con-
centration in a few occupations, some of which — particiUarly as
they practice them — are neither educational, uplifting, nor devel-
opmental. In 1900, for instance, 63 per cent of the male and 90
per cent of the female negro breadwinners were employed in un-
skilled trades, and the proportion confined to the unskilled
trades shows no signs of diminishing. This condition of affairs is
due in some degree to the economic inertia and shiftlessness of
the negroes themselves, but it is also due in part to the race preju-
dice of their white brethren, which, unfortunately, shows no abate-
ment with the passage of time. The trades unions, for instance,
evince a growing disinclination to receive negroes as members on
the same status as white workingmen. Vigorous efforts are now
being made in the South to provide industrial training of a sys-
tematic kind for the negroes, and in the future the rather men-
acing movement of the present day may be checked or wholly
reversed.
Immigration. — Next in importance to the negro question is
the problem of immigration. We have always had an immigra-
tion problem. "Governor Thomas Dongan, in 1685, made a re-
port to the King of England full of dreadful forebodings as to the
future of the 'Royal Province' of New England unless the tend-
ency to overcrowding were promptly checked. . . . George Wash-
ington and Thomas Jefferson are both recorded as opponents of
an unrestricted policy of immigration, and it may be safely asserted
that no considerable period has elapsed since their day without
producing eloquent and forceful advocates of a rigid restrictive
ECONOMIC DEVELOPMENT OF THE UNITED STATES 63
immigration poliqr." * Owing, however, to the extraordinary in-
aease of immigrants in recent years — the number rose from
223,299 in 1898 to 1,385,349 in 1907 — unusual interest in the
subject has been aroused, the restrictive features of oiur law have
been repeatedly strengthened, and a commission has been ap-
pointed by Congress to investigate the subject.
Most of the alarm which has recently been expressed, however,
is due to the change in character, rather than the increase in vol-
ume, of our immigration. Instructive statistics bearing upon this
point are given in Table I on the following page. From this
table it appears that until nearly the last decade of the nineteenth
century, most of the immigrants came from the United Kingdom,
Germany, and northwestern Europe, while since that time the
arrivals have been largely from southern Europe; and it is charged
that the new immigrants are more illiterate, more given to crime,
of poorer physique, and possessed of less property than the earlier
immigrants. "These people," it has been said, "have no history
behind them which is of a natiu-e to give encouragement. They
have none of the inherited instincts and tendencies which made
it comparatively easy to deal with the immigration of the earlier
time. They are beaten men from beaten races, representing the
worst failures in the struggle for existence. Centuries are against
them, as centiuies were on the side of those who formerly came
to us." *
There can be no doubt about the real gravity of the problem.
In times past charitable associations, and even certain foreign gov-
ernments, "assisted" the poorest and neediest of theu: citizens to
migrate to this country; famine and revolution in Europe spurred
the impecunious and the radical. to take refuge among us; regu-
larly, also, the tide of immigration has ebbed and risen in do^
correspondence with the business prosperity of this country, arti-
ficially swelling our laboring population in times of industrial ac-
tivity, encouraging our industrial managers in their spasmodic,
jerky methods of production, and thus augmenting the severity of
* Commissioner of Immigration, Robert Watchom, in The OiUloek, Vol. 87,
p. 900.
' WaUcer, Discussions in Economics and SUUisiics, "Restriction of Imm^im-
tion," p. 447.
64
OUTLINES OF ECONOMICS
our alternating periods of industrial depression. Moreover, in
certain industries the immigrant with his relatively low standard of
living has driven out the native workman; and most of the immi-
grants have shown an unfortunate tendency to linger in the cities
of the eastern seaboard, swarming in the slums and intensifying
all those social evils which have their origin in urban congestion.
In the light of history, on the other hand, the immigration prob-
lem is far less alarming than it is in the dry light of recent statistics.
In the first place, the statistics themselves, as ordinarily published,
TABLE I
Total Number of Immigrants (in Thousands) and Proportion coming
FROM Designated Countries by Specified Periods : 1821-1906.'
1821
1850
185 1
i860
1861
1870
1871
1880
1881
1890
1891
1900
190 1
1906
Total Number, 000
omitted
2456
2598
^3^5
2812
5247
3844
4934
Per cent
Oermanv
24.2
I .0
42.3
0.7
36.6
16.3
35-2
0.9
34.0
26.2
18.8
54
25.6
19.S
15.5
8.6
27.7
15.4
".5
12.5
14.1
8.9
10.S
9.9
4.3
5.4
4.4
7.0
Great Britain
Ireland
Norway, Sweden, and
Denmark
Total
Austria Hungary
Italy
82.2
0.2
o.i
89.0
0.3
o.i
84.4
0.4
o-S
0.2
69.2
2.6
2.0
1.8
68.1
6.7
5-9
43-4
I5-S
17.1
15.4
21. 1
24.5
25.0
17.7
Russia and Poland. . . .
Total
All other Countries. . .
Grand Total
0.3
17.S
100.
0.4.
10.6
100.
I.I
14.5
100.
6.4
24.4
100.
17.6
14.3
100.
48.0
8.6
100.
67.2
11.7
100.
< Data from Adams and Sumner : Labor Problems, p. 73, and the Statistical Abstract^
1906, p. 56. These figtires are not exact and not altogether comparable, owing to changes in
the immigration year, the distinction of nationalities, and the immigration laws. For the ef-
fect of these changes, see Boeckh : The Determination of Racial Stock anumg American Irn^
migrants. Publications of the American Statistical Association, December, 1906 ; and Willcox,
National Civic PtderoHon Review, November, December, 1906, p. 7.
ECONOMIC DEVELOPMENT OF THE UNITED STATES 65
are misleading, because they take no account of the large number
of immigrants who return to Europe. In the second place, the
importance of the number of immigrants depends largely upon
its relation to the population of the country; and relative to the
population immigration seems to be declining rather than increas-
ing. For instance, immigration reckoned in proportion to the
population was heavier in the period 1850-1855 than in the period
1 900-1 905. In the next place, the attraction of the city for the
immigrant has been exaggerated. While a great majority of the
immigrants are forced to locate temporarily in our large seaboard
cities, the later and more trustworthy studies indicate that the
immigrants are less rather than more disposed to remain perma-
nently in the cities than our native population, and that the new
immigrants show no greater tendency to stagnate in the cities than
the earlier immigrants. Finally, it is to be noted that our immi-
gration laws regarding the exclusion of diseased, criminal, im-
moral, feeble-minded, and indigent persons are constantly becoming
stricter and their administration more efficient. In addition to
the plainly undesirable classes just noted, Chinese laborers have
been excluded since 1882, aliens under contract to take up par-
ticular work since 1885, and anarchists since 1903.
Surveying the whole history of immigration, three general con-
clusions may be drawn which must be fully considered by those
engaged in the solution of the present problem.
(i) We have, as a people, shown a marvelous ability to assimi-
late rapidly people of diverse races, tongues, and religions, amal-
gamate them and stamp them with the characteristic qualities of
the American. Even at the close of the eighteenth century, about
one fifth of the population spoke some other language than Eng-
lish as their mother tongue, and probably one half of the popula-
tion were of other than Anglo-Saxon blood. The heterogeneous
character of the population is illustrated by the fact that nine of
the men most prominent in the early history of New York repre-
sented as many different nationalities. (2) We have failed, how-
ever, to amalgamate the negro and the Chinese; the incidental
feature of a dark skin creates especially difficult problems; and
it is this fact which makes the suggested exclusion of Japanese
66 OUTLINES OF ECONOMICS
laborers worthy of serious consideration. The high qualities of
the Japanese, their industry, intelligence, and native refinement
make them in many respects the most desirable kind of immi-
grants; but it is conceivable that they might come to this country
in sufficient numbers to create a problem similar in character and
gravity to the negro problem; and if investigation show that there
is real probability of such a result, they should be excluded, even
though the danger be attributable to race prejudice of the natives
rather than the clannishness and ezclusiveness of the Japanese
themselves. (3) In the main, however, the traditional policy of
this country has been " to improve rather than to check immigra-
tion,'' and the burden of proof is upon those persons who woidd
restrict immigration by arbitrarily limiting the number of immi-
grants.
Nattmd Resources. — Next to the character of the people with
which this continent has been stocked, the most powerful factor
in shaping the economic development of the United States has
been its enormous natural wealth. With a territory (excluding
Alaska and our insular possessions) more than three fourths as
large as all Europe, indented, particularly on the eastern coast>
with a large number of good harbors, intersected by internal water-
ways that make communication cheap and easy, endowed with
water power that in the opinion of one authority is probably "more
valuable than those of all other lands put together," marked by
every variety of climate and soil, covered in many places, at least
originally, with magnificent forests, and liberally stocked with
almost every variety of mineral wealth, it is not surprising that at
the present time the United States "leads the worid'* in the pro-
duction of iron and steel, cotton, coal, coffee, gold, silver, dairy
products, com, wheat, lead, lumber, tobacco, petroleum, and hogs.
It would be strange, indeed, with the vast mineral and agricultural
resources at our command, if we did not "lead the world" in
many things.
Of the 2,972,584 square miles of territory in continental United
States, about three fourths at one time or another has belonged to
the central government. The possession of this vast common treas-
ure by the United States has played an important part in digni-
ECONOMIC DEVELOPMENT OF THE UNITED STATES 67
fyiDg smd strengthening the federal government. But the lavish
alienation of the public lands in endowing free schools, subsidij^
ing railways, and other internal-improvement companies, and in
providing free homes for the landless, has been an even more po-
tent factor in hastening our economic development; even though
it has led, as has been said with some justification, " to the ravish-
ment rather than the development of our natural resources." The
public domain and its disposition are discussed at some length
in a later chapter, but one aspect of this subject — the part which
tree land has played in our economic development — is so vitally
important that it requires special notice at this point.
While it was not until the passage of the Homestead Act in
1863 that land could be legally acquired without cost by simple
occupation and cultivation, it is practically true to say that since
the seventeenth century any enterprising citizen, by the exercise
of a minimum amount of industry and frugality, could secure a
homestead large enough to support himself and family. This op-
portunity offered to the artisan a free choice between wage ser-
vice and farming, constantly depleted the ranks of mere laborers,
operated to keep wages at least as high as the earnings of a " no-
rent" homestead, and kept fresh and vigorous that sturdy feeling
of mdependence that has been the distinguishing mark of the
American workingman. By 1904, for instance, the national gov-
ernment had given away, imder the Homestead and Timber Cul-
ture Acts, 106,340,464 acres of land; and in addition to this,
278,001,612 acres had been sold at less than cost, that is, at less
than the cost of acquisition, management, survey, patenting, and
the Hke.
How long the public lands will hold out it is impossible to say.
Notwithstanding the fact that the national government is dispos-
ing of its lands at the rate of from fifteen to twenty million acres
a year, there is still left — if we count Alaska — almost as much
territory as we have alienated since the adoption of the Constitu-
tion. Much of this is worthless or unavailable; but irrigation and
dry farming are constantly reclaiming large districts formerly re-
garded as worthless, and the railways and some of the Western
states still possess large quantities of ordinary farming land which,
68 OUTLINES OF ECONOMICS
fortunately, they are willing to sell at low prices. All in all
we are tempted to say, there is still enough cheap land to exert in
the West that influence upon industry, wages, and the distribution
of wealth generally which has come to be the distinguishing
mark of the American social economy. But this is a matter of
dispute.
Fifteen sixteenths of the population reside in the eastern
half of the United States, and in the East land has become costly,
trade and manufactures taken together have outstripped agricul-
ture, and a large majority of the people lack the inclination and
necessary training, even if they possessed the courage and energy
to avail themselves of the cheap land of the West. Whatever
the amount of this cheap land, its importance has diminished and
must continue to diminish, as an outlet for the population upon
whose economic condition it formerly exerted so salutary an influ-
ence. Considering the population as a whole, the conclusion seems
irresistible that we have reached, if indeed we have not already
passed, the parting of the ways; and the assistance that in the
past free land rendered in maintaining wages and restraining the
evil tendencies of the modem system of capitalistic production
must in the future be secured from other sources. The distinc-
tive Americanism of the past was generated, as has been said, in the
performance of our national task "of winning a continent from
nature and subduing it to the uses of man" ;* it was a product
of the frontier. But the frontier has now disappeared.
QUBSTIONS
1. What peculiar characteristics mark the economic stages of the United
States?
2. Is the pastoral stage through which the people of our Great Plains have
passed essentially different from the pastoral stage through which the people
of Israel passed ?
3. Enumerate the great sectional struggles which have disturbed the
United States. Why does radicalism accompany the frontier?
4. Has the frontier and the work of settlement left a permanent impress
upon the American people? Of what kind?
5. How rapidly is the population increasing at the present time ? Are the
richer or poorer classes multiplying more rapidly ? Can you state the reason ?
^ Bogart, Economic History of the United States, p. z.
ECONOMIC DEVELOPMENT OF THE UNITED STATES 69
6. What are the distinctively economic factors of the negro problem?
7. When did the immigration problem first alarm residents of this
country? What chaiges are directed against the " newer immigrants " ?
8. Have we shown an ability to assimilate all kinds of immigrants?
What has been the historical policy of this country toward immigration ?
9. What part did the public domain play in bringing about and preserv-
ing the Union ? in maintaining wages ?
10. How does the growing size of the country modify the influence
exerted by free land ?
REFERENCES
BoGAST, E. L. Economic History of the United States, Contains bibli-
ography.
Bruce, P. A. Economic History of Virginia,
CoMAN, Katherine. The Industrial History of the United States, Con-
tains bibliography.
Commons, J. R. Races and Immigrants in America,
Ely, R. T. Studies in the Evolution of Industrial Society.
Emery, H. C. "Economic Development of the United States," in The
Cambridge Modem History, Vol. 7, Chap. XXII.
LiBBY, O. G. " The Geographical Distribution of the Vote of the Thirteen
States on the Federal Constitution," 1787-1788, Bulletin of the Uni-
versity of Wisconsin, Economics, Political Science, and History Series,
Vol. I, No. I.
McMaster, J. B. A History of the People of the United States.
McVey, F. L. Modern Industrialism, Part I, Chap. III.
Semple, Ellen C. American History and its Geographical Conditions.
Sealer, N. S., Ed. The United States of America.
Turner, F. J. " The Significance of the Frontier in American History."
Fifth Yearbook of the National Herbart Society. First edition in
Report of the American Historical Association, 1893, PP- 197-227.
Weeden, W. B. Economic and Social History of New England,
CHAPTER VI
THE ECONOinC DEVELOFMEin? OF THE UITHED STATES
(Continued)
In the preceding chapter attention was confined to certain fun-
damental and peculiarly American conditions which have influ-
enced the economic development of this country. They form the
background and setting of the picture. When we come to fill in
the details, however, the general effect is very similar to that pro-
duced by the description of English industrial development given
in Chapter IV. There are differences, of course, — differences
important enough to make this separate discussion of American
economic evolution necessary. But, on the whole, it is surpris-
ing how rapidly we have developed the industrial maladies and
economic problems of the old world.
Mercantilism in America. — In the American colonies, as in
England itself, the Industrial Revolution was preceded by a period
in which trade and industry were subject to minute regulation by
the government. Bounties were freely offered in several colonies
for the manufacture of leather, iron, paper, silk, and cloth; land
grants were made and taxes remitted particularly in the support
of the iron industry; and in order to encourage the home manu-
facture of shoes, for instance, the General Court of Massachusetts
ip 1640 commanded that every hide **be sent to a tannery under
penalty oi a. £12 fine," while "leather searchers" were appointed
to see that the law was obeyed.
This early colonial regulation was restrictive as well as protec-
tive. In the New England colonies, in the seventeenth century,
laws were repeatedly passed prohibiting idleness, fixing the hours
of labor, and prescribing rates of wages, with appropriate penal-
ties for workmen who took or employers who paid more than the
70
ECONOMIC DEVELOPMENT OF THE UNITED STATES 71
legal rate. In the Boston Town Records of 1635, (pr instance,
we find this resolution: '* That Mr. William Hutchinson, Mr. Wil-
liam Colborne and Mr. William Brenton shall sett pryces upon all
cattel, comodities, victuals and labourers and Workmen's Wages
and that noe other prises or rates shalbe given or taken." ^ But
the restrictive laws, in general, failed dismally. The abundance
of cheap land and the independent spirit generated by the pioneer
life prevented the enforcement of obnoxious colonial laws, and
eventually led the colonists into armed resistance against the re-
strictive legislation of the English government.
English Colonial Policy and the Navigation Acts. — In accord-
ance with mercantilist views of colonial relationships, English
statesmen of this period looked upon a colony as a community
which was to supply raw materials for the industries of the mother
country, secure its manufactured goods from the mother country,
and so far as trade with the rest of the world was concerned, buy
and sell through the mother country. In accordance with this
general policy, England gave bounties for the production in
America of raw materials such as flax, indigo, naval stores, barrel
staves, and the like, but restricted manufacturing proper — by
prohibiting, for instance, the erection of mills for slitting or rolling
iron, and furnaces for making steel — and fettered our commerce
KD a variety of ways. It is unnecessary to enter into the details of
this conflict, which is familiar to every student of American his-
toiy. The English laws were not so severe as might be inferred
from our brief statement of their nature and purpose; they were
laxly enforced; and it is to be remembered that England encour-
aged some industries while she attempted to destroy others. Eng-
lish colonial policy of this period was not so much malicious as
mistaken. The important points for us are these: that it did
not seriously hamper the development of American industry in gen-
eral, while it did strengthen and stimulate in the American peo-
ple that spirit of individualism which the industrial opportunities
of the new world and the frontier conditions of the time combined
to create. As a consequence the new nation, created in 1789, was
WitUhrof^s Journal, printed at Hartford, 1790, p. 188; reprint
fl« 1853, K>. 377-381.
72 OUTLINES OF ECONOMICS
pledged to the doctrine of individual liberty, and its constitution
contained specific guarantees of personal freedom not only in
matters political, but in industrial and social relationships as weU.
American Industries in 1776. — When the Revolutionary War
broke out, American industry was still in a primitive stage. The
extractive industries were, relatively, the most advanced. Large
quantities of lumber and timber products were exported to Eu-
rope; the fisheries were in a prosperous condition; and shipbuild-
ing had reached a really remarkable stage of development, — in
1775 "nearly one third of the tonnage afloat under the British
flag had been built in American dockyards." Agriculture, how-
ever, was carried on in the most wasteful and imsdentific way,
owing to the cheapness and fertility of the soil; and manufacturing
was still in the household stage. In the Middle and New England
Colonies spinning and weaving, the manufacture of shoes and food
products, were carried on within the home; and, in fact, the typi-
cal farm household of this period constituted almost an independ-
ent economic unit, raising or making what its occupants consumed,
and buying little save salt and a few necessary iron implements.
Of manufacturing for sale and export, however, there was little
worth mention. The absence of adequate means of transport was
largely responsible for this state of affairs. The roads were little
more than widened Indian trails. Some years later, when con-
ditions were considerably improved, the roads were still so poor
that " Madison spent a week going from New York to Boston by
stage, while the cost of cartage of a cord of wood for a 'distance
of twelve miles was three dollars." Agriculture, however, was the
dominant industry of the country. In 1787 less than one eighth
of the working population was engaged in manufactures, fishing,
navigation, and trade combined.
The Industrial Revolution in America. — The Industrial Revo-
lution was sudden, and in its consequences momentous in America
as well as in England. The Revolutionary War, by interrupting
trade with Europe, threw the American people upon their own
resources : goods that had hitherto been imported had now to be
manufactured at home; a large number of new industries sprang
up rapidly; and the idea became prevalent that the new nation
ECONOMIC DEVELOPMENT OF THE UNITED STATES 73
must make itself industrially as well as politically independent of
the old world. The state governments endeavored to foster the
new industries by protective tariffs, and this policy was later con-
tinued, in a moderate form, by the federal tariff act of July 4,
1789. Prizes were offered by various societies, and even by cer-
tain state governments, for the introduction of the new machines
and methods which were revolutionizing industry in England.
Attracted by one of these offers, Samuel Slater, "the father of
American manufactiu-es," who had been apprenticed to a manu-
facturer of cotton machinery, and was particularly familiar with
Arkwright's machines and processes, came to this country in 1789,
and in the following year started the first cotton JacUny at Paw-
tucket, Rhode Island.
The factory system secured its first real foothold, however, be-
tween 1806 and 1815, when the Non-Intercourse Acts, the Em-
bargo, and the War of 181 2, by suppressing trade with Europe,
forced the American people to do their own manufacturing, and
turned large amounts of capital, which had previously been em-
ployed in trade and shipping, into manufactures. The growth
during this period of isolation was extraordinary. In 1804 only
four cotton mills were in operation. "In 1807 there were fifteen
cotton mills running 8000 spindles and producing 300,000 pounds
of cotton yam annually. In i8ii there were eighty-seven mills
operating 80,000 spindles, producing 2,880,000 pounds of yam
per year and employing 4000 men, women, and children. In 1815
Soojooo spmdles gave employment to 76,000 persons, with a pay-
roll of $15,000,000 per year." * It is hardly necessary to add that
when resumption of peace with Great Britain opened the new
American industries to the fierce competition of the older English
manufacturers, increased protection was granted in the tariff acts
of 181 6, 1824, and 1828. A little later, in the Middle Adantic and
New England states, the period of factory production had fully
arrived. A separate class of wage eamers was appearing, who
were especially appealed to by new arguments concerning wages
in the tariff discussions; workingmen's parties were organized;
strikes and trades unions multiplied, and the latter were combined
* Coman, Industrial History of the United States^ p. i8i.
74 OUTLINES OF ECONOMICS
into municipal and state federations; in the thirties and forties
radical reformers linked the "white slaves" of the North with the
negro slaves of the South and worked for the abolition of both
"wage and chattel slavery"; the factory town and the dty slum
became recognized economic conditions, and the dangers of the
latter were multiplied by the heavy immigration after 1845. By
the middle of the nineteenth century the Industrial Revolution
was in full sway, and the economic triumph of modem capitalism
was assured.
As might be supposed, the Industrial Revolution produced fax
less suffering and want in the United States than in England.
The evils attributable to the Industrial Revolution in England
were of two kinds. One arose from the rapidity and magnitude
of the industrial change itself; the other was due, not to the change,
but to the system under which the new industry was conducted —
the system of capitalistic industry working in a regime of practi-
cally unregulated competition. In our country the evils resulting
from transition alone were slight. Our manufacturing industries
were scarcely started when the spinning jenny, the power loom,
and the steam engine were introduced, and so almost from the
beginning the factory system seemed the natural one. Thus, the
change which in England was a revolution was in America an
evolution, a process of construction with little destruction. And
for a time even those evils inherent in the system itself were miti-
gated and disguised by the immense natural wealth of this country,
the ease with which land could be obtained, and the unusual mo-
bility of our working people, which permitted them to take quick
advantage of the unusual opportunities open to them.
But, as will appear in the following pages, these ameliorating
agencies served only to check and delay, not to destroy, the evil
possibilities of the new industrial system. As free land has be-
come less and less abundant, the wage earners of the East have
had forced upon them conditions of life which have kept down,
although they have not absolutely lowered, their standard of life.
Extremes of wealth and alienation of social classes have become
so great as to arouse the apprehension of all thoughtful men.
Labor riots that call for military interference testify to the fact
ECONOMIC DEVELOPBIENT OF THE UNITED STATES 75
that we have not escaped, that in the future we can hope less and
less to escape, the friction that accompanies all unfratemal re*
ktions among men. We have been greatly blest in that we have
escaped the worst results so long.
The Bevelopoie&t of AgricuHcire. The presence and power
of those economic forces which softened the asperities of the new
industrial system in America are revealed in a particularly strik-
ing way in the history of American agriculture. In England, it
will be remembered, the changes in agriculture intensified the
evils of the industrial revolution, led to the consolidation of small
farms into large landed estates, and put the actual business of
farming largely into the hands of tenants. In the United States,
however, practically none of these tendencies has shown itself — at
least, not in an alarming form. There is a constant migration
from the country to the dty, to be sure, but this is in no sense
due to the consolidation of farms. Thus between 1870 and 1900
the proportion of all breadwinners (persons ten years of age and
over gainfully occupied) engaged in agriculture fell from 47.6 to
3S.6 per cent On the other hand, more persons are still employed
m agriculture than in any other branch of industry; and owing
to the opening up of old Indian reservations for farm settlement,
the constant alienation of the public domain, and the breaking
up of Southern plantations and '^ bonanza farms." the number of
famis seems to have increased quite as rapidly as the general
population.
The great improvement which has taken place in agricultural methods
and machinery enables the relatively smaller farm population to satisfy the
demand for agricultural produce even more completely than in the past.
That is to lay, the machine power introduced into farming has more than
taken the place of those penons and their descendants who have abandoned
agriculture. It has been estimated, for instance, that in 1895 it actually
required only about 120,000,000 days' work to produce the nine principal
fami crops of that year, whereas, had they been produced by the methods
and machinery of 1850, at least 570,000,000 days' work would have been
required.*
* H. W. Quaintance, "The Influence of Farm Machinery on Production and
labor," Publicstions ol the American Economic Association, Third Series, Vol 5,
No. 4, pp. a7-a9*
76 OUTLINES OF ECONOMICS
Notwithstanding the improvement of farm methods and ma
chinery, the agricultural industry shows no real tendency to assume
a capitalistic form. The average farm of to-day is smaller than it
was fifty years ago, and although it represents somewhat more
capital, the increase of the capital investment is not great, is much
less, in fact, than the increase in the wealth of the average individ-
ual. Moreover, a majority of American farmers own the farms
they cultivate, and the statistics indicate that it is still compara-
tively easy for an enterprising farm laborer to rise to the status
of tenant and from that condition into the ranks of the farm pro-
prietors.*
Manufactures. — In agriculture, as we have seen, the passage
of time has not brought about a highly capitalized form of indus-
try, the typical farm represents only a small investment and is
tilled by its owner, there is no sharp distinction between employees,
unions of wage earners are practically unknown, and passage from
the wage earning to the employing class is still comparatively
easy. In manufactures, practically all these conditions have been
reversed since the end of the eighteenth century. And it is the tone
of the manufacturing industry rather than that of agriculture
which represents the keynote of the modem economic movement,
because agriculture is constantly decreasing while manufacturing
and allied industries are constantly increasing in relative im-
portance. At the beginning of the last decade of the eighteenth
century, seven eighths of the working population were employed
in agriculture, and the manufactured products of the coun-
try were valued at $20,000,000. Half a centur}' later, in 1840,
77.5 per cent of the breadwinners were employed in agricultiure,
16.5 per cent in trades and manufactures alone, and the products
of the manufacturing industries were valued at $483,278,215.
Fifty years later, in 1890, 35.7 per cent of the workers were
in agriculture, 24.4 per cent in manufacturing and mechanical
pursuits, and the manufactured products were valued at
> Tenancy seems to be increasing in the United States, but the authorities differ
in their interpretation of the phenomenon, some regarding it as a favoraUe and
others as an unfavorable sign. This and other questions touched upon in the
preceding paragraphs are discussed at greater length in a later chapter.
ECONOMIC DEVELOPMENT OF THE UNITED STATES 77
$9,372^37,283. In 1905, to cite the latest figures, the value of
the products had reached the enormous sum of $16,866,706,985.
The change in the character of the industry has been even more
striking than its growth and expansion. In the first place, ma-
chinery and capital have become increasingly prominent. In
1850, for instance, $556 worth of capital was invested for each
wage earner, while in 1900 the average amount of capital per
wage earner was $1850.* In the second place, the organization of
the industry has changed, so that the individual owner and ordi-
nary partnership are rapidly being replaced by the corporation.
At the beginning of the nineteenth century, corporations, though
not unknown in commerce and banking, were very uncommon in
the manufacturing industries. In 1905, incorporated companies
employed 70.6 per cent of the wage earners and manufactured
73.7 per cent of the goods produced in all the manufacturing
industries.
This change in organization has been a powerful factor in de-
stroying the personal relation between the owners of capital and the
wage earners who man their plants, and has thus helped to widen
the growing breach between capital and labor. It has also con-
tributed gready to the concentration of industrial control. Law
and custom in this country have combined to make the small
stockholder in the largest corporations a virtual nonentity so far
as practical participation in the management of the corporation
is concerned; and the individual or clique of "insiders" who
own a bare majority of the stock rule the business despotically.
Incorporation, then, instead 9f introducing a greater measure of
real industrial cooperation and thus democratizing industry, has
too frequentiy turned out to be an ingenious device by which en-
ergetic promoters borrow or secure the spare savings of the com-
munity on the most flexible terms and with a minimum of respon-
sibility. The corporation thus, while it appeared to be diffusing
the ownership of industry, has in reality worked toward the con-
centration of industrial control.
* Owing to Tariations in the definition of "capital" and other similar changes,
file statistical comparisons made in this and the preceding paragraph are not Tery
accurate, and are to be accepted as illustrations rather than measurements.
78 OUTLINES OF ECONOMICS
Other forces, moreover, have been working toward industrial
concentradon, the most powerful of which, perhaps, has been ex-
cessive competition. For many decades in this country the unre-
stricted competition of rival manufacturers made them almost
Ishmaelites in their business relations with one another. Tied
down to their large investments of fixed capital, they were com-
pelled to stand and fight without quarter. In every such war
the number of combatants tends to decrease. As old rivals are
killed off, the successful acquire greater skill and greater power
in the conflict With the passage of time greater and greater
equipment is required to give any hope of a successfiil struggle,
and some of the contestants, learning prudence from the struggle,
combine to increase their fighting power. The inevitable result,
whether through simple survival of the fittest or through combi-
nation, is a marked increase in the size and importance of the in-
dustrial unit. Between 1900 and 1905, for instance, the number
of establishments in the factory industries increased only 4.2 per
cent, but their capital increased 41.3 per cent, and the value of
their products 29.7 per cent. In many of our most important in-
dustries the number of establishments is actually decreasing. In
the manufacture of agricultural implements between 1880 and
X905, to take a single illustration of the many that might be dted,
the number of establishments decreased from 1943 to 648, while
the capital grew from $62,109,668 to $196,740,700, the wage earn-
ers from 39,580 to 47,394, and the value of the products from
$68,640,486 to $112,007,344. There are industries, of course, in
which no such consolidation has taken place, but they are unim-
portant in comparison with those in which it has. The extent to
which the giant industry and large-scale production have come
to dominate our manufactiuing industries in the year 1905 is
shown in the following table, which will repay careful study. Es-
tablishments of the largest size, i,c, those whose annual output
exceeds $1,000,000, constitute less than i per cent of the number
of establishments, but manufacture nearly 40 per cent of all the
goods. Nearly three fourths of the wage-earners are employed in
industries having a capital of more than $ 100,000 each
ECONOMIC DEVELOPMENT OF THE UNITED STATES • 7
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8o OUTLINES OF ECONOMICS
Recently the movement toward large-scale industry has taken
on another phase. In addition to concentration or centralization
of industry, we are now having a rapidly increasing iniegration
of industry. Large business concerns are finding it profitable to
carry on under one management several closely related industries.
For illustration, take the case of the United States Steel Corpora-
tion. Here we have united under one management the American
Bridge Company, the American Sheet Steel Company, the Ameri-
can Steel Hoop Company, the American Steel and Wire Company,
the American Tin Plate Company, the Federal Steel Company,
the Lake Superior Consolidated Iron Mines, the National Steel
Company, the National Tube Company, and the Carnegie Steel
Company. Of the last itself, Mr. Charles M. Schwab says, in his
testimony before the Industrial Commission (Vol. XIH, p. 448) ;
"The Carnegie Company were large miners of ore — mined all
the ore that they required themselves, to the extent of over
4,000,000 tons per year. They transported a large percentage of
it in their own boats over the lakes; they carried a large percent-
age of it over their own railroad to their Pittsburg works, and
manufactured it there, by the various processes, into a great vari-
ety of iron and steel articles — I think perhaps a larger general
variety of steel articles than almost any other manufacturing con-
cern."
Traiisportation and Railways. — The industrial concentration of
which we have been speaking does not necessarily lessen competi-
tion at all. It merely gives the business into the hands of increas-
ingly powerful rivals among whom competition may be all the
more bitter because of the size of the contestants. But in the
principal transportation industries time has amply demonstrated
that another rule prevails: competition has utterly failed to pro-
tect the consumer, and the progress of consolidation has operated
to emphasize and strengthen the inherentiy monopolistic character
of the industry.
The history of transportation in this country since the estab-
lishment of the Union falls into three stages. The "turnpike
period" extends from 1790, the year in which the first turnpike
was constructed, until 181 6, when steam navigation upon the Ohio
ECONOMIC DEVELOPMENT OF THE UNITED STATES 8l
River became fairly regular. The second stage, the "river and
canal period," ends with the panic of 1837, and is marked particu-
larly by the introduction of steam travel on the Hudson (1807),
the Ohio, and Mississippi rivers (1808 to 1817) and the opening of
theErieCanalin 1826, The last stage, the "period of the railway,"
extends from about 1840 to the present time. Of course, in con-
trasting these periods, it is not meant to suggest that canals were
not built before 1790, or that turnpikes are not important at the
present time. As a matter of fact, a canal was built in Orange
County, New York, as early as 1750; and there are few economic
needs of greater importance at the present time than the improve-
ment of oiur roads. These "periods" merely indicate the kind of
transportation facilities which at different times have been most
prominent in the minds of the people.
In the development of the railway, certain approximately defi-
nite stages may also be distinguished. Between 1830 (when the
first railway — the Baltimore and Ohio — was opened for traffic)
and 1840, the railwa3rs were short, local lines used in large degree
to supplement or piece out the rivers and canals. In the next
period, 1840 to 1870, many new roads were built, and the process
of "linear consolidation" — the linking together of local com-
panies into through trunk lines — began. By 1869 both the New
York Central and the Pennsylvania had effected through connec-
tions with Chicago. In the same year, the completion of the Cen-
tral and Union Pacific raOways linked the Pacific Ocean with the
eastern railways, and the continent was spanned.
The period between 1870 and 1890 is marked by three striking
developments. First, it was a period of feverish expansion: the
railway mileage of the country increased from 52,000 to 160,000
miles, more than 200 per cent. Secondly, the completion of sev-
eral through routes from the Atlantic seaboard to Chicago brought
about a period of destructive competition, which led to discrimina-
tion and rebating in through traffic and the overcharging of local
or non-competitive traffic. "Wherever competition appeared,
discrimination followed; and in the scramble for business the
stronger shippers were favored at the expense of the weaker.
Where there was no competition the public felt that they were
o
82 OUTLINES OF ECONOMICS
being oppressed by a monopoly, to make up for sacrifice rates
elsewhere — a feeling which was intensified by the absentee own-
ership of the western roads." ^ Thirdly, this condition of demor-
alization led to a double reaction. The railways sought to re-
strain competition by the creation of pools and traffic agreements,
while the people sought to protect themselves through legislation
and the creation of railway commissions. The Federal or Inter-
state Commerce Commission was established in 1887.
The last period, from 1890 to the present time, has been marked
by an unprecedented amount of consolidation and combination
among competing roads, and by a general acceptance of the
truth that the railway industry is inherently monopolistic and
must be subjected to public control. Thus, at the same time that
the control of the magnificent railway system of thb country —
greater in extent than all the railways of Europe combined — has
fallen into the hands of seven or eight groups of men or '^ inter-
ests," donodnated by a number of men small enough, some one has
said, to sit about the same table, the people themselves have per-
fected administrative machinery strong enough, it is hoped, to
hold the great monopoly in check. Complete monopoly and effect-
ive public control are being perfected at the same time, and
with this dual consummation there doses a great epoch in eco-
nomic thought and public policy. The new Interstate Commerce
Act of 1906 is a public recognition of the fact that the old prob-
lem of private competition versus public regulation has given way
to the new problem of public regulation versus public ownership.
It would be almost impossible to exaggerate the part which transportatioii
agencies, and particularly the railways, have played in the economic develop-
ment of this country. Ours is a country of "magm'ficent distances/' and
because of this fact, it was particularly necessary that superior means of
communication and transportation should be early introduced, if the country
was to be held together. After the Revolutionary War there was real danger
that the settlers west of the AUeghanies would be completely alienated.
Washington was quick to realize this fact. " The Western settlers," he wrote
to the governor of Virginia, shortly after the Revolutionary War, ''stand as it
were upon a pivot. The touch of a feather would turn them any way. They
have looked down the Mississippi until the Spaniards, very impoliticly, I
> H. C. Emery in Th$ Cambridg$ Modem History, Vol. 7, p. 706.
ECONOMIC DEVELOPMENT OF THE UNITED STATES 83
think, for themselves, threw difficulties in their way ; and they looked that
way for no other reason than because they could glide gently down the
stream, without considering, perhaps, the difficulties of the voyage back againt
and the time necessary to perform it in ; and because they have no other means
of coming to us but by long land transportations and unimproved roads."
This danger was averted by the building of the Cumberland Road, the
introduction of steam navigation on the Ohio, and the completion of the Erie
Canal. Later it looked as if the use of the Mississippi and other natural
avenues of communication would link the Middle West more closely to the
South than the northeastern states, thus giving the South a preponderant
influence in the inevitable struggle over slavery. This problem, however,
was solved by the railways, which, unlike the rivers, ran east and west rather
than north and south. The railway was thus a strong factor in the preser-
vation of the Union. And since the Civil War, Western settlement has fol-
lowed the railroad. It has been the great pioneering agency of the last hall
century, and is entitled to as much credit as the public land policy for the
rapid settlement of the West.
In the development of our transportation facilities, however, the State has
been from the very first an active partner of private enterprise. Not only
has the State built roads, canals, and railways of its own, but it subsidised
the private companies which engaged in similar enterprises, with prodigal
HbezaUty. Of the total state debts — $170,806,187 in all — contracted prior
to 1838, $60,301,551 were chargeable to canals, $43,871,084 to railways,
$52,640,000 to banks, $6,618,868 to roads, and $8,474,684 to miscella-
neous objects. After the panic of 1837 there was little direct construction
by the State of internal improvements, but national, state, and local govern-
ments vied with one another in assisting private companies by exemptions
from taxation and by grants of land, money, and credit. How much these
subsidies amoimted to we do not know, but the aggregate must have been
enormous, as appears from the statistics of land grants. " During the twenty-
one years between 1850 and 1871, at which time land grants vTere discontin-
ued, more than 159,000,000 acres were placed at the disposal of railroad
corpoFations by the federal government and 55,000,000 by the state govern-
ments." ^ In their origin and genesis, therefore, as well as in their essential
nature, the railways are quasi-public institutions.
The Labor Movement. — In the preceding pages we have seen
how capitalistic industry under a regime of free competition passed
from an earlier period of cut-throat rivaky to a later period of com-
bination amounting in many cases to monopoly. A similar phe-
nomenon is discernible in the labor movement. At the beginning
of the nineteenth century there were probably less than a dozen
* Cf. Bogart, Economic History o/the Uniled Stales, pp. 195, 308, passim.
84 OUTLINES OF ECONOMICS
trades unions in the United States, and we actually know of the
existence of only one. Between 1825 and the panic of 1837, how-
ever, they multiplied rapidly, and efforts were made to unite the
scattered "locals" of separate trades into broader national unions,
and to confederate the unions of different trades into municipal
and district federations. These efforts were only partially suc-
cessful, however, and it was not until after 1850 that permanent
national unions were established, and not till the organization
of the Knights of Labor in 1869 that a fairly permanent national
federation was created. The Knights of Labor reached the zenith
of its power about 1886, and since the panic of 1893 its place has
been gradually taken by the American Federation of Labor, with
which most American unions, except the Railway Brotherhoods
and the socialistic unions west of the Mississippi River, are affili-
ated. In 1893 the membership of the American Federation of
Labor numbered about 250,000. By 1906 it had grown to ap-
proximately 1,444,200. These figures give some idea of the strik-
ingly rapid growth of trades unionism in the last fifteen years. As
the membership of the American Federation of Labor is usually
understated, and as there are probably from 500,000 to 700,000
members in organizations not affiliated with the American Fed-
eration, we conclude that the aggregate membership of American
labor organizations at the close of the year 1906 amounted to
about 2,300,000 persons, mostly men.
There are thus at least five periods distinguishable in the history
of American trades unionism: the germinal period, ijSg-iSas; the
revolutionary period, 182 5-1 850, so called because of the close con-
nection in this period between trades unionism and more radical
reforms such as socialism and cooperation; the period of nation-
alization, 1850-1865; the period of federation, 1865-1893; and
the period of collective bargaining, 1893 to the present time. We
speak of the present epoch as the period of collective bargaining
because it is only in recent years that employers and the general
public have recognized that the trades union is here to stay, and
must be regarded as an irrepressible, permanent institution with
which many employers of labor must bargain, whether they like it
or not.
ECONOMIC DEVELOPMENT OF THE UNITED STATES 8$
The avowed aim of the trades union b a complete combination
of all the workers in a given occupation or industry. The Broth-
erhood of Locomotive Engineers, for instance, probably counts
among its members more than 90 per cent of all the locomotive
engineers in North America, although there are few trades
which are so completely organized as this. With the passage of
dme, moreover, the trades unions have made increasing use of
the monopolistic principle of the closed shop — the principle which
leads union men to refuse to work with nonunion men, and which
finds expression in the trades-unionist's new commandment: '^ Thou
shalt not take thy neighbor's job." Very recently several authori-
tative court decisions have held that labor combinations, particu-
larly national or international combinations, are contracts or
agreements in restraint of trade, and as such are illegal under the
federal or state anti-trust acts. This is but official recognition of
the fact that the forces which have led to the rapid development of
trades unionism since the Industrial Revolution are the same forces
which explain industrial combination and consolidation. The
anti-trust acts need amendment: not all combinations in restraint
of trade, but only unreasonable combinations, should be prohibited.
The development of powerful combinations in the labor world
has engendered a counter movement among the employers, which
expresses itself concretely in the modern employers' association.
Such organizations are not new; we have record of such an associa-
tion among the master shoemakers of Philadelphia in 1789. But
in recent years these associations have become permanent, formal,
and aggressive. They fight the labor organizations with their
own weapons, matching the lockout against the strike, the black
list against the boycott, and the ''labor bureau" against the ''un-
fair list " with which the reader of trades-union journals b familiar.
Most of the employers' associations, like most of the trades unions,
have associated themselves for common action in a large national
federation, the Citizens' Industrial Association of America, with
which, in December, 1903, there were afliliated sixty national em-
fdoyers' associations, sixty-six state and district associations, and
three himdred and thirty-five local or municipal associations of
employers.
86 OUTLINES OF ECONOMICS
The bitter conflict between organized labor and organized capi-
tal has forced the State, in the interest of industrial peace, to
inaugurate '* Wage Boards " and Boards of Arbitration and Concili-
ation. Some of these, such as the New Zealand Court of Arbitra-
tion, are empowered to enforce their awards upon employers and
employees; while others, like the Canadian and some of the
American State Boards of Arbitration, have no power to settle
disputes authoritatively, although they may make '' compulsory
investigations" and publish their finding as to the equities of the
case. These and similar topics, however, are reserved for more
detailed discussion in a later chapter.
State R^^tion of Industry. — The growing interference of
the State in the conflict between capital and labor brings us natu-
rally to the general subject of the State in relation to industry.
When the American colonies were planted, mercantilism was the
dominant political philosophy ; but, as we have seen, mercantil-
ism gave way to a philosophy of individualism in the eighteenth
century, under the combined influence of the reaction against the
English Navigation Acts, the natural antipathy of a frontier com-
munity to legal restraint, the philosophy of Locke, and in a minor
degree the teachings of the French physiocrats. The triumph of
individualism, as a philosophical system, came at the critical pe-
riod when our State and federal constitutions were in the making,
and it thus became intrenched in the organic law of the nation,
giving constitutional sanction to the doctrine of laisses^faire, and
establishing a constitutional guarantee oi freedom of contract, in ac-
cordance with which adult men were left "free" to work as long
as they "pleased" (or were compelled), for whatever wages they
were "pleased" (or forced) to accept. Under the influence of
these doctrines, for instance, our courts have annulled such whole-
some regulations as laws prohibiting payment of wages in stbre
orders, and statutes limiting the hours of labor of men in bake-
shops, or other exhausting occupations. Decades of experience
have amply proved that the average wage earner is too weak to
protect himself against many evils; but our constitutional law
has made it exceedingly difficult for the State to protect him. For-
tunately, however, the American people have a fashion of bend-
ECONOMIC DEVELOPMENT OF THE UNITED STATES 87
ing their constitutional law to fit the facts, not blinding them-
selves to the facts by worshiping the law; and in recent years
the Supreme Court of the United States has progressed so far as
to sanction a state law restricting the hours of labor of men in
underground mines and smelters, although many of the state
Supreme Courts are far less enlightened.
It is impossible to show in detail how the free trade and indi-
vidualistic tendencies of the Revolutionary period gave way to a
constantly growing programme of State interference. The doctrine
of laisseS'faire was never adapted in its entirety, and year by
year we have moved farther and farther away from it. State in-
terference began with the adoption of a tariff act in 1789, "for
the support of the government, for the discharge of the debts of
the United States, and the encouragemetU and protecHan of manu^
factures"; reached almost a maximum in the Embargo Act of
1807; showed itself in the policy of internal improvements and
State aid to turnpike, canal, and railroad companies; brought us
the great mass of labor and factory legislation which has been
adopted by so many states since the Civil War; led in turn to the
Interstate Commerce Act of 1887 and the Sherman Anti-Trust Act
of 1890; and finally culminated in the new Interstate Commerce
Act, the National Meat Inspection Law, and the National Pure
Food Law. Excessive competition among laborers, which forced
them to accept work under conditions destructive of physique and
morab, has led to the factory acts, prohibition of child labor, and
limitation of the hours of labor of women; excessive competition
leading to the adulteration of products and their mantifacture
under insanitary conditions has given us the Meat Inspection and
Pure Food laws; excessive competition among corporations, lead-
ing to combination and oppressive monopoly, has brought us the
anti-trust acts and regulation through state and national commis-
sions. Whether the individualistic character of industrial society
endures or disappears, individualists and socialists alike are now
agreed that the State must interfere. As a prominent English
statesman expressed it, "We are all socialists now," although he
merely meant by this statement that the passive theory of govern-
ment has been wholly discredited.
88 OUTLINES OF ECONOMICS
Up to the present time State interference has had as its princi-
pal object the improvement and preservation of competition. The
conscientious manufacturer who would not poison consumers for
the sake of swelling his profits, the high-minded employer who
would not "sweat" women and children merely to reduce the cost
of production, the delicately scrupulous shipper who would not
undermine a rival by forcing a common carrier to pay him rebates,
— all these have suffered as much from the abuses of competition
as the general public itself. Industry under the competitive regime
is a rough game played for high stakes, and if it is to be played
fairly, there must be intelligent rules of the game and an umpire
powerful enough to enforce them upon all contestants alike. If
the manufacturers of Massachusetts are prohibited from employ-
ing children under fourteen years of age while those of South Caro-
lina are encouraged to do so, decency is penalized, and the vic-
tory goes to the contestant guilty of the greatest number of fouls.
State interference, as we have said, has had as its principal
object the maintenance of competition upon a higher and more
wholesome basis. But this has not been its sole object. Our re-
cent regulation of public utility companies aims not to bolster up
or preserve competition among such companies, but to introduce
a substitute for competition; and the strong movement now on
foot to modify the Federal Anti-Trust Act is partially based upon
a recognition of the possibility that perhaps regulated monopoly
may prove on the whole more beneficial than regulated competi-
tion. Upon this point we pass no judgment; time alone can tell.
Whether it is desirable, whether in the long run it will be possible,
to check the monopolistic tendency of the age and thus maintain
a competitive as^ distinguished from a socialistic regime of indus-
trial society, may be said to be the supreme economic problem of
the twentieth century.
QUESTIONS
z. How do you account for the failure of the early colonial restrictive
legislation?
3. What was the efifect of English colonial policy and the Navigation Acts
upon American manufactures? shipbuilding? American political philoBO-
phy?
ECONOMIC DEVELOPMENT OF THE UNITED STATES 89
3. What was the condition of American agriculture in 1776? of manu-
factures? shipbuilding? transportation?
4. Was the Industrial Revolution as important in this country as in Eng-
land? Was it attended with as much suffering? Why?
5. What part has been played by war in the tariff and industrial history
ofthe United States?
6. In what respects has the agricultural development of this country
differed from that of England? from that of the manufacturing industry?
7. What changes have taken place in the organization of manufacturing
industries i^ the last century?
8. What are the principal causes and effects of industrial concentration?
9. What is the difference between industrial concentration and integra-
tion? between largeHKrale production and monopoly?
10. What stages are distinguishable in the history of transportation and
railways in this country?
11. What part did the State play in the development of railways? Is
railway consolidation a recent phenomenon?
12. What movement has the development of trades unionism elicited from
employers? from the State?
13. How did the doctrine of non-interference secure such a strong foothold
in American constitutional law? What has been the principal object of
State interference up to the present time?
RXRRraCES
(See also References for Chapter V)
Bishop, J. L. History of American Manufadares.
Bryn, E. W. Progress of Invention in the Nineteenth Century,
Census Reports. Tenth Census, AgricuUnre, p. 131. Twelfth Ceiisus,
Manu/aaures, Part I, Chap. II, {{ I-VI, XVII, XXXIX.
Dewey, D. R. Financial History of the United States.
Hadley, a. T. Railroad Transportation, its History and its Laws,
Johnson, £. R. American Railroad Transportation, and Ocean and
Inland Water Transportation.
Rabbeno, Ugo. The American Commercial Policy.
Sumner, W. G. History of Banking in the United States.
Taussig, F. W. Tariff History of the United States.
Webbe^ a. F. The Growth of Cities in the Nineteenth Century. Columbia
Studies in History, Economics, and Public Law, Vol. II.
WellSi D. a. Recent Economic Changes.
BOOK II
PRINCIPLES AND PROBLEMS
PART I
INTRODUCTION
CHAPTER Vn
ELEMENTARY CONCEPTS
In political economy many of the technical terms employed are
often misunderstood because the same words are used in ordi-
nary speech with inconsistency and confusion. We have often to
choose between the alternatives of being inconsistent and of vio-
lating current usage. The present chapter is devoted to a defi-
nition of some of the fundamental notions in political economy.
The statement is sometimes made that economics is a mere
bread-and-butter science, and this charge is not without some
foundation, since the science studies men in their endeavor to
make a living, but it would be an error to suppose that we are
concerned with only the sordid aspects of human nature. This
is apparent if we enumerate the motives which impel men to
acquire wealth.
Motives in Economic Activity. — (i) There is, in the first
place, the endeavor to satisfy one's strictly personal wants, giving
rise to the struggle for food, shelter, comforts, amusement, etc.
These things are wanted for their own sake, because of the pleas-
urable effect which they produce upon the individual acquiring
them. We have here, in short, the motive of self-maintenance
and development. ^2) But every normal individual feels such a
degree of affection for certain other people that he is also anxious
for their maintenance and development. Striving for the wel-
fare of others is a second motive which impels men to labor for
the acquisition of material things, and in many cases is more effec-
tive as a spur to endeavor than the first. A man will hold him-
self to the daily grind more persistently when he feels some one
93
94 OUTLINES OF ECONOMICS
is dependent upon him than when he is standing alone. (3) A
third motive is the desire to gain the esteem of one's fellows.
This motive may take the form of an endeavor to do one's part
and to be deserving of the companionship of the class of people
whom we admire. But much of our wealth acquisition is motived
by the hope of impressing our fellows with a sense of our own
importance, to show that we are successful, admirable, enviable.
When the income permits, old coats are discarded, not because
they cease to give protection, nor because they have become aes-
thetically objectionable, but because the wearers wish to make a
favorable impression upon other people. Half the pleasure of
owning fine houses comes from the fact that most people do not
have them. This motive b not always a conscious one, since
our standards of beauty or propriety may themselves have been
the result in part of this desire for distinction. Now that bi-
cycles are within the means of workingmen, it is no longer fash-
ionable to ride these machines.
Somewhat similar to the desire for distinction is (4) the desire
for power. Men like to dominate and conmiand their fellows,
and this want may be satisfied by means of the dollar as well as
with the sword; hence our Napoleons of Finance, Captains of
Industry, and Railway Kings.
(5) Again, the desire for activity for its own sake may be men-
tioned. Enforced idleness is as painful as prolonged labor, ex-
cept to the degenerate. This desire may result in the production
of goods, but more conmionly it requires the use of goods that
have been produced, as, for example, the implements of athletic
exercise. Finally, (6) religion or the ethical impulse may be an
important factor in controlling the economic activity of the indi-
vidual. Observe, for instance, the difference in the history of
communistic experiments in which religious feeling has been
strong and those in which it has been weak.
In this discussion the use of the word ''motive'^ must not be
taken to mean that all of the economic life of the individual is a
consciously rational one, in which pleasures are balanced against
pains in such a way as to secure the maximum surplus of satis-
factions. Man is, it is true, a rational being, and as such pursues
ELEMENTARY CONCEPTS 95
de£uiite lines of action under the influence of conscious motives;
but he is also a creature of instincts and habits, and much of the
economic activity of the individual has to be interpreted as the
working out of instinct and habit. We speak, for example, of
such things as the "instinct of workmanship/' the ''habit of in-
dustry," the "habit of saving," and the like. The foregoing
analysis of the motives in economic activity is, however, broad
enough if we remember that "pleasure" is something that is not
always consciously sought, but is often to be understood as the
result of the functioning of inherited instincts and acquired
habits.
Utility. — As a result of these motives, human beings are striv-
ing for the possession of certain things. These we call goods or
utilities. To understand the meaning of the term "utility" in
economics, we must recall the central fact of our science, that eco-
nomics is a science of man. Goods may be of interest to chemistry
and physics merely as things, but they have no significance what-
ever in economics until they come into relation with man. That
fact in man which reflects upon things a new character and makes
them goods is the fact of human wants. Anything that is capable
of satisfying a human want possesses utility and is a good.
We need here to guard against a misunderstanding which the
word "utility" sometimes suggests. There is a tendency to con-
found it with the idea of benefit, and to suppose that articles are
useful just in proportion as they are beneficial. But in economics
these two ideas cannot be taken as identical. Utility is the power
to satisfy wants, not the power to confer benefits. Cigars are as
useful in the economic sense as bread or books, for all three sat-
isfy wants. Economic wants may be serious, frivolous, or even
positively pernicious, but the objects of these wants are all alike
"utilities" in the economic sense.
Free anA Econooiic Goods. — But it is apparent that the wants
we have mentioned are very unlike in character. Air and water,
for instance, we seldom think of as things we want at all. We
usually have them in abundance and without exertion, so that,
though they satisfy wants as vital as any we know, we seldom
spend any tinoe thinking about them or our dependence upon them.
96 OUTLINES OF ECONOMICS
These are Jtu goods, that is, goods that exist in quantities suffi-
cient to supply all wants for them. Land in a new country is
frequently a free good. But the list of things that are free is
quickly exhausted. On the other hand, goods that are the ob-
jects of exchange are called economic. Economic goods are those
which exist in quantities less than sufficient to satisfy all wants
for them. Hence, we must economize in the use of them, are
willing to undergo sacrifice to obtain them, and usually they are
obtained only by exertion. It is, however, their scarcity and
not the fact that they have cost labor that makes them economic
goods. Land, for example, a free gift of nature, is one of our
most important categories of economic goods at the present time.
Eflfort. — Fortunately, the supply of economic goods can, in
most cases, be increased by human exertion applied to the ma-
terials of nature; but this exertion, if carried beyond a certain
point, is irksome and has an important effect upon our economic
life. If the labor force of the community were unlimited, a
great many of the goods which we now use sparingly woidd be
as free as air. Idealists have pictured for us a condition of the
future where a few hours' work per day for each individual (an
enjoyable means of working off surplus energy) will be sufficient
to supply us with all of the goods that we have time to consume.
At present, however, most of us find that our consumption is
limited by the pain of additional effort. The end of our eco-
nomic activity is, therefore, not only to get the greatest amount
of satisfaction, but also to minimize the amount of painful labor.
Waiting. — Another fact that persists in our economic life is
the necessity for waiting. The people of the United States wish
to have the Panama Canal, but they cannot get it without years
of waiting. They must spend millions of days of labor with no
benefit in return for a long time to come. This waiting has
often been called abstinence; but that suggests that the waiting
is always painful, which is not true, as we shall see later in dis-
cussing the subject of interest.
Services. — Goods have been commonly divided into (i) ma-
terial things, such as food, clothes, and books, and (2) personal
services, such as the advice of a physician or lawyer.
ELEMENTARY CONCEPTS 97
The advisability of the distinction has been denied, Actors and singers,
it has been urged, sell us perishable material things, i.e. light and sound
waves of a peculiar kind. A recent writer also considers the distinction con-
fusing because it obscures the fact that material things give off services just
as human beings do. The piano yields services as does the singer. From
this point of view persons are durable economic goods along with catde and
wheelbarrows. But, on whatever ground the distinction is made, it is im-
portant to recognize that among the things that contribute to our well-being
are some — personal services — that are so perishable that they must be
used with the direct cooperation of some other human being, while in other
cases the services are, as it were, stored up in some inanimate material things,
and the relation between the producer and consumer becomes an impersonal
one. The service of a musician, for example, is personal and must be used
the moment it is rendered ; the purchase of a musical instrument, on the other
hand, means the purchase in a lump of a long series of uses.
Pteisonal Qualities as Goods. — The central point in our science
is the conception of man in his relations to his environment, and
hence it does not seem reasonable to include the personal quali-
ties of men under the head of goods. Good health and techni-
cal skill make a man's services more valuable and assist him in
the acquisition of wealth, but they are a part of him rather than
of his possessions. It is his services that he selLs, and it is these
that we have placed under the head of goods. When we con-
sider the importance of the priceless heritage which the present
generation has received in the shape of knowledge and skill, we
might make these a separate category as inmiaterial goods.
On this point Professor Marshall says : " German economists often lay
stress on the non-material elements of national wealth; and it is right to do
this in some problems relating to national wealth, but not in all. Scientific
knowledge, indeed, wherever discovered, soon becomes the property of the
whole civilized world, and may be considered as cosmopolitan rather than a
specially national wealth. The same is true of mechanical inventions and
of many other improvements in the arts of production ; and it is true of music.
But those kinds of literature which lose their force by translation may be
regarded as in a special sense the wealth of those nadons in whose language
they arc written. And the organization of a free and well-ordered State is to
be regarded for some purposes as an important element of national wealth."
But knowledge does not exist in a disembodied state, and we
shall omit nothing and avoid some confusion if we divide all
goods into material things and personal services.
98 OUTLINES OF ECONOMICS
Wealth. — Political economists have frequently called economic
goods wealth, thus excluding free goods. Some writers, however,
include free goods in the idea of wealth. The truth is, that this
term cannot be defmed satisfactorily unless we specify whether
we are speaking from the individual point of view or from the
social point of view. From the individual standpoint, wealth
means valuable claims to goods; from the social pomt of view,
we shall regard wealth as an aggregate or stock of goods. This
excludes personal services from the category of wealth, for they
disappear as soon as rendered, and in an inventory of existing
wealth, personal services would not appear.
Wealth and Income. — Wealth refers to the stock of goods on
hand at a particular time. Real income, on the other hand, has
reference to the satisfaction which we derive from the use of
material things or personal services during a period of time.
Money income should, perhaps, refer to the value of the goods
consumed and services enjoyed, although in popular speech and
by many economists the word is used in the literal sense of the
net amount of money that comes in, whether it is spent for en-
joyable things or is saved. In this book we shall use the term
" money income " in the latter sense.
The Individual and Society. — One distinction nms all the way
through political economy, and that is the distinction between
the social and the individual standpoint. That which is wealth
to the individual is often not wealth to society. An individual
holding a government bond finds that he can exchange it for the
things he wants almost as readily as though it were gold or some
other commodity. He recognizes that the paper itself cannot be
used directly for any useful purpose, yet he prizes it because it
represents an indisputable claim on the services or commodi-
ties of other people. If the bond should be destroyed, the holder
as an individual would suffer loss, but society as a whole would
be neither richer nor poorer, and society, exclusive of the bond-
holder, would have gained at his expense. From the social stand-
point the bond is not wealth at all, but only an evidence of a legal
right to a part of the social wealth. All property rights are sim-
ply claims to a part of the social wealth or income. The claims
ELEMENTARY CONCEPTS 99
to concrete, material things, such as farms and store buildings,
are included by an individual when he enumerates his wealth;
the farms and store buildings are social wealth. Again, in mak-
ing an inventory of his wealth, an individual would not ordinarily
mclude such an item as the post ofQce, which is public and not
private property; but, strictly speaking, the post office is owned
jointly with other members of society. A successful patent is
frequently looked upon as an item of wealth, but it is simply a
means by which the owner gets more from other people in return
for his services. If the patent is declared invalid, others gain
what he loses (not counting the check to the inventive impulse).
Again, ^'good will" in business is frequently paid for as though
it were an economic good, and is wealth from the individual
point of view, but it is not social wealth. If a business man loses
his established trade, his competitors are the gainers; society
as a whole is not affected. This distinction between individual
and social wealth, however, is valid only when we look upon the
social wealth as composed of concrete material objects. When
we are measuring the amount of wealth in dollars, no such dis-
tinction can be drawn. To attempt to say how much an item
of wealth is worth from the social point of view and how much
from the individual point of view, would be futile. The owner
of a franchise that is declared invalid suffers financial loss; the
community suffers no loss, for the tangible property which yields
the enjoyable services is not affected. Here is a valid distinction
between the individual and social points of view, but from any
point of view it cannot be denied that the selling value of the
property has been decreased.
Wealth and Value. — In the preceding paragraphs wealth has
been spoken of as consisting of particular things. A lead pencil
and the year's crop of wheat are both wealth. How shall we
measure the amount of wealth that these objects represent?
Since the items of wealth are composed of very heterogeneous
objects, we cannot use such units of measure as bushels, pounds,
or feet. We must select a measure that has reference to some
quality common to all kinds of wealth. This quality is the power
Id give satisfaction to those who have unsatisfied wants, and a
lOO OUTLINES OF ECONOMICS
measure based upon this quality is value. This is a subject
which will be discussed in detail later, the valuation of goods and
personal services being the central problem in economic theory.
It is sufficient to say at this point that high value in an object
implies the existence of important imsatisfied wants which this
object is capable of satisfying. Thus, free goods have no value,
not because they do not satisfy important wants, but because
these wants do not ordinarily go imsatisfied.
Capital and Other Forms of Wealth. — Some material things,
as well as personal services, yield satisfaction to human beings
directly. From clothes, dwellings, food upon the table, musi-
cal instnmients, and the like, we derive enjoyment directly.
These are consumption goods. Other goods are of service only
indirectly. A plow, we say, is useful, but we cannot eat or wear
it. It simply helps to produce the things that we can enjoy.
Such articles are production goods.
The distinction is a matter of degree. Even the food upon the table is not
quite ready to be enjoyed. It must be handled with knives and forks.
This has led some writers to make no distinction between wealth and capital
goods. But it has been pointed out that great differences in degree are more
important than many differences in kind. The distinction, it may also be
noted, is not made on the ground of durability. Consumption goods may
be very durable, such as a painting or work of fiction.
Production goods, again, are divided into capital goods and
land. Land is a gift of nature; capital goods — machinery,
warehouses, raw material, etc. — are produced by man. Other
differences between these two classes will be discussed later.
Capital Goods and Capital Value. — Capital goods, as well as
other forms of wealth, are of such a heterogeneous nature that
we cannot measure them by such units as pounds or inches.
Here, again, we must select some quality that is common to all
of them, which is value, and this can be measured in terms of
dollars. Very frequently the value of capital goods is confused
with the concrete good itself. A typewriter is a tangible, material
capital good; its weight is measured by pounds; its bidk by cu-
bic inches; its value by dollars. In this book the word " capital "
is frequently used as a short expression for either of the phrases
ELEMENTARY CONCEPTS lOI
" capital goods " and " capital value," but it will always be clear
from the conte3rt which is meant.
Social and Individual Capital. — The individual may include
items in an enumeration of his capital which are not capital
from the standpoint of society. The landlord who has dwell-
ings to let regards them as part of his capital, but from the social
standpoint they are consumption goods. We may call such
goods acquisitive capital. Again, a street railway may consider
its franchise as a part of its capital, but from the social standpoint
a franchise is not capital at all, nor even a good, but is simply a
right to use the streets in a certain manner. Destroy the fran-
diise, and the items of social capital would not be directly les-
sened.
Figure i will make clear these various distinctions: —
Cirde AB represents goods.
Cirde AC represents economic
goods.
Circle AE represents producers^
goods.
Cirde AF represents land.
Zone BC represents /ree goods.
Zone CE represents consumers'
goods.
Zone DE represents acqwisUive
capital.
Zone EP represents social capi'
laL
Tig. 1
The National Wealth and the National Dividend. — Attempts
have been made to ascertain the total wealth of a nation. The
latest estimate made for the United States by the census authori-
ties is given on the following page.
Such a table is useful, even though it may contain some rather
arbitrary estimates, as showing the relative importance of dif-
ferent classes of our material equipment. Notice the small total
value of the metals used as money and the relatively large value
embodied in real property. It is rather surprising that manu-
facturing machinery, took, and implements are worth less than
X02 OUTLINES OF ECONOMICS
Estimates of Wealth for 1900 and 1904
Fouis OF Wealth
1904
XQOO
Real property and improvements
— taxed
$551510,228,057
6,831,244,570
4,o73»79i»736
844,989»863
3»397»754,i8o
1,998,603,303
11,244,752,000
2,219,966,000
227400,000
585,840,000
123,000,000
846,489,804
275,000,000
562,851,105
i,899»379i65a
7,409,291,668
495,543*685
408,066,787
2,500,000,000
5,750,000,000
1461324,830,334
Real property and improvements
— exempt
Live stock
6,212,788,930
^,^06,47^,278
Farm implements and machinery
Manufacturing machinery, tools,
and implements.
Gold and silver coin and bullion
Raihoads and their equipment. .
Street Railways, etc.:
Street railwavs. ■
749»775»97o
2,541,046,639
1,677,379,825
9»o35»73a,ooo
1,^76,107,160
THpflTanh svstems ....... ^ , .
211,650,000
Telephone systems
Shipping and canals
Privately owned waterworks. .
Privately owned central elec-
tric light and power stations
Mother:
Agricultural products
Manufactured products
Imported merchandise
MininsT oroducts
400,324,000
98,836,600
537,849,478
267,752,468
402,618,653
1,455,069,323
6,087,151,108
424,970,592
326,851,517
Clothing and personal adorn-
ments
2 ,000,000 ,000
Furniture, carriages, and kin-
dred property
4,880,000,000
Total
$107,104,192,410
♦88,517,306,775
our live stock. But great caxe should be taken in comparing
the total wealth as estimated in this and in preceding census
valuations and in drawing conclusions as to the significance of a
growth in national wealth measured in dollars.
In addition to the difficulty of getting accurate information
on these various items, there are several things to be kept in
mind in making use of such an estimate. First, the returns are
ELEMENTARY CONCEPTS I03
made in money, so that fluctuations in the value of money will
show a change in the total valuation even if there is no change
in the relation between the wants of a community and its goods
other than money. Again, free goods are not included in such
an estimate. Also, a good deal of public property does not have
a money estimate put upon it. Who would attempt to say what
our rivers and harbors are worth, and yet why should not these
be mcluded in the estimate if our canals are?
It seems that much that is included in the estimate is wealth
from the individual standpoint only, but not from the social, as
in the case of the valuation of a busine^ whose value consists
largely of patents or monopolistic privileges. In the table above,
for example, the value of railways in 1904 was obtained by capi-
talizing their net earnings. Is this sum properly included in an
estimate of the total amount of wealth in the United States?
The inclusion is proper if we are confining ourselves to a state-
ment of the sum of the values of property rights, but it is mislead-
ing if we wish to show the relative importance of railways and of
property in a competitive industry, or if we are discussing rail-
ways in relation to the public welfare. A similar line of thought
is suggested with reference to land values. Ten years ago we
had about the same area and the same quality of land as we now
have, so that its high value to-day cannot mean that we are better
equipped with natural resources.
We must be on our guard against attaching improper signifi-
cance to estimates of total wealth. Changes in total value are
not an acourate index of changes in well-being. It is possible
that an increase in concrete material goods will actiially decrease
the total quantity of wealth measured in dollars. A hundred
bushels of wheat at $1 per bushel have a higher selling value
than two hundred bushels at 40 cents per bushel. If by some
magical process all goods could be made free as air, there would
be no value whatever. An estimate of the value of our stock of
wealth also necessarily omits to take account of personal services.
It is obvious also that per capita wealth has a more direct rela-
tion to well-being than total wealth. Individual wealth and value
connote scarcity; well-bein<r implies abundance. Nevertheless.
I04 OUTLINES OF ECONOMICS
under present conditions, it is probable that an increase in per
capUa individual wealth, when not due to fluctuations in the value
of money, also indicates an increase in well-being. There is no
likelihood of our being able to increase the quantity of economic
goods to such an extent as to render them free and hence value-
less; and, on the other hand, as will be more fully explained
later, new wants are constantly developing, and value is at bottom
the power to minister to unsatisfied wants.
The national income is a concept which takes accoimt of the
services rendered directly by persons as well as of the material
things that are used. The national income, objectively consid-
ered, is a gigantic stream of food, clothes, comforts, personal ser-
vices, etc., which is used up in the direct satisfaction of wants in a
specified period, such as a year, by the millions of individual acts
of consumption. Some writers would include also the additions
to our industrial equipment, such as new machines; but they
may also be regarded as promises of an enlarged future income
of society, not a part of its present real income. These two views
correspond to the two definitions of income on page 98.
It is difficult to make an accurate estimate of the national in-
come in terms of its money value, and not much confidence can
be placed in the estimates that have been made. A reliable cal-
culation of this kind would, however, be iiseful as an index of
the maximum gain that might be derived by the mass of the people
from agitation for a more nearly equal distribution of wealth. It
would be interesting to know what the scale of living would be if
the national income were equally distributed. At present we do
not know whether a family of five persons would have $800 or
$1600 to spend.
The national income may be looked upon as the national divi-
dend, the sum total of good things to be divided among the vari-
ous families or individuak. The forces determining the size of
this dividend, the manner of its division, and the saneness of its
use are the main topics for discussion in political economy, and
hence it will be our purpose in subsequent chapters to describe
the general tendencies in the consumption, the production, and
the distribution of wealth and income.
ELEMENTARY CONCEPTS lOS
QUESTIOirS AND BXERCISB8
1. Does the following statement agree with the definitions in the text?
"The true basis for an estimate of a nation's wealth is to be found in the en-
joyments of its members." Hadley, Economics, p. 4.
2. Are the following wealth: air? whisky? a copyright? Lake Michigan?
skill as a carpenter ? good health ?
3. Discuss the following : " Among the motives which lead men to accumu-
late wealth, the primacy, both in scope and intensity, therefore, continues to
belong to this motive of pecuniary emulation." Veblen, Theory of the
Leisure Class, p. 34.
4. State the significance of the following: "A horse is not wealth to us if
we cannot ride, nor a picture if we cannot see, nor can any noble thing be
wealth except to a noble person/' Ruskin, Munera Pulveris, p. 10.
5. Discuss the following statement: "In 1770 Arthur Young reckoned the
income of England to be £120,000,000; in 1901 the income may be roughly
set down at £1,600,000,000. Making correct allowances for population
and for prices, this growth of income would signify a large increase of com-
modities per head ; but would it tell us that we are working and living some-
what better than our ancestors ?" Hobson, The Social Problem, p. 43.
REFERENCBS
CAiVER, T. N. The Distribution of Wealth, Chap. III.
aARK, J. B. The Philosophy of Wealth, Chaps. I and III.
Fisher, Irving. The Nature of Capital and Income, Chaps. I and 11.
Hobson, J. A. The Social Problem, Book I, Chap. V.
Lesue, T. E. C. Essays in PolUical Economy, Chap. I.
Mallet, B. A Method of Estimating Capital Wealth from the Estate Duty
Statistics, Journal of the Royal Statistical Society, March, 1908.
Marshall, Alfred. Principles of Economics, Book II.
RusKiN, John. Munera Pulveris, Chap. I.
SiDGwiCK, Henry. The Principles of Political Economy, Book I, Chap. III.
Smart, William. Studies in Economics, Chap. VIII; and Distribution of
Income, Book II.
Spahr, C. B. The Present Distribution of Wealth in the United States,
ChapL V.
Veblen, T. B. The Theory of the Leisure Class, esp. pp. 24-34.
Wagner, Adolph. Grundlegung der politischen Oekonomie, 3d ed., Vol
I, pp. 83-135.
Special Census Reports, 1907, Wealth, Debt, and Taxation.
PART n
CONSUMPTION
CHAPTER Vm
CONSUMPTION
Consumption Defined. — Consumption in economics means the
use of goods in the satisfaction of human wants, which is the pur-
pose of a large part of our economic activity, but it is not the sole
purpose, since activity is to a certain extent an end in itself. Nev-
ertheless, in economic society as it is organized to-day we are per-
haps justified in looking upon consumption as the motive force
behind production. Wants are so far from satisfied at present
that men look for work, not because they seek to be rid of surplus
energy, but because they crave the goods which their wages will
buy. The power of imrestricted consumption seems to be the
prevailing ideal. Industry, furthermore, is organized and con-
ducted primarily to satisfy the consumer, not the worker. This
fact is the basis of the Consumers' League, which aims to improve
conditions of production by asking the consumer to refuse to pur-
chase the goods of unfair employers.
A study of the constmiption of wealth falls only partly within
the domain of economics, for the use of wealth is a large part of
the problem of life. Passing judgment on the standards accord-
ing to which the rationality of certain wants is to be measured
does not directly concern the economist
Productive and Final Consumption. — When used without quali-
fication, the word " consumption " in economics 5s commonly taken
to refer to the use of goods to satisfy wants directly. But some
goods, such as machines and raw materials, are used up in the
production of other goods. This we may call productive consump-
tion, while that consumption which attains the ultimate goal of
io6
CONSUMPTION 107
economic activity directly in the satisfaction of wants is final can-
sumpiion. It is now less necessary than it was in the days of Car-
lyle and Ruskin to insist that food consumed by laborers is not
productive consumption. They consume, not merely for the sake
of production, but also for the sake of satisfaction. Man is our
final term.
Human Wants. — In the study of human wants as a starting
point in economic theory, two facts stand out prominently: the
expansion in the ntmiber and variety of the wants, and the satia-
bility of any particular one of them. As man has progressed from
savagery to civilization, the variety of things he desires and even
considers necessary to his existence has expanded enormously.
His interests become more varied, his capacity to enjoy becomes
larger, and he lives a ftiller and more complex existence. There
are indeed those who would have us '^ return to nature " and live
a simple life, but taking the world as it is, we may assume that
there is no limit to the capacity of the community to use more
goods.
But when we turn to the consideration of some particular want
by itself 9 the matter is wholly different. Our nerves grow weary
of a repeated stimulus, and any attempt to continue indefinitely
the enjoyment of some sensation results in satiation. A phono-
graph record grows stale after a number of repetitions. An apple
does not always have the same degree of utility for any one of us,
varying from the highest degree, if we are on the point of starva-
tion, to disgust, if a considerable number have just been con-
sumed.
Law of Diminiahing Utility. — This fact is of fundamental im-
portance in the study of economics and has been dignified by the
term "the law of .diminishing utility." In formal words: Tke
ifUensUy of our desire far additional units of any comtnodiiy de-
creases as we consume successive portions. It should be observed
that an interval of time between the successive acts of consump-
tion may permit our nerves to recuperate so that no diminution in
the degree of utiBty is apparent. Again, the increase in a person's
stock of an article held for the purpose of exchange, such as money,
can cause a decrease m the utility of an additional unit only to the
lo8 OUTLINES OF ECONOMICS
extent that all of his wants are being satisfied, since such an ex-
changeable commodity in reality stands for all conmiodities avail-
able to him. Again, consumption of certain articles may result
in the development of new related wants. The amateur pho-
tographer, for example, finds that the crude pictures which de-
lighted him at first give him less and less pleasure, but his interest
in photography may continue to increase because he sees an end-
less variety of results to be achieved.
Different Uses for the Same Commodity. — In the preceding
paragraph mention was made of the different degrees of intensity
of a particular want. The utility of a commodity may also vary
because of its capacity to satisfy different wants of varying im-
portance. Thus water, first of all, satisfies thirst. The impor-
tance of this utility is altogether incalculable, for without it we
should die. Then it serves for bathing, a use which certainly
seems essential, but one which is far less urgent than the foregoing.
If we had to do without one or the other, there is no doubt which
we should prefer. Then it serves for washing dishes, clothes, and
a midtitude of such things, then for sprinkhng lawns and streets,
then for fountains, artificial ponds, etc. All these uses and many
more are economic, because men will and do pay for water to
satisfy these wants.
Marginal Utility. — It must be evident, therefore, that to say
that a certain thing is a utility is very indefinite. That merely
tells us that it is capable of satisfying some want, perhaps impor-
tant, perhaps unimportant. We become definite only when we
have specified the degree of utility possessed by the commodity.
This is commonly called its final or marginal utility, because when
we think of a commodity as consumed in successive portions, the
present is the last or marginal unit consumed. Marginal utility
means simply the importance which is attached to an additional
unit of the commodity at the present moment. This individual
valuation of a imit of the commodity may be spoken of as its sub-
jective value. This is to be distinguished from its market value,
or what can be obtained in exchange for the commodity, which is
a resultant of many individual valuations. Market value will be
discussed in subsequent chapters.
CONSUMPTION
109
Fio.
A dearer notion of subjective value (or marginal utility) may
be given with the help of Figure i, following. We return to
our illustration of water, which we remember had numerous
uses of various d^ees of importance. We have marked off dif-
ferent portions of the base
line representing quantities
of water available for man's
use. The first quantity, ab,
is just enough for drinking
purposes. Suppose this is
all the water to be had.
There will be no question
of sprinkling lawns or even
of bathing under such cir-
cumstances. What will be
the utility of water? Evi-
dendy the extent of the service which it renders us, and as this is
the preservation of our life we cannot estimate it. We will indi-
cate it by the area above the line ab which rims upward indefi-
nitely as the curved line fails to close in. What will be the impor-
tance of another portion of water at this point of supply ? As this
additional portion which we desire is not needed for drinking but
for a less important purpose, the subjective value of the water
wiD now depend upon this less-important want. Now suppose
we have three portions of water, represented by the lines ab, be,
and cd. We now have enough for all our wants, down to sprin-
kling the lawn and the street. We are willing to pay something
for more water for this purpose, but how much? As much as
when we had only water enough to drink ? By no means. The
next want on our list is comparatively unimportant, and of course
we value an increased supply accordingly. With two or three
more portions of water all our wants are satisfied, and water will
have for us no value whatever. Its marginal utility will have
become zero. As the amount of water is increased, the subjec-
tive value falls according to the curved line hi, till finally it touches
the base line, where the utility of the water ceases and it has no
value at alL
no
OUTLINES OF ECONOMICS
It should be carefully noted that marginal utility tells us noth-
ing about the total subjective value of the whole stock of the com-
modity. It refers solely to the present value of an additional unit,
or the sacrifice that would be occasioned by the loss of a unit.
We cannot get the total subjective value by multiplying the margi-
nal utility by the number of units, even though they be all alike.
The very term "marginal" tells us that the conception implies
successive additions, and the present value of an additional unit
tells us nothing definite about the marginal utility at a previous
period. If we wish to ascertain the total subjective value of a
stock of a commodity, we have simply to treat it as one large unit,
and ask what would be lost if it were taken away. By this test
all air would be found to have an immeasurable utility, at the
same time that the marginal utility, that is, the subjective value
of an additional quart, would be nothing. Thus it will be seen
that the cause of subjective value is utility under a condition of
scarcity; that is, such a limitation of the supply that all wants
cannot readily be satisfied.
The Ecoaomic Order of Consomption. — What has been said
regarding the way in which oiu- individual estimates of the im-
portance of a commodity are determined will help to explain how
we make our choices in attempting to obtain the largest amount
la
lb
le
Id
2a
£h
te
td
2t
FlQ, 2
Fio. 3
of satisfaction with the income at our disposal. Evidently we must
spend each succeeding dollar for purchasing that commodity of
CONSUMPTION
III
which a dollar's worth will give the greatest satisfaction. Let Fig
ures 2 and 3 show the declining importance of two commodities
which an individual is consuming, and suppose that each uni
of each commodity costs one dollar. If the individual has tei
dollars to spend upon these two commodities, his order of con-
sumption will be as follows: he would begin with 2a, but another
unit of commodity 2 would give him less satisfaction than a
unit of commodity i. Hence, his consumption will continue as
follows: —
la, 2bj 2Cy lb, iCf id, 2d, 2e, le.
In this illustration it was assumed that a unit of each commodity
had the same cost. In this case, the unit consumed is always the
one that has the largest marginal utility. But where the cost of
the units is different, cost must be considered also, and we com-
monly do so by asking ourselves whether the thing we are buying
is worth as much as other things which could be obtained with
the same expenditure. Thus we are constantly abstaining from
the further consumption of one thing, not because our wants for
it are fully satisfied, but because something else of equal cost
appears at that moment to be more important.
Futttie Wants. — Not all of the goods for which we strive are
wanted for present consumption. We recognize that we shall
have needs next month or next year, and we attempt to make some
preparation for them. These future wants, it is true, usually ap-
FlG.
peal to us less vividly than if they were present, but we attach a
definite importance to them and grade them, and they enter into
112 OUTLINES OF ECONOMICS
OUT calculations when we spend money, ntodifying the order oi
our consumption. This will be seen from Figures 4 and 5. Let
us suppose that in Figure 4y a,bf Cy d,e represent the diminishing
importance of successive units of a commodity for present con-
sumption, and that Figure 5 shows the importance of similar quan-
tities of the same commodity for future consumption. Then la
would be coasumed first, i,e. in the present But a second unit
now would be less important in this individual's estimation than
the saving of a unit for future use. The second imit, therefore,
that is consumed would be 2a, and then the order would be as
follows: lb, 2b, iCj etc. Thus this individual has saved two out
of five units, i.e. 2a and 2ft, with the same sort of mental calcu-
lation as he would use in deciding to spend a nickel for a peach
rather than for a pear. But if some one should ask him to spend
his fifth dollar for 2c instead of for ic, he would require some extra
inducement to repay him for the loss in enjoyment. It thus ap-
pears that a certain amount of saving is done without irksome-
ness, which emerges only when the saving is carried beyond a
certain point.
Alleged Present Consumption of Future Products. — We often
hear of consumption in advance of production. It is said people
live on the future. It is frequently argued that during the Civil
War we were consuming faster than we were producing. It is
alleged that the federal bonds represented the consumption of
future earnings. But it must be apparent that it is impossible
to consume faster than we produce unless we consume past sav-
ings by not replacing worn-out equipment. We cannot eat to-day
the wheat or potatoes of to-morrow, nor can we wear coats before
they are made. What is alleged can only be true of the individual
consumer within the nation, or in case of the nation as a whole
when the capital or other wealth of the country is diminishing,
whereas during our Civil War it increased. What really hap-
pened was thb: we as a nation became indebted to some extent
to foreigners, and within the nation some of us gained while the
rest were losing. Bonds do not represent a present consumption
of future wealth, but a special use of productive power for which
a government agrees to remunerate its owners in the future. li
CONSUMPTION 113
war can be carried on with the aid of bonds, it can, — lea\dng out
of consideration what foreigners send us, — with a sufficiently per-
fect taxing machinery, conceivably always and practically some-
times, be carried on without bonds. It is only a question of how
to get hold of the means of producing powder and bullets. War
was formerly carried on without bonds; they are a comparatively
recent contrivance. Consumption can never anticipate future
production for the nation as a whole taken by itself; it can only
anticipate future ownership.
Consumption and Savings. — It is difficult to say in practice at
what point consumption should stop and saving begin, but the
principle itself is clear. So much, and only so much, should be
saved as will maintain a maximum final consumption over long
periods of time. It is conceivable that the present generation
might deny itself everything except the barest necessities and
labor to increase the productive equipment to be used in the future;
but the next generation could not pursue the same policy, for
some one must consume the products of the factories built to-day,
otherwise the building of them was wasted effort.
To provide for old age or for possible accident may be a suffi-
cient motive for saving in some cases, but saving is stimulated
when the goods saved will bring an increase. It is, therefore,
necessary to an extensive saving that the conditions of profitable
investment should be provided; and if wealth is to be widely dif-
fused, opportunities for investment should be readily available.
It is a perceived opportunity to make an investment with proba-
bility of increase which stimtilates saving above everything else.
Another important condition is seciuity. If the investments of a
country fluctuate between loss of principal and unreasonable profit,
the condition is one to encourage speculation rather than saving.
Among the institutions which encoxu'age saving are private
property, corporations, cooperative enterprises, savings banks,
and insurance.
Loxciiy. — Luxury is the name of a vague something which
society has always viewed with a sense of mingled tolerance and
condemnation. In the first place, it is clear that people ordinarily
condder as luxuries many things in themselves innocent and de-
I
114 OUTLINES OF ECONOMICS
sirable, as sDk dresses, jewels, pictures, etc. No one but an ascetic
will condemn as wrong in themselves things that appeal to taste
and finer appreciations, and yet we feel that the use of such things
is often unjustifiable. Second, the popular idea of luxury recog-
nizes a difference in persons. We cannot help condemning in
one person what we approve in another. Third, we judge luxury
differently at different times. There is a continual transfer of
articles from the list of luxuries into that of comforts and neces-
sities. This transfer is brought about by the consensus of social
judgment, and is increasingly acquiesced in by all. So we see
that the term " luxury " does not apply to goods of a certain char-
acter, but to certain goods in their relation to time and person.
For the purpose of discussion, we shall define luxury simply as
excessive consumption. But what determines whether consump*
tion is excessive or not?
The answer to this question depends, first, upon our idea of
right living, and second, upon our idea of a just distribution of
wealth. The former question we shall not discuss. It is that
of the simple life versus the complex and varied life, and may be
left to the sociologists, philosophers, and moralists. But what is
a just distribution of wealth? In the world's speculation upon
this subject, three ideas stand out prominendy: (i) equality,
(a) product, (3) needs. Let us examine these three bases of
distribution.
The ability of men to use wealth sanely is enormously unequal,
and there is no probability that this inequality will soon be re-
moved. To distribute wealth equally, therefore, would be to use
goods where they satisfied trifling wants or none at all. But in
addition to its wastefulness, an equal distribution is further objec-
tionable because of the discouragement it might give to the ener-
getic members of the community. Would a man continue to
work hard if his lazy neighbor received as much as he? There
is only one sense in which we must regard men as equal, and that
is that the happiness of one is as important as the happiness of
another.
That wealth should be distributed according to what men pro-
duce is perhaps the most widely held idea at the present time^
CONSUMPTION 115
Bomedmes on the ground that it is theirs by natural right, which
is fallacious, and sometimes on the ground that such a method
of distribution is a cure for laziness. There is, however, great
difficulty in applying this test accurately under the complex con-
ditions of modern industry. Who shall say what the president of
a great life insurance society is producing ? How many dollars'
worth has a physician produced who has saved a man's life?
However satisfactory the test of productivity may be in the case
of a man who produces a pair of shoes with his own implements
and labor, it fails at many points under modem industrial condi-
tions, and its failure has become increasingly apparent with the
growth of large-scale production and monopoly.
Those who are impressed with the difficulty of saying what a
man has produced, suggest that we ascertain what he needs. This,
it is true, is not capable of exact determination; but any wide
departures from justice might be agreed upon by judicial inquiry.
Needs are the basis of the distribution within the family. The
solidarity of the family demands it, and this is but the epitome
and type of the solidarity of society. It is unquestionably in the
interest of society that those with the highest capacities should be
allowed to attain the fullest development of all their powers, pro-
rided these powers are used in the service of humanity. What
is necessary to make a man a good citizen? That, according to
this third view, is the ultimate test of a just distribution.
It is not necessary for us to select as a practical programme any
one of these tests and wholly reject the others. The first, equal-
ity, reminds us that the lowliest human being is to be looked upon
as an end, not as a means to the happiness of others; the second
is safe and convenient so far as it can be definitely applied; but
the final test, so long as we are social beings, will always be that
of needs, understanding by "needs," not what the individual asks
for, but what is required for a full development of his powers.
While, then, justifiable consumption will, according to these
principles, be exceedingly variable, can any one for a moment
claim that such principles now govern consumption? Immense
sums are squandered on passing caprices whose satisfaction can^
not by any standard be considered necessary. On the other hand,
Il6 OUTLINES OF ECONOMICS
multitudes of fine natures with keen appreciations and large ca-
pacities for development and present enjoyment are left without
the means for either. So long as these things exist, so long as a
vast amount of the world's wealth is destroyed by vulgar and in-
competent consumption which might impart satisfaction of a high
order if consumed otherwise, and by others, the moral sense of
the world will condemn luxury as a social wrong.
And what is the excuse for this abuse ? Usually the simple fact
of ownership. "It is ours," they say. But for what? Simply
because the interests of production require capital to be massed
under specialized control. There is no more reason why a mil-
lionaire should consume all the income he controls than there is
why a philosopher or an artbt should withhold from society the
satisfactions afiForded by his genius. A successful manufacturer
once expressed the opinion that a man has the right to put down
silk velvet on a muddy crossing to walk on if he is rich enough
to afford it. When a man tramples in the mire the fruit of human
industry, he tramples with it human rights and humanity, and he
should expect humanity to avenge the affront. The right of pri-
vate property, like other social institutions, is ever on trial. The
obsolete objection is sometimes urged that luxiuy gives employ-
ment to labor. Does not philanthropic and productive expendi-
ture do the same? But that is not the question. What comes
of the employment? The payment of wages only helps men to
get more of existing goods from other persons. That may be
good for those workmen individually, but the only way to help
society as a whole is to give men useful employment, to aid and
encourage them to produce needed goods. Every employment of
labor which encourages production of luxuries is a misdirection
of social energy, an encouragement to society to spend its money
for that which is not bread and its labor for that which satisfieth
not.
Harmful Consumption. — We have been careful to avoid the
impression that luxiuy consists in the use of pernicious goods.
It is a common query, "Why should I not have this if it does me
no harm?" This we have tried to answer in the preceding para-
graphs. A luxury may be a positive good in itself, a satisfaction
CONSUMPTION 117
which society may well hope to make general, but it is a good
which society camiot yet afiFord because other and greater wants
are yet unsatisfied. But there is another kind of consumption
which is objectionable in an entirely different way, not because
it is excessive or premature, but because it is harmful in itself.
Such are frequently drugs and alcoholic beverages. As we have
said before, these wants are as economic as any other, and we
have no intention of assuming the function of the physiologist or
the moralist in enumerating the evils which come from the con-
sumption of certain goods. But in one respect we have a distinct
part in this discussion. All production is for the sake of man,
aud consumption is its final term. But in turn man is the prin-
cipal factor in production, and as the consumption of certain
goods affects him, the result is necessarily transmitted to the pro-
ductive process. Now the consumption of certain goods clearly
unfits men for efficient production, lessening bodily vigor, blunt-
ing the perception, and these goods the economist regards as harm-
ful in the sense of being destructive of human energy.
Statistics of Consumption. — ^Instructive investigations have been
made as to the relative importance of the leading items in the fam-
ily budget. The late Ernst Engel, the former distinguished head
of the Prussian Statistical Bureau, advanced the theory that it
might be possible by a careful study of a sufficient number of
family budgets for a period of years to indicate the broad changes
in constunption, and thus by a sort of social signal service to pre-
dict the coming of industrial storms. Nothing has been so far
accomplished along this line, but Engel's tables are interesting.
From Table I (page 118) he deduces the following four propo-
sitions : —
First. — That the greater the income, the smaller the relative
percentage of outlay for subsistence.
Second. — That the percentage of outlay for clothing is approxi-
mately the same, whatever the income.
Third. — That the percentage of outlay for lodging or rent, and
for fuel and light, is invariably the same, whatever the income.
Fourth. — That as the income increases in amount the percent-
age of outlay for sundries becomes greater.
xi8
OUTLINES qF ECONOMICS
TABLE I
Engei^'s Law — Saxony
Inm OF EzrarDiTusx
Per Cent op the Expsndituxx op !
Family op
A Workingman
with an Income
of from lats
to $300 a year
A Man of the
Middle Class
with an Income
of from I450
to S600 a year
AMaainEa«7
Circumstances
with an Income
of from$7so
to $1000 a year
X. Subsistence
fl. Clothing
3. Lodging
4. Heat and light
5. Education, public warship,
etc
6. Legal protection . .
7. Care of health
8. Comfort, mental and bodily
recreation
Total
62.0'
x6.o
XS.O
a.o
i.o
x.o
x.o
950
5.P
5S.O
18.0
X9.0
3-5
2.0
2.0
»-5
•90.0
Z0.0
50.0
18.0
Z9.0
5-5
30
30
35
85.0
15.0
Subsequent investigations in the United States have confirmed
in a general way the conclusions of Engel, but the correspondence
is not exact, as will be seen from Table 11 (page 119), from the
reports of the United States Bureau of Labor, summarizing the
expenditure of over two thousand families in 1891 and over eleven
thousand in 1903.
A recent careful study of two hundred families in New York
gives the following division of expenditures : —
BxANca OP ExnMDrruxB
Amount Spent
Pxa CiMT OP TOTAI.
Food
Rent
$363-42
162.26
88.45
42.46
32.35
147.31
836.2s
43-4
X9.4
10.6
riotliinjr ...
^ *^**'"o • .. .
Light and Fuel
3-9
17.6
100.0
Insurance , .
Sundries •...,....*.* w ^
Total
CONSUMPTION
119
The author of this studj comes to the conclusion that a ''fair liv-
ing wage for a workingman's family of average size in New York
City should be ai Uast (728 a year, or a steady income of (14.
TABLE n
ExPENDrnTKES OP Amekican Families Investigated by the
Uottei) States Bureau op Labo&
(Fxom the Sefantfa [1891] and EightMoth Amnttl Reporti [1903])
Under $200
$200 or under
$300..
$300 or
$400..
$400 or
$500 ••
$500 or
$600..
$600 or
$700 •■
$700 or
$800..
iSoo or
$900..
I900 or
$1000.
$1000 or
$1100.
$1100 or
$1200.
$1200 or over
AD
under
under
under
under
under
under
under
under
under
Pit Cent of Total ExpgwDirum
Food
1891
49.6
44.3
45-6
451
43-8
41.2
38.9
38.1
34.3
34.7
30-7
28.6
41.1
X903
50-9
47-3
48.1
46.9
46.2
435
41.4
41.4
39-9
38.8
37-7
36.5
431
Qothlag
X89Z
Z2.8
14.3
I4.I
14.4
«5.3
iS-9
16.3
z6.8
175
16.S
iS-7
15.3
1903
8.7
8.7
lo.o
11.4
12.0
12.9
135
13-6
14.4
14.9
130
Rent
1891
14.7
15.0
15-3
iS-5
16.1
14.9
12.2
12.6
151
X903
16.9
18.0
X8.7
18.6
18.4
18.5
18.Z
17.1
17.6
17.5
16.6
17-4
18.1
Fuel and
light
Z891
8.1
7.6
7.0
6,6
6.6
59
5-3
5'3
4.7
4.5
3.9
30
S-9
igoj
8.0
7.2
6.7
6.2
5.8
5-3
5-0
S-o
4.9
4.7
5>o
5-7
MiflcelU-
1891
Z4.0
19. 2
18.3
z8.6
19.1
8X.6
a3-9
25-5
29. z
28.Z
3^-7
401^
22.7
iS-6
z8.8
x6.x •
X6.S
Z7.2
19.4
21.6
t3-o
fl3->
a3-7
96.Z
ill
20. z
I20 OUTLINES OF ECONOMICS
a week. Making allowance for a larger proportion of surplus
than was found in these families, which is necessary to provide
adequately for the future, the income should be somewhat larger
than this; that is, from $800 to $900 a year." ^
QUSSTIONS AND EXBRCISB8
I. If you had four sacks of corn all alike, could you tell which is the
marginal one ?
a. If an individual estimates his present wants as 10, 8, 6, 3, i, and his
future wants as equivalent to the present value of 9, 7, 5, 2, o, and if he has
$9, and if each want is satisfied with $1, h6w many dollars will he save?
3. Give as many expressions as possible that are equivalent to the term
"subjective value."
4. Comment on the following : '* Doubtless the best thing to do about them
(the spendthrifts) is to do nothing — not even to worry about their waste
of money. Their waste of money, in fact, is the least silly thing they do, for
the money is in constant flux and serves its purpose." World's Work, June,
1906, p. 7597-
5. Comment on the following words of Adam Smith : " Nothing is more
useful than water ; but it will purchase scarce anything ; scarce anything can
be had in exchange for it. A diamond, on the contrary, has scarce any value
in use, but a very great quantity of goods may frequently be had in exchange
for it." Wealth of Nations, Book I, Chap. IV.
6. Point out the differences in the tables of consumption statistica quoted
in the text.
REFERENCES
B5hm-Baw£RK, £. VON. Positive Theory of Capital, Book III, Chaps. 3
and 4.
Carver, T. N. "How Ought Wealth to be Distributed?" Atlantic
Monthly, 1906, Vol. 97, p. 727.
Devine, E. T. Economics, Chaps. V and VI.
HoBSON, J. A. The Social Problem, Book II, Chap. VII.
Jevons, H. S. Essays in Economics, Chaps. II and III.
Kelley, F. " Aims and Principles of the Consumers' League." American
Journal of Sociology, Vol. V, p. 289.
Marshall, Alfred. Principles of Economics, Book III.
Mayo-Smith, Richmond. Statistics and Economics, Book I, Chap. II.
More, L. B. Wage-Earners* Budgets.
ROWNTREE, B. S. Poverty, Chaps. VI, VII, and VIII.
Smart, William. Introduction to the Theory of Value, Chaps. I to VI.
Eighteenth Annual Report of the United States Bureau of Labor.
* More, Wage-Earners' Budgets, New York, 1907, pp. 908 and 369.
PART III
PRODUCTION
CHAPTER IX
PRODUCTION
Ptodnction Defined. — Man creates no new matter. Neither
the fanner nor the merchant adds one atom to the existing material
of the earth. Yet they are both properly called producers because
they increase our supply of economic utilities. Production, then,
means the creation of economic utilities by the application of
man's mental and physical powers to the materials of nature.
The act of production can be reduced to the following three opera-
tions: (i) changing the form of things, (2) changing their place,
and (3) keeping them until such times as they are wanted ; in other
words, production adds to the materials of nature, form utUUieSf
Ume utililies, and place utilities. It has seemed to some that the
farmer is more truly a producer than the manufacturer, and the
manufacturer than the merchant; but such is not at all the case.
AU of these industrial classes help at some stage in the process
of getting the materials of nature ready for consumption. The
miner gets iron ore from the ground, the manufacturer trans-
forms it into stoves, the railway company transports them, and
the merchant keeps them until they are wanted. One stage is as
essential as another if wants for stoves are to be satisfied. It
may well happen that the utilities produced by the merchant
could be produced with a smaller expenditure of economic force,
and that by a better organization of the factors of production saving
could be effected; or it may be that at times the merchant has
been able to secure a larger return for a given eflFort than the
farmer, but this is no justification whatever for the popular
impression that he is not a productive worker.
122 OUTLINES OF ECONOMICS
Factors of Production. — It has been customary to speak of
three factors of production — nature, labor, and capital. Under
nature are included all forces external to man, as the wind, the
movement of water, attraction of gravitation, cohesion, etc. Fre-
quently these things furnished by nature are called simply land,
because, of what belongs to external nature, it is with land that
we have principally to do in political economy.
Labor, as a factor of production, includes human activities of
every sort, intellectual as well as physical, which have economic
significance. We might better, perhaps, substitute man for labor
as the second factor. Labor is supplied by human beings and is
different from material goods because it is always connected with
a personality. Moral and intellectual qualities increase its pro-
ductiveness. Temperance, trustworthiness, skill, alertness, quick
perception, a comprehensive mental grasp, — all these and other
qualities belonging to the soul of man are of paramount impor-
tance. Man's mere physical strength in itself is a poor thing,
being surpassed by that of the lower animak, but man is far more
productive, and even as a slave sold for more than the lower
animals.
Man can get but little from nature with his unaided hands. The
instruments which assist him, as we have seen, are called capUal;
in other words, capital is every product which is used or held for
the purpose of producing or acquiring wealth. By this definition,
land is evidently excluded from the category. The nation's capital,
then, consists of tools, machinery, business buildings, transporta-
tion systems, raw material, etc. We may here again caution the
reader against confusing these concrete goods with their value.
Capital cannot be looked upon as an independent factor of produc-
tion, since it is derived from the labor of man applied to nature.
This fact has led some persons to say that capital is simply stored-
up labor, but this overlooks the important element of time re-
quired for production with the aid of capital. When we say that
to print a book according to present-day methods requires the co-
operation of labor and capital, we do not deny that the type-setdng
machines and printing presses which are used are themselves the
product of other kinds of labor. To substitute capital for labor
PRODUCTION 123
may seem to be simply substituting one kind of labor for another.
But a long time elapses between the digging of the iron ore and the
actual using of the machines in printing. Capitalistic production,
as distinct from simple hand labor, is merely a difiFerent method —
a roundabout method — of applying human labor to the materials
of nature. It is this time element which gives rise to the problem
of interest to be discussed in a later chapter.
" Capital is an intermediate product of nature and labour, nothing more.
Its own origin, its existence, its subsequent action, are nothing but stages in
the continuous working of the true elements, nature and labour. They, and
they alone, do everything from beginning to end in bringing consumption
goods into existence. The only distinction is that sometimes they do it all
at once, sometimes by several sta^s. In the latter case the completion of
each stage is marked outwardly by the appearance of a fore-product or inter-
mediate product, and capital has emerged. But, let me ask, is a thing any
the less the work of its author that It is not produced all at once, but in in-
stallments ? If to-day, by allying my labour with natural powers, I make
bricks out of day, and to-morrow, by allying my labour with natural gifts,
I obtain lime, and the day after make mortar and so construct a wall, can it
be said of any part of the wall that I and the natural powers have not made it ?
Again, before a lengthy piece of work, such as the building of a house, is
quite finished, it must naturally be at one time a fourth finished, then a half
finished, then three quarters finished. What, now, would be said if one were
to describe these inevitable stages of the work as independent requisites of
houae-building, and maintain that, for the building of a bouse, we require,
besides building materials and labour, a quarter-finished house, a half -finished
house, a three-quarters finished house ? In form perhaps it is less striking,
but in effect it is not a whit more correct, to elevate those intermediate steps
in the progress of the work, which outwardly take the shape of capital, into
an independent agent of production by the side of nature and labour." *■
It has been customary to distinguish fixed capital, which lasts
for a succession of operations, and only a part of the value of which
passes over into the product with each use, from circulating capital,
which is used up in one act of production. Coal used in a loco-
motive is an example of circulating capital; the car in which the
coal is hauled is fixed capital. The difference is one of degree only.
Saving and Capital Formation. — From the individual stand-
point, saving means the postponement of consumption. To lend
* Bdhm-Bawerk, PasUive Theory 0/ Capiial (trans, by W. Smart), p. 96.
124 OUTLINES OF ECONOMICS
to another, and thus secure a claim on his services for the futiu^, is
an act of individual saving, but this does not necessarily result in
saving from the social standpoint. An act can be termed social
saving only when the total social income in the future will be in-
creased thereby. It is conceivable that this might take the form
of merely hoarding up finished consumption goods in anticipation
of a famine, but that is not the kind of saving that is typical of
modern industrial nations. It is true that we frequently produce
durable consumption goods which will be used for a long time in
the future. The construction of a public library building in part
involves social saving. But true social saving may also consist
in bettering the industrial equipment of society. To provide more
and better machines it is necessary to use some of the labor which
might be used to increase our present income. If all of the labor
now used in the construction of new milling machinery, ovens, etc,
were employed in tinning into bread all of the flour we now have
on hand, we could doubtless greatly increase temporarily our
present income in bread, but it would be at the expense of the
future income. Thus the saving which results in the formation
of social capital requires two things: (i) abstaining from the
largest possible income to-day, and (2) using part of our labor in
bettering the industrial equipment. Individual saving, however,
itself commonly results in social saving also, as will be explained
in a later chapter.
Production and Sacrifice. — Over against the enjoyment re-
sulting from wealth consumption lies the discomfort of wealth
production. Enjoyment, we have
seen, grows less and less as the
consumption of a particular good
is continued, but the irksomeness
of producing it, on the contrary,
grows greater and greater the
longer labor is continued. Let
us take the case of Robinson
Crusoe picking berries. We may represent the diminishing
utility of the berries to him by the line ab (Fig. i), and the in-
creasing irksomeness of picking them by the line cd. He would
PRODUCTION las
not pick more than Ox, because the Ji^h berry costs him just as
much pain as it yields him pleasure, and any further continuance
of gathering fruit would result in an excess of pain. The degree of
utility represented by mx, then, represents at the moment that the
x\h berry is picked and eaten, both the marginal utility and the
marginal disutility, or marginal pain or sacrifice.
Each of us is continually making such comparisons — balancing
the pleasure of further consumption against the pain of further
production. Many persons who are working eight or ten hours a
day could increase their income somewhat by working twelve
hours, but the additional discomfort is greater in their estimation
than the additional fruits of their labor would be worth. To be
sure, much of our economic action goes on imconsciously. We
accept a position, considering its advantages and its disadvantages
m a general way as compared with the income it yields, but once
we enter upon the work, we accept the daily grind as inevitable,
and, in spending our income, think not of the pain it causes
us, but simply of how we can get the maximum satisfaction
from it
In discussing future wants we saw that postponing the con-
sumption of goods from the present to the future began to be irk-
some only after a certain amount of goods had been saved. Under
present methods of production, it has just been explained, a large
amount of this postponement of consumption is required. Ma-
chines must be made, and the result of this labor cannot be enjoyed
until these machines have been used up in making finished
products. This means that some one must wait for the result, and
in many cases this is irksome. Thus production may require, in
addition to the pain of labor, the sacrifice of irksome waiting or
abstinence. This is a point which will be discussed further in the
chapter on interest.
Cost of Production and Expense of Production. — The preceding
paragraphs explain the most fundamental sense in which the term
"cost of production " is used, i.e. (i) the subjective cost of painful
labor or irksome waiting. But (2) the phrase is conunonly used to
refer to the expense of production, that is, the number of dollars'
worth of labor and capital goods spent in getting an article on the
126 OUTLINES OF ECONOMICS
market. (3) A third meaning is also found, which may be termed
opportunity cost. Let us say that a person is confronted by the
alternative of engaging in either of two occupations. He may be
either a lawyer or a merchant, but he has not the time to be both.
If he chooses to be a lawyer, he sacrifices his opportimity of being
a merchant. In some cases this form of sacrifice is not easy to dis-
tinguish from the first. If a man is hesitating whether to accept a
position requiring nine hours' work per day or one requiring ten
hours, shall we think of him as considering the irksomeness of the
tenth horn-, or the leisure which he would be sacrificing? But
where the opportunity that is sacrificed is an occupation or busi-
ness, this "opportunity-cost" is simply one way of looking at
the fact that we aim to get the greatest possible return for our
labor.
Organization of the Productive Factora. — The three factors,
land, labor, and capital, must be brought together for purposes of
production. In the case of many farmers and small-scale manufac-
turers, all three are furnished by the same person, but under our
system of private property, a marked differendation of ownership
takes place as industrial development becomes more complex.
In a large-scale establishment it is the exceptional case where the
majority of the laborers have any share in the ownership of the
capital, but generally the owners of the capital are also the owners
of the land. In American agriculture, ownership of the land and
the capital by the same person is also widespread, but in England
at the present time it is the rule that the landowner and farmer are
different persons. On the other hand, factories arc frequently
built upon leased ground, and much land is farmed in America by
tenants who furnish their own capital. Separation in the owner-
ship of the productive factors and accurate accounting make neces-
sary a distinct valuation of the services of each one of the factors.
The Entrepreneur, or Undertaker. --The one who manages a
busmess for himself was formerly called an undertaker, or ad-
venturer, but the first word has been appropriated by one small
class of business men, and the latter has acquired a new meaning,
carrying with it the implication of rashness and even dishonesty.
We have consequentiy been obliged to resort to the French language
PRODUCTION 127
for a word to designate the person who organizes and directs the
productive factors, and we call such a one an entrepreneur; but
recently the term " undertaker " has been more frequently em-
ployed with this broad general meaning.
The function of the entreprenexu: has become such an important
one in modem society that it is often convenient to regard him
as a fourth factor in production, distinct from other classes of
laborers. He has been well called a captain of industry, for he
commands the industrial forces, and upon him more than any
one else rests the responsibility of success or failiu-e. A business
which has achieved magnificent success often becomes bankrupt
when, owing to death or other causes, an unfortunate change in
the entrepreneur is made. The prosperity of an entire town has
sometimes been observed to depend upon half a dozen shspwd^
captains of industry. v/
Divisioii of Labor. — A characteristic feature of the organiza-
don of the factors is what is commonly called a division of labor,
but this term suggests a number of related ideas which must be
distinguished, (i) We may mention first a separation of occupa-
tions, each one being independent of the other, as is shown, for
example, in the splitting up of medical work into various special-
ties, and again, entirely'new occupations are continually appearing.
(2) We also fijid production divided into stages, each one giving
rise to a commercial product, but not to a finished consumption
good. This becomes clear if we think of the history of almost any
article of daily use: the making of bread presupposes the flour and
wheat stages, (j) We have in the third place what is most com-
monly referred to by the term " division of labor," where the pro-
ductive process is divided into minute parts, and one part given
to each laborer. The organization of a cotton mill affords an
excellent illustration: —
In cotton mills, as in all other textile mills, there are men of skill and ex-
perience who superintend or oversee the work In various buildings and in
the rooms and yards. These supervisory employees have assistants, and
the division of superintendence is carried down to the secdons of rooms, so
that all sections have their supervisors, known variously as section bosses,
section hands, section girls, and third hands. The following list ci occupa^
laS OUTLINES OF ECONOMICS
tions will indicate the extent to which division of labor is carried in this
industry: alley boys (or girls); bundle boys; filling and roving carriers;
belt makers, blacksmiths, carpenters, machinists, masons, painters, steam
fitters, and other mechanics, including sometimes electricians and battery-
men; roll coverers; helpers; laborers (unskilled); bale openers; picker
hands or cotton shakers; lap tenders; card brushers; first and second
breaker hands; finisher pickers; card boys; card hands; waste hands;
wastemen; card clothiers; card strippers; card grinders; combers; lap-
head hands; doublers; drawing-frame tenders; railway-head tenders; slub-
bers; speeders, fly-frame tenders; jack tenders; rovers; spinAers; bobbin
boys; yarn pourers; piecer and doffer; back boy; band boys; doublers
and twisters; winders; yam untanglers ; spool boys, white spoolers; warp-
ers; slasher tenders; size makers; reel hands; dye-house hands (with further
subdivisions) ; beamers and splitters ; beam carriers ; warp drawers ; harness
menders; harness brusheis; handers-in; twisters-in; loom fixer; pattern
makers; putters-up of samples; cloth weavers; weavers of designs; yam
carriers ; smash piecers ; spare weavers ; inspectors ; trimmers. The finish-
ing of the cloth is a separate industry.^
This form of the division of labor may also exist without the
use of complex machinery, as in the slaughtering and meat-
packing industry.
"It would be difficult to fijid another industry where division of labor has
been so ingeniously and microscopically worked out. The animal has been
surveyed and laid off like a map; and the men have been classified in over
thirty specialties and twenty rates of pay from i6 cents to 50 cents an hour.
The 50-cent man is restricted to using the knife on the most delicate parts of
the hide (floorman) or to using the ax in splitting the backbone (splitter) ;
and wherever a less skilled man can be slipped in at 18 cents, 18} cents, ao
cents, 21 cents, 22! cents, 24 cents, 25 cents, and so on, a place is made for
him and an occupation mapped out. In working on the hide alone there are
nine positions at eight di£ferent rates of pay. A 20-cent man pulls off the
tail, a 22} cent man pounds off another part where the hide separates readily,
and the knife of the 40-cent man cuts a different texture and has a different
"feel" from that of the 50-cent man. Skill has become specialized to fit the
anatomy." '
Advantages of Division of Labor. — The advantages of a divi-
sion of labor have been enumerated as follows: (i) A gain of time.
A change of operations costs time. Less time is also consumed in
^ From the Glossary of Occupations in the volume on Employees and Wages.
Twclffli Census, Special Reports, 1903.
* Commons, Trade Unionism and Labor Problems ^ p. 924, in a chapter appear
lag originally in the Quarterly Journal of Economics, Vol. XIX, p. i.
PRODUCTION lag
learning one's business, as the labor of each is more simple.
(2) Greater skill is acqiiired, because each person confines himself
to one operation. (3) Labor is used more advantageously.
Some parts of an industrial process can be performed by a weak
person, others require unusual physical strength; some require
extraordinary intelligence, some can be performed by a man of
very ordinary intellectual powers, and so on indefinitely. Each
one is so employed that his entire power is utilized, and work is
found for all, yoimg and old, weak and strong, stupid and intel-
lectually gifted. (4) Inventions are more frequent, because the
industrial processes are so divided that it is easy to see just
where an improvement is possible. Besides this, when a per-
son is exclusively engaged in one simple operation, he often sees
how the appliances he uses could be improved. Workmen have
made many important inventions. (5) Capital is better utilized.
Each workman uses one set of tools, or one part of a set, and keeps
that employed all the time. When each workman does many
things, he has many tools, and some are always idle. (6) Finally,
where the division of labor results in the simplification of opera-
tions, it facilitates the substitution of machinery with mechanical
power in place of direct human labor. ''It is the largeness of
markets, the increased demand for great numbers of things of
the same kind, and in some cases of things made with great accu-
racy, that leads to subdivision of labor; the chief effect of the im-
provement of machinery is to cheapen and make more accurate
the work which would anyhow have been subdivided." ^
Effects upon the Worker. — The effect of the introduction of
machinery upon wages will be discussed in a later chapter, but
here some attention should be given to the effect of division of
labor and machinery upon the life of the worker. It is frequendy
said that when labor is rendered simple it loses both its attractive-
ness and its educational value. A man can like his work when
he manufactures a whole watch, bearing the impress of care and
skill, but who can like the mere routine of feeding material into
some machine? A workingman becomes a mere cog in a great
mechanism, driven at a certain speed, day after day, with no
'Marshall, Principles of Ecamfmics, 4th ed., p. 334.
130 OUTLINES OF ECONOMICS
further interest in the result of his labor than that it is the source
of his daily wage. But much may be said on the other side. To a
large extent the heaviest labor is done with mechanical appliances,
and those movements which are very simple and regular are precisely
the ones which are likely to be taken over by machinery, leaving
to human beings the work which requires intelligence and skill.
" Looked at broadly, is the average work of a laborer in a machine industry
less dignified, less agreeable, less humanizing than it was before the industry
reached the machine stage? From the nature of the question, it is danger-
ous to dogmatize, because neither the affirmative nor the negative is capable
of being demonstrated. The negative view seems to rest mainly upon the
assumption that it is more dignified to be occupied with a great many purely
mechanical operations than with a very few. The old-fashioned shoe-
maker, for example, was laigely occupied with purely mechanical opera-
tions, most of them of a very elementary nature, such as a machine can do
quite as well as a man. Each of these operations required great concen-
tration of attention, leaving him very little opportunity for other forms of
mental activity. He was the slave of each particular task as truly as a
modem machine worker can be said to be the slave of his single task.
But the old-fashioned shoemaker had to turn from one kind of work to an-
other. This increased the difficulty, and, on the whole, required of him a
greater amoimt of concentration than is now required of the operator of a
machine. The latter, who has but one routine task to learn, learns it
easily, and can carry it out without very intense concentration of mind.
His mind, therefore, would seem to be freer than that of the old hand
worker, though there was more variety to the work of the latter. Whether
this greater variety is to his advantage or disadvantage would be difficult
to determine ofifhand. It looks as though the operator of a machine in a
Shoe factory, being relieved of the necessity of acquiring several forms of
specialized manual dexterity, would be in a better position for free mental
activity than the old-fashioned shoemaker.*' '
It seems that those who declaim against factory life do not dis-
tinguish those things which are temporary and those things which
are inherent in the system. Long hoturs, insanitary conditions of
work, and frequent industrial accidents need not be inevitable ac-
companiments of the use of machinery. It is the efficiency of
machine methods that makes leisure possible for the workingmen,
and when they learn to use that lasure sanely, their condition will
»T. N. Carver, "Machinery and the Laborers," Quarterly Journal of Eeo*
nomics, February, 1908, p. 930.
PRODUCTION 131
be far in advance of what it could be under more primitive methods
of production.
The charge is also brought against machine production that it
is antagonistic to the development of art. Machine production
means uniform production. It is possible that a growth in the
desire for what is beautiful rather than cheap wiU limit the use of
machinery in some directions (e,g. we may insist upon more hand
work in the making of fumitiu-e), but an extensive use of machinery
will always be necessary as a servant of art, and that in two ways:
(i) for an appredadon of art there must be leisure, or at least
leisurely work, and without machine methods this is not possible
for the masses; (2) there is much work that is preliminary to the
work of the artist, and that can be done by machinery. Will a
building be less artistic because much of the heavy work of dress-
ing the stone is done by machinery?
Territorial Division of Labor. — The concentration of a certain
industry in a pai;;dcular region is often called the territorial division
of labor, or the localization of indiistry. Illustrations are seen in
the prominence of* the boqt and shpe industry in Massachusetts;
the collar and cuff manufacture in Troy, New York; oyster can-
ning in Baltimore; the manufacture of gloves in Gloversville and
Johnstown, New York ; of coke in the Connellsville district,
Pennsylvania; of brassware in Waterbury, Connecticut; of carpets
m Philadelphia; of jewelry in Providence, Rhode Island, Atdeboro,
and North Attleboro; slaughtering and meat packing in Chicago;
the manufacture of plated and britannia ware in Meriden, Con-
necticut; and the manufacture of silk in Paterson, New Jersey.
The following causes of localization have been mentioned: (i) prox-
imity to raw material, (2) accessibility to markets, (3) presence of
water power, (4) favorable climate, (5) availability of labor,
(6) availability of capital, and (7) the momentum of an early start.
The explanation of how these causes have operated in particular
instances is left as an exercise for the student.^
iConsnlt HaU, *'The Localization of Induaby," Census Bulletin, No. S44 (also
found in Twelfth Census, Manufactures), and Ross, "The Localization of
Industry," Quarterly Journal of Economies, Vol. X, p. 347- Also the Federal
Census of MaBofactures for 1905, Vol. I, Chap. XII.
132
OUTLINES OF ECONOMICS
Productive Orgaxiization of fhe American People. — According
to the Census of 1900, nearly two fifths of the total population and
about one half of the population ten years of age and over are
engaged in gainful occupations. In the following table the extent
to which persons in each age group are gainfully employed is shown
for each sex: —
TABLE I
NuuBER OF Males and of Females of Each Specified Age engaged
IN Gainfxtl Occupations compaeed with the Total Number of
THE Same Sex and Age : 1900.^
Aox Gkoups
aob and ovxk.
Pe» Cent of Total
» Each Gkoup
Age a2«d ovkx.
Pm Cent of Total
10 to I < vears
a6.i
76.8
93»
96.3
96.6
955
90.0
68.4
59-6
80.0
10.2
16 to ao 3^ears
33-3
30.8
19.9
15.6
14.7
13.2
9.1
24.2
18.8
21 to 24 yvftrs ...*t. ■..««**■«.
9? to t4. vcars
ic to AA vears
4.K to <A vears
^3 *" 0^ / wi»» 0.
c c to 6a vears
6<! vears and over.. ...........
Age unknown
Aggregate
The fact that women at work in their own households are not
counted as gainful workers is apparent from this table. The
effect of school attendance is seen in earlier age groups. In the
column for the female workers the effect of marriage is seen in the
decline in the percentages after twenty years. Old age makes its
influence felt in both columns.
The following table shows the distribution of the gainful workers
among the five main classes of occupations. The most striking
facts are the decline in the relative importance of agricultural piu*-
suits and the increase in the relative importance of trade and
transportation : —
s Twelfth Censtu, Special Report on Occapations, 1904, p. crrlfi.
PRODUCTION
lii
TABLE n
Dbthbution by Main Classes of Persons xnoaosd in Gazmtdl
occdpatioms 1
X900
1890
1880
35-7
4.3
Z9.3
16.4
244
39-2
4.0
18.1
14.3
24.4
44.3
35
Z9.6
10.8
ai.8
I^ofessiona] service
Domestic and persona] service
Trade and transportation
Manufacturing and mechanical pursuits. .
lOO.O
Z00.0
Z00.0
Tbe broad territorial division of labor is seen when these per-
centages are given separately for groups of states: —
TABLE m
Per Ctm of Gaiswxjl Workers in Each Class cat Occupations by
Groups of States: zpoo*
North Atlantic
Sooth Atlantic
North Central
South Central
Western
^
"5
50.8
36.6
63.4
27-3
4.8
30
S-o
a.9
S-7
az.6
90.0
Z8.4
az.8
9Z.8
Z7.4
9.Z
Z9.4
0.3
0.6
o.z
o.z
2-3
z.o
1-7
z.o
7-4
367
Z4.Z
90.8
8.3
Z7.9
In Table IV the various occupations differentiated in the Census
Report on Occupations have been classified somewhat in accord-
ance with their natural ranking, the amount of skill they require,
and the educational influence which they exercise over the people
who follow them. In each element of the population the females
^Twelfth Census Special Report on Occupations, 1904, p^ IzzxrL
• Special Report on Occupations, 1904, pp. zdv and dl.
134
OUTLINES OP ECONOMICS
are foimd to a larger extent than the males In the lower grades of
skill. For both male and female negroes, the percentage of those
engaged in unskilled labor is very large. For the other elements
of the population there is an upward trend out of this lowest
grade.
TABLE IV
PEItCENTAGE OF NATIVE AND FOREIGN BORN ElEICENTS AND NeoSOES
engaged in the special gsoups oe occupations classified by
Sex : 1880, 1890, and 1900
NAIIVITT AMD SKX
Native Born
Males.. .
Native Bom
Females.
Foreign Born
Males . .
Foreign Born
Females
Negroes
Male ..
Negroes
Female .
Yeak
1880
1890
1900
1880
1890
1900
z88o
1890
1900
1880
1890
1900
1890
1900
1890
1900
I
I
35-9'
35.83
3»-4i
3.28
7.72
8.67
27.81
24.77
33.36
4.16
7.08
7-95
26.65
25.98
5-45
6.07
3.X2
3-74
3-9^
7.54
9-3a
12.50
9.02
2.15
2.45
2.56
2.52
2.94
1.20
I.I5
.90
1.19
4.29
6.75
9.00
I.6I
536
X2.50
2.78
4.18
5."
.82
2.39
4.70
•39
.46
.08
.12
"•55
14.59
15.20
1.62
2.10
2.83
17-58
19.98
19.45
1.58
1.82
1.71
6.07
5-S»
.04
5.83
6.a6
6.43
20.65
23.40
29.00
13-25
12.78
14,19
30-37
27.46
30.18
3-37
3.92
2.91
2.86
39.30
33.84
34.00
66.30
52.10
34.50
36.56
36.14
35*44
60.5a
58.37
52.52
62.32
62.98
90.06
89.72
Prepared by Mr. H. J. Dahl. of the University of Wiscxmsin, from the Reports of the
Twelfth Census, and from Mr. W. C. Hunt's mono«rraph, entitled, Workers at GakiiiA Ocew
faHom^ published in the BuUetfai of the Department of Labor, No. zi, July, x897«
PRODUCTION 135
QUESTIONS
z. Is the employee in a planing mill in a worse position than the old-time
carpenter who has to do his planing by hand ?
3. Is an insurance agent a producer of wealth ?
3. What would happen if there should be too much saving?
4. When you spend money, do you ordinarily think of how hard you had
to work to get it?
5. Why is Massachusetts the center of the boot and shoe industry ?
KEFERSlfCES
Carvkr,T.N. The Diaribiaion of Wealth, Chap. II.
FiSHEK, Irvino. The Nature of Capital and Income, Chaps. V and VI,
HOBSON, J. A. The Social Problem, Book II, Chap. II.
Marshall, Alfred. Principles of Economics, Book IV.
Veblbn, T. B. The Theory of Business Enterprise, Chaps. II and III.
Valuable collateral reading will be found in recent bulletins of the
Cenras Buicau deicribiog specific banches of pzoductioo.
CHAPTER X
BUSINESS ORGANIZATION
The dominance of '' business'' in our present social economy is
so familiar and commonplace a thing that we are apt to forget its
real significance. But it indicates, as nothing else does, the
cleavage that exists in modem times between money making and
the other things of Ufe — between exchange economy and domes-
tic economy. Commerce and manufactures have each in turn
been brought under the dominion of business enterprise; busi-
ness methods and motives are also of the first importance in
agriculture, although in this last field production for domestic
use still continues and promises to continue hand in hand with
production for the market.
''Business" means profit seeking. It does not cover so broad
a field as does ''production," nor is it quite the same thing as
"production for the market." Business is acquisitive rather
than productive, and while acquisition usually implies produc-
tion, this is not invariably the case. The economic world, in its
business aspect, is a world of buying and selling rather than of
making and using things; it is a world in which prices, expenses,
debts and credits, and contractual relations are the dominating
things rather than the technical processes of production or the
ultimate costs of production as measured in human effort and
sacrifice.
The Nature of Business Units. — Under competitive conditions
profit seeking involves risk taking. The business world is made
up of profit-seeking, risk-taking units, — entrepreneurial units.
We are apt to think of business units as concrete things, com-
posed of individual men or groups of men. In an ultimate
sense this is true, but for present purposes we may more profit-
136
BUSINESS ORGANIZATION
137
ably view business units as abstract things, — the centers or
Joci of tbe contractual and other legal relations that bind the
business world together. These relations are recorded and stated
more or less fully in the accounts of each business unit; ulti-
mately, however, they are matters of legal fact, and, as we shall
see, the legal aspect and the occaunHng aspect of these relations
are not always identical.
Without entering into either the general theory or the details
of accounting, we may note that the simplest general way in
which a business unit can be described by its accoimts is by
means of the income sUUement^ which is a simple record of money
receipts and money expenditures during a given period, such as
a month or a year. Of more significance, however, in the present
connection, is the balance sheet, which b the statement of the
assets or resources and the liabilities or obligations of the busi-
ness unit as they exist at a particular time. The income state-
ment is a historical record, the balance sheet a photographic
snap-shot.^ The following is a simplified form of balance sheet
for a small manuf actiuing establishment : —
Assets
Land and buildings $190,000
Machinicry and fixtures. . . 50,000
Raw materials, goods in
process, and finished
goods on hand 6o/>oo
Accounts receivable 8,000
Cash on hand and in banks 7,000
Total assets $3x5,000
LiABiLrnss
Original capital invested. $200,000
Income reinvested 6o/>oo
Accounts payable 50,000
Profits d5t00o
Total liabilities $315,000
The itemized assets explain themselves, but the meaning of
the various liabilities may not be so clear. In this statement all
the items of the liabilities except '^accounts payable" refer to the
liabilities of the business unit, as an abstract entity, to the owner
' The proJU^nd4oss staUment is another important exhibit. It difiFers from
the income statement in that it is a showing of the amount of sales in a given period
compared with the expense of producing the particular things sold. Accurate
profit-and-loss statements represent the highest achievements of modem account-
ing aad cost-keeping methods.
138 OUTLINES OF ECONOMICS
or owners of the business, — the amount which would be left if
the business were sold as a whole at a price just equal to the
total imputed value of the assets minus the actual outstanding
obligations (the accounts payable).^ It will be noted that the
item called '^ profits'' is the variable by which the account is
balanced. On such a showing as this the owners might decide
to take $5000 out of the business as dividends, or personal profits,
as the case may be. This would reduce the ''cash " to $2000 and
correspondingly reduce profits. They may decide, also, per-
manently to retain $10,000 of their earnings in the business.
''Profits" would then be reduced to $10,000, and the "income
reinvested" or "siuplus," as it is often called, would be increased
to $70,000. In practice "surplus" and "profits" often constitute
only one item in the accounts. In the case of corporations the
"original investment" item is called "capital" and represents
the par value of the corporation's securities, whether the full
amoimt has been actually paid in or not. Siuplus profits in such
cases can be easily converted into "capital'* by means of "stock
dividends."
In the legal aspect, however, the business does not always
app)ear to have so distinct a unity of its own. This varies with
the form of business organization, of which there are three im-
portant types: the individual entrepreneur, the partnership, and
the corporation.
^ The Individual Entrepreneur. — Any individual may set him-
self up as a business man, an entrepreneur, without any legal
formality except the payment of the license fee which most states
impose on some kinds of business undertakings, such as liquor
dealing, and which some states, especially in the South, impose
upon many kinds of undertakings. The individual entrepreneur
still dominates the field in agriculture, small retail trade, and in
local "shop industries."
In the legal aspect the obligations of a business conducted by
^ The form of balance sheet given in the text Is in reality a simple adaptation
of the kind of balance sheet used in the published statements of corporation
accounting. But if the individual proprietor of a small business keeps an accurate
ledger account with himself, the result is the same so far as the independence of
the business as an accounting unit is concerned.
BUSINESS ORGANIZATION I39
an indiTidual entrepreneur are the personal obligations of the
entrepreneur. All of his possessions of whatever kind ^ are
jeopardized by his business risks. If the entrepreneur conducts
two distinct business undertakings, the assets of one may be
seized, if necessary, to secure the liabilities of the other. The
personal liability of the individual entrepreneur is accordingly
said to be unlimited. The usefulness of this kind of business
(Hganization is limited, obviously, to small imdertakings, where
the capital and credit of the individual business man are adequate.
Partnerah^. — A ''firm'' or partnership represents a joint
undertaking by individual entrepreneurs. Partnerships are most
common in mercantile imdertakings of moderate size, in small
manufacturing establishments, and in the professions. This join^
ing of interests makes larger undertakings possible, but relatively
increases the personal liability of the individual members of the
firm. For each member is personally liable for all of the obliga-
tions contracted by the firm, as well as those contracted in the
ordinary course of business by any other one member of the
firm.' The partners may have a contract binding among them-
selves as to their respective contributions (of money or time),
shares in profits, and liabilities. But a member released from
personal liability by an agreement of this kind is still liable for
all obligations incurred by the firm. The agreement only gives
a basis for instituting legal proceedings to recover the amount of
his personal losses from the other members of the firm.
Aside from (i) the excessive personal liability involved, the
partnership is open to objection from the business man's point
^ The "eiemption laws" of some states constitute an exception which does
not affect the principle involved.
'This refers to the status of the ordinary partnership under common law.
The statutes of some states provide for a special form of limited partnerships in
which one or more of the partners are special partners, who are not personally
liable, save for their investment in the business, and who are allowed to take no
active part in the management of the business. In a few states there is a special
form called a limited partnership association, in which the liability of all the
pajtncrs is limited. These are practically joint-stock companies with non-
transferable shares. The partnership in comntendam, which still exists in Louisi-
ana as a heritage of the dvil law, is essentially like the statutory limited partnerships
of other states.
140 OUTLINES OF ECONOMICS
of view, because: (a) It is impossible for a partner to retire from
a firm without dissolving the partnership and, possibly, break-
ing up the business. The death or insolvency of any partner has
the same effect. (3) A new member cannot enter the firm nor
can a member transfer his interests to another person without
the consent of all the members of a firm, — requirements which
naturally follow from the nature of a partnership. (4) The
partnership form of organization is not adapted to undertakings
requiring large investments of capital and hence requiring the
cooperation of a large number of persons. What advantage the
partnership has come from the ease with which it can be organ-
ized and dissolved, and from its elasticity, — that is, the ease
with which the contractual relations among the partners, bind-
ing as among themselves, can be altered to suit any contingencies
that may arise.
The Corporation. — The federal census of 1905 showed that
although less than one fourth of the manufacturing undertakings
included in that enumeration were organized as corporations,
yet these produced nearly three fourths of the total manufactur-
ing product (measured in money value). Most banks and insur-
ance companies are corporations, while in the field of railway
transportation corporations are in almost exclusive control. Ac-
count should also be taken of the large and growing number of
mercantile imdertakings organized as corporations.
In the case of the corporation the legal view and the account-
ing view of the business unit are practically identical. While
the ordinary partnership is in law simply a group of individual
entrepreneurs, the corporation is regarded, for some purposes, as
a ** person." To the incorporated business imit, — an abstract
thing, as we have seen, — the law imputes some of the attributes
of personality, — and of a personality distinct from that of the
individual men who are the stockholders of the corporation.*
Municipalities, universities, monasteries, guilds, etc., were commonly
incorporated by royal charter long before business corporations of the
^ Several states authorize the organization of "joint-stock companies" which
are like corporations in all essential particulars, and are sometimes called "quasi-
corporations." In theory they are incorporated partnerships with transferable
shares and (usually) with limited liability.
BUSINESS ORGANIZATION 141
modem kind arose, — for this did not occur until the rise of ''capitalism"
in the seventeenth century. The great trading and colonizing companies,
such as the British East India Company, the Virginia Company, the Guinea
CcHnpany, etc., were the prototypes of the modem business corporation.
In connection with these trading companies the joftU-stock principle, which
had already been used in a few isolated instances of banking, was developed.
This was the practice of issuing certifiicates to those who made contributions
to the "joint stock" (or capital) of a company, which entitled the holder
to a proportionate share in the profits accruing to the joint stock. The
modem business corporaticxi, like these early trading companies, is baaed
essentially on the combination of the joint-stock principle with the legal
recognition of the business unit as a distinct entity.
At the beginning of the nineteenth century what few corporations there
were in America were, for the most part, banks, insurance companies, or
canal and tumpike companies. The introduction of railways in the third
decade of the century greatly stimulated the organization of corporations,
because these new undertakings required larger investments of capital than
could be furnished by any individual or finn. State enterprise, it is tme,
promised at one time to be an important factor in canal and railway building,
but such state undertakings were usually planned with the purpose of de-
veloping natural resources, attracting immigration, and building up the
trade oi particular districts and particular cities rather than of getting money
profits. Most of these state undertakings had succumbed by 1840, so that
the field was left open for business enterprise. In the general expansion and
reorganization of business that followed the Civil War the corporation form
of organization began to be more generally used for all kinds of business
undertakings. The growing importance of corporations in business life is
partly an effect and partly a cause of the growing size of the business unit.
The Corporation Charter. — The corporation is a creature of
the state, its right to exist being dependent on a charter or on
arHdes of incorporation, granted or approved by the state. In-
corporation formerly necessitated a special act of the legislature
in each case. This gave opportunity for favoritism and monop-
oly and subjected corporations of all kinds to hostility and
suspicion. Most corporations are now organized under general
laws, whereby any group of men can secure a corporation charter
by complying with certain prescribed conditions. In fact, all
but six states now have constitutional provisions against the
granting of charters to business corporations by special act.
It was formerly a common practice to grant corporation char-
ters in perpetuity, but the decision of Chief Justice Marshall in
I4a OUTLINES OF ECONOMICS
the Dartmouth College case, whereby the corporation charter
was declared to constitute a binding contract between the state
and the corporation, which could not be altered or amended by
the state except with the consent of the corporation, has led to
the general practice of limiting the life of corporations to terms
of from twenty to one hundred years, fifty years being a common
period. The corporation may, of course, secure a new charter
at the expiration of the old, but the limited term gives the state
the opportunity to change the requirements of the charter from
time to time, or to refuse reincorporation altogether, as may seem
most desirable. Most states, moreover, now specifically reserve
the right to alter or amend the corporation charter at pleasure.
Corporation charters, or articles of incorporation, usually con-
tain details relating to such matters as the purpose or purposes
for which the corporation is formed, its principal place of busi-
ness, the number of its directors, and the amount of its capitali-
zation.
Lack of Uniformity in State Laws. — Many difficulties in the
public control of corporations have arisen from the fact that
while charters are granted by individual states, the activities of
many business corporations extend over the boundaries of many
states. Moreover, some states are much more lenient than
others in such matters as the control of capitalization, require-
ments as to publicity, limitations on the scope of activity of a
single corporation, taxes and fees, etc. New Jersey has become
known as the '^home of corporations" despite the fact that some
states have even more lenient laws than New Jersey. New Jersey
has been favored, however, on accoimt of the proximity of New
York. City, — the real home of most of the greater corporate in-
terests of the country, — as well as on account of its early start
and the adaptability of its laws to the most modem type of cor-
poration,— the holding company. (See p. 150.)
Other states, with stricter laws, could not prevent corporations
organized under lax laws from doing business within their terri-
tory so far as that business is interstate. So far, however, as a
corporation organized under the laws of one state carries on any
part of its business wholly within the borders of another state.
BUSINESS ORGANIZATION I43
the latter state has the right of refusing to recognize it as a cor-
poration; that is, the right to treat it as a mere partnership. In
practice, however, one state freely recognizes the corporations of
another state under the rule of "interstate comity." In fact,
many corporations transact all their business outside the borders
of the state which chartered them. The real standards, therefore,
are the laxest standards, not the highest. More use on the part
of American states of the power of exacting certain standards
from "foreign corporations," as they are called, is much to be
desired.
Corporation Capital and Secnrities. — In a strictly legal sense
the capUalizaiion of a corporation is the amount of its authorized
capital stock. This capitalization represents, in theory, the
amount of money actually invested in the business by the original
stockholders. As a matter of fact, the full amount of the au-
thorized capital is rarely paid in at the organization of a new cor-
poration. The capitalization is apt to be, in practice, a purely
arbitrary thing, — a nominal money sum divided into units or
shares, the rdaiwe holdings of different individuals being meas-
ured by the number of shares they own.
Corporation stock is divided into two general classes, — pr^
ferred stock and common slock, although many corporations issue
only the latter. Preferred stock represents a prior claim on the
earnings of the corporation. A corporation which has "6 per
cent preferred stock" outstanding can pay no dividends to its
common stockholders until it has paid 6 per cent dividends on
its preferred stock. Preferred stock may be cumulcUive (in which
the pricff* claims to dividends accumulate from year to year, if
unpaid) or tum-cumulaiive. It may or may not have any claim
on any part of the surplus profits remaining after a certain rate
of dividend has been paid on the common stock. There may be
several different grades of preferred stock, — first preferred,
second preferred, etc.
In the popular use of the word the capitalization of a corpora-
tion includes also its funded debt. The funded debt is represented
by bonds, which are interest-bearing promises to pay certain sums
of money at definite times in the future. There are many differ-
144 OUTLINES OF ECONOMICS
ent kinds of bonds, but three principal classes are: (i) mortgage
bonds, (2) collateral trust bonds, (3) income and debenture
bonds. The first class is based on a mortgage of all or of a specific
part of the property of a corporation. Collateral trust bonds are
secured by the pledge of securities issued by other corporations,
but owned by the corporation issuing the bonds. They have
been much used in financing railway consolidations. Income
and debenture bonds are usually secured only by the earning
capacity of the business. Industrial corporations make less use
vof bonds than do railways, and confine themselves usually to the
mortgage bond type, — of which, however, there are many sub-
ordinate varieties. In the case of many corporations the mort-
gage security behind an issue of bonds is in itself not of great
importance, for the property mortgaged is apt to be worthless
except as an integral part of a unified business establishment.
The mere power of foreclosure, however, gives mortgage bond-
holders a position of strength in the reorganization of insolvent
corporations.
Bonds are sometimes said to represent '^ creditor interests,"
and stock ''entrepreneur interests." This statement is sugges-
tive and is fairly accurate. In fact, however, stock and bonds
are simply different kinds of equities in a business, — conveying
the right to receive income, to share in the distribution of the
assets in case of insolvency, and to have a voice in the manage-
ment. Stockholders alone participate in the management of the
corporation, although bondholders are often able to dictate
policies when the affairs of a corporation are in a precarious con-
dition. Bonds differ from stock in being terminable at a definite
period of time in the future. In practice, however, the bonds of
great corporations are usually replaced by new issues as rapidly
as they mature.
Overcapitalization. — Much has been said about the over-
capitalization of corporations, — ''stock-watering," as it is called.
Only a few states require that all the nominal capitalization
should represent capital actually invested. In most states, more-
over, it is not difficult for a corporation to increase its capitali-
zation from time to time in order to secure fimds from the sale
BUSINESS ORGANIZATION 1 45
of securities, or (in the case of stock-dividends) in order to afford
a basis for the distribution of surplus profits without employing
an excessively high interest rate. It is this last cause of in-
creased capitalization that is of special importance in this con-
nection.
On the one hand it is urged that capitalization is a nominal
thing, that it is immaterial whether a corporation pays 12 per
cent dividends on $1,000,000 of capital stock or 6 per cent
dividends on $2,000,000 of capital stock. On the other hand it
is said that capitalization should not be a merely nominal thing,
but that it should represent the actual amoimt of the investment;
that, without regard to the amount of capitalization, regularly
recurring dividends of 12 per cent suggest excessive profits in a
way that 6 per cent dividends do not.
The argument in favor of a closer correspondence between
capitalization and real investment is especially strong in the
case of railways and other transportation corporations with
quasi-public functions, municipal public service corpbrations,
and corporations enjoying natural monopolies of all kinds. For
there is a growing feeling that such corporations are in a peculiar
sense social trustees, to whom have been conunitted certain'
public economic functions that might very properly be per-
formed by the state, if that coiurse were deemed the more advan-
tageous. That such corporations should be restricted to the
payment of a reasonable dividend on reasonable capitalization
would seem to be a proposition that is scarcely open to question.^
Yet excessive profits are what make excessive dividends possible,
and whether profits are excessive or not can be determined in
most cases without reference to capitalization by the compulsory
use of adequate accounting methods.
Overcapitalization should be looked at also from the point of
view of the investor, — a point of view too often overlooked.
When overcapitaUzation is permitted, it is frequently extremely
difficult and often, indeed, impossible for the ordinary investor
to know precisely what he is buying when he purchases a share
^ It is better to curtail excessive profits by public control of rates, prices, and
services than by arbitrarily Umitiog the dividend rate.
L
146 OUTLINES OF ECONOMICS
of stock of an overcapitalized company. It helps to approri-
mate equality of opportimity for all when there is an exact cor-
respondence between investment and capitalization. If a person
buys a share of national bank stock at $4000, he at once knows
that the original investment was $100. The apparently high
price immediately challenges attention, and the investor is led to
look into the grounds of the high price. There are cases in which
such a price would prove a remunerative investment, but it is
well to warn the investing public by prohibition of overcapitali-
zation. It has been strongly urged, and with some groimd, that
it is in every way highly desirable that the corporate property of
the country should be more widely distributed ; and to promote
this end, every measure which gives the average man a "square
dear* in investments must be strongly favored.
While overcapitalization has thus many undesirable features,
it has nevertheless sometimes been unduly emphasized in discus-
sions of corporation reform, to the neglect of other and more
important points.
In this connection we should note the difference between the
"capitalization" and the "capital" of a corporation. The busi-
ness world uses the term "capital" in two ways: it speaks of the
total permanent investments, — the amount of money "tied up,"
— in a business as its capital, and it also speaks of the total sell-
ing value of the business as a whole as its capital. This last may
depend in part on such intangible things as monopoly power or
good will. It is measured by the "capitalized" earning capacity
of the business, or, approximately, by the market value of the
corporation's securities, as distinct from the par values which
measiue the nominal capitalization of the corporation.
Form of Capitalization. — A significant feature of recent de-
velopment in corporation finance is the multiplicity of types of
corporate securities. It is no uncommon thing, for example, for
the equities in a railway corporation (in addition to the floating
debt, or accounts payable) to be divided among a dozen or twenty
varieties of bonds and two or three varieties of stock. This
multiplicity of securities is of advantage to the corporation in
that it enables it to offer to investors and speculators a carefully
BUSINESS ORGANIZATION I47
graded assortment of risks, — a fact which makes the total sell-
ing value of a corporation's securities greater than it would other-
wise be. This complex kind of capitalization has, however, some
undesirable features. If the owners of a particular security, —
the common stockholders, perhaps, — control the corporation,
they may desire to increase the value of their seciuities for specu-
lative purposes by the payment of imeamed dividends, very
properly a criminal proceeding according to the laws of some states
— a proceeding which would be opposed to the interests of the hold-
ers of all the other securities of the corporation. Moreover, in
cases of insolvency and reorganization, it is a difficult matter to
untangle and to adjust equitably the rights of the holders of the
different kinds of securities.
In times of prosperity corporations often pay for extensions of
their plants from the proceeds of bond sales, because it is esti-
mated that the earning power of such extensions will more than
suffice to pay the interest on the bonds and will afford a hand-
some surplus for the stockholders. Corporations thus accumu-
late in prosperous times an unwieldy load of fixed charges in the
form of interest on bonds, — a fact which is apt to be a source
of difficidty in less prosperous years. In periods of financial
stringency these fixed charges are a common cause of insolvency,
receiverships, and consequent reorganizations, from which the
bondholders are apt to emerge as stockholders, and in which
the stockholders are apt to lose their holdings. The legal restric-
tion of the securities issued by any one corporation to one kind
of stock and three or four varieties of bonds is both feasible and
desirable. Nor should the bonded debt be allowed to greatly
exceed the amoimt of the paid-up capital stock.
Corporation Management. — The management of business cor-
porations is, as a rule, in the hands of boards of directors^ elected
by the stockholders from among their own number. The details
of management are in the hands of officers, chosen usually by the
directors. In principle this system achieves something like repre-
sentative government of the affairs of the corporation. In prac-
tice, in the larger corporations, some of the directors are apt to
be "dununy directors," — usually employees of the corporation,
148 OUTLINES OF ECONOMICS
made directors in order to complete the number prescribed in
the charter, — or are the representatives of great financial in-
terests, and often of competing interests. Directors of this latter
sort are not primarily concerned with the management of a cor-
poration in the interests of its stockholders and bondholders.
They are directors for the purpose of guarding special interests,
and in many cases for the purpose of preventing "competition"
from becoming anything more active than an armed peace.
In many cases the real direction of a corporation's policies is
in the hands of an "executive committee " or "finance conmiittee "
of three or five directors representing the person or persons in
actual control of the corporation.
Advantages of the Corporation as a Form of Business Oiigan-
ization. — From the point of view of the business man the cor-
poration presents decided advantages over the partnership for
all undertakings of considerable size. Some of its points of
superiority are: (i) Stockholders usually have no personal lia-
bility for the corporation's obligations except so far as the full
par value of their stockholdings has not been paid up.* (2) The
relative permanence and stability of the corporation are of decided
advantage, especially in undertakings requiring large invest-
ments of capital in relatively fixed and permanent forms. (3) The
concentration of executive power in the hands of directors and
officers leads to efficiency in management. (4) The transfer-
ability of corporation securities makes it possible for stockholders
to enter or leave the undertaking at pleasure. (5) The division
of the securities into small units and into different grades and
classes affords opportunities to all kinds of investors, — the small
and the large, the conservative and the venturesome. (6) All of
the advantages named make it easier for the corporation to
attract and to use efficientiy large amounts of capital, furnished
by many different investors.
Social Aspects of the Growth of Corporations. — That corpora-
tions do possess desirable features, from the point of view of
^ Exception should be made of banking and insurance corporations, in the case
of which "double liability" on the part of the stockholders is common. A few
states impose some measure of personal liability upon the stockholdezs of all
corporations organized under their laws.
BUSINESS ORGANIZATION I49
business interests, is a fact clearly evidenced by the unprecedented
growth of this form of business organization. In the main, effi-
ciency for business purposes, for money making, means efficiency
from the social point of view, productive efficiency, also. But,
nevertheless, the two viewpoints are not identical, and what is
desirable from one point of view is not always desirable from
the other point of view.
The gap between money making and service to society (never
quite identical things) is distinctly widened when those in control
of a corporation's policies subordinate the profits to be obtained
by the sale of its products to the profits to be obtained by specu-
lation in its securities. Many of our greatest corporations are
directed by men to whom fluctuations in capital values (as repre-
sented in the prices of securities) are a much more important
source of personal income than are the net earnings of such
corporations. The payment of unearned dividends, the non-
payment of earned dividends, the direction of a corporati<Mi*s
policy for the benefit of the holders of one kind of security among
the different ones issued by the corporation, the effecting of cor-
porate combinations and reorganizations that will affect the stock
exchange rather than the produce market, — these' are some of
the more obvious results of the unfortunate relation between
corporation management and speculation in corporation securi-
ties.
It should also be noted in this connection that the growth of
corporations is bringing with it a subtle but very significant
change in the nature of the institution of private property. So
far as a large and increasing proportion of productive wealth is
concerned, we are losing that direct relation of ownership be-
tween men and goods which Arthur Young had in mind when he
said, ** The magic of property turns sand into gold.'* We often
have, instead, several layers of corporation securities interposed
between the ultimate owners and the ultimate objects of owner-
ship. The effect of this will undoubtedly be to bring about the
more thorough domination of business principles in the business
world. Sentiment, the honored traditions of long-established
firms, the ''pride of ownership," the joy of workmanship (which
IgO OUTLINES OF ECONOMICS
may be felt by the employer who tiims out a good product, as
well as by the workman) are bound to yield yet more completely
to the sway of the cold logic of corporation accoimts and stock*
market quotations. The adequacy of purely business principles
as the foundation of our economic life will be tested more thoroughly
under the corporation form of organization than ever before.
Trusts. — A distinctive feature of the economic development
of the past thirty years has been the combination of individual
corporations into larger concerns, or trusts. The "trust," in the
technical sense, involved either giving a board of trustees the
absolute control of the actual properties of the different con-
cerns in the combination, or what amounted to the same thing,
assigning the stock of each corporation, with its voting power,
to them in exchange for "trust certificates," on which dividends
were paid. The Standard Oil Trust of 1882 was the first com-
bination of this kind, but it was speedily followed by several
others. In 1890, in a case brought by the state of New York
gainst the sugar trust, the trust agreement was held to be illegal
under common law. Corporate combinations were not destroyed
by this decision. They changed, however, to a more definitely
coherent form, — that in which a single great corporation domi-
nates the consolidation.
In most cases, this corporation, which is usually organized
for the purpose, does not own the actual plants of the various
concerns in the combination, but simply owns all or a majority of
the stock of each. It is accordingly called a " holding company."
The holding company exchanges its own securities for the securi-
ties of constituent companies, or, when necessary, it buys the
securities of the constituent companies with funds seciired from
the sale of its own seciuities, — sometimes by the sale of bonds
secured by the pledge of the securities of constituent companies
as collateral. Not only in industrial consolidations,^ but also in
railway and electric railroad mergers has the holding company
device become important.
* A veiy complete Ust of "trusts," prepared by Mr. Byron W. Holt for the
World Almanac (1908), contains the names of about 250 industrial combinations,
mcMt of which are holding companies.
BUSINESS ORGANIZATION 15I
From the point of view of business organization the holding
company is simply an extension of the principle of the corpora-
tion. The holding company needs for purposes of control only
a majority interest in the stocks of its subsidiary corporations.
Various holding companies may in turn be combined by means
of one larger holding company, — and the process may, and
does, go even further. An individual capitalist may, by an
investment of $1,000,000, for example, control a holding company
with a stock issue of $2,000,000, which in turn may control cor-
porations with $4,000,000 of stock outstanding,^ — and some of
these last may in their turn be holding companies. The result
is a tremendous concentration of industrial and financial power,
with the minimum of liability. The uncontrolled use of the
holding company device leads to neglect of the interests of the
minority stockholders in the various corporations concerned; to
difficulty in fixing the legal responsibility for corporate mis-
deeds; to an undesirable complexity in the economic and legal
relations of the holders of securities in the different corporations,
and to the subordination of industrial to speculative ends.
The "trust problem," however, has attracted more attention
as a problem of monopoly than as a problem of business organi-
zation. The problem of monopoly will be considered in another
chapter. Here it is sufficient to note that combination and
monopoly are not identical things, that we may have either one
without the other. It is true, however, that the movement toward
combination originated as one manifestation of the efforts of men
engage^ in competitive undertakings to escape from the restraints
imposed upon them by the fact of competition. Price agreements,
selling bureaus, division of territory, limitation of output, pool*
ing, etc., are other forms of the same general effort.
The specific motives usually mentioned as the most important
causes of corporate combinations are (i) the greater economy of
the large-scale business; (2) the elimination of piirely competi-
tive expenses (some kinds of advertising, for example) ; (3) the
' It is assumed, for convenience, that the stock in each case is worth par and
that the ownership of half of it will give substantial control. In the case of in-
dustrial combinations ownership of all the stock of the subsidiary companies by
the holding company is not uncommon.
J
152 OUTLINES OF ECONOMICS
I)ower to limit output and control price. The first of these fac-
tors suggests the difficult question of the most profitable size of
the business imit. Without discussing this point in detail in this
connection we may note that the significant thing is the most
economical size of the industrial platU rather than of the busi-
ness unit itself. Some of our present-day business units are so
large that they operate a number of duplicate plants. To that
extent, at least, they are larger than is necessary to secure maxi-
mum technical efficiency. Whether competitive expenses and
competitive prices are eliminated by combination depends on
whether the combination has any real basis of monopoly power
over and above the mere fact of combination, which, taken alone,
can give at most only a temporary monopoly.
It is plain, however, that if any or all of these three classes of
advantages do exist in the case of a particular combination, the
earning power of the combination will be greater than the total
earning power of the separate concerns before consolidation, —
a difference which will be reflected in the value of the securities
of the holding company. It is this increment in capital value,
due to the real or expected advantages of consolidation, that has
been the chief cause of such combinations. The organization of
trusts has in many cases been effected by professional "pro-
moters," whose connection with an undertaking does not con-
tinue any longer than is necessary in order to secure the profits
of consolidation. A few great trusts like those which dominate
in the oil, sugar, steel, and tobacco industries have been con-
spicuously successful in a business way. Many others were
"made to sell " ; that is, were organized only in order that profits
might be gained through the sale of their securities, and have
been weighted down by a capitalization not justified by their
actual earning capacity. Some of these have already been re-
organized, with diminished capitalization; others, possibly, only
await the test of a prolonged period of financial depression.
Anti-tmst Laws. — Most states have statutes and some have
constitutional provisions against "combinations in restraint of
trade." These are aimed primarily against the large corpora-
tions of the kind described, although if strictly construed they
BUSINESS ORGANIZATION 1 53
also make illegal the whole mass of price agreements and trade
restrictions, general and local, which are a much more common
and characteristic feature of modem business than is generally
supposed. Anti-trust statutes have accomplished but little, be-
cause they have been aimed at forms rather than at facts, at
symptoms rather than at fundamental causes. If there is mo-
nopoly, with resulting high and discriminatory prices, the social
action needed is the rooting out of the fundamental cause of
monopoly, or, in some cases, a frank recognition of the fact of
monopoly, coupled with the proper public regulation of prices
and services. If evils appear in the undue concentration of
financial power, and in the dominance of speculative motives in
business management, the social action needed is more stringent
control of the methods, purposes, and conditions of corporation
organization and corporation management. The corporation
problem and the monopoly problem are distinct things. The
"trust problem" may mean either one thing or the other.
The Sherman anti-trust act of 1890 is a federal law, making
''combinations in restraint of trade" criminal, so far as the
field of interstate commerce is concerned. It has the defects of
the similar enactments of the individual states. It has been
used to some extent by the government as a means of breaking
up railway combinations, but the results of this application of
the Sherman act have been generally considered to be xmfortimate.
Publicity. — There is a general agreement among students of
corporation problems that greater publicity as to the details of
corporate management is much to be desired, both as an end
in itself, and as constituting a basis for the intelligent control
of corporations. We may distinguish four kinds of publicity:
(i) opening of accounts and records to the inspection of stock-
holders; (2) opening of accounts and records to the proper admin-
istrative officials of the state or federal governments; (3) periodi-
cal financial statements to stockholders; (4) periodical fijiandal
statements to proper administrative officials.
Of these different kinds of publicity the second, third, and
fourth are unquestionably desirable. The publicity of railway
accounts and the development of uniform railroad accounting
154 OUTLINES OF ECONOMICS
under the interstate commerce law has been of great benefit to
the public, to investors, and to the railways themselves. In re-
spect to the first kind of publicity mentioned, it can hardly be
thought right that every small stockholder should have an un-
limited right of access to a corporation's books, especially in
competitive undertakings.
Federal Control of Corporations. — It has been suggested by
many writers that the unfortunate effects of the lack of uniform
state requirements as to publicity, capitalization, purposes of
corporation organization, etc., could be remedied to some extent
by federal action. Canal, railway, and bridge companies have
in the past been chartered by the federal government, just as
national banks are now. It would be legally possible and eco*
nomicaUy advisable to require at least a federal license from all
corporations engaging in interstate commerce. Moderate and just
requirements as to publicity, and possibly as to capitalization
and other things, might very well be imposed as the price of a
federal license. Aside from the present lack of uniformity in
state laws, the mere size of modem business corporations and the
extent of their operations make it dificult for any individual
state or states to control them efficiently.
QtESnONS AND BZERCISBS
z. What are the terms under which corporations are chartered in your
own state? What "anti-trust" laws are in force there?
2. Explain the various items in the published balance sheet of some in-
dustrial corporation.
3. What limitations should be attached to the statement that "a corpora-
tion is a fictitious person."
4. Does the word "capital" mean the same thing in accounting and in
economics?
5. Report on the history of one of the following: United States Steel
Corporation; American Sugar Refining Company; American Tobacco
Company; International Harvester Company.
BUSINESS ORGANIZATION 1 55
REFERENCES
Bentley, H. C. Corporate Finance and Accounting,
Commissioner of Corporations, Annual and Special Reports.
CoNYNGTON, Thomas. Corporate Management ; and Corporate OrganizhUon.
Freund, Esnst. The Legal Nature of Corporations.
Greene, T. L. Corporation Finance.
Halle, E. L. von. Trusts, or Industrial Combinations and Coalitions in
the United States.
HoRACK, F. E. The Organization and Control of Industrial Corporations.
Industrial Commission, Report, Vols. I, II, XIII, XVIII, XIX. (See
general index in Vol. XIX under "Combinations," "Corporations,"
"Capitalization," etc.)
Jenks, J. W. The Trust ProUem.
Meade, £. S. Trust Finance.
Montague, G. H. Trusts of To-day,
Moody, John. The Truth about the Trusts.
Ripley, W. Z. (ed.)- Trusts, Pools, and Corporations.
Sparling, S. E. Business Orgamzation.
WiLGDS, H. L. Should there he a Federal IncorporaUon Law for Commercial
Corporations ?
Wood, W. A. Modem Business Corporations,
PART IV
VALUE AND EXCHANGE
CHAPTER XI
VALUE AND PRICE
If every family produced all the goods needed to supply the
wants of its members, most of the problems which to-day confront
economic science would not exist. Most of the world's workers
are, however, contributing their services either direcdy or indirectly
(through the production of goods) toward the satisfaction of the
wants of others. One's economic well-being to-day depends pri-
marily on two things: the money income which can be got from
others in return for one's services or for the use of one's land or
capital, and the amount of things that can be bought with this
money income. The federal census of 1900 showed that about
93 per cent of the men over twenty years old and about 18 per cent
of the women of corresponding age were employed in money-mak-
ing occupations; and this number does not include those land-
lords and capitalists whose income was derived entirely from
their investments. The work of the housewife and the services of
friendship embody utilities, that is, satisfy human wants, just as
do money-making activities, but they are not measured in terms
of dollars and cents. The production of wealth is in these days
mostly "for the market," and wants are satisfied very largely by
goods obtained from the market. Most goods get from those who
produce them to those who use them only by the processes of
exchange.
The Meaning and Significance of Value. — One of the most
fundamental of all economic problems relates to the ratios at
which goods are exchanged for one another. These ratios are
iq6
VALUE AND PRICE 157
called exchange values. The exchange value of a good is the quan^
tUy of other goods that can he obtained for it. Exchange value is
often called objective value, and is to be sharply distinguished
from subjective value, which, it will be remembered, measures
the importance attached by an individual to a particular unit of a
commodity. In this chapter the word " value " is to be understood
as meaning exchange value. It is evident that the value of a
commodity will vary with conditions of time and place, and that
at any particular time and place it might be expressed in a num-
ber of different ways. A pair of shoes might be exchanged for
four bushels of wheat, for two hats, or for other quantities of other
commodities. In this sense any one commodity will have not one,
but many, exchange values. It is, however, customary to-day to
express the values of all commodities in terms of one other com-
modity, money. Price is exchange value expressed in terms of
money. There are 23.22 grains of gold in our monetary unit, the
gold dollar. Thus, when we say that a pair of shoes is worth four
dollars, we indicate that they have four times the value of 23.22
grains of gold. When the words " value " and " price " are used in-
terchangeably, as will sometimes be the case in this chapter, there
is implied the assumption that the value of money is constant — an
assumption which, of course, does not tntirely correspond with
the facts.
The process by which the ratios at which goods are exchanged
is determined is called " valuation. " This word is used in a narrow
sense as referring to the fixing of the exchange values of commodi-
ties; in a broader sense it includes also the determination of the
different rewards received by those who have contributed to the
production of these conmiodities. In this broad sense the prob-
lem of valuation is the problem of the distribution of wealth. Im-
agine the case of a mechanic employed at a particular time in
the manufacture of machinery that will be used in a flour mill.
The final product of the mechanic's labor — the only product
directiy useful in the satisfaction of human wants — is the flour,
or bread made from the flour. To the making of this final prod-
uct thousands besides our mechanic — farmers, agricultural la-
borers, railway officers and employees, other mechanics, and so
158 OUTLINES OF ECONOMICS
on in a practically endless list — have contributed. What deter-
mines the value of the final product? What proportion of this
value goes to the mechanic? What is his share worth to him as
the means of getting the necessaries of life ? Of these three ques-
tions, the first and third fall within the problem of the valuation
of commodities; the second, relating to the valuation of the me-
chanic's services, falls within the problem of the distribution of
wealth. At present we are concerned with valuation in its nar-
rower sense, although the principles to be developed apply also
in the case of the valuation of the services of the factors in pro-
duction. The significance of the subject of value in economic
science lies in the fact that, within the conditions set by existing
institutions, and within the limits set by the total production of
wealth, human welfare, so far as it is dependent upon the pos-
session of economic goods, is largely determined by the process of
valuation.
The Market. — It is conceivable that the values of goods might
be fixed by public authority, or that the production of the most
important commodities might be monopolized. Then, too, it is
possible to imagine a condition of society in which custom should
have such power that values, when once established, would be
changed very infrequently. Still another possibility would be a
r^ime of competition in which every man would be left free to
buy and sell as he pleased at such prices as he could get. The
first three factors — public authority, monopoly, and custom —
are among the things which determine the ratios at which goods
are actually exchanged to-day; but the dominant factor is the
fourth one mentioned — the free competition of the market.
In this connection we mean by the market, not a particular
place for buying and selling, but ihe general field within which the
forces determining the price of a particular commodity operate. For
some commodities, especially perishable ones, like fresh milk and
cream, the market is distinctly a local one. In the case of great
sta^Je commodities like wheat and cotton, the market is a world
market, for it is impossible that the prices of wheat or cotton in
Europe should diflFer for any considerable time from their prices
in America by more than the expense of transportation. So-called
VALUE AND PRICE 1 59
''mternadonal'' securities, such as government bonds and the
stocks and bonds of certain great corporations, afford even a better
example of goods for which the market is a world market. Some
commodities are used only in a particular locality or country,
although produced in many different places. The American con-
sular rep)orts frequendy contain advice to American manufac-
turers as to special kinds and varieties of goods used in different
foreign countries. The cotton mills of England, Go-many, and
the United States all make special grades of cotton cloth designed
especially for the Oriental market. Much more niunerous, how-
ever, are the goods which, although of wide and general consump-
tion, are produced in but few localities. This is especially evi-
dent in the case of agricultural and mineral products, but it is
increasingly noticeable in manufactures.
Along with this localization of industry there has been a broad-
ening of the field of consumption of many commodities. Among
the factors which have contributed to this result may be men-
tioned, first, the increasingly cosmopolitan character of modern
life, — a result of more generally diffused facilities for higher edu-
cation, as well as of the growing ease of travel and communica-
tion, and secondly, what has been called the "standardization of
taste," — a result in part of modem advertising methods and of
the standardization of products which is one of the fundamental
features of modem machine industry. Notwithstanding the bar-
riers which still exist in the form of protective tariffs and local
prejudices, a dominant feature of modern markets is the localiza-
tion of production and the extension of the field of consumption.
The Conditions of Competitive Valuation. — It is often assumed
that competitive prices are in some way "natural" and right
{xices. To guard against this error it is only necessary to remind
ourselves that competition operates under the limitations imposed
by the fundamental institutions of the existing social order. In
the analysis of valuation under purely competitive conditions, we
sbaB assume the existence of private property, since, strictiy
speaking, it is the property rights in various goods that constitute
the things that are bought and sold. It is necessary, also, to as-
sume the existence of the right of free contract — the right of
l6o OUTLINES OF ECONOMICS
each man to sell for what he can get, and to buy for as little as he
can bargain to pay. So far as society limits the right of private
property and the right of free contract, it alters the conditions
of competition and correspondin^y affects the values fixed by
competition.
Sui^ly and Demand. — The only goods which are valued in the
market are economic goods ; that is, such goods as combine the
characteristics of utility and scarcity. This statement is a truism,
for no one will pay for things that he does not want or for things
that can be obtained freely. Utility and scarcity affect the mar-
ket value of goods through the operation of the forces of demand
and supply. The general "conmion-sense" explanation of the
valuation of goods takes the form of the statement that values are
determined by supply and demand. When rightly interpreted,
this statement cannot be criticised, but it is often used in an en-
tirely erroneous sense. Producers do not usually throw their
goods unreservedly on the market, accepting any price that can
be got for them, nor do consumers generally demand definite
amounts of goods, without reference to the price of them. An
entirely accurate statement, and one that is less apt to be misin-
terpreted, is that prices are among the factors determining supply
and demand. It may seem, accordingly, something like arguing
in a circle to attempt to explain value by using the formula of
supply and demand; but the fact is that the explanation of value
is to be sought in the action of mutually dependent forces, rather
than in any one principle. Our next task is, therefore, the analy-
sis of supply and demand.
The Nature of Demand. — Mere desu-e for a conmiodity is not
demand for it. The desire of the poor man for the counterpart
of his wealthy neighbor's automobile is in no sense demand.
Effective demand is sometimes defined as desire coupled with the
ability to pay. But to make demand really effective there must
be added to these the inclination to buy: desire must be intense
enough to lead to piu-chase. As has been shown in a previous
chapter, intensity of desire cannot be thought of as existing for
a commodity in general, but only for particular units of a com-
modity. The intensity of one's desire for an additional unit of a
VALUE AND PRICE l6l
commodity depends upon the extent to which one's wants are
satisfied by one's existing supply of that commodity. This is the
same as saying that the intensity of ow desire for a commodity
is measured by its marginal utility.
Every person tends to keep the marginal utilities of the differ-
ent kinds of commodities he consumes equal. Either by a con>
scious balancing against each other of the pleasures to be ob-
tained from two or more possible purchases, or oftener, by simply
buying the things which we want more than we want other things,
we tend to keep our unsatisfied wants in a state of approximately
equal intensity. Every person thus has what has been called a
margin of consumption, which is measured by the utility that
would be obtained by the expenditure of another dollar (or any
other small amount of money) for any one of the things that he
consumes. An important thing in the explanation of demand is
the fact that this margin of consumption differs for different per-
sons, as well as for the same persons at different times. An
mdividual's margin of consumption depends primarily on his
income, but also on his tastes and habits, his instinct for saving,
and the extent to which he estimates present wants more highly
than future wants. Then, too, one's desires are constantly chang-
ing under the influence of whim, fashion, satiety, sellers' adver-
tising, education, travel, reading, and new experiences of all kinds.
Expenditures of all sorts are thus called into being by the neces-
sity of maintaining the level of the margin of consumption. The
advertiser may succeed in making us think that we want his goods
more than we want other things that we could purchase with the
same amount of money; reading may so stimulate our desire for
travel that we are willing to curtail other expenditures in order
to secure it. Education ought to affect the quality as well as
the quantity of our wants.
But even if our desires were constant, changes in prices would
in themselves effect continual alterations in the proportions of
various things that make up our purchases. If the price of a
commodity decreases to such an extent that an additional dollar's
worth has a utility greater than our margin of consumption, we
normally purchase it. If the price rises, we normally ciutail our
i63
OUTUNES OF ECONOMICS
expenditures for this particular commodity, and may even, under
some circumstances, become sellers of it (as in the case of the
householder who has bought a large supply of coal at five dollars
per ton, and who, when the price rises to ten dollars, is willing to
sell part of it). Some of the foregoing discussion may seem to
be a statement of what is obvious and commonplace, but the neg-
lect of these seemingly obvious factors is responsible for more
than one erroneous explanation of the way in which values are
determined.
The Demand Curve. — The relations between price and de-
mand may be shown concretely by the analysis of the condi-
tions in a hypothetical
market. Imagine the case
of an isolated community
in which there is consider-
able use of wood as a fuel.
The conditions might be
such as are represented
graphically in Figure i . In
this diagram distances
measured from O along
the horizontal line OX represent different amounts of wood, while
distances measiued vertically from the line OX represent prices.
Assuming that the conditions of demand were as represented in
the diagram, if the price of wood were MP dollars a cord, OM
cords of wood would be bought. If MP represents a relatively
high price for wood, this might mean that many families would
choose to go without wood, using other kinds of fuel instead.
Others would be content with a scanty supply. If, however, the
price were reduced to JIf'P' dollars per cord, some of the families
who would have refused to buy at the higher price would purchase
wood, while others would increase their purchases, so that OM'
cords would be bought. Similarly, at the price M*'P'\ the amount
bought would be OM'* cords. Other possible prices might be in-
dicated on the diagram, so that, in general, the ciu-ve DD' (which
we may call the demand curve) represents the relation between
price and the amount demanded. The rectangle OM'P'A' rep-
VALUE AND PRICE 163
lesents the total amount the community pays for wood when the
price is M*P\ just as the rectan^e OAfP^'A" represents the
total amount paid when the price is M**P", It often happens
that this total value is less when the price is low than when the
price is high, although the amount bought at the lower price may
be double or treble the amount that would be bought at the higher
price. This means not only a better satisfaction of wants with a
smaller expenditiure of money, but also that more money is avail-
able for the purchase of other things; so that there is a general
lowering in the margin of consumption — a better satisfaction of
wants in general. If, however, the relations between price and
demand were such that the rectangle OM"P"A" would be largpr
than the rectangle OM'P^A', the existence of the lower price
would necessitate curtailing expenditiues for other things. This
might involve only a decreased use of substitutes for wood, such
as coal; more often, however, it would mean a diminished con-
sumption of a number of other things. But any decrease in the
price of any commodity of general consumption, other things re-
maining equal, means always a lowering of the margin of con-
sumption of all persons increasing their use of the commodity in
question. For the lower price would not be accompanied by the
piux:hase of a larger amount of wood if the additional wood did
not satisfy more intense wants than would other things that might
be purchased with the money.
In this way the demand for any one commodity is affected by
the demand for any other commodity. The competition of the
market thus embraces not only the buying and selling of a given
commodity (like wood), but also the buying and selling of all com-
modities. In this sense the wood dealers compete with the grocers
and the tailors, as well as with coal dealers and with each other.
The Elasticity of Demand. — By the elasticity of demand we
mean the extent to which the amounts demanded vary with changes
in price. In every family in poor or moderate circumstances
the housewife carefully economizes in the use of eggs during
periods when they are high in price, using them more freely when
the price is lower. In such a case the demand for eggs is an elastic
ODt. Relatively inelastic are the demands of most families for
164
OUTLINES OF ECONOMICS
Fig. 2
such things as flour and salt. Other commodities, such as sugar,
may occupy an intermediate position. Figures 2 and 3 repre-
sent, respectively,
elastic and inelas-
tic conditions of
demand. \^th-
out giving further
concrete exam-
ples, the follow-
ing propositions
respecting elas-
ticity of demand
maybe stated: —
(i) Demand for
necessities is in
general less elastic than demand for luxuries. (2)' Demand for
commodities the use of which constitutes a habit is less elastic
than demand for commodi- y
ties the use of which is gen-
erally a matter of conscious
decision. (3) The more
adequate the substitutes for
a particiilar commodity the
more elastic will be the
demand for it. (4) The
demand of persons of large
income is less elastic than
that of persons in poor or
moderate circumstances. (5)
A corollary of proposition
four is that the higher the
general level of well-being
A'
Fio. 3
in a community, the less elastic will be the demand for most
commodities.
Consumers' Surplus. — Whatever the price of a competitively produced
commodity may be, there are almost always some buyers who would have
paid more if it had been necessary. Referring to Figure i, if the price is
VALUE AND PRICE 16$
M'^'^ those who are just willing to pay that price, who would either have
bought less or bought none if the price had been higher, may be called the
marginal buyers. These are relatively few in number, however, as compared
with those who would have bought even if the price had been higher. The
utility of the marginal purchases to the buyers is but little more than the
utility of other things that could have been bought with the same amount of
money : in such cases the utility of the purchase only about equals the sacri-
fice involved. In the case of all other purchases, however, there is a surplus
of utiUy over costs (whether costs are measured as money costs or as the
utility of the other possible purchases which are given up) which is called
consumer f surplus (or sometimes consumers' rent, or buyers' gains). It
might be supposed at first thought that if the price were, for example, M'P'
(Fig. i), the area included between the horizontal line A'P' and the curve
DP' would represent consumers' surplus. This is not exactly true, however,
and that for two reasons: in the first place, the satisfaction of additional
wants which a lower price makes possible may make the more important
wants less intense. A man might be willing to give ten dollars for a cord of
wood in order that at least one room in his house could be heated during the
winter. He might also be willing to give seven dollars a cord for two cords,
so as to heat two rooms, but the heating of the second room might render the
heating of the first room less important to him. He might not be willing,
for example, to give ten dollars plus seven dollars in order to have the two
rooms heated. In the second place, utility itself is to a large extent affected
by price. So far as our purchases satisfy what has been called the desire for
distinction, or represent what Professor Veblen has called ''conspicuous
consumption," a lowering of the price of a commodity would lessen its utility
to us. The successful production of artificial diamonds at a low cost would
lessen the desire which most people have for natural ones. If touring cars
were less an indication of one's ability to spend money freely, they would be
less esteemed by a good many people. On the other hand, it might occur in
some cases that a certain amount of decrease in the price of a commodity,
permitting a more general consumption of it, would increase the esteem in
which it is held by those who are glad to follow fads. In general, we must say
that even if we had absolutely complete statistics of the actual relation of
prices to demand, consumers' surplus would still be an incommensurable
thing. It is nevertheless a real thing, and is especially significant as con-
stituting one of the differences between real income and money incomes.
It should be noted, however, that consumers' surplus relates only to one's
consumption of a particular commodity, taken by itself, for as we have seen,
the amount which we are willing to spend in the purchase of any one com-
modity depends not only on the price of that commodity, but also on the price
of the other commodities that make up our purchases. The surpluses which
a consumer gets in his different lines of consumption cannot be added to-
gether to form a total
106 OUTUNES OF ECONOMICS
The Nature of Supply. — The amount of goods that will be sup-
plied in a given market at a given time depends, like the amount
demanded, on the price. "Forced sales," in which goods are
offered for whatever can be got for them, form about the only
important exception. The effect of price on supply varies, how-
ever, according to the length of time that is taken into considera-
tion. The work that is being done to-day in the extension of old
factories and the building of new ones, the construction of rail-
ways, the taking up of new land, is based on estimates of future
prices, the present prices of agricultural and manufactured prod-
ucts and of railway transportation being of significance only so
far as they Indicate what future prices will be. The merchant's
stock in trade is bought on an estimate of future business condi-
tions; the amount of land the farmer allots to wheat and com,
respectively, depends on his estimate of the relative prices the
two will bring after the harvest. In a similar way the amounts of
goods that can be supplied to the market to-day are limited by
the estimates which business men and farmers have made in the
past of the prices which buyers are willing to pay to-day. It
would be possible, though not necessary for our purposes, to ana-
lyze the way in which the amount of the capital and labor which
have thus been applied to the production of things that will
satisfy present wants was partially determined by conditions which
existed still farther back in the past, and so on in an indefinitely
receding series. The amount of goods available for the market
of to-day is thus limited not only by past estimates and conditions,
but also by present estimates of future conditions. Every seller
has the option of selling at the present price or of waiting for
possibly higher future prices — an option which is limited only by
the perishability of his goods and the urgency of his need for
money. And the most urgent need for money does not neces-
sarily force an immediate sale if his opinion as to the future
value of his goods is a reasonable one, for in this case it is
usually easy to borrow money on the strength of the marketable
value of the goods.
The Supply Curve. — In the analysis of the conditions of sup-
ply existing in a particular market at a particular time we do not
VALUE AND PRICE
X67
btLVt to take account of the limitations imposed by the forms which
productive efforts have taken in the past. At any given time a
certain definite amount of a commodity is available for the market:
this forms what may be called
the potential supply. The pro-
portion of this potential supply
that sellers will be willing to part
with at a particular time will de-
pend primarily on the prices they
can get.. If the price of a unit
of a commodity is M'P' (Fig. 4),
the sellers will be willing to sell
a certain number of units of it,
which may be represented by
OM'. If the price were as low as PM^ however, some sellers
would prefer to wait for higher prices, the amount thus withheld
from the market being represented by MM'. At the price M^'P",
however, an additional supply (M'M") of the commodity would be
forthcoming from sellers who were not tempted by the price M'P\
In general, the supply curve SS' represents the relations between
price and the amount that will be supplied in a particular market
and at a particular time.
The Determination of Price. — The foregoing discussion of the
nature of demand and
of supply makes it pos-
sible to advance another
step in our analysis of
the determination of
price, by asking our-
selves what will be the
resiilt of the simultane-
ous operation of the
forces of demand and
supply. This condition
is represented graphic-
ally in Figure 5, where the demand curve and supply curve are
combined in one diagram. If the curve DD' represents the
l68 OUTLINES OF ECONOMICS
potential demand in a particular market at a particular time, and
the curve 55' represents the potential supply, the price which
would be fixed by the free working of competitive forces would
be PAf , located at the point where the two curves cross. At this
point demand and supply are equal, both being represented by
OM, It is impossible that the price should be fixed at any other
point, i/'P', for example. For if M"Q be drawn so as to equal
M^ P\ it will be evident that at this price OAf" units will be de-
manded, while only OM* units will be supplied. Most of the
buyers, however, are willing to pay more than M^P li necessary,
so that in order to secure their share they will bid the price up
until the supply equals the demand. This is what John Stuart
Mill meant when he said that ''value always adjusts itself in such
a manner that the demand is equal to the supply," — a state-
ment which has often been misinterpreted, and consequently un-
justifiably criticised.
Producer^ Surplus. — Just as the area APD (Fig. 5) has sometimes been
considered, not altogether accurately, to represent a "Consumers' Surplus"
(of utility over costs) , so the aresiAPS has been considered to correspond to
what has been called " Producers' Surplus " or " Sellers* Gains." This sur-
plus should not be thought of as corresponding to the actual profits of the
sellers; that is, as being in any way a surplus of value over and above the
expenses of production. It cannot be too strongly emphasized that the
analysis of demand and supply thus far presented relates only to the condi-
tions existing in a particular market at a particular time. All that we can say
is that when OM units are sold at the price of MP per unit, the total re-
ceipts of the sellers are represented by^the rectangle OMPA ; while the area
OMPS represents what they would have been willing to sell the same
amount of goods for, had they not been able to get a larger return. There
is, as we shall see, a relation between the prices of things and the expense
of producing them, when a considerable period of time is taken into con-
sideration. At any given time, however, sellers are mainly governed by the
relative profitableness of selling at existing prices or waiting for higher
ones. The only kind of surplus which the area APS represents is an intan-
gible, hypothetical thing.
QUESnOHS
1. Is there such a thing as "intrinsic value"? What is usually meant
when the expression is used?
2. How would you apply the concept of marginal utility to a non-divisible
good, like a house ?
VALUE AND PRICE 169
3. Does the tendency of each individual to maintain the equilibrium of
his margin of consumption result in the maximum satisfaction of his wants ?
4. What relation is there between the amounts which a college student
pays for room rent, for food, for clothing, for books, and for athletics?
5. Which of your customary purchases would you still make if prices
were doubled? Which would you curtail ? Which would you omit ?
6. Illustrate the propositions relating to elasticity of demand (p. 164) by
concrete examples.
Bohm-Bawerk, E. von. Positive Theory of Capital, Book IV» Chape.
I-VL
Cakver, T. N. Distribution of Wealth, Chap. I.
CuNYNGHAME, Henry. Geometrical Political Economy, Chaps. Ill and IV.
Hadley, a. T. Economics, Chap. III.
HoBSON, J. A. Economics of Distribution, Chaps. I and II.
Marshall, Alfred. Principles of Economics, 4th ed., Book III and Book
V, Chaps. I and II. Or [abridged] Economics of Industry, 3d ed.,
Book III and Book V, Chaps. I and II.
Mill, J. S. Principles of Political Economy, Book m, Chaps. I and IL
Wieser, F. von. Natural Value, Book II, Chaps. I-V.
CHAPTER XII
VALUE AITD PRICE (Continued)
SoiCE of the most important factors in the determination of ex-
change values are not revealed by an analysis of the conditions
existing at a particular time. We have assumed, for example,
an existing potential demand and an existing potential supply,
and have shown how these result in the equilibrium of actual
demand and supply at a certain price. An explanation of why
potential demand and potential supply are as they are necessi-
tates taking a considerable period of time into consideration.
The demand side of this particular problem need not detain us.
It has already been suggested that demand will change with
changes in incomes, tastes, fashions, and the like. The effect
of these influences is so obvious that it may be taken for granted.
Wth reference to the other side of the problem, however, it has
been pointed out that the potential supply of the present is lim-
ited by conditions set by past industry. The amounts of dif-
ferent kinds of consumption goods that are ready for present
use depends upon the direction which the work of production has
taken in the past. What, in the long run, is the relation between
supply and value? To answer this question we shall have to
push our analysis somewhat farther.
Normal Value. — The dominant motive that guides farmers and
business men in their investments of labor and capital is the de-
sire for money profits. By profits we mean in this connection
the difference between the expense involved in producing goods
and the money that can be obtained for them. If it were always
an easy matter for business men to change their interests and
their energies from one line of production to another, and if
capital and labor could likewise be freely transferred from one
undertaking to another, it is hard to see how profits in any one
competitive business could be for any length of time much higher
170
VALUE AND PRICE X7X
than in other competitive businesses. Managerial ability, labor,
and capital would gravitate always toward those employments
which promise the greatest profits. The effect would be a con-
tinual tendency toward equality of advantage in different lines
of business. This does not mean necessarily an equality of
profits as between individuals in any given line of business, for
the amount of profits depends largely upon the skill and enter-
prise of the individual business man. In a state of free compe-
tition, with managerial ability as free in its selection of oppor-
tunities as we have assumed, the profits of any business would
hardly be larger, for any period of time, than the business man
could get as salary by working for others — for if working for
others offered a greater return than assuming the risks of busi-
ness for himself, he would naturally choose the salaried position,
and vice versa, Piurely competitive profits, under conditions of
absolute ''fluidity" of business ability, of labor, and of capital,
would thus tend to adjust themselves according to the ability of
the individual business man; that is, to equal what we shall later
describe as the ''wages of management." If we include the
value of the business man's services among the expenses of pro-
duction, we may, obviously, state the tendency which we have
described as a tendency toward the equality of the prices received
for the products of any particular business and the expenses of
producing them.
The assumptions we have made do not, however, exactly cor-
respond to the conditions of actual business. Managerial ability,
labor, and capital are all specialized to a greater or less extent,
so that they cannot be changed from one emplo]rment to another
without loss of efficiency. But it is not necessary for the valid-
ity of our analysis that all managerial ability, all labor, and all
capital should be fluid enough to change from industry to indus^
try economically. There are always a certain number of business
men who are anxiously watching for the most inviting busi-
ness opportunities; there is always a certain amount of labor
awaiting the most remunerative employment, and there is always
a certain amount of money awaiting investment in those forms
of capital goods which produce the greatest value. These (acts
172 OUTLINES OF ECONOMICS
are enough to give substantial truth to the statement that in any
competitive industry the price of the commodity produced tends
to equal the cost of producing it. When the price of bicycles
was high, as compared with the expense of producing them,
existing bicycle factories were extended and new ones were built.
The supply of bicycles was thus so increased that they could not
be sold except at a much lower price. On this account and be-
cause of the cessation of demand, the profits in the manufacture
of bicycles became relatively low, and many former bicycle fac-
tories are now used for other purposes. If the excess of the
price of wheat over the expense of producing it promises to be
greater than the excess of the price of com over the expense of
producing it, farmers will raise less com and more wheat, and the
result will be higher prices for com and lower prices for wheat.
On account of this tendency of prices to equal the expenses of
production, the expense of producing a unit of a commodity is
called its normal value. It must be clearly understood that
normal values relate only to a tendency — not to the actual
prices of the market.
Different Conditions of Supply. — The strength of the tend-
ency of actual competitive values to equal normal values depends
upon- the length of the period of time that is taken into considera-
tion. The longer the period of time, the larger will be the pro-
portion of managerial abOity, labor, and capital that can be trans-
ferred from one industry to another. To buOd and to equip new
factories and to extend old ones takes time; the supply of skilled
labor in any occupation can often be increased but slowly, for
many trades involve an apprenticeship of three or more years.
In the undertakings that are becoming less profitable, although
capital specialized in the form of machines may not be useful for
other purposes, yet such machines need not be replaced as they
wear out; while a skilled laborer cannot take up another trade
without loss of efficiency, yet the incoming supply of laborers
may begin their apprenticeship in those occupations in which
there is a greater demand for labor.
While the conditions of long-period supply are thus such as to
result in a constant tendency toward the equalization of normal
VALUE AND PRICE 173
value and market value, this tendency may never work itself out
completely. For market values themselves are constancy chang-
ing under the influence of changing demand. The goal toward
which productive effort is working is a constantly shifting one.
Moreover, the expense of production itself often depends upon
the amount produced. The efforts of entrepreneurs to adjust
production to prices result inevitably in a readjustment of the
conditions that determine the expenses of productioh. Three
forms of productive undertaking may be here distinguished:
those in which increased production is accomplished with in-
creasing, decreasing, or constant expense.
If transportation facilities and other controlling conditions
remain constant, the amount of wheat raised in the United States
cannot be substantially increased without resort to lands less
well adapted to the production of wheat, or the more intensive
cultivation of lands ahready in use. Either alternative means
(as will be shown in a later chapter in more detail) the use of
relatively more labor and capital in producing the additional
wheat than was required for the wheat produced under the for-
mer conditions. This fact means that the production of wheat
cannot be substantially increased except at an increased expense
per bushel. When this condition of increasing expense is met
with, — and it holds true generally in agricultmre, — normal
value is fixed by the expense of production of the most expensive
part of the supply. That is, normal value tends to equal margi-
nal expense. If the price of the product is not high enough to
repay the cultivation of the poorest lands used, they will cease to
be cultivated. If the price of the product is appreciably higher
than the marginal expense, farmers will find it profitable to push
ciiltivation still farther, up to the point where the new marginal
expense equals the price.
In many manufacturing and commercial businesses, however,
it is cheaper to produce on a large scale, so that an increase in
amount produced means a relatively smaller expense per unit of
product. In such cases a general increase in production means
a decrease in the normal value of the product. At any definite
time a given product will be produced by a number of different
174 OUTLINES OF ECONOMICS
establishments of varying grades of efficiency, and if these are aO
to continue in operation, the price received for the product must
be sufficient to cover the expenses of production of the least effi-
cient of them. It is the supply coming from these least efficient
establishments that adjusts itself most acou-ately to changes in
price. From this point of view, we may say that in manufac-
tures, as in agriculture, normal values equal marginal expenses.
But this fact is not very significant, for as soon as we take a longer
period of time into consideration, we recognize that the higher
price which enables the marginal establishment to produce at
all, also enables the better establishments to produce on a larger
scale. The reduced expenses of production necessitate, through
competition, a lowering of the price, and the less efficient estab-
lishments find themselves forced out by the very conditions that
permitted them to produce at all. From the long-time point of
view, it is minimum, rather than maximum, expenses of produc-
tion that measure normal values in industries of decreasing ex-
penses. There is by this process a continual elimination of the
inefficient producers and a continual Insistence upon higher stand-
ards of efficiency on the part of the superior producers. The
minimum expenses of production to-day become the marginal
expenses of production to-morrow.
The condition of decreasing expenses dominates in most of the
great factory industries of the present.* Its effect is sometimes
offset by the increased cost of raw material produced under con-
ditions of increasing expenses. The diminution of expenses
which accompanies an increase in the amount of the business is
of special significance in railway transportation, and in a number
of other monopolistic businesses. The telephone business, how-
ever, is alleged to be subject to conditions of increasing expenses.
Some writers hold that the dominance of the condition of de-
creasing expenses in any business is enough to make it monopo-
listic in tendency.
In many hand industries, such as tailoring and cigar making,
the expense of production per unit does not vary to any great
' Some qualifications of this statement are suggested in the following sectien
on "Constant and Variable Expenses."
VALUE AND PRICE
175
extent with the amount produced. Figures i, 2, and 3 illustrate
supply under the conditions of increasmg, decreasing, and con-
stant expenses, respectively: — y
These diagrams illustrate the
relations between price and
supply when a considerable
period of time is taken into
account and must be carefully
distinguished from the supply
curve described in the preced-
ing chapter, which related
only to the conditions of
supply at a particular time.
The "supply" illustrated in
these long-period supply
curves is about the same as
the "potential supply" of
the preceding chapter.
Constant and Variable Ex-
penses.— There is no better
illustration of the necessity
of keeping definite periods of 0
time in mind when discussing
problems relating to valuation
than that furnished by the
problem of the apportionment
of specific expenses of produc-
tion to particular units of
products. In almost any
industrial establishment, any
increase in product will be
attended by some specific in-
crease in expenses: more raw
material and more labor will
Fio. 3
be tisedy possibly, more power; although the increased expenses
for labor and power may not be proportionate to the increase
in production. Such expenses are called variabh expinsesj and
176
OUTLINES OF ECONOMICS
are to be contrasted with constant expenses^ which remain
approximately the same, no matter what the amount pro-
duced is. The interest on the capital invested in the factory
building and its equipment of machinery is a constant expense;
the expense of management and general office expenses will be
increased but slightly by an increase in the annual product of an
establishment. It is often assumed that wherever only a part
of the expenses varies with the amoimt produced, the industry is
ipso facto one of decreasing expenses. Whether this assumption
holds true or not depends on the length of the period of time we
take into consideration. It is true that factories are built with
a certain maximum capacity, and until that maximum capacity
is utilized, production may be increased without a proportionate
increase in expenditure. When the maximum is reached, how-
ever, more eqmpment, and often more buildings, will be needed
before there can be a further increase in product. There is often
a certain most efficient size of plant; an increase in business be-
yond the capacity of the most efficient size of plant necessitates
either a curtailing of the business or a duplication of the plant.
When business conditions are such as to warrant temporarily
^ pushing the output
of a plant beyond
its normal capacity,
the result usually
is, as every manu-
facturer knows, that
this increased out-
put is produced at
relatively increased
expenses of produc-
^ Jf' "-^ ^^°- Many seem-
Fio. 4 ingly constant
expenditures (like
interest on the cost of the plant) are variable in the long run.
Such expenditures increase, but only at considerable intervals
of time. A supply curve corresponding to the conditions of
production in such a business might be something like Figure 4.
VALUE AND PRICE I77
When the product reaches OM units, and again when it reaches
OM' units, fresh investments of large amounts of capital are neces-
sary. From the long-time point of view, such a business might
very possibly be one of approximately constant expenses; although
of course the other economies of large-scale production may be
sufficient to bring them under the rule of decreasing expenses.
The problem which the economist has to deal with here is analo-
gous to the difficult one which the accountant has to face in fac-
tory cost keeping. Careful analysis of the relations of constant
and variable expenses in different modem businesses must pre-
cede any broad generalization.
Joint Expenses of Production. — When the production of one
commodity is inevitably accompanied by the production of one
or more other commodities, it is often impossible to assign a defi-
nite part of the total expense of production to any one of the com-
modities. It is obviously impossible to separate the expenses
of producing tenderloin steaks from the expenses of producing
soup bones, or either one of these from the expenses of producing
bides. Mutton and wool, cotton and cotton seed, coal gas and
coke, are familiar examples of commodities produced under
conditions of joint expense. Modem methods for the utilization
of industrial by-products have greatly increased the list of com-
modities produced under conditions of joint expense. Such com-
modities have only a collective normal value, which is equal to
the joint expenses of production. The potential supply is govemed
by the total price which the producer thinks he can get for the
joint products, as compared with the joint expenses of produc-
ing them. The division of the total price into specific prices for
the separate commodities is determined by the potential supply
and by the conditions of demand that exist at any one time for
the separate products.
The Sorphis of Bargaining. — Demand and supply do not al-
ways fix price at a definite point. The price of horses of any
given grade, for example, is fixed only approxinuttely by market
conditions. In the sale of a horse there is room for consider-
able latitude of opinion as to the price that should be paid. If
the lowest price that the seller will take is considerably below
178 OUTLINES OF ECONOMICS
the highest price that the buyer will give, just where between
these limits the actual price will be finally fixed will depend
upon the reladve skill at bargaining of the seller and buyer. In
the case of a horse trade, this opportunity for the ''higgling of
the market" has become proverbial, but in many other kinds
of exchanges the efficient bargainer has an opportunity to get
for himself a surplus above his minimum selling price, or below
his maximum bu3dng price. Real estate transactions furnish
a good example. In the case of the great commodities of the
world market, like wheat, cotton, and iron, the price is set so
accurately by market conditions that the gains of bargaining
are relatively smalL In general, ike wider the marked, the more
general the use of the commodity, the greater the ease wUh which the
commodity can be sorted into standard grades (as in the case of
wheat and cotton), the more accurately will competitive forces fix a
definite price. Goods which cannot be standardized, each unit of
which possesses some unique qualities, give most scope for the varia-
tions in the valuations of individual buyers and sellers. In such
cases supply and demand do not fix a price point, but only cer-
tain limits within which the price must fall. The widening of
the market, however, and the increasing standardization of
commodities — an effect of machine production — are bringing
a larger and larger proportion of goods into the field where the
uniform market valuations dominate.
Non-reproducible Goods. — Some economic writers have made
a special class of such goods as great works of art. These are
absolutely unique, in that no copy can have anything like the
value of the original. The price of such non-reproducible goods
has an upper limit fixed by the highest subjective valuation set
upon it by any possible buyer. The lower limit will be either
the seller's own subjective valuation, or the second highest valu-
ation set by any competing buyer, according as one or the other
of these two is the higher. Between the upper and lower limit
the exact fixing of the price is a matter of pme bargaining. Such
cases should not be confused with ordinary monopoly price, as
has been done by some writers. The products of almost all the
industrial handicrafts, as well as the products of the avowedly
VALUE AND PRICE I79
artistic pursuits, possess a non-reproducible element of individ-
uality, that removes them to a greater or less extent from the
operations of the law of normal value. A commodity may pos-
sess this quality of uniqueness to such an extent that it is not
affected at all by the forces determining the value of the general
class of goods to which it belongs, and in this case its owner may
be said to have a monopoly of it. But it is better to look upon
the valuations of such non-reprodudble goods as determined by
individual valuations and the process of bargaining. The "nor-
mal" price of such goods is simply the highest price that can be
got for them — a statement which does not hold true of most
monopoly goods. For monopoly goods are not necessarily unique
or non-reprodudble. They differ from ordinary competitive
goods, however, in that they cannot be reproduced except by
the monopolist.
Monopoly Values. — The subject of monopoly price will be
discussed in connection with an analysis of the general subject
of monopoly in a later chapter. It is sufficient in this connection
to note that the monopolist gets a special power over the price
of his product through his ability to control the supply of it.
The monopolist, like any other seller, seeks to get the price that
yields the greatest net returns, but unlike the competitive seller,
he is not hampered by an inability to fix the price very much
above the cost of production.
Retail Prices. — The retail prices paid by the individual con-
sumer do not always respond to the variations in wholesale prices
brought about by changes in supply and demand. There arc
sometimes tacit or explicit local price agreements between local
merchants, which apply even to competitively produced goods.
Some retailers consistently sell a few kinds of goods at less than
cost to attract custom for the goods on which they may make a
profit. Merchants who make a specialty of a high class of goods,
and thus cater to a wealthy clientele, are apt to exact higher prices
for ordinary goods than do those merchants who have to deal with
a poorer class of customers. Custom has more effect on retail
than on wholesale prices. The prices of various articles sold as
"men's furnishing goods" form a good example of the influence
l8o OUTLINES OF ECONOMICS
of custom. Retail prices are also governed by the vahie of the
coins that are in general use, and are generally expressed in
round numbers. In the long run, demand and supply govern
retail prices, but they do not set a definite price point so accu-
rately as they do in the case of wholesale prices.
Public Autfaoiity and Value. — In the middle ages there was
considerable speculation by theologians and legists about the
subject of "just price" — the value at which things ought to
exchange for other things. This idea denotes an important
difference between the mediaeval and modem Concept of value.
Professor Ashley has put it clearly in these words: "With Aqiii-
nas, the greatest of the mediaeval schoolmen, it [value] was some-
thing objective; something outside of the will of the individual
purchaser or seller; something attached to the thing itself, exist-
ing whether he liked it or not, and that he ought to recognize.
And as experience showed that individuals could not be trusted
thus to admit the real value of things, it followed that it was the
duty of the proper authorities of state, town, or gild to step in
and determine it, and what the just and reasonable price really
was." This "just and reasonable price" was very often thought
to be that price which would afford a reasonable compensation
for the labor of the producer. When in more modem times
theolo^cal speculations began to yield precedence to inquiries
into "natiural laws," the idea of just price was supplanted by
the idea of "natural price." Sometimes this was interpreted as
determined by the value of the labor put into a commodity (this
was the dominant idea during the eighteenth century), but the
growth of capitalistic production necessitated the recognition of
the other elements in the expense of producing a commodity as
part of its natural value. Modem economic science, as we have
seen, applies the term "normal value" to the expense of produc-
ing a thing, but interprets it only as an important factor control-
ling the long-period fluctuations of competitive exchange value.
The adjective "natural," with its misleading implications, has been
abandoned. Yet the competitive system is to-day so thoroughly
accepted as the "natural" economic order, that there is, as we
have previously noted, a deep-seated conviction that normal
VALUE AND PRICE l8l
competitive prices (measured by the expenses of production)
are natural and just prices. This conviction is, however, brought
face to face with the fact of the growth of a large industrial field
in which monopoly, rather than competition, rules. The ques-
tion of just price is again a live issue — as it was before the growth
of the competitive system. Public authority is frequently invoked
to insure that the prices fixed by holders of municipal franchises
and other monopolists are just and reasonable. The chief fun-
damental test which our courts are able to apply to the reason-
ableness of any particular price is its conformity to what the price
would have been under competitive conditions. Thus it is often
asked if a particular monopoly charge gives a more than normal
return upon the capital invested. The determination of what
the expense of producing a particular commodity or service really
is, is often a difficult, or even impossible, task (the distinction
between constant and variable expenses being frequently a stum-
bling-block), but, given the general acceptance of the competi-
tive system, it is hard to see what other standard could be used.
Moreover, the general consensus of recent court decisions is that
the Fifth and Fourteenth Amendments to the Federal Constitu-
tion, prohibiting the taking of property without due process of
law, prevent federal and state governments from going farther
than this in the regulation of monopoly charges.^ And even this
power is not conceded, except in the case of businesses affected
with a distinct public interest, such as those conducted by so-
called public-service corporations. In fixing prices for its own
services, such as postal charges, the government is controlled by
other considerations. These will be discussed in the chapters
on public finance.
bnpisted Value. — The only things to which market valuations
> It is the view of some courts that not only concrete physical objects, but also
the "franchise value" that has resulted from the ability of a company to charge
monopoly prices in the past must be counted as "property" in the meaning of the
Constitution. So far as this view governs the public regulation of monopoly
prices, it is impossible to reduce them to a competitive standard. It should be
possible, however, in any particular case, to prevent any increase in this acquired
franchise value; that is, to subject public-service monopolies to competitive
Mmdaidi so lar as the incmse of their earnings is concerned.
l82 OUTUNES OF ECONOMICS
actually apply are the specific units of goods that are actually
bought and sold. We are accustomed, however, to impute these
market values to all other existing goods of the same kinds. When
wheat is sixty cents a bushel, the only bushels of wheat actually
valued by the market at that price are the ones actually sold at
that price. Yet we impute or ascribe the same value to all other
bushels of the potential supply of wheat in the same market It
is obvious that all of the potential supply could not be sold at once
except at a very much lower price. Any seller could, however,
add a small amount to the supply, without materially affecting
the price. Exchange value, as a concrete fact, emerges only in
the actual process of exchange. The value imputed to goods
not in the actual process of exchange is a hypothetical value:
the price which could be obtained for any particular unit of a
good under exbting market conditions. This concept of im-
puted value in economics is in some ways like the concept of
potential energy in physics. A body of a given mass raised a
certain distance above the earth has a certain amount of poten-
tial energy, which, if the body be allowed to fall, will be realized
in an equivalent amount of actual energy. To make the analogy
between potential energy and potential value complete, how-
ever, one would not only have to conceive of the force of gravi-
tation as continually fluctuating, but also to imagine that the
amount of actual energy realized would be relatively diminished
according to the mass of the number of the bodies let fall at any
particular time.
Notwithstanding the hypothetical natiure of this imputed
value, it b often treated as though it were a real thing. Statis-
tical attempts to state the wealth of a nation in terms of dollars
and cents are only estimates of the sums of these potential values,
and involve the hypothesis stated above. A merchant's inven-
tory of his stock in trade is often accompanied by an estimate
of its potential value. Whether this value will be realized or
not depends upon the constancy of business conditions, the ca-
prices of fashion, and whether it can be sold in the regular course
of trade or whether it has to be disposed of at a forced sale. A
good many kinds of consumption goods, such as household fur*
VALUE AND PRICE 183
niture, are not customarily thought of by the owner in terms of
exchange value. It is often necessary for purposes of taxation
to ascribe value to them, but it should be remembered that this
imputed value is purely hypothetical.
The Vahiatioii of Prodoctioa Goods. — In our analysis of ex-
change value it has been assumed that the commodities valued
were wanted by consumers for the satisfaction of their wants;
that is, that they were consumption goods. It is possible to
say that producers* goods — capital and land — have a mar-
ginal utility for the producers, which measures the importance
attached to the possession of them. While one could thus, with
substantial accuracy, include producers' goods in the scope of
the foregoing analysis, there is a more instructive way of ap-
proaching the problem of the valuation of land and capital. Con-
sumption goods have value because they satisfy human wants;
that is, they 3deld an income of satisfactions, while production
goods are valued because they have the power of gaining a money
income for the owner. Just as the value of consumers' goods
varies with the intensity of the wants they satisfy, so the value
of producers' goods varies with their power to yield a money
income. The valuation of producers' goods will, accordingly,
be discussed in the chapters on the rent of land and interest
Other Theories of Value. — The older economists used to em-
phasize the relation between the value of a thing and the amount
or the expense of the labor spent in producing it, — a relation
much closer under the old methods of hand production than it
is at present. The development of a systematic labor theory
of value was, however, the work of Karl Marx, the founder of
modem "scientific" socialism. This theory is, in essence, that
labor produces all value and that the interest on capital and the
rent of land are deductions from the real wages of labor — de-
ductions that are made possible only by the existence of the sys-
tem of private property in producers' goods. It is so obvious
that things do not exchange to-day in proportion to the amount
of labor involved in producing them, that to point this out in de-
tail, as some economists have done, is unnecessary. Karl Marx
really meant that labor costs constitute the "natural" values
l84 OUTLINES OF ECONOMICS
of things, or the ratios at which they ought to exchange. But
the only "natural" values that can be recognized from the mod-
ern scientific point of view are the values that really exist — the
actual values of the market. Nor can we say that things oughl
to exchange in proportion to their labor costs, without b^ging
the whole question in favor of the abolition of private property
in land and capital. Moreover, it will be shown later that rent
and interest would not be eliminated, although they might be
changed in form, by a change from private to common owner-
ship of producers' goods. Although the labor theory of value
is still held by many followers of Marx, its place in the creed of
scientific socialism is diminishing in importance.
The relation between value and the expenses of production
has sometimes been stated in such a way as to lead to the infer-
ence that cost of production is the cause of value. The cost of
production theory of value, when so stated, is open to much
the same objections as the labor theory. Suppose I perfect a
machine at the expense of ten thousand dollars which will blow
soap bubbles at the rate of a thousand an hour. Will it be worth
ten thousand dollars? Certainly not; but why not? The theory
of costs will not explain it. To say that the labor and materials
have not been wisely used is simply to say that the machine has
no value, which is just what we are trying to explain. As a
fact, it is not worth ten thousand dollars simply because no one
b willing to give ten thousand dollars for it. The expenses of
production do not create value, but there is a sense in which
value is the cause of the expenses of production. That is, men
think it worth while to expend money in producing things be-
cause they think that the products will have value enough to
recompense them for the expenses of production.
Many of the economists who have written in the past about
the subject of value took the facts of demand for granted, and
devoted most of their treatment of the subject to an examina-
tion of the relation between value and the expenses of produc-
tion. This was in part an expression of a general tendency to
regard, the production of wealth as something to be desired for
its own sake; the fact that the satisfaction of human wants is
VALUE AND PRICE 185
the real goal of most economic efforts being underemphasized.
In more recent years economic writers have developed the analy-
sis of human wants; the fact that utility in the economic sense
is not utility in general, but the utility of a particular imit of a
commodity, being the most significant point in this new analysis.
Some writers have even gone so far as to take the facts of supply
for granted, and to assume that value is explained when mar-
ginal utility is described. Marginal utility is, as we have seen,
the equivalent of subjective value — the importance an indi-
vidual attaches to the possession of a particular unit of a com-
modity. To say that the marginal utility of an object determines
its exchange value is, however, to argue in a circle, for the mar-
ginal utility of a commodity to me depends on the intensity of
my wants and the extent to which they are satisfied. But the
extent to which our wants are satisfied depends very largely upon
the difi&culty or expense of acquiring the things that satisfy them.
In this sense value determines marginal utility. The concept
of marginal utility does, however, aid us in imderstanding the
causes of exchange value, because it forms a bridge by which
we can pass from the definite money units in which exchange
values are measured to the indefinite, subjective units of satis-
faction in which we measiu'e the utility of goods.
As a determining cause of value, utility has a logical priority
over scarcity, in the sense that demand is usually the cause of
supply. Yet in the analysis of the actual valuation process we
have to recognize that utility and scarcity, demand and supply,
are forces operating simultaneously, neither of which can be
neglected without obscuring the fundamental facts of the market.
Quxsnovs
I. Is there any relation between the price of a lead pencil and the expense
of producing it?
a. What elements of a fanner's expenses are "constant"? What are
"mriable"?
3. What different possible standards of just price can you suggest?
4. Draw diagrams illustrating the fixing of normal value under different
conditions of long-period supply, the conditions of demand being assumed to
be constant.
l86 OUTUNES OF ECONOMICS
5. What difierent possible meanings can be attached to the expression
"natural value"?
6. Discuss the following statement: —
" The fact is that labor once spent has no influence on the future value of any
article ; it is lost and gone forever. In commerce bygones are forever by-
gones ; and we are always starting clear at each moment, judging the value
of things with a view to future utility." Jevons, Theory of PolUical Econ-
omy, p. 164.
REFEREffCBS
Flux, A. W. Economic Principles, Chaps. IV and V.
Marshall, Alfred. Principles of Economics, 4th ed., Book V, Chaps, m,
IV, V, VI, Vn, XI, XII. Or [abridged! Economics of Industry, 3d
ed., Book V, Chaps. III-VIII.
Mill, J. S. Principles of Political Economy, Book III, Chaps. Ill and IV.
Seuoman, E. R. a. Principles of Economics, Chaps. XVI, XVIL
WnSES, £. VON. Natural Value, Book V, Chaps. I-VI.
CHAPTER Xm
MONOPOLY
The Idea of Monopoly. — One of the economic terms most fre-
quently used nowadays is monopoly, and at the same time it
is one of those terms which are peculiarly vague and ill-defined
in popular dbcussion. Even in law and economics, contradictory
meanings have been attached to the term, although recently there
has been a marked clarification of thought both on the part of
economists and jurists. This has been a natural result of the
discussion of the subject; and this discussion in turn has been a
necessary outcome of an economic situation in which monopoly
has played and is sdll playing a large r61e. While there has been
confusion of thought with respect to monopoly, all have agreed that
something to be called monopoly has existed, and that it has been
the cause of perplexing scientific and practical problems.
In economics, as in life, categories shade off into each other, and
at the boundaries discrimination is difficult. It is best, therefore,
to find highly developed, plainly marked types to furnish us the
subject-matter for definition and to compare one t3rpe with another.
This is an especially desirable mode of procedure in the present
case, because the term " monopoly " at once suggests the term " com-
petition," with which it is inevitably contrasted. When monopoly
exists, competition is thought of as absent. A state of full and
free competition, on the other hand, is incompatible with mo-
nopoly.
Competition means a market with rival sellers and buyers,
and prices determined, on the one hand, by efforts of sellers,
actii^ independendy of one another, to dispose of commodities
and services, and on the other hand, by efforts of purchasers,
acting independently of one another, to secure commodities and
services. Competition means goods and services freely produced;
187
1 88 OUTLINES OF ECONOMICS
in other words, without control by combination. We have seen
the forces that under competition limit producers and purchasers,
and thus determine value.
Monopoly, as the term contrasted with competition, means com-
bination and unified action, signifying restraint on the free offering
of commodities and services by rival sellers and on the free pur-
chase of these commodities and services by rivals who desire to
secure them. The word " monopoly " itself means a condition in
which there is a single seller and by extension a single purchaser,
and signifies imity in management of some kind of business in
some essential particular.
The particular in which unity is secured in the case of monopoly
may be in production, it may be in sales, it may be in purchases;
or it may be in any two or all three of these particulars. This
use of the term " monopoly " gives us a clear scientific concept which
is workable; and on its basis we may then formulate this definition
of monopoly: Monopoly means that substantial unily of action
on the part of one or more persons engaged in some kind of business
which gives exclusive control, more particularly ^ although not solely y
with respect to price.
A few points in our definition require comment. Price is
essential, and must be regarded as the fundamental test of monop-
oly, even if it is obvious that price formation and price control
do not exhaust monopoly, since its import reaches beyond price.
The other things than price control which monopoly carries with
it flow from such control and are not secure without it. A cer-
tain unity of action may be obtained without the establishment of
monopoly, since it does not give rise to monopoly until the power
to control price is secured.
It is possible that monopoly may not prevent price from falling
below cost, and such a condition of price is quite compatible with
the definition given. The advantage of unified action may be
that loss is diminished. Sometimes a monopoly will give, perhaps,
simply normal returns; sometimes there is loss, as in the case of
an improfitable copyrighted book; sometimes it might happen
that the monopoly price would be exactly the same as the com-
petitive price; sometimes it may go, and generally will go, above
MONOPOLY 189
the competitive price,^ although there might be other gains than
those resulting from higher price.
The precise definition given here of monopoly appears in the
main to be in accordance with the best English usage, and also to
be in harmony with the meaning given to the corresponding word
in other modem languages by those who use these languages
with discrimination. If we search our dictionaries for the
meanings of monopoly, it will be seen that there runs through them
all the notion of exclusiveness or unity as the dominating thought,
as the essential thing for which the mind is more or less success-
fully struggling and the thought about which other things are
grouped.
When we search our law books and judicial utterances on the
subject of monopoly, unsatisfactory as they have been to all in-
terests involved and contradictory to one another in their
interpretations in various particulars, we find, nevertheless, a
sound tendency to emphasize unified control of business as an
essential characteristic of monopoly. Lord Coke, in the seven-
teenth century, ladd emphasis upon the exclusive nature of mo-
nopoly, when he said that it consisted of power granted "to any
person or persons, bodies politic or corporate, for the sole buying,
selling, making, working, or using of an3rthing, whereby any per-
son or persons, bodies politic or corporate, are sought to be re-
strained of any freedom or liberty that they had before, or hindered
in their lawful trade." ' Blackstone, in his CammenUiries an the
Laws of En^ndy gave almost precisely the same definition in
the following century. Recent American decisions lay emphasis
on exclusiveness as a test of monopoly.
Tbe Idea of Monopoly and Industrial Evolution. — But the
meanings of economic categories change with industrial evolution.
Even such terms as freedom and liberty have to be newly inter-
preted with every new stage and even with every marked phase in
a stage of economic life. Naturally monopoly has acquired a new
significance, requiring new interpretation, which even courts are
* This point is discussed later in the present chapter, vide p. ao6.
'Coke, 3 Institutes, i8z. Quoted by C. F. Beach, Sr., in his Monopolies and
Indnsirial Tnuis, I 5.
igo OUTLINES OF ECONOMICS
gradually learning to give. The earlier legal definitions made
monopoly proceed from an express grant of public authority.
Lord Coke says: '* A monopoly is an institution or allowance by
the king, by his grant, commission, or otherwise ;" and Black-
stone uses similar language in defining monopoly '^ as a license or
privilege allowed by the king."
Historically, this source of monopoly power is of paramount
importance. From early times, English sovereigns granted mo-
nopolies either for public or private reasons, and they became a
grievous burden. Queen Elizabeth, in particular, sinned in this
respect, regarding the right to grant monopolies as ** one of the
fairest flowers " in her prerogative, and it was not long before
the citizen found himself restrained and shut in on every side by
a privileged class of monopolists.^
Our forefathers were so deeply impressed with the evils which
they had suffered at the hands of the monopolists in old England
that in the Bills of Rights and elsewhere in the early constitutions
of our commonwealths they frequentiy inserted severe denun-
ciations of monopolies, and prohibited them unqualifiedly; and
these declarations and prohibitions still last in several states.
Two illustrations will suffice. We read the following utterance in
Article 39 of the Declaration of Rights which forms part of the
constitution of Maryland: ''Monopolies are odious, contrary to
the spirit of a free government and the principles of commerce,
and ought not to be suffered." And the people of Texas still
cherish Section 26 of Article I of their constitution, which among
other things declares that " monopolies are contrary to the genius
of a free government, and shall never be allowed."
While the spirit of monopoly is as old as man, there was imtil
this century comparatively littie opportunity for monopoly on
any large scale save as it proceeded from express grants of public
authority. These grants were sometimes made for public purposes,
and sometimes they proceeded from mere abuse of monarchical
power, and were given to favorites of royalty. We cannot now
stop to discuss their merits and demerits, but call attention to the
^ For a scholarly treatment ol EUzabethan monopoUts, see English Paimitt
of Monopoly, by W. H. Price.
MONOPOLY 191
fact that they became odious, and were prohibited both in England
and in this country, exception being made of patents, copyrights,
and trade-marks. At the present time, however, monopolies pro-
ceed from the nature of industrial society, and are of far greater
significance in our economic and political life than ever before.
The really serious monopolies of our day are far more subtle,
and have for the most part grown up outside of the law, and even
in spite of the law.
And this has at last received full recognition in an utterance of
the Supreme Court of the United States in which the idea of mo-
nopoly, as stated in our definition, is reproduced; ^ and thus, for-
tunately, law and economics are brought into harmony, as tbey
always should be.
Complete and Partial Monopottes. — We have taken a perfect
type of monopoly to furnish us with our definition; but there are
imperfect types, or incamfkU monopolies^ as well as comfkie
monopolies. We have a partial monopoly where there is a unified
control aoer a considerable portion of the industrial fields hut not
ooer a sufficient portion to give complete domination of the whole
field. It can easily be understood that if 90 per cent of a
given business, but no smaller percentage, would afford control
over the whole business, 80 per cent, while it would not be
sufficient for domination, might carry with it an advantage to
the person or persons enjoying unified control over the 80 per
cent, yielding an excess above competitive returns which we
may properly designate as one sort of surplus value. Busi-
nesses must often be in this position, and a monopoly may
be obliged to go through several stages of partial monopoly be-
fore it reaches a position where it can exercise unified control
over the entire business. After all, it is a question of degree of
control; and nearly, if not quite all, economic distinctions are
matters of degree.
But we must distinguish sharply between a condition of mo-
nopoly and other conditions, if we are to think dearly and ac-
curately. One thing which does not yield monopoly is mere limi-
tation of supply, and it is strange that even an economist of the
'lifKenpa, J^ in National Cotton Oil Co. v, Texas, 197 U. S. Ka9.
192 OUTLINES OF ECONOMICS
ability of John Stuart Mill should have found the essential feature
of monopoly in this limitation; for this at once makes monopoly
cover the entire field of economic activity, inasmuch as economic
activity is for the acquisition of valuable things, and things lack
value whenever their supply is adequate for the satisfaction of
all wants. It is only things limited in proportion to hmnan desires
that have value.
Nor may we say that a valuable thing is monopolized because
its supply is limited and also graded in quality. Land exists in
quantities to which physical nature has assigned limits, and the
supply of land exists in grades varying in fertility and desirability
of situation, and as a consequence of this gradation we have the
rent of land. Land is not, however, a monopoly, and it is mis-
leading to speak of it as a natural monopoly. Nowhere do we
find monopoly either in the ownership or in the cultivation of
land, but everywhere comi)etition — competition among unequak,
to be sure, but still competition.
Land rent is a differential gain, a gain due to the superiority of
the land owned by rent receivers over that cultivated by those
who are making use of land which affords nothing beyond returns
to labor and to capital. Now we must distinguish between the
broad concept of differential gains enjoyed by those in competi-
tive pursuits, and the monopolistic gains which are based on the
absence of comi)etition.
Just as sharply must we distinguish between competitive busi-
nesses of large magnitude and monopolies. Department stores
in no city in the world enjoy monopolies, but are subjected to the
steady, permanent pressure of competition. There are those who
call every business operating on a vast scale monopoly, and would
put in the same economic category a gasworks without a compet-
itor and a huge retail dry-goods establishment with rivals at every
hand, ready to seize every opportunity for an advantage over it,
and certain to ruin it if its managers relax their intense activity
and watchfulness.
Classificatioii and Causes of Monopolies. — As our first step in
the treatment is the formulation of the idea of monopoly, our
second must be the classification of monopolies with an examina-
MONOPOLY 193
tkm of their caiises. Comparatively little can be said about mo-
nopolies that is applicable to all monopolistic businesses. Here,
as everywhere else in economics, we need analysis.
Many classifications of monopolies have been given, but we must
here confine ourselves to the three which seem of the greatest
importance to the general student.
First Classification
A. Public Monopolies.
B. Private Monopolies.*
C. Quasi-public Monopolies.
Public Monopolies are those businesses which are owned and
operated by some political unit, and this pditical unit is the direct
and immediate beneficiary; in other words, to this political unit in
the first place flow all the benefits of monopoly. A Private Mo-
nopoly, on the other hand, is a monopoly owned and operated by a
private person ; it may be a natural person, — that is, a human
being, — or some association of natural persons, as a partner-
ship, or it may be a private corporation. In this case the first and
immediate beneficiary of the benefits of the property and business
is the private person, although large benefits may flow to the
general public.
It is believed that this great fundamental distinction between
public and private monopolies is essential both to clear thinking
and to sound public policy. Whoever undertakes to tell us what
is true about monopolies, and what is wise for society to do with
respect to monopolies, must make it plain whether he is talking
about public monopolies or whether he is discussing private mo-
nopolies. We may also have an intermediate class designated as
Quasi-public Monopolies. An illustration is afforded by state-
owned railways operated by private corporations; although prac-
tically, in the United States, these differ in their management
Hide from the privately owned railways.
> In our dassificationB the co5rdinate classes will be Indicated by the same
letters or marks. The capital letters will indicate the chief classes; the Roman
numerals, dasses subordinate to them; and the Arabic, classes subordinate to
those indicated by Roman numerals, and so on.
o
194 OUTLINES OF ECONOMICS
#
Second Classification, — The second classification of monopolieB
is made with reference to the source of monopoly power, and is
based upon a different principle of classification, so that this second
classification will cut across the first We have again two main
classes, and these are: A, Social Monopolies; B. Natural Mo-
nopolies. These are further classified as follows:-^
A, Social Monopolies.
I. General welfare monopolies.
1. Patents.
2. Copyrights.
3. Trade-marks.
4. Public consumption monopolies.
5. Fiscal monopolies.
n. Special privilege monopolies.
I. Those based on public favoritism.
3. Those based on private favoritisoL
B, Natural Monopolies.
I. Those arising from limitation of supply of raw ma-
terial.
IL Those arising from peculiar properties inherent in
the business.
III. Those arising from secrecy.
Social Monopolies. — Businesses are social monopolies when ihey
are made monopolies not by their own inherent properties, but either
by legislative enactment or by forming so dose a connection with
great natural monopolies that ihey partake of the nature of the latter.
As already stated, in old dmes kings and queens frequently
granted exclusive business privileges to favored persons, and per-
mitted no one except those named to engage in such undertakings.
Such monopolies, however, became so odious that sovereigns were
compelled to cease granting them. Governments still create
exclusive privileges by patent and copyright laws, but they do so
in behalf of the general public. Authors and inventors are given
exclusive rights over their productions for a limited period. These
monopolies have justified themselves through the stimulus which
they have given to invention and authorship.
MONOPOLY 195
The trade-mark is a legal monopoly similar to the patent and the
copyright In connection with lavish advertising, trade-marks
in recent days have been made the basis of enormous pro&ts.^
Public consumption monopolies and fiscal monopolies call for
a word of special comment. They are to be distinguished the one
from the other only by the object which the government has in
view in establishing them. If the government manages for itself
or grants to another a monopoly of the liquor tra£5ic with the object
of regulating the consumption, the monopoly is a public consump-
tion monopoly. If, on the other hand, the chief object is not
regulation, but income, the monopoly is a fiscal one. Often the
two objects are so blended that it is difficult or impossible to say
to which class the resulting monopoly belongs.
Our classification names two kinds of special privilege monopo-
lies. Those monopolies which are due to special tariff advantages
or to other legislation are rightly said to be hosed on public favorit-
ism. The other class of special privilege monopolies consists of
those which grow up through special favors granted by other
monopolies, especially natural monopolies, such as railways.
Natural Monopolies, — Natural monopolies are those which
depend for their existence on natural forces as distinguished from
social arrangements. They grow up independentiy of man's will
and desire, and sometimes even in direct opposition to it. The
words which we have used in our classification wiU sufficienfly
explain the different sources from which they arise. By far the
most important of all monopolies are natural monopolies of the
second class, chief among which are the following: wagon roads
^ The full treatment of trade-marks involves theoretical points which would
necessitate a discussion too lengthy for the present treatise. They are used largely
in competitive businesses, and help to establish what is termed good-will. They
are an aid to the shrewd and capable in the general effort to escape what may be
designated as the "dead level*' of competition. They are a monopoly not in the
sense of giving exclusive control of one sort of business, but in the strictly legal
sense that no one else may use them. A clever device, coupled with excellence and
advertising, may have very high value. The purchaser of o3rsters, for example,
may feel that when he buys oysters of a particular ''brand" (trade-mark), he is
getting ojaters, plus something else ; or, in other words, not merely oysters such
as others sell, but a peculiar excellence which can nowhere else surely be had.
It is merely this "plus something else" that is a monopoly. Great importance is
attached thus to "establishing a brand."
196 OUTLINES OF ECONOMICS
and streets, canals, docks, bridges and ferries, waterways, harbors,
lighthouses, railways, telegraphs, telephones, the post office,
electric lighting, waterworks, gas works, street railways of all
kinds. Whenever there is a decided incremetU in gain resulHng
from cembinaiion^ we have a tendency to monopoly which will over-
came aU obstacles. This increment of gain, which is the cause of
monopoly^ is always present in businesses that occupy peculiarly
favorable spots or lines of land, and that furnish services or com-
modiHes which must be used in connection with the plant. This
may be said to be the law of natural monopolies.
Many economists believe that combination and production on the largest
possible scale give a decided increment in gain, and thus produce monopolies
to be designated as "capitalistic monopolies." The question really turns
upon the degree of growth of a business unit which adds to the rate of gain ;
and the position is taken in this book that in most kinds of business the point
of maximum efficiency is reached long before the point of monopoly is reached.
One or two very cogent reasons may, however, be stated. An exhaustive
study of the cases dted in support of the alleged tendency to monopoly in-
herent in large capital has failed to reveal a single one in which the monopoly
did not enjoy one or many of those monopoly advantages which we have al-
ready mentioned and explained. Moreover, many cases in which the pos-
session of large capital seemed on the surface to be a dominating influence,
have been cases in which the monopoly was so short-lived as to furnish little
support to the argument of those who cited them. After all, whatever may be
the advantage conferred by large capital, we must remember that capital is
so plentiful that one gigantic plant can always find a rival whenever a slight
margin of profit invites its establishment.
Our conclusion, then, may be stated as follows: There is a great
and growing field of industry in which competition is not natural
or permanently possible, for reasons explained in the text; there
is another field within which monopoly does not and cannot ezist,
and within which social monopoly is unlikely to arise.
Third Classification
A. Local Monopolies
These are monopolies extending over a relatively small area.
The gas supply of any city is an illustration. There are various
monopolies which are confined to a single locality. Then there
MONOPOLY 197
are temporary local monopolies which, under peculiar exigencies,
may arise. Two young men in Chicago a few winters ago
cornered the market on eggs, and made fifteen thousand dol-
lars out of the operation. The weather was so cold that eggs
could not be shipped to the city, and for a few days these
speculators had a monopoly.
B. National Monopolies
C. International or Universal Monopolies
There have been various attempts to seciire universal monopoly,
of which the copper monopoly of 1889 affords an illustration.
These are more or less arbitrary divisions, because a protective
tariff may enable a monopoly to exist in one country when the
same article or service is not monopolized in another country.
There are attempts to establish monopolies beyond the nation,
but how large will be the number of cases in which success will
be achieved, remains to be seen. There is no doubt that the oil
companies of the United States and Russia are endeavoring to
establish an international and even a world monopoly.
The area of monopoly is a topic that in an extended treatise would
require an elaborate treatment, for it has a significance which has
as yet not been an3rwhere adequately presented. We can narrow
down the area of monopoly until nearly every producer of goods
or seller of services has a monopoly. A may be the only seller
of shoes on a particular street of his city or in a particular block
or building on hb street. No one is especially disturbed or in-
convenienced by a monopoly of so limited an area. In general,
it may be said that, —
The larger the area, other things being equal, the more significant
is the numopoly.
Monopoly Price. — Price in general depends upon marginal
utility, and that depends upwn the intensity of desire and upon
the difficulty or ease of obtaining goods or services for the satis-
faction of desire. If payment is made in money or in money in-
struments, price depends on the relative abundance of the supply
198 OUTLINES OF ECONOMICS
of money and its instruments.^ We see that price, then, depends
upon limitation of supply in all cases, because it is the limitation
of supply which gives us the utility of a particular concrete good, or
our marginal utility. As the supply increases, the desires satisfied
are of a lower and lower order until the point of satiety is reached,
where all desires are satisfied and where value entirely disappears.
We now reach the chief peculiarity of monopoly price, which is
found in the power of the monopolist over supply. The very con-
cept of a unified control over business means power to control
and limit supply. Supply is limited by the monopolist at that
point where he gets the greatest returns, and if he receives surplus
returns, they are due to the fact that he is in a position to compel
men to forego satisfaction.
Under competition in the case of freely reproducible goods,
supply is limited by cost of production. If the cost of production
were nothing, there would be no limit to supply until all wants
were satisfied. Competition in its very nature means that supply
is not within the control of a single producer; and this fact ^ves
us the protection that competition affords to society; and it is
on this account that the courts regard competition as one of the
main pillars of our present social order.
Now as the supply is not determined as under competition by
the cost of production, it is determined by -the desire of the mo-
nopolist to secure the maximum of revenue possible in the existing
state of demand. In other words, the monopolist, freed from com-
petition, and governed only by demand, is able to adjust supply to
demand in such a way that the price will stand at the point of
highest net return. In determining what price shall be fixed and
what quantity supplied, — in other words, what is the point of
highest net returns, — the monopolist consciously or imconsdously
proceeds according to the following principles : —
I. He realizes that, other things being equal, every increase of
his monopolized product will result in lowering its price, while
every decrease in the supply will result in a higher price.
' And abundance of money will depend upon mai^giinal cost of production of
the precious metals. This subject is treated elsewhere, as also the general subject
of price, which is here presented only iu abbreviated form for present purposes.
MONOPOLY
199
2. Of the expenses of production there are some that in a well-
organized business vary roughly in proportion to variation in the
supply. It will frequentiy happen that if the product is doubled,
the cost of raw material will be about doubled. Such ejq)enses
may be called variable expenses.
3. Other expenses, within the limits of maximum efficiency,
remain more nearly the same, no matter what may be the amount
of the product. These, called the fixed or consiaiU expenses,
include the cost of plant, salary of superintendent, interest on
bonds, etc.
It follows from the above principles that the monopolist, in a
case of this kind, since he is seeking the maximum net revenue
from his business, will pay little attention to fixed charges in
establishing the price of the product, but will consider chiefly
the variable expenses in connection with the probable demand
for his goods at various points.^
An Illustration. — We may illustrate by an example the opera-
tion of these principles. The following table shows in parallel
columns the number of sales of a monopolized good at different
prices; the total resultant earnings; the variable expenses; the
fixed expenses; the total expenses; and finally, the net revenue or
monopoly profit : —
$.10
.09
.08
.07
.06
•OS
.04
600,000
800,000
1,200,000
1,800,000
2,500,000
3,500,000
5,500,000
$ 60,000
72,000
96,000
126,000
150,000
175,000
220,000
I03
•03
•03
.03
•03
.03
•03
$ 18,000
24,000
36,000
54,000
105,000
165,000
$50,000
50,000
50,000
50,000
50,000
50,000
50,000
$ 68,000
74,000
86,000
104,000
125,000
i55»ooo
215,000
-$8,000
— 2,000
+ 10,000
+22,000
+ 25,000
+ 20,000
+ 5»ooo
> This subject would require further treatment in a larger work, but the limit
of space and proper proportions compel us here to confine ourselves to the broad
general statement.
200 OUTLINES OF ECONOMICS
Study of the table will show why, in the case assumed here, the
monopoly price will stand at six cents. Competition, if it were
present, would keep on increasing the supply as long as normal
profit could be obtained. In our illfistration the lowest price at
which production could be carried on so as just to secure a profit
above the expenses of production would be four cents; and foiur
cents would therefore be the competitive price, or the price deter-
mined by the balancing of marginal utility against marginal cost
of production. But since the monopolist has such control over
the production that he can control the supply, he will cut off pro-
duction at 2,500,000 imits, at which point demand will fix a price
of six cents, and will give the largest net return, viz. $25,000.
But the case here assumed is one that is far simpler than the cases frequently
presented by real life. We should have to take many different illustrations
even to approximate the rich complexity of economic life. We have, for
example, assumed constant fixed charges, and such an assumption is one that
is frequently helpful, because it often corresponds to actuality. But "fixed
charges," so called, are, from the long-time point of view, variable. The
constant charges of a street-railway system imply a street-railway system at a
particular time and place and a street-railway system of a particular kind,
e.g. one with single track and switches. If a street-railway system is enlarged
so as to necessitate "double-tracking" and a new power plant, we will have
new fixed charges. But anything like an exhaustive discussion of these
points requires so much space as to be suitable only for special treatises.'
The Effect of a Tax. — Our numerical illustration may be made to convey
a lesson regarding the influence of taxation upon monopolies and monopoly
price. Fixed expenses have no influence in determining the price. If,
therefore, a fixed tax, say of $5000 a year, were to be laid upon this monopoly,
it would not result in an increase of price. A study of the table will show that
with such a tax the net revenue at price .08 would be $5000; at price. 07,
$17,000; at price .06, $20,000; at price .05, $15,000; at price .04, nothing.
Thus price .06 will still be the point of maximum net revenue, and hence the
monopoly price. On the other hand, a variable tax, for instance, a tax of one
cent per unit, would result in this case in raising the monopoly price. In
our illustration, such a tax would make the net revenue at the pricb .08,
— $2000; at the price .07, $4000; at the price .06, nothing; at the price .05,
— $15,000. Thus, though the monopoly would find its profits greatly curtailed
by such a tax, consumers would be compelled to pay one cent more per unit
for the monopoly product. The possible advantage which society might
' See references to literature at the close of the chapter. See also the treatment
cf Constant and Variable Expenses in Chapter XH on Value and Price.
MONOPOLY 20I
draw from tha tax would therefore be wholly or in part offset by the increased
cost of the commodity. Such a raising of the price will not take place, however,
if the demand at the higher price is not sufficient to make as great a net
revenue as at the lower price. We may conclude, therefore, that fixed taxes,
or taxes on the net revenue of a monopoly, cannot be shifted wholly or in part
by a change in price ; while taxes laid in proportion to the amount of business,
since they contribute an addition to the variable expenses, may be wholly or in
part shifted by a change in price.
A Law of Monopoly Price. — It is sometimes said that the price
of a monopolized good depends solely upon the will of the monop-
olist. In the strict sense of the phrase this is not true. As our
explanation has shown, the monopolist is forced by economic mo-
tives to establish such a price as will give the maximum net reve-
nue. There are certain conditions on the side of demand which
therefore have a decisive influence in determining monopoly price.
We may group the most important of these in a general statement
which may properly be called the law of monopoly price: The greater
the intensity of customary use of the monopolized commodity or
service^ the higher the general average of economic weU-being, and
ihe more readily wealth is generally expended, the higher will be
the monopoly price which will yidd the largest net returns.
The phrase, intensity of customary use, may require explanation.
It signifies simply the strength of custom with respect to the use
of a monopolized article. If the people of France, for example,
axe accustomed to use large quantities of tobacco, — there a gov-
ernment monopoly, — and if they cling with a high degree of in-
tensity to this custom, it will obviously be possible profitably to
raise the price a great deal above competitive price; whereas, if
the custom is one that is relatively weak, — that is, weak as com-
pared with the force to which they cling to their customary con-
sumption of other articles, — a very high price will so diminish
consumption as to lessen net profits.
Thus monopoly, without any effort of its own, shares in the in-
creasing wealth of a country, and absorbs a considerable part of
it It is, for example, among other influences, the larger wealth
and the greater willingness to spend freely that makes monopoly
more profitable in the United States than in Germany or other
European countries. The search for other illustrations of the
202 OUTLINES OF ECONOMICS
law should prove an interesting and valuable exercise for the
student.
Class Price. — Thus far we have assumed that the monopolist
charges one uniform price and sets the price at the point which
yields him the largest net returns. But it is obvious that his gains
will be increased if he is able to vary his price. His gains would
be highest if he could charge each individual that price which would
yield the largest net retiuns, taking into account the number of
sales and profits on each. A rich man and a free spender might
pay double the current rates for gas or electric light without
diminishing his consumption in the least. But in the case of any
large modem business it is obviously impracticable to fix a price
for each individual, even were there no legal difficulties in the way,
as there are in the case of the great monopolistic businesses such
as gas and electric lighting, railway transportation, etc. The
next best thing for the monopolist is to divide his public into classes,
and to charge to each class that price which will 3deld the largest
net retiuns. In the table already given, we found that six cents was
the monopoly price on the hypothesis of one uniform price, but
obviously, if the eight-cent and seven-cent prices could be secured,
and six cents reserved as a price for sales that could not be made
at eight or seven cents, the profits would be still higher. This
gives rise to what, in its broad, general terms, we call dass price.
The monopolist seeks in every possible way to divide his community
into classes and to secure from each the highest possible price.
We observe a remarkable development of class price in the case
of our railways; and, unless legal obstacles are interposed, this
development will doubtless go still farther. We have special
trains with an extra charge. We have privately owned railway
coaches; our drawing-rooms and single seats in ^' parior cars ";
our ordinary first-class tickets ; and our second-class tickets, the
purchasers of which frequently ride in the " day coach '* with
the first-class passengers. Then we have single tickets, fifty-trip
family tickets, monthly commutation tickets, etc., with enormous
variations in price. We may go farther and say that the whole
American railway rate system of " charging what the traffic will
bear " is a consummate example of monopoly prices.
MONOPOLY ao3
Nor Deed it be supposed that in all its ramifications class price
is a bad thing. It is, when ignorance and need are exploited by
a special high price ; frequently it works well when an attempt
is made to reach a class of limited means with a very low price,
as in the case of early and late workingmen's trains, etc.
Monopoly price will vary with use also ; and this is one special
subhead under class price, and may be designated as use price.
The typical instance is that of two prices frequently charged for
gas : a higher when it is used for illuminating purposes ; a lower
when it is used for fuel.
Monopoly price necessarily varies from country to country,
bom (dace to place, and from time to time. This follows neces-
sarily from our law of monopoly price, and is a matter of familiar
observation. The monopoly price yielding the highest net returns
iskwer among the careful, prudent Germans with relatively small
incomes than it is among the free-spending Americans with rela-
tively large incomes often easily earned.
A difficulty su^ests itself at this point, and this is found in the
departure from uniformity of price of non-monopolized articles and
services. We have to consider the question: Are the apparent
dass prices in competitive businesses class prices in the true sense
of the term? If so, wherein does the competitive class price differ
from the monopolistic class price ? To answer this question we
must first of all consider the distinction between what we may
term " commodity competition " and " business unit competition."
When we speak about commodity competition, we have refer-
ence to that competition with respect to a commodity which gives
uniform price, if competition works perfectly. We think of the
great staples like wheat and wool, — those staples which have a
woiid market. But the competition between retail business men
is a competition of a different sort. It is the competition of one
business unit as such with another business unit as such. It is
a kind of competition that exists between the grocers in the same
city, or mammoth department stores in New York and Chicago.
It is competition which is frequently very sharp ; but even when it
is the sharpest, it does not mean in retail trade real commodity
competition. It does not mean that the prices of all goods sold
fto4 OUTLINES OF ECONOMICS
9it the same, but it means this: where we have sharp competition
the gains are in proportion to expenditure of economic energy^
using that term ^* economic energy " as a composite term imply«
ing a certain output of economic force, whether this takes the form
of labor or capital or business management.
Each one of the business units will make a specialty of some
one line of commodities upon certain days. Special prices will
be offered ; but that means something very different from the class
price which we have considered in our discussion of monopoly.
Every one will agree that that is the case. The consumer considers
very generally the prices charged as a whole. He knows very well
when he goes to one retail establishment that for a certain par-
ticular article he may be paying a little bit more than he would
pay in some other store; but the retail purchaser as a general rule
does not consider each individual price, but he considers all the
prices that he pays. It is intolerable for the consumer to go
about a town searching for the lowest price of every little com-
modity, — to buy a paper of pins at one place because it is a little
cheaper than at any other place, to buy a pound of butter at one
place, a pound of sugar at another. People do not ordinarily
do that.
Now each retailer looks upon his business as a unit. He tries
to derive from the business as a whole the greatest profit. Each
one is putting his capacity into the business. One says, '^ I can
do better if I sell this article at cost, or if I sell that article some-
what below cost." It was not very long ago that a large depart-
ment store in New York City sold the popular magazines at less
than was paid for them. That was not a class price in any sense
of the term. That was a certain expenditure for advertising
purposes.
To some extent people do go about and try to get all the special
prices in each particular establishment, but that is not done usu>
ally, so far as purchases as a whole are concerned. On the other
hand, there is a limitation very often in the arrangement that a
store will sell only so much — one pair of gloves or so many yards
of silk at a special price — to one customer. But we are dealing
here with a different sort of phenomenon from class price.
MONOPOLY aoj
In wholesale business there is an attempt to unite the business
unit competition and the commodity competition. Here the pur-
chases are very much larger, and a person does not hesitate, to
a certain extent, to go from one wholesaler to another wholesaler
to make a particular purchase of some articles. Many persons
would be a little bit ashamed to divide their groceries among a
half-dozen grocers so as to get at each place the articles selling at
a special price. When we have a unity of these two sorts of com-
petition, then we have what we may call perfect competition, —
where we have a competition between the business \mits which
includes a commodity competition, so that all articles are selling
at the same price and each dealer has net returns in proportion
to what he puts in of economic energy.
It is in the nature of competition to cater to various economic
classes in the conmiunity, and this is an entirely different phenome-
non from that in the case of the gas company charging two different
prices for an article according to the use to which it is put. Every
retailer considers the class to which he will cater. Retailers tell
us that such is the case. One will say, " We try to cater to the
fashionable, wealthy people, the high-toned people." Another
will say: *' I do not try to reach the so-called * best people ';
I try to cater to the middle class. My training fits me better to
cater to this middle class than to cater to the fashionable people.
If I find that I can do this too, — very well; but I especially cater
to the middle class." ^ We find that at stores like Marshall Field's
they recognize the various classes of the community and try to
reach the various classes of the commimity by their basement
department, and by their first floor, and the upper floors. But
that does not mean the absence of competition in the business as
a whole; but, taking the business as a whole, it competes with other
retail establishments in Chicago. Here we have a different class
^ It must not be overlooked that there is a variation in cost of doing a retail
business dependent upon the class of people to which a particular retailer caters.
Orer against the higher prices charged, let us say by a fashionable grocer, we have
to put the higher quality of service. People of wealth and fashion require prompt
service, involving expense. Also, frequently the shops that cater to fashionable
people give very long credit and lose heavily in many cases. These are consider-
atioDS of a different kind from those mentioned in the text.
2o6 OUTLINES OF ECONOMICS
price from that we have considered. We have a competitive class
price which, if the competition is perfect, 3delds no surplus. This
does not mean that some will not gain more than others in com-
petitive business. The gain is in proportion to the output oj
energy.
Monopoly Price High Price. — It is often said, and frequently
even in judicial decisions, that the monopolist can charge any price
that he pleases. We have already seen that this is not the case.
The law of monopoly price shows that the price, even in the case
of monopoly, is determined by economic forces. It is conceivable
that there may be cases in which monopoly price will exactly coin-
cide with competitive price, although the probabilities would be
against a frequent coincidence of this kind. There axe also cases
where monopoly price may be even lower than competitive price.
If a monopolist should be able to effect great savings as compared
with the expense of doing business under competition, it could
theoretically happen that the price which would yield the largest
net returns would be a lower price than would be possible under
competition. Probably, and in fact almost certainly, under a
condition of competition, letters could not be carried as cheaply
as they are.
Generally there are strong reasons for the position that mo-
nopoly price is high price. Monopoly is formed for the sake of
gain. Gain may be secured in two ways by monopoly : first,
through economies of production; and it is alleged by trust pro-
moters that these economies are a chief motive in their activity.
There are some gains of this kind, but it is too early to say precisely
what they are. When we compare a monopolistic business with
a competitive business organized on such a scale as to secure the
maximimi of efficiency, the gains of competition in alertness and
inventiveness, stimulated by rivalry, have recentiy been too little
considered.
The second source of gain in monopoly is found in the ability to
charge high price. In confirmation of the position that monopoly
price is high price, we may refer to history, the utterances of which
seem to be clear and distinct. At any rate, there can be no doubt
that, in the opinion of historians who have treated the subject.
MONOPOLY 207
monopoly means high price. Hume, in his treatment of monop-
oly in his History of England, speaks of the price of monopolized
articles as exorbitant, and cites the price of salt, the price of which
had been raised by monopoly tenfold and even more. The pro-
duction or sale of salt, or both, is frequently a government mo-
nopoly, and it b generally conceded that in all cases of monopoly
the price has been so extremely high as to be a real popular griev-
ance; and it is generally necessary to inflict severe penalties to
prevent the people from securing the salt at a lower price from
non-authorized sources. But of still greater significance are the
results of the investigations of the Industrial Commission of the
United States, as seen in the Preliminary Report of 1900 (Vol. I
of the complete report). It is there made evident that when
monopoly appears in a form at all clear and well-defined, the
tendency is plain to increase the margin between the prices of
finished products and raw materials.^
The courts of the world have made it clear in their judicial ut-
terances that they regard monopoly price as high price; and, as
their opinions are based upon cases actually brought before them,
we cannot do otherwise than attach great importance to their
view.
Wherever conmiissions have been formed with power to regulate
monopoly price, and these commissions have been comprised of
independent and strong men, there has been a marked tendency
to reduce monopoly price; because unregulated monopoly price
has been found to be excessive and unjust. The judicially minded
Railroad Rate Commission of Wisconsin affords an illustration.
This Conmiission has authorized a higher price in a few cases, but
generally has been forced to lower prices, although in the notable
case of passenger rates it did not go so far as the legislature. The
investigations of the Railroad Rate Commission led the members
to believe that a reduction from three cents to two and one half
cents per mile for all the leading railways in Wisconsin was just;
whereas, subsequently, the legislature lowered the rate to two cents
1 See Report in Vol. I (Industrial Conmiission), by Professor J. W. Jenks,on
'* Industrial Combinations and Prices/' pp. 39-57 ; and also Chap. VIII, " Prices,"
in the same author's work. The Trust Problem.
aoS OUTLINES OF ECONOMICS
per mile. But even the decision of the Commission (which was
accepted by the railways) was a reduction of over i6 per cent
Investigations held have resulted very generally in a lower price
for gas. All important investigations of street-car service in the
great cities of the United States have terminated in the conclusion
that the monopoly price of five cents per passenger is a high price.
The recent settlements with the street-car companies of Chicago
have been based upon an agreement to maintain a five-cent fare
and to give to the city of Chicago 55 per cent of the net gains.
According to the statements of the interested parties, even this will
leave a very handsome return for the owners of the street-car
properties.
In the next place, we refer to the experience and observation of
men when they have had dealings with well-defined monopolies.
The express companies and the oil business afford illustrations
falling within the experience and observation of nearly all readers
and students of this work.
Monopolies and the Distribution of Wealth. — We have not the
precise statistical data which will enable us to state the exact
influence of monopoly upon the distribution of wealth. We have,
however, sufficient data to warrant the opinion that the high
price of monopoly and the gains resulting from the exclusive posi-
tion of the monopolist give us a large privileged class in countries
of modem civilization, but especially in the United States. An
advantage of the monopolist in the United States is found in the
law of monopoly price, coupled with the failure to regulate monop-
oly as carefully in our coimtry as it has been regulated in Europe,
generally speaking. Ours is a country in which there is large
wealth, in which wealth is easily acquired, and in which conse-:
quently people spend freely. Monopoly price must, then, be excep-
tionally high price and yield exceptional gains. Even when the
increment of price is comparatively small, it has large significance
in the case of the sale of a vast number of units of services or com-
modities. The difference between a four-cent street-car fare and
a five-cent street-car fare may not appear to be great, but it is a
difference of 25 per cent and is enormous.
All the many investigations that have been held recently in
MONOPOLY
209
various lines of business (especially in raOways, beef industry,
coal mining, etc.) point to monopoly as a prime cause of the so-
called swollen fortunes of this country. In this and other countries
some histories of families distinguished for wealth have been written,
and probably few if any cases could be found in which some mo-
nopoly element had not entered. Various lists of rich men have
been published, among them one published by the New York Sun
in 1855, and one published by the New York Tribune in 1892.
These lists cannot by any means be presumed to be accurate, and
yet they do afford very considerable evidence of the sources of
large fortimes, and point to monopoly as a prime cause of the mod-
em enormous fortunes. This is a subject which in itself would
require a larger book than the present one for adequate treatment.
The student must attempt by observation and study to carry for-
ward the lines of investigation and thought here suggested, being
constantly on his guard against undue haste in generalization.
Public Policy with Respect to Monopolies. — It is possible to
throw out only a few suggestions in this place. As many monopo-
lies have come as a result of underlying laws of industrial evolu-
tion, they cannot all be abolished. Experience and the nature of
industries like railways, gas works, etc., falling under the head of
'' public utilities," so called, should be conclusive. We must have
monopoly in these cases, and the only question we are concerned
with is, " What kind of monopolies shall we have ? " Again, we
cannot abolish monopoly simply as a result of legislative enact-
ment. The anti-trust laws of our states, so generally failures,
should be conclusive as to this point. On the other hand, legis-
lation is not powerless, but it must be in accord with the laws of
.industrial evolution. The problem is abolition of undesirable
monopoly where this is feasible; and very generally regulation
rather than destruction. Here, again, we have the experience
of the United States and of other modem nations as confirmation.
We may, to begin with, admit that unregulated monopolies in
private hands have alwajrs been odious and are opposed to the
principle of the laws of civilized nations. They are opposed to
that endeavor to secure equality of opportunity which is funda-
mental in modem democracy and which manifests itself as a red
2IO OUTLINES OF ECONOMICS
thread running through American history. Even George Wash*
ington, generally looked upon as so calm and self-contained,
denounced monopolizers and wished they might be " hunted down
as pests of society '^ and " hanged on a gallows five times higher
than the one prepared for Haman." ^ It is not so much high price
that disturbs the modem man as it is inequality of opportunity;
and this general sentiment has been very clearly and forcibly
expressed in court decisions. It makes little impression upon the
American public when it is attempted to show that the Standard
Oil Company has lowered price. The enormous fortunes to which
it has given rise suggest that price has been higher than it should
be, yielding far greater than competitive gains; but even if it could
be proved that the price had been voluntarily lowered, it would
not be convincing, because we are disturbed by the alleged engross-
ment of opportunities by a few members of the conmiunity and
not open to others. Nor would it satisfy the American public to
be convinced of the sincerity of the professed benevolence and of
the personal integrity of the leaders of this gigantic undertaking.
The question is one of the action of economic forces, largely im-
personal; the leaders are often really coerced by these forces;
and from one point of view are to be looked upon as their
victims.
Obviously, the first step in a treatment of monopolies is to dis-
criminate between monopolies owned and operated by organized
society (that is, nation, state, or city, and managed in the general
interest) and private monopoly. If it is true that a certain portion
of the industrial field is naturally monopolistic, special privilege
can be removed by government ownership. This is the first and
most obvious method. The difficulties of government ownership
are such, however, that another method is by many advocated
as preferable and is, as a matter of fact, being thoroughly tried
in the case of railways in the United States. And that is the method
of public control of monopolies privately owned and operated.
The public control, to secure equality of opportunity, must so
regulate monopolies and limit price that the gains will be no higher
than those produced by equally wise investments and equally wise
^ Bullock, Essays on the Monektry History of ike United SMeSt p. 67.
MONOPOLY an
and prudent management in the field of competition.^ Some-
times it is stated that owners of railways and other monopolistic
enterprises should have a competitive return upon all the money
that they have invested. This would give them a position of spe-
cial privilege^ inasmuch as in the competitive field a great deal of
money is lost. It is only wise investment and careful management
in the field of competition that can secure returns equal or supe-
rior to the current rates of interest. Imprudentiy invested capi-
tal is lost in the field of competition; and when it is imprudentiy
and unwisely invested in the field of monopoly, it cannot justiy
claim any return.
Finally, democratic sentiment demands that there should be no
needless extension of the field of monopoly through favoritism,
as seen in rebates and special rates of ndlway transportation com-
panies.
The Relation of Monopoly to Trusts. — The development of
industry is treated elsewhere in this work, and it is shown that, as
a result of the forces inherent in industrial society, we pass over
from labor aided with few and simple implements, scarcely more
than an extension of hands and feet, so to speak, to labor aided
by increasingly complicated and costiy tools, and then we find
labor supplemented and even replaced by machines, ushering
in the era of capitalism; and, as this transition is made, industry
is conducted on an ever larger and larger scale. The business unit
grows from the smaU, isolated shop to such a mammoth concern as
the United States Steel Corporation, owning an appreciable propor-
> This does not mean that in the case of old enterprises price must always be so
reduced that the gains shall yield a competitive return only on the physical value
of a plant. The principle of vested rights or interests has to be given a certain
rAle. These have often been created by society rather than by private persons, and
faith must be kept. In the case of railways and the telegraph, the American nation
and states have deliberately encouraged a wasteful policy of competition which
is in laiige measure responsible for high capitalization. It would not be right
to place upon holders of these properties all the burdens of a mistaken pubb'c
policy in the past. What is needed is to declare a public policy for the future
and to base returns for the future upon future actual investments in the case of
public utilities. In any case, we should have a physical valuation of railways,
gas works, etc., as a help in determining fair prices for present and future. Now
and here we can do no more than to throw out these suggestions in regard to a
presong present problem of great magnitude.
212 OUTLINES OF ECONOMICS
tion of the wealth of a vast nation. These large business units, as a
result of evolution, are commonly designated as trusts; but they
present simply the problems of large-scale industry unless they com-
prise elements of monopoly. This indeed very often, perhaps usually,
happens in the case of the largest industrial establishments. They
have been aided by rebates and other favors from railways, and
they have made themselves master of peculiarly rich and espe-
cially limited supplies of natural resources, such as petroleum oil,
anthracite coal, and the Mesabi iron range. The trust problem
resolves itself into two classes of problems: first, the class of prob-
lems belonging to large-scale business; and second, the class of
problems falling under monopoly. The discussion of so-called
trusts can be profitably considered under these two categories.
There is no magic in the mere word " trust," although it seems to
have power to awaken alarm and has helped produce precipitate
legblative action; whereas action must be preceded by an analy-
sis of the trust problem into its proper elements to make possible
its satisfactory solution.
QUESTIONS AUD EXERCISES
z. Has bigness anything to do with monopoly? Do you know any small
business which is a monopoly ? Do you know any very large business which
is keenly competitive? Contrast a state of competition with a state of
monopoly.
2. Define monopoly and discuss each point in the definition.
3. Describe as fully as you can the relation of industrial evolution to
the idea of monopoly.
4. Do you think that monopolists now show a worse spirit than formeriy?
a better spirit? Describe the monopoly established by Joseph in Egypt.
(Genesis, Chap, xlvii). What good effects did it have? Is it apparent
that it had evil effects?
5. What do we understand by partial monopolies f What is there, strictly
speaking, illogical in the term ? Is this a sufficient reason for not using it ?
6. Contrast land-ownership with monopoly.
7. Explain the importance of classification of monopolies, and especially
of distinguishing between private and public monopolies.
8. State the main classes of monopolies, and give the divisions and sub-
divisions in each class.
9. A public tobacco monopoly exists in France and produces large revenues.
The business is said otherwise to be well managed. Do you see any benefits
MONOPOLY il3
that would accrue from the establishment of such a monopoly in the United
States? any evil effects?
zo. Define monopoly price and show how it is determined.
II. What does class price mean? Compare monopoly class price with
competitive class price. Explain *^ use price."
z 2. Contrast " commodity competition " with ** business unit competition."
13. Why do we think of monopoly price as high price ? Do you know any
monopoly price which is a low price? What do you mean by high price?
by low price ?
14. What relation has monopoly to large fortunes? to small fortunes?
What, if any, to poverty?
15. What is the wise public policy with respect to monopolies ?
16. Describe the relation of trusts to monopolies.
LITERATURE
Bakes, C. W. Monopolies and the People^ Part II.
Bullock, C. J. Introduaion to the Study of Economics, Chap. XI. " Trust
Literature : A Survey and Criticism." Quarterly Journal of Economics,
Vol. XV, 1901, pp. 167-216. Reprinted in Riplejr's Trusts, Pools,
and Corporations, pp. 428-473.
Ely, R. T. Monopolies and Trusts, Chap. Ill, pp. 103-104 ; also Chap. VI,
pp. 339-331.
HoBSON, J. A. Evolution of Modern Capitalism, new and revised ed., 2907,
Chap. IX.
JENKS, J. W. The Trust Problem,
National Civic Federation Report, 1907 : Municipal and Private Operation
of Public Utilities, 3 vols.
Price, W. H. The English Patents of Monopoly,
Report of the Chicago Conference on Trusts.
Report of the United States Industrial Commission, Vols. I and II.
Ripley, W. Z. Trusts, Pools, and Corporations; Railway Problems,
Shaw, Albert. Municipal Government in Great Britain; also, Municipal
Government in Continental Europe, Chap. VI.
CEAPTER XIV
MONEY
The vast system of valuatioii and exchange, which is the most
characteristic single feature of present-day economy, rests upon
the use of money. Some economic writers have pictured an im-
aginary primitive state of "barter economy," in which, before the
use of money, goods were exchanged directly for goods. But what
little definite information there is on this point leads to the belief
that about as soon as men began to exchange things, and conse-
quently to attach exchange value to them, they began to use some
kind of money — some commodity or commodities for which things
were generally exchanged, and in terms of which the values of other
things were generally measured.
These earliest forms of money were crude and simple, but they
sufficed to meet simple needs. As exchange economy has ad-
vanced through the growth of individual and industrial specializa-
tion and the localization of industry to the present complex division
of labor, the monetary system has developed pari passu, the most
conspicuous feature of this development in modern times being the
growing importance of credit as a means of effecting exchanges.
Industrial and commercial progress has led to monetary progress,
and has, in turn, been stimulated and made possible by it.
Various Meanings of the Word "Money." — The word " money,"
like so many other terms with which economics has to deal, has
in common usage no restricted technical meaning, but may denote
any one of a number of different things. It sometimes means
individual wealth of any sort. A "monied" man is simply a
wealthy man. This is, however, only a colloquial and purely de-
rivative meaning. A second, and very common, use of the word is
in the sense of generally exchangeable purchasing power, whether
214
MONEY 315
this be embodied in concrete forms of money, or exist only in
the intangible form of credit. Money in this sense is synonymous
with "money funds." The "money market" is the market for
loanable money funds. When we speak of "money income,"
"money expenditures," "money investments," etc., we refer to
this exchangeable purchasing power.
Other meanings of the word "money" suggest that, for some
purposes, a distinction may he made between "money" and
credit instruments. But to look for any definite line of demar-
cation, consistently followed in common usage, or even in eco-
nomic writings, would be a vain search. The element of credit
is found in most forms of money, even, as we shall see, in some
kinds of metallic money. A useful and important distinction, how-
ever, is made by the very common practice of restricting the term
"money" to those instruments of general accefftabiliiy which pass
freely from hand to hand as media of exchange. The particular
things included in this third concept of money vary for different
periods and for different countries. In the United States this
freely exchangeable medium includes the metallic and paper money
issued by the federal government, together with national bank notes.
Checks drawn by individuals upon their bank accounts are not
money, or money instnmients, in this sense, because they do not
pass freely from hand to hand as media of exchange. They can be
used only in making payments to persons who know and have con-
fidence in the drawer, indorser, or holder of the check.
This third meaning of the word " money" possesses, as has been
suggested, the sanction of a very common and prevalent usage; it
corresponds, moreover, to the technical definition given to the word
by many economic writers, and to the official usage of the United
States Treasury. Some writers, however, have drawn the line
between money and other means of pa)rment somewhat differ-
ently, either refusing to count bank notes as money, thus limiting
the term to money instruments issued by the government, or nar-
rowing the application of the term yet further by using it to denote
only metallic money, all other media of exchange being counted
only as promises to pay money.
Yet another, and still more restricted, meaning is attached to the
2l6 OUTLINES OF ECONOMICS
word when it is employed to denote only that part of the stock of
metallic money which serves as a standard of value as well as a
medium of exchange. Although this extreme limitation of the
meaning of the word " money" is neither common nor justifiable,
the distinction suggested by it is a fundamental one. For, as
we shall see presently, the value of all other media of exchange
is determined by their relation to what is best distinguished by
calling it standard money.
All these different uses of the word " money " imply distinctions of
greater or less significance, but for purposes of economic analysis
the most important concepts are the second, third, and last in the
foregoing enumeration. Recognition of the fact that exchangeable
purchasing power, money instruments of general acceptability, and
the standard of value are different things is indispensable to clear
thinking in this field. In this chapter the word " money " will be
employed in the sense of money instruments of general accept-
ability.
Metallic Money. — The earliest and simplest forms of money
were commodities. Particular commodities came to serve as
money, not because they were arbitrarily designated as such by
king or chieftain, but because they possessed some properties which
made them exceptionably exchangeable. In some cases a primi-
tive community came to use a commodity as money because it was
something for which they had a dependable "foreign market" —
something, that is, which they customarily sold to other communi-
ties in exchange for their products. In other cases a commodity
which a community did not itself produce, but which it got only in
the course of trade with other communities, became the money
commodity. Or, if for any reason a particular commodity came
to be particularly esteemed as a mark of wealth or a badge of social
prestige, it was very apt to be used as money. But whatever the
original ground of the choice, a commodity which a community
once began to think of as money had its exchangeability, and con-
sequently its suitability for monetary uses, increased in a cumulative
way, just as to-day most of us are willing to accept an3rthing as
money which we think we can use as money.
A great variety of commodities have at one time or another been
MONEY 217
used as money. Some typical examples are cattle, grain, furs, oil,
salt, tobacco, ivory, sheUs, and tea. But with the advance of politi-
cal and economic civilization the metals have, through the process
of the survival of the fittest, proven themselves everywhere to be
preeminently and indisputably the best money commodities.
Copper, silver, and gold have each in turn been chosen as the prin-
cipal money metal of the civilized world, the transition from the
cheaper to the dearer metals indicating the growth of exchange and
the consequent need of larger money units.
Metak, and especially the precious metals, have certain qualities
that give them a peculiar fitness to serve as money. They are
durable, easily recognized and tested, and may be divided into
homogeneous units of convenient form and weight. Moreover, as
compared with most other commodities, the precious metak are
relatively stable in value — a fact that arises in part from their
durability, for any one year's output of the mines makes but a
comparatively small addition to the total stock of metallic money.
Coinage. — When metals were first used as money, they passed
from hand to hand simply by weight, or, in some cases, in the form
of ornaments. Coinage speedily developed, however, as a con-
venient way of certifying to the weight and fineness of money units.^
Such a guarantee is naturally of little avail unless it is generally
recognized as authoritative. On this account the coinage of money
has almost universally been regarded as a prerogative of the sov-
ereign. In England, even under the divided sovereignty of the
middle ages, the coining of gold and silver was generally a privilege
belonging to the king alone. The lesser feudal lords and the char-
tered cities issued token coins, made of the baser metals, and in-
tended especially for local use, but if they possessed the right of
coining the precious metak, it was through a special grant of the
king.
Seigniorage. — Sovereigns have in the past very often viewed
the monopoly of coinage as an opportunity for personal profit. By
^The names of many ancient coins and of some modem ones are also the
names of weights, although it has generally happened that through successive
debasements of the coinage these names have lost their original significance.
The Greek talent, the Jewish shekel, the Roman as, the English pound, and the
French livre are familiar examples.
2l8 OUTLINES OF ECONOMICS
calling in the stock of metallic money in the country for recoinagc^
they have frequently reduced the weight of coins without changing
their nominal value, thus increasing the number of coins, so that a
handsome profit was netted for the royal treasury. Debasement
of the ciurency was a favorite financial expedient of Henry
VIII, of England, and of Philip the Fair and Louis XIV, of
France.
Somewhat less reprehensible in theory, although amounting to
about the same thing in its effects, was the common practice of
making a charge for coinage, called seigniorage. This practice
was based on the idea that it was possible to maintain a dif-
ference between the value of a coin and the value of the bullion
put into it.^ A great deal has been written about the possibility
of seigniorage, for the subject is one that involves considerations
that are fundamental in monetary theory. It has been often said,
for example, that it k the "government stamp," rather than the
metallic content, that ^ves value to a coin. Leaving aside the-
matter of limited or subsidiary coinage (which will be considered
presently), we may dispose of this statement by saying that if it
means that the use of certain metals as money decreases the supply
of them available for other purposes, and thus increases their value,
it is a truism; but if it means that in coinage we can add an arbi-
trary and intangible element of value to the metallic content of the
coin, the statement is a false and misleading doctrine that has been
disproved over and over again by the monetary experience of
almost every country.
There is, however, a stronger statement of the theory of seignior
age. If the only way in which I can convert bullion into a medium
of exchange is by being content with 750 ounces of money for every
1000 ounces of biillion I take to the mint, will not the coins have a
value one third greater than that of the metal they contain ? May
not their "metallic content*' be said to be, in a figuratiye sense,
one third more than their weight, because they cost me that much
more in bullion? If their bullion value sinks below this point,
bullion will not be brought to the mint, as it would be worth more
> Under Phflip the Fair, of France, the seigniorage chai^ge went as high as
50 per cent. Charges of from a to 15 per cent were more common.
MONEY 219
than the coins one could get for it ; just as when the value of the
coins rises above this point the supply of bulUon would be stimu-
lated so that as a result the value of the coins would tend to maintain
this fixed relation to the value of bullion. Confidence in the sta-
bility of the government may be assumed in this reasoning; and
as a matter of fact^ it is probable that in a completely isolated
community the government could, through wise and careful regu-
lations, maintain a constant rate of profit on the coinage, with-
out endangering the stability of the monetary system.
The fundamental difficulty with seigniorage is, however, that in
foreign trade coins pass current only as bullion, so that when
seigniorage was charged, the prices of imported goods, measured
in money, were necessarily higher than thdr prices measured in
bullion, by an amount equal to the seigniorage. It was impossible
that one ratio could long be maintained between the value of coined
money and the value of bullion in domestic trade and another ratio
in foreign trade. The interdependence of the prices of all kinds
of goods prevented that. Money prices, in general, always rose ;
that is, the value of the coins sank to the level of the value of the
bullion they contained. Under these conditions no one would
voluntarily undergo the loss inseparable from taking bullion to the
mint for coinage, and with the cessation of coinage the profits from
coinage stopped. Every possible expedient, short of the absolute
prohibition of foreign trade, was tried by sovereigns in their efforts
to retain these profits.^ But market forces were found to be
stronger than royal regulations, which at best only served to retard
somewhat the depression in the value of the official coinage.
About the only effective way of getting seigniorage profits was for
the sovereign to admit that the coins in circulation possessed only
their bullion value, and then to call in the currency for recoinage
1 The use of any other circulating medium than the offidal one was prohibited;
no one was allowed to sell imported gold or silver, whether in bullion or coin,
save to the royal mint; if there were mines within the country, they were some-
times prohibited from disposing of their products except to the royal mint; gold-
smiths were forbidden to melt down coin or to purchase more bullion than they
needed, and this they were forbidden to buy at less than the mint price; restric-
tions were placed on the export of brdlion; these and other similar methods were
tried, but 1^ to no avail. Cf . W. Lexis, article " MUnzwesen/' in HandwMerbuch
ier Staatswissttuchaften.
220 OUTLINES OF ECONOMICS
into smaller pieces, in the manner that has already been mentioned,
thus starting afresh with a new seigniorage charge. The result
was invariably a repetition of the process of a more or less rapid
depreciation in the purchasing power of the coins, leading often to
further debasements of the currency.
Modern nations have abandoned the attempt to secure profits
from their monopoly of the coinage. Since 1666 England has
made no charge whatever for coining bullion into standard money.*
Most of the countries of continental Europe make a charge just
sufficient to cover the expense of coinage. This charge is some-
times called seigniorage, but it is usually, and more properly, called
brassage. The United States made no coinage charge until 1853,
when a charge of one half of i per cent was made for coining
standard money. This was reduced in 1873 ^^^ ^^ abandoned
entirely in 1875. At present the United States exchanges gold
coins, weight for weight, for bullion of standard fineness (nine
tenths gold, one tenth copper) brought to the mint in lots of one
hundred dollars or more in value. For crude bullion, or bullion
not of standard fineness, gold coins are exchanged containing as
much fine gold as is contained in the bullion, less a trifling charge
for assaying, refining, and for the alloy.*
Instead of viewing coinage as a profitable prerogative of the
government, we have come to view it as a government duty, to be
performed at government expense. The question of seigniorage
versus gratuitous coinage is no longer a live issue. But the student
who has grasped the significance of the lesson contained in the his-
tory of seigniorage has taken an important step toward the under-
' In practice most of the gold bullion coined in England is supplied to the mint
by the Bank of England, which is required by law to purchase it at the minimum
price of j^3 1 7 J. gd. per ounce. An ounce of bullion makes j^3 17*. lo^d. in
gold coin, the difference going to compensate the bank for the delay involved in
getting the bullion coined at the mint. In the United States the waiting devolves
upon the government, for gold coins, or, at the option of the depositor, checks
upon United States subtreasuries or upon depository banks are paid to depositors
as soon as their bullion can be weighed and assayed.
'The coinage mints are at Philadelphia, San Francisco, New Orleans, and
Denver. In addition there are assay offices at New York, Carson, Boise, Helena,
Charlotte, St. Louis, Deadwood, and Seattle, which receive bullion on the same
terms as the mints, plus an additional charge of one eighth of z per cent.
MONEY 221
standing of monetary theory. There is no mysterious element of
intangible value created by the operation of coinage. The coinage
of standard money is now in law, and always has been in fact, a
device for dividing the standard money metal into convenient units
of certified weight and fineness.
The Standard of Value. — We have seen in an earlier chapter
that prices are exchange values measured in terms of money.
Goods and services are exchanged for money in certain ratios, and
these ratios constitute the prices of the goods and services. Some
writers have made a distinction between the functions which
money performs as a medium of exchange^ and its functions as a
measure of value. These are not, however, two di£Ferent functions,
but merely two di£Ferent aspects of the same thing. By the very
process of exchanging a commodity for money, we of necessity
measure its value in terms of money, and only as a medium of ex-
change does money measure value. We may speak of a pound
weight as an instrument used in weighing or as a measure of weight,
but we would all recognize that this refers only to two aspects of
the same thing.
In the United States the actual medium of exchange with which
we measure values is heterogeneous in that it comprises a variety
of coins, made from different metals, together with several kinds of
paper money of many different denominations. But it is homo-
geneous in that first, all these different forms of money are alike in
name, — that is, they are dollars, or multiples or fractions of a
dollar, — and second, these various kinds of dollars are identical
in value. This familiar and very satisfactory condition of uni-
formity in the units in which we measure value does not, however,
suggest to us the real nature of the value of money in the way that a
less perfect monetary system would.
It would be possible to have a number of different monetary
units, just as the weight or size of an object may be stated in terms
of either the metric system or the English system of weights and
measures. In fact, before the United States had an adequate
monetary system of its own, the actual medium of exchange con-
sisted largely of English, French, Spanish, and Portuguese coins,
and there were as many different ways of stating prices, that is, of
222 OUTUNES OF ECONOMICS
measuring values, as there were units of value.^ Nor does the
mere name of ^^ dollar " give to different pieces of money a uniform
value. The silver dollar of Mexico is worth only about half as
much as the silver dollar of the United States, although it is of ap-
proximately the same size. More significant, however, is the fact
that in the United States we have had at different times ''dollars"
of unequal value.
What is it, then, that gives uniformity to the dollar as a unit of
value in our present monetary system ? To say that various kinds
of money are equal in vahie because they will purchase the same
amounts of goods is, obviously, to argue in a circle. But the an-
swer is found in the fact that they are interchangeable^ and so long
as any number of kinds of money, all named in dollar imits, are
freely exchangeable, dollar for dollar, it is impossible that a dollar
in one kind of money should be worth more than a dollar in any
other kind of money. We do not refer here to the fact that the
different kinds of money are exchanged for each other at par in
business transactions and in banking, for this is a result, rather
than a cause, of the uniform value of the money units. The ex-
changeability that underlies the uniform value of oiu: different
kinds of money is maintained by the federal government
All coins smaller than a dollar are by law exchangeable at the
United States Treasury for "lawful money," which includes gov-
ernment notes, silver dollars, and gold coins. Government notes,
in turn, are simply promises to pay, which are redeemable in gold
at the government Treasury. While there is no definite legal man-
date requiring the redemption of silver dollars in gold, yet the cur-
* An instructive bit of monetary experience may be found in the efforts of
some of the colonies to reduce this foreign money, especially Spanish numey,
to the English system of pounds, shillings, and pence, in which accoimts were
generally kept. They were not content with a simple official statement of the
actual ratios between the different value imits, but sought to give an artificially
enhanced value to the foreign coins by increasing the number of shillings to which
they were to be considered equivalent. The result was not, however, an increase
in the value of the coins, but a decrease in the value of the nominal "shilling"
in which accoimts were kept. This was the origin of the now rapidly vanishing
use of the word "shilling" as equivalent to la^ cents in some localities and to
z6f cents in others. The student may find an instructive parallel in this eaqieri-
ence and the official statements of coin values by which sovereigns tried to retain
their seigniorage profits.
MONEY 323
rency act of 1900 makes it the duty of the Secretary of the Treasury
to maintain all other forms of money at a parity with gold — a
requirement which means that he would have to redeem silver
dollars in gold if such action should at any time be needed to
maintain their parity. Gold certificates and silver certificates, are
simply a mechanism for putting gold and silver money into circu-
lation in convenient form. They are analogous to warehouse re-
ceipts, because they represent gold coins and silver dollars that are
stored in the government Treasury to the full amount of the certifi-
cates issued,, and which may be obtained at any time in exchange
for the certificates. National bank notes, which constitute a large
part of our actual circulating medium, are redeemed at the federal
Treasury in government notes. In practice the government is con-
tinually receiving all kinds of money, including silver dollars, and
exchanging other kinds of money for them.
The significarU thing is that all other kinds of money are eocchange-
able, directly or indirectly, for gold coin. In the case of gold coin,
there is a further kind of exchangeability — the unlimited and
free convertibility of gold coin and gold bullion. So long as any
one can secure gold coin in any amount for the same weight of gold
bullion of standard fineness, and so long as gold coin can be freely
melted down into gold bullion, it is impossible that there should be
any difference between the value of a gold coin and the value of its
metallic content. We have, then, not only the interchangeability of
all parts of the circulating medium, but also the positive physical
identity of one part of it and the material of which this part is made.
Gold, whether in coin or bullion, constitutes the standard of value,
for it is the value of gold that fixes the value of the dollar. The
measuring of values in terms of dollars through the exchange of
goods and services for money of different sorts, the equalizing of
the values of dollars in all varieties of money through their ex-
changeability, and the automatic standardization of the value of
the dollar through the free and unlimited coinage of gold * ; — these
are the fundamental facts of our monetary system.
' In fixing the -value of coins at the value of their metallic content, unlimited
coinage is of more importance than free coinage, as the history of seigniorage
shows. Some writers have emphasized the importance of the legal tender quality
224 OUTLINES OF ECONOMICS
Gold coins, because their value as bullion is equal to their value
as coins, constitute standard money. The gold dollar weighing
25.8 grains, and containing 23.22 grains of fine gold, is by law the
unU of value. The coinage of the gold dollar was discontinued in
1890, but the gold coins that are minted contain precisely this
amount of gold per dollar.
Limited Coinage. — Gold is the only metal which is made into
coins by the United States government for any one who deposits
bullion at the mints or assay offices. All other coins are made
from metal purchased from time to time for that purpose as Con-
gress may direct. In none of these coins is the bullion worth as
much as the coin. In 1878, when the United States began the
limited coinage of silver dollars, the value of the 371 J grains of pure
silver in a silver dollar was about 89 cents. The value of silver de-
clined steadily until 1902, when 371 J grains of silver were worth
only 41 cents. Since that time there has been a slight upward move-
ment, but nevertheless the present (1908) bullion value of a silver
dollar is only about one half its value as a coin. The bullion value
of the smaller silver coins is still less, for they contain but 347.22
grains of silver to the dollar, while the bullion value of our nickel
and bronze coins is yet smaller, relatively.
Such coins are sometimes called ^' token coins," the implication
being that the fact that they pass from hand to hand at their full
nominal value is merely a matter of habit or usage, supported by
general acquiescence. More accurately, however, they are credit
coins, because the excess of their coin value over their bullion value
depends ultimately, as we have seen, upon the good faith and credit
of the government, evidenced by their redeemability in gold. If,
for example, a catastrophy should overthrow the present federal
government, and if the new government should refuse to recognize
the obligations of the old, nothing could prevent these coins from
sinking to their bullion value.
in this connection. But experience has shown that while the fact that money must
be accepted by a creditor at full value sometimes makes an otherwise undesirable
kind of money a ''generally acceptable medium of exchange," it does not suffice
to maintain its value, so far as prices made after such money has been issued are
concerned.
MONEY 225
A very considerable profit accrues to the government from this
limited coinage. The difference between the amount paid for
silver bullion from 1878 to 1907, and the value of the coins made
from it, amounted to $143,000,000. In the accounts of the federal
treasury this profit is called seigniorage, but it is to be carefully
distinguished from real seigniorage, — a charge exacted for the
conversion of standard bullion into standard coin. If the federal
government should issue a general balance sheet of the kind used
in corporation accounting, the credit element in its outstanding
limited coinage would properly appear as a liability, which might
be greater or less than the profits that had accrued on such coinage,
depending upon whether the present value of the bullion in the
coins happened to be greater or less than the prices which the gov-
ernment had paid for it.
Bimetallism. — A monetary system like the present one of the
United States is a single standard system, because only one com-
modity is used as a standard of value. The double standard system,
under which two different commodities serve concurrendy as
legal standards of value, has, however, been used in the past
by many governments, including our own, and its superiority
over the single standard system has been alleged by many advo-
cates. Practically the only commodities that civilized nations
have used as standards of value in modem times are gold and
sUver. The question of the double standard resolves itself,
accordingly, into the question of the bimetallic standard, which
means in practice the unlimited coinage of both gold and
alver.
Bimetallism does not mean, in theory, as might be supposed, the
establishment of two different monetary units of different names,
one measured by the value of a certain amount of silver, the other
by the value of a certain amount of gold, prices being measured
according to convenience in terms of either unit. On the contrary,
it contemplates the establishment of one nominal unit, such as the
dollar, to be measured at the same time by the value of either a defi-
nite amount of gold or a definite amount of silver. More concretely
this means the opening of the mints to the unlimited coinage of both
gold and silver into dollars, or dollar multiples, the amount of silver
Q
226 OUTLINES OF ECONOMICS
in a silver dollar and the amount of gold in a gold dollar bdng
established by law.
Many of the arguments that have been advanced by bimetallists
have related to the alleged immediate advantages to be secured
from the adoption of the double standard imder particular condi-
tions of time and place. One argument, however, of more general
significance is based on the probable greater stability in value of
the double standard. Silver and gold are produced under some-
what different conditions, and are used for somewhat different pur-
poses. It has been suggested that tendencies toward fluctuations
in the value of silver and gold would, therefore, be as apt to be in
opposite directions as in the same direction, and that so far as they
were in opposite directions they would tend to counterbalance each
other.
Most opponents of bimetallism, while admitting that, if feasible,
it might possess some advantages, deny its possibility. The diffi-
culty is, they maintain, that while the ratio of the weight of gold in
the monetary unit to the weight of silver in the monetary unit has
to be fixed and definite, the ratio of the value of gold to the value of
silver is not fixed and definite, but is subject to the fluctuations
of the market. If one metal is relatively undervalued and the other
relatively overvalued by the legal ratio, the result will be that only
the overvalued metal will be brought to the mint for coinage, for the
undervalued metal will be worth no more than the overvalued one
as coin, but will be worth more as bullion. The actual result will
be, in such a case, not a bimetallic standard, but a single standard
composed of the metal which, at the mint ratio, is the cheaper.
Moreover, if, by a change in the relative market values of the two
metals, this one in turn becomes undervalued by the mint ratio,
the standard coins composed of that metal that are already in use
will, according to Gresham's law,* disappear from circulation,
being hoarded, melted down, or exported, and the other metal will
take its place as the actual standard of value.
* Gresham's law is that "bad money drives out good," or that "the cheaper
money drives out the dearer." Sir Thomas Gresham, master of the mint under
Queen Elizabeth, came to this conclusion as a result of his observation of the
difficulties encountered by that sovereign in her attempts to improve the condidon
of the debased, worn, and mutilated coinage bequeathed to her by her predecessors.
MONEY 1127
All but the most extreme bimetallists would admit the impossi-
bility of establishing and maintaining a coinage ratio between the
two metals that would differ by any considerable margin from the
ratio corresponding to their market values, but they maintain that
a mint ratio established as nearly as possible to the prevailing
market ratio will have a steadying influence upon the latter that
will tend to prevent any wide divergence between the two. If one
metal should rise in value to such an extent that it would not pay
to use it as money, more of the other metal would be used for mone-
tary purposes, thus decreasing the supply of it available for other
uses and consequently enhancing its value. The net effect would
be, it is claimed, a tendency toward the equilibrium of the value of
the two metals at the coinage ratio.
The appeal to history has been used both by bimetallists and
their opponents. The claim of the monometallists that legal bi-
metallism is apt to mean actual monometallism, with the relatively
cheaper metal as the standard, has been substantiated many times
in the monetary experience of different nations. The automatic
change from one single standard to the other, following a change
in miarket values, is also a phenomenon that has been illustrated by
a large number of concrete cases. On the other hand, the bimetal-
lists are able to point to some apparently successful bimetallic sys-
tems, such as that of France in the eighteenth century. But it is a
significant fact that no real bimetallic system has been able to en-
dure for any considerable time except when the annual production of
gold and silver was relatively small and relatively stable, and where
international trade was a relatively unimportant item. There is no
sdentiffc student of monetary problems who believes that it would
be possible for any nation to maintain independently the double
standard under the present conditions of a large and fluctuadng
annual production of the precious metak, coupled with an inter-
national commerce of vast proportions.
International bimetallism, that is, the adoption by each of the
leading nations of a bimetallic standard, at a ratio flxed by national
agreement, has had many supporters, even among those who do not
believe in the practicability of national bimetallism, and repre-
sentatives of different nations have assembled in several inter-
228 OUTLINES OF ECONOMICS
national monetary conferences for the discussion of this subject
International bimetallism would remove one difficulty experienced
in the attempts made by different nations to maintain independent
bimetallic systems at even slightly differing ratios, — and that is,
the tendency for each metal to flow from the countries in which it is
relatively undervalued in the mint ratio to the countries in which
it is relatively overvalued. Other difficulties, however, would still
remain, and the possibility of maintaining an actual bimetallic
standard even under international agreement, supposing that were
fX)ssible, is open to very serious doubt.
The waning of public interest in the question of bimetallism in
recent years is of great significance, because it indicates that the
real moving forces behind the bimetallist propaganda have not been
any real or assumed points of superiority of general significance
that may be imputed to a multiple standard, but rather that certain
specific results that would flow from the adoption of bimetallism
at a particular time and place have been desired. More specific-
ally, bimetallism has been supported by those who have desired
"cheaper money," and these have been particularly active when
the monetary standard in actual use has been increasing in value;
that is, when prices in general have been decreasing. The recent
great increase in the world's production of gold has, temporarily at
least, taken bimetallism out of the list of economic problems of
general public interest.
Bimetallism in the United States. — The national monetary sys-
tem was established by act of Congress in 1792.^ The mint was
opened to the free and unlimited coinage of both gold and silver,
the silver coins containing 371^ grains of fine metal per dollar, and
the gold coins 24! grains per dollar, the ratio of 15 to i being thus
established. It was soon found, however, that gold was worth in
the market slightly more than fifteen times as much as silver, and
* The act of 1799 followed in detafl the recommendations of a Report of the
Establishment of a Mint, by Alexander Hamilton, then Secretary of the Treasury.
Hamilton incorporated some of the recommendations contained in earlier reports
by Robert Morris and Thomas Jefferson. Hamilton's Report has been frequently
reprinted, but it, together with the reports of Morris and Jefferson and other
pertinent documents, may be conveniently foimd in the Report of the International
Monetary Conference of 1878.
MONEY 229
as a consequence but little gold was brought to the mint for coinage,
while the gold that was coined illustrated Gresham's law by speedily
disappearing from circulation.
Sflver dollars, too, disappeared from circulation, but for another reason.
They were somewhat lighter than the Spanish dollars which were in general
circulation at the time, and would, under the operations of Gresham's law,
have driven the latter out of circulation, had it not been that the Spanish
dollar commanded a slight premium over the American dollar in ordinary
purchases. But the American dollars, on account of their new and attractive
appearance, could be used a", 'dvantageously as the Spanish dollars in trade
with the Spanish possessions in America. They were consequently taken
from the country for that purpose, while Spanish dollars were brought
back and were often recoined into a larger number of American dollars.
This wasteful coinage of silver dollars was stopped in 1806 by order of
President Jefferson, leaving the mint open to the coinage only of gold, smaller
silver coins, and minor coins. As a matter of fact American coins made up
only an insignificant part of our circulating medium before 1834.
Realizing the impossibility of maintaining a gold coinage under
such conditions, Congress, in 1834, changed the legal ratio to 16 to i
by reducing the weight of the gold dollar. By this step, however,
they went too far in the other direction, for silver was undervalued
at this ratio, and while the number of gold coins increased, but little
silver was brought to the mint, and silver coins quickly disappeared
from circulation. In order to secure a supply of small change.
Congress was forced, in 1853, to abandon the principle of the free
and unlimited coinage of silver coins smaller than a dollar, and to
order that they should be coined, as at present, only from bullion
purchased by the government at the market price. At the same
time the weight of these subsidiary coins was reduced by one
seventh to insure their being retained in circulation.
The discovery of gold in California, in 1848, and in Australia, in
1851, suddenly increased the world's supply of gold by an unprece-
dented amount. In fact, the careful estimates of Dr. Soetbeer indi-
cate that as much gold was produced in the third quarter of the
nineteenth century as in the preceding three centuries and a half
following the discovery of America. The result was to increase the
discrepancy between the mint ratio and the actual market ratio of
gold and silver, although the production of silver had also been
23© OUTLINES OF ECONOMICS
greatly increased. Gold was brought to the mint for coinage in
enormous amounts, — a condition that lasted even after 1861, when
paper currency began to be used almost exclusively as the medium
of exchange.
In a general revision of the coinage laws, enacted in 1873, ^^^
silver dollar was dropped from the list of coins that could be manu-
factured at the mint. Although this action was almost unnoticed
at the time, a fictitious significance has, in subsequent years, been
attached to it. Silver was practically "demonetized," that is, its
free and unlimited coinage was actually prevented, by the estab-
lishment of the ratio of 16 to i in 1834. The act of 1873 gave legal
recognition to an existing fact.
But a sudden depreciation in the value of silver, which began at
about this time, brought the question of bimetallism again into the
foreground. Since the seventeenth century the relative values of
gold and silver had fluctuated only between relatively narrow mar-
gins, and in no year since the establishment of the United States
mint had the average annual value of an ounce of gold been less
than 15 or more than 16^ times the value of an ounce of silver. In
1875, however, the market ratio fell to 16.6 to i; by 1878 it was
18 to I ; by 1886 it was 20.8 to i ; and in 1894 it was 32.6 to i.^ It
is evident that if the opportunity for the free and unlimited coinage
of silver at the ratio of 16 to i had still existed, there would have
been another sudden change in the actual standard of value. Gold
would have been undervalued by that ratio, and would have disap-
peared from circulation, and silver would have taken its place. It
was the realization of this fact, coupled with the knowledge that the
silver standard would mean a "cheaper dollar," that led to a popu-
lar agitation for the free and unlimited coinage of silver which
continued for more than twenty years.
The first tangible result of this agitation was a compromise meas-
> The causes of this unprecedented decline in the relative value of one of the
precious metals were complex and intricate. The following may be mentioned,
however, as contributing circumstances: (x) Cessation of an extraordinary de-
mand for silver in India which had existed since 1850; (a) Stoppage of the unlim-
ited coinage of silver in several European countries ; (3) Discovery of large silver
mines in the United States; (4) Increase in the value of gold, as evidenced by a
general decrease in the pricea of commodities.
MONEY 231
ure, the Bland- Allison Act, passed by Congress in 1878, which in-
stituted the limited coinage of silver dollars by authorizing the sec-
retary of the treasury to piurchase at market prices not less than
$2,000,000 nor more than $4,000,000 worth of silver bullion per
month, and to coin it into dollars. The results of this enforced
coinage were satisfactory to neither party to the controversy. The
amount of silver coined was in excess of the demand for that bulky
kind of money, even thoi^h as much as possible was put into circu-
lation in the form of silver certificates, and although the govern-
ment tried to favor the distribution of silver by paying the expense
of transporting it to the localities where it was wanted. The move-
ment in favor of the unlimited coinage of silver continued to gain
in strength, however, its advocates claiming that ''more silver,"
rather than less, was needed.
A second compromise was effected in the Sherman act of 1890,
which provided for the increase in the amount of silver purchased
to 4,500,000 ounces each month, which was to be paid for in treas-
ury notes. These treasury notes were to be full legal tender, and
were redeemable in gold or silver coin at the discretion of the secre-
tary of the treasury. The silver was to be coined only so rapidly as
was found necessary for the redemption of the treasury notes. The
increase in the amount of silver purchased was a concession to the
advocates of the imlimited coinage of silver; the fact that the circu-
lating medium based immediately on these purchases was com-
posed of treasury notes, which were injected into circulation in
proportion to the market value of the silver purchased, was a con-
cession to thdr opponents.
The soundness of the principles embodied in the Sherman act
was soon tested by a period of financial and industrial depression.
Gold had to be exported to Europe in large quantities to settie an
adverse balance of trade, and the government found difl&culty in
maintaining its own gold reserve, which was already seriously
threatened by a decline in customs receipts, accompanied by an in-
crease in federal expenditiures. The gold reserve was at that time
simply the amount of gold in the treasury that was available for the
redemption of other forms of money, — especially the United
States notes, or greenbacks, that had been first issued during the
232 OUTLINES OF ECONOMICS
Civil War, but which did not become actually redeemable in gold
until 1879. During this scarcity of gold the banks were able to
secure gold for their own reserves or for export by presenting
United States notes at the treasury for redemption in gold. Under
the law the notes had to be immediately reissued, and were used in
government payments, but no sooner was this done than they were
again returned by the banks for redemption in gold.
The workings of this " endless chain " by which gold was pumped
from the government treasury were aggravated by the fact that the
treasury notes authorized by the Sherman act were used for the
same purpose. Although they were payable either in gold or silver
coin, they were actually redeemed on demand in gold. This was
at the urgent insistence of President Cleveland, who believed, with
good reason, that a refusal to redeem them in gold would probably
have forced the silver standard upon us, by destroying the ex-
changeability of silver and gold and thus putting an end to their
parity, and that it would certainly have injured the credit of the
government and put it to a disadvantage in the bond sales that
were needed to replenish the gold reserve. Under the operations
of the Sherman act the government was virtually exchanging gold
coin for silver bullion at a time when gold was sorely needed and
when the value of the purchased silver was steadily depreciating.
The gold reserve sank from $190,000,000 in 1890 to $95,000,000
in 1893. I^ J^^c ^^ t^c latter year the closing of the mints of India
to the unlimited coinage of silver gave an added impetus to the
downward movement of the value of that metal. These facts led
Congress, in a special session called in 1893 for that purpose, to
order, though with obvious reluctance, that the purchase of silver
under the Sherman act should be stopped.
The agitation for the free and unlimited coinage of silver con-
tinued, however, and with increased vigor, and it was made the sole
issue in the presidential campaign of 1896. It was alleged that the
yet continuing industrial depression could be alleviated only by
"more money" and "cheaper money." It was claimed by many
intelligent people that the unlimited coinage of silver would not
drive gold from circulation, but would increase the value of silver
and decrease the value of gold until they met at a parity established
MONEY 233
by the desired legal ratio of 16 to i. The most effective argument
of the protagonists of silver was found, however, in the admitted
fact that the value of gold, as shown by changes in the general price
level, had been increasing. All indications pointed toward a con-
tinued decrease in the annual production of gold, and a consequent
further increase in its value. This, it was argued, was a hardship
to those who had borrowed money on long time obligations, such
as mortgages, because they would be forced to repay in value or
piurchasing power more than they had borrowed.*
This agitation was, in fact, simply one of a series of cheap money
movements that have characterized the economic development of
the United States, and which have sprung from the fact that the
expense of opening up and developing new lands has necessitated
expenditures of capital in an amoimt far beyond the resoiurces of
the actual settlers. Newly settled regions have usually been
debtor regions, and there is more than mere coincidence in the fact
that demands for cheap money have always been voiced most
loudly on the frontier.^ This does not mean that a cheap money
movement is essentially dishonest; that it represents the conscious
attempts of debtors to escape the payment of their lawful debts.
The life and vigor in this movement for the imlimited coinage of
silver was put into it by men who saw the imputed value of their
assets sinking and the difficulty of paying their debts increasing in
a financial crisis for which they were not individually responsible.
Money funds were hard to get because individual credit, the founda-
tion of bank credit, was lacking. This scarcity of money funds
was confused, naturally, if erroneously, with the scarcity of
"money" in the sense of standard money, — gold; and the remedy
was sought in an action that would give more and cheaper standard
money.
The defeat of the advocates of bimetallism in 1896 would prob-
ably not have stopped the agitadon for the unlimited coinage of
silver, had it not been for the return of prosperous conditions,
^This aigument raises the problem of the standard of d^erred payments,
which is to be considered in Chapter XVI.
' Cf. C. J. Bullock, Essays in the Monetary History of the United States,
Parti.
234 OUTLINES OF ECONOMICS
coupled with an enormous increase in the world's annual produc-
tion of gold, which has brought with it a general increase in prices.
The single gold standard was formally and de^itely recognized
by law in 1900. All of the silver bullion purchased under the
Sherman act has been coined, and silver dollars sufficient in
amount to retire the treasury notes have been set aside for that
purpose. These treasury notes (which should not be confused
with United States notes, or greenbacks) are accordingly on sub-
stantially the same basis as silver certificates. Up to June 30, 1907,
their amount had been reduced from $156,000,000 to $6,000,000.
No silver dollars have been coined since 1904, and under the present
law no more can be coined until Congress authorizes the special
purchase of bullion for that purpose.
The Dcxminance of the Gold Standaxd. — Within the last few
years gold has been accepted more generally and more definitely
than ever before as the standard money metal of the world. The
change from a silver, or bimetallic standard, to the gold standard
is often a difficult and expensive national undertaking, but it brings
the advantages of a more stable unit of value and of increased
facility in international exchange. In October, 1906, the silver
standard prevailed only in Bolivia, four of the countries of Central
America, China, Persia, and the Straits Settiements.^
Goveniment Paper Money. — In metallic money of limited
coinage, there is, as we have seen, a considerable element of credit
value added to the actual bullion value of the coins. In paper
money the element of credit is alone present. Government paper
money is composed of instrmnents which bind the government to
pay, and usually to pay on demand, equivalent amounts of metallic
money, — usually standard money.
Government paper money ako di£Fers from metallic money of
limited coinage in respect to the motives which give rise to and regu-
late its issue. Subsidiary coins are issued by the government in
response to the demand for a circulating medium for use in small
transactions and in making change. The public convenience is the
first consideration; the profit accruing to the government on such
coinage is a secondary thing. In issuing government paper money,
* Report of the Director of the Mint, in Finance Report, 1907, p. 297.
MONEY 235
however, fiscal motives have predominated. When hard pressed
to swell the government income to cover an increase in expenditures,
those responsible for the financial policies of a government have
sometimes deemed it advisable for the government to make use of
its own notes, promises to pay, in discharging its obligations.
These differ from government bonds, which are often issued in
similar circumstances, in that the bonds bear interest, are sold to
voluntary buyers, and are usually payable at a definite time in the
future, while government notes are usually non-interest bearing,
represent a forced, rather than a voluntary loan, and are usually,
in form at least, payable on demand, or in practice, at an indefinite
time in the future. They are, moreover, issued in convenient form
for monetary use, and are usually made legal tender, so that they
pass from hand to hand as a medium of exchange. The forced
loan which they represent is therefore shifted from those who first
recdve the notes from the government in payment for goods or
services*
Colonial and Revolutionary Bills of Credit. — Paper money
issues have frequently been used in the United States as a means of
meeting a fiscal emergency, especially those springing from the
extraordinary expenditures occasioned by wars. The expense of
sending troops to the Indian wars was one of the things that led
most of the American colonies to issue paper money. The history
of these colonial "bills of credit," as they were called, illustrate two
dangers that seem to be inseparable from the use of this financial
and monetary device. In the first place, it was very easy to suc-
cumb to the temptation of paying ordinary as well as extraordinary
expenditures in this easy way. Some of the colonies got entirely
out of the habit of taxing themselves to meet current public ex-
penses. The refusal to levy taxes was a prolific cause of disputes
between colonial assemblies and royal governors.
In the second place, because no money was raised for the pur-
pose, these bills of credit were not redeemed promptly. Their
value, as compared with metallic money, fell because people lost
confidence in their redeemability. As the currency depreciated,
it took continually larger issues of it to meet the government ex-
penditures, and each increase in the amount in circulation led to a
236 OUTLINES OF ECONOMICS
further fall in value. After the currency had become practically
worthless, it was a common practice of the colonies to repudiate it
in whole or in part, and to start afresh with bills of a " new tenor."
Any attempt to restrict this reckless use of public credit was met
with determined resistance from the "cheap money" advocates of
that day. There were frequent complaints of the scarcity of money,
especially from the more newly settled districts. The greater the
quantity of money issued, the more insistent was the demand for
still further issues. In short, this colonial experience in itself gives
sufficient basis for the inference that from the monetary as well as
the fiscal point of view, the use of paper money easily degenerates
into a bad habit.
Again, in the Revolutionary War, paper money issues were made,
— this time by the Continental Congress as well as by the individual
colonies. The Continental Congress was really driven to this action
by its lack of the power of levying taxes. Its bills became practi-
cally worthless, although every effort was made to maintain their
parity with metallic money by appeals to patriotic sentiment.
After the formation of the national government a few of them were
redeemed at one cent on the dollar.
It was our unfortunate colonial and revolutionary experience
with paper money which led to the insertion of the wise provision
in the federal Constitution which forbids the individual states to
issue bills of credit or to make anything but gold and silver legal
tender in payment of debts.
The Greenbacks. — The federal government made no important
issues of paper money until the Civil War.* It was not generally
foreseen that that conflict would be so long continued and intense
as it was, and Congress consequently neglected to make adequate
provision for taxes that would help to meet the increased expendi-
tures and to sustain the government credit in the borrowing opera-
tions that were necessary. In 1861 the secretary of the treasury
was authorized to issue at his discretion $50,000,000 in "demand
'The federal government issued treasury notes in the war of 181 3 and the
Mexican War, and during the panics of 1837 and 1857. Most of these issues were
interest bearing, however; none of them were legal tender, and none of them got
into common use as media of exchange.
MONEY 237
notes/' which, although they were not legal tender, could be used
in all payments to the government. These were redeemed promptly
on demand until the end of the year, when the withdrawal of gold
from the banks by depositors for hoarding, and by the government
for its own uses, led first the banks and then the government to
suspend specie payments, — that is, to refuse to pay their current
obligations in gold.
In 1861, moved by the absolute necessity of providing some kind
of money for the federal treasury. Congress authorized the issue of
$150,000,000 in legal tender notes,^ or greenbacks, as they came to
be called. It was hoped, moreover, that this increase in the circu-
lating medium would improve the market for government bonds
for which the greenbacks were at first made convertible at par.
This action was not taken without strenuous opposition on the part
of those who foresaw some of the disastrous consequences of large
paper money issues. But as in earlier American experience with
paper money, succeeding issues met with less and less resistance.
AU together, greenbacks to the amount of $450,000,000 were
issued during the war.
It was the general expectation when the greenbacks were issued
that they would be retired as soon as possible after the conclusion
of the war. But when such action became possible, it was opposed
by many who thought that the reduction of the circulating medium
would decrease prices, impose additional burdens upon debtors,
injure business interests, reduce the public revenues, and hamper
the government in the refunding of its public debt. In 1866, how-
ever, Congress authorized the gradual retirement of the greenbacks,
but repealed the act in 1868. The amount in circulation in 1874
was $382,000,000, and in that year a bill requiring the definite in-
crease of the issue to $400,000,000 was prevented from becoming
law and thus establishing a dangerous precedent only by the veto
of President Grant. Some greenbacks were retired under the pro-
visions of an act of 1875, but inMay, 1878, there were $346,681,000
outstanding, and as a law then enacted provides for their constant
reissue after being received or redeemed at the treasury, the amount
still stands at that figure. The part that they played in the financial
' Including the "demand notes," which were now made le^^al tender.
238 OUTLINES OF ECONOMICS
difficulties of 1 890-1 893, together with the history of the treasury
of the notes of 1890, has been described in connection with the dis-
cussion of bimetallism.
At present the greenbacks constitute a useful and acceptable part
of the stock of money. But if another financial crisis should
deplete the government treasury, they would very likely prove
again to be a source of difficulty. Their retirement is feasible under
present conditions, but would be most difficult to accomplish under
the very financial conditions under which they would be most dan-
gerous. The currency act of 1900 provides for a gold reserve of
$150,000,000, to be held against them to insure their redeemability.
If the reserve falls below $100,000,000, the secretary of the treasury
is directed to replenish it from the proceeds of bond sales. Al-
though this gold reserve also constitutes part of the real security
behind our silver dollars, it could safely be diminished in amoimt
if the greenbacks were retired.
Economic Effects of the Greenbacks. — The greenbacks are in
form promises to pay, but they are not promises to pay on demand,
nor at any specific time. During the period of the suspension of
specie payments they were not actually redeemable in gold, nor
was gold in general circulation as a medium of exchange except on
the Pacific coast. Gold was, however, in addition to its industrial
uses, employed as money in international trade, in the payment of
interest on government bonds, and for customs duties (for which
the greenbacks were not legally receivable). There was thus a
constant demand for gold money, which was met by its sale as a
commodity in the New York market. The gold market was highly
speculative, the daily and even the hourly fluctuations in the price
of gold in greenbacks being considerable. Notwithstanding these
speculative features the prices paid for gold indicated very accu-
rately, in the long run, how much, in the expert judgment of market
specialists, the value of the greenbacks had depreciated.
Everything that was thought to affect the probability of the ulti-
mate redemption of the greenbacks in gold influenced their price.
Among these factors were the quantity of greenbacks issued, the
condition of the federal treasury, the military successes and re-
verses of the Union cause, and, in later years, the prospects for the
MONEY
239
r^umption of specie pa3nnents. Greenbacks reached a parity
with gold two weeks before the resumption of specie payments on
January i, 1879. A fact of special significance is that until July,
1863, ^^^ greenbacks were convertible at par into 6 per cent gold
bonds. These bonds formed an actual standard of value for the
greenbacks, and although themselves depreciated, exercised for
the time being a steadying influence upon their value.
As the common medium of exchange consisted almost entirely of
greenbacks * and of bank notes convertible only into greenbacks,
prices were measured in greenback "dollars" and naturally rose as
the gold value of the greenback depreciated. Reference to the
table on page 240 will show a rough correspondence between
changes in the general level of prices, expressed in greenbacks, and
changes in the value of gold, measured in greenbacks. But the
price of commodities rose relatively higher than did the price of
gold, and declined less rapidly.' Retail prices, in turn, declined
less rapidly than did wholesale prices. Wages advanced more
slowly than prices; maximum wages were not paid until 1872, —
seven years after retail prices and eight years after wholesale prices
had reached their maximum.
That there was not a closer correspondence between the movement in gen-
eral prices and the changes in the gold value of the greenback was due to two
sets of influences: (i) Even if greenbacks had not been issued, and if prices
had been measured in gold, there would have been marked fluctuations in
prices, — not only such as continually occur in normal years, but also those
due to such exceptional things as the withdrawal of a large number of men
from industry and agriculture to military service, the shifting of productive
effort in response to the enormous demand for military supplies, the period
of extraordinary business activity, of railway building, and of agricultural
and industrial expansion that followed the war, the reaction and flnandal
crisis in 1873, ^^d the return of prosperous conditions in the last years of the
* Subsidiary coins did not go out of circulation until 1862, when the value
of the greenback dropped below the value of the bullion in these coins. Postage
stamps and notes and tokens issued by cities and by business firms were for a
while used as small change. In 1863 the situation was helped by the issue
of fractional paper currency in denominations as low as three cents.
' The more detailed figures, of which the table given here is only a summary,
show that the prices of commodities also advanced more slowly than did the price
of gold. For an illuminating discussion of these price changes see Mitchell,
Gold, Prices, and Wages under the Greenback Standard, Chap. V.
240
OUTLINES OF ECONOMICS
TABLE I
Prices and Wages in the Greenback Period*
AVEEACE
July
Wholesale
Peices ■
Average Annual Prices'
YXAS
Annual Price
OF Gold in
Average
Wages 4
Gseenbacks
Wholesale
ReUU
i860
100
100
100
100
I86I
95
94
107
99
i86a
"33
120
109
131
104
1863
145-2
155
148
168
119
1864
203.3
236
225
215
142
1865
1573
183
224
219
155
1866
140.9
191
203
208
164
1867
138.2
170
177
193
167
1868
1397
165
180
190
170
1869
133-0
158
172
177
179
1870
114.9
145
156
166
179
1871
111.7
137
144
^5S
184
187a
iia.4
139
138
151
185
1873
113.8
140
143
148
183
1874
111.2
138
144
US
17s
1875
114.9
129
134
140
163
1876
iii.S
118
120
13s
153
1877
104.8
114
117
134
143
1878
100.8
99
99
127
142
1879
lOO.O
98
93
123
139
' Compiled from Gold, Prices, and Wages under the Greenback Standard, by Wesley C
Mitchell. The figures in the price column are " index numbers," that is, they are obtained
by counting the price of each commodity in each year as a percentage oi its price in x86o, and
then averaging the various relaUve prices thus obtained for each year. The figures in the
wage column are computed in a similar way. In the " price of gold " column parity between
greenbacks and gold is represented by 100.
■ pa commodities. s 21 commodities. * For 78 establishments.
greenback period.^ (2) The depreciation in the value of the greenback in
gold was measured quickly and accurately in the gold market, but the move-
ment of prices was hampered by habit, custom, existing contracts, local
influences, etc. We have seen in the discussion of value that retail prices
are less sensitive to changing market conditions than are wholesale prices.
^ This statement is subject to the limitation implied in the fact that general
commercial conditions were themselves caused in part by the influence of the
cheap and fluctuating mediiun of exchange.
MONEY 241
Wages, in turn, axe usually less mobile than retail prices. All these things
interacted. Wages, to give only one example, constitute an important part
of the expenses of producing commodities, and the sluggish movement of
wages kept the expenses of production from advancing, and, later, from
falling as rapidly as would otherwise have been the case, and must have had
a corresponding effect on the prices charged for commodities.
Aside from these general changes, the minor fluctuations, the short-
time variations in prices, were unusually wide and numerous, — ■
a fact which may be attributed to the uncertain value of the medium
of exchange. Such fluctuations were apt to upset all business cal-
culations; chance became more important and foresight less im-
portant as a factor in profits. Under such conditions an intense
and reckless spirit of speculation was bred, with unfortunate
effects on business morality as well as on economic conditions.
As a fiscal expedient, the greenbacks led to results as disastrous
as those which attended their use as money. The government was
forced to sell bonds for depreciated greenbacks, but in order to
maintain its credit it had to pay the interest and ultimately the prin-
cipal of these bonds in gold. Supplies for the army were paid for
in depreciated greenbacks, but these greenbacks had to be ulti-
mately redeemed in gold. It has been estimated that the use of
the greenbacks increased the cost of the Civil War by nearly
$600,000,000.
Fiat Money. — After 1873 the advocates of cheap money were
not content with merely opposing any reduction in the quantity
of the greenbacks. They went so far as to urge that the amount of
paper money should be greatly increased, and that the use of
metallic money should be definitely and permanently abandoned.
Bank notes were also attacked because they were issued by "privi-
leged corporations." The question came to be an important politi-
cal issue, and in 1876 it brought about the organization of the
Greenback party, which figured in three presidential campaigns,
and which polled more than a million votes in the congressional
elections of 1878. In more recent years similar demands were
voiced by the Populist party.
The theory of money which formed the basis of the contention
of the members of the Greenback party is sometimes called the
"fiat money" theory. Those who held this theory of money saw
242 OUTLINES OF ECONOMICS
no significance in the fact that the greenbacks were in form prom-
ises to pay and that they were generally regarded as only tem-
porarily irredeemable. In their view they were simply "dollars,"
made such by the expressed will of the government. Nor did they
see any significance in the fact that during the seventeen years of
the suspension of specie pa3rments over $500,000,000 in United
States gold coins issued from the mints. As a matter of fact the
fiat money advocates were misled by what some logicians have
called' the "jingle fallacy." That the "dollar" of the ordinary
medium of exchange and the "dollar" as a standard unit of
value were different things did not occur to them.
If they had succeeded in eliminating the credit element in the
value of the paper currency by ceasing to print "promises to pay"
(as they actually proposed to do), and had instituted a new name
for the money unit, — possibly (to reverse the spelling) "rallod,"
— they would surely have encountered difficulty in getting people
to accept pieces of printed paper, informing them that " This is a
raUodf " as money. It is hard to see how " the supply of money as
compared with the demand for it," on which the fiat money advo-
cates counted to fix the value of their money units, would have
helped matters very much. Nor would the convertibility of fiat
money into interest-bearing bonds, which was suggested by some,
have given us a standard of value. For the bonds would have
been simple promises to pay a certain sum in fiat money units, with
interest at a certain rate, also in fiat money units. The difficulties
that would have been encountered in international trade would
alone have sufficed to make fiat money impossible.
Some writers have referred to the greenbacks as the "standard
of value" during the suspension of specie payments. As a matter
of fact gold, under the operations of unlimited coinage, was the ulti-
mate standard, and the standard dollar was the gold dollar. The
value of the greenback dollar, in which prices were measured, was
the value of the gold dollar, discounted according to the outlook for
the ultimate redemption of the greenbacks in gold. The green-
backs were at most only a "secondary standard" of value.
(For Questiims a$td Rs/erences, see thefoUowing chafUr,^
CHAPTER XV
CREDIT AND BAIVKIN 6
Ci«dit TtaiiMCtioas. — Thus far, in our discussion of money , we
have failed to take account of the fact that the greater part of ex-
changes are credit transactions, which do not directly or immedi-
ately involve the use of money ^n the sense of generally acceptable
money instnunents). A credit transaction is a transfer of goods,
services, or money, for a future equivalent. In a "cash** transac*
tion there are only two elements, — the goods sold and the money
paid for them. But in a credit transaction a third element — time
— is added. The introduction of this third element leads to ex-
ceedingly important results. In the first place it makes possible an
enormous number of exchanges in which the buyer is either unable
or disinclined to render a present equivalent. In the second place
it obviates, to a very large extent, the necessity of using money.
Suppose, for example, that A and B are the only inhabitants of
an isolated community. Three ways of making exchanges are
open to them. They can use a system of direct exchange or
barter, which will prevent A from getting goods from B unless he
has some equivalent which he is willing to give up and which B
is willing to accept. Or, they may use one commodity as money,
in which case the purchasing power of either A or B at any given
time will be governed by the amount of that particular commodity
that he possesses, rather than by the total amoimt of all his posses-
sions. But by combining a system of credit with their use of
money, they will be able to make transfers freely, for in an occa-
sional balancing of accounts most of the payments due each other
will cancel, leaving only a relatively small amount to be paid in
money.
Something very much like this third process is continually going
on in contemporary economic life. The process is more complex,
243
244 OUTLINES OF ECONOMICS
however, because A actually sells things to one person or group oi
persons, and buys them from other persons. And it is very likely
that these two groups, the sellers and the buyers in A*s transactions,
have no direct business transactions with each other in which their
respective claims against A and debts to A can be canceled. If,
however, we take all buyers and all sellers into account, and if we
could push our analysis of the complex network of credit relations
far enough, we would find points of contact between A's credits
and his debts. That is, if A gives a promissory note in exchange
for a purchased good, this promissory note might be passed on
from hsuid to hand until it got into the possession of some one who
is indebted to A, — if the path it should take were known. The
difficulty is that the path is not known. The institution of banking,
however, provides clearing centers, where credits and debts are
balanced against each other and canceled.
A, for example, has a '^deposit" in a local bank, which means
that he has the right to demand payments from it at any time up to
the amount of his deposit. He usually makes a payment to B,
not by a promissory note, but by a check, — an instrument order-
ing the bank to pay B the specified amount. This check will be
presented for payment by B at a bank where he has a deposit, but
the "payment" will usually be made by adding the amount of the
check to B's deposit. If it is the bank where A also has his deposit,
the transaction is settled by the simple process of debiting A's de-
posit and crediting B's. If it is another bank in the same town,
and if the town is a small one, the check will enter into the daily
exchange by the two banks of such claims against each other, the
daily balance in favor of either bank being usually settled in money.
In the larger cities a further economy in the use of money is
achieved by means of the clearing house, to which a representative
of each bank brings daily all of the checks drawn against other
local banks which it has received since the last "clearing." At
the clearing house the checks are turned over to the representatives
of the banks against which they are drawn, but the balances are not
settled between the individual banks. Instead, a balance is struck
between the total sum of each bank's claims against other banks
and the total claims of other banks against it. Each bank then
CREDIT AND BANKING 245
pays to the clearing house, usually in money, or receives from it,
as the case may be, the amount of balance due to it or from it.
This system achieves a great economy of both time and money.*
If the banks in which A and B keep their deposits are in different
towns, A's check will probably be sent by B's bank to a bank in a
neighboring large city, in which B's bank has its own deposit ac-
count. If A's bank is also in the territory tributary to this same
city, the check may be sent by the city bank directly to A's bank
for collection, or to its own correspondent bank in the same town.
If A's bank is in another part of the country, the check will be sent
to a bank located in a large city in that region, which will attend
to its collection.' Thus a check drawn on a local bank in California,
deposited in a local bank in Illinois, will very likely be collected via
Chicago and San Francisco. The balances of credits and debits
which are thus created between city and country banks are settled
to a very large extent by means of crediting and debiting deposit
accounts in city banks, thus obviating by that much the necessity
for frequent shipments of money. In general, we have in the
United States a continuous balancing and cancellation of debts and
credits, first, in each locality; second, between each important city
and its tributary territory, and, third, between the different impor-
tant cities. Much the same process is characteristic of international
exchange, but that is a topic which will be treated in another
chapter.
* Over $95,300,000,000 in checks and drafts passed through the New York
Clearing House in the year ending September i, 1907. The money balances
paid amounted to $3,800,000,000, or only 4 per cent of the total clearings. The
average cash payments required during the last fifty-four years have amounted
to 4.64 per cent of the clearings. In times of financial stringency clearing houses
sometimes allow the payment of balances in "clearing house certificates," issued
to individual banks upon the basis of approved securities deposited with the
clearing house. In some cases the banks have temporarily put such certificates
into general circulation as an emergency currency.
'The London Clearing House clears for all England in a very simple and
efficient way. A country bank sends its daUy receipts of checks on banks in other
towns to the London bank in which it keeps a deposit. In a daily "country clear-
ing" these checks are distributed to the London banks with which the banks on
which the checks are drawn keep accomits. The mere territorial extent of the
United States makes such a scheme unworkable here. Various proposals have
hten made, however, for central clearing houses that will make clearances for
limited districts.
240 OUTLINES OF ECONOMICS
Personal Credit. — If a man does not hoard money on the one
hand, or fail to pay his debts on the other hand, his expenditures
(including investments) are bound to be, in the long run, approxi-
mately equal to his income. But for a business man a continuous
equality of income and expenditure is impossible. At some times
his deposit account will be built up more rapidly than he checks it
out; at other times his need for means of making payments will
outrun his receipts. If, for example, he is a contractor, whose ex-
penses of production are fairly constant, but whose product is paid
for only when completed, or a merchant, who replenishes his stock
of goods twice a year but whose sales are distributed throughout
the year, or a farmer who must pay his harvest expenses before he
sells his crops, he may find it necessary to utilize his credU. Now,
his personal credit, his power of purchasing things without immedi-
ate payment, will depend to some extent on his personal abiUty and
integrity. But, nevertheless, the fundamental measure of his
credit will be the amount of his realizable wealth. This, however,
is apt to consist largely of property that is not "for sale," — his
stock of consumption goods and his income yielding land or
capital.
These things do not have to be sold in order to convert them into
means of payment. To meet a temporary need they may be made
the basis of credit, through the process of hypothecation, a name
which means the conditional transfer of property rights. The
hypothecation may be definite and formal, as when a mortgage is
given on specific items of property or when valuable credit instru-
ments of various sorts (such as government or corporation bonds,
bills of lading, warehouse receipts, etc.) are put into the actual pos-
session of the creditor as "collateral security "; or it maybe simply
implied, as in the case of an " unsecured " personal note, for practi-
cally all of the property of a borrower, over and above the items
specifically hypothecated for certain debts is, in legal fact, hypothe-
cated for his remaining debts. It is important to note, too, that
future values, rather than present values, constitute the basis of
present credit. The lender's interest is in the question of the ade-
quacy of the value of the security at the time when payment be-
comes due. Present values being equal, a borrower can secure a
CREDIT AND BANKING 347
larger amount of credit when market conditions are improving
than when they are declining.
A man's probable future income and the probable future value
of his property, then, constitute the real measure and foundation
of his individual credit. His individual credit, however, is of very
little use to him as a means of payment. Some difficulties in the
way of using individual notes as media of exchange have already
been suggested.^ There is another difficulty in the fact that his
personal notes will not be willingly accepted by others in lieu of
money payments unless they know him, the value of hb property
and the extent to which it is already hypothecated. Moreover,
these same difficulties stand in the way of such notes being passed
from hand to hand through successive indorsements.
Bank Credit. — In order to make it readily available as a medium
of exchange, personal credit has to be transformed into bank credit.
Instead of using his own note as a medium of exchange, a business
man will normally have it ''discoimted" by his banker. If the
note is for sixty days, for example, the business man 3delds the right
to demand a specific amount of money from him in sixty days, in
exchange for a deposit credit, — the right to receive on demand the
same amount of money less the discount.' The business man adds
the note to his liabilities and a deposit to his assets. The bank adds
the note to its assets and the deposit to its liabilities.
Having converted his personal credit into a bank deposit, the
business man can now use it as a means of payment through the
checking system that has been described. Ordinary commercial
banking consists, in large part, of this purchase of personal credit
> It is true, of course, that business men often accept their customers' notes in
payment of accounts, or as an equivalent for goods purchased. These notes,
however, do not usually pass any farther as a medium of exchange, but are in-
dorsed by the business man and presented to a bank for discount. Such notes,
usually known as *' trade paper," constitute a large part of the securities of many
commercial banks.
* Discount is simply one form of interest. Banker's discount differs from
ordinary interest in that it is computed as a certain per cent of the total amount
that is repaid, while ordinary interest is computed as a per cent of the amount that
is loaned. Discount is deducted from the principal of the loan in advance; in-
terest b paid at the maturity of the loan or (on long time loans) at stated intervals.
On demand or "call" loans and on time loans on collateral security "interest**
rather than "discount" is charged.
248 OUTLINES OF ECONOMICS
and sale of banking credit. The bank builds up assets in the fonn
of loans and discounts at the same time that it builds up its obliga-
tions in the form of deposits.
The security behind the deposits in any bank consists of : (i) loans
and discounts, which in turn rest back upon personal credit or upon
specifically hypothecated property (as in the case of loans on col-
lateral security); (2) bonds, mortgages, and other securities owned
by the bank, which, if necessary, may be sold for the benefit of the
depositors, unless specifically pledged as security for bank note
issues; (3) the bank's own deposits in other banks, together
with the checks or similar claims against other banks that are in
its possession; (4) its other property (building, fixtures, etc.);
(5) (in national banks and some state banks) the personal liability
of the bank's stockholders; * (6) its stock of money.
But that these assets should suffice to cover the deposit liabilities
of a bank is not in itself sufficient to maintain its solvency. Much
depends upon the character of the assets, — the amoimt of money
included in them, and the ease and quickness with which other
parts of the assets can be converted into money. Each deposit
account is an obligation of the bank to pay in actual money if it is
demanded. The depositor cannot use checks for all kinds of pay-
ments, but will often have to draw on his deposit account for
money. Even when payments are made by checks, those who re-
ceive them will often prefer to cash them rather than to deposit
them. Moreover, the process of the cancelation of credit obliga-
tions is, as we have seen, not altogether perfect. Balances arise
between individual banks in the same city, between city and
country, and between different cities that very often have to be
settled in money.
A bank accordingly has to keep enough actual cash on hand to
enable it to meet any demands that may be made upon it for money.
1 Even in case some of the bank's loans or securities prove worthless there
is a margin of safety for the depositors in the fact that some of the assets of the
bank represent the original investments of the bank's stockholders (** capital")
or proEts which they have put back into the business (**surplus")t and on such
assets the depositors have the first claim. Moreover, in national banks and some
state banks the stockholders are personally liable up to an amount equal to the
par value of their holdings.
CREDIT AND BANKING 249
As deposits constitute the most important cash obligations of a
bank, the size of this money reserve, as it is called, is normally fixed
for safety's sake at a certain per cent of the amount of the deposits.
This proportion varies according to the location of a bank and the
nature of its business. In practice it varies in different conmierdal
banks from as low as 5 per cent to as high as 35 per cent of the
deposits.
If its reserve increases, a bank is at liberty to increase its deposits
by extending its loans and discounts, attracting these, possibly, by
lowering the discount rate. If the reserve is decreasing, the bank
must, for safety, contract its deposits by restricting its loans and
discounts, or by taking measures (such as the sale of securities for
money) that wiU replenish the reserve.* In order that the ratio of
reserve to deposits may be maintained near the point where the
right balance is struck between profitableness on the one hand and
safety on the other hand, it is necessary that the bank's assets should
be as fluid as possible. This is best accomplished by confining
most of the loans or discounts to notes or bills of exchange that are
payable in thirty, sixty, or ninety days, or, at most, in four or six
months, so that a constant flow of maturing obligations makes it
possible for a bank to expand or contract its loans and discoimts,
and hence its deposits, as seems most advisable.
There is in the larger cities of the United States, especially in
New York, a growing use of bank loans payable on demand. This
enables the banks to keep their outstanding loans much closer to the
maximum allowed by the state of their reserves than would other-
wise be the case, but the practice has, as we shall see presently,
other effects that are not so desirable.
By the "money market" is usually meant the market for ex-
changeable purchasing power in the form of loanable funds ; that is,
in reality, the bank credit market. The amount of bank credit
available, the freedom with which banks will make loans on certain
^ Some banks maintain a "bond reserve" of high grade securities that may be
sold to enable the bank to meet an extraordinary demand for money or to enable
it to extend its loans and discounts when necessary. Such investments are
normally made by commercial banks when the demand for loans does not absorb
the funds at the bank's disposal, that is, when money reserves are unprofitably
large.
250 OUTLINES OF ECONOMICS
kinds of securities, and the interest and discount rates charged for
bank credit are among the things that make up what is called '^ the
state of the money market." But it should be dear to the reader
that the state of the money market depends, primarily , on two things:
first, the amount and nature of the personal credit that can be converted
into bank credit, and second, the amount of money in the bank reserves.
Bank Notes. — There is one way, however, in which banks can
meet some of the demand for money without drawing on their re-
serves and thus reducing their power of extending credit. This is
by the issue of bank notes, which are simply the promises of banks
to pay money on demand, issued in convenient and familiar form
for use as paper money. These notes are paid as money to cus-
tomers of a bank who want the proceeds of their borrowings in cash,
and to depositors and to holders of checks who prefer money to
deposit credit. Bank notes pass readily from hand to hand as
money, and at the present time constitute an important part of the
circulating medium in most countries.
Bank notes are like deposits in that both are demand liabilities
of banks. Bank notes, however, circulate among persons who have
no means of informing themselves as to the solvency of the banks
issuing them. The holders of bank notes are accordingly usually
given special protection by laws which regulate the conditions of
their issue and redemption.
State Banks of Issue. — Before the Civil War the actual circu-
lating medium of the United States consisted in very large part of
notes issued by banks operating under state laws. The notes
issued by some of these banks were as ^'good as gold" because the
banks redeemed them promptly in gold, — a fact which was due in
some cases to wise and rigid state regulation of banking, and in
other cases, fewer in number, to conservative use of the too exten-
sive privileges granted by lax state laws. But the notes of other
banks were depreciated and in many cases were absolutely worth-
less.
Public ignorance of the real nature of banking gave rise to the
supposition that wealth could be mysteriously manufactured by
means of a bank charter and a printing press (the fiat money theory
applied to bank notes). This and the ever recurring demand for
CREDIT AND BANKING 251
cheap money were responsible for the situation. Prohibited by the
Constitution from issuing their own bills of credit, many of the states,
especially in the South and West, responded to the clamor for cheap
money by making it possible for their citizens to organize '^banks''
and issue their own bills of credit, imposing few or no requirements
as to the actual investment of capital, the accumulation of assets,
or the restriction of note issue.^ In the panics of 1814, 1837, and
1857 but few banks maintained specie payments. Even so late as
i860, although the hard lessons of experience had brought some
improvements, especially in the older states, the bank note circula-
tion was of decidedly varying quality. "Bank note reporters"
and "counterfeit detectors" had to be issued periodically in order
to give to business men the latest quotations and information relat-
ing to the depreciated currency they had to receive in the ordinary
course of business. After 1861 the suspension of specie payments
led to a general depreciation of bank notes as compared with gold
because most of them were thereafter redeemable only in green-
backs.
The National Banking System. — The successful state banking
system of New York was the model after which Congress, following
the recommendations of Secretary Chase, patterned the national
banking system which it established in 1863. The primary,
although not the only, motive that led to this action was the desire
to provide an artificial market for government bonds, which at the
time were a drug on the market. National banks were required to
use government bonds as the assets behind note issues, and further-
more, the national banks were, in 1866, given a monopoly of the
note issue privilege by the imposition of a prohibitive tax of 10
per cent per annum upon the note issues of state banks.
The details of the national banking law have been amended from
time to time, but the general principles of the regulation of the note
issue remained unchanged until Congress passed the Aldrich act in
1908. As the law has stood since 1900, national banks may not be
organized unless the stockholders contribute a minimum capital,
> Some states circumvented the constitutional prohibition mentioned by es-
tablishing their own banks for the manufacture of paper money. The Bank of
Kentucky was the most famous ol these.
252 OUTLINES OF ECONOMICS
varying from $25,000 for places of less than 3000 population to
$200,000 for places of more than 50,000 population. Three limita-
tions are put on the ordinary issue of circulating notes: (i) They
must not exceed in amount the capital stock of the bank. (2) United
States government bonds have to be. purchased by the bank in
amount sufficient to equal, dollar for dollar, the quantity of the
notes issued, and these bonds have to be deposited with the treas-
urer of the United States as security for the redemption of the notes.
(3) Each bank must maintdn in the United States treasury a re-
demption fund in "lawful money" equal to 5 per cent of its note
issue. As this last requirement indicates, bank notes are redeem-
able at the federal treasury. They may also be used in all pay-
ments to the government except customs duties, although they are
not legal tender.
The Reserve System. — While the note holder is thus protected
by a special kind of security set aside for the purpose, the depositor
in a national bank is protected only by its general assets. These,
however, are regulated to some extent by the federal government.
There are restrictions, for example, intended to prevent the bank
from tying up its funds in long-time investments, from lending too
much to one person or firm, or to directors or officers of the banks.
Five times a year national banks have to furnish full statements of
their condition to the comptroller of the currency at Washington.
Each bank is also examined twice a year, without notice, by federal
bank examiners.
But the most important requirement relates to the money re-
serves that must be held by national banks. Banks in "central
reserve cities " (which at present are New York, Chicago, and St.
Louis) are required to maintain a "lawful money reserve"*
equal to at least 25 per cent of their deposits. Banks in other
"reserve cities" (including at present about forty cities) are also
required to maintain 25 per cent reserves, but their deposits
in the national banks of the central reserve cities may be
counted for one half of this amount. In all other places the banks
are required to hold a 15 per cent reserve, three fifths of which
' Including all kinds of United States money except subsidiary silver, minor
coins, and national bank notes.
CREDIT AND BANKING
253
may consist of deposit accounts in banks in central reserve cities
or other reserve cities. In all cases the funds kept by the banks
with the United States treasurer for the redemption of their notes
are counted as part of their legal reserves.
The New York Money ISfarket. — Under the operations of this
system the cash reserves of the national banks are centered in New
York. This appears clearly in Table I, which shows that on the
date specified more than a third of the cash reserves of the 6544
TABLE I
Deposits and Reserves of National Banks: August 33, 1907*
Location
No. OF
Banks
Deposits'
Reszsvk
Classification of Rxsbxvb
c c <°
New York
Chicago
St. Louis
Other reserve cities
Country bonks . .
Total
38
14
8
306
6178
825.7
262.9
116.8
1423-4
2627.2
221.3
66.6
27.6
362.3
443-5
26.8
25-3
23.6
25-5
16.9
218.8
66.1
26.8
190-3
199.6
165.7
226.7
2.6
0.5
0.7
6.3
17.2
6544
5256.1
1121.4
21-3
701.6
392.4
27-3
> Camjikd from Report of the Comptroller of the Currency, 1907, pp. M9-9J4.
• MiUioDB of dollars. » Per cent.
national banks in the United States were in the vaults of thirty-
eight New York banks.^ These figures do not, however, convey
an adequate idea of the national importance of the New York bank
reserves. New York is the great wholesale nuu-ket for foreign ex-
change, the chief center of gold movements to and from Europe,
the principal importing and exporting center for commodities, —
in short, the chief market place of the continent and the focus of
financial operations. All state banks, private banks, and trust
companies of importance find it to their advantage to maintain
deposit accounts in New York, both for their own use, and in order
^ The bulk of the deposits of out of town banks were in from twelve to twenty
banks which make a specialty of this kind of business.
254 OUTLINES OF ECONOMICS
that they may supply New York exchange to their customers.
Even the deposit accounts of national banks in New York are in
the aggregate considerably larger than the amount they are allowed
to count as part of their reserves.
All together the deposits of other banks constituted more than
half of the $825,700,000 of deposits in New York national banks
in August, 1907. Moreover, something very much like the reserve
system obtains among other than national banks, the banks in
smaller places keeping deposits in national or other banks in larger
cities, which in turn keep deposits in New York. The trust com-
panies, and some of the state banks ^ keep in general very much
smaller reserves in their own vaults than are required of national
banks, — a fact which makes the strain on the New York bank
reserves all the greater. Recent legislation in New York has
raised the reserve requirements of state banks and trust com-
panies in that state.
like an inverted pyramid upon its apex, the great structure of
bank credit in the United States rests, in large measure, upon the
money reserves of the New York banks. Every important change
in the demand for money or credit in any part of the country has an
effect on the New York money market; similarly, every important
disturbance in the New York money market affects fmancial con-
ditions throughout the country.
The central reserve system leads to a great economy in the use
of money, and it seems to be a natural and necessary feature of
modem banking, for something like it is found in all of the leading
commercial nations, — although, in Europe, the central reserves
are kept in one great bank in each country. Some dangers seem
to attend its use in the United States, but these are in large measure
attributable to other features of our banking system, chief among
which are the dominance of speculative influences in the New York
money market, the independent treasury system, and the lack of
elasticity in our bank note issues.
> Savings banks keep reserves that average for the United States only four
fifths of one per cent of their deposits. On account of the nature of their busi-
ness, which is not banking in the commercial sense, they are a negligible factor
in this connection. *
CREDIT AND BANKING 355
S^MCuIation and the New York Honey Market. — As Table II
shows, a large and increasing proportion of the loans of New York
banks are not based on "commercial paper"; that is, on the notes
and bills of exchange that arise in the ordinary course of business,
but are either time loans on collateral security or demand loans,
nearly all of which are secured by collateral. Most of these col-
TABLE n
Loans and Discounts of New York National Banks on Specified
Dates*
(In millioos of dollars.)
Charactkk or Loan
1890
X896
xgot
1906
On demand
Z02
43
152
no
69
144
279
129
203
303
149
349
On time, with collateral security
On time, secured by commercial paper
> Compiled from Reports of the Comptroller of the Currency.
lateral securities are the stocks and bonds of corporations, and the
loans, especially the demand or ''call" loans, are used for the
greater part in financing speculation in such securities. This sys-
tem is partiy responsible for the excessive and useless expansion of
speculation over and above the amount that is necessary to secure
the best results for the economic interests of the country. Here
we are concerned, however, with its effects on the money market.
The supply of call loans depends primarily on the amount of the
surplus reserves of New York banks; that is, the excess of the re-
serves over and above the legal minimum of 25 per cent of
the amount of the deposits. If the weekly statement of the clearing
house banks ^ shows a relatively large surplus reserve, this means
that the banks can safely expand their loans, — the knowledge of
which fact has a stimulating effect on speculation. If, however,
the surplus reserve is low, the banks are bound to restrict their
loans of all kinds and to "call" some of their demand loans.
^ Some of the banks in the clearing house are state banks, but by the rules of
the clearing house these were required to maintain the same reserve as national
banks even before recent legislative enactments.
2S6 OUTUNES OF ECONOMICS
When the reserve is below the legal limit demand loans have to he
called in large quantities in order to enable the banks to meet press-
ing demands for credit on the part of their regular customers.'
The precipitate calling of demand loans by some banks simply in-
creases the demand for credit at other banks, which in turn have to
curtail their loans. Such a condition of the money market leads
to a depression in the price of speculative securities, which is in-
creased by the forced sales of securities in order to obtain the money
funds that had previously been lent on them; the fall in the price
of securities leads brokers to demand more '^margins" from the
customers for whom they have bought securities, and it leads the
banks to demand more securities as collateral for their outstanding
loans. Under such conditions the interest rate on call loans some-
times goes as high as 125 per cent, or even higher.^
If the ruling prices of speculative securities have been higher than
industrial conditions would warrant, such a disturbance of the
money market is apt to be long continued, and might easily develop
into a general financial crisis. The call loan market is essentially
> The rigidity of the New York bank reserves is itself an element of danger to
the money market. The Bank of England protects its reserves when they are
threatened by the simple process of raising its discount rate. The effect of this
is to restrict the loans of other banks as well as of the Bank of England to the
more necessitous borrowers. Under our national banking law limiting the rate
of interest, further loans have to be stopped absolutely when the reserve goes below
the legal minimum. The New York bank reserve is accordingly a real reserve
only in the sense that it makes it possible for the banks to meet extraordinary
demands for ready cash. So far as the extension of credit is concerned, it is not
a reserve, but a dead line. In practice the law is not rigidly observed, a warning
from the comptroller of the currency being the only penalty exacted for a tem-
porary deficit in the reserves. Nevertheless the reserve does not often fall more
than one or two points below the legal minimum. The sudden curtailment of
loans which the rigidity of the reserve entails is one of the things that tends to
convert an incipient panic into a real panic.
' That is, the rate on what may be called marginal call loans, effected at the
stock exchange by bankers' agents, or by individuals or corporations. Many
banks continue to make call loans to their regular customers at such times at
rates not exceeding 6 per cent. Under normal conditions the rate on call loans
is lower than the rate on time loans. For the period 1 901-1906 the bank rate
on call loans averaged 3.3 per cent as against an average rate of about 4.5 per cent
on time loans. Excessive variability is the chief characteristic of the call loan
rate. Cf. W. A. Scott, "Rates on the New York Money Market," Journal of
PoUHeal Economy, Vol. XVI, pp. 273-298.
CREDIT AND BANKING 257
speculative, and it is unfortunate that the condition of the supply
of credit for the normal commercial needs of the country should be
periodically unsettled on account of this fact. In no other great
money center of the world do call loans occupy the important place
that they do in New York.^
The Independent Treasury System. — The United States govern-
ment is to a very large extent its own banker. It keeps its own
money in its own strong boxes, quite after the fashion of a mediaeval
monarch. The strong boxes in this case are, however, the vaults
of the treasury in Washington and of nine sub-treasuries located
in important cities. Apart from the fact that the government
revenue and the government expenditures are naturally not dis-
tributed evenly throughout the year, the government has the further
difficulty that a close balance of revenues and expenditures for any
given year must be wholly accidental Even if the federal budget
were carefully and scientifically constructed, as it is not, the public
revenues would be liable to uncertain fluctuations, — a result in
part of the importance of customs receipts among them. The gov-
ernment, furthermore, receives most of its income in money, not
in bank credit instruments. When a surplus accumulates in the
government treasury, that much money is taken out of circulation,
which reduces the bank reserves, and contracts the amoimt of bank
credit available.
The government is permitted, however, by the national bank act
of 1863 to deposit money in selected national banks. Some secre-
taries of the treasury have made little use of this privilege, but in
recent years such deposits have become more common.
Until 1902 banks had always been required to deposit government bonds
with the federal treasury as security for federal deposits, but in that year and
again in 1906 Secretary Shaw offered to accept approved state and munici-
pal bonds in lieu of a certain amount of government bonds, on condition
that the latter should be immediately used as security for increased note
issues. In 1897 only 168 banks were government depositories. In 1907
^ The control of groups of powerful banks by great chains of "financial inter-
ests" is another anomalous condition of the New York money market. For
an account and criticism of this situation as it existed in 1903, see C. J. Bullock,
''The Concentration of Banking Interests in the United States," AtiantU
MoiUhly, Vol. 93, pp. 183-193.
8
2S8 OUTLINES OF ECONOMICS
there were 1255, which held on June lo of that year $167,000^000 out of a
total treasury balance of $433,000,000. Part of this increase is attributable
to the effect of a law enacted in 1907 allowing custom receipts to be deposited
in banks. Previously to this deposits could only be made from the proceeds
of internal revenue duties and miscellaneous receipts. The Aldrich act of
1908 provided for the payment of one per cent interest on all government
deposits except the active checking accounts.
The government has, on several occasions, come to the rescue of the banks
by cash purchases of its own bonds. The decline in the market price of
government bonds in periods of financial stringency makes these purchases
relatively advantageous to the government. The periodic shifting of govern-
ment deposits to localities where money is most needed, the temporary
deposit of gold in New York banks equal in amount to their engagements of
gold for transportation from Europe, and even the arbitrary withdrawal
of government money from the banks when it was "not needed," in order
that it might not be made the basis of speculative activities but kept till the
time when it "was needed," * have been recent developments in the relation
of the treasury to the money market.
In favor of this system as at present developed it may be said that a sur-
plus in the government treasury constitutes a real cash reserve, the wise use
of which by the secretary of the treasury may possibly avert a serious crisis.
But there are dangers in intrusting so much financial power to one man.
If used without discretion it is bound to do more harm than good. More-
over, some of the recent treasury operations have not been free from the
suspicion of favoritism to certain banks. It is to be feared, too, that the
knowledge that the government surplus will, in time of necessity, be put at
their disposal, will tend to encourage unsound banking by relieving the
banks of the proper responsibility for the maintenance of their own reserves.
All in all it seems probable that a definite and known policy with regard to
government deposits is better than the recently developed system of un-
certainty and arbitrary action.
The Moven^ent of Money. — The demand for loanable funds
varies locally, according to the business conditions that exist in dif-
ferent parts of the country. These differences make loans worth
more in some localities than in others, and result in some shifting
of bank credit. New York banks, »f or example, sometimes invest
in "out of town" commercial paper when this is more profitable
than employing their funds at home. More frequently, interior
banks place loans in New York, either through their correspondent
banks there, or by the purchase of securities from note brokers.
^ See Finance Report, 1906, p. 41.
CREDIT AND BANKING 359
This shifting of credit, however, is unimportant as compared with
the movement of money itself. Money is continually flowing from
New York to the interior and from the interior to New York, ac-
cording as it can be more profitably employed in bank reserves in
one place or the other. Similar movements take place between the
various cities of the country. This movement, it will be noted, is
not one that is apt to disturb financial conditions. On the con-
trary, it tends to prevent extreme local fluctuations in money market
conditions by leading to the expansion of credit where it is most
needed, and similarly, to the contraction of credit where it is least
needed.
There is another kind of money movement, however, which is
not so fortunate in its effects upon the money market. The amount
of money needed as an actual medium of exchange varies for dif-
ferent seasons and for different localities. The demand for money
to serve as the basis of credit in bank reserves and the demand for
money as an actual medium of exchange are different and compet-^
ing demands. When more money is needed as a medium of ex-
change, reserves have to yield and credit has to be contracted.
The most important movement of this sort is in response to the
annual demand for money to be used in "moving the crops."
Harvest expenses are very largely wages, and these have to be paid
in cash. Many farmers, moreover, insist on receiving money pay-
ments when they sell their crops. The cotton crop of the South
and the grain crop of the West necessitate the conversion of bank
deposits in those regions into money, and to the negotiation of loans
on the security of the crops, the proceeds of which are also taken in
cash. The banks in these sections of the country in turn convert
their deposits in other banks into money, and in large part this
money is obtained, directly and indirectly, from the New York
bank reserves. The movement of money from New York to the
South and West usually commences in August of each year and
continues through November, when the return movement sets in,
continuing usually till February. Despite the fact that the New
York bankers are forewarned of this movement, it always reduces
their surplus reserves and leads to stringent and often precarious
conditions in the New York money market, — conditions which are
26o
OUTLINES OF ECONOMICS
frequently reflected in difficulties in the money maxket throughout
the country.
Elastic Currency. — To the arbitrary flow of money to and from
the treasury, and to its movement to and from the interior, there
must be added the movement of gold between this and other coun-
tries. This will be discussed in another place; it is sufficient to
note at this point that this external money movement is at the same
time a cause and effect of changing money market conditions.
That these money movements affect the supply of bank credit as
they do is partly attributable to the inelastic character of our bond-
secured bank currency. Under the provisions of the national bank
law that have been described, the variations in the amount of
bank notes outstanding bear a close relation to variations in the
price of government bonds, — and these variations are affected by
many other things than money market conditions, and in recent
years have been very small.
As will be seen in Table m, the creation of the two per cent
bonds, payable in 193O1 stimulated the issue of bank notes, because
TABLE III
Amottnts of Bank Note Circitlation secured by Specified
Classes of Bonds: 1900-1907'
Sbcurtty
March 13,
1900
Oct. 31,
1903
Oct. 31,
1904
Oct 31,
190S
Oct 31.
1906
Oct 31,
1907
Loan Z908, 3'8 . .
Loan 1907. 4*s • •
Loan 1935, 4*8 . .
Loan 1904, 5'« ■ .
Loan 1891, 3*8 . .
Consols 1930, 3*8
Panama Canal . .
$56,164,830
130,303,350
14,697350
ax. 996.350
30,490,150
fii79r.58o
3,797,300
1,4x0,100
718,650
$1,933,940
S.857.S00
1,791,600
$3,315,540
4.050,350
4,465.000
$3,373,700
35,134,650
4,603,100
$6,473,080
10,733,900
376,003,300
416,973,750
483,181,900
493,170,650
14,483,080
533,543.550
x7.a45.380
Total
3431651.430
383,736,830
436,544.700
493.9x3,790
S39,653.x8o
566,994,910
' From Report d the Comptroller of the Currency, Finance Report, 1907, p. 390.
the federal tax b only one fourth of one per cent semiannually on
bank notes secured by two per cent bonds as against one half of
one per cent on notes secured by bonds paying a higher rate of
interest. The relative stability of the amount issued in more recent
years is noticeable, what increase there was being a natural
CREDIT AND BANKING 261
result of the increasing number and size of banks. Nor does the
amount of note issue respond to any marked extent to the regu-
lar seasonal demands for money to move the crops or to the less
regular operations of the treasury department or of the foreign
exchanges.
Students of banking problems have for many years thought that
it would be better to allow the national banks to issue part, if not
all, of their notes on the security of their general assets, thus placing
them on the same basis as deposits. It is clear that if this were
done any sudden increase in the demand for money as a circulat-
ing medium might be met by the creation of bank credit in the form
of bank notes, or by the shifting of bank credit from the form of
deposits to the form of note issues. ''Asset banking," as this is
called, is used in Canada, and enables the banks there to furnish
money for crop moving purposes without endangering their re-
serves. Most of the great national banks of continental Europe
also issue notes on the security of their general assets.
To achieve real elasticity it is necessary to provide for the ready
contraction of note issues when the special demand for money is
over as well as to provide for their ready expansion in time of need.
It seems probable that this could best be accomplished under the
difficult conditions that prevail in the United States by a system
similar in some ways to that governing the Reichsbank of Germany,
whereby all note issues above a certain amount are subject to a
special tax. This should be coupled, however, with a more ade-
quate mechanism for redeeming the notes than the present one,
and it would be desirable to graduate the tax according to the
amount of the excess note issues outstanding.
The first tangible result of years of discussion of this subject in Congress
and elsewhere was the Aldrich act of 1908. This measure supplements the
existing system by permitting banks which have outstanding notes secured
by government bonds equal in amount to 40 per cent of their capital to in-
crease their circulation in one or both of two ways. First, on the security
of approved state, county, or municipal bonds deposited with the treasurer
at Washington, such note issues being restricted to 90 per cent of the par
value of the bonds. Second, through the voluntary organization of "Na-
tional Currency Associations,'' which are to be composed of not less than
ten banks in contiguous territory whose combined capital is not leas than
202 OUTLINES OF ECONOMICS
$5,000,000. Banks in such associations can issue notes to an auKmnt not
exceeding 30 per cent of their capital and surplus on the basis of securities
deposited with the association, if the securities are approved by the associ-
ation and by the comptroller of the currency. Such securities may be (i)
bonds of the kind that may be used for the extension of note issue under the
alternative plan already mentioned, in which case the issue may be 95 per
cent of the par iralue of the bonds, or (2) two-name commercial paper of
not over four months' duration, or the bonds or other securities of corpora-
tions, in which case the issue must not exceed 75 per cent of the face value
of the securities. The association is responsible for the maintenance of the
redemption fund of each of its members. A bank's entire note issue must
not exceed its capital and surplus.
The extra note issues authorized by the Aldrich act must not at any time
exceed $500,000,000 in the aggregate, and are taxed at the heavy rate of 5
per cent per month for the &rst month and i per cent for each additional
month up to a maximum of 10 per cent. Very little can be expected from
the Aldrich act in the way of securing elasticity of the currency. The first
of the two alternative methods may possibly be helpful, but the excessive
rate of taxation will tend to prevent its extensive use save in extreme emer-
gendes. It is difficult to organize national currency associations save in
important financial centers, and the provision for the use of corporate securi-
ties only projects into the field of note issue what is already an unfortunate
tendency of deposit banking in the United States. The Aldrich act may
afford some relief in periods of the most extreme stringency in the money
market but it does not advance us very far toward the desired goal of a cur-
rency that will automatically expand and contract with business needs.
Some favor the issue of such a currency by the government instead of the
banks, but this would be undesirable. There are no such points of contact
between the government treasury and the needs of the business world as
exist in the case of the banks. Government paper currency can be controlled
in amount only by arbitrary methods. It is by ^ry nature inelastic.
A Cential Bank. — The great national banks of European coun-
tries, such as the Bank of England, the Bank of France, and the
Imperial Bank of Germany, combine the functions of our independ-
ent treasury system, the general note issue functions of our national
banks, and the function of the New York national banks as cus-
todians of the central reserve. That is, they have a practical
monopoly of the privilege of issuing notes; ^ they hold the govem-
* In England and Germany some other banks than the central banks have a
limited right to issue notes, but this is only a survival, a vested ligfati which Hi
various ways is gradually being extinguished.
CREDIT AND BANKING
263
ment funds and act as fiscal agents of the government, and they
hold the ultimate banking reserves of their respective countries.
The United States Bank (1791-1811) and the Second Bank of
the United States (1816-1811) were institutions of this kind. In
each case Congress refused to recharter the bank at the expiration
of its original twenty-year charter. In each case, also, this oc-
curred when the country was temporarily imder the dominance of
a strong democratic sentiment opposed to political or financial cen-
tralization in any form. Jealousy on the part of state banks was,
however, the immediate cause of the demise of the first United
States bank, while the second succumbed to the still more potent
hostility of Andrew Jackson. There are many who think that the
abandonment of the independent treasury system and the re-
establishment of a great central reserve bank would be the best
solution of our currency difficulties. Such a bank might very
properly be limited to the field of issuing notes, and receiving the
deposits of and making loans to the government and other banks.
The Preaent Position of State and Private Banks. — The figures
in Table TV give only a partial idea of the present position of bank-
TABLE IV
NuiCBER OY Banks and Amottnt of Deposits in Specified Kinds of
Banks: 1907^
Dsposm
State banks.
Savings banks
Private banks
Loan and trust companies
National banks
Total
$3,068,600,000
3,495,400,000
151,100,000
9,061,600,000
4,322,900,000
$13,099,600,000
s FVom RepMt of Comptroller of tbe Currency, Finance Report, xgo?, p. 418.
ing in the United States, for while they are complete as to national
banks, there were, in 1907, over 4000 other banks which failed to
make reports to the comptroller of the currency.
264 OUTLINES OF ECONOMICS
"State banks,'' in the narrow sense, include only oorporations chartered
by the individual states to conduct a general commercial banking business.
In a broader sense savings banks and trust companies incorporated under
state law may be said to be state banks.
Savings banks do not usually do a commercial banking business ; that is,
they are not engaged in the sale of bank credit in a form that can be used in
making payments. Their deposit accounts are not usually transferable by
means of checks. They receive deposits of small savings and invest them
in long time securities, such as real estate mortgages and bonds of various
sorts. They perform an important social service by stimulating saving and
by increasing the financial power of small investors through concentrating
and combining their resources. Savings banks are organized either as cor-
porations or as mutual societies managed by a board of trustees acting for
the depositors. The latter type is especially common in the eastern states.
The advantages of savings banks are less available in the rural districts
than in the cities, — a fact which is perhaps the strongest argument for the
establishment of postal savings banks by the federal government.
Trust companies were at first organized to take charge of trust funds and
to act as executors and administrators of estates. They have, however,
developed the functions of both savings banks and commercial banks, and
have even entered such specialized banking fields as foreign exchange and
the underwriting of corporation securities. They have thus the character
of free lances in the banking field. Their banking functions have developed
so rapidly that in many states they have been put under no such rigid control
as is exercised over state and savings banks.
Private banks are of two very distinct types. Some are small unincor-
porated banks in country towns. Others are great concerns in the financial
centers which deal in investment securities, buy and sell foreign exchange,
finance great corporate undertakings, and, in some cases, act as brokers in
the stock market.
It is impossible, in fact, to draw a definite line between "banking" and
other financial undertakings. Building and loan associations, private money
lenders, note brokers, life insurance companies, etc., frequently perform
functions which are very much like some kinds of "banking." But banking
as the institution which converts personal credit into bank credit in the form
of deposit accounts and bank notes is a clearly defined thing, and has a dis-
tinct economic significance of its own.
QUESnOVS
I. Do you make a loan to the government when you receive greenbacks
as money ?
3. Compare the history of the assignais of the French revolution with
the history of the bills of credit issued by the Continental Congress.
CREDIT AND BANKING 265
3. Explain the various items in the published "statement" of a national
bank.
4. Because a national bank can buy interest-bearing government bonds
and use them as security for its own issues of paper money, advocates of
government paper money issues have alleged that it gets ''double interest
on its money." Is this true?
5. How should one compare the profitableness of issuing notes with the
profitableness of extending deposit credit?
6. What restrictions does your state impose on state banking corporations ?
7. Why would wheat not make a satisfactory money conmiodity ? iron ?
platinum ? diamonds ?
8. Would it be possible to maintain a seigniorage of zo per cent on United
States gold coinage?
9. Report on the following questions not answered in this chapter:
(i) What is the "limit of tolerance"? (2) On whom does the loss due to
the wear of gold coin fall ? (3) To what extent are different kinds of United
States money legal tender?
10. If the United States had adopted the free and unlimited coinage of
silver in 1896, how would prices have been affected ?
11. Is the actual standard of value pure gold or gold of standard fineness?
12. What elements of truth are there in the statement that "coins get
their value from the government stamp" ?
13. Would it be possible to have a rtandard of vaiue^that could not be
used as a medium of exchange?
RBFERBKCBS
Bttllock, C. J. Essays in the Monetary History of the United States.
Cleveland, F. A. Funds and Their Uses.
Comptroller of the Currency, Annual Report.
CoNANT, C. A. History of Modem Banks of Issue.
Dewey, D. R. Financial History of the United States. (See index.)
Director of the Mint, Annual Report.
DuNBAK. Chapters on the Theory and History of Banking.
Hepbxtsn, a. B. The Contest for Sound Money.
Indianapolis Monetary Commission, 1898 Report.
Jevons, W. S. Money and the Mechanism of Exchange.
Johnson, J. F. Money and Currency.
KiNLEY, David. The Independent treasury System; also, Money.
Knox, J. J. History of Banking in the United States, and United States Note».
Laughlin, J. L. History of Bimetallism in the United States ^ and The
Principles of Money.
Mitchell, W. C. History of the Greenbacks, and Gold, Prices, and Wages
under the Greenback Standard. (University of California Publications,
Ecc»iomics, Vol. I.)
266 OUTLINES OF ECONOMICS
NoYES, A. D. Thiriy Years of American Fittance.
Pratt, S. S. The Work of WaU Street.
Scott, W. A. Money and Banking,
Sumner, W. G. History of Banking in the United States.
Treasurer of the United States, Annual Report. (This, together with
abbreviated forms of the reports of the Director of the Mint and the
Comptroller of the Currency, are printed as appendices to the Report
of the Secretary of the Treasury in the bound edition of the annual
Finance Report.)
Walker, F. A. Money, and Money in its Relation to Trade and Industry,
Watson, D. K. History of American Coinage,
White, Horace. Mon^y and Banking.
CHAPTER XVI
OTHER PROBLEMS IN MONEY AND BANKING
Crises. — Crises are frequently recurring phenomena of current
economic life. They are of all degrees of severity, but are generally
characterized by a scarcity of bank credit, a sudden drop in prices,
industrial depression, lack of employment for wage earners, and
kindred symptoms.
Crises are frequently attributed to "over production," or, when
that expression is criticised (because human wants are never fully
satisfied) to "under consumption." The two expressions are dif-
ferent ways of describing the same thing, and both are misleading
because they put the emphasis in the wrong place. Production
and consumption have to do with quantities of things and their
fitness to satisfy human wants. Crises spring from mishaps in the
valuation of things; they relate to what might be called the dollars
and cents aspect of economic life. It is difficult, even impossible,
for observers to analyze all the factors entering into a particular
crisis, and it is even more difficult to formulate a theory of crises
that will be of general applicability. There are some important
things about crises, however, that are relatively well known, and
these will form the basis of our discussion.
It is a significant fact that crises generally occur only as sharp
interruptions of periods of business prosperity, when credit is abun-
dant, prices relatively high, and employment plentiful. What-
ever may be the cause of a period of exceptional business prosperity,
it is apt to contain within itself the seeds of its own destruction.
The point will appear clearly if we put together two conclusions
that were reached in the preceding chapter: first, that the supply
of loanable funds in the form of bank credit is a function of two
variables, — the supply of personal credit and the supply of money
267
268 OUTLINES OF ECONOMICS
available for bank reserves; second, that personal credit is based on
the probable amount of future incomes and probable future value
of property.
Suppose, for example, that business conditions are prosperous
and promise to continue so, and that there is a plentiful supply of
money in the bank reserves. Expected prices and expected profits
are large, expected interest payments seem certain. The power to
get this future income depends, however, upon the possession of
land, capital goods, franchises and other privileges, the estab-
lished business relations that give rise to " good-will values," or upon
the possession of income-yielding securities, such as mortgages,
bonds, stocks, etc. Under such conditions, these things command
good prices in the market and may easily be hypothecated, either
formally or implicitly, in order to secure purchasing power, —
bank credit. The bank credit thus created is put into further in-
vestments of capital and into the creation of further business
opportunities. These things serve in turn, so long as their income-
yielding power seems certain, as the basis of further extensions of
bank credit, and thus the process of business expansion continues
in a cumulative fashion. An extensive period of increasing pros-
perity of this kind is, however, scarcely possible unless the supply
of money is increasing; for bank reserves as well as the amount of
expected personal incomes condition the supply of purchasing
power.
Any one of a number of things may be sufficient to precipitate a
panic under such conditions. The whole business structure may
fall to pieces through sheer topheaviness. That is, so much pro-
duction to-day is indirect, so large a share of productive effort is
devoted to forwarding in indirect ways the production of goods that
will be ripe for human use only in the comparatively distant future,
that the mere operations of supply and demand among business
men themselves may maintain prosperous business conditions for
some time. But in the long nm the maintenance of the values of
producers' goods and privileges depends on the demand, and hence
on the income, of ultimate consumers. Wages do not usually rise
as rapidly as prices in periods of business expansion. This simple
fact may in itself keep the average purchasing power of consumers
PROBLEMS IN MONEY AND BANKING 269
from expanding rapidly enough to furnish a solid support for the
growing structure of capital values.
Crop failures may precipitate a panic by diminishing the pur-
chasing power of those engaged in agriculture, and, possibly, by
reducing exports and thus necessitating the taking of gold from
the bank reserves to ship to Europe in payment for our imports.
When the credit situation is at all strained the failure of one im-
portant bank may be enough to precipitate a panic. The bank's
creditors are prevented from meeting their own obligations; the
solvency of others is in turn dependent upon them, and thus losses
in expected and often already hypothecated income are transmitted
from firm to firm and from industry to industry in a constantly
widening circle.
In fact, whatever may be the inmiediate cause of a panic, it is
bound to grow, in a condition of inflated capital values, with tre-
mendous rapidity. The collapse of credit leads to forced sales of
property in order that credit obligations may be met. These lower
property values, lessen the security on which credit is foimded, and
render banks less able and less willing to make loans. Moreover,
the hoarding of money, which is apt to be a feature of a panic, has
a destructive effect on bank reserves. In a serious panic the
liquidation of obligations has to work itself out. Then the indus-
trial process starts afresh, with lowered values, and with property
rights shifted, in some measure, to creditors.
Crises seem to be unpreventable so long as competition and the
credit system dominate in industry. Yet there are some recent
developments that may make them less frequent, and possibly less
serious.
The "integration of industry,*' whereby a whole series of pro-
ductive processes, from the production of the raw material to the
sale of the finished product, are brought together imder one man-
agement, decreases the number and complexity of credit relations
between producers, and tends to prevent the undue expansion of
those parts of the productive process that are farthest removed
from the consumer. The strong position of the steel industry in
the United States is a case in point. The improvements in the
bargaining power of wage earners resulting from their organization
270 OUTLINES OF ECONOMICS
have enablod them partly to prevent the widening of the gap be
tween wages and prices in prosperous times, as recent American
statistics show. On the other hand, crop failures are and always
will be a factor of uncertainty. The lack of an elastic currency is
also an element of danger, but this can and should be remedied.
The Economic Effects of Changes in the Value of Money. — It
has already been suggested that an increase in the amoimt of
money available for bank reserves leads to the expansion of credit,
stimulates business, and as a result usually increases prices, —
temporarily, at least The same results are achieved, although in
not the same way, by a depreciation in the value of money, such as
comes from a sudden change in the standard of value, or from the
introduction of irredeemable paper money as the medium of ex-
change. Without understanding the exact process we know that
prices are gradually increased under such conditions, there bdbg
an unmistakable tendency to adjust them to the change in the
''dollar" or other unit of the medium of exchange.^ The lising
prices stimulate business by increasing profits. Profits are in-
creased because most of the expenses of production are incurred
before the goods are sold, so that the rise in prices increases the
margin between prices and the expenses of production, and be-
cause, moreover, some of the expenses of production do not usually
rise as rapidly as do prices. An expansion of business activity of
the kind already described is apt to be the result, and this is not
generally soon restrained by insufficient bank reserves, for de-
preciated money is usually, though not always, money that is
coined or issued in large quantities.
That periods of prosperity induced in this way are inevitably
short-lived and usually end in severe crises does not make them any
the less real. Nor should the fact that such artificial conditions
of business enterprise are apt to be accompanied by excessive
* Possibly the effect upon other prices of the increased prices (measured in
the depreciated money) that have to be paid for imported commodities and that
are received for exported commodities is the key to this problem, just as It was
undoubtedly the chief cause of the rise of prices to fit the bullion value of ooint
from which scipniorage had been taken. This Is the explanation of the rise of
P'-iccs under the greenbacks suggested by Professor W. C. Mitchell, the historian
of that movement.
PROBLEMS IN MONEY AND BANKING 271
speculation and other unhealthy features blind us to the fact that
they accomplish some good. The encouragement given to ven-
turesome undertakings leads to the trial of new methods of
production, to the development of new natural resources, to under-
takings of vast proportion, to a general freeing of industrial organi-
zation and methods from the restraints of habit and tradition.
The foundations of modem large-scale industry in the United
States were laid in the period between the Civil War and the panic
of 1873. ^^^ period of state bank note inflation preceding the
panic of 1837 was a period in which the industrial map of the
United States was almost wholly changed, and, in the long run,
for the better.
A rapid increase in the supply of standard money may have a
similar effect A tremendous expansion of international trade
followed the gold discoveries in California and Australia. In the
sixteenth century, increases in the supply of the money metals,
economic writers are agreed, hastened the fall of the medieval
economic system. The almost unparalleled development of in-
dustry and industrial organization in the United States since 1897,
must, with its good features as well as its bad, be attributed in part
to the increased supply of gold.
Business prosperity, however, does not always coincide with the
real economic welfare of the masses of the people. If prices are
rising faster than money wages, real wages are obviously declining.
A period of falling prices is very apt to be a period of increasing
wdl-being for those whose incomes are wages or salaries, although
here we have to remember that even if daily or weekly wages do
not fall so rapidly as prices, an increase of unemployment may
affect total yearly incomes adversely.
The Standard of Deferred Payments. — The relation of changes
in the purchasing power of money to long-time debts and credits
has been suggested in another connection. If prices increase, the
principal of a loan represents less purchasing power at time of re-
payment than at the time the loan was made. If prices decrease,
the reverse is, of course, true. In periods of cheap money agita-
tions the additional burdens imposed upon debtors in a period of
decreasing prices are emphasized. An important function of
272 OUTLINES OF ECONOMICS
money, then, is found in its use as a standard of deferred
payments.*
As Professor Irving Fisher has shown, there is a partial com-
pensation for the injustice worked to debtors or creditors by chang-
ing money values in the fact that the interest rate varies inversely
with the value of money. If the value of money is increasing and
promises to continue to increase, money lenders are forced by com-
petition to offset the expected increase in the value of a loan by
accepting a lower interest rate. When the value of money is de-
creasing, the expected decline in the value of the principal causes a
higher rate of interest to be charged. So far then as the increase
in the value of the principal is discounted in the interest rate at the
time when a loan is made, to that extent is the debtor's claim of in-
justice unfounded. The decline in the interest rate as prices de-
crease makes it possible, moreover, for debtors to pay off their old
obligations with money funds borrowed on more favorable terms.
We may expect that less emphasis will be given to the question of
the standard of deferred payments in future periods of declining
prices, because American farmers are becoming in increasing
numbers lenders rather than borrowers of money. Corporation
bonds are taking the place of farm mortgages as the most significant
form of long-time credit instruments.
Index Numbers. — Changes in the purchasing power of money
are indicated statistically by the use of index numbers.* The
prices of a number of important commodities in some one year, or
their average prices for a term of years, are taken as the basis of the
computation. The price of each commodity in each year covered
1 From the analysis in the preceding chapters it should be dear that money
serves also as (i) the medium of exchange and measure or denominator of value,
(3) the standard of value, (3) the basis of bank credit. The first of these functions
is performed by all money; the second function only by standard money and
bullion; the third by all money that can be lawfully used in bank reserves. Legal
tender money, and, if there are differences in the value of different kinds of money,
the cheapest legal tender money, serves as the standard of deferred payments.
Before the development of credit facilities one's purchasing power did not depend
so much on his property as on his own stock of ready cash. An important early
function of money was, accordingly, that of a store or reserve of value or purchasing
power.
* Of, the table on p. 940.
PROBLEMS IN MONEY AND BANKING 273
by the statistics is then stated as a per cent of its price in the basing
year or years. The series of per cents thus obtained are called
relative prices. These relative prices are then combined into typi-
cal prices, or index numbers for each year. Most frequently a
simple arithmetic average of the various relative prices for a given
year is used as the relative typical relative price. Sometimes a
weighted arithmetic average is used. This differs from the simple
average in that the relative prices of the more important com-
modities are counted more than once in making up the average, —
the precise amount of weight given to them being fixed according
to the importance of the commodities to which they relate. Weight-
ing is not of great practical importance unless the list of commodi-
ties used is very small, or unless the index number is to be used for
some special purpose, — such as to show changes in the cost of
living, where relative prices are weighted according to the average
distribution of the expenditures of families in the wage-earning
A simple and useful way of obtaining a typical price is to find the
median. The median is the relative price which divides all of the
relative prices for a given date into halves, — one half being lower
and one half being higher than the median. Less used are the
mode, — the relative price that occurs most frequendy in a given
year, — and the geometric average, — the «th root of the prod-
uct of the relative prices of n commodities. Much has been
written about the relative advantages of the different kinds of
averages, but the questions involved are highly technical. Whether
one kind of average is better than another usually depends upon
the character of the data and the use that is to be made of the re-
sults. Statisticians now emphasize the importance of knowing
the distribution as well as the trend of price changes. That is, in
order to know whether the average is really typical of the different
relative prices we should know how closely most of them approxi-
mate to it. The range of the variation of the different relative
prices from the average might, for example, be comparatively
small below the average and comparatively large above it. There
are various ways of measuring and stating the distribution of
prices.
T
274 OUTLINES OF ECONOMICS
Wage changes as well as price changes can be measured in index
numbers. Weighting is of more importance in the case of relative
wages than in the case of relative prices, because the number of
men represented in the data for single series of relative wages (such
as those in a given occupation in a given establishment) is con-
stantly changing.
Index numbers are available for the United States for the period
since i860. For the period 1860-1880 Mitchell's* are the best;
the period from 1890 to the present is covered by the United States
Bureau of Labor,* and for the gap from 1880 to 1890 Falkner's are
available.' DufCs Review and Bradstreel's also publish tables of
price changes.*
Some writers have suggested the possibility of a tabular standard
of value, to be maintained by frequently changing the value of the
money unit in accordance with the showings of an officially kept
system of index numbers. To do this by periodically altering the
amount of bullion in standard money would be impracticable,
while to abandon the use of a standard commodity and to attempt
to regulate prices by issuing fiat money and controlling the amount
in circulation would be, as we have seen, chimerical. A tabular
standard of deferred payments might be put in operation by laws
providing for the increase or diminution of the principal of debts
according to changes in prices. It is probable, however, that this
would be satisfactory to neither debtors nor creditors. The really
essential thing is to have a commodity standard of value that shall
be as stable as possible, and to maintain the convertibility of all
other forms of money with it. With gold as the standard of value,
and with all other forms of money redeemable in gold, changes in
prices are not apt to be rapid enough to work much injustice to
either debtor or creditor. The compensating influence of changes
in the interest rate must also be taken into account. The question
of the grievances of debtors and creditors has been overemphasized
* In his Go/4, Prices^ and Wages under the Greenback Standard.
* In various numbers of the Bulletin of the Bureau of Labor.
*In **Aldrich Report" on Wholesale Prices, Wages, and Transportation,
Senate Doc., 32d Cong., 2d Session, No. 1394'
* For an exhaustive account of various index numbers and other price statistics
sec Laughlin, The Principles of Money, pp. 171-211.
PROBLEMS IN MONEY AND BANKING 275
as compared with the really important economic problems growing
out of changes in the value of money. These are, as we have seen,
first, the effect on business enterprise, and second, the effect on real
incomes as distinguished from money incomes.
Vahte of Money. — We have not as yet answered one very
important question, and that is, "What determines the value of
money?" Now by the " value of money" we cannot mean any-
thing but the purchasing power of money. There is no such thing
in fact as "the general purchasing power of money," although we
have found it convenient to use that and similar expressions.
Money has, in reality, a large number of different values, measured
by the different quantities of different things that it will purchase.
If the price of wheat is one dollar per bushel, then one value — the
wheat value — of money is a bushel per dollar. Similarly, the
purchasing power of money in sirloin steaks may be four poimds
per dollar. But how are we to blend sirloin steaks, wheat, and
other things into one concept ? Index numbers do not tell us what
the general value of money is; they simply reveal average varia-
tions in the different values of money. The concept of the general
value of money is simply a useful abstraction, based on a broad
view of all its different specific values.
When we fix our attention upon changes in the various purchas-
ing powers of money, however, we are able to make a distinction
between changes that are widespread and fairly imiform, and
changes that affect only one or two commodities. For exa^mple, a
new invention may decrease the price of a particidar commodity,
without affecting the prices of other things except through the
shifting of demand from other things to the commodity in question,
— an effect which would usually be slight so far as the price of any
one of these other things is concerned, as the demand would prob-
ably be shifted from many different lines of consumption. Or, if
the demand for the commodity in question is relatively inelastic, a
diminution in its price may increase the demand for other things.
But there are, on the other hand, price fluctuations which are wide-
spread and fairly uniform, and these we call, with substantial
accuracy, changes in the value of money.
We have already discussed the nature of price fluctuations due
276 OUTLINES OF ECONOMICS
to the use of a discounted medium of exchange, like the greenbacksy
as well as the temporary fluctuations in values, — especially capital
values, — that spring from alternating periods of prosperity and
depression in business. But what are the underlying causes of
general changes in the value of money? — the kind of changes we
referred to when we mentioned the decreasing value of the mone-
tary standard itself as a stimulus to business enterprises?
Leaving theory aside, we know from experience that, other
things being equal, the value of money will decrease when the
supply of the standard commodity increases rapidly.^ We know
that the value of money imits sometimes increases when the world's
supply of the standard metal is being increased only slowly. We
then say, and it is only a reasonable inference, that the value of
money depends, other things being equal, on the supply and
demand of the standard commodity. But this is only an empirical
generalization. It leaves us ignorant of the way in which a value
equilibrium is really struck between a certain amount of gold and a
certain amount of another commodity.
In analyzing the relation of the supply and demand of other com-
modities to their prices, we assumed, for simplicity of the analysis,
that the value of gold was not changing. That is, we assumed that
the general level of prices was not changing, and so really limited
our analysis to the way in which the values of all commodities
except gold vary as compared with one another.
The marginal utility analysis, which formed the basis of our ex-
planation of the shifting of demand from one commodity to another,
does not help us to explain the demand for gold as money. Mar-
ginal utility springs from the capacity of things to satisfy individual
wants, and money does not directly satisfy a single human want,
except the abnormal wants of the miser. The subjective values we
set upon money imits are only the reflected values of the things
that money will buy for us.'
Our standard money commodity is, however, a commodity that
* We refer bere to a more pennanent and thoroughgoing change in the prices
than that resulting from the business expansion following an increase in the supply
of money available for bank reserves.
' When we speak of the utility of money we use the word "utility" in the sense
of usefulness, rather than of want-satisfying capacity.
PROBLEMS IN MON£Y AND BANKING 277
has other than monetary uses. Gold ornaments an4 other articles
made from gold are subject to the law of diminishing utility just as
other things are. From the estimates of the director of the mint,
it appears that in recent years from one fourth to one third of the
world's annual production of gold finds its way into industrial uses.
The United States mints and assay offices refine nearly all the crude
gold bullion produced in or brought to this country, and allow the
depositor to take the proceeds in money or in bars of gold for indus-
trial use, as he prefers. There is thus a constant balancing between
the industrial and monetary uses of gold.
In effect ihe monetary units which can be got by the sale of gold
jewelry, etc., for money are balanced against the monetary units
which can be got by the simple conversion of bullion into coin.^
Consumers, on the one hand, are balancing the marginal utility of
gold jewelry, etc., against the marginal utility of other things that
they can buy with the same number of money units. Producers,
on the other hand, are balancing the relative profitableness of pro-
ducing articles made from gold and articles made from other
materials. The valuations placed on gold in its industrial uses,
where a direct comparison with the values of other commodities is
possible, in this way fix a standard to which the value of gold as
money must approximate.
There is another way in which society makes direct comparisons
between the value of gold and the value of other things. Mining,
tike agriculture, is subject to the law of increasing expenses, and
the tendencies of prices to equal marginal expenses is true for both
industries. Not only are there marginal mines, mines which it just
pays to operate, but in the most productive mines there are mar-
gins, — certain depths, for example, beyond which the expense of
mining more than eats up the value of the product. Through the
operators of mines, society is continually comparing the values of
the labor and the capital goods used up in the production of gold
with the value of the things that can be bought with the produced
gold. If the gold produced at the margin will purchase things
which consumers value less than they value other things which
' The expense of transforming bullion into jewelry, etc., is left out of account,
as it does not affect the real point under consideration.
Sty& OUTLINES OF ECONOMICS
could have been produced with the use of the same amount of capi-
tal and labor, capital and labor will gradually be shifted from its
marginal use in gold mining to the production of other things.
Here, then, as in the case of the balancing between the monetary
and industrial uses of gold, we have a comparative valuation of
gold and other things.
Several years ago the Bureau of the Mint undertook an investi-
gation into the relation of the expense of gold mining to the
amount of gold produced. Some of the conclusions reached are
worth quoting in this connection : —
In every mining district there are mines producing at good profits, mines
producing at small profits, mines barely paying expenses, and mines
operated at a loss, but with the hope that they will do better. Every increase
in costs would submeiige the latter more deeply, add to the list of the un>
profitable, and probably close some of them. ... A higher scale of working
costs will bring losing experiments to an earlier conclusion, reduce profits,
and make mining ventures generally less attractive, and thus diminish the
output.*
To smnmarize our conclusions: The law of marginal utility ap-
plies in the industrial uses of gold. The particular form of the law
of normal value that is operative in agricidture also holds true in
gold mining (although it has to be stated in a somewhat different
way.) An increase in the supply of gold diminishes its marginal
utility in industrial uses, that is, diminishes the valuation put on
gold as compared with other conunodities. This is bound to affect
the value of gold as money, on account of the ease with which the
supply of gold can be shifted to one use or the other. The resulting
increase in prices may be slow and irregular, but it is none the less
certain. The rise of prices, however, cannot continue indefinitely.
The increase of prices and wages brings increasing expenses in
gold mining. The marginal part of the supply of gold vrill nor-
mally be cut off, — a process which will continue until a rise in the
value of gold diminishes the expense of producing it.
These suggestions are not put forward as an exhaustive state-
ment of all the relations between the supply of gold and its value,
although they are possibly the most impc^ant ones. Increases in
* Report on the Pnxluctton of the Precious Metals,* Z904, p. 41* .
PROBLEMS IN MONEY AND BANKING
279
the quantity of other kinds of money and improvements in the
mechanism of credit, for example, probably have an effect on prices
similar to that of an increase in the quantity of gold, in that they
economize the use of that metal. Silver and paper money do not
TABLE I
Production 07 Gold in the Woiod smcB 184 1
(From 1841 to 1885 the estimate u from a table of avenges for certain periods, compiled
by Dr. Adolph Soetbeer; for the years x886 to 1906 the production is the axmual estimate of
the Bureau of the Mint.)
Annual Aveiaoe voa Peuod
Peuod
Value
1841-1850
1,7^,502
$36,393,000
1851-1855
6^10,334
i3«»5i3»ooo
1856-1860 ,
6,486,262
134,083,000
1861-1865
5,949»58a
122,989,000
1866-1870
6,270,086
129,614,000
1871-1875
S»59i»oH
"5,577,000
1876-1880
S»543»"o
114,586,000
1881-1885
4,794,755
99,116,000
1886-1890
5,461,282
112,895,000
1891-1895
7,883,565
162,947,000
1896-1900
13,446,939
257,301,100
1901
12,625,527
260,992,900
1902
14,354,680
296,737,600
1903
15,852,620
327,702,700
1904
16,804,372
347,377,200
1905
18,268,696
377,647,700
1906
19,366,550
400,342,100
take the place of an equivalent amount of gold, however, because
some gold has to be held m reserve to maintain their convertibility.
The so-called "quantity theory" of the value of gold money has been
much discussed in recent years. This is the doctrine that, other things being
equal, prices vary directly as the amount of money in circulation. In
reality many different theories of the value of money have been put forward
under the name of the quantity theory. The theory just outlined, for
example, may be called a conservative form of the quantity theory. Some
statements of the theory are open to objection because they (i) place too
28o
OUTLINES OF ECONOMICS
much stress on the very doubtful problem of the exact mathematical ratio
between variations in the quantity of money and variations in prices, or
(9) confuse the "measure" or "denominator" of value with the standard of
value, or (3) fail to recognize the necessity of a commodity standard of value,
and consequently attach no significance to the influence of the industrial
use of the standard commodity on its value. The most extreme form of
the quantity theory is that which forms the foundation of the argument
for the possibility of fiat money.
The Increase in the Production of Gold. — Although probably
more gold was produced between 1850 and 1875 than from 1492 to
1850, yet, as Table I shows, the production of gold in any three
TABLE n
Recent Production 07 Gold in Different Countries^
(In thousands of kilograms)
CODNTIY
1897
igoo
1904
Africa
88
97
86
35
9
13
ZI
9
36
13
III
119
31
42
14
13
8
35
139
13a
131
Australia
Russia
37
35
18
Canada
British India
Mejdco
19
7
35
China
All others
Total
355
385
523
■ Fhm Jomnal of PdiHcal Economy^ Vol. X, p. 580, and Finance Report, 1907, p. 363.
years since 1896 or in any two years since 1902 was as great as the
total production in the period first mentioned. Most of this great
output of gold, as Table II indicates, comes from relatively few
countries. At present the British empire supplies over one half
and the United States (including Alaska) nearly one fourth of the
total product. The causes of this enormous increase were, in part,
the opening up of new gold fields in South Africa, Canada, Alaska,
and Colorado, and in part the improvements in methods of extract-
ing gold from low grade and refractory ores, in which connection
PROBLEMS IN MONEY AND BANKING
281
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2&2 OUTLINES OF ECONOMICS
the development of the "cyanide process " has been of special im-
portance.* Dredging for gold in the beds of rivers which drain
gold-yielding lands, is a very recent development that promises to
be of considerable importance. Notwithstanding the decrease in
the value of gold, the bulk of the gold produced in California to-day
is from ore bodies that twenty-five or thirty years ago were generally
considered worthless.
The effects of this enormous output have been felt in both Europe
and America in a general increase of both prices and wages. There
are some who expect that the value of gold will continue to depreci-
ate for a long time in the future. Account must be taken, however,
of the automatic check which the increase in wages and prices is
bound to put on the production of gold by increasing mining ex-
penses. On the other hand, still further economies in productive
methods are possible.
QUESnOKS AND EXERCISES
I. Report on the Note Issue systems of Canadian banks, the Bank
of England, the Bank of France, and the Imperial Bank of Germany.
3. Make a diagram showing the weekly changes in the total reserves
and the surplus reserves of New York clearing house banks for any recent
year. (Statistics may be obtained from the annual Financial Review, the
Commercial and Financial Chronicle, the Banker's Magazine, or other finan-
cial journal.)
3. Construct a simple index number for wholesale prices, in one city,
covering the period of a few weeks. (Use the market quotations of a daily
paper as data.)
4. If half the gold in the world were destroyed, would prices be doubled ?
REFERENCES
(See also references for Chap. XV.)
Adams, T. S. "Index Numbers and the Standard of Value," Journal of
Political Economy, December, 190X, March, 1902.
* "There arc many mines in operation now at a profit which could not have been
worked at a profit ten years ago. There has been an important addition to the
gold and silver product by the recovery of these metals from lead and copper ores
by modem processes. The most important gains seem to have come, however^
through economies in management, particularly by enlarging the scale of opera-
tions and by more complete extraction of the values from the ores treated." —
Report on the Production of the Precious Metals, 1904, p. 41.
PROBLEMS IN MONEY AND BANKING 283
BUETON, T. E. Crises and Depressions.
BowLEY, A. L. SUUistics, Chap. VII.
Director of the Mint. Annual Report on the Production of the Precious
Metals.
Jones, E. D. Economic Crises,
Mayo-Smith, SUUistics and Economics,
United States Geological Survey, annual Toluxoe on the Mineral Industry.
CHAPTER XVn
mTERKATIONAL TRADE
The subject of international trade brings us to an examination
of exchange from a new viewpoint. In principle, international
trade does not differ essentially from other kinds of trade. In the
last analysis it amounts to an aggregate of exchanges between pairs
of traders. But in discussing international trade we lay the em-
phasis upon the aggregate rather than the specific exchange, take
a larger view of commercial relations, try to determine how great
districts of the world combine to supply one another's wants, and
analyze the machinery by which commerce overcomes the obsta-
cles of trade restrictions and the difficulties growing out of the use
of different monetary units in different parts of the world. Much
of the confusion met with in this branch of economic thought is
due to mere forgetfulness of the elementary axioms of exchange,
and for this reason it is desirable, even at the cost of some repe-
tition, to reexamine briefly the nature and function of trade.
Nature and Advantage of International Trade. — The function
of trade is to create the utilities of time and place. Industry
itself, " production " in the narrow sense of the word, is like-
wise confined to the creation of utilities — form utilities, prin-
cipally. Trade, therefore, is as beneficial, as truly productive, as
agriculture or manufactures. The American people are just as
truly engaged in production when they buy books from Grermany
as when they cut down their own spruce trees and manufacture
them into paper for the "yellow journals."
Trade is not only productive in the sense that it creates utilities,
but it is also an indispensable part or process of the division of
labor. Upon this self-evident fact it is unnecessary to dwell. It
is, however, desirable to recall the fact that specialization of func-
284
INTERNATIONAL TRADE 28$
tion is profitable even to those individuals or classes which are
plainly superior in general productive efficiency. A successful
lawyer does not write his own letters, even though he is an expert
operator on the typewriter. He specializes in that occupation in
which he has the greatest advantage, and hires some one to
write his letters for him.
This rule — frequently referred to as the law of comparative costs
— holds for communities and nations, as well as for individuals.
If, in Holland, it costs ten times as much to produce a barrel of
flour as a yard of cloth, while in America it costs only six times as
much, it will be profitable for the Dutch to confine themselves to
the production of cloth, and for the Americans to confine themselves
to the production of flour; even though both floiu: and cloth could
be produced more cheaply in America than in Holland.*
If this conclusion is true, it follows that so long as the compara-
tive costs of producing goods vary among the different nations of
the world, so long there will be some international trade. And,
furthermore, since it is impossible to conceive that the costs of
producing all kinds of transportable goods will ever be exactly
proportional in the several countries of the world, it is evident that
international trading is bound to continue. It can be permanently
suppressed only by raising freight charges to a prohibitive level,
or by deliberately manipulating customs tariffs so as to suppress
every new international trade connection as soon as it springs up,
or by the complete destruction of industry in other parts of the
world; and none of these possibilities is ever likely to be realized.
The ideal of an exclusive home market is a delusion. The last
thirty years have witnessed a remarkable increase of protection
throughout the civilized world, but international trade has in-
creased by leaps and bounds.
International trade, then, is productive, profitable, and for prac-
tical purposes irrepressible. The tariff controversy can never be
settled until these elementary truths are thoroughly appreciated.
On the other hand, it is equally plain that these facts do not settle
the tariff controversy. Ordinarily, trade is mutually advantageous
* Assuming, as Mill points out, that capital and labor will not emigrate
m masse from Hdland to America, and that freight charges are small.
286 OUTLINES OF ECONOMICS
to both parties; and in one sense it is always so. If Smith trades
X to Jones for y. Smith must have wanted y more than Xy and
Jones must have wanted x more than y, so that the temporary
happiness of both is increased by the transaction. But this is not,
as has sometimes been intimated, sufficient reason for permitting
all kinds of trade and condemning all kinds of trade restrictions.
If Smith b an ignorant Indian, X' a blue fox pelt, Jones an un-
scrupulous trader, and y a pint bottle of adulterated whisky, the
" sense " in which this trade is adjudged " mutually profitable "
is scarcely distinguishable from nonsense. The logic which ap-
proves unrestricted trading of this sort would also sanction unre-
stricted child labor and the contemptible extortion of the '^ loan
shark " who charges a desperate widow 200 per cent a year on a
small loan which the woman in her ignorance and necessity
must secure. Trade restrictions have existed as long as
international trade itself, and the real problem is not whether
there should be any restriction, but when and where particular
varieties of restraint are justifiable.
Restriction of International Trade. — In ancient times among
many nations, such as the Hebrews and Chinese, contact with other
peoples was feared and foreign trade was practically prohibited.
In Greece and Rome the greatest thinkers entertained a profound
contempt for trade, based in part upon the belief that in exchange
one party is usually cheated; and this prejudice was partially
justified by the character of the primitive trader who was part
sailor, part pirate, part merchant, and took all the profit he could
possibly extort in every transaction as insurance against the great
risks of his calling.
At a later date, in the middle ages, when commerce between
the semi-independent cities of western Europe increased, trade
came to be highly prized by the average citizen, although it was
still condemned by the philosophic schoolmen; and it was regu-
lated in the most exclusive spirit.
" Every effort was made to keep trade as much as possible in the hands
of native citizens. For example, the Venetians forbade the Germans from en-
gaging in trade with the East by way of Venice, and the citizens of Lttbeck strove
to keep the Baltic trade from the Dutch. . . . Foreigners were mistrusted
INTERNATIONAL TRADE 287
and partnerships with them were forbidden. Foreign visitors were restricted
in many ways in their commercial dealings with native citizens. Many
occupations were closed to them ; the length of their sojourn and the number
of their visits were limited; they could not pass a town without exposing their
wares for sale and paying the required market dues. The wants of the con-
sumer took precedence over those of the producer or merchant. At the
weekly markets consumers could supply their needs before the baker or mer-
chant was allowed to make purchases. There was a community interest
in the supplies of necessities, and often their exportation was prohibited. The
trade of neighboring peasants was restricted to the home city, and laws
regulating price, weight, measure, and quality were common. This restrict-
ive municipal policy was very much relaxed at the great fairs which were
held periodically in various parts of Europe.' ' ^
In the early modern period mercantilism became dominant.
Commercial policies were controlled by the desire to get and keep
the precious metals. At first the exportation of specie was pro-
hibited; merchants trading abroad were compelled to bring home
cash for the goods they had taken out with them; foreign mer-
chants trading within the home country were compelled to
exchange their cash for domestic goods before they departed;
exportation — except the exportation of raw materials needed
in the manufacturing industries — was encouraged; and impor-
tation— except in the case of the precious metals and skilled
artizans who were encouraged to immigrate — was discouraged
or prohibited. When it became apparent that the supply of
money had to be secured through international trading, the
greatest emphasis came to be laid upon the ^' favorable balance
of trade"; and means, ranging all the way from bounties to
war, were vigorously employed to secure the carrying trade for
native ships. In a large historical sense mercantilism was merely
a cry elicited by one of the sharpest of the world's great growing
pains. It was a symptom more than a cause or an explanation.
It marked the establishment of the division of labor on a territorial
basis, and recorded the replacement of the independent economy
of the middle ages by the modern economy of exchange. For
the latter, money was indispensable, and had to be secured at any
cost
^ProCesior G. M. Fisk, InUmaUonal Commercial Policies, pp. 15-16.
288 OUTLINES OF ECONOMICS
The mercantilist period has been followed — after a brief
laissez-faire reaction in some countries — by the period of protec-
tion in which we still linger. The extensive taxation of imports
still continues; but trade prohibitions, export and tran^t duties,
have been largely abandoned in the more advanced countries. In
the United States export duties are prohibited by constitutional
law. But few nations have wholly risen above mercantilist prac-
tices. Canada prohibits the importation of oleomargarine and
similar substitutes for butter ; Great Britain prohibits the impor-
tation of sugar from countries paying bounties on its production;
Switzerland levies an export tax on cattle, hides, and skins shipped
from the country, while Norway and Sweden tax the exportation
of timber ; and Russia still attempts to control the Persian trade
by levying transit duties upon goods passing through her terri-
tories destined for Persia. But export and transit duties in their
old mercantilist uses have nearly disappeared.
Extensive use is still made of export taxes for revenue purposes in South
America and the Orient; and trade prohibitions based upon grounds of
sanitation, morals, and what Americans call the "police powers," are in-
creasing rather than decreasing. Turkey, for instance, levies an ad valorem
tax of I per cent upon all exports; and in general the most important
tropical products are still subject to export taxes. As for trade prohibitions
the continued necessity for their occasional employment is illustrated by our
federal law authorizing the President to suspend the importation of any
article which he regards as " dangerous to the health or welfare of the people
of the United States." For a more complete enumeration of modem export
duties and trade prohibitions, see Fisk's International Commercial Policies^
Chap. VI.
Mercantilist ideas die hard, and current discussion of inter-
national trade by reputable legislators and intelligent journalists
is still permeated with fallacious notions which had their origin in
the conditions and economic philosophy of the seventeenth century.
One of these notions, the idea that there is something essentially
favorable in an excess of exports, and something essentially un-
favorable in an excess of imports, demands careful consideration.
Balance of Trade. — Suppose, for purposes of discussion, that
the United States succeeded in prohibiting imports for a long
period, while at the same time it succeeded in selling a large
INTERNATIONAL TRADE 289
amount of merchandise to foreign purchasers. What would
happen? Evidently a large portion of the money of the world
would accumulate in the vaults of American bankers, interest
rates would fall, — possibly to rise again later, — and eventually,
if the process continued long enough, the prices of American com-
modities would ascend to such a level that foreign nations would
be unable to continue buying in this country. At this point,
evidently, our hypothesis breaks down, and we are forced to con-
clude that the original supposition was an impossible one.
This hypothetical case and its reducHo ad absurdum are sufficient
to establish certain important practical conclusions. The first is
that a country cannot permanently sell goods for money alone.
If it produces large quantities of the money metals, it will regu-
larly sell those metals for the goods and services of other nations.
If it produces no gold or silver itself, it will secin-e them through
exchange; although, even in this case, gold and silver are likely to
constitute only a minor part of its imports. Perhaps the gravest
error one can commit in studying an international trade balance
is to treat it as an exchange of goods for money. It is not even an
exchange of goods for goods. The true international balance is
one of claims against obligations, of credits against debits. The
complete statement is that the goods, moneys, and services ren-
dered by one country to other countries, plus its claims and credits
of all kinds, will be balanced by the goods, moneys, and services
received by the same country plus its debts and obligations of all
kinds. Or, to put the matter concretely, we must include, along with
the exports and imports of merchandise and bullion, loans which
the country makes or receives, annual interest payments on loans
and capital invested abroad, repayment of loans or the purchase
of seciudties, earnings of ships, insurance premiums, and commis-
sions of all kinds for international services, governmental ex-
penditures in foreign countries for diplomatic service, pajrment
of subsidies and war indemnities, remittances of immigrants,
expenditiu-es of travelers, and a thousand and one other items,
all tending, according as they depress or raise the price of foreign
exchange, to bring about the importation or exportation of gold
for the occasional balancing of the account
290 OUTLINES OF ECONOMICS
A mere glance at this list of items entering into foreign trade is
sufficient to puncture the old mercantilist idea that a '^favorable
balance of trade" or an excess of merchandise exports brings about
an increase of the money supply. This idea is as fully refuted by
commercial statistics as by economic analysis. In the thirty-three
years, 1 874-1 906, for instance, we had a large excess of merchan-
dise exports in all except four years, but there was an excess of
gold imports in only sixteen years. So, similarly, there is no neces-
sary truth in the statement which we hear so often, that our present
''favorable balance" indicates that the United States is settlmg its
indebtedness to foreign capitalists, repurchasing American securi-
ties owned abroad, and thus bringing the control of American
enterprises more completely into the hands of Americans. It may
mean this, to be sure, but it may also merely mean that we are
paying England in goods for canying and insiu-ing our exports,
or that foreign owners of American securities are taking in this
form the annual interest or profits due to them. The recent excess
of exports may thus represent the continuance of indebtedness
rather than its liquidation. For the same reasons an "unfavor-
able balance of trade" or an excess of merchandise imports is open
to a variety of diflFerent interpretations. It may mean that foreign
capital is investing more heavily in the country under discussion,
or that thb coimtry is taking, in the form of consumable commodi-
ties, interest and profits on investments which it has previously
made abroad, or that it is selling its holdbgs in foreign enterprises
and taking the proceeds in the form of consumable goods. An
** unfavorable balance" of trade may thus be, in reality, highly
encouraging; and a "favorable balance" indicative of national
waste and extravagance. The precise meaning of any particular
balance can only be determined after the most careful study, and
no dependence should be placed upon the offhand interpretations
of casual investigators. The great truth is that there must be
some sort of balance between the credits and liabilities of any
country, and that in practice a nation must be wflling to buy if it
is anxious to sell.
A scholariy analysis of the foreign trade of the United States, with a careful
interpretation of the meaning of the trade balance at various periods, may
INTERNATIONAL TRADE 291
be found in the North American Review for July, 1901, from the pen of
Professor C. J. Bullock. Professor Bullock's explanation of the balance in
two or three periods may be given, in order to illustrate the variety of factors
which must be taken into account when dealing with this subject. In the
period 1 789-1830 the imports of merchandise and specie exceeded the cor-
responding exports by $511,000,000, and our obligations were further in-
creased by interest on foreign capital invested in the United States to the
amount of $200,000,000 approximately. This total indebtedness of some-
thing over $700,000,000 was offset by the earnings of the American mer-
chant marine, estimated at about $800,000,000 for the period in question.
"So far, then, from the country being drained of its money in payment for
the balance of imported merchandise, the banks held not less than $20,000,-
000 of specie in the year 1820; while Gallatin and Crawford estimated that
there had never been more hard cash in circulation."
In the decade 1 831-1840, owing to the high prices current in this country,
imports exceeded exports by $159,700,000; the imports of specie also ex-
ceeded the exports by $50,650,000 ; and the earnings of our merchant marine,
$90,000,000, sufficed only to reduce this "unfavorable balance" to about
$120,000,000. This remaining balance is accounted for by new foreign
investments in the United States, in particular by foreign purchases of state
bonds. "Our large imports of merchandise and specie had been made
necessary by the movement of foreign capital toward the United States."
In the decade 1 851- 1860 the merchandise imports again exceeded the ex-
ports by $355,800,000; the net amount due to foreign creditors was some-
where between $100,000,000 and $130,000,000; and to offset these adverse
balances our merchant marine earned in this period only $ 1 58,000,000. The
remaining balance in this case was covered by our lax^ge excess of specie
exports, which amounted to $417,608,000, and was due to the discovery of
gold in California. " The United States had become one of the leading gold-
producing regions, and the course of the exchanges was inevitably altered."
In the periods briefly described above, the striking factors in our inter-
national trade were, respectively, the earnings of our merchant marine, new
investments of foreign capital in the United States, and large specie exports
following the discovery of gold in California. ^ the last period, from 1874
to 1896, our exports both of merchandise and specie greatly exceeded our
imports. "This meant simply," concludes Professor Bullock, "that the
country had assumed its normal position as a debtor nation on the* various
items of invisible exchanges, and was paying annually something like
$122,500,000 on such accounts."
In concluding this aspect of the subject the student should be warned that
trade statistics are full of pitfalls for the unwary and can safely be handled
only by experts. Exports are sometimes overvalued, imports are generally
undervalued: some countries state values at the point of departure (thus
excluding cost of carriage) ; other countries state values at the point of entry
292 OUTLINES OF ECONOMICS
(thus including cost of carriage) ; some countries make special efiForts to ex<
elude values of reexported goods from their statistics; others make little
or no efifort to eliminate such nominal items ; while the complete prevention
of such reduplication is probably impossible. Eminent statisticians are now
making earnest effort to harmonize the trade statistics of the various countries
of the world, but it will be a long time before trustworthy conclusions con-
cerning the real significance of the so-called balance of trade can be drawn
by the average student.
Foreign Exchange. — The preceding discussion makes it dear
that, compared to the enormous values of the goods exchanged in
international trade, only a small amount of money is used. As
in domestic trade, purchase is set against sale, debt canceled by
credit, and money employed only for the occasional settlement of
balances. This cancellation of offsetting claims is effected by the
banks and brokers who engage in foreign exchange; and a brief
description of their economic function becomes necessary at this
point. For it should never be forgotten that the international
banker has been in the past and will be in the future an indis-
pensable factor in the development of foreign trade. Without
his good offices the vast international traffic of the world would be
but a shadow of what it now is. It need hardly be said, more-
over, that in its detailed operation the work of foreign exchange
is exceedingly complex, and that only a sketch of the essentials of
the process can be given here.
As illustrative of the process, let us take the important case of
our trade with England. Ordinarily, an American exporter who
has sold goods to England draws an order — a biU of eocchange —
on the English debtor, directing him to pay the claim at some
specified time and place in London. American importers, on the
other hand, commonly pay their foreign balances by buying bills
of exchange, or drafts on London, and sending them to their Eng-
lish creditors. In this way American debts and credits are bal-
anced in London without transferring any money at all, except
occasionally to settle the balance of indebtedness.
Bills of exchange differ from ordinary drafts in that the latter
are usually drawn on a bank, while the bill is drawn on a com-
mercial creditor. They are usually accompanied by bills of
lading, insurance receipts, certificates of weight and origin, and
INTERNATIONAL TRADE 293
all the documents necessary to give the purchaser of the bill full
title to the goods until the bill is accepted or paid. They are
accordingly referred to as "documentary bills" or "commercial
bills," to distinguish them from "bankers' bills" and other instru-
ments of international credit described hereafter. Documentary
bills are freely negotiable, passing from hand to hand by indorse-
ment, and gathering strength with each new indorsement. It is
important, also, to note the difference between "sight bills" and
"long bills," the former calling for payment upon presentation,
the latter for inunediate "acceptance" by the drawee and payment
after thirty, sixty, or ninety days. The price of ninety-day bills,
for instance, is fixed by the price of sight bills and the discount
rate in London.
We may now enlarge our simplified illustration to something
like life-size. Documentary bills drawn by exporters or creditors
all over the country are sold by the drawers to bankers, usually
New York bankers, who may be called the "wholesalers of ex-
change." The sale may be either direct or through exchange
brokers, "the jobbers of exchange." These documentary bills
are sent by the New York banks to their foreign correspondents for
collection (in the case of sight bills) or acceptance (in the case
of long bills). The balances thus built up abroad by the New
York banks constitute the fimd against which they draw their
own bills. These are sold directly or through smaller banks
— the "retailers of exchange" — located in all parts of the
country. Foreign exchange is sold in a great yariety of forms
— bankers' drafts, travelers' checks, travelers' letters of credit,
conunercial letters of credit, cable transfers, and the like —
descriptions of which may be foimd in the references cited at the
end of the chapter.
The illustrations used above, while typical of a large part of the
foreign exchange of this country, fail to represent adequately the
complexity which marks some of the interactions of international
credit. An illustration of the more complex class is found in the
"three-cornered" or "triangular exchange." We import from,
very much more than we export to, South America. A part of
the debit balance — though possibly not the larger part at the
294 OUTLINES OF ECONOMICS
present time — is settled by the transmission of London drafts to
our South American creditors, who can use them advantageously
in the settlement of their debts in Europe. London thus ''clears"
for the world as New York "clears" for America and Paris for
France. Just as the net balance of our foreign trade is struck in
New York, so final internadonal balances are cleared or settled
in London, although London's preeminence in international ex-
change is now not so striking as it has been in the past.
The question next arises how the price or rate of exchange is
determined. The factors controlling the price or rate of exchange
are as numerous and as difficult to trace as the influences which
affect the price of any economic good of world-wide bargain and
sale. However, to facilitate discussion, we may classify them as:
(a) the amount of pmre gold in the monetary units which are to be
exchanged, (b) the cost of shipping gold, and (c) "general credit
conditions."
An English pound sterling contains as much fine gold as 4.866
American dollars, and when exacdy this amount must be paid in
New York for a draft or order for one pound payable in London,
exchange is said to be a/ par. Sterling exchange and German
exchange are tisually quoted in dollars and cents, i.e. the amount
of American money required to buy one poimd or fowr marks
respectively. Consequently, they rise or become dear when ex-
change nl^ounts above par. French exchange, on the contrary,
is usually quoted in francs, the number of francs purchasable
with one dollar; and it is consequently cheap when above par and
dear when below par. Exchange between the United States and
countries with silver or paper standards lack the steadying in-
fluence of a par determined by the actual mass of fine gold in the
respective standards of value, and hence fluctuates much more
than exchange between countries on a gold basis. In order to be
as brief and clear as possible, the following discussion will be con-
fined to exchange between countries on a gold basis.
Fluctuations in the rate of exchange depend upon the "general
credit conditions" mentioned above, but it is plain that upper and
lower limits to these variations are established by the actual cost
of shipping gold. Suppose, for a moment, that it costs three cents
INTERNATIONAL TRADE 29$
to transport $4,866 worth of gold biiUion between New York and
London. Except under unusual circumstances, then, sterling
exchange cannot rise above $4,896, nor fall below $4,836. These
limits are frequently spoken of as the "gold points," ''specie
points," "shippmg points," or "export and import points"; and
it is necessary to mention them because of their frequent employ-
ment in discussions of foreign exchange. But they are usually
defined in much too definite terms. The cost of shipping gold
varies with the size of the shipment, with freight, insurance, and
interest rates, and in some degree with the steamer and the season
of the year. Furthermore, gold is so important as the basis of
bank credit in all parts of the world, that it is frequently imported
regardless of the rate of exchange. During the war between
Russia and Japan, for instance, the Bank of France imported
large quantities of American gold in this semiarbitrary way in
order to protect reserves. The "gold points," then, while in one
sense very real, represent extreme limits and are in themselves
variable.
Within these extreme limits set by the cost of shipping gold,
the rate of exchange varies according to general credit conditions,
i.e. with the supply of and demand for bills of exchange, with
interest rates here and abroad, and the innumerable forces which
influence interest rates. Suppose, for instance, that our imports
of merchandise in a given season greatly exceed our exports of
merchandise. The demand for bills on London would greatly
exceed the supply of bills against London, and the price of sterling
exchange would rise very high if no other factors were involved.
But it may happen at the same time that interest rates in New
York are higher than in London, and under these circumstances
oxir foreign creditors may prefer to lend their balances in New
York in order to earn the high rate of interest obtaining there.
The placing of these loans in New York will in turn reduce the
demand for foreign exchange, and thus moderate both the interest
rate and the rate of exchange.
This interaction of the domestic and the international money
markets gives rise to a number of complex transactions which can
only be suggested here. In discussing the sale of foreign exchange
296 OUTLINES OF ECONOMICS
on page 393 above, American bankers were described as drawing
against credit balances which they had built up abroad. Some
bankers' bills, however, the so-called " finance bills," are drawn
in excess of the foreign balances, and thus represent borrowings
abroad. Finance bills are used (a) to tide over the time before a
plentiful supply of documentary bills is available; and, (b) to
take advantage of low discount rates abroad, e.g. in London, by
borrowing in London and lending the proceeds in New York.
Under the latter circumstances, finance bills payable in London
at sixty or ninety days are sold in large quantities in New York,
the sellers commonly covering their risk by the purchase of future
drafts calling for the payment of the same amounts in London at
the dates when the bills mature. The finance bill is thus one of
many credit instruments used to bring the loanable funds of the
world to the market where they will command the highest rate of
interest; and it is hardly necessary to add that it assumes at times
a highly speculative character. ** Bankers sometimes purchase
outright entire new issues of securities from corporations with
proceeds obtained by the issue of finance bills, sell the securities
to investors during the currency of the finance bills, and apply the
proceeds realized through the sale of the securities to the payment
of the bills at maturity." *
Regulation of the Gold Supply. — We may now return to the
general topic of trade regulation, from which we digressed in
order to consider the fundamental principles of foreign exchange.
Historically, it will be remembered, many of the most important
restrictions of trade have had as their object the regulation of the
gold supply. And the movement of gold is still of great interest
to the world of high finance because of the dependence of the
volume of bank credits upon the gold reserves of the banks. But
the preceding discussion would seem to make it clear that, ordi-
narily, there is little that the government can do, or needs to do,
in the way of regulating the supply of gold. Through interna-
tional trade and foreign exchange, the gold supply of the world
is automatically distributed among the countries which need gold,
in accordance with the intensity of their respective demands.
^ Margraff, International Exchange, p. 41.
INTERNATIONAL TRADE 297
In ordinary or normal times, the interest rate is the most power-
ful of the many influences which control the distribution of the
gold supply. International banking houses keep funds in both
the United States and Europe, and they are constantly shifting
their money to the market in which it will earn the highest rate of
interest. The means employed to move their funds may vary, as
has been explained, all the way from the simple sale of foreign
exchange to the actual importation of gold. So great is the influ-
ence exercised by the rate of interest over the gold supply that the
Bank of England usually flnds it necessary to do nothing more
than raise its discount rate when it desires to attract gold to Eng-
land or discourage its exportation.
The ordinary price level, that is, of merchandise, also exercises
a great influence upon the rate of exchange and the movement of
gold. When prices abroad are high compared with American
prices, foreign countries increase their purchases, the supply of
American bills increases, sterling exchange falls, and if it goes low
enough, may cause the shipment of gold to this country. Such a
condition of affairs, for instance, is likely to occur in the autumn
months, when large exportations of American cotton, wheat, and
agricultural products create a plethora of bills on London, and,
other things being equal, depress the price of sterling exchange.
There can be no doubt, then, that the price level does influence
the movement of gold. Whether the gold movement influences
prices, however, is disputed. Some opponents of the so-called
" quantity theory " of money hold that it does not, maintaining
that before a drain of gold, for instance, could raise prices, it
would so elevate the interest rate that the drain would be checked
and gold be brought back. In their view, the interest rate acts
as a safety valve, through whose variations any protracted gold
movement which threatens to disturb the price level is checked and
reversed before it acquires the momentum requisite to accom-
plish the larger task. Without attempting to decide the question,
we may be sure at least of this relevant conclusion: that if the
movement of gold continued indefinitely, prices would unques-
tionably be affected.
The gold supply thus adjusts itself automatically to the respec-
apS OUTLINES OF ECONOMICS
tive demands of the various districts of the world. This truth
is important because it establishes a prima facie presumption
against laws or policies which interfere with the normal distri-
bution of the precious metals. This presumption is only an initial
one, however. It does not follow that *' Artificial " interference
with the distribution of the gold supply is never warranted. In
times of war, panic, or severe financial stringency, extraordinary
expedients for obtaining gold are sometimes used which, like the
heroic remedies employed in desperate illness, are necessitated by
the exigencies of the situation. In the undignified scramble for
gold which often attends a panic, the country or the individual
who stands aloof and waits for the normal laws of distribution to
bring him " his " share of the gold supply, may have cause to
regret his inaction. Nevertheless, it is true that such expedients,
like strong drugs, are to be used with the greatest caution. They
are frequentiy employed when the situation does not demand
them, their use tends to become a fixed habit, and they seldom
accomplish more than the postponement of the crisis.
An expedient of the kind described was employed by Mr.
Shaw, then Secretary of the Treasury, in the spring of 1906.
The following critical account of the action of the Secretary
may be unjust to him, for it must be remembered that the financial
stringency of the time threatened to become dangerous; but it
illustrates in a striking way the subtie modem devices sometimes
used to increase the supply of gold.
"On April 14 It was officially announced for the first time, that the Sec-
retary would allow any depositary bank which engaged to import gold to
anticipate the arrival of the gold by withdrawing a like amount in cash from
the Treasury upon pledge of saving-bank collateral as security. The sum
so withdrawn was to be regarded as a temporary loan, and to be returned to
the Treasury as soon as the gold arrived. In providing such an arrangement,
Mr. Shaw virtually reduced the cost of importing gold by the amount of
interest during transit, and raised by so much the 'gold import point.' In
other words, he endeavored to make it profitable for the depositary bank,
to import gold without waiting for sterling exchange to fall to the normal
'gold point.* . . . In accomplishing this, Mr. Shaw, temporarily eliminated,
so far as the national banks were concerned, one item of expense in their
foreign exchange operations. He gave them an advantage, for the time being,
over all other firms engaged in the same business; and his action naturally
INTERNATIONAL TRADE 299
excited critidsm among the private bankers who found themselves discrimi-
nated against. Critics also attacked his method of announcing his decision.
It appeared that several days before the public or the other banks were
informed of his intention, Mr. Shaw had seen fit to make private arrangements
with two New York banks for gold imports under the plan . . . Nor was
hostile critidsm mitigated by the general publication at this moment of the fact,
which had not been widely known before, that one of these same banks had
been favored by the Treasury for several weeks, and possibly months, pre-
ceding, with virtually the same privilege under a different guise. This had
been accomplished by allowing the bank in question to count as part of its
reserve its importations of gold during their period of transit to New York.
The imported gold had thus been made practically available as a basis for
loans from the moment of its purchase abroad, and the item of time cost in
such imports had been as completely eliminated as under the subsequently
adopted plan. . . . His [Secretary Shaw's] statement issued at the time
seemed to indicate that, in his opinion, the natural movement of gold was
toward this country, but that the flow was being lured to other markets
by the practices of European banks. He apparently hoped to overcome what
he took to be an artificial diversion of gold from the United States by adopting,
through the agency of the Treasury, measures similar to those which were
being employed by the French and German central banks." *
* A. P. Andrew, Quarterly Journal qfEconomia, August, 1907, pp. 544-546.
{For QuesH&ns and lUferonces, soe ihofoUaunng chapior.)
CHAPTER XVIII
PROTECTION AIVD FREE TRADE
We are now in a position to review intelligibly the pros and
cons of the modem tariff controversy. Because of the limitations
of space, it will be desirable to confine the discussion almost
wholly to American conditions, although most of the arguments
are applicable to other countries as well.
The Case for Protection. — (i) One of the most captivating
arguments for protection is the assertion that it promotes nation-
alism, which is held to be a good thing. Domestic trade, it is
claimed, draws the citizens of a country together, whUe international
trade is cosmopolitan and tends to their separation. Upon the
creation of our federal government, state tariffs were abolished
and their place taken by a national tariff designed partly to pro-
tect the whole of the country against the rest of the world. The
introduction of national protection thus went hand in hand with
the promotion of internal free trade; and Professor SchmoUer
even maintains the general thesis that, historically, this double
process of internal abolition and external extension of tariffs
marks the formation of new states, particularly federal states.
Protection against foreign competition, he asserts, is thus his-
torically coincident with the enfranchisement of internal trade;
and has as its main object the creation of a strong national eco-
nomic unity, without which permanent political imity, he thinks,
is impossible.
(2) Government should, the protectionists say, foster infant
industries in order to develop our natural resources and to pro-
duce diversity in industrial pursuits. It is admitted that protec-
tion is temporarily expensive, but so is the prohibition of child
labor temporarily expensive. We prevent children from earning
300
PROTECTION AND FREE TRADE 30I
a little while they are young in order that they may earn more
when they are old. For the same reasons trades unions rightfully
insist that apprentices shall be given a broad knowledge of the
trade they are learning, although it is more profitable for the em-
ployer to have them specialize early in some narrow branch of
the work. So, similarly, protection prevents a nation from special-
izing too exclusively in its undeveloped stage, in order that it may
the sooner arrive at industrial manhood.
Economists have generally admitted that there is a certain
amount of truth in this argument. If an industry gets an early
start in a given district, this locality is likely to retain its advan-
tage because of the concentration there of capital and labor ac-
quainted with the requirements and possibilities of the industry.
Thus, 69.3 per cent of all the clocks manufactured in this country
are made in Connecticut, for no other reasons that one can see
than those suggested in the explanatory phrase — "the momen-
tum acquired by an early start." And this localization of indus-
try is artificially fostered by the habit, common to exporters all
over the world, of selling abroad more cheaply than at home.
The export trade seems to be universally coddled. Of course,
such localized industries can be maintained only when the cost
of transporting the article is small; and when other districts do
not possess unusual natural advantages in the way of accessibility
to superior raw material, power, or skilled labor. The census
studies in the localization of domestic industries ^ seem to indicate
that while the industrial inertia of which we have been speaking
is an important factor, it is not so important as the opposing
forces making for territorial diffusion of industry.
A most interesting illustration of an attempt to crush the " infant indus-
tries "^of a competing nation is found in the effort of English manufacturers,
after the War of 181 2, to recover the American market of which they had been
temporarily deprived by the long period of non-intercourse. "English
manufacturers, eager to regain control of the lost markets, sent in shiploads
of cotton and woolens and iron manufactures, which they oflFercd on the most
liberal terms to their agents in this country. The goods were taken on credit
and disposed of at auction. The object was to undersell at any cost, and thus
^Special Census Report, "Manufactures," 1905, Part I, p. cdx. Cf, also,
Twelfth Census, " Mluiufactures," Part I, pp. cdz-ccay.
302 OUTLINES OF ECONOMICS
break down the infant industries. Lord Brougham justified the speculative
charactec of this trade on the ground that ' it was well worth while to incur
a loss upon the first exportation, in order, by the glut, to stifle in the cradle
those rising manufactures in the United States which the war had forced into
existence contrary to the natural course of things.' " *
(3) Closely connected with the preceding arguments is a de-
fense of protection based upon grounds of war and military neces-
sity. Industrial independence, it is asserted, prepares a nation
better for international war. There is unquestionably a great
deal of truth in the argument. Certainly a wise nation will see
to it that within its boimdaries factories exist which can manu-
facture arms and all the necessary munitions of war. But success
in war is not dependent upon arms and ammunitions alone. There
must be a plentiful supply of money, and whatever use may be
made of credit, enormous amounts of money must be raised by
taxation.* But the source of taxation is a floxu-ishing condition
of private industry; and the industry of the average nation de-
pendent upon international trade cannot flourish in times of war.
The failure of the South in the Civil War was very largely due
to her industrial dependence upon the cotton export trade. A
sufficient diversification of industry to prevent industrial paralysb
in times of war is, we believe, manifestly desirable.
(4) The home market argument for protection naturally fol-
lows. Much that is said in defense of this claim is childish or
silly. One distinguished American economist seriously main-
tained that a country can remain permanentiy prosperous only
on condition that what is taken from the soil shall be returned in
manure and other kinds of fertilizers, and that this will be accom-
plished only when the products of the soil are consumed at home.
A much stronger application of the argument, however, is found
in the assertion that the home market is superior because it is a
surer market. A foreign market is usually a precarious market.
It is likely to be closed by war or by capricious changes in tariff
policy. Protection is unquestionably expensive to the coimtry
* Coman, Industrial History of the United States ^ p. 185.
* For a classic explanation of the dependence of both public credit and taxation
upon a flourishing condition of private business in times of war, see PtMic Debt^
by Henry C. Adams.
PROTECTION AND FREE TRADE 303
that protects, but it is worth paying something to keep industries
in continuous operation. 1
(5) This brings us to the argument against "dumping/* By
dumping is meant the sale of products abroad at prices lower than
those charged at home. Dumping arises in a variety of ways.
Export bounties may be granted by the home country for the spe-
cific purpose of encouraging foreign trade; or a monopoly may
find it profitable to dispose of a surplus abroad at prices which
would be needlessly low in the highly protected home country;
and, indeed, there is good reason to believe that many manufac-
turers for the export trade make it a practice to sell abroad at
unusually low prices whenever they believe that their foreign
market is threatened. As was stated above, the custom of "cod-
dling " the export trade seems to be very general.
Now if the reduction of prices were permanent, the country in
which the products are dumped would have no real cause for com-
plaint. On the contrary, it might logically regard itself as the
beneficiary of the costly bounties of the other nadon. But real
dumping is not, and in the nature of things cannot be, permanent.
So far as it may be said to have a rational object, it aims to sup-
press competing industries by selling temporarily below cost; and
when those industries are forced out of business, prices will be
raised. So true is this that economists have generally indorsed
import taxes and other temperate retaliatory measures designed to
abolish dumping. Canada, for instance, has authorized the levy
in such cases of a special dumping duty "equal to the difference
between the selling price of the article for export and the fair
market value thereof for home consumption." A few years ago
the beet-sugar industry of France and Germany was so stimu-
lated by bounties that even England, the principal dumping
ground of the product, was forced to threaten reprisals in the shape
of countervailing import duties. England's resolute attitude, it
may be added, led finally to the virtual abolition of sugar boimties
at the International Sugar Conference of 1903. In general, there
seems to be ample justification for protective duties that are hon-
estly used to ward off destructive attacks upon home industries
which, if subjected only to legitimate competition, would be able
304 OUTLINES OF ECONOMICS
to maintain themselves in the long run. It is evident that we
have hdte returned to the substratum of truth contained in the
infant industry and home market arguments.
Dumping has been more productive of arguments against protection than
of arguments for protection, in the United States ; and the opponents of pro-
tection have laid great emphasis upon the fact that many articles of American
manufacture are sold abroad more cheaply than at home. That this is a fact
is now generally admitted. But the protectionists maintain that most of this
can be explained by the rebates allowed to American exporters under our
drawback laws. Ex-Secretary of the Treasury Shaw estimates that in 1906,
owing to these drawbacks, about $140,000,000 of American manufactures
might have been legitimately sold abroad at less than domestic prices.'
(6) Intimately related to the arguments which we have been
considering is the claim that the dbtribution of labor and capital
of a free-trade nation is subject to the control, and indeed, one
may say, to the whim and caprice of foreign nations. Industries
differ in their effect upon the physique and character of the people
who pursue them. The builder, the skilled engineer, the electrical
worker, are benefited intellectually, physically, and morally by
their occupations. But the tailor, the maker of ready-made cloth-
ing, and the sweat-shop worker are probably harmed rather than
elevated by the nature of their employment. Now if foreign na-
tions subsidize by protection and bounty the desirable industries,
they may leave to the free-trade nation only those industries which
the protected nations do not wish to maintain.
(7) Finally, protectionists appeal to the wage-earning classes
with the argument that protection increases wages by diversify-
ing industry and thus stimulating the demand for labor. Indeed
the typical protectionist goes farther than this, and maintains that
every American industry is entitled to an amount of protection
equal to the difference between the wages which it pays and the
wages paid by its most efficient foreign competitor. The latter variety
of this argument seems to be plainly absurd, or at least obviously
inconsistent with the initial assertion that protection raises wages.
For, taken together, — and they are frequently advanced in com-
pany,— they result in this magnificently cumulative plea for
ever increasing tariffs: protection raises wages, — but high wages
> Leslie M. Shaw, CurretU Issues, Chap. XXI.
PROTECTION AND FREE TRADE 305
put the American manufacturer at a disadvantage in competing
with foreign producers, — and the home producer must lie pro-
tected to the extent of the difference in wages, — therefore every
advance in protective duties laid for the benefit of the wage earner
must be accompanied by an additional advance for the benefit of
the manufacturer, — and so ad infinitum.
Arguments of Free Tradezs. — In the first place, we may dis-
miss a number of arguments which are so extreme as to weaken
rather than strengthen the cause of free trade, (i) For instance,
it is frequently alleged that protective tariffs violate the assumed
natural right of every man to buy his goods where he will and sell
his products wherever he sees fit, untrammeled by human laws.
The futility of arguments based upon an assumption of natural
rights has been sufficiently exposed elsewhere, and needs no elabo-
ration at this point.
(2) It has also been claimed that protective tariffs in the United
States are unconstitutional, but this argument is idle; it would be
most unfortimate and anomalous if nowhere in our country were
lodged the power to pass such regulations regarding international
commerce as might appear to be required for the promotion of
the public welfare. Furthermore, the charge of unconstitution-
ality does not correspond to the opinion of our best jurists, and it
is very certain that we shall never see a supreme court in the
United States which will venture to pronounce protectionism
unconstitutional.
(3) In a similar vein protectionism has been called socialism,
but this epithet is so generally applied to whatever a person in-
competent to argue a cause does not like that it will scarcely ter-
rify any one.
The really able argimients of free traders are those which aim
to show either that protection actually does positive harm, or that
it fails to accomplish its ends, or that those ends may be better
accomplished without protection.
(4) The natural starting point of the free-trade argument, and
the goal to which it inevitably returns is the theory of compara-
tive costs laid down on page 285, the proposition that, so long as
there are relative, not necessarily absolute, differences in the cost
X
3o6 OUTLINES OF ECONOMICS
of producing cheaply portable articles in various countries of the
world, so long will there be international trade in those articles.
Protective tariffs, therefore, merely divert capital and labor from
intrinsically more productive to intrinsically less productive in-
dustries. To revert to our simile of the lawyer and his stenog-
rapher, protection aims to induce the lawyer to write his own
letters, on the general grounds that lawyers are more intelligent
people than stenographers, and if sufficient encouragement be
held out to them they may, in the course of time, be educated up
to the point of operating their own typewriting machines better
than the stenographers whom they have previously hired.
Temperate advocates of "freer trade" do not contend that this
law of comparative costs demonstrates the desirability of complete
free trade imder all circumstances. They admit that it may occa-
sionally be profitable for a country to pay enormous bounties —
this is what protection amounts to — for the development of cer-
tain industries. But they do contend that it establishes free
trade as the general rule, every departure from which should re-
quire the most positive justification. More particularly, they
hold, that at the present time, after a century of industrial devel-
opment that obviates any military necessity for a further diversifica-
tion of industry, capital and labor shoidd be freely allowed to
take themselves to those employments in which they can reap the
largest natural reward, a reward, that is to say, which is not arti-
ficially enhanced by subsidies wrung from the general body of
consumers.
(S) Moreover, it is not clear that protection is necessary to di-
versify industry in a country with such varied natural resources as
the United States. The claims of the protectionists at this point
may be tested by examining conditions within the wide borders
of our own country, within which trade is wholly free. Now, if
protection were necessary to foster infant industries and bring
them to maturity, the manufacturing industries of this country
would still be concentrated in the northern states of the Atlantic
seaboard where they first gained a foothold. But they have not
been so confined. The early establishment of the textile indus-
tries in New England has not prevented their xecent development
PROTECTION AND FREE TRADE
307
in the South. Indeed, the so-called "center of manufactures"
moved steadily west from south-central Pennsylvania in 1850 to
central Ohio in 1900; and the increase, at the present time, is
much more rapid in the South and West than in older sections of
the country. Internal free trade has not prevented the diversifi-
cation of industry in the United States, and has not delayed it
longer than was desirable. For who shall say that the Dakotas
and other typical agricultural states of the Union have greatiy
suffered from the absence of grimy factory towns and the slums
which almost inevitably accompany them?
(6) The inevitable spread of manufactures throughout the
United States suggests the essential weakness of the home market
argument. International trade expands just as inevitably as the
manufacturing area. It might be desirable to confine domestic
producers to the more certain home market, which cannot be de-
stroyed by tariff wars or international complications. But, as a
matter of fact, home producers will seek foreign markets, and the
nation that sells abroad must buy abroad. Since the Civil War we
have protected home producers with extremely high tariffs. But
in the last twenty-five years our foreign trade has increased at a
rate imequaled by any of the other great commercial countries
of the world.* Protective tariffs can cripple and harass and dis-
tract foreign trade, but they cannot permanentiy suppress it. No
tariff can make the costs of producing all the articles common to
commerce precisely proportional in all quarters of the globe.
(7) The protectionistic appeal to the wage earner seems par-
ticularly inconclusive. One reason for distrusting it is the double-
faced way in which it is manipulated to suit the particular re-
quirements of time and place. France wants protection in order
to protect her low-paid workmen against the greater skill and
efficiency of America's highly paid workers. The United States,
on the other hand, must have protection in order to shield her
highly paid employees from competition with the "pauper labor
of Europe." When first used in the United States, the argument
was that wages were ahready so high in this country as compared
» Spedal Reports of the Census Office, " Manufactures,** 1905, Part I, p. ccc.
The spedfic period referred to is the twenty-fiv» years, 1880-1905.
3o8 OUTLINES OF ECONOMICS
with England, that it was impossible for manufacturers in this
country to pay the American rates and continue to compete with
English manufacturers. Later, cause and effect, as related in the
earlier syllogism, were reversed, and it was asserted that the high
wages in this country were due to protection, from which it
followed naturally that in order to raise wages higher, still more
protection would have to be given.
We cannot arrive at any useful conclusions concerning wages,
however, without considering the efficiency of labor and the pro-
ductivity or f avorableness of the environment in which the laborer
works. The reason why American labor may receive higher
wages and yet have nothing to fear from the competition of less
highly paid workmen in Europe is found in the greater produc-
tivity of American labor (though this greater productivity may
depend more upon the natural wealth of this country than upon
any innate technical superiority of the American workmen). The
average American workman is in no more danger from the goods
produced by the "pauper labor" of Europe than the highly paid
workman of Montana is threatened by the products of his less
remimerated fellow-workmen of New England and the South.
Labor competes with labor, not with commodities. Consequently,
if it is really desired to protect labor, the logical way would be to
place a tax on imported labor, or by other measures to reduce
immigration. If this were done, those who desire labor would be
obliged to pay heavily for it, as actually happened in England
after the *' Black Death" in the fourteenth century had killed off
a large part of the laboring population. Indeed, if our tariff
makers are sincerely anxious to benefit labor, they should, after
rendering labor scarce and dear by restricting immigration, en-
courage the importation of such commodities as are consimied
primarily by wage earners, in order that labor may secure an
abundance of them cheaply.
No intelligent free trader would deny that there are now dependent upon
protection many industries which pay high wages, nor that the sudden aboli-
tion of protection would throw many wage earners out of work. Their con-
tention in the first case is merely that by taxation and by diverting capital
and labor into naturally unproductive industries, protection lowers the general
PROTECTION AND FREE TRADE 309
level of real wages. Their reply to the second point is that protection affects
the industrial organism much as the alcoholic habit affects the human organ-
ism. To abandon the habit suddenly would certainly be painful and prob-
ably dangerous — but this is sufficient reason neither for increasing the dram
nor delaying the gradual abandonment of the habit.
(8) Turning to the fiscal aspects of the question, the free trader
asserts that there is little or nothing to be said in favor of protection.
The protective import duty, as compared with the import duty "for
revenue only," is a poor tax. It is uncertain and viciously vari-
able, and in the great majority of cases is borne by the home
consumer. To the extent that it does not prevent importation it
affords no protection; and in so far as it does protect, it yields no
revenue to the government. If it raises the price of the article upon
"which it is levied, however, the increase constitutes a tax upon one
class of society — the consumer — for the benefit of another class
— the producers of the article. One authority, perhaps the fore-
most authority, upon the American tariff problem, estimates that
the present tariff upon sugar results in an annual tax upon Ameri-
can consumers of $101,000,000, of which $52,400,000 go into the
treasury and $48,600,000 into the hands of sugar producers, prin-
cipally resident in Hawaii, Porto Rico, and Cuba.*
In answer to this charge that protection involves the taxation of
one class for the benefit of another class, it is not sufficient to
reply that everybody is free to take advantage of the subsidy and
engage in a protected industry. Everybody is not free to estab-
lish a rolling mill or a silk factory or a tin-plate plant. Protection
means the taxation of the less acute, the less enterprising, the less
educated and the poorer classes in order to create additional com-
mercial opportunities for the abler, wealthier, and better-educated
classes, thus reversing the whole spirit of modem taxation which
contemplates — so far as it may be done without danger — rather
the taxation of the rich for the assistance of the poor than the
taxation of the poor for the benefit of the rich. It is not implied,
of course, that protection involves class legislation of an unlawful
character, nor that taxes are collected from one class and handed
over in cold cash to the members of another class. The point
* Professor F. W. Taussig, in the Atlantic Monthly for March, 1908, p. 34a.
3IO OUTLINES OF ECONOMICS
turns upon the relative ability of the various social classes to take
advantage of artificial opportunities created by the state at enor-
mous expense to all.
(9) This brings us naturally to the ethical criticism of protection,
the charge that by making the temporary prosperity of influential
classes dependent upon government bounty, protection encour-
ages those classes to exert a demoralizing pressure upon federal
legislation. So great is the stake of private interests in tariff legis-
lation, that systematic lobbying, log rolling, and corruption of the
voter follow as inevitable consequences. The beneficiary of the
tariff sacrifices his disinterested convictions concerning the general
welfare, in order to preserve his own little subsidy from the gov-
ernment. Neither the citizen nor the legislator can vote purely,
when his pocketbook is so vitally affected. Even if we admit
what is probably true, that protection has resulted in comparatively
little direct bribery of legislators, there seems no escape from the
conclusion that it creates a kind of interest in legislation which
is inherently dangerous and exceedingly difficult to keep within
legitimate bounds. And as the manufacturing industries of the
country fall more and more into the hands of large corporations
and trusts, the possibilities of political corruption become more
and more sinister, while the character of the chief beneficiaries of
protection make them more and more undeserving of the bounties
which they receive.
(10) Finally, it is alleged that protection fosters monopolies by
shutting off international competition. This contention forms the
subject-matter of a particularly heated dispute, and the exact ex-
tent to which the charge is true cannot be determined at this time.
Certain modifications of the more extreme charge, however, are
hardly open to question. Protectionists confessedly take it for
granted that if foreign competition is shut off or lessened, home
producers will still compete. Nevertheless, highly protective du-
ties are still levied upon commodities whose manufacture in the
United States has fallen under the substantial control of monopo-
lies. It is furthermore admitted that such monopolies frequently
sell their products at lower prices in foreign countries than in the
United States; while it is impossible to deny that — whether the
4
PROTECTION AND FREE TRADE 311
mSinU^ was created by protection or not — the abolition of the
duties, by giving foreign producers a chance to compete in this
country, would tend to reduce prices, and thus give the American
public a valuable aUy in their struggle against monopoly. The
tariff therefore may or may not be the mother of trusts, but it
unquestionably deprives the American people of a strong weapon
against the trusts.
Some General Considerations. — Before attempting to sum up
the preceding arguments and strike, a practical working balance,
it is necessary to call attention to certain general considerations
which have not figured in the foregoing ''starched procession" of
pros and cans. In the first place, it is necessary to remember that
the federal government must secure a large revenue from tariff
duties, and that in consequence the question which we are dis-
cussing is not one of protection versus free trade, but of protection
versus freer trade. In the second place, the economic importance
of the whole controversy has unquestionably been exaggerated.
We find a country like England prosperous under free trade; we
find coimtries like France and the United States prosperous under
protection. It is of real but not of vital importance. Our inter-
nal trade vastly exceeds our foreign trade in every way. The
domestic trade of the Mississippi Valley alone is far greater than
our entire foreign commerce. In the third place, the American
tariff is a historical growth, and bad as it may be in many respects
it has taken deep root. During the last century it has become
part of our life, and cannot be suddenly eradicated with impunity.
If it is true that American labor would be better off without it, it
does not follow that it ought to be removed suddenly in the inter-
ests of American labor. If the industrial growth is abnormal, it
is none the less true that adjustment to normal conditions is a
painful process and should be conducted cautiously. Displace-
ments of labor and capital cause suffering and loss, and it is clear
that any reform of the tariff must be conservative and careful,
a movement toward freer trade, not the sudden withdrawal of
protection.
Conclusions. — Most of the arguments enumerated above, both
for and against protection, contain a measure of truth. Historic-
312 OUTLINES OF ECONOMICS A
aUy, we believe that protection was inevitable in fl0Vmte<^^
States, and in the early period of the country's development, bene-
ficial. During the three great wars which seriously threatened the
stability of this country, many new industries sprang up which,
upon the cessation of war and the resumption of international
trade, were seriously threatened by foreign competition. Many
of these industries were so suited to our soil and our people that
only a short period of protection was needed to make them self-
supporting. Under the circumstances it would have been unwise
to permit the sacrifice of the capital invested in these industries;
and whether it would have been unwise or not, human nature is
such that the needed protection was sure to be granted. In short,
there is a large measure of real truth in the infant industry argu-
ment.
Circumstances, however, have radically changed in the last few
decades. Our quondam infant industries have, for the most part,
attained a very vigorous maturity, and in some instances have
become belligerent and prone to monopolistic bullying; our manu-
factures have become sufficiently diversified to remove all danger
of industrial collapse in time of war; and, above all, we are rapidly
entering the economic stage in which, according to the ablest ex-
ponent of protection that economic science has ever known, —
Frederick List, — protection is a hindrance rather than a help.
That is to say, we are rapidly building up an extensive export
trade in manufactured articles; year by year raw materials con-
stitute a larger proportion of our imports and a smaller propor-
tion of our exports; and we have already become the greatest
exporting country of the world. All this means that in the near
future our manufacturers themselves will look with kindlier eyes
upon the withdrawal of the protection they do not need, which in
fact actually increases the cost of some of their raw materials,
and incites foreign governments to retaliatory taxation upon goods
imported from the United States. Our growing export trade will
itself bring a wider appreciation of those fundamental principles
which have led economists, with but few exceptions, to condemn
protection as a permanent policy applicable to all stages of eco-
nomic development.
PROTECTION AND FREE TRADE 313
QUBSTIDirS
z. What b meant by the law of comparative costs? Is the American
custom of importing the finer textile fabrics and manufacturing the coarser
ones an effect of this law ?
2. In the illustrative case dted on page 285, would America confine herself
wholly, or only chiefly, to the production of flour ? Would the fact that some
doth was produced in America, and some flour in Holland, affect the validity
of the law of comparative costs ?
3. If a widow needs money so badly that she is willing to pay 300 per
cent a year for its use, why is it wrong for a money lender to charge this rate ?
4. What is the real nature of the balance of trade ? Does our excess of
exports (merchandise) mean that we are paying off our foreign indebtedness,
or merely that we are paying interest on our foreign indebtedness ?
5. In what respects does foreign exchange differ from exchange between
two American dties ?
6. What are the prindpal influences which affect the rate of exchange ? i^
7. Is the gold supply distributed according to the needs or the respective
demands of the various countries ? Are needs and demands in this connection
identical ?
8. Mention as many methods as you can by which governments have
endeavored to increase the supply of gold.
9. To what extent is the infant industry argument true? The home-
market argument? The argument against "dumping"?
10. In what form was the wages argument first employed in the United
States? In what does its essential error consist?
LITERATUSX'
Ashley, Percy. Modern Tariff Hisiory.
Ashley, W. J. Tariff Problems,
Bastable, C. F. Theory of Iniernational Trade,
BsooKS, H. K. Foreign Exchange Text-Book,
Clake, George. The ABC of the Foreign Exchanges; The Money Marker
Primer,
Day, Clive. History of Commerce,
Ely, R. T. Problems of To-day, Chaps. I-XV.
FiSK, G. M. International Commercial Policies,
GiFFEN, Robert. The Use of Export and Import Statistics; and Economic
Inquiries and Studies, Vol. I, Chap. IX.
George, Henry. Protection or Free Trade.
GosGHEN, G. J. Theory of the Foreign Exchanges,
Lauohlin, J. L. The Principles of Money, Chap. X, pp. 336-370.
Marosait, a. W. International Exchange,
314 OUTLINES OF ECONOMICS
Patten, S. N. The Economic Basis of Protection,
Pratt, S. S. The Work of Wall Street.
Rabbsno, V. The American Commercial Policy,
Stanwood, £. American Tariff Controversies in the Nineteenth Centnry,
Sumner, W. G. History of ProUction in the United States,
Taussig, F. W. Tariff History in the United States, "The Present
Position of the Doctrine of Free Trade," Publications of the American
Economic Association, Third Series, VoL VI, pp. 99-65; also State
Papers and Speeches on the Tariff,
r"
• -j, .
PART V
DISTRIBUTION
CHAPTER XIX
DISTRIBUTION AS AN ECONOMIC PROBLEM
It has already been remarked that the production and the dis-
tribution of the annual income of society cannot be sharply sepa-
rated, and more or less has already been said about the four parts
into which the products of industry are usually divided; namely,
wages, interest, rent, and profits. The greater part of distribu-
tion might undoubtedly be considered under the general heading
"Production," but on the other hand, it is frequently asserted that
distribution is "the true center of aU economic inquiries," and it
would be possible to treat nearly the whole of production from
the standpoint of distribution. The truth is that these old tra-
ditional divisions of oiu- subject-matter indicate different points of
view, and on this account it seems desirable to retain them. When
we pass from production to distribution, we do not enter an entirely
new field, but we look at an old field of investigation from a new
point of view.
The center of interest in the practical applications of economic
principles has shifted from production to distribution. The mer-
cantilistic writers of the seventeenth and eighteenth centiuies were
primarily interested in the most efficient ways of increasing the
sum total of a nation's wealth. Even Adam Smith, as the dtle of
his great work. An Inquiry into the Nature and Causes of the
Wealth of Nations, indicates, had chiefly in mind the same prob-
lem, although he emphasized the fact that the real well-being of a
nation consists in the well-being of the great body of its people.
During the past century the production of wealth has increased
beyond all precedent, the chief factors contributing to this result
315
3l6 OUTLINES OF ECONOMICS
being the factory system, the exploitation of vast natural re-
sources (made possible only by modern methods of transportation)
and the free scope given to the initiative of the individual business
man. In the United States, at least, we do not feel that there are
any pressing problems concerning the production of wealth. Yet
poverty still exists, and its harsh features are thrown into sharper
relief by contrast with the fact that the present production of
wealth per capita m the United States is indisputably the highest
that the world has ever known. Moreover, while the social dis-
content arising from inequalities in the distribution of wealth is
a very old thing, it is only in modem times that democracy has
given it an adequate opportimity for formulated, organized ex-
pression. It is not too much to say that nearly all the economic
problems which are felt to press upon society to-day for solution
relate directiy or indirectiy to the distribution of wealth.
It should be noted, however, that we have to discuss under
the name " distribution '' two different processes. The first and
inclusive meaning of the term is the distribution of the wealth or
income of society among individuals and families ; in other
words, the question of individual fortunes, poverty and wealth.
The second kind of distribution is the division of the product
among the different factors of production. This is not a question
of wealth versus poverty, but of wages versus interest, profits,
and rent. Of course, this kind of distribution affects the personal
distribution of wealth, but it is by no means the same question.
To explain why lots in New York City command high rents is one
thing; to explain why a large amount of these rents go to the Astor
family is another thing. In the case of wages, however, the two
kinds of distribution amount to about the same thing. There is
another sense in which the word is not used in this chapter. We
do not mean by distribution the moving of goods from the place
where they are produced to the place where they are consumed.
When we hear of railways or other concerns as "distributive
agencies," we are using the term "distribution " in a sense very
different from that of the technical economic term "distribution."
Distribution is a question of ownership, not a question of the
location of goods.
DISTRIBUTION AS AN ECONOMIC PROBLEM 317
Distributum anUroUed hy Existing InstUuiions. — The statement that
distribution is a matter of ownership suggests at once the relation of private
property to distribution. Individual wealth is, fundamentally, a sum of
property rights. Every extension of property rights by society, as, for ex-
ample, in permitting the private ownership of the rights to supply cities with
water, electricity, or transportation facilities, extends the field of private
gain and correspondingly affects the distribution of wealth. The income
received by the successful manager of a municipal waterworks plant is un-
doubtedly a very different thing from the income the same individual would
receive if he were the owner of a franchise permitting him to conduct the
business of supplying the city with water as a private undertaking. The
policy of leasing, rather than selling, public lands, which has been adopted
by some ol the newer American states, is bound to have an. appreciable,
even if not a very important, effect upon the distribution of wealth.
In the institution of inheritance we have an instrument which once in a
generation redistributes the property rights in existing wealth. It is not
strange that those who wish to limit or retard the growth of large individual
fortunes have looked to the control and especially to the taxation of inherit-
ances as a means to this end. Doubtless the prevalence of large landed
estates in England is closely connected with the English law of primogeniture,
just as the predominance of small holdings in France is in part due to the
French law forbidding the disinheritance of any of one's children.
Personal freedom, as a legally guaranteed institution, is also of fundamental
importance. The factors determining the income of the free workingman
are very different from those determining the portion of the slave. It should
be remembered, too, that the actual processes by which wealth is distributed
are to-day largely controlled by the institution of contract. What rent, wages,
or interest one gives or receives is no longer fixed by custom, as in the middle
ages, but is a matter of agreement between individuals. So far as society
limits the right of contract, as in the case of legislation regulating the employ-
ment of women and children, it correspondingly affects the distribution of
wealth.
These fundamental institutions are discussed more fully elsewhere in this
treatise. They are mentioned in this connection in order to emphasize more
definitely the fact that the distribution of wealth takes place under the con-
ditions imposed by the existing social order. Even the most radical advocates
of greater equality in the distribution of wealth do not propose an arbitrary
leveling down of fortunes. They direct their attacks against one or more of
these fundamental institutions, such as inheritance, private property in land,
or private property in production goods. Then there are many persons who
are willing to accept the conditions imposed by the existing social order,
as a field for the operation of competUive forces in wealth distribution, but
who object to monopoly and special privilege. This suggests that the forces
bringing about distribution on the basis of the existing social order are in
3l8 OUTLINES OF ECONOMICS
themselves amenable to aodal control. If those who secure the chief prises
in the economic struggle may plume themselves on the fact that they are the
victors in a game that is open to all, it is none the less true that society lays
down the rules of the game.
A large part of the complex of institutions and regulations through which
sodety controls distribution work smoothly and silently, their action, so far
as society at large is concerned, being unconscious. It is only when obvious
conflicts arise between some of the effects of this unconscious control on the
one hand and present-day ideals of social welfare on the other hand, that the
significance of any part of this fundamental institutional control becomes
generally felt. It is not the least of the merits of the study of economics that
it emphasizes the fundamental character of that part of the social control
of wealth production and wealth distribution which lies below the horizon
of social consciousness.
The Distributive Process. — If each family produced all that it
consumedi as most families still do in part, there would be no
problem of distribution, except whatever problems might arise
as to the factors determining the amount produced by each
fanuly. But, since most men to-day are working in more or less
specialized employments, and for money incomes, the fact is, as
was suggested in a previous chapter, that distribution takes place
through a process of valuation. Some men (manufacturers, mer-
chants, farmers) make a money income by selling goods for more
than it costs them to produce them or to buy them from others,
while other men (laborers, salaried employees, professional men,
capitalists, landowners) get a money income by selling their serv-
ices or by selling the use of their capital or land. In the first
case, the money income takes the form of profits; in the second
case, it is wages, interest, or rent, as the case may be. A man's
real income consists of the commodities and services that satisfy
his wants; and the extent to which his mone^ income can be
transmuted into real income depends on the prices of these things.
One always has the option, of coiirse, of investing part of hb
money income in production goods rather than in consumption
goods, thus giving up part of his present real income for a larger
f utiure income. However, since different men have to pay about
the same prices for the same kinds of goods, a discussion of the
factors determining money incomes will be, ipso facto, a discus-
sion of the factors determining real incomes, except as it is found
DISTRIBUTION AS AN ECONOMIC PROBLEM 3I9
that certain kinds of incomes are changed more readily to meet
the conditions imposed by changes in prices than are other kinds
of incomes.
It is obvious that one person may be the recipient of more than
one kind of income. The American farmer who owns the land,
buildings, farm machinery, and live stock that make up his pro-
ductive equipment, and who does part of his own work, is at the
same time entrepreneur, landlord, capitalist, and laborer; and
his income is made up of different proportions of profits, rent,
interest, and wages. The net income of a tenant farmer, utilizing
only borrowed capital, and employing only hired labor, would, on
the other hand, consist entirely of profits. The economic analysis
that seeks to determine the rules governing the apportionment of
the annual dividend under the categories of profits, wages, rent,
and interest, bears only indirectly upon the question of the per-
sonal distribution of wealth. The income that any individual re-
ceives depends primarily upon his relative efficiency as a wage
earner or as an entrepreneiu', or upon the amount and the in-
come-yielding capacity of the capital and land which he owns.
His ownership of capital and land may have come about through
the thrifty husbanding of portions of his income in previous years,
or it may have come about through gifts or inheritance.
Bistribtttion as Valuation. — To explain the value which society
puts upon personal services is to explain wages; to explain the
values attached to the use of land and capital is to explain rent and
interest. Certain special and distinguishing characteristics enter
into the determination of each of these three kinds of value. The
conditions governing the supply of labor are, for example, very
different from the conditions governing the supply of land. Yet
there are some fundamental facts that are the same for all of these
three kinds of valuation. The most important of these common
factors is the law of diminishing productivUy.
Assume as an illustration that a certain farm is cultivated by a
farmer who uses only his own labor, together with a certain amount
of capital in the form of draft animals and agricultural imple-
ments. Let us assume further that his land is devoted exclusively
to the growing of one crop, — com, for instance. His money
3^0 OUTLINES OF ECONOMICS
income will depend on the amount of com he can produce and the
prices he can get for it. If prices remain constant, he can increase
his income only by increasing his product. His product may be
increased by the use of any one of a number of different methods.
In the first place, he can hire a farm laborer to assist him. The
two men, working together, will undoubtedly be able to get a
larger product from the farm than one man could. In some cases
they may be able to get double, or even, through the advantages
of cooperation, more than double, what the farmer could produce
working alone. More often, perhaps, the employment of the sec-
ond man will not double the total product However that may
be, it is absolutely certain that if the farmer employs a third, a
fourth, or even more men, he will sooner or later reach a point
where it will be found that the employment of the last man has
not increased the product as much as it was increased by the
last previous laborer. That is, the addition of the third man may
not have increased the product as much as the employment of the
second man did, or the fourth man may not have increased the
product as much as the third man did. This point is called
the point of diminishing productivity,* for after this point is once
reached it will be found that, save under the most exceptional
conditions, each successive additional laborer will increase the ag-
gregate product by an amount less than the last previous laborer
added to it. This fact is not due to any differences in the laborers,
whom we assume to be of equal efficiency. It means simply that
as the productive possibilities of the farm with its equipment of
capital become more fully exploited through more careful tillage,
it requires increasingly greater efforts, in the form of still more
careful and thorough tillage, to increase the product by a given
amount. This is a fact of such common observation that it needs
no statistical proof; although various agricultiu-al experiment
stations have made records of the effect of different degrees of
thoroughness of cultivation upon the yield of different crops.
^ In some economic writings what is here called "diminishing productivity'*
is termed "diminishing returns." It seems preferable to reserve the latter term
for its more familiar application to the phenomenon of the increasing costs connected
with the 9xUnsi(m of agricultural cultivation.
DISTRIBUTION AS AN ECONOMIC PROBLEM 3^1
One might imagine, at first thought, that, after the point of
diminishing productivity had been reached, it would not pay the
farmer to hire additional laborers. But the only quesdon that
directly concerns the farmer in this connection is whether an addi-
tional laborer will "earn his wages," — that is, whether the added
product will sell for enough to cover the additional expense incurred
for wages. It will pay the farmer to extend his employment of
labor up to the point where the addition of another laborer to the
working force would increase the product by an amount too small
to sell for enough to pay the wages of the laborer, and where the
deduction of & laborer from the working force would decrease
the product by an amount at least sufficient to pay the wages of
the laborer. If the farmer stops short of this point, he is not mak-
ing all the possible profits; if he goes beyond it, he is cutting
down his profits by employing labor which does not "earn its
'wages." The last laborer employed (not necessarily any particu-
lar laborer, nor the last in point of time) is the marginal laborer^
and the increase in the total product attributable to the marginal
laborer (the part which would be lost if one less laborer were em-
ployed) is the marginal product 0/ labor. If the farmer has esti-
mated product and prices accurately, it will be found, of course,
that the value of the marginal product of labor will be appron-
mately equal to the wages of the marginal laborer. Or, since the
laborers are supposed to be of equal efficiency, and hence to re-
ceive uniform wages, the statement may be put in the broader
and more significant form that wages and the marginal product of
labor will tend to equal each other.
The diagrams iUustrate the principle of the diminishing productivity of
labor, developed in the foregoing analysis. In Figure i the rectangle OM
represents the amount of com that the farmer could raise on his land U work-
ing alone, with his given equipment of capital. The rectangle A N represents
the increase in the product effected by the addition of another worker. Simi-
larly, BP, CQ, DR, and ES represent respectively the additions to the product
resulting from the employment of a third, fourth, fifth, and sixth laborer.
If DR bushels of corn — the increment in the product attributable to the fifth
laborer — sells for about enough to pay the wages of one laborer, the
farmer will refuse to employ the sixth laborer, while the employment of the
fifth would be a matter of indifference. If the fifth laborer were employed,
Y
322
OUTLINES OF ECONOMICS
the proceeds of the sale of that part of the total product represented by the
rectangle OERH would be used up in the payment of wages (indttding paj-
SL
c
Flo. I
ment for the farmer's own work as a laborer), while the part o! the product
represented by the small rectangles above the line HW would be left to rec-
ompense the farmer for the use of his land, for the interest on and wear and
tear of his capital. If any surplus is left after these demands are satisfied, it
would, of course, constitute the farmer's profits. If the conditions were as
assumed, the fifth la-
borer would be the mar-
ginal laborer, and the
product represented by
the rectangle DR would
be the marginal product
of labor.
If we were dealing with
a very large undertaking,
in which many laborers
are employed, the succes-
sive rectangles represent-
ing the increments in the
product attributed to the
hypothetical addition of
successive laborers could be conceived as indefinitely narrow, so that the
graphic representation would take the form represented in Figure a, where
the line AM is located at the point of diminishing productivity, and
where the line BN represents the marginal product of labor. In this
case the rectangle OBNH represents the part of the total product which
will jtttt suffice to pay the wages of all the laborers employed.
DISTRIBUTION AS AN ECONOMIC PROBLEM 323
Thus far we have supposed that the farmer is content to get
along with his original amount of land and capital, and to increase
his product by means of an increased use of labor. Other pos-
sibilities are, of course, open to him. It might happen that he
would be content to do without additional laborers, using instead
an increased equipment of capital. By purchasing more draft
animals, more labor-saving machinery, improved fertilizers, or
possibly by installing drains or irrigation ditches, as the case may
be, he may be able to raise considerably more com than he could
without such investments. But here, again, he will find the possi-
bilities of increasing his product subject to the same limitations
that would have prevailed had he increased his labor force. With
a team of horses he will be able to accomplish more than he could
with one horse; two teams of horses may still further increase the
productivity of the farm; a third would probably be of very little
advantage, and a fourth team still less useful. So with invest-
ments of capital in other forms: the law of diminishing produc-
tivity is a remorseless physical fact which the farmer has to reckon
with. But the concrete form in which the problem presents itself
to him is this: Will a further investment of money in a specific
kind of capital goods pay me? Here the farmer has to make on
the one hand the best estimate he can of the amount which the
proposed capital goods will add to his annual product, and of the
probable selling value of the increased product. On the other
hand, he has to count his increased annual expenses. These will
include (i) the original cost of the additional equipment, divided
into annual costs according to its probable durability (each year's
costs being properly only the wear and tear, or "depreciation"
attributabk to that year's use); (a) the maintenance or upkeep
(including such things as ordinary repairs on machinery and the
cost of feeding horses), and (3) the interest on the investment (what
the farmer has to pay if he borrows the necessary funds from
some one else, or what he might have lent his money for to
some one else if he uses his own funds). Guided by these esti-
mates, the farmer will naturally increase his equipment of capital
goods so far as the returns from the added product would more
than suffice to cover his increased costs. Beyond this point he
324 OUTLINES OF ECONOMICS
could not wisely go. The last inciemeiit of capital — which just
suffices to pay for itself — is the marginal increment of capUal^
and the added product attributable to it is the marginal product of
capital.
The diagrams portraying the operation of the law of the diminishing prod-
uctivity of labor will serve as well to illustrate the diminishing productivity
of capital. Assuming that the amount of land and the amount of labor to
be utilized are definite in quantity, the successive rectangles in Figure i rep-
resent the increase in the gross product attributable to each of successive
increments of capital. Figure a represents the same conditions, except that
each increment of capital is assumed to be indefinitely small.
If (in Figure 3) BN represents the marginal product of capital, the whole
return imputed to capital is, of course, represented by the rectangle OBNH.
The area above the line HN represents the part of the product which is avail-
able for rent and wages, the farmer's profits being derived from any surplus
that is left after these demands are satisfied.
There is one difficulty in the foregoing analysis, however, that may have
been noted by the reader. What is meant by an "increment of capital" ?
In the case of labor the "increment of labor'* can be interpreted as the labor
of one man (for any definite period of time that may be chosen), the one man
being assumed (for the purpose of simplicity in the analysis) to be of equal
efficiency with all others constituting the labor supply. It is just as practicable,
of course, to assume that one horse is, for the farmer's purposes, just as
efficient as another horse, that only one kind of plow is available, and that
one bushel of fertilizer is exacdy like any other bushel of fertilizer ; but this
does not help us out of our difficulty. For how can we blend horses, plows,
and fertilizers into one concept, and divide them into " increments of capital " ?
One way of getting around the difficulty is to think of the capital which the
farmer combines with his labor and his land in terms of its money value. Tn
this sense an increment of capital might be a dollar's worth of capital, or ten
dollars' worth of capital, without reference to the di£Ferent kinds of concrete
production goods really composing it. This device is useful for some purposes,
but it obscures the fundamental fact that capital gets its value from its ability
to secure an income for its owner. The purpose of this analysis of diminish-
ing productivity is to open the way for a discussion of the valuation of the
services of land, labor, and capital. To use the term " capital " in the sense
of capital value at this stage in the discussion would only lead us into a circular
argument. This point cannot be further elaborated here, but should be
kept in mind by the reader in connection with the discussion of interest in a
subsequent chapter.^ As a matter of fact the law of diminishing productivity
^ Professor J. B. Clark avoids the difficulty here discussed by using the term
"capital" in a sense which corresponds neither to the concrete instruments of pro-
duction that make up capital goods, nor to the value cf these capital goods.
DISTRIBUTION AS AN ECONOMIC PROBLEM 335
holds for each specific kind of capital that the farmer uses. For example,
imagine that the farmer is limited to the use of a fixed amount of all forms of
capital except one, — horses, for instance. Then the successive rectangles in
Figure i would represent very well the increments of product gained by the
use of additional horses, while if the product added by the use of a fifth
horse is just about enough to pay for the increased expense, the rectangle DR
would represent the marginal product. The illustration can, by a similar
process, be made to apply to any other kind of capital. The farmer will
normally make use of each specific kind of capital up to the marginal point.
A third way of increasing his product is also open to the farmer.
He may think it wiser to get along with his original equipment of
capital and his own labor, and to increase his product by utilizing
more land. The adoption of this procedure would mean a less
intensive cultivation per acre of land. The use of labor and capital
would have to be distributed more thinly over the larger acreage.
This would result in a smaller product per acre, but the procedure
would be warranted if the increase in the annual product should
sell for more than the annual cost of the additional acreage. By
the annual cost of additional land we mean the rent which the
farmer has to pay for the land if he leases it, or the interest on the
amoimt of the purchase price, if he buys it. It is obvious, how-
ever, that the combination of more and more land with a fixed
amount of labor and capital will result in a smaller and smaller
return per acre of land, and that a point will soon be reached be-
yond which it will not pay the farmer to go. In other words, the
law of diminishing productivity rules when land is considered as
the variable factor, just as it does when labor or capital is consid-
ered as the variable.
The diagrams already used may be adapted to the illustration ol the present
hypothesis by assuming that equal areas, if successively combined with a
given amount of labor and capital, would yield increments of product as
represented by the successive rectangles in Figure i, or by the curve in Fig-
ure 2. It is assumed for the sake of simplicity in the illustration that the dif-
ferent acres of land available for the farmer's use are of equal fertility.
but as denoting a self-perpetuating fund which bears the same relation to concrete
production goods (including hind) that a river does to the drops of water of which it,
at a given time, is composed. Professor Clark finds this concept useful in his
own analysis (tf. his DistribiUian of WeaUh and Essentials of Economic Theory),
bat it is altoge^ier too abstract and hypothetical to be of use in the premit con-
nection.
3»6 OUTLINES OF ECONOMICS
The Actual OperatliDii of Diminishing Prodtictivity. — It has
been assumed thus far that the farmer of our illustratioQ has to
be content with a fixed quantity of two of the three factors in
production! but that he is at liberty to increase his use of the third
factor up to the point where the maximum profits will be gained
for himself. Assuming in turn that each of the three factors in
production was the variable one, we found that in each case the
law was the same — maximum profits were obtained when the
product added by the last increment of the variable factor would
sell for just enough * to cover the increased expense. In one way,
however, this assumption does not correspond with the facts.
The farmer is at liberty to increase his products by increasing his
utilization, not only of any one, but of any two, or all of the three,
factors of production. He may, for example, purchase more draft
animals and more machinery, employ moi^ labor, and at the same
time acquire more land. To a certain extent the use of one factor
may lessen the use of another (as in the case of labor-saving ma-
chinery and labor). More often, however, the reverse is true.
The acquisition of machinery may necessitate the use of more
horses, while the acquisition of more land will often make profit-
able the use of more labor as well as more capital — a fact
which is itself implied in the law of diminishing productivity.
Although the employment of labor, capital, and land can thus be
ihcreased simultaneously, the significance of the law of diminish-
ing productivity is in no wise diminished. The farmer, in decid-
ing upon the purchase of a particular kind of capital good, has to
take into account his present and, to some extent, even his prob-
able futtuie supply of other kinds of capital goods, as well as of
land and labor, before he can form a judgment as to the amount
which the use of the particular capital good will add to his annual
product. Moreover, he has to choose between additional invest-
ments in labor as against additional investments in land, or ad*
ditional investments in different kinds of capital. But his effort
to get maximum profits will lead him to make those investments
* Whether this last unit, which just pays for itself, will be added. Is, of course,
a matter of indifference. The maz^ is consequently sometiinies calkd tht
"margin ol indifference."
DISTRIBUTION AS AN ECONOMIC PROBLEM 337
which promise to result in the greatest additions to his product.
The result of this mXL be, nonnally, that each factor in producti(Mi
will be utilised up to the marginal point — the point where further
utilisation would add a product so small as to sell for less than
the increased expenses.
Why the farmer should not Increase his product indefinitely by increasing
his use of all three of the factors in production is a question which does not
concern us in this connection. The law of diminishing productivity relates
only to the proporiums in which land, labor, and different forma of capital
are combined. The question of the most profitable size of farm is quite
another thing.*
It is not only in agriculture that the kw of diminishing produc-
tivity is the fundamental thing in determining the proportions in
which the factors of production are combmed. Every manufac*
turer has the option of using either relatively more machinery and
relatively less labor, or relatively less machinery and relatively
more labor in order to produce a certain quantity of goods. He
may have to decide, also, between building a six-story factory
covering an acre of ground, and a one-story factory covering six
acres of ground — a problem which is paralleled by the farmer's
problem of deciding between the cultivation of a relatively large
acreage and the more intensive cultivation of a smaller acreage.
The entrepreneur in every kind of undertaking has to decide as
to the advisability of a particular investment in land, capital, or.
labor, with reference to the fundamental question, ^'WiU it
pay?" And the profitableness of any such investment is always
a matter of the cost of the unit of land, labor, or capital, as com-
pared with the selling value of the quantity which it will add to
the entrepreneur's total product.
* The limitations to the profitable sixe of a farm or other business unit arise
from the fact that the managerial efficiency of the entrepreneur is itself subject
to the law of diminishing productivity. Under competition there is a constant
tenciency for labor, capital, and land to get into the hands of those entrepreneurs
who can use them most efficiently, that is, who can pay most for them because they
can get the largest product from them. But even if A is a better entrepreneur than
B, it may easily happen that B can get a larger product from additional units of
labor, capital, and land than A can, if B's existing equipment is considerably
smaller than A's. A given fanner cannot extend his use of land, labor, and capital
indefinitely, simply because, after his establishment reaches a certain stee, other
328 OUTUNES OF ECONOMICS
In order to achieve maximum profits, each entrepreneur mU en^
deavor, so far as is practicable^ to apportion his use of land, labor,
and capital so that the value of the increment of produa attributoMe
to the marginal unit of each factor in produOion wOl about equal
its expense.
The significance of the law of dimimshing productivity in rela-
tion to the distribution of wealth now becomes apparent. If a
given class of laborers in a given employment receive like wages,
thdr wages (being the same as the wages of the marginal laborer)
will tend to equal the marginal product of labor. The expense
incurred by the entrepreneur for any unit of a certain kind of capi-
tal goods will tend to equal the value of the margmal product of
that particular kind of capital goods. The rent which the farmer
will pay for any acre of a quantity of land of uniform quality will
tend to equal the value of the marginal product of land of that
quality. But so far as Competition works freely, different entre-
preneurs in the same market will have to pay the same wages for
the same kind of labor, the same price for the same kind of capi-
tal goods, and the same rent for the same kind of land; and th^
will get the same prices for the same kinds of products. So it is
possible to state in more general terms that the remuneration of
each factor in production tends to equal its marginal product.^
farmers can use additional units of the productive factors more profitably than he
can. The most profitable size of the business unit will vary, other things being
equal, with the efficiency of the entrepreneur.
Some writers have introduced the efficiency of the entrepreneur as a fourth
variable in their discussion of diminishing productivity. Such a procedure is
avoided in this book, because it leads to theoretical complexities and because it
involves a shifting of the point of view. The diminishing productivity of each of
the three factors in production is a physical fact which every entrepreneur has to
deal with, and which we can explain most clearly by adhering to the analysis of
the motives controlling the individual entrepreneur. The analysis of the dimin-
ishing productivity of the entrepreneur's efficiency, on the other hand, involves of
necessity the social point of view, for the only kind of estimate that is made of the
entrepreneur's productivity is expressed through the social process of the valuation
of the entrepreneur's products. In this book the diminishing productivity analysis
is applied only to the entrepreneur's expenses of production, the entrepreneur
being regarded (as he is in accounting practice) as the "residual claimant."
1 The statement that rewards tend to equal products has no ethical significance,
and should not be interpreted as a justification of the present economic order, — '
and this for the following reasons among others: (i) That distribution ought to
DISTRIBUTION AS AN ECONOMIC PROBLEM 329
It is not necessary for the validity of this marginal productivity
theory of distribution, as it is called, that in any particular under-
taking at any given time the proportions in which the factors of
production are actually combined should be adjusted with the
nicety which the theory seems to imply. The amount of land which
the fanner holds at any one time is apt to be fixed by his estimate
of his future rather than of his present production, while custom,
pride of ownership, and the chance of gain through an increase
in land values (which is not to be confused with the motives guid-
ing his activity as a producer) have their influence. Moreover,
the size of the government homesteads into which a large part of
be according to productivity is itaelf a debatable proposition. Some socialists,
for example, maintain that distribution according to needs is a higher ideaL
(3) The ethical side of the problem of distribution relates to personal dtBtributioo,
while the marginal productivity doctrine relates to the determination of the in-
comes going to the different factors in production. To state that the rent ol aa
acre of land tends to equal the value of its product is not to say that the laadoinier
has "earned " his income. The private receipt ol tent depends upon sach sodil
institutions as private property, inheritance, and free contract, and these have to
be judged from the broad viewpoint of sodal welfare. (3) The efficiency ol the
individual laborer, which is one of the things determining his productivity, often
depends upon the opportunity he has had to "make the most ol himself." But
opportunity depends largely on environment, and this in turn is to a large eitent
amenable to social control. (4) The amount of the marginal product ol any one
factor in production u itself a resultant of all the forces affecting the supply of all
the factors in production and ol all the conditions that affect their fitness to serve
in the production of the things that consumers are demanding. (5) This theory
is only a statement of a normal tendency. It does not, properly understood*
conflict with the fact that such things as custom and other forms ol economic
friction and inertia, the higgling of the market, the conscious efforts ol sodal classes
to better their condition, imperfections in the monetary system, short-sighted
selfishness on the one hand, altruism on the other, as well as the conscious sodal
control expressed in labor legislation, usury laws, and the like, all have important
effects upon the incomes actually received by those who furnish labor, capital, and
land for the work ol production. Actual wages may differ from the normal wages
measured by marginal product just as contractual rent may differ from economic
rent. (6) We can imagine an economic order very different from the present one in
which it would still be true that incomes would tend to equal products. If, for
example, wages were arbitrarily increased 50 per cent by law, while one result
would undoubtedly be an increase in unemployment, it would still be true that
wages Would tend to equal the marginal product of labor, or, rather, that the
marginal product of labor would tend to equal wages. To attempt to avoid this
difficulty by assuming that the present order, or a purdy competitive order, is the
"natural " older ol things, is to beg the whole question in favor ol the <
status.
330 OUTUNES OF ECONOMICS
the public domain was divided has had an important effect on
the size of the farmer's holding in a large section of the United
States. The average American farmer uidoubtedly holds more
land than he would if he were looking only for maximum present
profits. The practical problem for him is apt to be how inten-
sively he shall cultivate it: how much labor and capital he shall
combine with it That is, he is apt to use relatively more land
and relatively less labor and capital than he would use if every
additional acre of land used meant an additional expense for
land. This conclusion is not altered by the fact that his land is
probably not of uniform quality, and that some of it may not repay
cultivation under present conditions. In a similar way the manu-
facturer builds his factory for the future, and may even equip it
with a larger complement of some kinds of machines (such as
boilers and engines) than present requirements justify. On the
other hand, a sudden and probably temporary increase in demand
for a product will be met by the manufacturers by the employ-
ment of more labor (even at the high rate charged for overtime or
night work) rather than by the installation of more labor-saving
machinery, even though the latter might, in the long run, be more
economical. In general, when considerations which take into
account a period of years dominate, land and the more perma-
nent forms of capital goods will be used more freely, labor and
the less permanent forms of capital goods less freely. When
short-time considerations are dominant, the reverse will be
true.
These limitations do not invalidate the law of the equality of
the remimeration of the factors in production and the value of
their marginal products any more than the fact that a feather
does not fall through the atmosphere as rapidly as a stone invali-
dates the law of gravitation. This law, like other economic laws,
is the statement of a fundamental tendency, which, in this case, is
bound up with the universal desire of entrepreneurs to get for
themselves the largest possible profits.
Marginal Productivity and Valuation. — The reader who has
firmly grasped the concept of marginal utility will find that a
recognition of some similarities in the r61es which marginal utility
DISTRIBUTION AS AN ECONOMIC PROBLEM 331
and marginal productivity play in the process of valuation will
help him to grasp the significance of the latter concept. The value
of consumption goods is determined by their capacity to yield an
income of satisfactions; the value of production goods is deter-
mined by their capacity to yield a money income to the entre-
preneur. In the one case the law of diminishing utility is domi-
nant; in the other case, the law of diminishing productivity. Just
as we cannot speak of the utility of a commodity in general, but
only of the utility of particular units of a commodity, so we can-
not speak of the productivity of land, labor, or capital in general,
but only of the productivity of particular units of land, labor, and
capital — a productivity which is attributed or imputed to other
similar units of the supply of these factors in production. The
consumer is getting the maximum of satisfaction of his wants when
the final dollar spent for one commodity satisfies just as intense
wants as the final dollar spent for any other commodity, and he
tends to apportion his expenditures accordingly. The entrepreneur
is not making maximum profits if his final expenditures for any
one of the factors in production add more to his product than his
final expenditure (of equal amount) for either of the other factors
in production, and he tends to apportion his employment of land,
labor, and capital accordingly. But it must not be supposed that
the statement that the prices paid for land, labor, and capital tend
to equal the value of their mai^nal products is a complete explana-
tion of the valuation of the services of the factors in production
any more than the principle of marginal utility is a complete ex-
planation of the valuation of consumption goods. In fact, from
one point of view, marginal productivity is itself partly deter-
mined by the prices which the entrepreneur has to pay for the
services of the factors in production.
TTie demand for the use of land, labor, and capital is ultimately
a demand for their products — the goods that satisfy human wants.
The entrepreneur's task is to anticipate and meet this demand —
a problem that takes the concrete form of producing goods that
will sell for more than the expense of production. On the one
hand he has to estimate the quantities which he can sell at certain
prices; on the other hand, he has to take account of the quantities
3$2 OUTLINES OF ECONOMICS
which various units of land, labor, and capital will contribute to
his product, together with the prices (wages, rent, and interest)
that be has to pay for these units. Through his mediation the
demand of society for want-satisfying goods becomes a demand
for the services of certain quantities of land, labor, and capital,
combined in certain proportions. And the principle that guides
the entrepreneur's transformation of the social demand for the
products of land, labor, and capital into his own demand for the
services of these factors in production is the principle of marginal
productivity. The wages, rent, and interest that are actually paid
for the services of the factors in production are the resultants of
the demand of entrepreneurs, on the one hand, and of the supply
of these factors on the other hand. The prindpU of marginal
frodudivUy is an illuminating way of stating the problem of the
distribution of wealth, rather than a solution of it. Just how supply
and demand operate in the case of each factor in production is a
topic to be considered in later chapters.
Social Aspects of Diminishing Productivity. — Since the entre-
preneurs are only the intermediaries between society viewed as a
body of consumers and society viewed as a body of producers, we
may, for present purposes, leave them out of consideration, in
order to fix our attention upon some of the more general results
of the fact of diminishing productivity.
If the number of laborers within the boimdaries of a nation b
increased by immigration, without a corresponding increase in
capital or in the amoimt of land available for use, the result will be
an increase in the total amoimt of goods produced, which means
an increase in the amoimt of wealth produced per unit oi land and
capital, but (on account of the operation of the law of diminishing
productivity) a decreased amount per laborer; a higher margmal
product for land and capital, and a lower margiu&l product for
labor; consequentiy, higher rent and higher interest, but lower
wages. If the supply of capital within a country is increased,
while labor and land remain constant, the result will be higher
wages and higher rents, but a smaller remuneration for capital
Similariy, if the available supply of land be increased (as by im-
provements in transportation facilities), rent will absorb relatively
DISTRIBUTION AS AN ECONOMIC PROBLEM 333
less, and wages and interest relatively more, of the value of the
total product
In a very real sense the same laborer is more productive in a
country where land is relatively plentiful than in a country where
land b relatively scarce. A laborer may gain no technical effi-
ciency by migration from Europe to America, but the increment
of product attributable to his work is apt to be considerably larger
in the United States than it was in Europe. Here he really creates
a larger product and earns a larger wage. The migrations of
labor and capital from one region to another, or from one country
to another, are guided by the endeavors of capitalists and laborers
to get the maximum remuneration, — which will always be found
where the value of the marginal product of capital or labor is a
maximum.
In a prosperous country it is apt to be the case that the supply
of labor and the supply of capital are being increased simultane-
ously, though not necessarily with equal rapidity, while more land
is at the same time being made available through improvements
in transportation. Save under such exceptional conditions of rail-
way building as have prevailed in the United States during the
past fifty years, the available supply of land is apt to increase
more slowly than the other factors in production increase. In
general, the law of diminishing productivity will necessitate a con-
tinual increase in the proportion of the product set aside for the
remuneration of each unit of the most slowly increasmg factor in
production; while, of the other two factors, the one that increases
more rapidly will receive, per unit, a relatively smaller and smaller
proportion of the value of the total product.
QunnonB ahd xzmcmBs
I. Do you know of any instances where the distribution of wealth has been
affected, directly or indirecUy, by conscious social action?
3. Prepare tables or diagrams illustrating the operation of the law of
diminishing productivity in some industry with which you nt familiar.
3. Why is the same laborer more productive in America than in Europe ?
Is this a condition that wiU probably continue indefinitely ?
4. Why do lands in Belgium produce more per acre than similar lands In
the United States?
334 OUTLINES OF ECONOMICS
5. Why are twenty-story office buildings not erected in small dtles?
6. What is the relation of the discussion in this chapter to the sodaliit
coutention that labor produces all wealth?
BBFERXnCBS
Casvbr, T. N. The DistribuUon of Wealth, Chap. IL
Commons, J. R. The Distribuiion of Wealth, Chs^. IIL
Fetter, F. A. The Principles of Economics, Chap. DC.
Marshall, Alfred, Principles of Economics, Vol. I, 4th ed., Book VI,
Chaps. I and II.
CHAPTER XX
THE PERSONAL DISTRIBUTION OF WEALTH
In the present chapter we shall study the distribution of wealth
and income among individuals simply as individuals, and not as
factors of production. What is the cause of large fortunes ? Is
the middle class disappearing? Can we abolish poverty? In
the chapter on Consumption, reference has been made to the ideal
distribution of wealth, — here we shall deal chiefly with actual
conditions. But to beg^n with, certain distinctions must be clearly
drawn.
Weatih and Income. — The distribution of wealth and income
should be distinguished. If we have in mind simply the enjoy-
ment of material things, then we must pay attention to the distri-
bution of income. ^ A man of vast possessions may be very frugal
in his consumption, acting with respect to most of his property
simply as a trustee for society. But when we are interested in
social classes, industrial democracy, and personal power and inde-
pendence, then the distribution of wealth is the important con-
sideration.
Abtolote and Relative Well-being. — Two entirely ihdependent
inquiries are very frequently confused, (i) We may wish to
know whether the condition of the mass of the people is getting
better or worse. Do they have more or less of the good things of
life than their ancestors had? But we may also ask, (2) What
share of the total product of industry is' received by each section
of the community? Which section is gaining upon the others?
If A and B divide a catch of ten fish equally to-day, and if to-
morrow A gets ten out of a total catch of thirty, then absolutely
his income has increased, but relatively it has declined.
Concentration of Wealth and Large-scale Production. — It is per-
haps worth while to warn the reader against confusing the question
335
336
OUTLINES OF ECONOMICS
of large and small fortunes with the quesdon of large and small
scale production. However improbable, it is at least conceivable
that there might be an equality of property with production
carried on largely as it is to-day, for we have but to imagine an
equal distribution of stock holdings.
Hetbods of measttring Concentration of Wealth and Income. —
How shall we tell whether the middle class is tending to disappear ?
A common method is to make a classification of wealth and income,
and then to compare the number of persons in each class at dif-
ferent dates. The unreliability of the conclusions based on such a
procedure is made clear by the following hypothetical illustra-
tion: Let $ioo be distributed among ten persons as follows:
♦i» ts, iSf *7i S9» *"> Si3i *iS» *i7, Si9- Then suppose each
individual's holding is doubled, thus: $a, |6, $io, $14, $18,
$22, $26, $30, $34, $38. Relatively to each other they hie
all in the same posidon as before, but by the erroneous method
of comparison referred to, there appears to have been a concen-
tradon because the number in the highest class has increased most
rapidly: —
TABLE I
dun
Nuiazi
DoUms
First Cue
Second Case
0 and less than 5
K and leSs than 10
a
3
2
3
z
I
10 and less than 15
15 and over
3
6
A satisfactory method of comparing the distribudon of wealth at
different epochs must take account of the changing significance of
fixed dassificadons when there has been a change in the per capita
wealth. This can be done by observing what propordon of the
wealth is owned by certain secdons of the populadon, such as the
poorest third, the middle third, or the upper third. If a larger
propordon of the total wealth falls into the hands of the upper
thirdi we may say there is evidence of a growing concentration of
THE PERSONAL DISTRIBUTION OF WEALTH 337
wealth. It is clear that no definite movement is necessarily dis-
cernible even when changes are taking place, for these changes
may tend toward concentration in one part of sodety and toward
diffusion in another.
Statistics of DistrilmtioiL — There are many investigations
showing the earnings of particular classes of workers, but in the
United States there is no reliable statement of the division of the
national wealth or income among all classes of sodety. We could
not use the property tax assessments for this purpose because of
their inaccuracy, and because of the fact that one individual may
be taxed in various jurisdictions. The returns of the probate
courts have been used as a basis for a statement of wealth distri-
bution in the United States on the assumption that the distribution
of wealth among persons who die in any year is an index of the
distribution of wealth among those who are living. But the in-
completeness of our probate returns make this method ako a
hazardous one. Such statistics as we have do not enable us to
say more than that a small proportion of the population at the top
of the social scale controls a large proportion of the nation's wealth,
but no marked tendency either toward concentration or diffusion
in the last fifty years has been proved.
The growth of the number of millionaires has been used as an
evidence of growing wealth concentration, but it should be noted
that a growth of population and wealth in a conununity would
cause an increase in the number of millionaires, even if the reladon
between the various classes remained the same. Suppose that in
1850 there had been in the United States but fifty millionaires, that
three hundred and fifty persons had from $750,000 to $1,000,000,
and that six hundred persons had from $500,000 to $750,000. If
the population had remained the same and every one's wealth had
been doubled, in 1900 there would have been one thousand mil-
lionaires, and if the population at the same time increased fourfold,
with the relations among the new population the same as in the old,
we should then have four thousand millionaires without any tend-
ency toward concentration. Nevertheless, the increase of large
fortunes has been so startling that in spite of these considerations
one may perhaps regard them as an indication of a growing con-
z
338
OUTLINES OF ECONOMICS
ccntration of wealth. The lists of very rich men published in the
United States from time to time are instructive on this point. In
z8ao men with a personal property of $20,000 were included; in
1846 a total property of $50,000 was considered very large; in
1855 this was doubled; in 1892 a man must be a millionaire to be
considered very rich, and at present one may speak of even a
billionaire.
More satisfactory statements can be made for those countries
which collect an income tax. The following figures are from a
table prepared by Professor Wagner, in a study of the income-tax
returns of Prussia: —
TABLE n
iNcoicBS IN Prussia, 1892 and 1909 *
Classxs n DatLAKs
Pn Ckmt of Piioons
(Heads of Families or Single
Adults)
Pkb Cent ov iNooia
(That bekm |ax4 la catinatad)
xSga
x9oa
xSga
xgoa
Below 214
214-714
714-2261
9361-7959
7259-33800. . .
Over 23800. . .
78.18
18.98
2-33
0.41
0.08
O.OI
70.66
25-83
2.88
0.51
O.IO
0.02
41.21
30.01
12.8;
7.37
4.65
3-93
32.97
34.92
1373
7.84
540
Absolute amouats
(Total)
Number
11,162,000
Number
12,813,000
Dollars
2,3091076,000
Dollars
3»039>49S»«»
■ Fh)m Zeitschzift des Preusaischen Statisdaeben Bureaus, 1904, p. ajx.
The great mass of the people are too poor to pay any income tax
at ally the minimum income taxed being $214. The upper 3.51
per cent of the population receives about one third the total
income, but in connection with such a statement it should be said
that even if incomes should be equally distributed, the average
income per fanaily, or single adults, would be very small ($337 in
1903). With a very moderate inequality in distribution, the mass
of the people must still be unable to pay an income tax. Thus,
the table shows as much the niggardliness of nature as the injustice
THE PERSONAL DISTRIBUTION OF WEALTH 339
of man to man. From 189a to 190a there seems to have been an
absolute increase in money incomes among the lowest class of the
people, since a considerably smaller proportion of the population
is found in the class with incomes below $214 in 190a than in 189a.
But the table as a whole shows a slight tendency toward a concen-
tration of incomes in the hands of the upper classes.
When we turn from the question of relative well-being to that of
the actual condition of each class taken by itself, we find two facts
standing out prominently: (i) the fruits of economic progress
have not been confined to a small class, but have been shared by
the masses, and (2) a surprisingly large section of the population
is still in poverty.
With respect to the first, we may say that in material comforts
the people of this generation are better off than they have ever been
before. The work of settlement in which so many of our fore-
fathers engaged was laborious and exhausting. Food was often
scarce, disease was rife in many settlements, and the women and
children in particular suffered greatly. After the wilderness was
cleared, there ensued a period of "rude plenty." Food was
abundant, but it was coarse in quality and restricted in variety,
whilst everything that had to be brought from a distance was very
expensive. Education was difficult to secure, books scarce, and
the lives of most people were, in the main, monotonous and
uneventful.
The course of wages from the middle of the eighteenth century
to the year 1905, and the movement of prices from i860 to the
latter date, are given in Table III following. The figiu-es are not
altogether comparable, nor so trustworthy as could be wished, but
the general impression which they give is correct. Speaking
generally, money wages have steadily risen, and the hours of labor
have declined, with minor interruptions, since the colonial period,
while prices have fluctuated irregularly. Taking all kinds of com-
modities into account, the level of prices in the last half century
has probably been little if any above the level of prices in the first
half of the nineteenth century. The standard of living has per-
ceptibly risen, and the working classes save no more, possibly,
than they did several generations ago. But they live better.
340
OUTLINES OF ECONOMICS
TABLE in
Wages, Pxicbr, ans
HouBS OF Labor 1
Wages
, Prices, and
H0US8
IN z86o TAKEN AS
zoo
OF Labor in 1890 taken
AS 100
Employeks in Manvfactuking
Gbnbeal Industey, excluding
Aguculturb, Mining, and
Tkanspoktation
Relatzvb
Rklativb
Rkla-
1
Pekiod
YiAm
Cost
Hours
Ybab
Hours
Waoxs
Wafes*
of
of
Ubor3
Wages 4
Prices 5
of
Ijihor*
i75a-^
.29
i860
100
100
100
1881
95-3
"4.5
103
1761-70
1771-80
•3^5
1861
100
III
99.1
1882
96.9
II7-S
1 14.8
103
.376
1862
100
"3
98.2
1883
97-7
103
1781-90
.428
1863
109
137
98.2
1884
98.5
97.8
107.7
103
1791-00
I80I-IO
.623
1864
120
163
98.2
1885
100.8
103
.817
1865
141
175
97-3
1886
97.8
99.6
102
i8n-2o
.910
1866
153
172
98.2
1887
98.6
100.3
100
1821-30
:!?$
1867
1868
172
164
98.2
1888
99.2
102.1
100
1831-40
167
165
96.4
1889
99.6
102.1
100
1841-50
.852
1869
174
163
96.4
1890
100.0
100.0
100
1851-60
•975
1870
:;i
'57
95-5
1891
99-7
101.4
99.8
1871
148
95-5
1892
100.3
995
99.8
1872
174
147
95-5
1893
100.2
102.0
99.6
1873
175
149
95-5
1894
96.7
97-4
99.1
1874
170
M5
95-5
1895
97.4
955
99-4
1875
161
141
93-6
1896
98.5
93-3
99.1
1876
156
134
93-6
1897
98.2
94.0
98.9
1877
146
131
93-6
1898
99.0
96.4
99.0
1878
142
126
93-6
1899
100.2
97.2
98.5
'52^
140
"3
93-6
1900
103. 1
98.7
98.0
1880
137
"5
93-6
1901
1902
1903
1904
190S
104.8
108.2
III. 2
III. I
1 1 2.8
102.7
108.3
107.7
109. 1
109.8
97-4
96.6
95-9
95«
95.3
■ Data from Report of Massachusetts Bureau of Statistics of Labor for 1885, p^ 455.
■ Data from Mitchell, Gold, Prices^ and Wages under the Greenback Standard, pp. s4S-944-
The cost of living here is based upon retail prices and covers rent as well as food, etc
3 Baaed upon statistics covering ax industries given in the Aldrich Report on Wholesale
Prices, Wages, and Transportation.
* Statistics for 1881-1889 cover 2$ city occupations, and are based upon data given in Bui-
ktin of the Bureau of Labor, No. 18, p. 669. Statistics for 1890-1905 cover 549 occupations,
and are baaed upon data given in Bulletin of the Bureau of Labor, No. 65, p^ 30.
« Wholesale prices from x88x to 1889, based upon data given m the Aldrich Report on
Wholesale Wages, Prices, and Transportation, Part I, p. 99. Retail prices of food from 1890
to X905, from the Bulletin last dted.
* From the Aldrich Report and Bulletin dted above. After 1890, statistict are based* on
hours of labor per week.
THE PERSONAL DlSTRIBUtlON 6f WfiALtii ^4!
Regarding the second proposition, we may say that reliable
English investigations show that more than one fourth of the popu-
lation of the cities of London and York are below the poverty line.
To be sure, it is not easy to determine definitely how poor a person
must be in order to be ''in poverty," but the statement just made
is based upon standards that are undeniably conservative. But
a number of those actually in poverty have enough income to pur-
chase the minimum physical requirements if they knew how to
spend their money wisely. In the dty of York 9.91 per cent of
the population had insufficient earnings for minimum require-
ments estimated at $5.25 per week for a family of five. This
minimum is very low, and it is easily within the mark to say that
at least a fifth of the population of York did not have in 1899 a
sufficient income for a decent existence. In the United States
the proportion of the urban population below the poverty line is
probably somewhat less, but reliable statistics cannot be quoted.
A recent writer has estimated that ten million persons in the
United States are in poverty, not all in distress, but "much of the
time underfed, poorly clothed, and improperly housed." The
estimate is based on statistics of imemployment, retiuns of boards
of charity, court records of evictions, and pauper burials. What-
ever the actual figiu*es may be, they would doubdess be startling
in comparison with statistics of oiu* industrial progress.
Causes of Poverty and Riches. — The explanations of poverty
and riches may be divided into two classes : (i) those that empha-
size individual responsibility, and (3) those that emphasize social
responsibility. According to the first, a comfortable fortime is the
reward of efficiency, and poverty the penalty of inefficiency. To
find fault with existing wealth distribution, it is alleged, is to find
fault with natiu-e for making individual differences in ability so
enormous. That there are idle and worthless persons among the
rich is not to be denied, but they, it is said, are to be regarded as
the exceptions. As a class, according to this view, the rich add
more to the wealth of society than they consume, and they do not
m reality deduct anything from the income of the lower classes.
Those who emphasize the second explanation, on the other hand,
point to the existence of all sorts of special privileges which enable
^Ct OUTLINES OF ECONOMICS
the few to levy toll on the commerce of the nation. They assert
that the fortunes of most millionaires originated under the shelter
of some monopolistic enterprise. As to the poori they call atten-
tion to the fact that inefficiency may be the result of poverty as
well as the cause of it. Society must, therefore, take active meas-
ures to better the environment of the poor. They must be taught
to live wisely, and their children must be given a fair chance in Uf e.
Children who do not get enough to eat when young cannot be ex-
pected to take care of themselves when they are men and women.
"The prime importance of monopoly privileges in the distribution of
wealth is shown by the results of the investigation of the New York Tribune
(1892) in its efforts to ascertain the sources of the fortunes of the millionaires
of the United States. That investigation was undertaken to show that the
system of protection has not been the main cause for monopolies and great
fortunes. The investigation amply demonstrated this proposition. Of
the 4047 millionaires reported, only 11 25, or 28 per cent, obtained their
fortunes in protected industries. The following partly estimated summaries
are based on the Tribune report. They show that about 78 per cent of the
fortunes were derived from permanent monopoly privileges and only 01,4
per cent from competitive industries unaided by natural and artificial monopo-
lies. Yet there can be no question that if these 21.4 per cent were fully
analyzed, it would appear that they were not due solely to personal abili-
ties unaided by these permanent monopoly privileges. They were mostly
obtained from manufactures, and five sixths of the manufactures of the
country are based on patents. Besides, fortunate investments in real estate.
Stocks, etc., have often contributed to fortunes where they do not appear
prominently. Furthermore, if the size of the fortunes is taken into account,
it will be found that perhaps 95 per cent of the total values represented
by these millionaire fortunes is due to those investments classed as land
values and natural monopolies and to competitive industries aided by such
monopolies." ^
Those who take this second view do not deny that individual
differences in ability exist and are a cause for a difference in for-
tune. But they think that conditions are such that differences in
reward are quite out of proportion to the difference in ability. A
little shrewdness may accumulate a fortune just as the touch of a
child's hand may start a bowlder down the moimtain side.'
The controversy as to the ultimate responsibOity for poverty
' Commons, The Distribution of Wealth, p. 352.
* The relation of competitive wages to effidency is discussed In Chapter XXu.
•THE PERSONAL DISTRIBUTION OF WEALTH 343
cannot be settled by an appeal to the results of the investigations
that have been made as to the immediate causes of poverty. The
investigation in the city of York, before referred to, gives the fol-
lowing as to the immediate causes of primary poverty, that is,
where the income was insufficient to provide the minimum re«
quirements for physical efficiency even if wisely spent: -^
TABLE IV
Immsdiate Causes op "Primary*' Poverty*
PkI CKMT or POPOLAtlOM
« FOVXRTT
Death ol chief wage earner
Illness or old age of chief wage earner
Chief wage earner out of work
Irregularity of work
Largeness of family, >.«. more than four children.
In regular work but at low wages
15.63
S-"
a.31
t.83
M.16
51-96
^ Rowntree, Pcveriy, p. xao.
la Greater Diffoaion Possible?— Most people agree that a
greater equality of possessions would be desirable if it could be
brought about without any confiscation of the real earnings of the
more efficient members of society. The idea of a leisure class
whose mission is to further culture without great contribudon to
the production of what it consumes, does not find much favor in
this democratic age. The disadvantages of wide extremes in
wealth have been so often pointed out by social philosophers that
they need not be emphasized here. But those who believe that
the competitive system roughly apportions rewards according to
individual production will say that nothing can be done directiy to
diffuse wealth. That each individual should bear the consequences
of his own conduct, they think is necessary as a discipline for the
race. ** Give the children of the shiftiess, by thoughtiess charity
or various systems of poor relief, the right to eat the substance of
the efficient and the prudent, and you will soon lose both the
344 OUTLINES OF ECONOMICS
capital and the morality under which that capital has been cre-
ated," * says a writer of this class.
Those, on the other hand, who think that something can and
should be done directly, question the possibility of discovering the
separate productivity of workers under modem complex indus-
trial conditions with any degree of exactness, and think there is
little danger of discouraging industry and thrift. If the highest
incomes were $100,000 per year, men would struggle just as hard
as they do now to get into the highest class.
If we take the view that something can be done to lessen the
extreme inequality in wealth distribution that exists at the present
time, it is necessary to formulate some programme of social re-
form. In framing such a progranune it must be remembered, on
the one hand, that the right of private property is not an abso-
lute right. No one has a vested interest in that institution, and we
are at liberty to make such modification in the institution as will
contribute to the social welfare. For the present the measures here
advocated are not in the slightest danger of being carried so far as
to discourage that wealth-getting ambition which is considered by
many to be essential to progress. On the other hand, there is
danger of injuring by wrong methods the very persons whom it is
desirable to elevate. Indiscriminate charity may convert poverty
to pauperism.
"This distinction between the poor and the paupers may be seen every-
where. There are, in all large cities in America and abroad, streets and courts
and alleys where a class of people live who have lost all self-respect and
ambition, and who rarely if ever work, who are aimless and drifting, who like
drink and who have no thought for their children, and who live aimless and
contentedly on rubbish and alms. ... In our American cities, Negroes,
Whites, Chinese, Mexicans, Half-breeds, Americans, Irish, and others are
indiscriminately housed together in the same tenements and often in the
same rooms. The blind, the crippled, the consumptive, the aged, — the
ragged ends of life; the babies, the children, the half -starved, underdad
beginnings in life, all huddled together, waiting, drifting. This is pauper-
bm. There is no mental agony here; they do not work sore; there is no
dread ; they live miserable, but they do not care.
"In these same cities, and indeed everywhere, there are great districts of
people who are up at dawn, who wash and dress, and eat breakfast, kiss
* Hadlcy, Economics, p. 49.
THE PERSONAL DISTRIBUTION OF WEALTH 345
wives and children, and hurry away to work or to aeek work. The world
rests upon their shoulders; it moves by their muscle; everything would stop
if for any reason they should decide not to go into the fields and factories and
mines. But the world is so organized that they gain enough to live upon
only when they work ; should they cease, they are in destitution and hunger.
The more fortunate of the laborers are but a few weeks from actual distress
when the machines are stopped. Upon the unskilled masses want is con-
stantly pressing. As soon as employment ceases, suffering stares them in
the face. They are the actual producers of wealth, but they have no home
nor any bit of soil which they can call their own. They are the millions who
possess no tools and can work only by permission of another. In the main
they live miserably, they know not why. They work sore, and yet gain noth-
ing. They know the meaning of hunger and the fear of want. They love
their wives and children. They try to retain their self-respect. They have
some ambition. They give to neighbors in need, yet they are themselves the
actual children of poverty.'' '
We shall not discuss here the methods of alleviating the suffer-
ing that comes from poverty. The best methods of charitable
relief are necessary as palliatives, but they cannot cure the evib of
poverty. Two classes of reform measures should be distinguished:
(i) those that aim to alter the methods of wealth acquisition in the
future, and (2) those that aim to diffuse the excessive accumu-
lations of the past.
Modifying the Methods of Wealth Acquisition. — These methods
again faU into two classes: (a) prevention of improper methods of
wealth acciunulation; (b) eliminating or strengthening the in-
efficient members of society. Under the first of these falls the
problem of reducing to lower terms such incomes as are indi-
vidually unearned. There must be such control of monopolistic
privileges as to keep them from being the means of exploiting the
masses. Fraud and favoritism must be eliminated so that income
shall not be wholly out of proportion to service or needs.
The second class includes a large variety of methods, (i) It is
possible to do something to prevent defective human beings from
being bom. There is a growing sentiment in favor of preventing
the marriage of persons who are not fit for marriage. No indi-
vidual would be deprived of any important right if a medical cer-
tificate of good health were made a condition precedent to the
* R. Hunter, Povtriyy pp. 3-5.
346 OUTLINES OF ECONOMICS
granting of a marriage license. (3) Education should be made
compulsory with the endeavor of making the rising generation
not only efficient producers of wealth, but also wise spenders of
what they receive. (3) It is possible to provide against the mis-
fortunes of life by insurance of various kinds. If men will not
voluntarily make provision for themselves and for those dependent
upon them in cases of sickness, accident, old age, and premature
death, they should be helped to do so indirectly by some com-
prehensive system of workingmen's insurance and old age pen-
sions. (4) The solution of the problem of unemployment depends
upon more indirect measures, such as monetary and banking
reform, which steady the progress of industry, although European
experiments show that there are possibilities in insurance against
unemplo3anent. (5) Opportunities for saving should be multi-
pb'ed. The establishment of postal savings banks would be of
some assistance. (6) The health and vigor of the people should
be improved by sanitation and by legislation which improves the
conditions of work.
The DUfasion of Wetlth. —To some extent large fortunes dis-
appear without governmental interference, but it takes com-
paratively slight ability to maintain an inherited estate. It does
not seem practicable or desirable to limit directly the total amount
of wealth which a man may own, but there is no reason why the
'government should refrain from consciously encouraging the dif-
fusion of wealth. The regulation and taxation of inheritances
seems to be the proper remedy in this connection, even if its action
is somewhat slow.
QUESTIONS AKD EXERCISES
I. Can anything be said in favor of a leisure class?
3. Would Mr. Carnegie's plan of levying an inheritance tax of 50 per
cent destroy the incentive to work?
3. Explain the various systems of poor relief.
4. Describe the German system of compulsory insurance.
5. Describe the old age pension system in Australia.
6. What objections have been offered against postal savings banks?
7. Discuss the following statement: "We have, then, little reason for
expecting that the prevailing insecurity in the lot of the modern workman
will ever be removed by the development of individual thrift." — A. S. JOBW-
SON, Political Science Quarterly, Vol. XXII, p. 244.
THE PERSONAL DISTRIBUTION OF WEALTH 347
REFERENCES
Adams, T. S., and Sumner, H. L. Labor Problems, Chap. V.
Brooks, J. G. The Social Unrest, Chap. VII.
Booth. Life and Labour of the People in London, final volume.
Cannan, Edwin. " Division of Income," Quarterly Journal of Economics^
Vol. 19, p. 341.
Commons, J. R. DistribuHon of Wealth, pp. 95a sqq,
Devine, E. T. Principles of Relief.
Eliot, C. W. " Great Riches," World^s Work, Vol. 11, p. 7451.
Ely, R. T. Evolution of Industrial Society, Chap. VI, Part I.
Hadley, a. T. Economics, pp. 39-63 and 330-335.
Hunter, Robert. Poverty.
Hobson J. A. The Social Problem, Chap. IV, and Problems of Poverty,
Chap. IX.
Henderson, C. R. Modern Methods of Charity.
Johnson, A. S. " Influences afiFecting the Development of Thrift," PeHtical
Science Quarterly, Vol. XXII, No. a.
London, Jack. The People of the Abyss.
Laughlin, J. L. "Large Fortunes," Atlantic Monthly, Vol. 96, p. 40.
Mallocx, W. H, ** Great Fortunes and the Community," North American
Review, Vd. 183, p. 349.
Paupers in Almshouses, 1904. Special Report of the Bureau of the Census.
Rowntree. Poverty, A Study in ToTvn Life.
Spargo, John. Socialism, Chap. V.
Spahr, C. B. The Present Distribution of Wealth in the United States.
Ssager, H. R. Outline of a Program of Social Reform, Charities and
the Commons, February a, 1907.
Warner, A. G. American Charities.
Watdns, G. B. "The Growth of Large Fortunes," Publications of the
American Economic Association, November, 1907.
Yottngman, Anna. "The Fortune of John Jacob Astor," Journal of
Political Economy, June, 1908.
CHAPTER XXI
THE RENT OF LAND
Rent is the price paid for the services of land. In common
usage the meaning of the word is, however, much less exact.
That which one pays for the use of durable goods of any kind
owned by another is conmionly caUed rent. The payment for
the use of a house or a business building is, for example, counted
as rent. We shall see that in this case the so-called rent really
consists of two elements, — one a ground rent, or rent proper, the
other capital rent, or what we shall call gross interest. If this
distinction seems fanciful, it is only because we are accustomed
to see the two united under one ownership. But in most large
dties separate ownership is common. Sometimes one man owns
the land and leases it for a long term of years to another who
erects buildings upon it, which, either with or without payment,
become the property of the landowner at the expiration of the
lease, unless it is renewed, and if it is renewed, the one who pos-
sesses the building must frecjuendy pay for it. Often, however,
the separation in ownership is a permanent one, the house owner
pa3dng perpetually an annual sum for the use of the ground.
This is the case in Baltimore, for example, where ground rents
are an important feature in the economic life of the city. In
such cases the two kinds of income are very clearly distinguished.
Some modem economists have extended the meaning of both
rent and interest, using them as two different ways of describ-
ing one form of income, rather than as two distinct kinds of in-
come. This usage is based on the obvious fact that the rent
which a landlord receives for an acre of land may easily be com-
puted as a certain rate of interest on the money value of the land,
just as the amount earned by a machine may be viewed either
348
THE RENT OF LAND 349
as the rent of the machine or as interest on its money value.
But we shall see later that the income from other production
goodsy while governed in part by the same laws that control the
income from land, is also governed in part by very different laws.
Without dwelling further upon this distinction at this stage of
our discussion, let us remember that in the great majority of eco-
nomic writings the term " rent " means only an income from land,
and that it is used only in this sense in the following discussion.
The Services of Land. — The first thing to be noted about
land is its quality. Differences of fertility are familiar to every one,
and depend upon what has been known as the "original and
indestructible properties of the soil." An effort has been made
by certain writers to minimize or deny the significance of this
factor. It has been said that "soil "is not indestructible, that
it may be exhausted or removed from land altogether, and that
it may in turn be created by means of fertilization. These writers
recognize in land no other indestructible property than standing
room. This objection arises from the use of the word " soU " in a
narrow sense. If by " sofl " we mean only that thin top layer
containing some elements necessary to plant life, it is true that
this may be carted on or off at pleasure, that it may be wasted
or replenished. But, granting this, there still remain many
qualities of land which are indestructible and unprodudble,
and which so directly affect the productiveness of the land that
we may not inappropriately call them "properties of the sofl."
Such a property is the conformation of the land. A steep, grav-
elly hillside will by no possible effort equal a plain in fertility.
The north side of a mountain cannot be made to produce the
same as the south side. Climate is not, to be sure, a " property
of the sofl," but it is an inseparable appurtenance of the land,
and upon it the productiveness of the land primarfly depends.
It is needless to say that the ownership of a piece of land carries
with it the advantage of all the conditions which attach to that
land. It is simply true, therefore, that the expression "original
and indestructible properties of the soU" is an inadequate and
misleading expression; not that there is nothing but standing
room to be considered under such a term.
350
OUTLmES OF ECONOMICS
Wo will, therefore, adopt another expression to explain what
we mean by quality in land; namely, the irremovable conditions
affecting its productiveness. Of these its extent (standing room),
its conformation, and its climate are essentially original and in-
destructible. Others, such as are connected with the ** soil " in
the narrow sense, are not indestructible nor necessarily original,
but they affect rent none the less. In defining quality as the
conditions affecting productiveness of land, we have discarded
the word "soil" because it has proved itself treacherous; we
have omitted the words "original and indestructible" because
fertility may be artificial, and is always destructible. On the
other hand, fertility, even when artificial, becomes essentially a
property of the land. While it is physically removable, it is not
economically so. From the case where capital is embodied in
land and entirely assimilated to it in character, we pass by in-
sendble gradations to fences, bams, houses, etc., which more
and more assume the character of capital as distinguished from
land. It would be possible to restrict the term " land " to strictiy
natural land, and apply the term " capital " to all products, in-
cluding the soils of old land. This would be a logical distinction,
but, like so many logical distinctions, it would be confusing. On
the other hand, if we include under land all capital that has been
incorporated in it, we must recognize that there is no absolute
line of division between land and capital. Thus we are again
reminded that distinctions in economics, as well as in practical
life, are questions of convenience, and are good or bad according
as they are more or less useful.
The second great fact regarding land is locaHon. On one side
this is closely connected v/ith climate. Land situated near a
body of water or near a mountain range is much affected by
these great controllers of climate. But a more distinct meaning
of the word is location with regard to the consumers of products.
Everybody knows that land a hundred miles from market is,
other things being equal, worth more than land a thousand miles
from market. This, however, is a question of accessibility rather
than of mere distance. Land may be far away and yet easy to
reach, or near and difficult of access. It will be noted that any
THE RENT OF LAND 351
change in the co&t of transportation affects rents. The rents of
England have been revolutionized by cheap ocean transporta-
tion, which has practically brought distant land very near to her
shores. To this fact of location we must ascribe almost wholly
the enormous rents paid for dty lots. Here, again, transporta*
tion facilities, such as are afforded by good rapid transit systems,
powerfully affect rents.
One important difference in the way quality and location affect
rent must, however, be noted. The quality of a piece of land
affects the amount of its physical product; it determines how
many bushels of wheat or how many pounds of cotton it will
yield with a given amount of cultivation. The location of land
does not, it is true, affect the amount of its phydcal product,
but it does affect the price of the product, since that varies with
the expense of transporting the product to market. The value
of a piece of land to the user depends upon the value of its yield,
which is ascertained by multiplying the number of units of prod-
uct by the price per unit. Suppose a man owns two wheat farms
of equal size, one in Dakota and one in Illinois. If the farm in
Dakota produces thirty bushels of wheat to the acre, and it costs
twenty cents a bushel to get it to the Chicago market, where wheat
is selling at a dollar per bushel, while the farmer in Illinois pro-
duces twenty-five bushels to the acre, and it costs four cents a
bushel to get this to the Chicago market, the farms are equally
productive so far as the owner is concerned, for in each case he
will get $24 for an acre's yield of wheat. If the other conditions
of production are the same, the farms are equally valuable to the
owner. From the social point of view, too, one of the farms is
as good as the other. For the costs of transportation, of moving
things to where they are wanted, have to be counted among the
legitimate and necessary costs of production. In short, we may
say that the two pieces of land are equally gi>od land. When we
speak of good land, therefore, in connection with the subject of
rent, we mean land which for all purposes taken together is de-
sirable.
Rent under Assumed Conditions of Uniform Intensivity of
Cultivation. — The first settlers in a new country have no need to
352
OUTLINES OF ECONOMICS
pay rent. They find plenty of land, and even the best of it will be
a free good, like air or water. So long as any man can get land
of the best quality free, there is no reason why he should pay rent
to any one else. But this fortunate state of affairs will last only
so long as some of the best lands remain unoccupied. When
increase in the population makes the utilization of inferior lands
necessary, the owners of the better lands will be able to demand
and receive a rent for the use of their lands. This will be made
clear by reference to Figiure i, which is constructed on the assump-
G D M F "
Flo. I ^
tk>n that there are six grades of land, A^ B,Cy D, E, and F, and
that for all these lands the same amount of cultivation per acre
b necessary. The successive rectangles represent the selling
value of the product that can be raised on one acre of each of
these different grades of land, by the use of a fixed amount of
labor and capital. The product of an acre of the best land, A,
will sell for Oamy dollars. Until all of this best land is occupied,
no rent will be paid, and the entire value of the product will be
available for the expense of the capital and the wages of labor
employed in its cultivation.*
As soon, however, as it becomes necessary to cultivate some of
the B lands, the situation will be altered. The owners of the A
lands can now exact a rent for their use, and the farmer has no
^ The profits which the farmer may receive as entrepreneur do not affect th«
analysis, and may accordingly be neglected.
THE RENT OF LAND 353
alternative, except to utilize land of the second grade, on which
the fixed amount of labor and capital will onljr produce a prod-
uct per acre selling for abnk dollars. The rent which will be
charged per acre for A lands will amount to the difference between
the value of the products of the two grades of land (hkmy in the
diagram). For if the landowners attempt to charge more than
this difference, the farmers will find it more advantageous to use
the B lands; if they charge less, the A lands will be the more
remunerative to the farmer, and competition among the farmers
for the leases of A lands will force the rent up. In short, rent
will normally be fixed at the point which will just equalize the
advantages of cultivating the two kinds of land.
As soon as increased population and the consequent need of
a larger food supply and more raw materials have forced men to
begin to cultivate lands of the C grade, the B lands will conunand a
rent, while the rent of the A lands will be increased by an amount
equal to the rent of the B lands. And as cultivation is pushed
down to still poorer and poorer lands, the rents which these better
lands command will be still further increased. Thus, when some
lands of grade E are in use, the value of the product which can
be got from this free land, by the use of the fixed amount of labor
and capital, will be deii dollars per acre. This sum will just pay
the cost of labor and capital, for if it amounts to less than these
expenses of production, the E lands will not be worth cultivating;
if it amounts to very much more, it will pay to cultivate still poorer
land. But if dert dollars will just pay wages and interest on the
E lands, the same amount will pay wages and interest on the
better lands, for we have assumed that the same amount of labor
and capital is used on each grade of land. The expense for labor
and capital will, therefore, be represented on each rectangle by
the area below the line gt, while the area above this line will rep-
resent in each case the rent per acre which the landowner will
receive.
Rent, under these conditions, is a differential which measures
accurately the superiority of the rent-bearing land over the mar-
ginal land — the land which just repays the expenses of cultiva-
tion. It is not necessary to the significance of the theory that
354
OUTLINES OF ECONOMICS
all, or even any, of the farmers should be tenant farmers. If
the farmer owns the land that he operates, the part of his income
which measures the superiority of his land over an equal area of
marginal land, must, in any accurate analysis, be counted as rent
Rent under Actual Conditions. — The conditions assumed in
the foregoing analysis depart from actual conditions in one im-
portant particular, — the assumption that equal amounts of labor
and capital, that is, a uniform intensivity of cultivation, would
be applied to lands of different grades. As a matter of fact, even
after the A lands are all occupied, the supply of agricultural prod-
ucts can be increased without resort to poorer lands. All that is
really necessary is the more intensive cultivation of the A lands.
This cannot be done, however, without encountering the law of
diminishing productivity. Successive equal amounts of labor
and capital used on the same lands cannot be expected to yield
uniformly large increments of product. It will pay, however,
to make use of more intensive cultivation up to the point where
the last unit of labor and capital adds barely enough to the prod-
uct to pay for the increased expense, — a point which is called
the intensvve margin. The result of this more intensive culti-
vation is represented in Figure a.
Now the first rectangle in this dia-
gram (Oamy) represents precisely
the same thing as is represented by
the first rectangle in Figure i, the
return 0n value of product) from
the cultivation of an acre of land
of A grade by the use of a fixed
amount of labor and capital. The
second rectangle in Figiue a, how-
ever, represents the additional
product resulting from the use of a
similar unit of labor and capital on
the same acre, while the third rep-
resents the increment of product due to the emplojrment of yet a
third unit of labor and capital on the same land. Assume that
this third unit, A^ adds just enough to the selling value of the
Flo. i
THE RENT OF LAND
355
product to pay for itself. Then, as already explained in the
discussion of diminishing productivity, the area Ocph will represent
that part of the farmer's income which will be used up by the
expense incurred for the three units of labor and capital used on
this one acre of land, and the area above the line hq will repre-
sent the real rent of that acre. If land E (Figure i) just repays
the expenses of cultivation when one unit of labor and capital
is used per acre, the value of the product per acre of this land
will equal the value of the increment of product attributable to
the third unit of labor and capital used on land A, (That is, the
area deti, Figure i, equals the area bcpq. Figure 2.) So far,
then, as the margin of cultivation is concerned. Figure i repre-
sents the conditions accurately. The productivity of capital and
labor at the intensive and extensive margins are the same. But
Figure i does not represent the complete theory of rent in that
(i) it does not indicate the fact that larger quantities of capital
and labor are used on the better lands than on the poorer lands,
and (2) it does not represent the larger products due to this
more intensive cultivation of the better lands. These considera-
tions are taken account of
in Figure 3, which also, by
the substitution of curves
for successive rectangles,
represents the infinite vari-
ety of degrees of goodness
of the different acres mak-
ing up the land supply of
a country. In Figure 3
the line am represents the
value of a product of a unit
of labor and capital on the
poorest land in use, and the
area hmi represents what
rent would be under con-
ditions of uniform intensivity of cultivation. The area Oamg
represents the diminishing amounts of labor and capital used
per acre as we pass from the better to the poorer lands, while the
356 OUTLINES OF ECONOMICS
area ymg represents the rent per acre of the different grades of
lands. The foregoing analysis leads to the following statement
of the theory of rent, which the reader may verify for himself by
referring to Figures i and 2: —
The rent of any piece of land is measured by Ike difference between
the value of the products obtained from it by the use of the most profit-
able amounts of labor and capital and the value of the products
which could be obtained by the use of the same amounts of labor and
capital on marginal land, or at the intensive margin of cultivation.
This statement should not be understood as comparing the
total product raised on a given piece of land with the total product
which could be got from the same amount of marginal land.
This would be to reintroduce the assumption of uniform inten-
sivity of cultivation — an assumption which impaired the ade*
quacy of the theory of rent illustrated in Figure i above. On the
contrary, it is assumed in the present statement that the farmer
would use whatever amount of the marginal land he found most
profitable. If it were profitable to use twenty times as much
labor and capital on a certain piece of land as on a similar amount
of marginal land, to employ the same amount of labor and capi-
tal profitably on marginal land would take twenty times as much
land.
Rent and the Marginal Product of Land, — In an earlier chapter it was
suggested that rent could be measured by the marginal product of land; in
other words, that the amount which a farmer would pay per acre for the use
of land would depend upon the value of so much of his product as was depend-
ent upon the possession of any one acre of land. In that discussion it was
assumed, however, that land was of a uniform degree of goodness. Obviously,
if all land really were of a uniform degree of goodness, in all ways equally
desirable, no rent would be paid until all lands were utilized, when rent would
arise on account of the necessity of increased intenstvity of cultivation.
But even under the actual conditions of the existence of different grades of
land and of a large body of land which is below the margin of cultivation,
the rent of any acre of the better lands can be stated in terms of the value
of its product. For the rent of any acre of land is measured by the value of
the amount of the product imputed to it (as distinct from the product imputed
to the labor and the capital employed upon it). Now the product that must
be imputed to any acre of land is, of course, the amount which it adds to the
total product, or, what amounts to the same thing, the amount by which the
THE RENT OF LAND 357
total product would be decreased if just as much labor and capital were em-
ployed in agriculture, but if this particular acre of land were not available.
This means, however, that the labor and capital which would haye been
employed on this land would have to be utilized either in cultivating the lands
already utilized more intensively or in cultivating lands previously unculti-
vated; that is, at either the intensive or extensive margin. Obviously
the product imputed to the land in question would be the difference between
the total product got from it and the product Nvhich would result from the
employment of the same amount of labor and capital at the margin. Thus, by
a somewhat different line of analysis, we have again reached the statement
of the theory of rent given in the preceding section.
The Dififoient Uses of Land. — We have seen that] the better
lands will repay a more intensive cultivation than the poorer
lands, and have found this fact to be of great significance in the
theory of rent. By varying degrees of intensivity of cultivation
we do not mean only the more thorough cultivation of the land
in the raising of any one crop. Land produces a great variety
of products, and some of these need much more intensive culti-
vadon than others. In the business of raising cattle, as it is con-
ducted on a large Western ranch, the total investment of capi-
tal and labor may be very considerable, but the investment per
acre of land is very small indeed, while a small market garden,
located near a great city, will repay a very high degree of inten-
sivity of cultivation. It is only on the best lands that crops neces-
sitating a large amount of labor per acre can be raised profitably.
By the best lands we mean in this connection not only those lands
which are best fitted by soil and climate for the production of
particular crops, but the best lands in the sense that they are
nearest the market. For example, cities in the eastern part of
the United States get part of their supply of fresh vegetables
from market gardens in their own environs, while another part
of this supply may come from the Southern states and even across
the continent from California. The local market gardens are
good lands on account of their situation; the more distant lands
are good lands on account of special qualities of soil or climate
which enable them to furnish ''out of season" vegetables.
Because certain lands are adapted, on account of quality or
location, for intensive cultivation, they command high rents.
358 OUTLINES OF ECONOMICS
On the other hand, lands which command high rents generaUy
have to be cultivated intensively, because the entrepreneur is
forced by the very fact of high rent to economize in his use of
land as compared with his use of capital and labor. The raising
of flax as raw material for linen is a profitable agricultural indus-
try in densely populated Belgium, but it has never met with much
success in the United States because flax straw of a quality fit for
the better grades of linen demands a large amount of care and
labor. Land is so plentiful here that it pays us better to special-
ize in a less intensive kind of agriculture — to spread our labor
and capital more thinly over a larger number of acres.
The poorest land that can be profitably used in the growing
of any one kind of product is not necessarily marginal land.
Land too poor to use for market gardening may be good wheat
land; land too poor to devote to wheat may be good grazing land.
The poorest land devoted to any one purpose may yield a rent,
arising from its relative superiority for some other use. It will
be readily understood that the marginal lands used as a bads of
comp)arison in our statement of the law of rent are the poorest
lands used for any purpose — grazing lands, possibly. But, as
we have seen, rent may also be measured from the intensive mar-
gin of cultivation, and the intensive margin is found on all
lands, even the best.
Although all our illustrations of the theory of rent have been
drawn from agriculture, the theory is, in fact, perfectly geneni^.
The rent of land used for industrial or commercial purposes is
determined in precisely the same way as the rent of agricultural
land. In fact, different kinds of manufacturing, wholesale and
retail trading, quarrying, forestry, etc., may be looked upon as
different possible uses of land, differing in the amount of labor
and capital they require, and all subject to the law of diminish-
ing productivity, and hence to the law of rent. W^en we pass
from the agricultural uses of land to its commercial and indus-
trial Uses, the fact of quality becomes of practically no importance
in the determination of rent, while the fact of location becomes
the fundamental one.
In addition to these different productive uses of land, w« haw
THE RENT OF LAND 359
to take account of its other uses, such as for pleasure grounds and
residence sites. Here the explanation of rent is simpler than in
the case of productive lands. For these lands yield their utilities
directly, and hence come under the general law of value. Such
lands command a rent on account of their capacity to satisfy
human wants directly, the extent of this capacity being measured
by their marginal utility. In the case of productive lands, it is
only their products that satisfy human wants direcdy. The
lands themselves are valued according to the specific share of the
valuable product that can be imputed to their productivity, as
distinct from the productivity of labor and capitaL
The Capitalization of Rent. — To the individual who has a cer-
tain amount of money for which he is seeking the most profitable
use, the question whether he shall invest it in land or other f