Chapter 2 - Background

2.4 Crisis

In 1873, the world economy fell victim to the Great Depression. For an interminable twenty-three years, economic life seemed as if on a slippery slope to a destiny neither understood, nor to be escaped. It was little different in America. A first depression began in 1873 and lasted to 1879 – the longest in history. Deflation also set in, lasting twenty years until 1893, when prices were 64% of those of 1873, a free-fall of 36%. (See Exhibit 2.2 Deflation 1850-1950) The many small businesses that constituted competitive capitalism were being shown to be what they really were – small, local monopolies. For those that could not adapt to the new competitive conditions, it meant failure, and, between 1869 and 1879, 64,000, or 15%, of them did. (See Exhibit 2.3 Business Concerns) Paradoxically, 274,000 new businesses formed, a decade over decade growth rate of an astounding 222%. An economy in historic aggregate decline, and, simultaneously, unprecedented churning and new growth among businesses. What were owner-managers of the businesses of competitive capitalism to do? And given the institutional constraints of state-based control, uncertain corporation rights, and the lack of capital markets, what could they do? Out of this caldron of uncertainty and change emerged corporate capitalism – an economy of Big Business and Big Government.

Exhibit 2.2 Deflation 1850-1950

The American depression that began in 1873 happened suddenly. In September, railroads’ defaulted on debt payments and caused a financial panic.106 Speculation in railroad securities collapsed, soon followed by the failures of prominent business firms, brokerages, and banks; the stock exchange closed for ten days; banks suspended currency payments; gold reached a new low by year-end, and silver was demonetized.107 The years to follow were described by those there as a depression and disturbance of industry.108 Economic growth that had seemed so certain, when simply left to the competitive forces of natural liberty, became elusive. Using change in Gross National Product as proxy for economic growth, robust growth of 5.58 percent in the late 1860’s slowed to 2.55 percent by the end of the depression in the period 1893 to 1897 – the first “industrial” depression. (See Exhibit 2.4 Growth in GNP Per Annum)

Exhibit 2.3 Business Concerns (In thousands)

Year	Total factories	Total business concerns	Total business concerns (not factories)	Increase in total business concerns (not factories)	Business failures of the last 10 years	Business churning of the last 10 years
1859	140	230	90	N/A	N/A	N/A
1869	252	427	175	85	24	109
1879	253	702	449	274	44	338
1889	355	1051	696	247	89	336
1899	207	1148	941	245	126	371

Source: Statistical Abstract of the United States, no. 721, p. 745.

Contributing to the severity of the depression of 1873 was the reversal in Federal spending following the Civil War. In 1859, Federal debt totaled $58 million; in 1866, $2,756 million. The Federal Government, in essence, borrowed more than $2.5 billion prosecuting the war.109 The money sloshed around in the economy until extracted – the government began paying down the national debt in 1867, and did so every year but one until 1879 – or until the exchange needs of a market economy used the money.110 Once the Civil War money transient dampened, the drastically reduced demand for goods and services by the Government meant supply chased less demand, and so prices dropped. (The economies between 1869-1873 had average GNP of $6.5 billion; the increases in the national debt in the two years 1865 and 1866 were each more than $600 million, 10% of the then economies.)111

Contributing to the decline of prices as well was the telegraph. The telegraph had been seen for the change agent it truly was as early as 1847: “operations are made in one day with its aid, by repeated communications, which could not be done in from two to four weeks by mail – enabling [businessmen] to make purchases and sales which otherwise would be of no benefit to them, in consequence of length of time consumed in negotiation.”112 In 1869, 8 million telegraph messages were being sent and received. By 1879, the number had jumped to 25 million.113 Information riding lightning made for drastically more transactions, significantly lower transaction costs,114 and prompted the emergence of entirely new markets, such as security trading and commodity markets115 (using contracts never before imagined). Price dispersion, “the measure of ignorance in the marketplace” had been attacked, driving prices lower and uncompetitive firms from the market.

Exhibit 2.4 Growth in GNP Per Annum

Years	GNP Growth
1869-78 to 1874-83	5.58%
1874-83 to 1879-88	4.76%
1879-88 to 1884-93	3.68%
1884-93 to 1889-98	2.55%

Source: Livingston (Robert E. Gallman, “Gross National Product in the United States, 1834 - 1909,” Output, Employment, and Productivity in the United States after 1800 (new York, 1966). Tables 2,6 at pp. 9,22

Lower prices, talk of depression everywhere, record number of business concerns going under, no end in sight – and on the other hand – record numbers of new concerns forming, and for the adaptive firm, new markets with growing demand for product. The telegraph revolutionized business news, and then made it possible for entrepreneurs to act on the news and contact distant buyers or sellers. To them, lower prices meant more business and profits. It also was incentive to successful industrial firms to invest in expanding production capacity.116 Taking excess information and transaction costs out of commerce did not necessarily mean unprofitable business. Marginal sales could still mean very profitable sales, for if the fixed costs of operations were already covered, new, marginal, sales need only recover variable costs before contributing to the absolute dollars of profits.

Businessman acted. The number of industrial firms, those classified as factories, were the same in 1869 as 1879 – 252,000 to 253,000 – but the value of product sold increased by 59% to $5.4 billion, up from $3.4 billion. Taking into account deflation of 16%, unit output grew even faster than dollar growth. (See Exhibit 2.5 Manufactures: Summary, 1849 to 1923) Industrial concerns – increasingly operating as corporations – were getting both larger, in scale and scope,117 and becoming more efficient producers.

Efficiency, or productivity, became essential when declining prices finally began affecting profits. Fortunately, a new source of energy, steam, was becoming more widely used. In the 1870’s, steam became more important than water power for industrial production.118 Steam enabled a gigantic – discontinuous – improvement in the productive layout and location of factories. For those willing to take the business and capital risks of upgrading to steam, the potential rewards were unprecedented. Not until after the turn of the century did steam power give way to electricity. (Electricity first found use in factories as electric lighting,119 and not until the 1920’s would it become the dominant source of power used in manufacturing.)

As factories were designed to leverage the use of steam energy, they could also upgrade to the latest new capital equipment, the assets needed to competitively produce product.120 And new technologies began to affect the productivity potential of capital equipment in the mid-to-late 1870’s, and were ubiquitous in the 1880’s.121 Where did all the innovation come from? As soon as the Civil War was over, the annual number of patents awarded took a step function increase from roughly 6,000 to 20,000 patents awarded a year. (See Exhibit 2.6 Patents 1850-1890) A large number of socio-cultural influences caused inventive activity, including two decades of experience developing “American manufacturing,” building and improving railroads and the telegraph, and government spending during the Civil War.122 The needed executives to manage these expansions and new activities were just then becoming available, owing much to the experience gained building and managing the railroads.

Exhibit 2.5 Manufactures: Summary, 1849 to 1923

Year	Establishments	Wage earners (average)	Primary horse-power	Capital	Wages	Cost of materials	Value of products	Value added by manufacture
Factories and hand and neighborhood industries
1849	123,025	957,059	-2	533	237	555	1,019	464
1859	140,433	1,311,246	-2	1,001	379	1,032	1,886	854
1869	252,148	2,053,996	2,346	1,695	620	1,991	3,386	1,395
1879	253,852	2,732,595	3,411	2,790	948	3,397	5,370	1,973
1889	355,405	4,251,535	5,939	6,525	1,891	5,162	9,372	4,210
1899	512,191	5,306,143	10,098	9,814	2,321	7,344	13,000	5,657
Factories, excluding hand and neighborhood industries and establishments with products valued at less than $500
1899	207,514	4,712,763	-3	8,975	2,008	6,576	11,407	4,831
1904	216,180	5,468,383	13,488	12,676	2,610	8,500	14,794	6,294
1909	268,491	6,615,046	18,675	18,428	3,427	12,143	20,672	8,529
1914	275,791	7,036,247	22,437	22,791	4,078	14,368	24,246	9,878
1919	290,105	9,096,372	29,505	44,467	10,533	37,376	62,418	25,042
Factories, excluding establishments with products valued at less than $5000
1914	117,110	6,896,190	NA	NA	NA	14,278	23,988	9,710
1919	214,383	9,000,059	NA	NA	NA	37,233	62,042	24,809
1921	196,267	6,946,570	-2	-2	88,202	25,321	43,653	18,332
1923	196,309	8,778,156	33,094	-2	11,009	34,706	60,556	25,850

Statistical Abstract of the United States, 1925 (Washington, D. C.: Government Printing Office, 1926)

The rewards of financial success awaited those organizations expanding productive capacity. Successful business concerns acted, and grew in scale and scope. But to do so meant doing business interstate, and having employees and other representatives in other states – two acts, among many, highly constrained by the existing institutions of competitive capitalism. Firm growth also meant new, increased capital investment. During the 1870’s, the period including the longest depression in history, capital investment in factories increased $1.1 billion, up 65%. In the 1880’s, capital investment increased another $3.7 billion, up 134%. Where and how was this new capital raised if the capital markets of the 1880’s did not make it possible?

This then was the crisis: growing markets and technological advances rewarded industrial expansion and the growth of large corporations. Yet expansion also brought corporations into direct conflict with state laws meant to prevent interstate commerce. Nor did the capital markets exist to finance corporate growth. These constraints would be resolved in the next stage of capitalism, corporate capitalism.

Exhibit 2.6 Patents 1850-1890