Growth of Industry after the Civil War

Changes in Industry Struture

• Increase in the importance of manufacturing• Decrease in importance of agriculture• Consider labor force statisitics

Labor Force Expansion, 1860–1910: Select 1910 Multiples of 1860

Notice number of workers in agriculture is not declining, but it is growing more slowly that other industries.

Changing Industry structure

• Some of this change is predictable– Income elasticity of food is low

• As income increase less of the increase is spent on food

– Income elasticity of manufactured goods is higher

• Also see a change in what industries are important

The 10 Largest Industries, 1860 and 1910 (by Value Added)

What accounts for changes in industry structure?

• Notice size of industries grow but some grow more than others

• Increases in income effect demand for goods differently.

• Technological changes is not the same in all industries– Alters relative prices– Alters quality– Reduced demand for woolen clothes, wagons in 1910– Increased demand for machinery, railroad cars

Changing Industry StructureCapital/labor ratio

1840 1.0

1850 1.24

1860 1.82

1870 2.25

1880 2.51

1890 3.78

1900 4.56

Increased importance of capital in manufacturing, leads to bigger firms

Source of Technological change

• Power Sources– # of steam engines doubled from 1860 to 1880

and then doubled again from 1880-1900– Electric power began to replace steam power in

late 1880– By 1890 could power machines with electric

motors

• New machines– Tobacco industry

• Bonsack cigarette machines 60,000 a day, much more than could have been rolled by hand.

– Grain processing machines lead to modern cereal industry

– Boots/shoes• Goodyear welt process

Average costs

Av Cost 1

Av Cost 2

$

Qq1 q2

Technological change causes average cost curve to shift from 1 to 2. Firm size should shift from q1 to q2. Firms will be larger. Also expect a decrease in price of product.

Steel Industry

• Innovations– Bessemer Process and open hearth process kept

iron in liquid form though out process of making steel

• Result was increase in size of Blast Furnaces and increase in steel production– 1860 Blast furnaces produced 6-10 tons of pig iron

per day. By 1910 average production was 500 tons per day

Steel Industry

• Large increase in steel production and big decrease in price of steel rails

• Decrease in price of machinery made of steel– Price of farm machinery falls over 50% from 1870

to 1910

1873 $120/ton

1898 17/ton

1902 28/ton

Oil Industry

• Before Civil War, most oil is used for lighting– 20% from coal– 80% whale oil

• Civil War disrupts whaling, increase in oil prices (First US energy crisis)

• Increases incentives to drill for oil – Oil is discovered in PA, big decrease in price

• 1880, 66% of families use oil for heating

Oil Industry

• Crude oil is refined into kerosene• 1860 1 million barrels, cost $12-16/barrel• 1900 63 million barrels , cost < $1/ barrel• Oil is first distributed by Railroads, then

technological changes allows for distribution by pipelines.

Changes in Firm Structure

• Increase in Plant size– Increase in K/L ratio

• How do firms increase in size– Horizontal Growth

• Bigger plants and/or multi-plant firms• Merger

– Vertical integration (Merger)

• New forms of Ownership– Modern corporation

• All of these trends are related

Vertical Integrations

• Different stages of the production process combined in one firm

• What determines make or buy decisions?– Assume the firms will choose the least cost

method

• Examples from steel and oil.

Two types of Vertical Integration

• Technological changes allows pig iron to be transferred to steel plant in molten form

• Blast furnaces and steel plants integrate• Backward integration into iron mining • Result is large firms

• Even as early as 1870 only 10 firms producing steel in US

• In 1901 US Steel has 65% of market

Oil

• Technological change increases the size of refineries

• Refiners first use railroads to distribute oil• By 1880 refiners integrate forward into

pipelines and backwards into oil production• By 1890, fully integrated

Legal Changes-Rise of the corportation

• Prior to 1880, most firms in the US were owner managed firms which were not incorporated.

• Increase in the number of incorporated firms begins after the Civil War

• Change in the types of firms that are incorporated, large industrial firm– First jt. stock companies are trading companies or

banks or railroads

What does it mean to be incorporated?

• Corporation – Ownership in the firm can be sold to many

investors– Firm is a legal person. – Limited Liability, Firm’s liability is not the owners’

liability• Early Jt stock companies do not have limited liability

Benefits of incorporation

• Spread risk over many owners• Diversification• Shares can be traded

– Incorporation and stock market growth go together

– Before 1890, there were few industrial stocks traded on New York exchange

– By 1914, rare to find a large industrial firm which was not publically held

Costs of incorporation

• Separation of Ownership and Control• What keeps manager’s acting in the

shareholders best interest?

Changes in Industry Structure

• Increase in size of firms, both vertically and horizontally and change in structure of firms cause concern about monopoly power

• Trusts (Organizations of firms to control price and output) and mergers also caused concern

• Firms with monopoly power can restrict output and charge higher prices than firms in a competitive industry.

Firm Growth

• Growth can happen as a result of increase in plant size– Economies of Scale– New technologies change shape of average cost

curve– Should reduce costs and price

• Larger firms are also more likely to have monopoly power.

Firm growth

• Firms could also grow large to increase monopoly power. (Ability to set price above marginal cost)

• Firms could also achieve power to set price above marginal cost through price fixing agreements.– If there are no economies of scale this would be cheaper

than increasing firm size either through growth or merger.– Such agreements were not initially illegal. (Trusts become

common)

– Growth can happen through horizontal mergers

Mergers

• Horizontal Merger wave 1879-1893• Vertical Mergers 1898- 1904• Lots of public concern about these large firms.• Led to the Sherman Anti-trust Act of 1890

When should mergers be illegal?

• Economist’s answer is “it depends” • If merger creates monopoly power and no

efficiency or cost savings it should be illegal• If merger creates no monopoly power it should

not be illegal– Vertical mergers generally do not create monopoly

power

• If merger does both, then court should decide which is larger

• Sherman Antitrust passed in 1890• Outlawed “every contract, combination in the

form of a trust or otherwise or conspiracy in restraint of trade…” illegal.

• Also made it illegal to monopolize or attempt to monopolize an industry

• Not clear what this meant. Determined by the courts

Important Cases

• 1899 Addyston Pipe and Steel Company v. United States ruled cast iron pipe pool illegal

• Price fixing is illegal per se– only defense is “we did not do it”

• Economist agree that cartels create nothing but dead weight loss

• What about mergers or large firms?• 1904 Northern Securities ruled mergers for

monopoly power were illegal• Court ruled against Standard Oil in 1909• Court ruled in favor of US Steel in 1920

– “Size alone is no offense’’

• Mergers or large firms are not per se illegal

Two Questions

• What about mergers during this period were they for monopoly power or cost savings?

• How were Antitrust laws enforced? What were the effect on efficiency?

Cause of mergers?

• If mergers increase monopoly power, prices should increase– If there are no barriers to entry high prices should

attract entry and firms would loose monopoly power and prices would go down eventually

• If mergers were to lower costs and take advantage of economies of scale prices should decrease

Market Share

• 4 firm concentration ratio– Share of industry output produced by 4 largest firms

• Can be misleading• No clear link between structure and performance• Concentration does not increase by that much• Chandler finds evidence that mergers for market

power loose market share over time

Industrial ConcentrationNE 1860 MW

1860S 1860 1901 1963

Machinery 30 15 25 41 93

Iron Bars 29 100 37 46 50

Lumber 10 6 9 .5 11

Cotton Goods

14 99 30 20 30

Prices

• Wholesale price index declines during this period

• Price of steel rails falls from $120/ton in 1873 to $17/ton in 1898 and then is stable at $28/ton from 1902-1919

• Price of farm machinery falls 55% from 1870 to 1910

• Price of oil falls from $24.67 in 1865 to $3.36 in1884

• Evidence does not suggest monopoly power in spite of mergers, trust and other price fixing agreements

• Consistent with what economic theory would predict

Antitrust

• Economic theory suggests practices which do not increase monopoly power should not be prohibited

• Assumes consumer welfare is goal• Law may have other goals

– Protect competitors

• How were cases decided? What was effect on efficiency?

Standard Oil

• Formed in 1872 by JD Rockefeller – Refining– Cleveland, favorable for Rail transport– 10 % of refining market– Market competitive– Attempt to form cartel in 1870s failed– Increases size of Standard oil through merger to get rebate

from RR– Integrates forwards into pipelines in 1880

• Reduced number of firms

• Integrates backwards into oil drilling in late 1880s

• Fully integrated by 1890s• Market share in 1880 was 95%

• Justice dept brought suit in 1911– Predatory behavior in acquiring rivals, reducing

price to reduce value of assets– Not clear this would pay, must be able to increase

price latter on and keep entry out– Not clear whether they did this

• Court ruled against Standard Oil– Broken up into 33 companies

What was effect of decision on efficiency?

• Price had fallen from $24.67 in 1873 to $3.36 in 1884

• Market share was falling as well

• Not clear there was any effect

1880 95

1899 62

1906 70

1911 64

US Steel

• Andrew Carnegie pioneered new techniques in steel production– Carnegie Steel had 15-20 % of market in 1898

• JP Morgan created Federal Steel by merging several companies in 1898. About same size as Carnegie Steel

• US Steel result of merger of these two companies in 1901. Had about 65% of market.

• Justice dept brought suit in 1911, not decided until 1920

• Court ruled in favor of US Steel in 1920 – “Size alone is no offense’’

• Market share was 40% in 1929• Prices 1873 120/ton

1898 17

1902-1919 28

• US Steel was not dissolved because it did not lower prices competitively

• Good for competitors, not for consumers

• Overall, not clear what effect antitrust laws have had on industry structure or efficiency