EH.net is owned and operated by the Economic History Association
with the support of other sponsoring organizations.

The International Origins of the Federal Reserve System

Author(s):Broz, J. Lawrence
Reviewer(s):Wheelock, David C.

Published by EH.NET (June 1999)

J. Lawrence Broz. The International Origins of

the Federal Reserve System. Ithaca: Cornell University Press, 1997. xiii

+ 269 pp.

$35,ISBN: 0-8014-3332-0.

Review for EH.NET by David C. Wheelock, Federal Reserve Bank of St. Louis.

Why was the Federal Reserve System established? The common view is that the

Fed was established as a public good to correct deficiencies in the U.S.

banking and payments system that made the system inefficient and prone to

crises. Reform proponents blamed crises on the nation’s “inelastic currency”–

stocks of currency and bank reserves that did not adjust with seasonal or

cyclical fluctuations in demand, let alone in response to bank runs. Other

proponents of reform pointed to the difficulty of making inter-regional

payments, citing long delays and high costs associated with the clearing of

checks and drafts. Still other reformers decried the concentration of bank

reserves in the central money markets and the investment of correspondent

balances in stock market call loans. A less import ant goal of reformers, the

traditional view argues, was to promote use of the dollar in international

trade and finance.

J. Lawrence Broz argues that the goal of promoting the dollar as an

international currency was in fact the primary consideration of reform

proponents, and that reform was achieved only by alignment of strong private

interests for promoting international usage of the dollar with the general

public interest of improving the stability of the U.S. payments system. The

establishment of the

Federal Reserve System thus fits a “joint products” model, in which

institutional change produces a public good, but occurs only because of the

efforts of a narrow interest group seeking private gain.

The United States’ share of world exports, particular ly of manufactured goods,

rose during the last decades of the nineteenth century, and by the early

twentieth century the Untied States enjoyed an increasingly persistent current

account surplus. Despite these gains, the dollar was not used widely in inter

national commerce because, Broz contends, U.S. banks were prohibited from

issuing bankers acceptances to finance international trade and the U.S. lacked

a central bank with the power to create liquidity as needed by re-discounting

commercial paper. Because the dollar was not an international currency,

American exporters faced exchange risk and high transactions costs, while

American banks were largely shut out of the market for financing international

transactions. A coalition of leading bankers and manufacturers thus developed

with the goal of enhancing the dollar’s role as an international currency by

reforming American banking laws and institutions.

For the dollar to be acceptable to international markets, the stability and

efficiency of the U.S. banking and payments system had to be enhanced.

Thus, the interests of large U.S. banks and exporters aligned with the public

interest generally. The creation of the Federal Reserve System, Broz argues,

was an institutional reform that was consistent with both sets of interests.

Various alternatives for improving the domestic payments system, such as

adoption of nationwide branch banking, were insufficient to meet the interests

of internationally-oriented bankers and businessmen, and hence failed

to inspire a

strong coalition to push for their adoption.

Broz points to two features of the Federal Reserve Act that were crucial for

gaining acceptance of the dollar for international payments. First, the act

permitted U.S. banks to issue bankers acceptances to finance foreign trade.

Second, the act established facilities to re-discount acceptances and other

commercial paper, thereby adding depth and liquidity to the U.S.

money market. Other features of the legislation directly benefiting large banks

included a reduction of reserve requirements and authority for banks with

capital of at least $1 million to establish foreign branches. The legislation

thereby solved, apparently, the problems of an inelastic currency and an

inefficient payments system, while promoting the dollar’s use as an

international currency.

While the fundamental reforms embedded in the Federal Reserve Act provided the

key ingredients for promoting the dollar as an international currency,

specific features of the Act reflected give and take among various private and

public interests. Banks outside the central money market, for example,

were strong proponents of a currency backed by commercial paper, while New York

City bankers by and large preferred a currency backed by government bonds.

Banks

outside New York City also favored a decentralized system that limited the

ability of New York City banks to dominate. Bankers in general and many in

Congress favored a system controlled by banks themselves, but the Wilson

Administration, and especially

William Jennings Bryan, pushed for strong public oversight in the form of a

Federal Reserve Board. The Federal Reserve System was the product of compromise

at every stage and detail.

Broz supports his study of the origins of the Federal Reserve by examining how

well the founding of other central banks fit his joint products model.

The central banks he considers are the Bank of England, and the First and

Second Banks of the United States. In contrast to the Federal Reserve, each of

these banks was created

in part for government revenue. In exchange for providing loans on favorable

terms to the government, the owners of the banks were granted certain monopoly

privileges. The Bank of England was given a monopoly over note issuance, while

the First and Second Banks of the United States profited as the government’s

fiscal agents, as well as from their unique ability to branch nationwide. Broz

argues persuasively that the Bank of England survived, while the two U.S. banks

did not because in the United States federalism created a potent political

opposition that could be exploited by private enemies of the central bank.

While Andrew Jackson’s militant “hard money” philosophy explains his opposition

to the Second Bank, Wall Street bankers also sought to kill the

Bank on the grounds that its monopoly position as the government’s fiscal

agent gave the Bank advantages that state-chartered banks did not have.

I find little to quibble with Broz’s explanation of the origins of the Federal

Reserve System. Clearly the

most ardent proponents of establishing a central bank, especially the New York

bankers, sought to establish a major international money market in the United

States and to promote the dollar in international commerce and finance. There

was, however, strong

opposition to the establishment of a “central bank,” particularly one dominated

by New York bankers, and key players in shaping the Federal Reserve Act, such

as Carter Glass, William Jennings Bryan and Woodrow Wilson, sought to limit the

influence on the

System of New York banks.

Nonetheless, Broz has persuaded me that establishment of the Federal Reserve

required the ongoing support of leading banks and others who sought to firmly

establish the U.S. dollar as an international currency. I highly recommend

this book for anyone interested in either the history of the Federal Reserve or

other central banks, or for those interested in the origins of institutions and

institutional change more broadly.

David C. Wheelock is Assistant Vice President and Economist at the Federal

Reserve Bank of St. Louis. His research interests are the history of the

Federal Reserve System and other monetary policy institutions, and the

regulation and performance of commercial banks.

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):North America
Time Period(s):20th Century: Pre WWII

The Defining Moment: The Great Depression and the American Economy in the Twentieth Century

Author(s):Bordo, Michael D.
Goldin, Claudia
White, Eugene N.
Reviewer(s):Cain, Louis P.

Published by EH.NET (September 1998)

Michael D. Bordo, Claudia Goldin, and Eugene N. White, editors, The Defining

Moment: The Great Depression and the American Economy in the Twentieth

Century. An NBER Project Report. Chicago: The University of Chicago

Press, 1998. xvi + 474 pp. $60.00 (cloth). ISBN: 0-226-06589-8

(cloth), 0-226-06589-8 (paper).

Reviewed

for EH.NET by Louis P. Cain, Departments of Economics, Loyola University of

Chicago and Northwestern University.

The “moment” is the Great Depression; what is being “defined” is public policy.

The editors have assembled twelve papers from a distinguished cast of authors

who are closely associated with their subject. The papers discuss almost all

of the programs that persisted from the First and,

particularly, the Second New Deals, but few of those that did not. In their

introduction,

the editors discuss that this is potentially a controversial hypothesis, but

most of the papers simply explain why they agree or disagree with the

proposition, and some do find this was NOT a

“defining moment.” Whether each reader ultimately accepts or

rejects the hypothesis may be little more than a matter of definition.

In any event, each of the papers makes a substantial contribution to our

understanding of the depression. Most will be widely cited. Many readers,

including undergraduates, will want to consult the volume for more than one

paper. Thus, in the interest of disclosure, a thumbnail sketch of each of the

papers is appropriate. These brief synopses emphasize the relation of each

paper to the volume’s general theme. Each contains much more.

The

collection is divided into four sections of three papers each. The first is

entitled “The Birth of Activist Macroeconomic Policy.” Charles Calomiris

and David Wheelock ask whether the substantial changes in the monetary

environment of the 1930s had lasting effects? Those familiar with Wheelock’s

work will not be surprised to note they find little change in the thinking of

the Federal Reserve System. One effect of the New Deal banking laws was to

shift power from the Fed toward the Treasury,

a shift they feel imparted an inflationary bias, especially when conjoined with

the more activist approach to policy that was undertaken concurrently. The

most important legacy of the depression was the departure from gold creating

“the permanent absence

of a ‘nominal anchor’ for the dollar” (63).

The Bretton Woods dollar system allowed the Fed to “stumble” into the inflation

of the 1960s, and the continued absence of something like the gold standard

“provides an enduring legacy of uncertainty” (63) as to monetary policy in the

long run.

Brad De Long notes that the U.S. did not have a fiscal policy

in the

contemporary sense of the term before the Great Depression. It borrowed

heavily during periods of war and tried to redeem the debt as quickly as

possible during periods of peace. Government deficits in peacetime were rare

until

the 1930s, when they proved unavoidable despite the fiscal conservatism of both

Hoover and FDR. Yet, even before Keynes, there was an understanding that

“deficits in time of

recession helped alleviate the downturn” (83). After the second World War, a

fiscal policy consensus emerged that De Long characterizes as: “set tax rates

and expenditure plans so that the high-employment budget would be in surplus,

but do not take any steps to neutralize automatic stabilizers set in motion by

recession” (84).

That consensus proved hard to maintain: “The U.S. government simply lacks the

knowledge to design and the institutional capacity to exercise discretionary

fiscal policy in response

to any macroeconomic cycle of shorter duration that the Great Depression

itself” (82). What has persisted is the willingness to adopt a fiscal policy

stance that imposes a cost — perhaps higher than necessary (higher inflation,

lower saving and productivity) — to insure that there is no return to

Depression-era conditions.

Deposit insurance, the topic of Eugene White’s essay, was a result of the

Depression and is generally considered to be one of its great successes.

Banks became a scapegoat, and the

restrictions placed on the banking business diverted part of what they once

did to other parts of the financial sector. Banking became smaller than it

might have been. Deposit insurance was an attempt to insure the banking system

did not fail again.

White attempts to estimate bank failures under the assumption that deposit

insurance was not adopted. He finds that a stronger, larger banking system

would have resulted in lower failure rates and higher recovery rates.

Thus, it is possible the FDIC increased bank losses. A more important outcome

is that the FDIC changed the distribution of losses. The cost of those losses

is now “distributed to all depositors and hidden in the premialevied on banks”

(119). Thus, even if losses increased, they were unseen by individual

depositors, with the result that a marginal institution remains extremely

popular.

The second part, “Expanding Government,” begins with a paper by Hugh Rockoff on

the expansion of the government sector, largely as a result of a large number

of new federal programs. As Rockoff notes,

“it is easy to see that there was an ideological shift … it is harder to see

what produced it” (125). This ingenious article looks back at the publications

of economists in the 1920s and earlier and finds there were champions for

almost all of the New Deal programs. Curiously, one of the programs economists

did not endorse, one measure that FDR did not champion, was deposit insurance.

When the Depression came and the economic doctors were called, microeconomists

had what they considered successful prescriptions. Some part of that must have

been conditioned by the role of the government in World War I. But another

part is something that Rockoff does not discuss, and it surely is one of the

factors producing an ideological change within the profession.

Even before the Great Depression, the competitive paradigm was under attack.

The merger movement at the turn of the century called into question the

assumptions of constant returns to scale and easy entry and exit. The

emergence of a consumer society called into question the assumption of

homogeneous products. Robinson and Chamberlin’s models are independent of the

Depression, and what impact they would have had in the absence of the

Depression is unclear. It is clear that FDR came into the White House with a

mandate to do something, and the economic doctors had a long list of things to

try, things that had been used successfully elsewhere.

John Wallis and Wallace Oates argue persuasively that the New Deal had a

profound effect on the nature of American federalism through its use of a

little used fiscal instrument — intergovernmental grants. Before the

Depression, different levels of government operated with a much greater degree

of independence than they would thereafter. Intergovernmental grants created

the necessity for cooperation that has characterized the fiscal federalism ever

since; “fiscal centralization and administrative decentralization” (170). They

argue that the new structure was conducive to the growth of government. Like

Rockoff, they note the growth of the federal government did not come at the

expense of state and local governments; both grew. They show how this new

pattern was “the result of the struggle between state and national

governments, and also between the president and Congress, for control over

these programs” (178). How much of this has to do with a states rights’ bias

in the legislative and judicial branches, and how much with the depression

itself, is uncertain.

Gary Libecap examines the regulatory laws effecting agriculture between 1884

and 1970 and the budgetary expenditures that were derived from those laws

between 1905 and 1970. His contention is that “the New Deal increased the

amount and breadth of agricultural regulation in the economy and …

shifted it from providing public goods and transfers to controlling supplies

and directing government purchases to raise prices” (182).

Acreage restrictions and government purchases were the most apparent of what

he terms, “unprecedented, peacetime government intervention into agricultural

markets” (216). Abstracting from those policies, Libecap asks what

agricultural policy might have been in the absence of the Depression.

He believes it would have been more like it had been, but that is the result

of an exercise in which he subtracts laws passed after 1939 with a direct link

to “key New Deal statutes.” One wonders how many any of those statutes would

have been passed in any event; some represent ideas that pre date the

depression.

In the first paper of Section III, “Insuring Households and Workers,”

Katherine Baicker, Claudia Goldin, and Lawrence Katz note that there are three

differences between the system of unemployment compensation in the U.S. and

elsewhere: experience rating, a federal-state structure, and limitations on

benefit duration. The question they address is how that system would have been

different had it not been created during the New Deal. There is an implicit

assumption the U.S. ultimately would have adopted some form of unemployment

compensation in the absence of the Depression. To how many other New Deal

programs is this assumption relevant? The authors point to the federal-state

structure as the key difference. Their counterfactual

system is strictly a federal system with no experience rating, a system

consistent with the administration’s recommendation. We got the system we did

because, “The federal-state structure and the manner in which the states were

induced to adopt their own

UI legislation assured passage of the act and guaranteed its

constitutionality” (261). They criticize the system for not having

“changed with the times,” but that is no surprise after reading Wallis and

Oates.

While most people look to the labor legislation of the 1930s as “a defining

moment,” Richard Freeman argues that to be defining an event must “lock in

certain outcomes that persist … when, given a blank slate, society could have

developed something very different” (287). This test creates two interesting

dichotomies in Freeman’s story. The first concerns the framework versus the

results. The legal framework for private sector labor relations has persisted,

and Freeman considers that framework to be

“outmoded.” On the other hand, the unionization attendant to the adoption of

that framework “looks more like a diversion from American

‘exceptionalism’ … than a critical turning point in labor relations”

(287). The density of private sector unions today is similar to what it was

just after the

turn of this century; the voice of those unions in national political discourse

is barely audible. The second dichotomy concerns private versus public unions.

State regulation of the latter has resulted in a relatively stable environment

in which collective bargaining proceeds with less confrontation, but that may

be because public sector managers are not as accountable to the taxpayers as

private sector managers are to the company’s profits. In sum, Freeman

acknowledges that the framework in which lab or relations takes places was

defined during the Depression, but that was not a “defining moment” for labor

relations.

In their study of the creation and evolution of social security, Jeffrey Miron

and David Weil do not examine the role the Great Depress ion might have played

in the program’s adoption. Their emphasis is on the evolution of the program

since its inception. They find that “in a mechanical sense,

there has been a surprising degree of continuity in social security since the

end of the Great

Depression” (320). That is, there has been little change in what each of the

parts does; it is clear the balance between them has changed and that change

has had an impact on the economy. As the population has aged, the balance

between the old-age assistance component,

the basic response to the depression, and the old-age and survivors insurance

component has transformed what was an insurance program benefiting few to a

transfer program benefiting many.

Doug Irwin’s paper on trade policy begins the final section, “International

Perspectives.” Irwin shows that, during the 1930s, the locus of control of

trade policy passed from the legislative to the executive branch of government

largely as a result of “the depression as an

international phenomenon”

(326). Smoot-Hawley marked the end of the old approach. By the end of the

1930s, the average tariff rate had decreased from over 50% to less than 40%.

In another ten years it would be below 15%. While part of this change is

attributable to trade policy,

part should be attributable to fiscal policy (a return to the days of the

Underwood tariff) as the federal income tax came to play a much larger role,

especially in the 1940s. Similarly, the Reciprocal Trade Agreements Act was

passed during the depression, but it was not “institutionalized”

until after World War II. When, during the war, Republicans moved to seek

congressional approval and to protect domestic firms competing with imports, it

was clear that the policy changes of the 1930s would persist. Then, after the

war, “the new economic and political position of the United States in the world

… made a return to Smoot-Hawley virtually unthinkable” (350).

The paper by Maurice Obstfeld and Alan Taylor is in many ways the most

expansive in the volume. They begin by investigating more than a century of

data on capital mobility, then propose a framework in which both the downtrend

initiated by the Great Depression and the uptrend of recent years can be

understood. The framework is a policy “trilemma” faced by all national

policymakers: “the chosen macroeconomic policy regime can include at most two

elements of the ‘inconsistent trinity’ of (i) full freedom of cross-border

capital movements, (ii) a fixed exchange rate, and (iii) an independent

monetary policy oriented toward domestic objectives” (354). To the authors,

the

Great Depression was caused by subordinating the third element to the second.

Under the classic gold standard, monetary policy was concerned with exchange

rate stability, not

domestic employment, and capital mobility was facilitated. The abandonment of

gold led to a system

“based on capital account restrictions and pegged but adjustable exchange

rates, one whose very success ultimately led to increasingly unmanageable

speculative flows and floating dollar exchange rates….” (397).

The gold standard plays an equally prominent role in the paper by Michael Bordo

and Barry Eichengreen. To address the question of what the Great Depression

meant for the international monetary sy stem, they examine a counterfactual

world without the Great Depression — but with World War II and the Cold War.

They assume the gold standard would have persisted through the 1930s, been

suspended during the war, and resumed in the early 1950s. Under

these assumptions, “the depression interrupted but did not permanently alter

the development of international monetary arrangements”

(446). The system that did develop in the U.S. was very different than the

hypothesized one, but the factors that ultimately led to the collapse of the

Bretton Woods arrangements would have caused the collapse of the gold standard

– and possibly at an earlier date. Those factors include “the failure of the

flow supply of gold to match the buoyant growth of the world economy and hence

of government’s demand for international reserves” (447).

This, in turn, led to questions about U.S. official foreign liabilities and the

gold convertibility of the dollar. Bordo and Eichengreen believe that,

in these circumstances, a floating system would have resulted leaving us with

more or less what we have today. If one accepts the “ifs” in their argument,

the institutional structure that emerged in the wake of the Great Depression

postponed the transition.

This is a remarkable thought on which to end this volume. Calomiris and

Wheelock discuss the Fed’s recent emphasis on price stability as a short-run

policy concern as a “throwback.” Obstfeld and Taylor discuss the deregulation

and recent growth of the financial sector as creating

a barrier to the reimposition of capital controls. Both discussions concern

long-run adjustments the economy has made as a result of the abandonment of

gold, but both would have taken place had there been no Great Depression if

Bordo and Eichengreen are

correct.

The editors point to four common themes supporting the “defining moment”

hypothesis (6). “First, skepticism about the efficacy of government

intervention withered as the public adopted the attitude that the government

could ‘get the job done’

if the free market did not.” It is unquestionably the case that there was a

loss of faith in the tenets of the competitive model. While this faith was

wavering among social scientists well before the depression, the general

bewilderment of the 1930s created a search for someone who was willing to try

anything. To paraphrase the late John Hughes, before the Great Depression the

federal government only knew how to spend money on rivers, harbors, and post

offices. As Rockoff documents, there were a number of other projects waiting

in the wings.

“Second, many innovations introduced by the New Deal were forms of social

insurance.” While much of the First New Deal took the form of World War I

programs modified for peacetime use, many of the Second New Deal programs were

aimed at ameliorating specific types of suffering, particularly those where

successful experiments had been tried elsewhere. Some undoubtedly would have

been adopted eventually; the depression meant they started earlier than

otherwise would have been the case.

“Third, the character of federalism moved from ‘coordinate’ to

‘cooperative’ with extensive intergovernmental grants, giving greater influence

to centralized government.” This change in form, it is argued,

was necessary to get them through Congress and the Supreme Court, but that is

not necessarily a result of the Great Depression; the states rights’ bias was

present much earlier.

“Last, the conduct of economic policy … changed to give more weight to

employment targets and less

to a stable price level and exchange rate.”

These changes in turn imparted what several authors refer to as a bias in favor

of inflation, but, in a simple Phillips curve world, what developed was a bias

against a return to the conditions of the 1930s. To put it as simply as

possible, those who lived through the Great Depression defined for

policy-makers then and for their grandchildren today that all possible steps

should be taken to avoid repeating the trauma.

Louis P. Cain Departments of Economics Loyola University of Chicago and

Northwestern University

Louis Cain and the late Jonathan Hughes are the authors of American Economic

History published by Addison Wesley. Cain’s article with Dennis Meritt,

Jr., “The Growing Commercialization of Zoos and

Aquariums,”

appeared in the Journal of Policy Analysis and Management, Spring 1998.

His article with Elyce Rotella, “Urbanization, Sanitation, and Mortality in the

Progressive Era, 1899-1929,” will appear in Gerard Kearns, W.

Robert Lee, Marie C. Nels on, and John Rogers, editors, Improving the

Public Health: Essays in Medical History.

Subject(s):Economic Planning and Policy
Geographic Area(s):North America
Time Period(s):20th Century: Pre WWII

Socializing Capital: The Rise of the Large Industrial Corporation in America

Author(s):Roy, William G.
Reviewer(s):Levenstein, Margaret

H-NET BOOK REVIEW Published by H-Business@eh-net.muohio.edu (August, 1998)

William G. Roy. Socializing Capital: The Rise of the Large Industrial Corporation in America. Princeton, N.J.: Princeton University Press, 1997. xv + 338 pp. Figures, tables, notes, bibliography, and index. $35.00 (cloth), ISBN 0-69-104353- 1.

Reviewed for H-Business by Margaret Levenstein , University of Michigan

This book is extraordinarily ambitious and wide-ranging in its treatment of a very significant topic. At times Roy focuses specifically on the merger wave of the 1890s during which many large firms turned to public capital markets to facilitate mergers. But much of the book, and, from my perspective, the most interesting parts, take a much longer term view, examining changes in property rights and the use of those rights by railroads and then manufacturing firms over the course of the century. Most of the central points of the book I think are correct and many of Roy’s methodological points provide useful correctives to tendencies in business and economic hi story. There were sections of the book that I found insightful bordering on brilliant. There were also sections of the book that I thought were unconvincing, and others that were simply wrong.

The central points of the book can be summarized as follows :

1. The large, widely-held manufacturing corporation is a social creation, not a natural entity.

2. The corporation as it exists today is historically contingent and developed from pre-existing forms. In particular, it evolved from the public corporation, used by the state to accomplish public purposes and was given special privileges (monopoly, eminent domain, limited liability) in order to do so. The happenstance convergence of the economic crisis of 1837, the emergence of the railroad, and the po wer of the “anti-monopoly, anti-state” version of Jacksonian anti-corporatism privatized and democratized the corporation. Thus the corporate form retained many of its privileges (limited liability, alienability of ownership) but made those privileges available to all through general incorporation laws. In doing so, the corporation lost its public purpose and its public accountability (as well as its claim to monopoly).

3. There existed historical alternatives. Manufacturing could have continued to be conducted in firms that were not corporations. The corporate form could have retained its public purpose and its public accountability. The state could have remained a more active economic player in its own right — owning railroads or banks or manufacturing as today the state owns highways. It could have developed a stronger regulatory apparatus, developing the capability to administer public enterprises and assure that those who received the privilege of incorporation fulfilled a public responsibility. In other words, the boundaries between public and private could have been drawn quite differently in many dimensions.

4. Manufacturing firms followed the incorporation practices of railroads because that was required by investment banking firms to get access to large pools of capital, not because the corporate form was demanded by manufacturers to coordinate increasingly complex, large-scale, high-throughput technology.

5. Manufacturing firms (the “trusts”) turned to New Jersey’s incorporation law in order to legalize collusive activities, not to coordinate increasingly complex, large- scale, high-throughput technology.

6. The corporation was privatized – lost its public use and public accountability – and the corporation was socialized – its securities widely owned but no longer controlled by owners – not because this organizational form was the most “efficient” way to organize manufacturing production. Rather, manufacturing firms embrace and continuing use of the corporate form was the result of a “logic of power.”

Roy uses several methods to make his case. He first presents a theoretical argument that a “social logic based on institutional arrangements, including power” (p. 6) is more useful for understanding the dimensions and dynamics of the economy than is an analysis based on “the logic of efficiency.” The latter position he identifies with Chandler, and much of the book is cast as a polemic against Chandler. While I am very sympathetic to his historicizing and “de-naturalizing” of the corporation, I thought this framing of the issue was largely counter- productive. His presentation of Chandler sometimes bordered on caricature. Chandler’s point is not that managers are concerned only with efficiency or that clever managers always pi ck the most efficient organizational design. His point is that it was only in firms where managers made choices that gave the firm a competitive advantage that the firm survived. But Roy ignores the role of competition. He argues that “efficiency theorists” are functionalists, simply providing an ex post rationalization of whatever happened to emerge. While he is certainly correct that some business history is functionalist, and neo-classical economic historians are apt to fall back on “best of all possible worlds” descriptions of whatever institutions exist, the competitive model does provide a story of why it is that we should think that those that survive are different from those that didn’t; their survival is taken as an indication that they are better at competing. Thus it would have been useful to explain how power influenced who survived the competitive process and how power determined the rules of the competitive process. That is, it would have been useful to explain why the firms that survive the competitive process are not necessarily the most efficient. Instead, for the most part, Roy simply ignores competition as a significant force in capitalist economies, arguing that “the social arrangement that governed American industry could only vaguely be described as a market. American businessmen have always been aware that they share common interests at least as much as they compete over conflicting interests” (pp. 176-7). Roy is absolutely correct that American businessmen have often cooperated. But that does not mean that there is no market; it means that those who have been able to cooperate, and better yet, dominate cooperative agreements, are the firms that have survived and prospered. I would dispense with the word “efficiency” altogether. A more useful question is whether firms survived because they were good at inventing new, lower cost technology, good at getting workers to work harder, good at getting tax breaks from local governments, good at increasing demand for their product, good at getting access to others’ property through eminent domain, good at getting cheap capital because of connections to investment bankers. Whether or not any of these particular attributes improves efficiency or is a Good Thing for society as a whole (as if there is such a thing) is an altogether separate question.

Roy then turns to an econometric test of the “power” and “efficiency” explanations. He asks which industries were more likely to adopt the corporate form during the 1890s merger wave (which he measures by their use of publicly-traded securities, thus excluding incorporated firms that were not traded on public exchanges). He finds that average size of the firm and capital intensity are significantly and positively related to an industry’s use of publicly-traded securities. He also finds that labor productivity was negatively related to the use of such securities and that industry growth rates were insignificant. He concludes from this that Chandler and “the efficiency theorists” are wrong. Size matters even when controlling for other things. Labor productivity is lower in “incorporated” industries, so it must not be that incorporation makes firms more efficient. There are several problems with this analysis: he looks only at the 1890s and therefore conflates where the merger wave took place with where the corporate form endured. He groups “Chandlerian” causes of incorporation (growth and capital intensity) with effects (i.e. labor productivity); perhaps the negative relations hip between productivity and incorporation reflects the need for organizational change in low-productivity industries? His unit of analysis is the industry, which groups together large and small firms, and he treats large industries and small industries equivalently. Are we surprised that there are no large firms in the hammock or lapidary works industries despite a faster rate of growth than electrical machinery (p. 30)? Chapter two, which presents this econometric analysis, should be skipped entirely by anyone who has read Naomi Lamoreaux’s The Great Merger Movement (and if you haven’t read it you should). Lamoreaux presents a much more convincing and complete econometric rejection of the Chandlerian contention that the merger wave of the 1890s was motivated by the need for vertical coordination of inherently high-throughput technology. Save your time for the more edifying chapters to come.

In Chapters 3 and 6, Roy compares the history of public enterprise, the legal rights of corporations, and the emerging dominance of “socialized capital” in three states: New Jersey, Pennsylvania, and Ohio. He examines the evolution of the corporation from a tool used by states to encourage economic development and raise revenues to its emergence as a private agent, available to all through general incorporation statutes with no public responsibility or accountability. Roy argues that the differences in the experience of public investment during the canal and early railroad period, as well as the political interpretations placed on that experience, determined the rules under which corporations operated in each state at the end of the century. New Jersey had the most limited experience with public corporations, both quantitatively and qualitatively. It participated as an investor in the Camden and Amboy, and was able to keeps its taxes low as a result, but the railroad controlled the state rather than the other way around. Pennsylvania had both mixed corporations in which it invested and public corporations. Ohio had the most activist policy, both the most successful- the Ohio canal system developed the region and integrated it into the national economy – and the most spectacular failure when logrolling resulted in the expansion of public subsidization of canals and railroads and nearly bankrupted the state. Roy examines the implications of these different experiences for three aspects of corporate law: the permissibility of corporations owning other corporations, the powers of boards of directors (relative to shareholders), and the extent of limited liability. Roy finds that in all three aspects of corporate law, the experience with public and mixed corporations during the canal era shaped state attitudes such that New Jersey’s corporate law was the most “privatized,” allowing corporations broad flexibility in owning other corporations, giving power to corporate boards, and extending unlimited liability through both a general incorporation statute and special charters. Ohioans were at the other end of the spectrum, suspicious of the corporate form, retaining double liability and strictly limiting the activities of corporations to those for which they were chartered. Roy finds that these differences in corporate law led to differences in the importance of corporate capital in the three states. While some of this difference in corporate capital obviously reflects capital mobility – corporations with operations elsewhere chartered in New Jersey to take advantage of its lax laws – Roy’s fundamental point is that business in Ohio was simply less likely to be organized within a corporation. Thus, he suggests, economic activity need not have taken place within the socialized corporation, or at least not within a corporation with no social responsibility . Where the state legislature was unwilling to confer such generous benefits on the corporation, businesses made do with other forms of organization.

This empirical conclusion supports Roy’s argument that there were actually two distinct political responses to the canal crisis within the Jacksonian anti-corporate movement. One demanded more accountability on the part of the quasi-public corporation (i.e. more government) while the other demanded privatization (less government). Roy makes the interesting argument that the privatization ideology won out because it was self-fulfilling. Suspicion of the state led to weak oversight. With no oversight, projects were corrupt or failed; that failure was then interpreted as the failure of public investment (p. 74). But it is not clear from his comparison of the three states that strong state oversight was ever really in consideration. As he shows elsewhere in the book, the choices considered were either democratization of access to corporate privileges through general incorporation statutes or limitation of those privileges by statutes such as Ohio’s requiring double liability and strictly limiting the activities of corporations to those for which they were chartered.

Here and elsewhere, Roy compares the choices made in the United States to those made in France where a strong and competent state apparatus was created. This comparative perspective, though presented more casually than those between the U.S. states, is often very helpful. Unlike the U. S. case where states competed with one another and were, therefore, forced into a prisoner’s dilemma race to the bottom in terms of the social responsibilities of private actors, France was able to chart a very different course. Whether the “strong state ” approach was one that could ever have emerged in the United States will, of course, be debated by many. But that is not Roy’s point. The point is that there is nothing natural or inevitable about the present configuration of rights and responsibilities that constitute the corporation.

Chapters 4 and 5 examine the way that the railroad and investment banking influenced the construction of the corporation. Many of the generalizations he makes in his history of the railroads will not sit well with most economic and business historians. One could read these chapters and think that the railroads were a failure, both privately and publicly. For the most part, neither was the case. And the reader might understandably be confused when he presents Rockefeller’s demand for railroad rebates as an example of how the railroads exercised power. But try to ignore that and focus on the his fundamental point. The financing of railroads was not simply corrupt, or political, or determined by power games among the major players (though all that was certainly the case). The development of institutions to finance railroads determined the set of institutions that industrial corporations could choose from when they needed to finance growth and short term operations. The structure of those inherited institutions favored concentrated over unconcentrated industries, favored incorporation and management-owner separation, perhaps favored some technologies, organizations of work, and regions over others. This point is important and profound. The evidence he gives in its support is not always well organized to make his point. But the challenge that he lays out is clear. The observed choices of corporations are not necessarily the optimal ones in a global sense. They are the choices corporations made given the incentives created by institutions created for a different purpose and as part of deeply politicized process.

Chapters 7 and 8 return to the merger movement of the 1890s. He correctly argues that it is wrong to see this period as one of a shift from a competitive market to an administered or monopolized one. U.S. firms had been cooperating to control prices in many industries throughout the nineteenth century. In fact, he argues, it is only with the emerging dominance of a “free market” ideology that the state makes the strong distinction, now taken for granted in anti-trust law, between contracts promoting trade and those in restraint of trade. Others will argue that there was a long-standing tradition in common law not to enforce contracts in restraint of trade. But there is also a long-standing tradition of allowing quasi- public organizations, such as guilds and corporations, to engage in behavior that we would today think of as monopolistic. Roy perhaps takes this argument too far when he says, “If governments did not enforce contracts between buyers and sellers, markets would collapse by the same sort of opportunism that wrecked the pools” (p. 190). While the current state of the economy in Russia reflects the underlying truth of this statement, we should also recognize that there is not the same inherent incentive to deviate from a mutually beneficial contract to exchange that there is with a contract to restrict output or fix prices. It is true that the state creates and enforces markets, but there is a difference between a self-enforcing contract and one that is inherently a prisoners’ dilemma.

This chapter includes a very interesting section examining the interaction between the first use of the New Jersey incorporation statute and the terms of the statute. He not only shows that the writing of the statute was the result of a complex political process. He also shows that the way that it was used differed substantially even from the purposes of the first corporations for which it was written.

In these chapters he presents the histories of particular industries, arguing that their use of the corporate form cannot be explained by changes in their technology (i.e. by managerial demand). The histories of the sugar and tobacco industries, familiar to business historians, are re-told in a new light. Rather, he argues, the desire for monopoly control and the expectation of financiers that the corporate form would be used, led firms to incorporate. He also makes the interesting argument that the merger wave of the 1890s changed the expectations of investors so that “when a group of entrepreneurs wanted to establish a large-scale industrial enterprise, henceforth the standard procedure would be to mobilize the resources of the corporate institutions by recruiting investment bankers, brokerage houses, and the investment press in order to attract sufficient capital” p. 254. Prior to the 1890s it was deemed acceptable for Andrew Carnegie to operate his steel business as a limited partnership; after the merger wave of the 1890s investors perceived non- corporate firms as higher risk. Trying to operate outside the corporate sphere was now a more costly choice, but only because the prior history had changed investors’ (and investment bankers’ in particular) ideas about how business had to be organized.

The comparison of the three states is intended to suggest that there were various paths that the development of the corporation could have taken. But sin ce the corporation is now firmly ensconced in all three a more overarching point is that competition between the three states limited the power of any individual state to determine the structure of the corporation. The three states are also relatively similar in terms of their level of economic development, industrialization, and integration into the national economy. A slightly different story might have been told, and Roy’s argument made stronger, if he had looked at states that were less developed and continued to have more active state economic development policies throughout the century, including state investment in banks, railroads, and corporations. Did those states making post bellum public investments in corporations demand public accountability? Or had the prevailing ideology of the private corporation so come to dominate by the second half of the century that even where there was substantial and direct state investment the corporation was seen as an autonomous and privately responsible agent?

Roy makes several important methodological points that economic and business historians should heed. First, he emphasizes that actors can exercise power without power being the motivation for their actions. Individuals and groups exercise power when their actions determine the choice set or the constraints faced by others. I think this broad definition of power is very useful and would help economic and business historians to understand and analyze political movements, from late 19th century populism to late 20th century resistance to free trade. But defined this broadly we also have to recognize that the exercise of power is not inherently a bad thing. For example, in a capitalist economy with strong patent protection technological innovation gives the innovator power. Users of older technologies cannot simply continue to operate as they have in the past. This is the creative destruction that Schumpeter celebrated- and it is really does destroy something that someone values. That’s why the technocratic distinction between efficiency and distribution that economists cling to is silly. Any policy choice that has a significant impact on the “efficiency” of the economy will also have distributional consequences. That doesn’t mean that we don’t want technological change. Much of the time we probably do. But this perspective forces us to acknowledge that there are social decisions to be made, not simply private actors doing whatever they please, and that those social decisions require tradeoffs. Second, this book will serve as an enormously useful corrective to the tendency among economists studying the firm, property rights, and institutions generally (a growing trend that is very healthy in and of itself) to follow Oliver Williamson’s “In the beginning, there were markets” approach. Roy argues forcefully, and correctly, that both the market and the firm are social constructions. That does not mean that they are arbitrary or unreal. It means that their structure and their existence are the result of past political decisions and the outcome of social and political conflict. This is also a useful corrective to an approach that conflates the notion of the existence of a market with “rational” behavior by individuals. The existence of a market changes how rational individuals behave. Competitive pressure forces rational individuals to calculate more, and it increases the weight of monetary factors in those calculations relative to very real concerns for community and the quality of human inter action. Economic historians recognize this effect of the market on individual behavior when they can cast it in a positive light (see Sokoloff’s 1992 work on the spread of markets and the rate of patenting, for example), but tend to downplay it otherwise (see Rothenberg 1992, for example).

Third, Roy makes an interesting case for an interplay between contingency and determinacy in the book. He argues for contingency in order to make the case that there is nothing natural or inevitable about the current institution of the corporation. The current configuration of rights and responsibilities that constitute the corporation is the result of highly contingent events in the past. But he does not accept the standard version of path dependence and raises questions that I have long thought were problematic with that approach. He makes clear that while the current construction of the corporation is contingent and path dependent in the sense that it would and could have been different if different events had occurred at key turning points (particularly during the 1830s canal crises), he does not see this as simply the result of chance. The key events were themselves the result of who had power at the time. This approach opens up a whole line of fruitful research in this area. Why was it that the response to the canal crisis was privatization rather than increased regulation? Why was it that some state constitutions were modified to limit direct involvement in economic activity and others weren’t? These were explicitly political decisions that had long term economic ramifications. Understanding the political forces behind these decisions would be very useful. Roy also makes the point, applicable quite generally to the path dependence approach, that what matters is not simply the cost of shifting from one path to another (e.g. from one keyboard to another) but who bears that cost. If those who have the power to make the decisions about whether to switch paths do not bear the costs, then the switch will appear “costless” (see McGuire, Granovetter, and Schwartz, forthcoming).

In making the argument for the contingency of the corporation Roy plays down some forces – powerful forces I am sure he would agree – that led to its current incarnation. On a mundane level he downplays competition among states allowed by the federal structure that led to a spiraling down of public responsibilities for private actors. But on a more basic level, the transformation of assets from things that natural individuals own, use, and are responsible for, to capital personified in the corporation, responsible no longer to the state and barely to its nominal owners, seems to me not a happenstance, contingent event. The corporation gives agency to capital. It’s not for nothing that we call it a capitalist economy.

Finally, Roy’s “de-naturalizing” of the corporation is a giant step forward for business history. So is his problematizing of the boundaries between private and public, the economy and the state, and the rejection of the dichotomy of an “interventionist state” and a “natural market.” As Roy makes clear, the state creates the market, so it is meaningless to talk of it intervening in it. That language simply serves to de-legitimize some actions of the state relative to others. Finally, acknowledging that there are social choices to be made that influence how the economy will function in the future is important, and not simply for academics. Post-cold war ideology presents the corporation not only as natural but all- powerful. It is good to remind people that they can, through social and political action, make choices about how such social creations operate.

Bibliography

Lamoreaux, Naomi R. The Great Merger Movement in American Business, 1895-1904. Cambridge, England: Cambridge University Press, 1985.

McGuire, Patrick, Mark Granovetter, and Michael Schwartz. Forthcoming. The Social Construction of Industry: Human Agency in the Development, Diffusion, and Institutionalization of the Electric Utility Industry. New York, N.Y. and Cambridge, England: Cambridge University Press.

Rothenberg, Winifred (1992). From Market Places to a Market Economy: The Transformation of Rural Massachusetts . Chicago, Ill.: University of Chicago Press.

Sokoloff, Kenneth (1992). “Invention, Innovation, and Manufacturing Productivity Growth in the Antebellum Northeast” in Robert Gallman and John Wallis American Economic Growth and Standards of Living before the Civil War (Chicago, Ill.: University of Chicago Press), pp. 345-378 .

Williamson, Oliver E. (1985). The Economic Institutions of Capitalism. New York, N.Y.: The Free Press.

?

Subject(s):Markets and Institutions
Geographic Area(s):North America
Time Period(s):19th Century

Between the Dollar-Sterling Gold Points: Exchange Rates, Parity, and Market Behavior

Author(s):Officer, Lawrence H.
Reviewer(s):Taylor, Alan M.

Published by EH.NET (March 1998)

Lawrence H. Officer, Between the Dollar-Sterling Gold Points: Exchange Rates, Parity, and Market Behavior. Cambridge: Cambridge University Press, 1996. xxi, 342 pp. $59.95 (cloth), ISBN: 0521365384.

Reviewed for EH.NET by Alan M. Taylor, Department of Economics, Northwestern University.

Lawrence Officer has been making influential contributions to international and monetary economics and history for many years. He is perhaps best known to economic historians for his work on exchange market arbitrage under gold (or read, metallic) standards. In a series of tightly-argued journal articles he challenged the widely accepted revisionist scholarship that had sought to depict the gold standard as inefficient and unstable, building his case on a monumental collection of primary data, careful statistical inference, and elegant theory. The present book extends and buttresses these arguments, sustaining a well-documented analysis of this monetary regime for over three hundred pages. The work focuses on the U.K.-U.S. foreign exchange market and leaves us with probably the most comprehensive and informative single treatise on this centuries-old institution. The work will be invaluable to macroeconomic historians interested in Britain and the U.S. in the late nineteenth and early twentieth centuries, and it should provide a good model for others wishing to understand similar monetary regimes at other times and places.

The introduction itself lays out the plan of the book. Officer makes his key point here that the subject is not just about whether gold points were violated, but that a complete analysis must examine the position of the exchange rate as an object of study, at all points inside and outside the gold-point boundaries. To this end, the author makes the case for getting the best possible data, at the highest frequency, for the longest time span. Finally, the key questions of market integration and efficiency (of the market and of the regime) are to be considered.

Part One of the book lays down the key historical and institutional features of the landscape from the beginning of the dollar-sterling gold standard in 1791 (when the U.S. went to a formal metallic standard) to its demise in 1931 (when Britain suspended convertibility). The laws and mechanics of coinage, minting, convertibility of paper to metal, dealings in the market and at banks, and so forth are all carefully described. The text and tables note significant legislative acts forcing regime changes for both countries in this entire time span, including changes in the metal of the standard for the U.S., and changes in parities for both countries (i.e., the metal content of the unit of account). Periods of convertibility and inconvertibility are shown.

Part Two comprises an exhaustively constructed data set to permit the study of this institution. First, the relatively simple job of computing implied parities is achieved using the information on metallic content in Part One, plus data on market prices of gold and silver (in U.S. bimetallic episodes). We find that from 1837, until 1931, after its initial wavering, the dollar-pound parity rate settled at the famous 4.8665635 point for well nigh a century. The market exchange rate was not so stable, and a long chapter discusses the sources and their quality, usefulness, and representativeness. Officer is eventually able to present data on the dollar-pound exchange rate for the entire period at quarterly frequency. In addition, monthly series are constructed for some periods: 1890-1906; 1925-1931; and, for a Bretton-Woods era comparison, 1950-66. Pre-1879 great care is taken (following Perkins, not Davis and Hughes) to adjust the bills of exchange to a uniform zero (“sight”) maturity. This ensures temporal consistency with the later cable rates; it also reflects the ultimate dominance of the sight bill as an instrument in the 1879-1914 heyday of the gold standard. An implicit sight rate is derived from the price of non-demand bills and the British interest rate. Care is also taken to find a mid-point of the buy-sell rates, using information on brokers’ commissions; and further care to correct the exchange rate for devaluations of paper during paper standard periods. This level of care exceeds previous studies, and survives testing for the consistency and homogeneity of the series. This is probably the best quality data for the dollar-sterling exchange rate we now have for the entire period; it will be an essential series for future scholars. Some interesting patterns appear just from a quick look at this series (Figure 7.1, p. 102): the volatility of the exchange rate declined dramatically in the early nineteenth century; the standard deviation in 1791-1820 was about 4-6%, but had fallen to less than 0.5% after 1871, and less than 0.2% in 1901-14.

Part Three makes the next logical step: comparing the above exchange rate series with the level of known arbitrage costs; i.e., the question is whether the exchange rate remained within the gold points. This is a point of departure for another exhaustive data-building effort. To construct gold points requires information on costs of freight, insurance, brassage, knowledge of any gold devices used by the monetary authorities, and interest costs due to the time delay of shipment across the Atlantic Ocean. All of these are put together with the same thoroughness as the exchange rate data. The care taken places these estimates on a far firmer footing than earlier estimates which had typically cut corners (cf. Clark, who had assumed ad hoc constant transaction costs). And the method is clearly far superior to any of the simpler techniques offered in other sources: taking a consensus estimate of brokers; using the terribly flawed gold flow data in a revealed preference method; using a pure max-and-min spread (violations impossible!); or using piecemeal aggregate arbitrage cost data from temporally disjoint sources. Essentially Officer proceeds with a laborious first-principles approach: each and every arbitrage cost component is individually estimated, then summed up, at each point in time. This consumes 62 pages; it is hard to imagine any improvement on these series for gold import and export points in this market, and this is the model for similar work on any other market.

The data are valuable and inform two integration tests in Part IV. The decline of gold point spreads mirrors that of the decline of exchange rate volatility, as expected. After 1880, this spread was at an all-time low level (even looking forward to 1925-1931 and Bretton Woods) of just above 1.0% for gold arbitrage. (Compare with around 5% in 1780, falling to about 2% in the 1840s). Officer sees this as improved “external” integration (external to the gold points) over time. Officer then studies whether even within the band, the exchange rate can reveal improved “internal” integration over time. Econometrically this section is less fully developed. For example, the relevant time series properties of the exchange rate series are not fully spelled out, making for some problems of inference. It is not clear whether we expect, say, a random walk between the gold points. (And what about beyond?) In a complicated nonlinear model such as this, the unconditional (raw) distribution of the exchange rate can have peculiar shapes. Officer, however, considers that a uniform distribution is “natural” (p. 189) in this zone. For the criterion of “internal integration” as Officer terms it, the focus is on whether “on average” the deviation of the exchange rate from parity is less than half the gold point spread, looking at absolute deviations. Again, by this measure, integration rapidly increases prior to the 1870s, then holds steady. A big jump is seen in the 1820s. Econometrics aside, this chapter places greater emphasis on explaining long-run tightening in the exchange rate distribution, and, especially within the band. As an explanation, Officer considers the role of the Second Bank of the United States critical in reducing dispersion in the 1820s. This trend was assisted by private agents such as the House of Brown, and, later in the nineteenth century, the New York private banks.

Part V conducts various tests for violations of market efficiency. The first test looks at gold-point violations: they are few– only four months during 1890-1906, and none in 1925-1931, for example. Far fewer than in previous studies, we should note. Thus Officer’s findings are very favorable to an efficient gold standard. Earlier work is faulted for using the wrong data (e.g., cable rates) or poor measures of arbitrage costs (bad gold point estimates). Correspondingly, Officer tests for failures of uncovered interest arbitrage (following Morgenstern), covered interest arbitrage and forward speculation for the 1925-31 period. Here there are substantial failings, with unexploited profit opportunities. These are seen as following from episodic losses of confidence in the regime. It would be interesting to see similar work on the classical gold standard regime pre-1914. However, in Part VI some comparisons are drawn and, under auxiliary assumptions about the exchange rate distribution (once more) it is shown that the interwar standard was not markedly worse than its prewar cousin. Part VII concludes.

Overall, this book offers an exhaustingly comprehensive analysis of the dollar-sterling market from the 1790s to the early post-WWII period. The data work cannot be faulted, and pushes our knowledge to a much higher plane than ever before. The empirical analysis confirms our priors concerning the convergence of this market on a high level of integration by 1880. The work leaves open some interesting doors for more sophisticated econometric analysis that could engage future scholars, but in many other respects this is the final word.

(Lawrence H. Officer is Professor of Economics at the University of Illinois, Chicago.)

Alan M. Taylor is an Assistant Professor of Economics at Northwestern University, a Faculty Research Fellow of the National Bureau of Economic Research, and a 1997-98 National Fellow at the Hoover Institution, Stanford University. His current research is in two main areas: the evolution of global capital markets, and the economic history of Argentina. He serves as co-editor of the EH.Net discussion list EH.Res.

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):General, International, or Comparative
Time Period(s):19th Century

Funding American State, 1941-1995: The Rise and Fall of the Era of Easy Finance

Author(s):Brownlee, W. Elliot
Reviewer(s):Vedder, Richard K.

EH.NET BOOK REVIEW

Published by EH.NET (December 1997)

W. Elliot Brownlee, Editor. Funding the Modern American State, 1941-1995: The Rise and Fall of the Era of Easy Finance. Cambridge: Woodrow Wilson International Center for Scholars and Cambridge University Press, 1996. ix + 467 pp. $59.95 (cloth), ISBN: 0521552400.

Reviewed for EH.NET by Richard Vedder, Department of Economics, Ohio University.

The good news is that seven scholars from a variety of disciplines (economics, history, political science, law) have given us an engaging narrative on various aspects of the contemporary history of American federal taxation in a volume that should be oft-cited. The bad news is, as is typically the case in edited volumes, the quality of the analysis is uneven and in a few places even historically inaccurate.

The book was probably largely written in 1994 or at the beginning of 1995. I was a little turned off by the very first sentence of text in the book, in a promotional blurb preceding the title page: “The fiscal crisis faced by the American federal government represents the end of a fiscal regime that began with the financing of World War II.” My reaction was: what fiscal crisis? At the time I read the book, President Clinton had just announced that the 1997 fiscal year budget deficit was about $22 billion, the smallest deficit in relation to total output in a generation. Moreover, the tax changes implemented in the 1997 budget deal merely extended the fiscal regime arising out of World War II.

Yet the claim is probably not so wrong after all. Americans are extremely unhappy with the administration of the tax system, and with its complexity. The public mood is ripe for reform, perhaps radical change that involves the replacement or profound modification of the progressive marginal rate income tax. The booming economy has given some temporary respite in dealing with the entitlement problem, but in the long run the existing fiscal equilibrium is clearly untenable given what C. Eugene Steuerle appropriately calls (p. 428) “the yoke of prior commitments.” It looks increasingly likely that major fiscal changes will occur at some time in the next decade.

Two of the essays (totaling more than one hundred pages) are by Elliot Brownlee. One summarizes the volume and the second provides a historical overview of the tax system since the beginning of the Republic. Brownlee correctly notes that new tax regimes implemented during four national emergencies (Civil War, World War I, the Great Depression, and World War II) facilitated the enormous growth of the federal government. High wartime taxes were only modestly lowered after those conflicts, which, combined with reduced defense spending, allowed for expanded social programs without incurring large political costs.

Brownlee emphasizes the tensions between the Republican emphasis on consumption and tariff taxation and the Democratic yearning for progressive income taxation in the late nineteenth century. Indeed, one can argue that the entire fiscal history of the country since 1860 is one of the changing political importance of two impulses: the progressive impulse to use the tax system to bring about income redistribution, and the conservative impulse to reduce the inefficiencies, resource distortions, and growth drag associated with high rates, particularly with regards to income.

A point that gets occasional mention but little emphasis in the book (possibly excepting Steuerle) is that progressive taxation gave political incentives to encourage price inflation, as bracket creep provided a politically clever way to raise taxes in a stealth fashion to finance social programs. I do not think it is entirely an accident that inflation in the United States was low or non-existent in the era before sharply progressive taxation, was high in the era of high progressive rates, and has moderated since tax indexation reduced (although not eliminated) the bracket creep dimensions of the progressive income tax. Did fiscal policy drive monetary policy?

Brownlee makes its abundantly clear that progressives in both the Wilson and Roosevelt administrations used war emergencies as an opportunity to impose their redistributionist ideas. As he hints, a case can be made that the notion of progressive income taxation was saved, by all people, Secretary of the Treasury Andrew Mellon, who in the 1920s defused Republican efforts to replace the progressive income tax with a national sales tax, an effort that has had a renaissance of sorts today.

Brownlee’s account of tax history emphasizes the progressive impulses at redistribution, and pays little attention to the efficiency difficulties that extremely high marginal rates pose. Few economists today would claim that sharply raising marginal tax rates in 1932 was an intelligent move from either a demand or supply side perspective, yet Brownlee does not discuss whether this viewpoint was articulated at the time. Had equity concerns completely silenced the traditional efficiency arguments that arise in tax debates? The emphasis throughout the Brownlee article is on tax changes that provided fiscal support for an increased state: he gives very little attention to the important Kennedy and Reagan tax cuts, and completely ignores several moderately important changes in the tax system, such as in 1954, 1990, and 1993.

Turning from the general to the specific, Carolyn C. Jones competently explores how the government used public relations techniques to convince Americans to comply with high income taxation in the 1940s, when most Americans first became payers of the tax. Edward D. Berkowitz nicely summarizes the history of social security taxation, showing how liberals associated with the administration of the program (such as Wilbur Cohen) played an influential role in crafting Social Security expansion. They convinced legislators that large increases in benefits were possible with only moderate tax increases. In time, of course, political leaders learned this lesson too well, increasing benefits in the 1970s in an actuarially untenable fashion. The modern troubles of Social Security are less extensively explored than the program expansion, although Berkowitz perceptively notes that “Americans have historically tolerated taxes reflecting shared social purpose but that even these taxes can reach a threshold that threatens to undermine the enterprise the tax supports” (p. 183).

In a long and important essay, Herbert Stein updates his Fiscal Revolution in America (Chicago: University of Chicago Press, 1969). The era before the 1960s was dominated by tensions between three alternative budget philosophies (old-fashioned Keynesian “functional finance”, a more conservative or “domesticated” Keynesianism advocated by Stein, and a traditional Republican balanced budget rule). By contrast, Stein correctly tells us that fiscal policy in the post-1964 era was not governed by any specific budget philosophy. The problem was “the unwillingness of policy-makers to subordinate their desires for specific tax and expenditure programs to any aggregate goal” ( p. 200).

Stein then goes into a long discussion of the specifics of fiscal policy, emphasizing the era when he was a player, namely the Nixon Administration. The fact is that, for all the policy angst and debate, federal taxation absorbed about 20 percent of the national output throughout the period. Whenever taxes started to rise above that amount from bracket creep, a tax revolt would ensue, culminating in what Stein (p. 266) terms the “Big Budget Bang” of 1981. Whenever taxes fell much lower than one-fifth of the nation’s output, tax increases ensued (1982, 1990 and 1993 come especially to mind). The increasing contempt for aggregate fiscal rules of any kind reflected growing tensions posed by the growth of entitlement programs and, on occasion, other spending needs. The marginal political benefits to politicians of spending money exceeded the marginal political costs. The “automatic” nature of entitlement spending increases was aggravated by new programs in the 1960s and 1970s. Deficits were a politically less painful way to finance government constrained by a tax threshold imposed by popular sentiment. Like inflation- induced tax increases, deficits are a stealth form of taxation. As Stein concludes, in the early 1960s it was true that “economic science had provided commands that politics would and should obey. That belief has now disappeared.” (p. 286)

Julian E. Zelizer’s account of Wilbur Mill’s role in the fiscal policy changes is well crafted. Mills shrewdly used experts to help him make important changes in the fiscal system, and to stand up to Administration and congressional pressures. At the same time, he was a creature of Congress and knew how to win votes and maintain power. In a less successful essay, Cathie Jo Martin looks at the role that business played in the tax changes of the postwar era. The paper is marred with significant factual errors. Speaking of the Reagan era, we learn (p. 382) that “neoclassical economists concentrated in the CEA under Murray Weidenbaum and then Alan Greenspan.” Alan Greenspan did serve as Chairman of the Council of Economic Advisers – but in the Ford administration several years earlier. I read (p. 394) that administration official Richard Darman was a “supply-side economist.” First of all, Darman was (and is) not an economist (his most recent Who’s Who in America bio refers to him as a “former investment banker” and “former educator” and earlier biographies as “business consultant.”). Secondly, most of the prominent supply siders I know from that era viewed Darman as their enemy, the very antithesis of a “supply side economist.” The essay makes several assertions based on interviews with anonymous committee staffers. As a congressional staffer myself in this era, I would suggest that staff interpretations of major congressional events varied widely, and too many assertions are made that at the very least should be qualified.

The book ends on a more solid scholarly note. Steuerle nicely uses fact and logic to suggest that the era of “easy finance” ended in 1981. Up to that date, economic growth, defense cuts, social security tax increases and the impact of inflation in raising taxes and lowering the real burden of the debt made it possible to expand social programs without dire budgetary consequences. After 1981, “the yoke of prior commitments”, the productivity growth slowdown, tax indexation and other factors brought about “the fiscal straitjacket era.” On the spending side, the growth in entitlements set the stage for a future fiscal crisis that will force some change in the nation’s fiscal (and probably tax) regime.

Taken as a whole, this volume advances our understanding of the historical trends in tax policy in important ways. While not pretending to be a balanced or comprehensive survey of history of modern taxation, it is a nonetheless a welcomed addition to the literature that scholars will utilize for years to come.

Richard Vedder Department of Economics Ohio University

Richard Vedder is Distinguished Professor of Economics at Ohio University, where he does research on labor and fiscal policy issues. His latest book, with Lowell Gallaway, is Out of Work: Unemployment and Government in Twentieth-Century America, updated edition (New York: New York University Press, 1997).

?

Subject(s):Government, Law and Regulation, Public Finance
Geographic Area(s):North America
Time Period(s):20th Century: WWII and post-WWII

Historical Statistics of U.S.

Author(s):Press, 1997 Cambridge University
Reviewer(s):Hutchinson, William

EH.NET ELECTRONIC REVIEW

Published by EH.NET (December 1997)

Historical Statistics of the United States: Bicentennial Edition. New York: Cambridge University Press, 1997. $195 (CD-ROM). ISBN 0-521-58541-4 (CD-ROM). ISBN 0-521-59710-2 (User’s Guide).

Reviewed for EH.NET by William Hutchinson, Department of Economics, Miami University of Ohio.

Availability of these data on CD-ROM is a great asset to those who use data from the printed version of Historical Statistics of the United States from Colonial Times to 1970. Electronic access makes it easier to use these data than when one must transfer data by hand from the book to a computer before performing statistical analyses.

Previous users of the printed version of Historical Statistics will soon realize that a few changes have been made, mostly to enhance the ease with which the data can be accessed in an electronic text. For example, all data have been placed in column form for easier access for spreadsheet users. Footnotes are numbered sequentially for an entire table, no matter how many pages the table may occupy. When new columns or rows have been added to accommodate situations where data appeared in combinations of columns or rows, footnotes were added in square brackets, [ ], to indicate the specific change. Errors noted on the Errata sheet dated February 1977 for the printed text have been corrected in the electronic version. However, the few errors that were subsequently discovered in the printed version have not been corrected. A few tables and series do not appear in the electronic version because these were in copyright and permission could not be obtained to include them.

The DynaText program that allows one to read the text and data from the CD-ROM is easy to install and use, once you have read the manual to familiarize yourself with the workings of the program. As someone who uses a PC (desktop or laptop computer) primarily for word processing, I found the instructions easy to follow and clearly written in terms that someone who is not a “techy” would understand.

Having loaded the DynaText program into my laptop, I began searching data series by first examining the Notes subcategory for Prices and then the series subcategories. Text of the notes to the series was easy to access and to read on screen. The data series that one can view on the screen at one time are limited to five columns on a twelve inch laptop screen or a fourteen inch screen. Using the View option to reduce the font size and expand the range of columns observed makes the data illegible. This is not really a major problem since most users will most likely not wish to see a larger number of columns of data at one time. That is, I would expect that most users will know the data series they wish to access and will not need to see each series before downloading the data to a file.

One is able to easily use the Table of Contents with the mouse and the scroll bar. Using the Table of Contents along with the Notes button provides all the information that one would want regarding the data. Once one has decided which series to look for it is easy to access the data series by clicking on the desired series. If one chooses, one can access the general series category and then use the Find bar at the bottom of the text screen to find the series you wish by typing in the name of the series or some part of the name. For example, typing in Wholesale Prices would move you to the next part of the text where the phrase Wholesale Prices appears. It would also list the number of times the words ‘wholesale prices’ appeared in each of the Chapters and Notes sections. By accessing the Book pull-down menu one can search either text or tables for particular words or phrases.

Annotations and Bookmarks can be inserted at desired points for future reference. One can use hyperlinks to connect various series or a series and the notes that apply to the particular series. These hypertext links can be set as either one way or two way which makes it an easy matter to navigate from one point to another that is frequently accessed in conjunction with the first.

Downloading data to your hard drive, a floppy disk or elsewhere is relatively easy because it is all menu driven. One need only use the hypertext links at the top of each table, ‘Lotus 123′ or ‘Text file’. (By going to the root level of the CD-ROM one can either access Lotus 1-2-3 files or tab-delimited text files from the LOTUS123 or TEXT directories, respectively, without first opening the electronic book.) The Lotus 1-2-3 files can be accessed directly from nearly any type of spreadsheet program. If one has a spreadsheet program that will not download the Lotus 1-2-3 files, then it will most likely download data from the tab-delimited text files. These files can be renamed and saved onto the hard drive or a floppy disk. If one is using DynaText on a network, then data can be saved to another location as desired.

When viewing a data series, the Scrollable Table option is very handy because it allows one to see additional columns and move down the columns faster than when one is scrolling down a series in the standard screen. One can also use the Find bar while in the Scrollable Table mode which enables the user to move to a new series with ease.

Use of the Journal option is very helpful if you need to repeatedly access a number of series or texts and series. Recording in a Journal sets up a group of locations to which one can move with ease by using the commands on the Journal bar. I did encounter difficulty when I attempted to use the Snapshot option for adding lines to the Journal. An “Error in Program” message kept appearing on the screen, making it necessary to reboot the computer in order to continue work. I am not sure if this is a problem with the particular CD or a problem with the program in general. It would definitely make work easier if the snapshot option in the Journal menu worked as described in the manual.

DynaText can be customized to fit the individual user’s preferences by accessing the Preferences command under the File menu. One can alter the settings for the various operations that DynaText performs while accessing Historical Statistics.

One can also access the coding used to construct the electronic form of the book, if highly sophisticated searches are necessary. The average user would not need to take advantage of this possibility.

Those who have contributed to producing this CD ROM version of Historical Statistics of the United States from Colonial Times to 1970 have provided a great service to the economic history and history professions alike. We can only wish them luck with the Millennium edition of Historical Statistics.

DynaText software for accessing Historical Statistics runs on either a PC: 386 or later with Windows 3.1+; 8 MB of RAM and a double speed CD-ROM drive. For a Macintosh, it must be a System 7 or later and have 4 MB of RAM along with a CD-ROM drive.

William K. Hutchinson Department of Economics Miami University

William Hutchinson has authored an annotated bibliography on American Economic History as well as articles on monetary policy and interregional and international trade and growth.

?

Subject(s):Development of the Economic History Discipline: Historiography; Sources and Methods
Geographic Area(s):North America
Time Period(s):General or Comparative

The Evolution of International Business: An Introduction

Author(s):Jones, Geoffrey
Reviewer(s):Taylor, Graham D.

H-NET BOOK REVIEW Published by H-Business@cs.muohio.edu (July 1996)

Geoffrey Jones, The Evolution of International Business: An Introduction . London and New York: Routledge, 1996. xii + 360 pp. Bibliographical references and index. Cloth, ISBN 0-415-10775-X; paper, ISBN 0-415-09371-6.

Reviewed for H-Business by Graham D. Taylor, Professor of History/Dean of Arts and Social Sciences, Dalhousie University, Halifax, Nova Scotia

During the 1960s multinational enterprises emerged as a focus of interest (and much controversy) both for economists and for the general public. Much of the literature of that era (leaving aside the important pioneering works of Raymond Vernon, Charles Kindleberger, and John Dunning) provided a very time-bound perspective on this phenomenon. Economists tended to treat multinationals as byproducts of post-World War II international financial integration and improvements in communications and transport technologies. To the broader public, in the United States and elsewhere, they were associated with U.S. economic expansion and indeed were perceived as reflecting a particularly “American” form of business organization.

Since that era, the international economy has changed dramatically: multinational enterprises became truly “multinational” as East Asian and European firms expanded (or, perhaps more properly in many instances, reappeared) in global markets and new cross-national “strategic partnerships” of firms emerged. During the same period, the historiography of multinational enterprise was vastly enriched by scholars such as Mira Wilkins, D. K. Fieldhouse, Peter Hertner, Shin’ichiYonekawa, and many others, who not only probed well into the pre-twentieth-century origins of multinational activities, but also linked their work with broader reinterpretations of the dynamics of business evolution and organization.

Geoffrey Jones has been very much a part of that international community of scholarship on multinationals, and in this book he has undertaken to synthesize that literature. Jones far too modestly designates the study as a “text book” or “introductory survey.” It is in fact a substantial contribution to our understanding of the historical significance of multinational business, broadly defined to encompass more than the conventional category of “foreign direct investment” (FDI). His book provides a needed overview of the global dimensions of this phenomenon and a coherent framework for analysis of major historical trends and central issues emerging from the literature.

Jones’s study opens with a review of the major interpretive approaches to analyzing multinationals, including concepts of ownership advantage, internalization/transaction cost, and Dunning’s “eclectic model,” all of which are well integrated into the historical chapters that follow. He also links the study of multinational evolution to the themes of organizational development associated with Alfred Chandler and the literature on the firm and national competitiveness.

This section is followed by a general overview of the major trends in multinational operations since the mid-nineteenth century, highlighting the distinctiveness of different periods in that evolution (1880-1914; the interwar period; the 1940s to 1960s; and the period since 1971). This periodization indicates both the continuities of growth of international business and the volatility of that history, reflecting shifts in external factors (“the business environment,” encompassing the impact of wars, shifts in global trade and monetary arrangements, nationalizations and other governmental regulatory measures) and consequent changes in the strategies of firms.

The next chapters review the role of multinationals in specific industrial sectors: natural resources, manufacturing and services. There is a certain degree of repetition in these sections, as Jones works through each period for the different sectors. But it is also clear that very different patterns can be discerned in the forms and motivations underlying international direct investment in each sector, as well as in the internal dynamics of firm organization, relations among firms, and between multinationals and governments.

The final chapters focus on particular issues that have emerged in the literature. These include: the variations among nations and cultures in the propensity of their business enterprises to engage in foreign investment; the relationship between foreign direct investment and economic development, in terms of both home economies (of the multinationals) and host economies; and the relationships of multinationals and governments.

Despite its relative brevity, this is a dense book that covers a wide range of topics relating to the history and theory of multinational business, each in a balanced but succinct manner. Consequently, it would be an oversimplification to suggest that it embraces a particular set of themes or line of argument. But there are certain general characteristics of the history that emerge from the study.

From the late nineteenth to well into the twentieth century, most foreign direct investment was focused on the development of natural resources, with some spinoff growth of ancillary services. Latin America and Asia were particularly notable recipients of this investment. FDI in manufacturing expanded slowly through the early twentieth century and more dramatically in the period after World War II, and the geographic center for such investment shifted to Western Europe. This trend in turn was overtaken by developments in the service sector (particularly in finance) in the past two decades, with East Asia and Western Europe, along with the United States, as major areas of investment activity.

Although there have been periods of single-country dominance in outward investment (the United Kingdom between the 1880s and 1914, and the United States in the 1950s and 1960s), perhaps more significant has been the consistent growth of multinational operations over the past century. As noted earlier, Jones’s approach embraces a range of international business activities. During the pre-World War I era, investment flows were tied to some extent to the “imperial” territories of various European nations (with regions such as Latin America becoming a battleground for European and American investors), and occurred through a peculiar (and primarily British) form called “free-standing companies” (local enterprises owned by foreign syndicates) as well as the more familiar home-and-branch operations.

In the interwar period, as national governments imposed a variety of constraints on international trade and capital flows, international cartels flourished, in part as a means of circumventing them. In the period since the 1970s, a new form of “strategic partnership” among firms of different nationalities has emerged, reflecting both the diverse origins of enterprises in global markets and the effects of financial integration coupled with the growth of regional trade blocs. In each era multinational businesses have altered their forms of operation to suit contemporary conditions, while sustaining a general trend toward growth and integration.

The strength of the book lies in its coherence, its ability to provide a clear framework for a complex process of development over a fairly long time-span. Some of this coherence might have been lost had Jones extended his analysis even further back in time, but it might have been a useful exercise to provide a broader historical perspective on the evolution of international business (as opposed to the evolution of multinational enterprise). Jones does devote a section of his chapter on “Multinationals and Services” to a discussion of the large international trading companies of the seventeenth and eighteenth centuries; but generally he focuses on the period after 1880, with an emphasis on improvements in technology (enhancing the internal management of firms in international markets) and financial integration, accompanied by nationalistic trade policies, in shaping a business environment congenial to multinationals.

But, as studies by Larry Neal (on international capital markets), James Tracy and Jonathan Israel (on the Dutch and British “merchant empires”), and Ann Carlos and Steve Nicholas (on the internal organization of trade companies) indicate, by the eighteenth century the international economy had developed strong financial and logistical links, and businesses such as the Hudson’s Bay Company and the East India companies were developing mechanisms for internal communication and management.

Jones’s chapter on multinationals and natural resources understandably gives pride of place to the “nonrenewable” resource sector (mining and petroleum) and does not ignore the “renewable” area. But a review of multinationals in the forest products industry could reinforce some of the points he makes in other contexts. As a capital-intensive industry, forest products (especially pulp and paper) has been a field with a number of multinational actors, such as the British firm Bowater, the Swedish Stora, the U.S. Weyerhaeuser, and Canada’s MacMillian-Bloedel. The intricate links between publishing companies and paper manufacturers in international markets provide another interesting feature of this industry, ranging from direct-investment ventures (such as the Chicago Tribune‘s Canadian pulpmills) to Bowater’s “strategic partnerships” in the 1920s-1940s (not without endless friction) with the British newspaper barons, Rothermere and Beaverbrook, to exploit the forestry resources of North America.

These are minor caveats, however, and do not detract from the general quality and significance of Jones’s study. As noted earlier, the book represents a well-organized synthesis of the state of the historiography of international business today, which at the same time can provide a basis for future research in the field, by identifying major lines of argument and the areas of uncertainty and controversy that still must be addressed.

Graham D. Taylor Dalhousie University

?

Subject(s):Business History
Geographic Area(s):General, International, or Comparative
Time Period(s):20th Century: WWII and post-WWII