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The Roots of American Industrialization, 1790-1860

David R. Meyer, Brown University

The Puzzle of Industrialization

In a society which is predominantly agricultural, how is it possible for industrialization to gain a foothold? One view is that the demand of farm households for manufactures spurs industrialization, but such an outcome is not guaranteed. What if farm households can meet their own food requirements, and they choose to supply some of their needs for manufactures by engaging in small-scale craft production in the home? They might supplement this production with limited purchases of goods from local craftworkers and purchases of luxuries from other countries. This local economy would be relatively self-sufficient, and there is no apparent impetus to alter it significantly through industrialization, that is, the growth of workshop and factory production for larger markets. Others would claim that limited gains might come from specialization, once demand passed some small threshold. Finally, it has been argued that if the farmers are impoverished, some of them would be available for manufacturing and this would provide an incentive to industrialize. However, this argument begs the question as to who would purchase the manufactures. One possibility is that non-farm rural dwellers, such as trade people, innkeepers, and professionals, as well as a small urban population, might provide an impetus to limited industrialization.

The problem with the “impoverished agriculture” theory

The industrialization of the eastern United States from 1790 to 1860 raises similar conundrums. For a long time, scholars thought that the agriculture was mostly poor quality. Thus, the farm labor force left agriculture for workshops, such as those which produced shoes, or for factories, such as the cotton textile mills of New England. These manufactures provided employment for women and children, who otherwise had limited productive possibilities because the farms were not economical. Yet, the market for manufactures remained mostly in the East prior to 1860. Consequently, it is unclear who would have purchased the products to support the growth of manufactures before 1820, as well as to undergird the large-scale industrialization of the East during the two decades following 1840. Even if the impoverished-agriculture explanation of the East’s industrialization is rejected, we are still left with the curiosity that as late as 1840, about eighty percent of the population lived in rural areas, though some of them were in nonfarm occupations.

In brief, the puzzle of eastern industrialization between 1790 and 1860 can be resolved – the East had a prosperous agriculture. Farmers supplied low-cost agricultural products to rural and urban dwellers, and this population demanded manufactures, which were supplied by vigorous local and subregional manufacturing sectors. Some entrepreneurs shifted into production for larger market areas, and this transformation occurred especially in sectors such as shoes, selected light manufactures produced in Connecticut (such as buttons, tinware, and wooden clocks), and cotton textiles. Transportation improvements exerted little impact on these agricultural and industrial developments, primarily because the lowly wagon served effectively as a transport medium and much of the East’s most prosperous areas were accessible to cheap waterway transportation. The metropolises of Boston, New York, Philadelphia, and, to a lesser extent, Baltimore, and the satellites of each (together, each metropolis and its satellites is called a metropolitan industrial complex), became leading manufacturing centers, and other industrial centers emerged in prosperous agricultural areas distant from these complexes. The East industrialized first, and, subsequently, the Midwest began an agricultural and industrial growth process which was underway by the 1840s. Together, the East and the Midwest constituted the American Manufacturing Belt, which was formed by the 1870s, whereas the South failed to industrialize commensurately.

Synergy between Agriculture and Manufacturing

The solution to the puzzle of how industrialization can occur in a predominantly agricultural economy recognizes the possibility of synergy between agriculture and manufacturing. During the first three decades following 1790, prosperous agricultural areas emerged in the eastern United States. Initially, these areas were concentrated near the small metropolises of Boston, New York, and Philadelphia, and in river valleys such as the Connecticut Valley in Connecticut and Massachusetts, the Hudson and Mohawk Valleys in New York, the Delaware Valley bordering Pennsylvania and New Jersey, and the Susquehanna Valley in eastern Pennsylvania. These agricultural areas had access to cheap, convenient transport which could be used to reach markets; the farms supplied the growing urban populations in the cities and some of the products were exported. Furthermore, the farmers supplied the nearby, growing non-farm populations in the villages and small towns who provided goods and services to farmers. These non-farm consumers included retailers, small mill owners, teamsters, craftspeople, and professionals (clergy, physicians, and lawyers).

Across every decade from 1800 to 1860, the number of farm laborers grew, thus testifying to the robustness of eastern agriculture (see Table 1). And, this increase occurred in the face of an expanding manufacturing sector, as increasing numbers of rural dwellers left the farms to work in the factories, especially after 1840. Even New England, the region which presumably was the epitome of declining agriculture, witnessed a rise in the number of farm laborers all the way up to 1840, and, as of 1860, the drop off from the peak was small. Massachusetts and Connecticut, which had vigorous small workshops and increasing numbers of small factories before 1840, followed by a surge in manufacturing after 1840, matched the trajectory of farm laborers in New England as a whole. The numbers in these two states peaked in 1840 and fell off only modestly over the next twenty years. The Middle Atlantic region witnessed an uninterrupted rise in the number of farm laborers over the sixty-year period. New York and Pennsylvania, the largest states, followed slightly different paths. In New York, the number of farm laborers peaked around 1840 and then stabilized near that level for the next two decades, whereas in Pennsylvania the number of farm laborers rose in an uninterrupted fashion.

Table 1
Number of Farm Laborers by Region and Selected States, 1800-1860

Year 1800 1810 1820 1830 1840 1850 1860
New England 228,100 257,700 303,400 353,800 389,100 367,400 348,100
Massachusetts 73,200 72,500 73,400 78,500 87,900 80,800 77,700
Connecticut 50,400 49,300 51,500 55,900 57,000 51,400 51,800
Middle Atlantic 375,700 471,400 571,700 715,000 852,800 910,400 966,600
New York 111,800 170,100 256,000 356,300 456,000 437,100 449,100
Pennsylvania 112,600 141,000 164,900 195,200 239,000 296,300 329,000
East 831,900 986,800 1,178,500 1,422,600 1,631,000 1,645,200 1,662,800

Source: Thomas Weiss, “U.S. Labor Force Estimates and Economic Growth, 1800-1860,”American Economic Growth and Standards of Living before the Civil War, edited by Robert E. Gallman and John Joseph Wallis (Chicago, IL: University of Chicago Press, 1992), table 1A.9, p. 51.

The farmers, retailers, professionals, and others in these prosperous agricultural areas accumulated capital which became available for other economic sectors, and manufacturing was one of the most important to receive this capital. Entrepreneurs who owned small workshops and factories obtained capital to turn out a wide range of goods such as boards, boxes, utensils, building hardware, furniture, and wagons, which were in demand in the agricultural areas. And, some of these workshops and factories enlarged their market areas to a subregion as they gained production efficiencies; but, this did not account for all industrial development. Selected manufactures such as shoes, tinware, buttons, and cotton textiles were widely demanded by urban and rural residents of prosperous agricultural areas and by residents of the large cities. These products were high value relative to their weight; thus, the cost to ship them long distances was low. Astute entrepreneurs devised production methods and marketing approaches to sell these goods in large market areas, including New England and the Middle Atlantic regions of the East.

Manufactures Which Were Produced for Large Market Areas

Shoes and Tinware

Small workshops turned out shoes. Massachusetts entrepreneurs devised an integrated shoe production complex based on a division of labor among shops, and they established a marketing arm of wholesalers, principally in Boston, who sold the shoes throughout New England, to the Middle Atlantic, and to the South (particularly, to slave plantations). Businesses in Connecticut drew on the extensive capital accumulated by the well-to-do rural and urban dwellers of that state and moved into tinware, plated ware, buttons, and wooden clocks. These products, like shoes, also were manufactured in small workshops, but a division of labor among shops was less important than the organization of production within shops. Firms producing each good tended to agglomerate in a small subregion of the state. These clusters arose because entrepreneurs shared information about production techniques and specialized skills which they developed, and this knowledge was communicated as workers moved among shops. Initially, a marketing system of peddlers emerged in the tinware sector, and they sold the goods, first throughout Connecticut, and then they extended their travels to the rest of New England and to the Middle Atlantic. Workshops which made other types of light, high-value goods soon took advantage of the peddler distribution system to enlarge their market areas. At first, these peddlers operated part-time during the year, but as the supply of goods increased and market demand grew, peddlers operated for longer periods of the year and they traveled farther.

Cotton Textiles

Cotton textile manufacturing was an industry built on low-wage, especially female, labor; presumably, this industry offered opportunities in areas where farmers were unsuccessful. Yet, similar to the other manufactures which enlarged their market areas to the entire East before 1820, cotton textile production emerged in prosperous agricultural areas. That is not surprising, because this industry required substantial capital, technical skills, and, initially, nearby markets. These requirements were met in rich farming areas, which also could draw on wealthy merchants in large cities who contributed capital and provided sale outlets beyond nearby markets as output grew. The production processes in cotton textile manufacturing, however, diverged from the approaches to making shoes and small metal and wooden products. From the start, production processes included textile machinery, which initially consisted of spinning machines to make yarn, and later (after 1815), weaving machines and other mechanical equipment were added. Highly skilled mechanics were required to build the machines and to maintain them. The greater capital requirements for cotton mills, compared to shoes and small goods’ manufactures in Connecticut, meant that merchant wholesalers and wealthy retailers, professionals, mill owners, and others, were important underwriters of the factories.

Starting in the 1790s, New England, and, especially, Rhode Island, housed the leaders in early cotton textile manufacturing. Providence merchants funded some of the first successful cotton spinning mills, and they drew on the talents of Samuel Slater, an immigrant British machinist. He trained many of the first important textile mechanics, and investors in various parts of Rhode Island, Connecticut, Massachusetts, New Hampshire, and New York hired them to build mills. Between 1815 and 1820, power-loom weaving began to be commercially feasible, and this effort was led by firms in Rhode Island and, especially, in Massachusetts. Boston merchants, starting with the Boston Manufacturing Company at Waltham, devised a business plan which targeted large-scale, integrated cotton textile manufacturing, with a marketing/sales arm housed in a separate firm. They enlarged their effort significantly after 1820, and much of the impetus to the growth of the cotton textile industry came from the success entrepreneurs had in lowering the cost of production.

The Impact of Transportation Improvements

Following 1820, government and private sources invested substantial sums in canals, and after 1835, railroad investment increased rapidly. Canals required huge volumes of low-value commodities in order to pay operating expenses, cover interest on the bonds which were issued for construction, and retire the bonds at maturity. These conditions were only met in the richest agricultural and resource (lumbering and coal mining, for example) areas traversed by the Erie and Champlain Canals in New York and the coal canals in eastern Pennsylvania and New Jersey. The vast majority of the other canals failed to yield benefits for agriculture and industry, and most were costly debacles. Early railroads mainly carried passengers, especially within fifty to one hundred miles of the largest cities – Boston, New York, Philadelphia, and Baltimore. Industrial products were not carried in large volumes until after 1850; consequently, railroads built before that time had little impact on industrialization in the East.

Canals and railroads had minor impacts on agricultural and industrial development because the lowly wagon provided withering competition. Wagons offered flexible, direct connections between origins and destinations, without the need to transship goods, as was the case with canals and railroads; these modes required wagons at their end points. Within a distance of about fifty miles, the cost of wagon transport was competitive with alternative transport modes, so long as the commodities were high value relative to their weight. And, infrequent transport of these goods could occur over distances of as much as one hundred miles. This applied to many manufactures, and agricultural commodities could be raised to high value by processing prior to shipment. Thus, wheat was turned into flour, corn and other grains were fed to cattle and pigs and these were processed into beef and pork prior to shipment, and milk was converted into butter and cheese. Most of the richest agricultural and industrial areas of the East were less than one hundred miles from the largest cities or these areas were near low-cost waterway transport along rivers, bays, and the Atlantic Coast. Therefore, canals and railroads in these areas had difficulty competing for freight, and outside these areas the limited production generated little demand for long distant transport services.

Agricultural Prosperity Continues

After 1820, eastern farmers seized the increasing market opportunities in the prosperous rural areas as nonfarm processing expanded and village and small town populations demanded greater amounts of farm products. The large number of farmers who were concentrated around the rapidly growing metropolises (Boston, New York, Philadelphia, and Baltimore) and near urban agglomerations such as Albany-Troy, New York, developed increasing specialization in urban market goods such as fluid milk, fresh vegetables, fruit, butter, and hay (for horse transport). Farmers farther away responded to competition by shifting into products which could be transported long distances to market, including wheat into flour, cattle which walked to market, or pigs which were converted into pork. During the winter these farms sent butter, and cheese was a specialty which could be lucrative for long periods of the year when temperatures were cool.

These changes swept across the East, and, after 1840, farmers increasingly adjusted their production to compete with cheap wheat, cattle, and pork arriving over the Erie Canal from the Midwest. Wheat growing became less profitable, and specialized agriculture expanded, such as potatoes, barley, and hops in central New York and cigar tobacco in the Connecticut Valley. Farmers near the largest cities intensified their specialization in urban market products, and as the railroads expanded, fluid milk was shipped longer distances to these cities. Farmers in less accessible areas and on poor agricultural land which was infertile or too hilly, became less competitive. If these farmers and their children stayed, their incomes declined relative to others in the East, but if they moved to the Midwest or to the burgeoning industrial cities of the East, they had the chance of participating in the rising prosperity.

Metropolitan Industrial Complexes

The metropolises of Boston, New York, Philadelphia, and, to a lesser extent, Baltimore, led the industrial expansion after 1820, because they were the greatest concentrated markets, they had the most capital, and their wholesalers provided access to subregional and regional markets outside the metropolises. By 1840, each of them was surrounded by industrial satellites – manufacturing centers in close proximity to, and economically integrated with, the metropolis. Together, these metropolises and their satellites formed metropolitan industrial complexes, which accounted for almost one-quarter of the nation’s manufacturing (see Table 2). For example, metropolises and satellites included Boston and Lowell, New York and Paterson (New Jersey), Philadelphia and Reading (Pennsylvania), and Baltimore and Wilmington (Delaware), which also was a satellite of Philadelphia. Among the four leading metropolises, New York and Philadelphia housed, by far, the largest share of the nation’s manufacturing workers, and their satellites had large numbers of industrial workers. Yet, Boston’s satellites contained the greatest concentration of industrial workers in the nation, with almost seven percent of the national total. The New York, Philadelphia, and Boston metropolitan industrial complexes each had approximately the same share of the nation’s manufacturing workers. These complexes housed a disproportionate share of the nation’s commerce-serving manufactures such as printing-publishing and paper and of local, regional, and national market manufactures such as glass, drugs and paints, textiles, musical instruments, furniture, hardware, and machinery.

Table 2
Manufacturing Employment in the Metropolitan Industrial Complexes
of New York, Philadelphia, Boston, and Baltimore
as a Percentage of National Manufacturing Employment in 1840

Metropolis Satellites Complex
New York 4.1% 3.4% 7.4%
Philadelphia 3.9 2.9 6.7
Boston 0.5 6.6 7.1
Baltimore 2.0 0.2 2.3
Four Complexes 10.5 13.1 23.5

Note: Metropolitan county is defined as the metropolis for each complex and “outside” comprises nearby counties; those included in each complex were the following. New York: metropolis (New York, Kings, Queens, Richmond); outside (Connecticut: Fairfield; New York: Westchester, Putnam, Rockland, Orange; New Jersey: Bergen, Essex, Hudson, Middlesex, Morris, Passaic, Somerset). Philadelphia: metropolis (Philadelphia); outside (Pennsylvania: Bucks, Chester, Delaware, Montgomery; New Jersey: Burlington, Gloucester, Mercer; Delaware: New Castle). Boston: metropolis (Suffolk); outside (Essex, Middlesex, Norfolk, Plymouth). Baltimore: metropolis (Baltimore); outside (Anne Arundel, Harford).

Source: U.S. Bureau of the Census, Compendium of the Sixth Census, 1840 (Washington, D.C.: Blair and Rives, 1841).

Also, by 1840, prosperous agricultural areas farther from these complexes, such as the Connecticut Valley in New England, the Hudson Valley, the Erie Canal Corridor across New York state, and southeastern Pennsylvania, housed significant amounts of manufacturing in urban places. At the intersection of the Hudson and Mohawk rivers, the Albany-Troy agglomeration contained one of the largest concentrations of manufacturing outside the metropolitan complexes. And, industrial towns such as Utica, Syracuse, Rochester, and Buffalo were strung along the Erie Canal Corridor. Many of the manufactures (such as furniture, wagons, and machinery) served subregional markets in the areas of prosperous agriculture, but some places also developed specialization in manufactures (textiles and hardware) for larger regional and interregional market areas (the East as a whole). The Connecticut Valley, for example, housed many firms which produced cotton textiles, hardware, and cutlery.

Manufactures for Eastern and National Markets

Shoes

In several industrial sectors whose firms had expanded before 1820 to regional, and even, multiregional markets, in the East, firms intensified their penetration of eastern markets and reached to markets in the rapidly growing Midwest between 1820 and 1860. In eastern Massachusetts, a production complex of shoe firms innovated methods of organizing output within and among firms, and they developed a wide array of specialized tools and components to increase productivity and to lower manufacturing costs. In addition, a formidable wholesaling, marketing, and distribution complex, headed by Boston wholesalers, pushed the ever-growing volume of shoes into sales channels which reached throughout the nation. Machinery did not come into use until the 1850s, and, by 1860, Massachusetts accounted for half of the value of the nation’s shoe production.

Cotton Textiles

In contrast, machinery constituted an important factor of production which drove down the price of cotton textile goods, substantially enlarging the quantity consumers demanded. Before 1820, most of the machinery innovations improved the spinning process for making yarn, and in the five years following 1815, innovations in mechanized weaving generated an initial substantial drop in the cost of production as the first integrated spinning-weaving mills emerged. During the next decade and a half the price of cotton goods collapsed by over fifty percent as large integrated spinning-weaving mills became the norm for the production of most cotton goods. Therefore, by the mid-1830s vast volumes of cotton goods were pouring out of textile mills, and a sophisticated set of specialized wholesaling firms, mostly concentrated in Boston, and secondarily, in New York and Philadelphia, channeled these items into the national market.

Prior to 1820, the cotton textile industry was organized into three cores. The Providence core dominated and the Boston core occupied second place; both of these were based mostly on mechanized spinning. A third core in the city of Philadelphia was based on hand spinning and weaving. Within about fifteen years after 1820, the Boston core soared to a commanding position in cotton textile production as a group of Boston merchants and their allies relentlessly replicated their business plan at various sites in New England, including at Lowell, Chicopee, and Taunton in Massachusetts, at Nashua, Manchester, and Dover in New Hampshire, and at Saco in Maine. The Providence core continued to grow, but its investors did not seem to fully grasp the strategic, multi-faceted business plan which the Boston merchants implemented. Similarly, investors in an emerging core within about fifty to seventy-five miles of New York City in the Hudson Valley and northern New Jersey likewise did not seem to fully understand the Boston merchants’ plan, and these New York City area firms never reached the scale of the firms of the Boston Core. The Philadelphia core enlarged to nearby areas southwest of the city and in Delaware, but these firms stayed small, and the Philadelphia firms created a small-scale, flexible production system which turned out specialized goods, not the mass-market commodity textiles of the other cores.

Capital Investment in Cotton Textiles

The distribution of capital investment in cotton textiles across the regions and states of the East between 1820 and 1860 capture the changing prominence of the cores of cotton textile production (see Table 3). The New England and the Middle Atlantic regions contained approximately similar shares (almost half each) of the nation’s capital investment. However, during the 1820s the cotton textile industry restructured to a form which was maintained for the next three decades. New England’s share of capital investment surged to about seventy percent, and it maintained that share until 1860, whereas the Middle Atlantic region’s share fell to around twenty percent by 1840 and remained near that until 1860. The rest of the nation, primarily the South, reached about ten percent of total capital investment around 1840 and continued at that level for the next two decades. Massachusetts became the leading cotton textile state by 1831 and Rhode Island, the early leader, gradually slipped to a level of about ten percent by the 1850s; New Hampshire and Pennsylvania housed approximately similar shares as Rhode Island by that time.

Table 3
Capital Invested in Cotton Textiles
by Region and State as a Percentage of the Nation
1820-1860

Region/state 1820 1831 1840 1850 1860
New England 49.6% 69.8% 68.4% 72.3% 70.3%
Maine 1.6 1.9 2.7 4.5 6.1
New Hampshire 5.6 13.1 10.8 14.7 12.8
Vermont 1.0 0.7 0.2 0.3 0.3
Massachusetts 14.3 31.7 34.1 38.2 34.2
Connecticut 11.6 7.0 6.2 5.7 6.7
Rhode Island 15.4 15.4 14.3 9.0 10.2
Middle Atlantic 46.2 29.5 22.7 17.3 19.0
New York 18.8 9.0 9.6 5.6 5.5
New Jersey 4.7 5.0 3.4 2.0 1.3
Pennsylvania 6.3 9.3 6.5 6.1 9.3
Delaware 4.0 0.9 0.6 0.6 0.6
Maryland 12.4 5.3 2.6 3.0 2.3
Rest of nation 4.3 0.7 9.0 10.4 10.7
Nation 100.0% 100.0% 100.0% 100.0% 100.0%
Total capital (thousands) $10,783 $40,613 $51,102 $74,501 $98,585

Sources: David J. Jeremy, Transatlantic Industrial Revolution: The Diffusion of Textile Technologies Between Britain and America, 1790-1830s (Cambridge, MA: MIT Press, 1981), appendix D, table D.1, p. 276; U.S. Bureau of the Census, Compendium of the Sixth Census, 1840 (Washington, D.C.: Blair and Rives, 1841); U.S. Bureau of the Census, Report on the Manufactures of the United States at the Tenth Census, 1880 (Washington, D.C.: Government Printing Office, 1883).

Connecticut’s Industries

In Connecticut, industrialists built on their successful production and sales prior to 1820 and expanded into a wider array of products which they sold in the East and South, and, after 1840, they acquired more sales in the Midwest. This success was not based on a mythical “Yankee ingenuity,” which, typically, has been framed in terms of character. Instead, this ingenuity rested on fundamental assets: a highly educated population linked through wide-ranging social networks which communicated information about technology, labor opportunities, and markets; and the abundant supplies of capital in the state supported the entrepreneurs. The peddler distribution system provided efficient sales channels into the mid-1830s, but, after that, firms took advantage of more traditional wholesaling channels. In some sectors, such as the brass industry, firms followed the example of the large Boston-core textile firms, and the brass companies founded their own wholesale distribution agencies in Boston and New York City. The achievements of Connecticut’s firms were evident by 1850. As a share of the nation’s value of production, they accounted for virtually all of the clocks, pins, and suspenders, close to half of the buttons and rubber goods, and about one-third of the brass foundry products, Britannia and plated ware, and hardware.

Difficulty of Duplicating Eastern Methods in the Midwest

The East industrialized first, based on a prosperous agricultural and industrialization process, as some of its entrepreneurs shifted into the national market manufactures of shoes, cotton textiles, and diverse goods turned out in Connecticut. These industrialists made this shift prior to 1820, and they enhanced their dominance of these products during the subsequent two decades. Manufacturers in the Midwest did not have sufficient intraregional markets to begin producing these goods before 1840; therefore, they could not compete in these national market manufactures. Eastern firms had developed technologies and organizations of production and created sales channels which could not be readily duplicated, and these light, high-value goods were transported cheaply to the Midwest. When midwestern industrialists faced choices about which manufactures to enter, the eastern light, high-value goods were being sold in the Midwest at prices which were so low that it was too risky for midwestern firms to attempt to compete. Instead, these firms moved into a wide range of local and regional market manufactures which also existed in the East, but which cost too much to transport to the Midwest. These goods included lumber and food products (e.g., flour and whiskey), bricks, chemicals, machinery, and wagons.

The American Manufacturing Belt

The Midwest Joins the American Manufacturing Belt after 1860

Between 1840 and 1860, Midwestern manufacturers made strides in building an industrial infrastructure, and they were positioned to join with the East to constitute the American Manufacturing Belt, the great concentration of manufacturing which would sprawl from the East Coast to the edge of the Great Plains. This Belt became mostly set within a decade or so after 1860, because technologies and organizations of production and of sales channels had lowered costs across a wide array of manufactures, and improvements in transportation (such as an integrated railroad system) and communication (such as the telegraph) reduced distribution costs. Thus, increasing shares of industrial production were sold in interregional markets.

Lack of Industrialization in the South

Although the South had prosperous farms, it failed to build a deep and broad industrial infrastructure prior to 1860, because much of its economy rested on a slave agricultural system. In this economy, investments were heavily concentrated in slaves rather than in an urban and industrial infrastructure. Local and regional demand remained low across much of the South, because slaves were not able to freely express their consumption demands and population densities remained low, except in a few agricultural areas. Thus, the market thresholds for many manufactures were not met, and, if thresholds were met, the demand was insufficient to support more than a few factories. By the 1870s, when the South had recovered from the Civil War and its economy was reconstructed, eastern and midwestern industrialists had built strong positions in many manufactures. And, as new industries emerged, the northern manufacturers had the technological and organizational infrastructure and distribution channels to capture dominance in the new industries.

In a similar fashion, the Great Plains, the Southwest, and the West were settled too late for their industrialists to be major producers of national market goods. Manufacturers in these regions focused on local and regional market manufactures. Some low wage industries (such as textiles) began to move to the South in significant numbers after 1900, and the emergence of industries based on high technology after 1950 led to new manufacturing concentrations which rested on different technologies. Nonetheless, the American Manufacturing Belt housed the majority of the nation’s industry until the middle of the twentieth century.

This essay is based on David R. Meyer, The Roots of American Industrialization, Baltimore: Johns Hopkins University Press, 2003.

Additional Readings

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Baker, Andrew H., and Holly V. Izard. “New England Farmers and the Marketplace, 1780-1865: A Case Study.” Agricultural History 65 (1991): 29-52.

Barker, Theo, and Dorian Gerhold. The Rise and Rise of Road Transport, 1700-1990. New York: Cambridge University Press, 1995.

Bodenhorn, Howard. A History of Banking in Antebellum America: Financial Markets and Economic Development in an Era of Nation-Building. New York: Cambridge University Press, 2000.

Brown, Richard D. Knowledge is Power: The Diffusion of Information in Early America, 1700-1865. New York: Oxford University Press, 1989.

Clark, Christopher. The Roots of Rural Capitalism: Western Massachusetts, 1780-1860. Ithaca, NY: Cornell University Press, 1990.

Dalzell, Robert F., Jr. Enterprising Elite: The Boston Associates and the World They Made. Cambridge, MA: Harvard University Press, 1987.

Durrenberger, Joseph A. Turnpikes: A Study of the Toll Road Movement in the Middle Atlantic States and Maryland. Cos Cob, CT: John E. Edwards, 1968.

Field, Alexander J. “On the Unimportance of Machinery.” Explorations in Economic History 22 (1985): 378-401.

Fishlow, Albert. American Railroads and the Transformation of the Ante-Bellum Economy. Cambridge, MA: Harvard University Press, 1965.

Fishlow, Albert. “Antebellum Interregional Trade Reconsidered.” American Economic Review 54 (1964): 352-64.

Goodrich, Carter, ed. Canals and American Economic Development. New York: Columbia University Press, 1961.

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Hoke, Donald R. Ingenious Yankees: The Rise of the American System of Manufactures in the Private Sector. New York: Columbia University Press, 1990.

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Sokoloff, Kenneth L. “Productivity Growth in Manufacturing during Early Industrialization: Evidence from the American Northeast, 1820-1860.” In Long-Term Factors in American Economic Growth, edited by Stanley L. Engerman and Robert E. Gallman, 679-729. Chicago: University of Chicago Press, 1986.

Ware, Caroline F. The Early New England Cotton Manufacture: A Study in Industrial Beginnings. Boston: Houghton Mifflin, 1931.

Weiss, Thomas. “Economic Growth before 1860: Revised Conjectures.” In American Economic Development in Historical Perspective, edited by Thomas Weiss and Donald Schaefer, 11-27. Stanford, CA: Stanford University Press, 1994.

Weiss, Thomas. “Long-Term Changes in U.S. Agricultural Output per Worker, 1800-1900.” Economic History Review 46 (1993): 324-41.

Weiss, Thomas. “U.S. Labor Force Estimates and Economic Growth, 1800-1860.” In American Economic Growth and Standards of Living before the Civil War, edited by Robert E. Gallman and John Joseph Wallis, 19-75. Chicago University of Chicago Press, 1992.

Wood, Frederic J. The Turnpikes of New England. Boston: Marshall Jones, 1919.

Wood, Gordon S. The Radicalism of the American Revolution. New York: Alfred A. Knopf, 1992.

Zevin, Robert B. “The Growth of Cotton Textile Production after 1815.” In The Reinterpretation of American Economic History, edited by Robert W. Fogel and Stanley L. Engerman, 122-47. New York: Harper & Row, 1971.

Citation: Meyer, David. “American Industrialization”. EH.Net Encyclopedia, edited by Robert Whaples. March 16, 2008. URL http://eh.net/encyclopedia/the-roots-of-american-industrialization-1790-1860/

Industrial Sickness Funds

John E. Murray, University of Toledo

Overview and Definition

Industrial sickness funds provided an early form of health insurance. They were financial institutions that extended cash payments and in some cases medical benefits to members who became unable to work due to sickness or injury. The term industrial sickness funds is a later construct which describes funds organized by companies, which were also known as establishment funds, and by labor unions. These funds were widespread geographically in the United States; the 1890 Census of Insurance found 1,259 nationwide, with concentrations in the Northeast, Midwest, California, Texas, and Louisiana (U.S. Department of the Interior, 1895). By the turn of the twentieth century, some industrial sickness funds had accumulated considerable experience at managing sickness benefits. A few predated the Civil War. When the U. S. Commissioner of Labor surveyed a sample of sickness funds in 1908, it found 867 non-fraternal funds nationwide that provided temporary disability benefits (U.S. Commissioner of Labor, 1909). By the time of World War I, these funds, together with similar funds sponsored by fraternal societies, covered 30 to 40 percent of non-agricultural wage workers in the more industrialized states, or by extension, eight to nine million nationwide (Murray 2007a). Sickness funds were numerous, widespread, and in general carefully operated.

Industrial sickness funds were among the earliest providers of any type of health or medical benefits in the United States. In fact, their earliest product was called “workingman’s insurance” or “sickness insurance,” terms that described their clientele and purpose accurately. In the late Progressive Era, reformers promoted government insurance programs that would supplant the sickness funds. To sound more British, they used the term “health insurance,” and that is the phrase we still use for this kind of insurance contract (Numbers 1978). In the history of health insurance, the funds were contemporary with benefit operations of fraternal societies (see fraternal sickness insurance) and led into the period of group health insurance (see health insurance, U. S.). They should be distinguished from the sickness benefits provided by some industrial insurance policies, which required weekly premium payments and paid a cash benefit upon death, which was intended to cover burial expenses.

Many written histories of health insurance have missed the important role industrial sickness funds played in both relief of worker suffering and in the political process. Recent historians have tended to criticize, patronize, or ignore sickness funds. Lubove (1986) complained that they stood in the way of government insurance for all workers. Klein (2003) claimed that they were inefficient, without making explicit her standard for that judgment. Quadagno (2005) simply asserted that no one had thought of health insurance before the 1920s. Contemporary commentators such as I. M. Rubinow and Irving Fisher criticized workers who preferred “hopelessly inadequate” sickness fund insurance over government insurance as “infantile” (Derickson 2005). But these criticisms stemmed more from their authors’ ideological preconceptions than from close study of these institutions.

Rise and Operations of Industrial Sickness Funds

The period of their greatest extent and importance was from the 1880s to around 1940. The many state labor bureau surveys of individual workers, since digitized by the University of California’s Historical Labor Statistics Project and available for download at EH.net, often asked questions such as “do you belong to a benefit society,” meaning a fraternal sickness benefit fund or an industrial sickness fund. Of the surveys from the early 1890s that included this question, around a quarter of respondents indicated that they belonged to such societies. Later, closer to 1920, several states examined the extent of sickness insurance coverage in response to movements to create governmental health insurance for workers (Table 1). These later studies indicated that in the Northeast, Midwest, and California, between thirty and forty percent of non-agricultural workers were covered. Thus, remarkably, these societies had actually increased their market share over a three decade period in which the labor force itself grew from 13 to 30 million workers (Murray 2007a). Industrial sickness funds were dynamic institutions, capable of dealing with an ever expanding labor market

Table 1:
Sources of Insurance in Three States (thousands of workers)

Source/state Illinois Ohio California
Fraternal society 250 200 291
Establishment fund 116 130 50
Union fund 140 85 38
Other sick fund 12 N/a 35
Commercial insurance 140 85 2 (?)
Total 660 500 416
Eligible labor force 1,850 1,500 995
Share insured 36% 33% 42%
Sources: Illinois (1919), Ohio, (1919), California (1917), Lee et al. (1957).

Industrial sickness funds operated in a relatively simple fashion, but one that enabled them to mitigate the usual information problems that emerge in insurance markets. The process of joining a fund and making a claim typically worked as follows. A newly hired worker in a plant with such a fund explicitly applied to join, often after a probationary period during which fund managers could observe his baseline health and work habits. After admission to the fund, he paid an entrance fee followed by weekly dues. Since the average industrial worker in the 1910s earned about ten dollars a week, the entrance fee of one dollar was a half-day’s pay and the dues of ten cents made the cost to the worker around one percent of his pay packet.

A member who was unable to work contacted his fund, which then sent either a committee of fellow fund members, a physician, or both to check on the member-now-claimant. If they found him as sick as he had said he was, and in their judgment he was unable to work, after a one week waiting period he received around half his weekly pay. The waiting period was intended to let transient, less serious illnesses resolve so that the fund could support members with longer-term medical problems. To continue receiving the sick pay the claimant needed to allow periodic examinations by a physician or visiting committee. In rough terms, the average worker missed two percent of a work year, or about a week every year, a rate that varied by age and industry. The quarter of all workers who missed any work lost on average one month’s pay; thus a typical incapacitated worker received three and a half weeks of benefit per year. Comparing the cost of dues and expected value of benefits shows that the sickness funds were close to an actuarially fair bet: $5.00 in annual dues compared to (0.25 chance of falling ill) x (3.5 weeks of benefits) x ($5.00 weekly benefit), or about four and a half dollars in expected benefits. Thus, sickness funds appear to have been a reasonably fair deal for workers.

Establishment funds did not invent sickness benefits by any means. Rather, they systematized previous arrangements for supporting sick workers or the survivors of deceased workers. The old way was to pass the hat, which was characterized by random assessments and arbitrary financial awards. Workers and employers both observed that contributors and beneficiaries alike detested passing the hat. Fellow workers complained about the surprise nature of the hat’s appearance, and beneficiaries faced humiliation upon grief when the hat contained less money than had been collected for a more popular co-worker. Eventually rules replaced discretion, and benefits were paid according to a published schedule, either as a flat rate per diem or as a percentage of wages. The 1890 Census of Insurance reported that only a few funds extended benefits “at the discretion of the society,” and by the time of the 1908 Commissioner of Labor survey the practice had disappeared (Murray 2007).

Labor union funds began in the early nineteenth century. In the earliest union funds, members of craft unions pledged to complete jobs that ill brothers had contracted to perform but could not finish due to illness. Eventually cash benefit payments replaced the in-kind promises of labor, accompanied by cash premium payments into the union’s kitty. While criticized by many observers as unstable, labor union funds actually operated in transparent fashion. Even funds that offered unemployment benefits survived the depression of the mid-1890s by reducing benefit payments and enacting other conservative measures. Another criticism was that their benefits were too small in amount and too brief in duration, but according to the 1908 Commissioner of Labor survey, labor union funds and establishment funds offered similar levels of benefits. The cost-benefit ratio did favor establishment funds, but establishment fund membership ended with employment at a particular company, while union funds offered the substantial attraction of benefits that were portable from job to job.

The cash payment to sick workers created an incentive to take sick leave that workers without sickness insurance did not face; this is the moral hazard of sick pay. Further, workers who believed that they were more likely to make a sick claim would have a stronger incentive to join a sickness fund than a worker in relatively good health; this is called adverse selection. Early twentieth century commentators on government sickness insurance disagreed on the extent and even the existence of moral hazard and adverse selection in sickness insurance. Later statistical studies found evidence for both in establishment funds. However, the funds themselves had understood the potential financial damage each could wreak and strategized to mitigate such losses. The magnitude of the sick pay moral hazard was small, and affected primarily the tendency of the worker to make a claim in the first place. Many sickness funds limited their liability here by paying for the physician who examined the claimant and thus was responsible for approving extended sickness payments. Physicians appear to have paid attention to the wishes of those who paid them. Among claimants in funds that paid the examining physician directly, the average duration of their illness ended significantly earlier. By the same token, physicians who were paid by the worker tended to approve longer absences for that worker—a sign that physicians too responded to incentives.

Testing for adverse selection depends on whether membership in a company’s fund was the worker’s choice (that is, it was voluntary) or the company’s choice (that is, it was compulsory). In fact among establishment funds in which membership was voluntary, claim rates per member were significantly higher than in mandatory membership funds. This indicates that voluntary funds were especially attractive to sicker workers, which is the essence of adverse selection. To reduce the risks of adverse selection, funds imposed age limits to keep out older applicants, physical examinations to discourage the obviously ill, probationary periods to reveal chronic illness, and pre-existing condition clauses to avoid paying for such conditions (Murray 2007a). Sickness funds thus cleverly managed information problems typical of insurance markets.

Industrial Sickness Funds and Progressive Era Politics

Industrial sickness funds were the linchpin of efforts to promote and to oppose the Progressive campaign for state-level mandatory government sickness insurance. One consistent claim made by government insurance supporters was that workers could neither afford to pay for sickness insurance nor to save in advance of financially damaging health problems. The leading advocacy organization, the American Association for Labor Legislation (AALL), reported in its magazine that “Savings of Wage-Earners Are Insufficient to Meet this Loss,” meaning lost income during sickness (American Association for Labor Legislation 1916a). However, worker surveys of savings, income, and insurance holdings revealed that workers rationally strategized according to their varying needs and abilities across the life-cycle. Young workers saved little and were less likely to belong to industrial sickness funds—but were less likely to miss work due to illness as well. Middle aged workers, married with families to support, were relatively more likely to belong to a sickness fund. Older workers pursued a different strategy, saving more and relying on sickness funds less; among other factors, they wanted greater liquidity in their financial assets (Murray 2007a). Worker strategies reflected varying needs at varying stages of life, some (but not all) of which could be adequately addressed by membership in sickness funds.

Despite claims to the contrary by some historians, there was little popular support for government sickness insurance in early twentieth century America. Lobbying by the AALL led twelve states to charge investigatory commissions with determining the need for and feasibility of government sickness insurance (Moss 1996). The AALL offered a basic bill that could be adjusted to meet a state’s particular needs (American Association for Labor Legislation 1916b). Typically the Association prodded states to adopt a version of German insurance, which would keep the many small industrial sickness funds while forcing new members into some and creating new funds for other workers. However, these bills met consistent defeat in statehouses, earning only a fleeting victory in the New York Senate in 1919, which was followed by the bill’s death in an Assembly committee (Hoffman 2001). In the previous year a California referendum on a constitutional amendment that would allow the government to provide sickness insurance lost by nearly three to one (Costa 1996).

After the Progressive campaign exhausted itself, industrial sickness funds continued to grow through the 1920s, but the Great Depression exposed deep flaws in their structure. Many labor union funds, without a sponsoring firm to act as lender of last resort, dissolved. Establishment funds failed at a surprisingly low rate, but their survival was made possible by the tendency of firms to fire less healthy workers. Federal surveys in Minnesota found that ill-health led to earlier job loss in the Depression, and comparisons of self reported health in later surveys indicated that the unemployed were in fact in poorer health than the employed, and the disparity grew as the Depression deepened. Thus, industrial sickness funds paradoxically enjoyed falling claim rates (and thus reduced expenses) as the economy deteriorated (Murray 2007).

Decline and Rebirth of Sickness Funds

At the same time, commercial insurers had been engaging in ever more productive research into the actuarial science of group health insurance. Eventually the insurers cut premium rates while offering benefits comparable to those available through sickness funds. As a result, the commercial insurers and Blue CrossBlue Shield came to dominate the market for health benefits. A federal survey that covered the early 1930s found more firms with group health than with mutual benefit societies but the benefit societies still insured more than twice as many workers (Sayers, et al 1937). By the later 1930s that gap in the number of firms had widened in favor of group health (Figure 1), and the number of workers insured was about equal. After the mid-1940s, industrial sickness funds were no longer a significant player in markets for health insurance (Murray 2007a).

Figure 1: Health Benefit Provision and Source
Source: Dobbin (1992) citing National Industrial Conference Board surveys.

More recently, a type of industrial sickness fund has begun to stage a comeback. Voluntary employee beneficiary associations (VEBAs) fall under a 1928 federal law that was created to govern industrial sickness funds. VEBAs are trusts set up to pay employee benefits without earning profits for the company. In late 2007, the Big Three automakers each contracted with the United Auto Workers (UAW) to operate a VEBA that would provide health insurance for UAW members. If the automakers and their workers succeed in establishing VEBAs that stand the test of time, they will have resurrected a once-successful financial institution previously thought relegated to the pre-World War II economy (Murray 2007b).

References

American Association for Labor Legislation. “Brief for Health Insurance.” American Labor Legislation Review 6 (1916a): 155–236.

American Association for Labor Legislation. “Tentative Draft of an Act.” American Labor Legislation Review 6 (1916b): 239–68.

California Social Insurance Commission. Report of the Social Insurance Commission of the State of California, January 25, 1917. Sacramento: California State Printing Office, 1917.

Costa, Dora L. “Demand for Private and State Provided Health Insurance in the 1910s: Evidence from California.” Photocopy, MIT, 1996.

Derickson, Alan. Health Security for All: Dreams of Universal Health Care in America. Baltimore: Johns Hopkins University Press, 2005.

Dobbin, Frank. “The Origins of Private Social Insurance: Public Policy and Fringe Benefits in America, 1920-1950,” American Journal of Sociology 97 (1992): 1416-50.

Hoffman, Beatrix. The Wages of Sickness: The Politics of Health Insurance in Progressive America. Chapel Hill: University of North Carolina Press, 2001.

Klein, Jennifer. For All These Rights: Business, Labor, and the Shaping of America’s Public-Private Welfare State. Princeton: Princeton University Press, 2003.

Lee, Everett S., Ann Ratner Miller, Carol P. Brainerd, and Richard A. Easterlin, under the direction of Simon Kuznets and Dorothy Swaine Thomas. Population Redistribution and Economic Growth, 1870-1950: Volume I, Methodological Considerations and Reference Tables. Philadelphia: Memoirs of the American Philosophical Society 45, 1957.

Lubove, Roy. The Struggle for Social Security, 1900-1930. Second edition. Pittsburgh: University of Pittsburgh Press, 1986.

Moss, David. Socializing Security: Progressive-Era Economists and the Origins of American Social Policy. Cambridge: Harvard University Press, 1996.

Murray, John E. Origins of American Health Insurance: A History of Industrial Sickness Funds. New Haven: Yale University Press, 2007a.

Murray, John E. “UAW Members Must Treat Health Care Money as Their Own,” Detroit Free Press, 21 November 2007b.

Ohio Health and Old Age Insurance Commission. Health, Health Insurance, Old Age Pensions: Report, Recommendations, Dissenting Opinions. Columbus: Heer, 1919.

Quadagno, Jill. One Nation, Uninsured: Why the U. S. Has No National Health Insurance. New York: Oxford University Press, 2005.

Sayers, R. R., Gertrud Kroeger, and W. M. Gafafer. “General Aspects and Functions of the Sick Benefit Organization.” Public Health Reports 52 (November 5, 1937): 1563–80.

State of Illinois. Report of the Health Insurance Commission of the State of Illinois, May 1, 1919. Springfield: State of Illinois, 1919.

U.S. Department of the Interior. Report on Insurance Business in the United States at the Eleventh Census: 1890; pt. 2, “Life Insurance.” Washington, DC: GPO, 1895.

U.S. Commissioner of Labor. Twenty-third Annual Report of the Commissioner of Labor, 1908: Workmen’s Insurance and Benefit Funds in the United States. Washington, DC: GPO, 1909.

Citation: Murray, John. “Industrial Sickness Funds, US”. EH.Net Encyclopedia, edited by Robert Whaples. June 5, 2008. URL http://eh.net/encyclopedia/industrial-sickness-funds/

The Economic History of Indonesia

Jeroen Touwen, Leiden University, Netherlands

Introduction

In recent decades, Indonesia has been viewed as one of Southeast Asia’s successful highly performing and newly industrializing economies, following the trail of the Asian tigers (Hong Kong, Singapore, South Korea, and Taiwan) (see Table 1). Although Indonesia’s economy grew with impressive speed during the 1980s and 1990s, it experienced considerable trouble after the financial crisis of 1997, which led to significant political reforms. Today Indonesia’s economy is recovering but it is difficult to say when all its problems will be solved. Even though Indonesia can still be considered part of the developing world, it has a rich and versatile past, in the economic as well as the cultural and political sense.

Basic Facts

Indonesia is situated in Southeastern Asia and consists of a large archipelago between the Indian Ocean and the Pacific Ocean, with more than 13.000 islands. The largest islands are Java, Kalimantan (the southern part of the island Borneo), Sumatra, Sulawesi, and Papua (formerly Irian Jaya, which is the western part of New Guinea). Indonesia’s total land area measures 1.9 million square kilometers (750,000 square miles). This is three times the area of Texas, almost eight times the area of the United Kingdom and roughly fifty times the area of the Netherlands. Indonesia has a tropical climate, but since there are large stretches of lowland and numerous mountainous areas, the climate varies from hot and humid to more moderate in the highlands. Apart from fertile land suitable for agriculture, Indonesia is rich in a range of natural resources, varying from petroleum, natural gas, and coal, to metals such as tin, bauxite, nickel, copper, gold, and silver. The size of Indonesia’s population is about 230 million (2002), of which the largest share (roughly 60%) live in Java.

Table 1

Indonesia’s Gross Domestic Product per Capita

Compared with Several Other Asian Countries (in 1990 dollars)

Indonesia Philippines Thailand Japan
1900 745 1 033 812 1 180
1913 904 1 066 835 1 385
1950 840 1 070 817 1 926
1973 1 504 1 959 1 874 11 439
1990 2 516 2 199 4 645 18 789
2000 3 041 2 385 6 335 20 084

Source: Angus Maddison, The World Economy: A Millennial Perspective, Paris: OECD Development Centre Studies 2001, 206, 214-215. For year 2000: University of Groningen and the Conference Board, GGDC Total Economy Database, 2003, http://www.eco.rug.nl/ggdc.

Important Aspects of Indonesian Economic History

“Missed Opportunities”

Anne Booth has characterized the economic history of Indonesia with the somewhat melancholy phrase “a history of missed opportunities” (Booth 1998). One may compare this with J. Pluvier’s history of Southeast Asia in the twentieth century, which is entitled A Century of Unfulfilled Expectations (Breda 1999). The missed opportunities refer to the fact that despite its rich natural resources and great variety of cultural traditions, the Indonesian economy has been underperforming for large periods of its history. A more cyclical view would lead one to speak of several ‘reversals of fortune.’ Several times the Indonesian economy seemed to promise a continuation of favorable economic development and ongoing modernization (for example, Java in the late nineteenth century, Indonesia in the late 1930s or in the early 1990s). But for various reasons Indonesia time and again suffered from severe incidents that prohibited further expansion. These incidents often originated in the internal institutional or political spheres (either after independence or in colonial times), although external influences such as the 1930s Depression also had their ill-fated impact on the vulnerable export-economy.

“Unity in Diversity”

In addition, one often reads about “unity in diversity.” This is not only a political slogan repeated at various times by the Indonesian government itself, but it also can be applied to the heterogeneity in the national features of this very large and diverse country. Logically, the political problems that arise from such a heterogeneous nation state have had their (negative) effects on the development of the national economy. The most striking difference is between densely populated Java, which has a long tradition of politically and economically dominating the sparsely populated Outer Islands. But also within Java and within the various Outer Islands, one encounters a rich cultural diversity. Economic differences between the islands persist. Nevertheless, for centuries, the flourishing and enterprising interregional trade has benefited regional integration within the archipelago.

Economic Development and State Formation

State formation can be viewed as a condition for an emerging national economy. This process essentially started in Indonesia in the nineteenth century, when the Dutch colonized an area largely similar to present-day Indonesia. Colonial Indonesia was called ‘the Netherlands Indies.’ The term ‘(Dutch) East Indies’ was mainly used in the seventeenth and eighteenth centuries and included trading posts outside the Indonesian archipelago.

Although Indonesian national historiography sometimes refers to a presumed 350 years of colonial domination, it is exaggerated to interpret the arrival of the Dutch in Bantam in 1596 as the starting point of Dutch colonization. It is more reasonable to say that colonization started in 1830, when the Java War (1825-1830) was ended and the Dutch initiated a bureaucratic, centralizing polity in Java without further restraint. From the mid-nineteenth century onward, Dutch colonization did shape the borders of the Indonesian nation state, even though it also incorporated weaknesses in the state: ethnic segmentation of economic roles, unequal spatial distribution of power, and a political system that was largely based on oppression and violence. This, among other things, repeatedly led to political trouble, before and after independence. Indonesia ceased being a colony on 17 August 1945 when Sukarno and Hatta proclaimed independence, although full independence was acknowledged by the Netherlands only after four years of violent conflict, on 27 December 1949.

The Evolution of Methodological Approaches to Indonesian Economic History

The economic history of Indonesia analyzes a range of topics, varying from the characteristics of the dynamic exports of raw materials, the dualist economy in which both Western and Indonesian entrepreneurs participated, and the strong measure of regional variation in the economy. While in the past Dutch historians traditionally focused on the colonial era (inspired by the rich colonial archives), from the 1960s and 1970s onward an increasing number of scholars (among which also many Indonesians, but also Australian and American scholars) started to study post-war Indonesian events in connection with the colonial past. In the course of the 1990s attention gradually shifted from the identification and exploration of new research themes towards synthesis and attempts to link economic development with broader historical issues. In 1998 the excellent first book-length survey of Indonesia’s modern economic history was published (Booth 1998). The stress on synthesis and lessons is also present in a new textbook on the modern economic history of Indonesia (Dick et al 2002). This highly recommended textbook aims at a juxtaposition of three themes: globalization, economic integration and state formation. Globalization affected the Indonesian archipelago even before the arrival of the Dutch. The period of the centralized, military-bureaucratic state of Soeharto’s New Order (1966-1998) was only the most recent wave of globalization. A national economy emerged gradually from the 1930s as the Outer Islands (a collective name which refers to all islands outside Java and Madura) reoriented towards industrializing Java.

Two research traditions have become especially important in the study of Indonesian economic history during the past decade. One is a highly quantitative approach, culminating in reconstructions of Indonesia’s national income and national accounts over a long period of time, from the late nineteenth century up to today (Van der Eng 1992, 2001). The other research tradition highlights the institutional framework of economic development in Indonesia, both as a colonial legacy and as it has evolved since independence. There is a growing appreciation among scholars that these two approaches complement each other.

A Chronological Survey of Indonesian Economic History

The precolonial economy

There were several influential kingdoms in the Indonesian archipelago during the pre-colonial era (e.g. Srivijaya, Mataram, Majapahit) (see further Reid 1988,1993; Ricklefs 1993). Much debate centers on whether this heyday of indigenous Asian trade was effectively disrupted by the arrival of western traders in the late fifteenth century

Sixteenth and seventeenth century

Present-day research by scholars in pre-colonial economic history focuses on the dynamics of early-modern trade and pays specific attention to the role of different ethnic groups such as the Arabs, the Chinese and the various indigenous groups of traders and entrepreneurs. During the sixteenth to the nineteenth century the western colonizers only had little grip on a limited number of spots in the Indonesian archipelago. As a consequence much of the economic history of these islands escapes the attention of the economic historian. Most data on economic matters is handed down by western observers with their limited view. A large part of the area remained engaged in its own economic activities, including subsistence agriculture (of which the results were not necessarily very meager) and local and regional trade.

An older research literature has extensively covered the role of the Dutch in the Indonesian archipelago, which began in 1596 when the first expedition of Dutch sailing ships arrived in Bantam. In the seventeenth and eighteenth centuries the Dutch overseas trade in the Far East, which focused on high-value goods, was in the hands of the powerful Dutch East India Company (in full: the United East Indies Trading Company, or Vereenigde Oost-Indische Compagnie [VOC], 1602-1795). However, the region was still fragmented and Dutch presence was only concentrated in a limited number of trading posts.

During the eighteenth century, coffee and sugar became the most important products and Java became the most important area. The VOC gradually took over power from the Javanese rulers and held a firm grip on the productive parts of Java. The VOC was also actively engaged in the intra-Asian trade. For example, cotton from Bengal was sold in the pepper growing areas. The VOC was a successful enterprise and made large dividend payments to its shareholders. Corruption, lack of investment capital, and increasing competition from England led to its demise and in 1799 the VOC came to an end (Gaastra 2002, Jacobs 2000).

The nineteenth century

In the nineteenth century a process of more intensive colonization started, predominantly in Java, where the Cultivation System (1830-1870) was based (Elson 1994; Fasseur 1975).

During the Napoleonic era the VOC trading posts in the archipelago had been under British rule, but in 1814 they came under Dutch authority again. During the Java War (1825-1830), Dutch rule on Java was challenged by an uprising led by Javanese prince Diponegoro. To repress this revolt and establish firm rule in Java, colonial expenses increased, which in turn led to a stronger emphasis on economic exploitation of the colony. The Cultivation System, initiated by Johannes van den Bosch, was a state-governed system for the production of agricultural products such as sugar and coffee. In return for a fixed compensation (planting wage), the Javanese were forced to cultivate export crops. Supervisors, such as civil servants and Javanese district heads, were paid generous ‘cultivation percentages’ in order to stimulate production. The exports of the products were consigned to a Dutch state-owned trading firm (the Nederlandsche Handel-Maatschappij, NHM, established in 1824) and sold profitably abroad.

Although the profits (‘batig slot’) for the Dutch state of the period 1830-1870 were considerable, various reasons can be mentioned for the change to a liberal system: (a) the emergence of new liberal political ideology; (b) the gradual demise of the Cultivation System during the 1840s and 1850s because internal reforms were necessary; and (c) growth of private (European) entrepreneurship with know-how and interest in the exploitation of natural resources, which took away the need for government management (Van Zanden and Van Riel 2000: 226).

Table 2

Financial Results of Government Cultivation, 1840-1849 (‘Cultivation System’) (in thousands of guilders in current values)

1840-1844 1845-1849
Coffee 40 278 24 549
Sugar 8 218 4 136
Indigo, 7 836 7 726
Pepper, Tea 647 1 725
Total net profits 39 341 35 057

Source: Fasseur 1975: 20.

Table 3

Estimates of Total Profits (‘batig slot’) during the Cultivation System,

1831/40 – 1861/70 (in millions of guilders)

1831/40 1841/50 1851/60 1861/70
Gross revenues of sale of colonial products 227.0 473.9 652.7 641.8
Costs of transport etc (NHM) 88.0 165.4 138.7 114.7
Sum of expenses 59.2 175.1 275.3 276.6
Total net profits* 150.6 215.6 289.4 276.7

Source: Van Zanden and Van Riel 2000: 223.

* Recalculated by Van Zanden and Van Riel to include subsidies for the NHM and other costs that in fact benefited the Dutch economy.

The heyday of the colonial export economy (1900-1942)

After 1870, private enterprise was promoted but the exports of raw materials gained decisive momentum after 1900. Sugar, coffee, pepper and tobacco, the old export products, were increasingly supplemented with highly profitable exports of petroleum, rubber, copra, palm oil and fibers. The Outer Islands supplied an increasing share in these foreign exports, which were accompanied by an intensifying internal trade within the archipelago and generated an increasing flow of foreign imports. Agricultural exports were cultivated both in large-scale European agricultural plantations (usually called agricultural estates) and by indigenous smallholders. When the exploitation of oil became profitable in the late nineteenth century, petroleum earned a respectable position in the total export package. In the early twentieth century, the production of oil was increasingly concentrated in the hands of the Koninklijke/Shell Group.


Figure 1

Foreign Exports from the Netherlands-Indies, 1870-1940

(in millions of guilders, current values)

Source: Trade statistics

The momentum of profitable exports led to a broad expansion of economic activity in the Indonesian archipelago. Integration with the world market also led to internal economic integration when the road system, railroad system (in Java and Sumatra) and port system were improved. In shipping lines, an important contribution was made by the KPM (Koninklijke Paketvaart-Maatschappij, Royal Packet boat Company) that served economic integration as well as imperialist expansion. Subsidized shipping lines into remote corners of the vast archipelago carried off export goods (forest products), supplied import goods and transported civil servants and military.

The Depression of the 1930s hit the export economy severely. The sugar industry in Java collapsed and could not really recover from the crisis. In some products, such as rubber and copra, production was stepped up to compensate for lower prices. In the rubber exports indigenous producers for this reason evaded the international restriction agreements. The Depression precipitated the introduction of protectionist measures, which ended the liberal period that had started in 1870. Various import restrictions were launched, making the economy more self-sufficient, as for example in the production of rice, and stimulating domestic integration. Due to the strong Dutch guilder (the Netherlands adhered to the gold standard until 1936), it took relatively long before economic recovery took place. The outbreak of World War II disrupted international trade, and the Japanese occupation (1942-1945) seriously disturbed and dislocated the economic order.

Table 4

Annual Average Growth in Economic Key Aggregates 1830-1990

GDP per capita Export volume Export

Prices

Government Expenditure
Cultivation System 1830-1840 n.a. 13.5 5.0 8.5
Cultivation System 1840-1848 n.a. 1.5 - 4.5 [very low]
Cultivation System 1849-1873 n.a. 1.5 1.5 2.6
Liberal Period 1874-1900 [very low] 3.1 - 1.9 2.3
Ethical Period 1901-1928 1.7 5.8 17.4 4.1
Great Depression 1929-1934 -3.4 -3.9 -19.7 0.4
Prewar Recovery 1934-1940 2.5 2.2 7.8 3.4
Old Order 1950-1965 1.0 0.8 - 2.1 1.8
New Order 1966-1990 4.4 5.4 11.6 10.6

Source: Booth 1998: 18.

Note: These average annual growth percentages were calculated by Booth by fitting an exponential curve to the data for the years indicated. Up to 1873 data refer only to Java.

The post-1945 period

After independence, the Indonesian economy had to recover from the hardships of the Japanese occupation and the war for independence (1945-1949), on top of the slow recovery from the 1930s Depression. During the period 1949-1965, there was little economic growth, predominantly in the years from 1950 to 1957. In 1958-1965, growth rates dwindled, largely due to political instability and inappropriate economic policy measures. The hesitant start of democracy was characterized by a power struggle between the president, the army, the communist party and other political groups. Exchange rate problems and absence of foreign capital were detrimental to economic development, after the government had eliminated all foreign economic control in the private sector in 1957/58. Sukarno aimed at self-sufficiency and import substitution and estranged the suppliers of western capital even more when he developed communist sympathies.

After 1966, the second president, general Soeharto, restored the inflow of western capital, brought back political stability with a strong role for the army, and led Indonesia into a period of economic expansion under his authoritarian New Order (Orde Baru) regime which lasted until 1997 (see below for the three phases in New Order). In this period industrial output quickly increased, including steel, aluminum, and cement but also products such as food, textiles and cigarettes. From the 1970s onward the increased oil price on the world market provided Indonesia with a massive income from oil and gas exports. Wood exports shifted from logs to plywood, pulp, and paper, at the price of large stretches of environmentally valuable rainforest.

Soeharto managed to apply part of these revenues to the development of technologically advanced manufacturing industry. Referring to this period of stable economic growth, the World Bank Report of 1993 speaks of an ‘East Asian Miracle’ emphasizing the macroeconomic stability and the investments in human capital (World Bank 1993: vi).

The financial crisis in 1997 revealed a number of hidden weaknesses in the economy such as a feeble financial system (with a lack of transparency), unprofitable investments in real estate, and shortcomings in the legal system. The burgeoning corruption at all levels of the government bureaucracy became widely known as KKN (korupsi, kolusi, nepotisme). These practices characterize the coming-of-age of the 32-year old, strongly centralized, autocratic Soeharto regime.

From 1998 until present

Today, the Indonesian economy still suffers from severe economic development problems following the financial crisis of 1997 and the subsequent political reforms after Soeharto stepped down in 1998. Secessionist movements and the low level of security in the provincial regions, as well as relatively unstable political policies, form some of its present-day problems. Additional problems include the lack of reliable legal recourse in contract disputes, corruption, weaknesses in the banking system, and strained relations with the International Monetary Fund. The confidence of investors remains low, and in order to achieve future growth, internal reform will be essential to build up confidence of international donors and investors.

An important issue on the reform agenda is regional autonomy, bringing a larger share of export profits to the areas of production instead of to metropolitan Java. However, decentralization policies do not necessarily improve national coherence or increase efficiency in governance.

A strong comeback in the global economy may be at hand, but has not as yet fully taken place by the summer of 2003 when this was written.

Additional Themes in the Indonesian Historiography

Indonesia is such a large and multi-faceted country that many different aspects have been the focus of research (for example, ethnic groups, trade networks, shipping, colonialism and imperialism). One can focus on smaller regions (provinces, islands), as well as on larger regions (the western archipelago, the eastern archipelago, the Outer Islands as a whole, or Indonesia within Southeast Asia). Without trying to be exhaustive, eleven themes which have been subject of debate in Indonesian economic history are examined here (on other debates see also Houben 2002: 53-55; Lindblad 2002b: 145-152; Dick 2002: 191-193; Thee 2002: 242-243).

The indigenous economy and the dualist economy

Although western entrepreneurs had an advantage in technological know-how and supply of investment capital during the late-colonial period, there has been a traditionally strong and dynamic class of entrepreneurs (traders and peasants) in many regions of Indonesia. Resilient in times of economic malaise, cunning in symbiosis with traders of other Asian nationalities (particularly Chinese), the Indonesian entrepreneur has been rehabilitated after the relatively disparaging manner in which he was often pictured in the pre-1945 literature. One of these early writers, J.H. Boeke, initiated a school of thought centering on the idea of ‘economic dualism’ (referring to a modern western and a stagnant eastern sector). As a consequence, the term ‘dualism’ was often used to indicate western superiority. From the 1960s onward such ideas have been replaced by a more objective analysis of the dualist economy that is not so judgmental about the characteristics of economic development in the Asian sector. Some focused on technological dualism (such as B. Higgins) others on ethnic specialization in different branches of production (see also Lindblad 2002b: 148, Touwen 2001: 316-317).

The characteristics of Dutch imperialism

Another vigorous debate concerns the character of and the motives for Dutch colonial expansion. Dutch imperialism can be viewed as having a rather complex mix of political, economic and military motives which influenced decisions about colonial borders, establishing political control in order to exploit oil and other natural resources, and preventing local uprisings. Three imperialist phases can be distinguished (Lindblad 2002a: 95-99). The first phase of imperialist expansion was from 1825-1870. During this phase interference with economic matters outside Java increased slowly but military intervention was occasional. The second phase started with the outbreak of the Aceh War in 1873 and lasted until 1896. During this phase initiatives in trade and foreign investment taken by the colonial government and by private businessmen were accompanied by extension of colonial (military) control in the regions concerned. The third and final phase was characterized by full-scale aggressive imperialism (often known as ‘pacification’) and lasted from 1896 until 1907.

The impact of the cultivation system on the indigenous economy

The thesis of ‘agricultural involution’ was advocated by Clifford Geertz (1963) and states that a process of stagnation characterized the rural economy of Java in the nineteenth century. After extensive research, this view has generally been discarded. Colonial economic growth was stimulated first by the Cultivation System, later by the promotion of private enterprise. Non-farm employment and purchasing power increased in the indigenous economy, although there was much regional inequality (Lindblad 2002a: 80; 2002b:149-150).

Regional diversity in export-led economic expansion

The contrast between densely populated Java, which had been dominant in economic and political regard for a long time, and the Outer Islands, which were a large, sparsely populated area, is obvious. Among the Outer Islands we can distinguish between areas which were propelled forward by export trade, either from Indonesian or European origin (examples are Palembang, East Sumatra, Southeast Kalimantan) and areas which stayed behind and only slowly picked the fruits of the modernization that took place elsewhere (as for example Benkulu, Timor, Maluku) (Touwen 2001).

The development of the colonial state and the role of Ethical Policy

Well into the second half of the nineteenth century, the official Dutch policy was to abstain from interference with local affairs. The scarce resources of the Dutch colonial administrators should be reserved for Java. When the Aceh War initiated a period of imperialist expansion and consolidation of colonial power, a call for more concern with indigenous affairs was heard in Dutch politics, which resulted in the official Ethical Policy which was launched in 1901 and had the threefold aim of improving indigenous welfare, expanding the educational system, and allowing for some indigenous participation in the government (resulting in the People’s Council (Volksraad) that was installed in 1918 but only had an advisory role). The results of the Ethical Policy, as for example measured in improvements in agricultural technology, education, or welfare services, are still subject to debate (Lindblad 2002b: 149).

Living conditions of coolies at the agricultural estates

The plantation economy, which developed in the sparsely populated Outer Islands (predominantly in Sumatra) between 1870 and 1942, was in bad need of labor. The labor shortage was solved by recruiting contract laborers (coolies) in China, and later in Java. The Coolie Ordinance was a government regulation that included the penal clause (which allowed for punishment by plantation owners). In response to reported abuse, the colonial government established the Labor Inspectorate (1908), which aimed at preventing abuse of coolies on the estates. The living circumstances and treatment of the coolies has been subject of debate, particularly regarding the question whether the government put enough effort in protecting the interests of the workers or allowed abuse to persist (Lindblad 2002b: 150).

Colonial drain

How large of a proportion of economic profits was drained away from the colony to the mother country? The detrimental effects of the drain of capital, in return for which European entrepreneurial initiatives were received, have been debated, as well as the exact methods of its measurement. There was also a second drain to the home countries of other immigrant ethnic groups, mainly to China (Van der Eng 1998; Lindblad 2002b: 151).

The position of the Chinese in the Indonesian economy

In the colonial economy, the Chinese intermediary trader or middleman played a vital role in supplying credit and stimulating the cultivation of export crops such as rattan, rubber and copra. The colonial legal system made an explicit distinction between Europeans, Chinese and Indonesians. This formed the roots of later ethnic problems, since the Chinese minority population in Indonesia has gained an important (and sometimes envied) position as capital owners and entrepreneurs. When threatened by political and social turmoil, Chinese business networks may have sometimes channel capital funds to overseas deposits.

Economic chaos during the ‘Old Order’

The ‘Old Order’-period, 1945-1965, was characterized by economic (and political) chaos although some economic growth undeniably did take place during these years. However, macroeconomic instability, lack of foreign investment and structural rigidity formed economic problems that were closely connected with the political power struggle. Sukarno, the first president of the Indonesian republic, had an outspoken dislike of colonialism. His efforts to eliminate foreign economic control were not always supportive of the struggling economy of the new sovereign state. The ‘Old Order’ has for long been a ‘lost area’ in Indonesian economic history, but the establishment of the unitary state and the settlement of major political issues, including some degree of territorial consolidation (as well as the consolidation of the role of the army) were essential for the development of a national economy (Dick 2002: 190; Mackie 1967).

Development policy and economic planning during the ‘New Order’ period

The ‘New Order’ (Orde Baru) of Soeharto rejected political mobilization and socialist ideology, and established a tightly controlled regime that discouraged intellectual enquiry, but did put Indonesia’s economy back on the rails. New flows of foreign investment and foreign aid programs were attracted, the unbridled population growth was reduced due to family planning programs, and a transformation took place from a predominantly agricultural economy to an industrializing economy. Thee Kian Wie distinguishes three phases within this period, each of which deserve further study:

(a) 1966-1973: stabilization, rehabilitation, partial liberalization and economic recovery;

(b) 1974-1982: oil booms, rapid economic growth, and increasing government intervention;

(c) 1983-1996: post-oil boom, deregulation, renewed liberalization (in reaction to falling oil-prices), and rapid export-led growth. During this last phase, commentators (including academic economists) were increasingly concerned about the thriving corruption at all levels of the government bureaucracy: KKN (korupsi, kolusi, nepotisme) practices, as they later became known (Thee 2002: 203-215).

Financial, economic and political crisis: KRISMON, KRISTAL

The financial crisis of 1997 started with a crisis of confidence following the depreciation of the Thai baht in July 1997. Core factors causing the ensuing economic crisis in Indonesia were the quasi-fixed exchange rate of the rupiah, quickly rising short-term foreign debt and the weak financial system. Its severity had to be attributed to political factors as well: the monetary crisis (KRISMON) led to a total crisis (KRISTAL) because of the failing policy response of the Soeharto regime. Soeharto had been in power for 32 years and his government had become heavily centralized and corrupt and was not able to cope with the crisis in a credible manner. The origins, economic consequences, and socio-economic impact of the crisis are still under discussion. (Thee 2003: 231-237; Arndt and Hill 1999).

(Note: I want to thank Dr. F. Colombijn and Dr. J.Th Lindblad at Leiden University for their useful comments on the draft version of this article.)

Selected Bibliography

In addition to the works cited in the text above, a small selection of recent books is mentioned here, which will allow the reader to quickly grasp the most recent insights and find useful further references.

General textbooks or periodicals on Indonesia’s (economic) history:

Booth, Anne. The Indonesian Economy in the Nineteenth and Twentieth Centuries: A History of Missed Opportunities. London: Macmillan, 1998.

Bulletin of Indonesian Economic Studies.

Dick, H.W., V.J.H. Houben, J.Th. Lindblad and Thee Kian Wie. The Emergence of a National Economy in Indonesia, 1800-2000. Sydney: Allen & Unwin, 2002.

Itinerario “Economic Growth and Institutional Change in Indonesia in the 19th and 20th centuries” [special issue] 26 no. 3-4 (2002).

Reid, Anthony. Southeast Asia in the Age of Commerce, 1450-1680, Vol. I: The Lands below the Winds. New Haven: Yale University Press, 1988.

Reid, Anthony. Southeast Asia in the Age of Commerce, 1450-1680, Vol. II: Expansion and Crisis. New Haven: Yale University Press, 1993.

Ricklefs, M.C. A History of Modern Indonesia since ca. 1300. Basingstoke/Londen: Macmillan, 1993.

On the VOC:

Gaastra, F.S. De Geschiedenis van de VOC. Zutphen: Walburg Pers, 1991 (1st edition), 2002 (4th edition).

Jacobs, Els M. Koopman in Azië: de Handel van de Verenigde Oost-Indische Compagnie tijdens de 18de Eeuw. Zutphen: Walburg Pers, 2000.

Nagtegaal, Lucas. Riding the Dutch Tiger: The Dutch East Indies Company and the Northeast Coast of Java 1680-1743. Leiden: KITLV Press, 1996.

On the Cultivation System:

Elson, R.E. Village Java under the Cultivation System, 1830-1870. Sydney: Allen and Unwin, 1994.

Fasseur, C. Kultuurstelsel en Koloniale Baten. De Nederlandse Exploitatie van Java, 1840-1860. Leiden, Universitaire Pers, 1975. (Translated as: The Politics of Colonial Exploitation: Java, the Dutch and the Cultivation System. Ithaca, NY: Southeast Asia Program, Cornell University Press 1992.)

Geertz, Clifford. Agricultural Involution: The Processes of Ecological Change in Indonesia. Berkeley: University of California Press, 1963.

Houben, V.J.H. “Java in the Nineteenth Century: Consolidation of a Territorial State.” In The Emergence of a National Economy in Indonesia, 1800-2000, edited by H.W. Dick, V.J.H. Houben, J.Th. Lindblad and Thee Kian Wie, 56-81. Sydney: Allen & Unwin, 2002.

On the Late-Colonial Period:

Dick, H.W. “Formation of the Nation-state, 1930s-1966.” In The Emergence of a National Economy in Indonesia, 1800-2000, edited by H.W. Dick, V.J.H. Houben, J.Th. Lindblad and Thee Kian Wie, 153-193. Sydney: Allen & Unwin, 2002.

Lembaran Sejarah, “Crisis and Continuity: Indonesian Economy in the Twentieth Century” [special issue] 3 no. 1 (2000).

Lindblad, J.Th., editor. New Challenges in the Modern Economic History of Indonesia. Leiden: PRIS, 1993. Translated as: Sejarah Ekonomi Modern Indonesia. Berbagai Tantangan Baru. Jakarta: LP3ES, 2002.

Lindblad, J.Th., editor. The Historical Foundations of a National Economy in Indonesia, 1890s-1990s. Amsterdam: North-Holland, 1996.

Lindblad, J.Th. “The Outer Islands in the Nineteenthh Century: Contest for the Periphery.” In The Emergence of a National Economy in Indonesia, 1800-2000, edited by H.W. Dick, V.J.H. Houben, J.Th. Lindblad and Thee Kian Wie, 82-110. Sydney: Allen & Unwin, 2002a.

Lindblad, J.Th. “The Late Colonial State and Economic Expansion, 1900-1930s.” In The Emergence of a National Economy in Indonesia, 1800-2000, edited by H.W. Dick, V.J.H. Houben, J.Th. Lindblad and Thee Kian Wie, 111-152. Sydney: Allen & Unwin, 2002b.

Touwen, L.J. Extremes in the Archipelago: Trade and Economic Development in the Outer Islands of Indonesia, 1900‑1942. Leiden: KITLV Press, 2001.

Van der Eng, Pierre. “Exploring Exploitation: The Netherlands and Colonial Indonesia, 1870-1940.” Revista de Historia Económica 16 (1998): 291-321.

Zanden, J.L. van, and A. van Riel. Nederland, 1780-1914: Staat, instituties en economische ontwikkeling. Amsterdam: Balans, 2000. (On the Netherlands in the nineteenth century.)

Independent Indonesia:

Arndt, H.W. and Hal Hill, editors. Southeast Asia’s Economic Crisis: Origins, Lessons and the Way forward. Singapore: Institute of Southeast Asian Studies, 1999.

Cribb, R. and C. Brown. Modern Indonesia: A History since 1945. Londen/New York: Longman, 1995.

Feith, H. The Decline of Constitutional Democracy in Indonesia. Ithaca, New York: Cornell University Press, 1962.

Hill, Hal. The Indonesian Economy. Cambridge: Cambridge University Press, 2000. (This is the extended second edition of Hill, H., The Indonesian Economy since 1966. Southeast Asia’s Emerging Giant. Cambridge: Cambridge University Press, 1996.)

Hill, Hal, editor. Unity and Diversity: Regional Economic Development in Indonesia since 1970. Singapore: Oxford University Press, 1989.

Mackie, J.A.C. “The Indonesian Economy, 1950-1960.” In The Economy of Indonesia: Selected Readings, edited by B. Glassburner, 16-69. Ithaca NY: Cornell University Press 1967.

Robison, Richard. Indonesia: The Rise of Capital. Sydney: Allen and Unwin, 1986.

Thee Kian Wie. “The Soeharto Era and After: Stability, Development and Crisis, 1966-2000.” In The Emergence of a National Economy in Indonesia, 1800-2000, edited by H.W. Dick, V.J.H. Houben, J.Th. Lindblad and Thee Kian Wie, 194-243. Sydney: Allen & Unwin, 2002.

World Bank. The East Asian Miracle: Economic Growth and Public Policy. Oxford: World Bank /Oxford University Press, 1993.

On economic growth:

Booth, Anne. The Indonesian Economy in the Nineteenth and Twentieth Centuries. A History of Missed Opportunities. London: Macmillan, 1998.

Van der Eng, Pierre. “The Real Domestic Product of Indonesia, 1880-1989.” Explorations in Economic History 39 (1992): 343-373.

Van der Eng, Pierre. “Indonesia’s Growth Performance in the Twentieth Century.” In The Asian Economies in the Twentieth Century, edited by Angus Maddison, D.S. Prasada Rao and W. Shepherd, 143-179. Cheltenham: Edward Elgar, 2002.

Van der Eng, Pierre. “Indonesia’s Economy and Standard of Living in the Twentieth Century.” In Indonesia Today: Challenges of History, edited by G. Lloyd and S. Smith, 181-199. Singapore: Institute of Southeast Asian Studies, 2001.

Citation: Touwen, Jeroen. “The Economic History of Indonesia”. EH.Net Encyclopedia, edited by Robert Whaples. March 16, 2008. URL http://eh.net/encyclopedia/the-economic-history-of-indonesia/

Hours of Work in U.S. History

Robert Whaples, Wake Forest University

In the 1800s, many Americans worked seventy hours or more per week and the length of the workweek became an important political issue. Since then the workweek’s length has decreased considerably. This article presents estimates of the length of the historical workweek in the U.S., describes the history of the shorter-hours “movement,” and examines the forces that drove the workweek’s decline over time.

Estimates of the Length of the Workweek

Measuring the length of the workweek (or workday or workyear) is a difficult task, full of ambiguities concerning what constitutes work and who is to be considered a worker. Estimating the length of the historical workweek is even more troublesome. Before the Civil War most Americans were employed in agriculture and most of these were self-employed. Like self-employed workers in other fields, they saw no reason to record the amount of time they spent working. Often the distinction between work time and leisure time was blurry. Therefore, estimates of the length of the typical workweek before the mid-1800s are very imprecise.

The Colonial Period

Based on the amount of work performed — for example, crops raised per worker — Carr (1992) concludes that in the seventeenth-century Chesapeake region, “for at least six months of the year, an eight to ten-hour day of hard labor was necessary.” This does not account for other required tasks, which probably took about three hours per day. This workday was considerably longer than for English laborers, who at the time probably averaged closer to six hours of heavy labor each day.

The Nineteenth Century

Some observers believe that most American workers adopted the practice of working from “first light to dark” — filling all their free hours with work — throughout the colonial period and into the nineteenth century. Others are skeptical of such claims and argue that work hours increased during the nineteenth century — especially its first half. Gallman (1975) calculates “changes in implicit hours of work per agricultural worker” and estimates that hours increased 11 to 18 percent from 1800 to 1850. Fogel and Engerman (1977) argue that agricultural hours in the North increased before the Civil War due to the shift into time-intensive dairy and livestock. Weiss and Craig (1993) find evidence suggesting that agricultural workers also increased their hours of work between 1860 and 1870. Finally, Margo (2000) estimates that “on an economy-wide basis, it is probable that annual hours of work rose over the (nineteenth) century, by around 10 percent.” He credits this rise to the shift out of agriculture, a decline in the seasonality of labor demand and reductions in annual periods of nonemployment. On the other hand, it is clear that working hours declined substantially for one important group. Ransom and Sutch (1977) and Ng and Virts (1989) estimate that annual labor hours per capita fell 26 to 35 percent among African-Americans with the end of slavery.

Manufacturing Hours before 1890

Our most reliable estimates of the workweek come from manufacturing, since most employers required that manufacturing workers remain at work during precisely specified hours. The Census of Manufactures began to collect this information in 1880 but earlier estimates are available. Much of what is known about average work hours in the nineteenth century comes from two surveys of manufacturing hours taken by the federal government. The first survey, known as the Weeks Report, was prepared by Joseph Weeks as part of the Census of 1880. The second was prepared in 1893 by Commissioner of Labor Carroll D. Wright, for the Senate Committee on Finance, chaired by Nelson Aldrich. It is commonly called the Aldrich Report. Both of these sources, however, have been criticized as flawed due to problems such as sample selection bias (firms whose records survived may not have been typical) and unrepresentative regional and industrial coverage. In addition, the two series differ in their estimates of the average length of the workweek by as much as four hours. These estimates are reported in Table 1. Despite the previously mentioned problems, it seems reasonable to accept two important conclusions based on these data — the length of the typical manufacturing workweek in the 1800s was very long by modern standards and it declined significantly between 1830 and 1890.

Table 1
Estimated Average Weekly Hours Worked in Manufacturing, 1830-1890

Year Weeks Report Aldrich Report
1830 69.1
1840 67.1 68.4
1850 65.5 69.0
1860 62.0 66.0
1870 61.1 63.0
1880 60.7 61.8
1890 60.0

Sources: U.S. Department of Interior (1883), U.S. Senate (1893)
Note: Atack and Bateman (1992), using data from census manuscripts, estimate average weekly hours to be 60.1 in 1880 — very close to Weeks’ contemporary estimate. They also find that the summer workweek was about 1.5 hours longer than the winter workweek.

Hours of Work during the Twentieth Century

Because of changing definitions and data sources there does not exist a consistent series of workweek estimates covering the entire twentieth century. Table 2 presents six sets of estimates of weekly hours. Despite differences among the series, there is a fairly consistent pattern, with weekly hours falling considerably during the first third of the century and much more slowly thereafter. In particular, hours fell strongly during the years surrounding World War I, so that by 1919 the eight-hour day (with six workdays per week) had been won. Hours fell sharply at the beginning of the Great Depression, especially in manufacturing, then rebounded somewhat and peaked during World War II. After World War II, the length of the workweek stabilized around forty hours. Owen’s nonstudent-male series shows little trend after World War II, but the other series show a slow, but steady, decline in the length of the average workweek. Greis’s two series are based on the average length of the workyear and adjust for paid vacations, holidays and other time-off. The last column is based on information reported by individuals in the decennial censuses and in the Current Population Survey of 1988. It may be the most accurate and representative series, as it is based entirely on the responses of individuals rather than employers.

Table 2
Estimated Average Weekly Hours Worked, 1900-1988

Year Census of Manu-facturing JonesManu-

facturing

OwenNonstudent Males GreisManu-

facturing

GreisAll Workers Census/CPS All Workers
1900 59.6* 55.0 58.5
1904 57.9 53.6 57.1
1909 56.8 (57.3) 53.1 55.7
1914 55.1 (55.5) 50.1 54.0
1919 50.8 (51.2) 46.1 50.0
1924 51.1* 48.8 48.8
1929 50.6 48.0 48.7
1934 34.4 40.6
1940 37.6 42.5 43.3
1944 44.2 46.9
1947 39.2 42.4 43.4 44.7
1950 38.7 41.1 42.7
1953 38.6 41.5 43.2 44.0
1958 37.8* 40.9 42.0 43.4
1960 41.0 40.9
1963 41.6 43.2 43.2
1968 41.7 41.2 42.0
1970 41.1 40.3
1973 40.6 41.0
1978 41.3* 39.7 39.1
1980 39.8
1988 39.2

Sources: Whaples (1990a), Jones (1963), Owen (1976, 1988), and Greis (1984). The last column is based on the author’s calculations using Coleman and Pencavel’s data from Table 4 (below).
* = these estimates are from one year earlier than the year listed.
(The figures in parentheses in the first column are unofficial estimates but are probably more precise, as they better estimate the hours of workers in industries with very long workweeks.)

Hours in Other Industrial Sectors

Table 3 compares the length of the workweek in manufacturing to that in other industries for which there is available information. (Unfortunately, data from the agricultural and service sectors are unavailable until late in this period.) The figures in Table 3 show that the length of the workweek was generally shorter in the other industries — sometimes considerably shorter. For example, in 1910 anthracite coalminers’ workweeks were about forty percent shorter than the average workweek among manufacturing workers. All of the series show an overall downward trend.

Table 3
Estimated Average Weekly Hours Worked, Other Industries

Year Manufacturing Construction Railroads Bituminous Coal Anthracite Coal
1850s about 66 about 66
1870s about 62 about 60
1890 60.0 51.3
1900 59.6 50.3 52.3 42.8 35.8
1910 57.3 45.2 51.5 38.9 43.3
1920 51.2 43.8 46.8 39.3 43.2
1930 50.6 42.9 33.3 37.0
1940 37.6 42.5 27.8 27.2
1955 38.5 37.1 32.4 31.4

Sources: Douglas (1930), Jones (1963), Licht (1983), and Tables 1 and 2.
Note: The manufacturing figures for the 1850s and 1870s are approximations based on averaging numbers from the Weeks and Aldrich reports from Table 1. The early estimates for the railroad industry are also approximations.

Recent Trends by Race and Gender

Some analysts, such as Schor (1992) have argued that the workweek increased substantially in the last half of the twentieth century. Few economists accept this conclusion, arguing that it is based on the use of faulty data (public opinion surveys) and unexplained methods of “correcting” more reliable sources. Schor’s conclusions are contradicted by numerous studies. Table 4 presents Coleman and Pencavel’s (1993a, 1993b) estimates of the average workweek of employed people — disaggregated by race and gender. For all four groups the average length of the workweek has dropped since 1950. Although median weekly hours were virtually constant for men, the upper tail of the hours distribution fell for those with little schooling and rose for the well-educated. In addition, Coleman and Pencavel also find that work hours declined for young and older men (especially black men), but changed little for white men in their prime working years. Women with relatively little schooling were working fewer hours in the 1980s than in 1940, while the reverse is true of well-educated women.

Table 4
Estimated Average Weekly Hours Worked, by Race and Gender, 1940-1988

Year White Men Black Men White Women Black Women
1940 44.1 44.5 40.6 42.2
1950 43.4 42.8 41.0 40.3
1960 43.3 40.4 36.8 34.7
1970 43.1 40.2 36.1 35.9
1980 42.9 39.6 35.9 36.5
1988 42.4 39.6 35.5 37.2

Source: Coleman and Pencavel (1993a, 1993b)

Broader Trends in Time Use, 1880 to 2040

In 1880 a typical male household head had very little leisure time — only about 1.8 hours per day over the course of a year. However, as Fogel’s (2000) estimates in Table 5 show, between 1880 and 1995 the amount of work per day fell nearly in half, allowing leisure time to more than triple. Because of the decline in the length of the workweek and the declining portion of a lifetime that is spent in paid work (due largely to lengthening periods of education and retirement) the fraction of the typical American’s lifetime devoted to work has become remarkably small. Based on these trends Fogel estimates that four decades from now less than one-fourth of our discretionary time (time not needed for sleep, meals, and hygiene) will be devoted to paid work — over three-fourths will be available for doing what we wish.

Table 5
Division of the Day for the Average Male Household Head over the Course of a Year, 1880 and 1995

Activity 1880 1995
Sleep 8 8
Meals and hygiene 2 2
Chores 2 2
Travel to and from work 1 1
Work 8.5 4.7
Illness .7 .5
Left over for leisure activities 1.8 5.8

Source: Fogel (2000)

Table 6
Estimated Trend in the Lifetime Distribution of Discretionary Time, 1880-2040

Activity 1880 1995 2040
Lifetime Discretionary Hours 225,900 298,500 321,900
Lifetime Work Hours 182,100 122,400 75,900
Lifetime Leisure Hours 43,800 176,100 246,000

Source: Fogel (2000)
Notes: Discretionary hours exclude hours used for sleep, meals and hygiene. Work hours include paid work, travel to and from work, and household chores.

Postwar International Comparisons

While hours of work have decreased slowly in the U.S. since the end of World War II, they have decreased more rapidly in Western Europe. Greis (1984) calculates that annual hours worked per employee fell from 1908 to 1704 in the U.S. between 1950 and 1979, a 10.7 percent decrease. This compares to a 21.8 percent decrease across a group of twelve Western European countries, where the average fell from 2170 hours to 1698 hours between 1950 and 1979. Perhaps the most precise way of measuring work hours is to have individuals fill out diaries on their day-to-day and hour-to-hour time use. Table 7 presents an international comparison of average work hours both inside and outside of the workplace, by adult men and women — averaging those who are employed with those who are not. (Juster and Stafford (1991) caution, however, that making these comparisons requires a good deal of guesswork.) These numbers show a significant drop in total work per week in the U.S. between 1965 and 1981. They also show that total work by men and women is very similar, although it is divided differently. Total work hours in the U.S. were fairly similar to those in Japan, but greater than in Denmark, while less than in the USSR.

Table 7
Weekly Work Time in Four Countries, Based on Time Diaries, 1960s-1980s

Activity US USSR (Pskov)
Men Women Men Women
1965 1981 1965 1981 1965 1981 1965 1981
Total Work 63.1 57.8 60.9 54.4 64.4 65.7 75.3 66.3
Market Work 51.6 44.0 18.9 23.9 54.6 53.8 43.8 39.3
Commuting 4.8 3.5 1.6 2.0 4.9 5.2 3.7 3.4
Housework 11.5 13.8 41.8 30.5 9.8 11.9 31.5 27.0
Activity Japan Denmark
Men Women Men Women
1965 1985 1965 1985 1964 1987 1964 1987
Total Work 60.5 55.5 64.7 55.6 45.4 46.2 43.4 43.9
Market Work 57.7 52.0 33.2 24.6 41.7 33.4 13.3 20.8
Commuting 3.6 4.5 1.0 1.2 n.a n.a n.a n.a
Housework 2.8 3.5 31.5 31.0 3.7 12.8 30.1 23.1

Source: Juster and Stafford (1991)

The Shorter Hours “Movement” in the U.S.

The Colonial Period

Captain John Smith, after mapping New England’s coast, came away convinced that three days’ work per week would satisfy any settler. Far from becoming a land of leisure, however, the abundant resources of British America and the ideology of its settlers, brought forth high levels of work. Many colonial Americans held the opinion that prosperity could be taken as a sign of God’s pleasure with the individual, viewed work as inherently good and saw idleness as the devil’s workshop. Rodgers (1978) argues that this work ethic spread and eventually reigned supreme in colonial America. The ethic was consistent with the American experience, since high returns to effort meant that hard work often yielded significant increases in wealth. In Virginia, authorities also transplanted the Statue of Artificers, which obliged all Englishmen (except the gentry) to engage in productive activity from sunrise to sunset. Likewise, a 1670 Massachusetts law demanded a minimum ten-hour workday, but it is unlikely that these laws had any impact on the behavior of most free workers.

The Revolutionary War Period

Roediger and Foner (1989) contend that the Revolutionary War era brought a series of changes that undermined support for sun-to-sun work. The era’s republican ideology emphasized that workers needed free time, away from work, to participate in democracy. Simultaneously, the development of merchant capitalism meant that there were, for the first time, a significant number of wageworkers. Roediger and Foner argue that reducing labor costs was crucial to the profitability of these workers’ employers, who reduced costs by squeezing more work from their employees — reducing time for meals, drink and rest and sometimes even rigging the workplace’s official clock. Incensed by their employers’ practice of paying a flat daily wage during the long summer shift and resorting to piece rates during short winter days, Philadelphia’s carpenters mounted America’s first ten-hour-day strike in May 1791. (The strike was unsuccessful.)

1820s: The Shorter Hours Movement Begins

Changes in the organization of work, with the continued rise of merchant capitalists, the transition from the artisanal shop to the early factory, and an intensified work pace had become widespread by about 1825. These changes produced the first extensive, aggressive movement among workers for shorter hours, as the ten-hour movement blossomed in New York City, Philadelphia and Boston. Rallying around the ten-hour banner, workers formed the first city-central labor union in the U.S., the first labor newspaper, and the first workingmen’s political party — all in Philadelphia — in the late 1820s.

Early Debates over Shorter Hours

Although the length of the workday is largely an economic decision arrived at by the interaction of the supply and demand for labor, advocates of shorter hours and foes of shorter hours have often argued the issue on moral grounds. In the early 1800s, advocates argued that shorter work hours improved workers’ health, allowed them time for self-improvement and relieved unemployment. Detractors countered that workers would abuse leisure time (especially in saloons) and that long, dedicated hours of work were the path to success, which should not be blocked for the great number of ambitious workers.

1840s: Early Agitation for Government Intervention

When Samuel Slater built the first textile mills in the U.S., “workers labored from sun up to sun down in summer and during the darkness of both morning and evening in the winter. These hours ? only attracted attention when they exceeded the common working day of twelve hours,” according to Ware (1931). During the 1830s, an increased work pace, tighter supervision, and the addition of about fifteen minutes to the work day (partly due to the introduction of artificial lighting during winter months), plus the growth of a core of more permanent industrial workers, fueled a campaign for a shorter workweek among mill workers in Lowell, Massachusetts, whose workweek averaged about 74 hours. This agitation was led by Sarah Bagley and the New England Female Labor Reform Association, which, beginning in 1845, petitioned the state legislature to intervene in the determination of hours. The petitions were followed by America’s first-ever examination of labor conditions by a governmental investigating committee. The Massachusetts legislature proved to be very unsympathetic to the workers’ demands, but similar complaints led to the passage of laws in New Hampshire (1847) and Pennsylvania (1848), declaring ten hours to be the legal length of the working day. However, these laws also specified that a contract freely entered into by employee and employer could set any length for the workweek. Hence, these laws had little impact. Legislation passed by the federal government had a more direct, though limited effect. On March 31, 1840, President Martin Van Buren issued an executive order mandating a ten-hour day for all federal employees engaged in manual work.

1860s: Grand Eight Hours Leagues

As the length of the workweek gradually declined, political agitation for shorter hours seems to have waned for the next two decades. However, immediately after the Civil War reductions in the length of the workweek reemerged as an important issue for organized labor. The new goal was an eight-hour day. Roediger (1986) argues that many of the new ideas about shorter hours grew out of the abolitionists’ critique of slavery — that long hours, like slavery, stunted aggregate demand in the economy. The leading proponent of this idea, Ira Steward, argued that decreasing the length of the workweek would raise the standard of living of workers by raising their desired consumption levels as their leisure expanded, and by ending unemployment. The hub of the newly launched movement was Boston and Grand Eight Hours Leagues sprang up around the country in 1865 and 1866. The leaders of the movement called the meeting of the first national organization to unite workers of different trades, the National Labor Union, which met in Baltimore in 1867. In response to this movement, eight states adopted general eight-hour laws, but again the laws allowed employer and employee to mutually consent to workdays longer than the “legal day.” Many critics saw these laws and this agitation as a hoax, because few workers actually desired to work only eight hours per day at their original hourly pay rate. The passage of the state laws did foment action by workers — especially in Chicago where parades, a general strike, rioting and martial law ensued. In only a few places did work hours fall after the passage of these laws. Many become disillusioned with the idea of using the government to promote shorter hours and by the late 1860s, efforts to push for a universal eight-hour day had been put on the back burner.

The First Enforceable Hours Laws

Despite this lull in shorter-hours agitation, in 1874, Massachusetts passed the nation’s first enforceable ten-hour law. It covered only female workers and became fully effective by 1879. This legislation was fairly late by European standards. Britain had passed its first effective Factory Act, setting maximum hours for almost half of its very young textile workers, in 1833.

1886: Year of Dashed Hopes

In the early 1880s organized labor in the U.S. was fairly weak. In 1884, the short-lived Federation of Organized Trades and Labor Unions (FOTLU) fired a “shot in the dark.” During its final meeting, before dissolving, the Federation “ordained” May 1, 1886 as the date on which workers would cease working beyond eight hours per day. Meanwhile, the Knights of Labor, which had begun as a secret fraternal society and evolved a labor union, began to gain strength. It appears that many nonunionized workers, especially the unskilled, came to see in the Knights a chance to obtain a better deal from their employers, perhaps even to obtain the eight-hour day. FOTLU’s call for workers to simply walk off the job after eight hours beginning on May 1, plus the activities of socialist and anarchist labor organizers and politicians, and the apparent strength of the Knights combined to attract members in record numbers. The Knights mushroomed and its new membership demanded that their local leaders support them in attaining the eight-hour day. Many smelled victory in the air — the movement to win the eight-hour day became frenzied and the goal became “almost a religious crusade” (Grob, 1961).

The Knights’ leader, Terence Powderly, thought that the push for a May 1 general strike for eight-hours was “rash, short-sighted and lacking in system” and “must prove abortive” (Powderly, 1890). He offered no effective alternative plan but instead tried to block the mass action, issuing a “secret circular” condemning the use of strikes. Powderly reasoned that low incomes forced workmen to accept long hours. Workers didn’t want shorter hours unless their daily pay was maintained, but employers were unwilling and/or unable to offer this. Powderly’s rival, labor leader Samuel Gompers, agreed that “the movement of ’86 did not have the advantage of favorable conditions” (Gompers, 1925). Nelson (1986) points to divisions among workers, which probably had much to do with the failure in 1886 of the drive for the eight-hour day. Some insisted on eight hours with ten hours’ pay, but others were willing to accept eight hours with eight hours’ pay,

Haymarket Square Bombing

The eight-hour push of 1886 was, in Norman Ware’s words, “a flop” (Ware, 1929). Lack of will and organization among workers was undoubtedly important, but its collapse was aided by violence that marred strikes and political rallies in Chicago and Milwaukee. The 1886 drive for eight-hours literally blew up in organized labor’s face. At Haymarket Square in Chicago an anarchist bomb killed fifteen policemen during an eight-hour rally, and in Milwaukee’s Bay View suburb nine strikers were killed as police tried to disperse roving pickets. The public backlash and fear of revolution damned the eight-hour organizers along with the radicals and dampened the drive toward eight hours — although it is estimated that the strikes of May 1886 shortened the workweek for about 200,000 industrial workers, especially in New York City and Cincinnati.

The AFL’s Strategy

After the demise of the Knights of Labor, the American Federation of Labor (AFL) became the strongest labor union in the U.S. It held shorter hours as a high priority. The inside cover of its Proceedings carried two slogans in large type: “Eight hours for work, eight hours for rest, eight hours for what we will” and “Whether you work by the piece or work by the day, decreasing the hours increases the pay.” (The latter slogan was coined by Ira Steward’s wife, Mary.) In the aftermath of 1886, the American Federation of Labor adopted a new strategy of selecting each year one industry in which it would attempt to win the eight-hour day, after laying solid plans, organizing, and building up a strike fund war chest by taxing nonstriking unions. The United Brotherhood of Carpenters and Joiners was selected first and May 1, 1890 was set as a day of national strikes. It is estimated that nearly 100,000 workers gained the eight-hour day as a result of these strikes in 1890. However, other unions turned down the opportunity to follow the carpenters’ example and the tactic was abandoned. Instead, the length of the workweek continued to erode during this period, sometimes as the result of a successful local strike, more often as the result of broader economic forces.

The Spread of Hours Legislation

Massachusetts’ first hours law in 1874 set sixty hours per week as the legal maximum for women, in 1892 this was cut to 58, in 1908 to 56, and in 1911 to 54. By 1900, 26 percent of states had maximum hours laws covering women, children and, in some, adult men (generally only those in hazardous industries). The percentage of states with maximum hours laws climbed to 58 percent in 1910, 76 percent in 1920, and 84 percent in 1930. Steinberg (1982) calculates that the percent of employees covered climbed from 4 percent nationally in 1900, to 7 percent in 1910, and 12 percent in 1920 and 1930. In addition, these laws became more restrictive with the average legal standard falling from a maximum of 59.3 hours per week in 1900 to 56.7 in 1920. According to her calculations, in 1900 about 16 percent of the workers covered by these laws were adult men, 49 percent were adult women and the rest were minors.

Court Rulings

The banner years for maximum hours legislation were right around 1910. This may have been partly a reaction to the Supreme Court’s ruling upholding female-hours legislation in the Muller vs. Oregon case (1908). The Court’s rulings were not always completely consistent during this period, however. In 1898 the Court upheld a maximum eight-hour day for workmen in the hazardous industries of mining and smelting in Utah in Holden vs. Hardy. In Lochner vs. New York (1905), it rejected as unconstitutional New York’s ten-hour day for bakers, which was also adopted (at least nominally) out of concerns for safety. The defendant showed that mortality rates in baking were only slightly above average, and lower than those for many unregulated occupations, arguing that this was special interest legislation, designed to favor unionized bakers. Several state courts, on the other hand, supported laws regulating the hours of men in only marginally hazardous work. By 1917, in Bunting vs. Oregon, the Supreme Court seemingly overturned the logic of the Lochner decision, supporting a state law that required overtime payment for all men working long hours. The general presumption during this period was that the courts would allow regulation of labor concerning women and children, who were thought to be incapable of bargaining on an equal footing with employers and in special need of protection. Men were allowed freedom of contract unless it could be proven that regulating their hours served a higher good for the population at large.

New Arguments about Shorter Hours

During the first decades of the twentieth century, arguments favoring shorter hours moved away from Steward’s line that shorter hours increased pay and reduced unemployment to arguments that shorter hours were good for employers because they made workers more productive. A new cadre of social scientists began to offer evidence that long hours produced health-threatening, productivity-reducing fatigue. This line of reasoning, advanced in the court brief of Louis Brandeis and Josephine Goldmark, was crucial in the Supreme Court’s decision to support state regulation of women’s hours in Muller vs. Oregon. Goldmark’s book, Fatigue and Efficiency (1912) was a landmark. In addition, data relating to hours and output among British and American war workers during World War I helped convince some that long hours could be counterproductive. Businessmen, however, frequently attacked the shorter hours movement as merely a ploy to raise wages, since workers were generally willing to work overtime at higher wage rates.

Federal Legislation in the 1910s

In 1912 the Federal Public Works Act was passed, which provided that every contract to which the U.S. government was a party must contain an eight-hour day clause. Three year later LaFollette’s Bill established maximum hours for maritime workers. These were preludes to the most important shorter-hours law enacted by Congress during this period — 1916’s Adamson Act, which was passed to counter a threatened nationwide strike, granted rail workers the basic eight hour day. (The law set eight hours as the basic workday and required higher overtime pay for longer hours.)

World War I and Its Aftermath

Labor markets became very tight during World War I as the demand for workers soared and the unemployment rate plunged. These forces put workers in a strong bargaining position, which they used to obtain shorter work schedules. The move to shorter hours was also pushed by the federal government, which gave unprecedented support to unionization. The federal government began to intervene in labor disputes for the first time, and the National War Labor Board “almost invariably awarded the basic eight-hour day when the question of hours was at issue” in labor disputes (Cahill, 1932). At the end of the war everyone wondered if organized labor would maintain its newfound power and the crucial test case was the steel industry. Blast furnace workers generally put in 84-hour workweeks. These abnormally long hours were the subject of much denunciation and a major issue in a strike that began in September 1919. The strike failed (and organized labor’s power receded during the 1920s), but four years later US Steel reduced its workday from twelve to eight hours. The move came after much arm-twisting by President Harding but its timing may be explained by immigration restrictions and the loss of immigrant workers who were willing to accept such long hours (Shiells, 1990).

The Move to a Five-day Workweek

During the 1920s agitation for shorter workdays largely disappeared, now that the workweek had fallen to about 50 hours. However, pressure arose to grant half-holidays on Saturday or Saturday off — especially in industries whose workers were predominantly Jewish. By 1927 at least 262 large establishments had adopted the five-day week, while only 32 had it by 1920. The most notable action was Henry Ford’s decision to adopt the five-day week in 1926. Ford employed more than half of the nation’s approximately 400,000 workers with five-day weeks. However, Ford’s motives were questioned by many employers who argued that productivity gains from reducing hours ceased beyond about forty-eight hours per week. Even the reformist American Labor Legislation Review greeted the call for a five-day workweek with lukewarm interest.

Changing Attitudes in the 1920s

Hunnicutt (1988) argues that during the 1920s businessmen and economists began to see shorter hours as a threat to future economic growth. With the development of advertising — the “gospel of consumption” — a new vision of progress was proposed to American workers. It replaced the goal of leisure time with a list of things to buy and business began to persuade workers that more work brought more tangible rewards. Many workers began to oppose further decreases in the length of the workweek. Hunnicutt concludes that a new work ethic arose as Americans threw off the psychology of scarcity for one of abundance.

Hours’ Reduction during the Great Depression

Then the Great Depression hit the American economy. By 1932 about half of American employers had shortened hours. Rather than slash workers’ real wages, employers opted to lay-off many workers (the unemployment rate hit 25 percent) and tried to protect the ones they kept on by the sharing of work among them. President Hoover’s Commission for Work Sharing pushed voluntary hours reductions and estimated that they had saved three to five million jobs. Major employers like Sears, GM, and Standard Oil scaled down their workweeks and Kellogg’s and the Akron tire industry pioneered the six-hour day. Amid these developments, the AFL called for a federally-mandated thirty-hour workweek.

The Black-Connery 30-Hours Bill and the NIRA

The movement for shorter hours as a depression-fighting work-sharing measure built such a seemingly irresistible momentum that by 1933 observers predicting that the “30-hour week was within a month of becoming federal law” (Hunnicutt, 1988). During the period after the 1932 election but before Franklin Roosevelt’s inauguration, Congressional hearings on thirty hours began, and less than one month into FDR’s first term, the Senate passed, 53 to 30, a thirty-hour bill authored by Hugo Black. The bill was sponsored in the House by William Connery. Roosevelt originally supported the Black-Connery proposals, but soon backed off, uneasy with a provision forbidding importation of goods produced by workers whose weeks were longer than thirty hours, and convinced by arguments of business that trying to legislate fewer hours might have disastrous results. Instead, FDR backed the National Industrial Recovery Act (NIRA). Hunnicutt argues that an implicit deal was struck in the NIRA. Labor leaders were persuaded by NIRA Section 7a’s provisions — which guaranteed union organization and collective bargaining — to support the NIRA rather than the Black-Connery Thirty-Hour Bill. Business, with the threat of thirty hours hanging over its head, fell raggedly into line. (Most historians cite other factors as the key to the NIRA’s passage. See Barbara Alexander’s article on the NIRA in this encyclopedia.) When specific industry codes were drawn up by the NIRA-created National Recovery Administration (NRA), shorter hours were deemphasized. Despite a plan by NRA Administrator Hugh Johnson to make blanket provisions for a thirty-five hour workweek in all industry codes, by late August 1933, the momentum toward the thirty-hour week had dissipated. About half of employees covered by NRA codes had their hours set at forty per week and nearly 40 percent had workweeks longer than forty hours.

The FSLA: Federal Overtime Law

Hunnicutt argues that the entire New Deal can be seen as an attempt to keep shorter-hours advocates at bay. After the Supreme Court struck down the NRA, Roosevelt responded to continued demands for thirty hours with the Works Progress Administration, the Wagner Act, Social Security, and, finally, the Fair Labor Standards Acts, which set a federal minimum wage and decreed that overtime beyond forty hours per week would be paid at one-and-a-half times the base rate in covered industries.

The Demise of the Shorter Hours’ Movement

As the Great Depression ended, average weekly work hours slowly climbed from their low reached in 1934. During World War II hours reached a level almost as high as at the end of World War I. With the postwar return of weekly work hours to the forty-hour level the shorter hours movement effectively ended. Occasionally organized labor’s leaders announced that they would renew the push for shorter hours, but they found that most workers didn’t desire a shorter workweek.

The Case of Kellogg’s

Offsetting isolated examples of hours reductions after World War II, there were noteworthy cases of backsliding. Hunnicutt (1996) has studied the case of Kellogg’s in great detail. In 1946, 87% of women and 71% of men working at Kellogg’s voted to return to the six-hour day, with the end of the war. Over the course of the next decade, however, the tide turned. By 1957 most departments had opted to switch to 8-hour shifts, so that only about one-quarter of the work force, mostly women, retained a six-hour shift. Finally, in 1985, the last department voted to adopt an 8-hour workday. Workers, especially male workers, began to favor additional money more than the extra two hours per day of free time. In interviews they explained that they needed the extra money to buy a wide range of consumer items and to keep up with the neighbors. Several men told about the friction that resulted when men spent too much time around the house: “The wives didn’t like the men underfoot all day.” “The wife always found something for me to do if I hung around.” “We got into a lot of fights.” During the 1950s, the threat of unemployment evaporated and the moral condemnation for being a “work hog” no longer made sense. In addition, the rise of quasi-fixed employment costs (such as health insurance) induced management to push workers toward a longer workday.

The Current Situation

As the twentieth century ended there was nothing resembling a shorter hours “movement.” The length of the workweek continues to fall for most groups — but at a glacial pace. Some Americans complain about a lack of free time but the vast majority seem content with an average workweek of roughly forty hours — channeling almost all of their growing wages into higher incomes rather than increased leisure time.

Causes of the Decline in the Length of the Workweek

Supply, Demand and Hours of Work

The length of the workweek, like other labor market outcomes, is determined by the interaction of the supply and demand for labor. Employers are torn by conflicting pressures. Holding everything else constant, they would like employees to work long hours because this means that they can utilize their equipment more fully and offset any fixed costs from hiring each worker (such as the cost of health insurance — common today, but not a consideration a century ago). On the other hand, longer hours can bring reduced productivity due to worker fatigue and can bring worker demands for higher hourly wages to compensate for putting in long hours. If they set the workweek too high, workers may quit and few workers will be willing to work for them at a competitive wage rate. Thus, workers implicitly choose among a variety of jobs — some offering shorter hours and lower earnings, others offering longer hours and higher earnings.

Economic Growth and the Long-Term Reduction of Work Hours

Historically employers and employees often agreed on very long workweeks because the economy was not very productive (by today’s standards) and people had to work long hours to earn enough money to feed, clothe and house their families. The long-term decline in the length of the workweek, in this view, has primarily been due to increased economic productivity, which has yielded higher wages for workers. Workers responded to this rise in potential income by “buying” more leisure time, as well as by buying more goods and services. In a recent survey, a sizeable majority of economic historians agreed with this view. Over eighty percent accepted the proposition that “the reduction in the length of the workweek in American manufacturing before the Great Depression was primarily due to economic growth and the increased wages it brought” (Whaples, 1995). Other broad forces probably played only a secondary role. For example, roughly two-thirds of economic historians surveyed rejected the proposition that the efforts of labor unions were the primary cause of the drop in work hours before the Great Depression.

Winning the Eight-Hour Day in the Era of World War I

The swift reduction of the workweek in the period around World War I has been extensively analyzed by Whaples (1990b). His findings support the consensus that economic growth was the key to reduced work hours. Whaples links factors such as wages, labor legislation, union power, ethnicity, city size, leisure opportunities, age structure, wealth and homeownership, health, education, alternative employment opportunities, industrial concentration, seasonality of employment, and technological considerations to changes in the average workweek in 274 cities and 118 industries. He finds that the rapid economic expansion of the World War I period, which pushed up real wages by more than 18 percent between 1914 and 1919, explains about half of the drop in the length of the workweek. The reduction of immigration during the war was important, as it deprived employers of a group of workers who were willing to put in long hours, explaining about one-fifth of the hours decline. The rapid electrification of manufacturing seems also to have played an important role in reducing the workweek. Increased unionization explains about one-seventh of the reduction, and federal and state legislation and policies that mandated reduced workweeks also had a noticeable role.

Cross-sectional Patterns from 1919

In 1919 the average workweek varied tremendously, emphasizing the point that not all workers desired the same workweek. The workweek exceeded 69 hours in the iron blast furnace, cottonseed oil, and sugar beet industries, but fell below 45 hours in industries such as hats and caps, fur goods, and women’s clothing. Cities’ averages also differed dramatically. In a few Midwestern steel mill towns average workweeks exceeded 60 hours. In a wide range of low-wage Southern cities they reached the high 50s, but in high-wage Western ports, like Seattle, the workweek fell below 45 hours.

Whaples (1990a) finds that among the most important city-level determinants of the workweek during this period were the availability of a pool of agricultural workers, the capital-labor ratio, horsepower per worker, and the amount of employment in large establishments. Hours rose as each of these increased. Eastern European immigrants worked significantly longer than others, as did people in industries whose output varied considerably from season to season. High unionization and strike levels reduced hours to a small degree. The average female employee worked about six and a half fewer hours per week in 1919 than did the average male employee. In city-level comparisons, state maximum hours laws appear to have had little affect on average work hours, once the influences of other factors have been taken into account. One possibility is that these laws were passed only after economic forces lowered the length of the workweek. Overall, in cities where wages were one percent higher, hours were about -0.13 to -0.05 percent lower. Again, this suggests that during the era of declining hours, workers were willing to use higher wages to “buy” shorter hours.

Annotated Bibliography

Perhaps the most comprehensive survey of the shorter hours movement in the U.S. is David Roediger and Philip Foner’s Our Own Time: A History of American Labor and the Working Day (1989). It contends that “the length of the working day has been the central issue for the American labor movement during its most vigorous periods of activity, uniting workers along lines of craft, gender, and ethnicity.” Critics argue that its central premise is flawed because workers have often been divided about the optimal length of the workweek. It explains the point of view of organized labor and recounts numerous historically important events and arguments, but does not attempt to examine in detail the broader economic forces that determined the length of the workweek. An earlier useful comprehensive work is Marion Cahill’s Shorter Hours: A Study of the Movement since the Civil War (1932).

Benjamin Hunnicutt’s Work Without End: Abandoning Shorter Hours for the Right to Work (1988) focuses on the period from 1920 to 1940 and traces the political, intellectual, and social “dialogues” that changed the American concept of progress from dreams of more leisure to an “obsession” with the importance of work and wage-earning. This work’s detailed analysis and insights are valuable, but it draws many of its inferences from what intellectuals said about shorter hours, rather than spending time on the actual decision makers — workers and employers. Hunnicutt’s Kellogg’s Six-Hour Day (1996), is important because it does exactly this — interviewing employees and examining the motives and decisions of a prominent employer. Unfortunately, it shows that one must carefully interpret what workers say on the subject, as they are prone to reinterpret their own pasts so that their choices can be more readily rationalized. (See EH.NET’s review: http://eh.net/book_reviews/kelloggs-six-hour-day/.)

Economists have given surprisingly little attention to the determinants of the workweek. The most comprehensive treatment is Robert Whaples’ “The Shortening of the American Work Week” (1990), which surveys estimates of the length of the workweek, the shorter hours movement, and economic theories about the length of the workweek. Its core is an extensive statistical examination of the determinants of the workweek in the period around World War I.

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Whaples, Robert. “The Shortening of the American Work Week: An Economic and Historical Analysis of Its Context, Causes, and Consequences.” Ph.D. dissertation, University of Pennsylvania, 1990a.

Whaples, Robert. “Winning the Eight-Hour Day, 1909-1919.” Journal of Economic History 50, no. 2 (1990b): 393-406.

Whaples, Robert. “Where Is There Consensus Among American Economic Historians? The Results of a Survey on Forty Propositions.” Journal of Economic History 55, no. 1 (1995): 139-154.

Citation: Whaples, Robert. “Hours of Work in U.S. History”. EH.Net Encyclopedia, edited by Robert Whaples. August 14, 2001. URL http://eh.net/encyclopedia/hours-of-work-in-u-s-history/

An Overview of the Great Depression

Randall Parker, East Carolina University

This article provides an overview of selected events and economic explanations of the interwar era. What follows is not intended to be a detailed and exhaustive review of the literature on the Great Depression, or of any one theory in particular. Rather, it will attempt to describe the “big picture” events and topics of interest. For the reader who wishes more extensive analysis and detail, references to additional materials are also included.

The 1920s

The Great Depression, and the economic catastrophe that it was, is perhaps properly scaled in reference to the decade that preceded it, the 1920s. By conventional macroeconomic measures, this was a decade of brisk economic growth in the United States. Perhaps the moniker “the roaring twenties” summarizes this period most succinctly. The disruptions and shocking nature of World War I had been survived and it was felt the United States was entering a “new era.” In January 1920, the Federal Reserve seasonally adjusted index of industrial production, a standard measure of aggregate economic activity, stood at 81 (1935–39 = 100). When the index peaked in July 1929 it was at 114, for a growth rate of 40.6 percent over this period. Similar rates of growth over the 1920–29 period equal to 47.3 percent and 42.4 percent are computed using annual real gross national product data from Balke and Gordon (1986) and Romer (1988), respectively. Further computations using the Balke and Gordon (1986) data indicate an average annual growth rate of real GNP over the 1920–29 period equal to 4.6 percent. In addition, the relative international economic strength of this country was clearly displayed by the fact that nearly one-half of world industrial output in 1925–29 was produced in the United States (Bernanke, 1983).

Consumer Durables Market

The decade of the 1920s also saw major innovations in the consumption behavior of households. The development of installment credit over this period led to substantial growth in the consumer durables market (Bernanke, 1983). Purchases of automobiles, refrigerators, radios and other such durable goods all experienced explosive growth during the 1920s as small borrowers, particularly households and unincorporated businesses, utilized their access to available credit (Persons, 1930; Bernanke, 1983; Soule, 1947).

Economic Growth in the 1920s

Economic growth during this period was mitigated only somewhat by three recessions. According to the National Bureau of Economic Research (NBER) business cycle chronology, two of these recessions were from May 1923 through July 1924 and October 1926 through November 1927. Both of these recessions were very mild and unremarkable. In contrast, the 1920s began with a recession lasting 18 months from the peak in January 1920 until the trough of July 1921. Original estimates of real GNP from the Commerce Department showed that real GNP fell 8 percent between 1919 and 1920 and another 7 percent between 1920 and 1921 (Romer, 1988). The behavior of prices contributed to the naming of this recession “the Depression of 1921,” as the implicit price deflator for GNP fell 16 percent and the Bureau of Labor Statistics wholesale price index fell 46 percent between 1920 and 1921. Although thought to be severe, Romer (1988) has argued that the so-called “postwar depression” was not as severe as once thought. While the deflation from war-time prices was substantial, revised estimates of real GNP show falls in output of only 1 percent between 1919 and 1920 and 2 percent between 1920 and 1921. Romer (1988) also argues that the behaviors of output and prices are inconsistent with the conventional explanation of the Depression of 1921 being primarily driven by a decline in aggregate demand. Rather, the deflation and the mild recession are better understood as resulting from a decline in aggregate demand together with a series of positive supply shocks, particularly in the production of agricultural goods, and significant decreases in the prices of imported primary commodities. Overall, the upshot is that the growth path of output was hardly impeded by the three minor downturns, so that the decade of the 1920s can properly be viewed economically as a very healthy period.

Fed Policies in the 1920s

Friedman and Schwartz (1963) label the 1920s “the high tide of the Reserve System.” As they explain, the Federal Reserve became increasingly confident in the tools of policy and in its knowledge of how to use them properly. The synchronous movements of economic activity and explicit policy actions by the Federal Reserve did not go unnoticed. Taking the next step and concluding there was cause and effect, the Federal Reserve in the 1920s began to use monetary policy as an implement to stabilize business cycle fluctuations. “In retrospect, we can see that this was a major step toward the assumption by government of explicit continuous responsibility for economic stability. As the decade wore on, the System took – and perhaps even more was given – credit for the generally stable conditions that prevailed, and high hopes were placed in the potency of monetary policy as then administered” (Friedman and Schwartz, 1963).

The giving/taking of credit to/by the Federal Reserve has particular value pertaining to the recession of 1920–21. Although suggesting the Federal Reserve probably tightened too much, too late, Friedman and Schwartz (1963) call this episode “the first real trial of the new system of monetary control introduced by the Federal Reserve Act.” It is clear from the history of the time that the Federal Reserve felt as though it had successfully passed this test. The data showed that the economy had quickly recovered and brisk growth followed the recession of 1920–21 for the remainder of the decade.

Questionable Lessons “Learned” by the Fed

Moreover, Eichengreen (1992) suggests that the episode of 1920–21 led the Federal Reserve System to believe that the economy could be successfully deflated or “liquidated” without paying a severe penalty in terms of reduced output. This conclusion, however, proved to be mistaken at the onset of the Depression. As argued by Eichengreen (1992), the Federal Reserve did not appreciate the extent to which the successful deflation could be attributed to the unique circumstances that prevailed during 1920–21. The European economies were still devastated after World War I, so the demand for United States’ exports remained strong many years after the War. Moreover, the gold standard was not in operation at the time. Therefore, European countries were not forced to match the deflation initiated in the United States by the Federal Reserve (explained below pertaining to the gold standard hypothesis).

The implication is that the Federal Reserve thought that deflation could be generated with little effect on real economic activity. Therefore, the Federal Reserve was not vigorous in fighting the Great Depression in its initial stages. It viewed the early years of the Depression as another opportunity to successfully liquidate the economy, especially after the perceived speculative excesses of the 1920s. However, the state of the economic world in 1929 was not a duplicate of 1920–21. By 1929, the European economies had recovered and the interwar gold standard was a vehicle for the international transmission of deflation. Deflation in 1929 would not operate as it did in 1920–21. The Federal Reserve failed to understand the economic implications of this change in the international standing of the United States’ economy. The result was that the Depression was permitted to spiral out of control and was made much worse than it otherwise would have been had the Federal Reserve not considered it to be a repeat of the 1920–21 recession.

The Beginnings of the Great Depression

In January 1928 the seeds of the Great Depression, whenever they were planted, began to germinate. For it is around this time that two of the most prominent explanations for the depth, length, and worldwide spread of the Depression first came to be manifest. Without any doubt, the economics profession would come to a firm consensus around the idea that the economic events of the Great Depression cannot be properly understood without a solid linkage to both the behavior of the supply of money together with Federal Reserve actions on the one hand and the flawed structure of the interwar gold standard on the other.

It is well documented that many public officials, such as President Herbert Hoover and members of the Federal Reserve System in the latter 1920s, were intent on ending what they perceived to be the speculative excesses that were driving the stock market boom. Moreover, as explained by Hamilton (1987), despite plentiful denials to the contrary, the Federal Reserve assumed the role of “arbiter of security prices.” Although there continues to be debate as to whether or not the stock market was overvalued at the time (White, 1990; DeLong and Schleifer, 1991), the main point is that the Federal Reserve believed there to be a speculative bubble in equity values. Hamilton (1987) describes how the Federal Reserve, intending to “pop” the bubble, embarked on a highly contractionary monetary policy in January 1928. Between December 1927 and July 1928 the Federal Reserve conducted $393 million of open market sales of securities so that only $80 million remained in the Open Market account. Buying rates on bankers’ acceptances1 were raised from 3 percent in January 1928 to 4.5 percent by July, reducing Federal Reserve holdings of such bills by $193 million, leaving a total of only $185 million of these bills on balance. Further, the discount rate was increased from 3.5 percent to 5 percent, the highest level since the recession of 1920–21. “In short, in terms of the magnitudes consciously controlled by the Fed, it would be difficult to design a more contractionary policy than that initiated in January 1928” (Hamilton, 1987).

The pressure did not stop there, however. The death of Federal Reserve Bank President Benjamin Strong and the subsequent control of policy ascribed to Adolph Miller of the Federal Reserve Board insured that the fall in the stock market was going to be made a reality. Miller believed the speculative excesses of the stock market were hurting the economy, and the Federal Reserve continued attempting to put an end to this perceived harm (Cecchetti, 1998). The amount of Federal Reserve credit that was being extended to market participants in the form of broker loans became an issue in 1929. The Federal Reserve adamantly discouraged lending that was collateralized by equities. The intentions of the Board of Governors of the Federal Reserve were made clear in a letter dated February 2, 1929 sent to Federal Reserve banks. In part the letter read:

The board has no disposition to assume authority to interfere with the loan practices of member banks so long as they do not involve the Federal reserve banks. It has, however, a grave responsibility whenever there is evidence that member banks are maintaining speculative security loans with the aid of Federal reserve credit. When such is the case the Federal reserve bank becomes either a contributing or a sustaining factor in the current volume of speculative security credit. This is not in harmony with the intent of the Federal Reserve Act, nor is it conducive to the wholesome operation of the banking and credit system of the country. (Board of Governors of the Federal Reserve 1929: 93–94, quoted from Cecchetti, 1998)

The deflationary pressure to stock prices had been applied. It was now a question of when the market would break. Although the effects were not immediate, the wait was not long.

The Economy Stumbles

The NBER business cycle chronology dates the start of the Great Depression in August 1929. For this reason many have said that the Depression started on Main Street and not Wall Street. Be that as it may, the stock market plummeted in October of 1929. The bursting of the speculative bubble had been achieved and the economy was now headed in an ominous direction. The Federal Reserve’s seasonally adjusted index of industrial production stood at 114 (1935–39 = 100) in August 1929. By October it had fallen to 110 for a decline of 3.5 percent (annualized percentage decline = 14.7 percent). After the crash, the incipient recession intensified, with the industrial production index falling from 110 in October to 100 in December 1929, or 9 percent (annualized percentage decline = 41 percent). In 1930, the index fell further from 100 in January to 79 in December, or an additional 21percent.

Links between the Crash and the Depression?

While popular history treats the crash and the Depression as one and the same event, economists know that they were not. But there is no doubt that the crash was one of the things that got the ball rolling. Several authors have offered explanations for the linkage between the crash and the recession of 1929–30. Mishkin (1978) argues that the crash and an increase in liabilities led to a deterioration in households’ balance sheets. The reduced liquidity2 led consumers to defer consumption of durable goods and housing and thus contributed to a fall in consumption. Temin (1976) suggests that the fall in stock prices had a negative wealth effect on consumption, but attributes only a minor role to this given that stocks were not a large fraction of total wealth; the stock market in 1929, although falling dramatically, remained above the value it had achieved in early 1928, and the propensity to consume from wealth was small during this period. Romer (1990) provides evidence suggesting that if the stock market were thought to be a predictor of future economic activity, then the crash can rightly be viewed as a source of increased consumer uncertainty that depressed spending on consumer durables and accelerated the decline that had begun in August 1929. Flacco and Parker (1992) confirm Romer’s findings using different data and alternative estimation techniques.

Looking back on the behavior of the economy during the year of 1930, industrial production declined 21 percent, the consumer price index fell 2.6 percent, the supply of high-powered money (that is, the liabilities of the Federal Reserve that are usable as money, consisting of currency in circulation and bank reserves; also called the monetary base) fell 2.8 percent, the nominal supply of money as measured by M1 (the product of the monetary base3 multiplied by the money multiplier4) dipped 3.5 percent and the ex post real interest rate turned out to be 11.3 percent, the highest it had been since the recession of 1920–21 (Hamilton, 1987). In spite of this, when put into historical context, there was no reason to view the downturn of 1929–30 as historically unprecedented. Its magnitude was comparable to that of many recessions that had previously occurred. Perhaps there was justifiable optimism in December 1930 that the economy might even shake off the negative movement and embark on the path to recovery, rather like what had occurred after the recession of 1920–21 (Bernanke, 1983). As we know, the bottom would not come for another 27 months.

The Economy Crumbles

Banking Failures

During 1931, there was a “change in the character of the contraction” (Friedman and Schwartz, 1963). Beginning in October 1930 and lasting until December 1930, the first of a series of banking panics now accompanied the downward spasms of the business cycle. Although bank failures had occurred throughout the 1920s, the magnitude of the failures that occurred in the early 1930s was of a different order altogether (Bernanke, 1983). The absence of any type of deposit insurance resulted in the contagion of the panics being spread to sound financial institutions and not just those on the margin.

Traditional Methods of Combating Bank Runs Not Used

Moreover, institutional arrangements that had existed in the private banking system designed to provide liquidity – to convert assets into cash – to fight bank runs before 1913 were not exercised after the creation of the Federal Reserve System. For example, during the panic of 1907, the effects of the financial upheaval had been contained through a combination of lending activities by private banks, called clearinghouses, and the suspension of deposit convertibility into currency. While not preventing bank runs and the financial panic, their economic impact was lessened to a significant extent by these countermeasures enacted by private banks, as the economy quickly recovered in 1908. The aftermath of the panic of 1907 and the desire to have a central authority to combat the contagion of financial disruptions was one of the factors that led to the establishment of the Federal Reserve System. After the creation of the Federal Reserve, clearinghouse lending and suspension of deposit convertibility by private banks were not undertaken. Believing the Federal Reserve to be the “lender of last resort,” it was apparently thought that the responsibility to fight bank runs was the domain of the central bank (Friedman and Schwartz, 1963; Bernanke, 1983). Unfortunately, when the banking panics came in waves and the financial system was collapsing, being the “lender of last resort” was a responsibility that the Federal Reserve either could not or would not assume.

Money Supply Contracts

The economic effects of the banking panics were devastating. Aside from the obvious impact of the closing of failed banks and the subsequent loss of deposits by bank customers, the money supply accelerated its downward spiral. Although the economy had flattened out after the first wave of bank failures in October–December 1930, with the industrial production index steadying from 79 in December 1930 to 80 in April 1931, the remainder of 1931 brought a series of shocks from which the economy was not to recover for some time.

Second Wave of Banking Failure

In May, the failure of Austria’s largest bank, the Kredit-anstalt, touched off financial panics in Europe. In September 1931, having had enough of the distress associated with the international transmission of economic depression, Britain abandoned its participation in the gold standard. Further, just as the United States’ economy appeared to be trying to begin recovery, the second wave of bank failures hit the financial system in June and did not abate until December. In addition, the Hoover administration in December 1931, adhering to its principles of limited government, embarked on a campaign to balance the federal budget. Tax increases resulted the following June, just as the economy was to hit the first low point of its so-called “double bottom” (Hoover, 1952).

The results of these events are now evident. Between January and December 1931 the industrial production index declined from 78 to 66, or 15.4 percent, the consumer price index fell 9.4 percent, the nominal supply of M1 dipped 5.7 percent, the ex post real interest rate5 remained at 11.3 percent, and although the supply of high-powered money6 actually increased 5.5 percent, the currency–deposit and reserve–deposit ratios began their upward ascent, and thus the money multiplier started its downward plunge (Hamilton, 1987). If the economy had flattened out in the spring of 1931, then by December output, the money supply, and the price level were all on negative growth paths that were dragging the economy deeper into depression.

Third Wave of Banking Failure

The economic difficulties were far from over. The economy displayed some evidence of recovery in late summer/early fall of 1932. However, in December 1932 the third, and largest, wave of banking panics hit the financial markets and the collapse of the economy arrived with the business cycle hitting bottom in March 1933. Industrial production between January 1932 and March 1933 fell an additional 15.6 percent. For the combined years of 1932 and 1933, the consumer price index fell a cumulative 16.2 percent, the nominal supply of M1 dropped 21.6 percent, the nominal M2 money supply fell 34.7 percent, and although the supply of high-powered money increased 8.4 percent, the currency–deposit and reserve–deposit ratios accelerated their upward ascent. Thus the money multiplier continued on a downward plunge that was not arrested until March 1933. Similar behaviors for real GDP, prices, money supplies and other key macroeconomic variables occurred in many European economies as well (Snowdon and Vane, 1999; Temin, 1989).

An examination of the macroeconomic data in August 1929 compared to March 1933 provides a stark contrast. The unemployment rate of 3 percent in August 1929 was at 25 percent in March 1933. The industrial production index of 114 in August 1929 was at 54 in March 1933, or a 52.6 percent decrease. The money supply had fallen 35 percent, prices plummeted by about 33 percent, and more than one-third of banks in the United States were either closed or taken over by other banks. The “new era” ushered in by “the roaring twenties” was over. Roosevelt took office in March 1933, a nationwide bank holiday was declared from March 6 until March 13, and the United States abandoned the international gold standard in April 1933. Recovery commenced immediately and the economy began its long path back to the pre-1929 secular growth trend.

Table 1 summarizes the drop in industrial production in the major economies of Western Europe and North America. Table 2 gives gross national product estimates for the United States from 1928 to 1941. The constant price series adjusts for inflation and deflation.

Table 1
Indices of Total Industrial Production, 1927 to 1935 (1929 = 100)

1927 1928 1929 1930 1931 1932 1933 1934 1935
Britain 95 94 100 94 86 89 95 105 114
Canada 85 94 100 91 78 68 69 82 90
France 84 94 100 99 85 74 83 79 77
Germany 95 100 100 86 72 59 68 83 96
Italy 87 99 100 93 84 77 83 85 99
Netherlands 87 94 100 109 101 90 90 93 95
Sweden 85 88 100 102 97 89 93 111 125
U.S. 85 90 100 83 69 55 63 69 79

Source: Industrial Statistics, 1900-57 (Paris, OEEC, 1958), Table 2.

Table 2
U.S. GNP at Constant (1929) and Current Prices, 1928-1941

Year GNP at constant (1929) prices (billions of $) GNP at current prices (billions of $)
1928 98.5 98.7
1929 104.4 104.6
1930 95.1 91.2
1931 89.5 78.5
1932 76.4 58.6
1933 74.2 56.1
1934 80.8 65.5
1935 91.4 76.5
1936 100.9 83.1
1937 109.1 91.2
1938 103.2 85.4
1939 111.0 91.2
1940 121.0 100.5
1941 131.7 124.7

Contemporary Explanations

The economics profession during the 1930s was at a loss to explain the Depression. The most prominent conventional explanations were of two types. First, some observers at the time firmly grounded their explanations on the two pillars of classical macroeconomic thought, Say’s Law and the belief in the self-equilibrating powers of the market. Many argued that it was simply a question of time before wages and prices adjusted fully enough for the economy to return to full employment and achieve the realization of the putative axiom that “supply creates its own demand.” Second, the Austrian school of thought argued that the Depression was the inevitable result of overinvestment during the 1920s. The best remedy for the situation was to let the Depression run its course so that the economy could be purified from the negative effects of the false expansion. Government intervention was viewed by the Austrian school as a mechanism that would simply prolong the agony and make any subsequent depression worse than it would ordinarily be (Hayek, 1966; Hayek, 1967).

Liquidationist Theory

The Hoover administration and the Federal Reserve Board also contained several so-called “liquidationists.” These individuals basically believed that economic agents should be forced to re-arrange their spending proclivities and alter their alleged profligate use of resources. If it took mass bankruptcies to produce this result and wipe the slate clean so that everyone could have a fresh start, then so be it. The liquidationists viewed the events of the Depression as an economic penance for the speculative excesses of the 1920s. Thus, the Depression was the price that was being paid for the misdeeds of the previous decade. This is perhaps best exemplified in the well-known quotation of Treasury Secretary Andrew Mellon, who advised President Hoover to “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” Mellon continued, “It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people” (Hoover, 1952). Hoover apparently followed this advice as the Depression wore on. He continued to reassure the public that if the principles of orthodox finance were faithfully followed, recovery would surely be the result.

The business press at the time was not immune from such liquidationist prescriptions either. The Commercial and Financial Chronicle, in an August 3, 1929 editorial entitled “Is Not Group Speculating Conspiracy, Fostering Sham Prosperity?” complained of the economy being replete with profligate spending including:

(a) The luxurious diversification of diet advantageous to dairy men … and fruit growers …; (b) luxurious dressing … more silk and rayon …; (c) free spending for automobiles and their accessories, gasoline, house furnishings and equipment, radios, travel, amusements and sports; (d) the displacement from the farms by tractors and autos of produce-consuming horses and mules to a number aggregating 3,700,000 for the period 1918–1928 … (e) the frills of education to thousands for whom places might better be reserved at bench or counter or on the farm. (Quoted from Nelson, 1991)

Persons, in a paper which appeared in the November 1930 Quarterly Journal of Economics, demonstrates that some academic economists also held similar liquidationist views.

Although certainly not universal, the descriptions above suggest that no small part of the conventional wisdom at the time believed the Depression to be a penitence for past sins. In addition, it was thought that the economy would be restored to full employment equilibrium once wages and prices adjusted sufficiently. Say’s Law will ensure the economy will return to health, and supply will create its own demand sufficient to return to prosperity, if we simply let the system work its way through. In his memoirs published in 1952, 20 years after his election defeat, Herbert Hoover continued to steadfastly maintain that if Roosevelt and the New Dealers would have stuck to the policies his administration put in place, the economy would have made a full recovery within 18 months after the election of 1932. We have to intensify our resolve to “stay the course.” All will be well in time if we just “take our medicine.” In hindsight, it challenges the imagination to think up worse policy prescriptions for the events of 1929–33.

Modern Explanations

There remains considerable debate regarding the economic explanations for the behavior of the business cycle between August 1929 and March 1933. This section describes the main hypotheses that have been presented in the literature attempting to explain the causes for the depth, protracted length, and worldwide propagation of the Great Depression.

The United States’ experience, considering the preponderance of empirical results and historical simulations contained in the economic literature, can largely be accounted for by the monetary hypothesis of Friedman and Schwartz (1963) together with the nonmonetary/financial hypotheses of Bernanke (1983) and Fisher (1933). That is, most, but not all, of the characteristic phases of the business cycle and depth to which output fell from 1929 to 1933 can be accounted for by the monetary and nonmonetary/financial hypotheses. The international experience, well documented in Choudri and Kochin (1980), Hamilton (1988), Temin (1989), Bernanke and James (1991), and Eichengreen (1992), can be properly understood as resulting from a flawed interwar gold standard. Each of these hypotheses is explained in greater detail below.

Nonmonetary/Nonfinancial Theories

It should be noted that I do not include a section covering the nonmonetary/nonfinancial theories of the Great Depression. These theories, including Temin’s (1976) focus on autonomous consumption decline, the collapse of housing construction contained in Anderson and Butkiewicz (1980), the effects of the stock market crash, the uncertainty hypothesis of Romer (1990), and the Smoot–Hawley Tariff Act of 1930, are all worthy of mention and can rightly be apportioned some of the responsibility for initiating the Depression. However, any theory of the Depression must be able to account for the protracted problems associated with the punishing deflation imposed on the United States and the world during that era. While the nonmonetary/nonfinancial theories go a long way accounting for the impetus for, and first year of the Depression, my reading of the empirical results of the economic literature indicates that they do not have the explanatory power of the three other theories mentioned above to account for the depths to which the economy plunged.

Moreover, recent research by Olney (1999) argues convincingly that the decline in consumption was not autonomous at all. Rather, the decline resulted because high consumer indebtedness threatened future consumption spending because default was expensive. Olney shows that households were shouldering an unprecedented burden of installment debt – especially for automobiles. In addition, down payments were large and contracts were short. Missed installment payments triggered repossession, reducing consumer wealth in 1930 because households lost all acquired equity. Cutting consumption was the only viable strategy in 1930 for avoiding default.

The Monetary Hypothesis

In reviewing the economic history of the Depression above, it was mentioned that the supply of money fell by 35 percent, prices dropped by about 33 percent, and one-third of all banks vanished. Milton Friedman and Anna Schwartz, in their 1963 book A Monetary History of the United States, 1867–1960, call this massive drop in the supply of money “The Great Contraction.”

Friedman and Schwartz (1963) discuss and painstakingly document the synchronous movements of the real economy with the disruptions that occurred in the financial sector. They point out that the series of bank failures that occurred beginning in October 1930 worsened economic conditions in two ways. First, bank shareholder wealth was reduced as banks failed. Second, and most importantly, the bank failures were exogenous shocks and led to the drastic decline in the money supply. The persistent deflation of the 1930s follows directly from this “great contraction.”

Criticisms of Fed Policy

However, this raises an important question: Where was the Federal Reserve while the money supply and the financial system were collapsing? If the Federal Reserve was created in 1913 primarily to be the “lender of last resort” for troubled financial institutions, it was failing miserably. Friedman and Schwartz pin the blame squarely on the Federal Reserve and the failure of monetary policy to offset the contractions in the money supply. As the money multiplier continued on its downward path, the monetary base, rather than being aggressively increased, simply progressed slightly upwards on a gently positive sloping time path. As banks were failing in waves, was the Federal Reserve attempting to contain the panics by aggressively lending to banks scrambling for liquidity? The unfortunate answer is “no.” When the panics were occurring, was there discussion of suspending deposit convertibility or suspension of the gold standard, both of which had been successfully employed in the past? Again the unfortunate answer is “no.” Did the Federal Reserve consider the fact that it had an abundant supply of free gold, and therefore that monetary expansion was feasible? Once again the unfortunate answer is “no.” The argument can be summarized by the following quotation:

At all times throughout the 1929–33 contraction, alternative policies were available to the System by which it could have kept the stock of money from falling, and indeed could have increased it at almost any desired rate. Those policies did not involve radical innovations. They involved measures of a kind the System had taken in earlier years, of a kind explicitly contemplated by the founders of the System to meet precisely the kind of banking crisis that developed in late 1930 and persisted thereafter. They involved measures that were actually proposed and very likely would have been adopted under a slightly different bureaucratic structure or distribution of power, or even if the men in power had had somewhat different personalities. Until late 1931 – and we believe not even then – the alternative policies involved no conflict with the maintenance of the gold standard. Until September 1931, the problem that recurrently troubled the System was how to keep the gold inflows under control, not the reverse. (Friedman and Schwartz, 1963)

The inescapable conclusion is that it was a failure of the policies of the Federal Reserve System in responding to the crises of the time that made the Depression as bad as it was. If monetary policy had responded differently, the economic events of 1929–33 need not have been as they occurred. This assertion is supported by the results of Fackler and Parker (1994). Using counterfactual historical simulations, they show that if the Federal Reserve had kept the M1 money supply growing along its pre-October 1929 trend of 3.3 percent annually, most of the Depression would have been averted. McCallum (1990) also reaches similar conclusions employing a monetary base feedback policy in his counterfactual simulations.

Lack of Leadership at the Fed

Friedman and Schwartz trace the seeds of these regrettable events to the death of Federal Reserve Bank of New York President Benjamin Strong in 1928. Strong’s death altered the locus of power in the Federal Reserve System and left it without effective leadership. Friedman and Schwartz maintain that Strong had the personality, confidence and reputation in the financial community to lead monetary policy and sway policy makers to his point of view. Friedman and Schwartz believe that Strong would not have permitted the financial panics and liquidity crises to persist and affect the real economy. Instead, after Governor Strong died, the conduct of open market operations changed from a five-man committee dominated by the New York Federal Reserve to that of a 12-man committee of Federal Reserve Bank governors. Decisiveness in leadership was replaced by inaction and drift. Others (Temin, 1989; Wicker, 1965) reject this point, claiming the policies of the Federal Reserve in the 1930s were not inconsistent with the policies pursued in the decade of the 1920s.

The Fed’s Failure to Distinguish between Nominal and Real Interest Rates

Meltzer (1976) also points out errors made by the Federal Reserve. His argument is that the Federal Reserve failed to distinguish between nominal and real interest rates. That is, while nominal rates were falling, the Federal Reserve did virtually nothing, since it construed this to be a sign of an “easy” credit market. However, in the face of deflation, real rates were rising and there was in fact a “tight” credit market. Failure to make this distinction led money to be a contributing factor to the initial decline of 1929.

Deflation

Cecchetti (1992) and Nelson (1991) bolster the monetary hypothesis by demonstrating that the deflation during the Depression was anticipated at short horizons, once it was under way. The result, using the Fisher equation, is that high ex ante real interest rates were the transmission mechanism that led from falling prices to falling output. In addition, Cecchetti (1998) and Cecchetti and Karras (1994) argue that if the lower bound of the nominal interest rate is reached, then continued deflation renders the opportunity cost of holding money negative. In this instance the nature of money changes. Now the rate of deflation places a floor on the real return nonmoney assets must provide to make them attractive to hold. If they cannot exceed the rate on money holdings, then agents will move their assets into cash and the result will be negative net investment and a decapitalization of the economy.

Critics of the Monetary Hypothesis

The monetary hypothesis, however, is not without its detractors. Paul Samuelson observes that the monetary base did not fall during the Depression. Moreover, expecting the Federal Reserve to have aggressively increased the monetary base by whatever amount was necessary to stop the decline in the money supply is hindsight. A course of action for monetary policy such as this was beyond the scope of discussion prevailing at the time. In addition, others, like Moses Abramovitz, point out that the money supply had endogenous components that were beyond the Federal Reserve’s ability to control. Namely, the money supply may have been falling as a result of declining economic activity, or so-called “reverse causation.” Moreover the gold standard, to which the United States continued to adhere until March 1933, also tied the hands of the Federal Reserve in so far as gold outflows that occurred required the Federal Reserve to contract the supply of money. These views are also contained in Temin (1989) and Eichengreen (1992), as discussed below.

Bernanke (1983) argues that the monetary hypothesis: (i) is not a complete explanation of the link between the financial sector and aggregate output in the 1930s; (ii) does not explain how it was that decreases in the money supply caused output to keep falling over many years, especially since it is widely believed that changes in the money supply only change prices and other nominal economic values in the long run, not real economic values like output ; and (iii) is quantitatively insufficient to explain the depth of the decline in output. Bernanke (1983) not only resurrected and sharpened Fisher’s (1933) debt deflation hypothesis, but also made further contributions to what has come to be known as the nonmonetary/financial hypothesis.

The Nonmonetary/Financial Hypothesis

Bernanke (1983), building on the monetary hypothesis of Friedman and Schwartz (1963), presents an alternative interpretation of the way in which the financial crises may have affected output. The argument involves both the effects of debt deflation and the impact that bank panics had on the ability of financial markets to efficiently allocate funds from lenders to borrowers. These nonmonetary/financial theories hold that events in financial markets other than shocks to the money supply can help to account for the paths of output and prices during the Great Depression.

Fisher (1933) asserted that the dominant forces that account for “great” depressions are (nominal) over-indebtedness and deflation. Specifically, he argued that real debt burdens were substantially increased when there were dramatic declines in the price level and nominal incomes. The combination of deflation, falling nominal income and increasing real debt burdens led to debtor insolvency, lowered aggregate demand, and thereby contributed to a continuing decline in the price level and thus further increases in the real burden of debt.

The “Credit View”

Bernanke (1983), in what is now called the “credit view,” provided additional details to help explain Fisher’s debt deflation hypothesis. He argued that in normal circumstances, an initial decline in prices merely reallocates wealth from debtors to creditors, such as banks. Usually, such wealth redistributions are minor in magnitude and have no first-order impact on the economy. However, in the face of large shocks, deflation in the prices of assets forfeited to banks by debtor bankruptcies leads to a decline in the nominal value of assets on bank balance sheets. For a given value of bank liabilities, also denominated in nominal terms, this deterioration in bank assets threatens insolvency. As banks reallocate away from loans to safer government securities, some borrowers, particularly small ones, are unable to obtain funds, often at any price. Further, if this reallocation is long-lived, the shortage of credit for these borrowers helps to explain the persistence of the downturn. As the disappearance of bank financing forces lower expenditure plans, aggregate demand declines, which again contributes to the downward deflationary spiral. For debt deflation to be operative, it is necessary to demonstrate that there was a substantial build-up of debt prior to the onset of the Depression and that the deflation of the 1930s was at least partially unanticipated at medium- and long-term horizons at the time that the debt was being incurred. Both of these conditions appear to have been in place (Fackler and Parker, 2001; Hamilton, 1992; Evans and Wachtel, 1993).

The Breakdown in Credit Markets

In addition, the financial panics which occurred hindered the credit allocation mechanism. Bernanke (1983) explains that the process of credit intermediation requires substantial information gathering and non-trivial market-making activities. The financial disruptions of 1930–33 are correctly viewed as substantial impediments to the performance of these services and thus impaired the efficient allocation of credit between lenders and borrowers. That is, financial panics and debtor and business bankruptcies resulted in a increase in the real cost of credit intermediation. As the cost of credit intermediation increased, sources of credit for many borrowers (especially households, farmers and small firms) became expensive or even unobtainable at any price. This tightening of credit put downward pressure on aggregate demand and helped turn the recession of 1929–30 into the Great Depression. The empirical support for the validity of the nonmonetary/financial hypothesis during the Depression is substantial (Bernanke, 1983; Fackler and Parker, 1994, 2001; Hamilton, 1987, 1992), although support for the “credit view” for the transmission mechanism of monetary policy in post-World War II economic activity is substantially weaker. In combination, considering the preponderance of empirical results and historical simulations contained in the economic literature, the monetary hypothesis and the nonmonetary/financial hypothesis go a substantial distance toward accounting for the economic experiences of the United States during the Great Depression.

The Role of Pessimistic Expectations

To this combination, the behavior of expectations should also be added. As explained by James Tobin, there was another reason for a “change in the character of the contraction” in 1931. Although Friedman and Schwartz attribute this “change” to the bank panics that occurred, Tobin points out that change also took place because of the emergence of pessimistic expectations. If it was thought that the early stages of the Depression were symptomatic of a recession that was not different in kind from similar episodes in our economic history, and that recovery was a real possibility, the public need not have had pessimistic expectations. Instead the public may have anticipated things would get better. However, after the British left the gold standard, expectations changed in a very pessimistic way. The public may very well have believed that the business cycle downturn was not going to be reversed, but rather was going to get worse than it was. When households and business investors begin to make plans based on the economy getting worse instead of making plans based on anticipations of recovery, the depressing economic effects on consumption and investment of this switch in expectations are common knowledge in the modern macroeconomic literature. For the literature on the Great Depression, the empirical research conducted on the expectations hypothesis focuses almost exclusively on uncertainty (which is not the same thing as pessimistic/optimistic expectations) and its contribution to the onset of the Depression (Romer, 1990; Flacco and Parker, 1992). Although Keynes (1936) writes extensively about the state of expectations and their economic influence, the literature is silent regarding the empirical validity of the expectations hypothesis in 1931–33. Yet, in spite of this, the continued shocks that the United States’ economy received demonstrated that the business cycle downturn of 1931–33 was of a different kind than had previously been known. Once the public believed this to be so and made their plans accordingly, the results had to have been economically devastating. There is no formal empirical confirmation and I have not segregated the expectations hypothesis as a separate hypothesis in the overview. However, the logic of the above argument compels me to be of the opinion that the expectations hypothesis provides an impressive addition to the monetary hypothesis and the nonmonetary/financial hypothesis in accounting for the economic experiences of the United States during the Great Depression.

The Gold Standard Hypothesis

Recent research on the operation of the interwar gold standard has deepened our understanding of the Depression and its international character. The way and manner in which the interwar gold standard was structured and operated provide a convincing explanation of the international transmission of deflation and depression that occurred in the 1930s.

The story has its beginning in the 1870–1914 period. During this time the gold standard functioned as a pegged exchange rate system where certain rules were observed. Namely, it was necessary for countries to permit their money supplies to be altered in response to gold flows in order for the price-specie flow mechanism to function properly. It operated successfully because countries that were gaining gold allowed their money supply to increase and raise the domestic price level to restore equilibrium and maintain the fixed exchange rate of their currency. Countries that were losing gold were obligated to permit their money supply to decrease and generate a decline in their domestic price level to restore equilibrium and maintain the fixed exchange rate of their currency. Eichengreen (1992) discusses and extensively documents that the gold standard of this period functioned as smoothly as it did because of the international commitment countries had to the gold standard and the level of international cooperation exhibited during this time. “What rendered the commitment to the gold standard credible, then, was that the commitment was international, not merely national. That commitment was activated through international cooperation” (Eichengreen, 1992).

The gold standard was suspended when the hostilities of World War I broke out. By the end of 1928, major countries such as the United States, the United Kingdom, France and Germany had re-established ties to a functioning fixed exchange rate gold standard. However, Eichengreen (1992) points out that the world in which the gold standard functioned before World War I was not the same world in which the gold standard was being re-established. A credible commitment to the gold standard, as Hamilton (1988) explains, required that a country maintain fiscal soundness and political objectives that insured the monetary authority could pursue a monetary policy consistent with long-run price stability and continuous convertibility of the currency. Successful operation required these conditions to be in place before re-establishment of the gold standard was operational. However, many governments during the interwar period went back on the gold standard in the opposite set of circumstances. They re-established ties to the gold standard because they were incapable, due to the political chaos generated after World War I, of fiscal soundness and did not have political objectives conducive to reforming monetary policy such that it could insure long-run price stability. “By this criterion, returning to the gold standard could not have come at a worse time or for poorer reasons” (Hamilton, 1988). Kindleberger (1973) stresses the fact that the pre-World War I gold standard functioned as well as it did because of the unquestioned leadership exercised by Great Britain. After World War I and the relative decline of Britain, the United States did not exhibit the same strength of leadership Britain had shown before. The upshot is that it was an unsuitable environment in which to re-establish the gold standard after World War I and the interwar gold standard was destined to drift in a state of malperformance as no one took responsibility for its proper functioning. However, the problems did not end there.

Flaws in the Interwar International Gold Standard

Lack of Symmetry in the Response of Gold-Gaining and Gold-Losing Countries

The interwar gold standard operated with four structural/technical flaws that almost certainly doomed it to failure (Eichengreen, 1986; Temin, 1989; Bernanke and James, 1991). The first, and most damaging, was the lack of symmetry in the response of gold-gaining countries and gold-losing countries that resulted in a deflationary bias that was to drag the world deeper into deflation and depression. If a country was losing gold reserves, it was required to decrease its money supply to maintain its commitment to the gold standard. Given that a minimum gold reserve had to be maintained and that countries became concerned when the gold reserve fell within 10 percent of this minimum, little gold could be lost before the necessity of monetary contraction, and thus deflation, became a reality. Moreover, with a fractional gold reserve ratio of 40 percent, the result was a decline in the domestic money supply equal to 2.5 times the gold outflow. On the other hand, there was no such constraint on countries that experienced gold inflows. Gold reserves were accumulated without the binding requirement that the domestic money supply be expanded. Thus the price–specie flow mechanism ceased to function and the equilibrating forces of the pre-World War I gold standard were absent during the interwar period. If a country attracting gold reserves were to embark on a contractionary path, the result would be the further extraction of gold reserves from other countries on the gold standard and the imposition of deflation on their economies as well, as they were forced to contract their money supplies. “As it happened, both of the two major gold surplus countries – France and the United States, who at the time together held close to 60 percent of the world’s monetary gold – took deflationary paths in 1928–1929” (Bernanke and James, 1991).

Foreign Exchange Reserves

Second, countries that did not have reserve currencies could hold their minimum reserves in the form of both gold and convertible foreign exchange reserves. If the threat of devaluation of a reserve currency appeared likely, a country holding foreign exchange reserves could divest itself of the foreign exchange, as holding it became a more risky proposition. Further, the convertible reserves were usually only fractionally backed by gold. Thus, if countries were to prefer gold holdings as opposed to foreign exchange reserves for whatever reason, the result would be a contraction in the world money supply as reserves were destroyed in the movement to gold. This effect can be thought of as equivalent to the effect on the domestic money supply in a fractional reserve banking system of a shift in the public’s money holdings toward currency and away from bank deposits.

The Bank of France and Open Market Operations

Third, the powers of many European central banks were restricted or excluded outright. In particular, as discussed by Eichengreen (1986), the Bank of France was prohibited from engaging in open market operations, i.e. the purchase or sale of government securities. Given that France was one of the countries amassing gold reserves, this restriction largely prevented them from adhering to the rules of the gold standard. The proper response would have been to expand their supply of money and inflate so as not to continue to attract gold reserves and impose deflation on the rest of the world. This was not done. France continued to accumulate gold until 1932 and did not leave the gold standard until 1936.

Inconsistent Currency Valuations

Lastly, the gold standard was re-established at parities that were unilaterally determined by each individual country. When France returned to the gold standard in 1926, it returned at a parity rate that is believed to have undervalued the franc. When Britain returned to the gold standard in 1925, it returned at a parity rate that is believed to have overvalued the pound. In this situation, the only sustainable equilibrium required the French to inflate their economy in response to the gold inflows. However, given their legacy of inflation during the 1921–26 period, France steadfastly resisted inflation (Eichengreen, 1986). The maintenance of the gold standard and the resistance to inflation were now inconsistent policy objectives. The Bank of France’s inability to conduct open market operations only made matters worse. The accumulation of gold and the exporting of deflation to the world was the result.

The Timing of Recoveries

Taken together, the flaws described above made the interwar gold standard dysfunctional and in the end unsustainable. Looking back, we observe that the record of departure from the gold standard and subsequent recovery was different for many different countries. For some countries recovery came sooner. For some it came later. It is in this timing of departure from the gold standard that recent research has produced a remarkable empirical finding. From the work of Choudri and Kochin (1980), Eichengreen and Sachs (1985), Temin (1989), and Bernanke and James (1991), we now know that the sooner a country abandoned the gold standard, the quicker recovery commenced. Spain, which never restored its participation in the gold standard, missed the ravages of the Depression altogether. Britain left the gold standard in September 1931, and started to recover. Sweden left the gold standard at the same time as Britain, and started to recover. The United States left in March 1933, and recovery commenced. France, Holland, and Poland continued to have their economies struggle after the United States’ recovery began as they continued to adhere to the gold standard until 1936. Only after they left did recovery start; departure from the gold standard freed a country from the ravages of deflation.

The Fed and the Gold Standard: The “Midas Touch”

Temin (1989) and Eichengreen (1992) argue that it was the unbending commitment to the gold standard that generated deflation and depression worldwide. They emphasize that the gold standard required fiscal and monetary authorities around the world to submit their economies to internal adjustment and economic instability in the face of international shocks. Given how the gold standard tied countries together, if the gold parity were to be defended and devaluation was not an option, unilateral monetary actions by any one country were pointless. The end result is that Temin (1989) and Eichengreen (1992) reject Friedman and Schwartz’s (1963) claim that the Depression was caused by a series of policy failures on the part of the Federal Reserve. Actions taken in the United States, according to Temin (1989) and Eichengreen (1992), cannot be properly understood in isolation with respect to the rest of the world. If the commitment to the gold standard was to be maintained, monetary and fiscal authorities worldwide had little choice in responding to the crises of the Depression. Why did the Federal Reserve continue a policy of inaction during the banking panics? Because the commitment to the gold standard, what Temin (1989) has labeled “The Midas Touch,” gave them no choice but to let the banks fail. Monetary expansion and the injection of liquidity would lower interest rates, lead to a gold outflow, and potentially be contrary to the rules of the gold standard. Continued deflation due to gold outflows would begin to call into question the monetary authority’s commitment to the gold standard. “Defending gold parity might require the authorities to sit idly by as the banking system crumbled, as the Federal Reserve did at the end of 1931 and again at the beginning of 1933” (Eichengreen, 1992). Thus, if the adherence to the gold standard were to be maintained, the money supply was endogenous with respect to the balance of payments and beyond the influence of the Federal Reserve.

Eichengreen (1992) concludes further that what made the pre-World War I gold standard so successful was absent during the interwar period: credible commitment to the gold standard activated through international cooperation in its implementation and management. Had these important ingredients of the pre-World War I gold standard been present during the interwar period, twentieth-century economic history may have been very different.

Recovery and the New Deal

March 1933 was the rock bottom of the Depression and the inauguration of Franklin D. Roosevelt represented a sharp break with the status quo. Upon taking office, a bank holiday was declared, the United States left the interwar gold standard the following month, and the government commenced with several measures designed to resurrect the financial system. These measures included: (i) the establishment of the Reconstruction Finance Corporation which set about funneling large sums of liquidity to banks and other intermediaries; (ii) the Securities Exchange Act of 1934 which established margin requirements for bank loans used to purchase stocks and bonds and increased information requirements to potential investors; and (iii) the Glass–Steagal Act which strictly separated commercial banking and investment banking. Although delivering some immediate relief to financial markets, lenders continued to be reluctant to extend credit after the events of 1929–33, and the recovery of financial markets was slow and incomplete. Bernanke (1983) estimates that the United States’ financial system did not begin to shed the inefficiencies under which it was operating until the end of 1935.

The NIRA

Policies designed to promote different economic institutions were enacted as part of the New Deal. The National Industrial Recovery Act (NIRA) was passed on June 6, 1933 and was designed to raise prices and wages. In addition, the Act mandated the formation of planning boards in critical sectors of the economy. The boards were charged with setting output goals for their respective sector and the usual result was a restriction of production. In effect, the NIRA was a license for industries to form cartels and was struck down as unconstitutional in 1935. The Agricultural Adjustment Act of 1933 was similar legislation designed to reduce output and raise prices in the farming sector. It too was ruled unconstitutional in 1936.

Relief and Jobs Programs

Other policies intended to provide relief directly to people who were destitute and out of work were rapidly enacted. The Civilian Conservation Corps (CCC), the Tennessee Valley Authority (TVA), the Public Works Administration (PWA) and the Federal Emergency Relief Administration (FERA) were set up shortly after Roosevelt took office and provided jobs for the unemployed and grants to states for direct relief. The Civil Works Administration (CWA), created in 1933–34, and the Works Progress Administration (WPA), created in 1935, were also designed to provide work relief to the jobless. The Social Security Act was also passed in 1935. There surely are other programs with similar acronyms that have been left out, but the intent was the same. In the words of Roosevelt himself, addressing Congress in 1938:

Government has a final responsibility for the well-being of its citizenship. If private co-operative endeavor fails to provide work for the willing hands and relief for the unfortunate, those suffering hardship from no fault of their own have a right to call upon the Government for aid; and a government worthy of its name must make fitting response. (Quoted from Polenberg, 2000)

The Depression had shown the inaccuracies of classifying the 1920s as a “new era.” Rather, the “new era,” as summarized by Roosevelt’s words above and initiated in government’s involvement in the economy, began in March 1933.

The NBER business cycle chronology shows continuous growth from March 1933 until May 1937, at which time a 13-month recession hit the economy. The business cycle rebounded in June 1938 and continued on its upward march to and through the beginning of the United States’ involvement in World War II. The recovery that started in 1933 was impressive, with real GNP experiencing annual rates of the growth in the 10 percent range between 1933 and December 1941, excluding the recession of 1937–38 (Romer, 1993). However, as reported by Romer (1993), real GNP did not return to its pre-Depression level until 1937 and real GNP did not catch up to its pre-Depression secular trend until 1942. Indeed, the unemployment rate, peaking at 25 percent in March 1933, continued to dwell near or above the double-digit range until 1940. It is in this sense that most economists attribute the ending of the Depression to the onset of World War II. The War brought complete recovery as the unemployment rate quickly plummeted after December 1941 to its nadir during the War of below 2 percent.

Explanations for the Pace of Recovery

The question remains, however, that if the War completed the recovery, what initiated it and sustained it through the end of 1941? Should we point to the relief programs of the New Deal and the leadership of Roosevelt? Certainly, they had psychological/expectational effects on consumers and investors and helped to heal the suffering experienced during that time. However, as shown by Brown (1956), Peppers (1973), and Raynold, McMillin and Beard (1991), fiscal policy contributed little to the recovery, and certainly could have done much more.

Once again we return to the financial system for answers. The abandonment of the gold standard, the impact this had on the money supply, and the deliverance from the economic effects of deflation would have to be singled out as the most important contributor to the recovery. Romer (1993) stresses that Eichengreen and Sachs (1985) have it right; recovery did not come before the decision to abandon the old gold parity was made operational. Once this became reality, devaluation of the currency permitted expansion in the money supply and inflation which, rather than promoting a policy of beggar-thy-neighbor, allowed countries to escape the deflationary vortex of economic decline. As discussed in connection with the gold standard hypothesis, the simultaneity of leaving the gold standard and recovery is a robust empirical result that reflects more than simple temporal coincidence.

Romer (1993) reports an increase in the monetary base in the United States of 52 percent between April 1933 and April 1937. The M1 money supply virtually matched this increase in the monetary base, with 49 percent growth over the same period. The sources of this increase were two-fold. First, aside from the immediate monetary expansion permitted by devaluation, as Romer (1993) explains, monetary expansion continued into 1934 and beyond as gold flowed to the United States from Europe due to the increasing political unrest and heightened probability of hostilities that began the progression to World War II. Second, the increase in the money supply matched the increase in the monetary base and the Treasury chose not to sterilize the gold inflows. This is evidence that the monetary expansion resulted from policy decisions and not endogenous changes in the money multiplier. The new regime was freed from the constraints of the gold standard and the policy makers were intent on taking actions of a different nature than what had been done between 1929 and 1933.

Incompleteness of the Recovery before WWII

The Depression had turned a corner and the economy was emerging from the abyss in 1933. However, it still had a long way to go to reach full recovery. Friedman and Schwartz (1963) comment that “the most notable feature of the revival after 1933 was not its rapidity but its incompleteness.” They claim that monetary policy and the Federal Reserve were passive after 1933. The monetary authorities did nothing to stop the fall from 1929 to 1933 and did little to promote the recovery. The Federal Reserve made no effort to increase the stock of high-powered money through the use of either open market operations or rediscounting; Federal Reserve credit outstanding remained “almost perfectly constant from 1934 to mid-1940” (Friedman and Schwartz, 1963). As we have seen above, it was the Treasury that was generating increases in the monetary base at the time by issuing gold certificates equal to the amount of gold reserve inflow and depositing them at the Federal Reserve. When the government spent the money, the Treasury swapped the gold certificates for Federal Reserve notes and this expanded the monetary base (Romer, 1993). Monetary policy was thought to be powerless to promote recovery, and instead it was fiscal policy that became the implement of choice. The research shows that fiscal policy could have done much more to aid in recovery – ironically fiscal policy was the vehicle that was now the focus of attention. There is an easy explanation for why this is so.

The Emergences of Keynes

The economics profession as a whole was at a loss to provide cogent explanations for the events of 1929–33. In the words of Robert Gordon (1998), “economics had lost its intellectual moorings, and it was time for a new diagnosis.” There were no convincing answers regarding why the earlier theories of macroeconomic behavior failed to explain the events that were occurring, and worse, there was no set of principles that established a guide for proper actions in the future. That changed in 1936 with the publication of Keynes’s book The General Theory of Employment, Interest and Money. Perhaps there has been no other person and no other book in economics about which so much has been written. Many consider the arrival of Keynesian thought to have been a “revolution,” although this too is hotly contested (see, for example, Laidler, 1999). The debates that The General Theory generated have been many and long-lasting. There is little that can be said here to add or subtract from the massive literature devoted to the ideas promoted by Keynes, whether they be viewed right or wrong. But the influence over academic thought and economic policy that was generated by The General Theory is not in doubt.

The time was right for a set of ideas that not only explained the Depression’s course of events, but also provided a prescription for remedies that would create better economic performance in the future. Keynes and The General Theory, at the time the events were unfolding, provided just such a package. When all is said and done, we can look back in hindsight and argue endlessly about what Keynes “really meant” or what the “true” contribution of Keynesianism has been to the world of economics. At the time the Depression happened, Keynes represented a new paradigm for young scholars to latch on to. The stage was set for the nurturing of macroeconomics for the remainder of the twentieth century.

This article is a modified version of the introduction to Randall Parker, editor, Reflections on the Great Depression, Edward Elgar Publishing, 2002.

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1 Bankers’ acceptances are explained at http://www.rich.frb.org/pubs/instruments/ch10.html.

2 Liquidity is the ease of converting an asset into money.

3 The monetary base is measured as the sum of currency in the hands of the public plus reserves in the banking system. It is also called high-powered money since the monetary base is the quantity that gets multiplied into greater amounts of money supply as banks make loans and people spend and thereby create new bank deposits.

4 The money multiplier equals [D/R*(1 + D/C)]/(D/R + D/C + D/E), where

D = deposits, R = reserves, C = currency and E = excess reserves in the

banking system.

5 The real interest rate adjusts the observed (nominal) interest rate for inflation or deflation. Ex post refers to the real interest rate after the actual change in prices has been observed; ex ante refers to the real interest rate that is expected at the time the lending occurs.

6 See note 3.

Citation: Parker, Randall. “An Overview of the Great Depression”. EH.Net Encyclopedia, edited by Robert Whaples. March 16, 2008. URL http://eh.net/encyclopedia/an-overview-of-the-great-depression/

The Freedmen’s Bureau

William Troost, University of British Columbia

The Bureau of Refugees, Freedmen, and Abandoned Lands, more commonly know as the Freedmen’s Bureau, was a federal agency established to help Southern blacks transition from their lives as slaves to free individuals. The challenges of this transformation were enormous as the Civil War devastated the region – leaving farmland dilapidated and massive amounts of capital destroyed. Additionally, the entire social order of the region was disturbed as slave owners and former slaves were forced to interact with one another in completely new ways. The Freedmen’s Bureau was an unprecedented foray by the federal government into the sphere of social welfare during a critical period of American history. This article briefly describes this unique agency, its colorful history, and many functions that the bureau performed during its brief existence.

The Beginning of the Bureau

In March 1863, the American Freedmen’s Inquiry Commission was set up to investigate “the measures which may best contribute to the protection and improvement of the recently emancipated freedmen of the United States, and to their self-defense and self-support.”1 The commission debated various methods and activities to alleviate the current condition of freedmen and aid their transition to free individuals. Basic aid activities to alleviate physical suffering and provide legal justice, education, and land redistribution were commonly mentioned in these meetings and hearings. This inquiry commission examined many issues and came up with some ideas that would eventually become the foundation for the eventual Freedmen’s Bureau Law. In 1864, the commission issued their final report which laid out the basic philosophy that would guide the actions of the Freedmen’s Bureau.

“The sum of our recommendations is this: Offer the freedmen temporary aid and counsel until they become a little accustomed to their new sphere of life; secure to them, by law, their just rights of person and property; relieve them, by a fair and equal administration of justice, from the depressing influence of disgraceful prejudice; above all, guard them against the virtual restoration of slavery in any form, and let them take care of themselves. If we do this, the future of the African race in this country will be conducive to its prosperity and associated with its well-being. There will be nothing connected with it to excite regret to inspire apprehension.”2

When the Congress finally got down to the business of writing a bill to aid the transition of the freedmen they tried to integrate many of the American Freedmen’s Inquiry Commission’s recommendations. Originally the agency set up to aid in this transition was to be named the Bureau of Emancipation. However, when the bill came up for a vote on March 1, 1864 the name was changed to the Bureau of Refugees, Freedmen, and Abandoned Lands. This change was due in large part to objections that the bill was exclusionary and aimed solely towards the aid of blacks. This name changed was aimed at enlarging support for the bill.

The House and the Senate argued about the powers and place that the bureau should reside within the government. Those in the House wanted the agency placed within the War Department, concluding that the power used to free the slaves would be best to aid them in their transition. Oppositely, in the Senate Charles Sumner’s Committee on Slavery and Freedom wanted the bureau placed within the Department of the Treasury – as it had the power to tax and had possession of confiscated lands. Sumner felt that they “should not be separated from their best source of livelihood.”3 After a year of debate, finally a compromise was agreed to that entrusted the Freedmen’s Bureau with the administration of confiscated lands while placing the bureau within the Department of War. Thus, On March 3, 1865, with the stroke of a pen, Abraham Lincoln signed into existence the Bureau of Refugees, Freedmen, and Abandoned Lands. Selected to head of the new bureau was General Otis Oliver Howard – commonly known as the Christian General. Howard had strong ties with the philanthropic community and forged strong ties with freedmen’s aid organizations.

The Freedmen’s Bureau was active in a variety of aid functions. Eric Foner writes it was “an experiment in social policy that did not belong to the America of its day”.4 The bureau did important work in many key areas and had many functions that even today are not considered the responsibility of the national government.

Relief Services

A key function of the bureau, especially in the beginning, was to provide temporary relief for the suffering of destitute freedmen. The bureau provided rations for those most in need due to the abandonment of plantations, poor crop yields, and unemployment. This aid was taken advantage of by a staggering number of both freedmen and refugees. A ration was defined as enough corn meal, flour, and sugar sufficient to feed a person for one week. In “the first 15 months following the war, the Bureau issued over 13 million rations, two thirds to blacks.”5 The size of this aid was staggering and while it was deemed a great necessity, it also fostered tremendous anxiety for both General Howard and the general population – mainly that it would cause idleness. Because of these worries, General Howard ordered that this form of relief be discontinued in the fall of 1866.

Health Care

In a similar vein the bureau also provided medical care to the recently freed slaves. The health situation of freedmen at the conclusion of the Civil War was atrocious. Frequent pandemics of cholera, poor sanitation, and outbreaks of smallpox killed scores of freedmen. Because the freed population lacked the financial assets to purchase private healthcare and were denied care in many other cases, the bureau played a valuable role.

“Since hospitals and doctors could not be relied on to provide adequate health care for freedmen, individual bureau agents on occasion responded innovatively to black distress. During epidemics, Pine Bluff and Little Rock agents relocated freedpersons to less contagion-ridden places. When blacks could not be moved, agents imposed quarantines to prevent the spread of disease. General Order Number 8…prohibited new residents from congregating in towns. The order also mandated weekly inspections of freedmen’s homes to check for filth and overcrowding.”6

In addition to preventing and containing outbreaks, the bureau also engaged more directly in health care. Being placed in the War Department, the bureau was also able to assume operations of hospitals established by the Army during the war. After the war it expanded the system to areas previously not under military control. Observing that freedmen were not receiving an adequate quality of health services, the bureau established dispensaries providing basic medical care and drugs free of charge, or at a nominal cost. The Bureau “managed in the early years of Reconstruction to treat an estimated half million suffering freedmen, as well as a smaller but significant number of whites.”7

Land Redistribution

Perhaps the most well-known function of the bureau was one that never came to fruition. During the course of the Civil War, the U.S. Army took control of a good deal of land that had been confiscated or abandoned by the Confederacy. From the time of emancipation there were rumors that confiscated lands would be provided to the recently freed slaves. This land would enable the blacks to be economically self-sufficient and provide protection from their former owners. In January 1865, General Sherman issued Special Field Orders, No. 15, which set aside the Sea Islands and lands from South Carolina to Florida for blacks to settle. According to his order, each family would receive forty acres of land and the loan of horses and mules from the Army. Similar to General Sherman’s order, the promise of land was incorporated into the bureau bill. Quickly the bureau helped blacks settle some of the abandoned lands and “by June 1865, roughly 10,000 families of freed people, with the assistance of the Freedmen’s Bureau, had taken up more than 400,000 acres.”8

While the promise of “forty acres and a mule” excited the freedmen, the widespread implementation of this policy was quickly thwarted. In the summer of 1865, President Andrew Johnson issued special pardons restoring the property of many Confederates – throwing into question the status of abandoned lands. In response, General Howard, the Commissioner of the Freedmen’s Bureau, issued Circular 13 which told agents to conserve forty-acre tracts of land for the freedmen – as he claimed presidential pardons conflicted with the laws establishing the bureau. However, Johnson quickly instructed Howard to rescind his circular and send out a new circular ordering the restoration to pardoned owners of all land except those tracts already sold. These actions by the President were devastating, as freedmen were evicted from lands that they had long occupied and improved. Johnson’s actions took away what many felt was the freedmen’s best chance at economic protection and self-sufficiency.

Judicial Functions

While the land distribution of the new agency was thwarted, the bureau was able to perform many duties. Bureau agents had judicial authority in the South attempting to secure equal justice from the state and local governments for both blacks and white Unionists. Local agents individually adjudicated a wide variety of disputes. In some circumstances the bureau established courts where freedmen could bring forth their complaints. After the local courts regained their jurisdiction, bureau agents kept an eye on local courts retaining the authority to overturn decisions that were discriminatory towards blacks. In May 1865, the Commissioner of the bureau issued a circular “authorizing assistant commissioners to exercise jurisdiction in cases where blacks were not allowed to testify.”9

In addition to these judicial functions, the bureau also helped provide legal services in the domestic sphere. Agents helped legitimize slave marriages and presided over freedmen marriage ceremonies in areas where black marriages were obstructed. Beginning in 1866, the bureau became responsible for filing the claims of black soldiers for back pay, pensions, and bounties. The claims division remained in operation until the end of the bureau’s existence. During a time when many of the states tried to strip rights away from blacks, the bureau was essential in providing freedmen redress and access to more equitable judicial decisions and services.

Labor Relations

Another important function of the bureau was to help draw up work contracts to help facilitate the hiring of freedmen. The abolition of slavery created economic confusion and stagnation as many planters had a difficult time finding labor to work their fields. Additionally, many blacks were anxious and unsure about working for former slave owners. “Into this chaos stepped the Freedmen’s Bureau as an intermediary.”10 The bureau helped planters and freedmen draft contracts on mutually agreeable terms – negotiating several hundred thousand contracts. Once agreed upon, the agency tried to make sure both planter and worker lived up to their part of the agreement. In essence, the bureau “would undertake the role of umpire.”11

Of the bureau’s many activities this was one of its most controversial. Both planters and freedmen complained about the insistence on labor contracts. Planters complained that labor contracts forbade the use of corporal punishment used in the past. They resented the limits on their activities and felt the restrictions of the contracts limited the productivity of their workers. On the other hand, freedmen complained that the contract structures were too restrictive and didn’t allow them to move freely. In essence, the bureau had an impossible task – trying to get the freedmen to return to work for former slave owners while preserving their rights and limiting abuse. The Freedmen’s Bureau’s judicial functions were of great help in enforcing these contracts in a fair manner making both parties live up to their end of the bargain. While historians have split over whether the bureau favored planters or the freedmen, Ralph Shlomowitz in his detailed analysis of bureau-assisted labor contracts found that contracts were determined by the free interplay of market forces.12 First, he finds contracts brokered by the bureau were extremely detailed to an extent that would not make sense in the absence of compliance. Second, contrary to popular belief he finds the share of crops received by labor was highly variable. In areas of higher quality land the share awarded to labor was less than in areas with lower land quality.

Educational Efforts

Prior to the Civil War it had been policy in the sixteen slave states to fine, whip, or imprison those who gave instruction to blacks or mulattos. In many states the punishments for teaching a person of color were quite severe. These laws severely restricted the educational opportunity of blacks – especially access to formal schooling. As a result, when given their freedom, many former slaves lacked the literacy skills necessary to protect themselves from discrimination and exploitation, and pursue many personal activities. This lack of literacy created great problems for blacks in a free labor system. Freedmen were repeatedly taken advantage of as they were often unable to read or draft contracts. Additionally, individuals lacked the ability to read newspapers and trade manuals, or worship by reading the Bible. Thus, when emancipated there was a great demand for freedmen schools.

General Howard quickly realized that education was perhaps the most important endeavor that the bureau could undertake. However, the financial resources and the few functions that the bureau was authorized to undertake limited the extent to which it was able to assist. Much of the early work in schooling was done by a number of benevolent and religious Northern societies. While initially the direct aid of the bureau was limited, it provided an essential role in organizing and coordinating these organizations in their efforts. The agency also allowed the use of many buildings in the Army’s possession and the bureau helped transport a trove of teachers from the North – commonly referred to as yankee school marms.

While the limits of the original Freedmen’s Bureau bill hamstrung the efforts of agents, subsequent bills changed the situation as the purse strings and functions of the bureau in the area of education were rapidly expanded. This shift in attention followed the lead of General Howard whose “stated goal was to close one after another of the original bureau divisions while the educational work was increased with all possible energy.”13 Among the provisions of the second bureau bill were: the appropriation of salaries for State Superintendents of Education, the repair and rental of school buildings, the ability to use military taxes to pay teachers’ salaries, and the establishment of the education division as a separate entity in the bureau.

These new resources were used to great success as enrollments at bureau-financed schools grew quickly, new schools were constructed in a variety of areas, and the quality and curriculum of the schools was significantly improved. The Freedmen’s Bureau was very successful in establishing a vast network of schools to help educate the freedmen. In retrospect this was a Herculean task for the federal government to accomplish. In a region where it was illegal to teach blacks how to read or write just a few years prior, the bureau was able to help establish nearly 1,600 day schools educating over 100,000 blacks at a time. The number of bureau-aided day and night schools in operation grew to a maximum of 1,737 in March 1870, employing 2,799 teachers, and instructing 103,396 pupils. In addition, 1,034 Sabbath schools were aided by the bureau that employed 4,988 teachers and instructed 85,557 pupils.

Matching the Integrated Public Use Sample of the 1870 Census and a constructed data set on bureau school location, one can examine the reach and prevalence of bureau-aided schools.14 Table 1 presents the summary statistics of various school concentration measures and educational outcomes for individual blacks 10-15 years old.

The variable “Freedmen’s Bureau School” equals one if there was at least one bureau-aided school in the individual’s county. The data reveals that 63.6 percent of blacks lived in counties with at least one bureau school. This shows the bureau was quite effective in reaching a large segment of the black population – as nearly two thirds of blacks living in the states of the ex-Confederacy had at least some minimal exposure to these schools. While the schools were widespread, it appears their concentration was somewhat low. For individuals living in a county with at least one bureau-aided school, the concentration of bureau-aided schools was 0.3165 per 30 square miles, or 0.4630 bureau aided-schools per 1,000 blacks.

Although the concentration of schools was somewhat low it appears they had a large impact on the educational outcomes of southern blacks. Ten to fifteen year olds living in a county with at least one bureau-aided school had literacy rates that were 6.1 percentage points higher. This appears to have been driven by the bureau increasing access to formal education for black children in these counties as school attendance rates were 7.5 percentage points higher than in counties without such schools.

Andrew Johnson and the Freedmen’s Bureau

Only eleven days after signing the bureau into existence, Abraham Lincoln was struck down by John Wilkes Booth. Taking his place in office was Andrew Johnson, a former Democratic Senator from Tennessee. Despite Johnson’s Southern roots, hopes were high that Congress and the new President could work closer together than the previous administration. President Lincoln and Congress had championed vastly different policies for Reconstruction. Lincoln preferred the term “Restoration” instead of “Reconstruction,” as he felt it was constitutionally impossible for a state to succeed.15 Lincoln championed the quick integration of the South into the Union and believed it could best be accomplished under the direction of the executive branch. Oppositely, Republicans in Congress led by Charles Sumner and Thaddeus Stevens felt the Confederate states had actually seceded and relinquished their constitutional rights. The Republicans in Congress advocated strict conditions for re-entry into the Union and programs aimed at reshaping society.

The ascension of Johnson to the presidency gave hope to Congress that they would have an ally in the White House in terms of Reconstruction philosophy. According to Howard Nash, the “Radicals were delighted….to have Vice President Andrew Johnson, who they had good reason to suppose was one of their number, elevated to the presidency.”16 In the months before and immediately after taking office, Johnson repeatedly talked about the need to punish rebels in the South. After Lincoln’s death Johnson became more impassioned in his speeches. In late April 1865 Johnson told an Indiana delegation “Treason must be made odious…traitors must be punished and impoverished…their social power must be destroyed.”17 If anything, many feared that Johnson may stray too far from the Presidential Reconstruction offered by Lincoln and be overly harsh in his treatment of the South.

Immediately after taking office Johnson honored Lincoln’s choice to head the bureau by appointing General Oliver Otis Howard as commissioner of the bureau. While this action raised hopes in Congress they would be able to work with the new administration, Johnson quickly switched course. After his selection of Howard, President Johnson and the “Radical” Republicans would scarcely agree on anything during the remainder of his term. On May 29, 1865, Johnson issued a proclamation that conferred amnesty, pardon, and the restoration of property rights for almost all Confederate soldiers who took an oath pledging loyalty to the Union. Johnson later came out in support of the black codes of the South, which tried to bring blacks back to a position of near slavery and argued that the Confederate states should be accepted back into the Union without the condition of ratifying and adopting the Fourteenth Amendment in their state constitutions.

The original bill signed by Lincoln established the bureau during and for a period of one year after the Civil War. The language of the bill was somewhat ambiguous, and with the surrender of Confederate forces military conflict had ceased. This led people to debate when the bureau would be discontinued. Consensus seemed to imply that if another bill wasn’t brought forth that the bureau would be discontinued in early 1866. In response Congress quickly got to work on a new Freedmen’s Bureau bill.

While Congress started work on a new bill, President Johnson tried to gain support for the view that the need for the bureau had come to an end. Ulysses S. Grant was called upon by the President to make a whirlwind tour of the South, and report on the present situation. The route set up was exceptionally brief and skewed to those areas best under control. Accordingly, his report said that the Freedmen’s Bureau had done good work and it appeared as though the freedmen were now able to fend for themselves without the help of the federal government.

In contrast, Carl Schurz made a long tour of the South only a few months after Grant and found the freedmen in a much different situation. In many areas the bureau was viewed as the only restraint to the most insidious of treatment of blacks. As Q.A. Gilmore stated in the report,

“For reasons already suggested I believe that the restoration of civil power that would take the control of this question out of the hands of the United States authorities (whether exercised through the military authorities or through the Freedmen’s Bureau) would, instead of removing existing evils, be almost certain to augment them.”18

While the first bill was adequate in many ways, it was rather weak in a few areas. In particular, the bill didn’t have any appropriations for officers of the bureau or direct funds earmarked for the establishment of schools. General Howard and many of his officers reported on the great need for the bureau and pushed for its existence indefinitely or at least until the freedmen were in a less vulnerable position. After listening to the reports and the recommendations of General Howard, a new bill was crafted by Senator Lyman Trumbull, a moderate Republican. The new bill proposed the bureau should remain in existence until abolished by law, provide more explicit aid to education and land to the freedmen, and protect the civil rights of blacks. The bill passed in both the Senate and House and was sent to Andrew Johnson, who promptly vetoed the measure. In his response to the Senate, Johnson wrote “there can be no necessity for the enlargement of the powers of the bureau for which provision is made in the bill.”19

While the President’s message was definitive, the veto came as a shock to many in Congress. President Johnson had been consulted prior to its passage and assured General Howard and Senator Trumbull that he would support the bill. In response to the President’s opposition, the Senate and House passed a bill that addressed some of the complaints that Johnson had with the bill, including limiting the length of the bill to two more years. Even after this watering down of the bill, it was once again vetoed. However, the new bill garnered enough support to override President Johnson’s veto. The veto of the bill and the subsequent override officially established a policy of open hostility between the legislative and executive branch. Prior to the Johnson administration, overriding a veto was extremely rare – as it had only occurred six times up until this time.20 However, after the passage of this bill it became mere commonplace for the remainder of Johnson’s term, as Congress would overturn fifteen vetoes during the less than four years Johnson was in office.

End of the Bureau

While work in the educational division picked up after the passage of the second bill, many of the other activities of the bureau were winding down. On July 25, 1868 a bill was signed into law requiring the withdrawal of most bureau officers from the states, and to stop the functions of the bureau except those that were related to education and claims. Although the educational activities of the bureau were to continue for an indefinite period of time, most state superintendent of education offices had closed by the middle of 1870. On November 30, 1870 Rev. Alvord resigned his post as General Superintendent of Education.21 While some small activities of the bureau continued after his resignation, these activities were scaled back greatly and largely consisted of correspondence. Finally due to lack of appropriations the activities of the bureau ceased in March 1871.

The expiration of the bureau was somewhat anti-climatic. A number of representatives wanted to establish a permanent bureau or organization for blacks, so that they could regulate their relations with the national and state governments.22 However, this concept was too radical to get passed by enough of a margin to override a veto. There was also talk of moving many of its functions into other parts of the government. However, over time the appropriations began to dwindle and the urgency to work out a proposal for transfer withered away in a manner similar to the bureau.

References

Alston, Lee J. and Joseph P. Ferrie. “Paternalism in Agricultural Labor Contracts in the U.S. South: Implications for the Growth of the Welfare State.” American Economic Review 83, no. 4 (1993): 852-76.

American Freedmen’s Inquiry Commission. Records of the American Freedmen’s Inquiry Commission, Final Report, Senate Executive Document 53, 38th Congress, 1st Session, Serial 1176, 1864.

Cimbala, Paul and Randall Miller. The Freedmen’s Bureau and Reconstruction: Reconsiderations. New York: Fordham University Press, 1999.

Congressional Research Service, http://clerk.house.gov/art_history/house_history/vetoes.html

Finley, Randy. From Slavery to Uncertain Freedom: The Freedmen’s Bureau in Arkansas, 1865-1869. Fayetteville: University of Arkansas Press, 1996.

Johnson, Andrew. “Message of the President: Returning Bill (S.60),” Pg. 3, 39th Congress, 1st Session, Executive Document No. 25, February 19, 1866.

McFeely, William S. Yankee Stepfather: General O.O. Howard and the Freedmen. New York: W.W. Norton, 1994.

Milton, George Fort. The Age of Hate: Andrew Johnson and the Radicals. New York: Coward-McCann, 1930.

Nash, Howard P. Andrew Johnson: Congress and Reconstruction. Rutherford, NJ: Fairleigh Dickinson University Press, 1972.

Parker, Marjorie H. “Some Educational Activities of the Freedmen’s Bureau.” Journal of Negro Education 23, no. 1 (1954): 9-21.

Q.A. Gillmore to Carl Schurz, July 27, 1865, Documents Accompanying the Report of Major General Carl Schurz, Hilton Head, SC.

Ruggles, Steven, Matthew Sobek, Trent Alexander, Catherine A. Fitch, Ronald Goeken, Patricia Kelly Hall, Miriam King, and Chad Ronnander. Integrated Public Use Microdata Series: Version 3.0 [Machine-readable database]. Minneapolis, MN: Minnesota Population Center [producer and distributor], 2004.

Shlomowitz, Ralph. “The Transition from Slave to Freedman Labor Arrangements in Southern Agriculture, 1865-1870.” Journal of Economic History 39, no. 1 (1979): 333-36.

Shlomowitz, Ralph, “The Origins of Southern Sharecropping,” Agricultural History 53, no. 3 (1979): 557-75.

Simpson, Brooks D. “Ulysses S. Grant and the Freedmen’s Bureau.” In The Freedmen’s Bureau and Reconstruction: Reconsiderations, edited by Paul A. Cimbala and Randall M. Miller. New York: Fordham University Press, 1999.

Citation: Troost, William. “Freedmen’s Bureau”. EH.Net Encyclopedia, edited by Robert Whaples. June 5, 2008. URL http://eh.net/encyclopedia/the-freedmens-bureau/

Fraternal Sickness Insurance

Herb Emery, University of Calgary

Introduction

During the nineteenth and early-twentieth century, lost income due to illness was one of the greatest risks to a wage earner’s household’s standard of living (Horrell and Oxley 2000, Hoffman 2001). Prior to the introduction of state health insurance in England in 1911, similar “patchworks of protection” — that included fraternal organizations, trade unions and workplace-based mutual benefit associations, commercial insurance contracts and discretionary charity — were available to workers in England and North America. Within the patchwork the largest source of illness-related income protection was through Friendly Societies; voluntary organizations such as fraternal orders and trade unions that provided stipulated amounts of “relief” for members who were sick and unable to work. Conditions have changed since the 1920s. Health care for family members, not loss of the family head’s income, has become the chief cost of sickness. Government social programs and commercial group plans have become the principal sources of disability insurance and health insurance. Friendly societies have largely discontinued their sick benefits. Most of them, moreover, have had declining memberships in growing populations.

Overview

This article

  • Explains the types of fraternal orders that existed in the late nineteenth and early twentieth centuries and the types of insurance they offered.
  • Provides estimates of the share of the adult male population that participated in fraternal self-help organizations – over 40 percent in the UK and almost as high in the US – and describes the characteristics of these society’s members.
  • Explains how friendly societies worked to provide sickness insurance as a reasonable price by overcoming the adverse selection and moral hazard problems, while facing problems of risk diversification.
  • Discusses the decline of fraternal sickness insurance after the turn of the twentieth century.
    • Concludes that fraternal lodges were financially sound despite claims that they were weakened by unsoundly pricing sickness insurance.
    • Examines the impact of competition from other insurers – including group insurance, government programs, labor unions, and company-sponsored sick-benefits societies.
    • Examines the impact of broader social and economic changes.
    • Concludes that fraternal sickness insurance was in greatest demand among young men and that its decline is tied mainly to the ageing of fraternal membership.
  • Closes by examining historians’ assessments of the importance and adequacy of fraternal sickness insurance.
  • Includes a lengthy bibliography of sources on fraternal sickness insurance.

Some Details and Definitions Pertaining to Fraternal Sickness Insurance

Fraternal orders were affiliated societies, or societies with branches. The branches were known by various names such as lodges, courts, tents, and hives. Fraternal orders emphasized benefits to their members rather than service to the community. They used secret passwords, rituals, and benefits to attract, bond, and hold members and distinguish themselves from members of rival orders.

Fraternal orders fell into three groups from an insurance perspective. The Masonic order and the Elks comprised the no-benefit group. Lodges in these orders often aided their members on a discretionary basis; that is where members were determined to be in “need” of assistance. They did not provide stipulated stated) insurance benefits (or relief).

econd group, the friendly societies, provided stipulated sick and funeral benefits to their members. The Independent Order of Odd Fellows, the Knights of Pythias, the Improved Order of Red Men, the Loyal Order of Moose, the Fraternal Order of Eagles, the Ancient Order of Foresters and the Foresters of America were the largest orders in this group.

A third group, the life-insurance orders, provided stipulated life-insurance, endowment, and annuity benefits to their members. The Maccabees, the Royal Arcanum, the Independent Order of Foresters, the Woodmen of the World, the Modern Woodmen of America, the Ancient Order of United Workmen, and the Catholic Order of Foresters were major orders in this group. In historical usage, the term “fraternal insurance” meant life insurance, but not sickness and funeral (burial) insurance.

The boundaries between the categories blur on close examination. Certain friendly societies, such as the Knights of Pythias and the Improved Order of Red Men, offered optional life-insurance at extra cost through their centrally-administered endowment branches. Certain insurance orders, such as the Independent Order of Foresters, offered optional sick and funeral benefits at extra cost through centrally-administered separate sickness and funeral funds. In other cases, the members of a society had privileged access to third-party insurance. The Canadian Odd Fellows Relief Association, for example, was entirely separate from the IOOF, but sold life policies exclusively to Odd Fellows.

Friendly Societies and Sickness Insurance

From the late eighteenth and early nineteenth centuries, friendly societies were often local lodges with no affiliations to other lodges. Over time, larger national and sometimes international orders that consisted of local lodges affiliated under jurisdictional grand lodges and national or international supreme bodies displaced the purely local lodge.1 The Ancient Order of Foresters was one of England’s larger affiliated Orders and it had subordinate Courts and jurisdictions in North America. The first Independent Order of Odd Fellows (IOOF) subordinate lodge in North America opened in Baltimore in 1819 under the jurisdiction of the British IOOF Manchester Unity. In the 1840s, the North American Odd Fellows seceded from the IOOFMU and founded the IOOF Sovereign Grand Lodge (SGL) that had jurisdiction over state and province level Grand Lodge jurisdictions in North America.

Membership Estimates

For the United Kingdom near the peak of the self-help movement in the 1890s, estimates of participation in friendly societies and trade unions for insurance against the costs of sickness and/or burial range from as many as 20 percent of the population (Horrell and Oxley 2000), to 41.2 percent of adult males (Johnson 1985) to one-half or more of adult males and as many as two-thirds of workingmen (Riley 1997). Estimates for participation in self-help organizations in North America are somewhat lower but they suggest a similar importance of friendly societies for insuring households against the costs of sickness and burial. Beito (1999) argues that a conservative estimate of participation in fraternal self-help organizations in the United States would have one of three adult males as a member in 1920, “including a large segment of the working class.” Millis (1937) reports that 30 per cent of Illinois wage-earners had market insurance for the disability risk in 1919 where fraternal organizations were the principal source of market insurance.

Characteristics of Friendly Society Members

Studies of British friendly societies suggest that friendly society membership was the “badge of the skilled worker” and made no appeal whatever to the “grey, faceless, lower third” of the working class (Johnson 1985, Hopkins 1995, Riley 1997). The major friendly societies in North America found their market for insurance among white, protestant males who came from upper-working-class and lower-middle-class backgrounds. Not surprisingly, the composition of local lodge memberships bore a resemblance to that of the local working population. Most Odd Fellows in Canada and the United States, however, were higher-paid workers, shop keepers, clerks, and farmers (Emery and Emery 1999). As Theodore Ross, the SGL’s grand secretary, noted in 1890, American Odd Fellows came from “the great middle, industrial classes almost exclusively.” Similarly, studies for Lynn, Massachusetts and Missouri found a heavy working-class representation among IOOF lodge memberships (Cumbler, 1979, p.46; Thelen, 1986, p. 165). In Missouri the social-class composition of Odd Fellows was similar to those for the Knights of Pythias and three life-insurance orders (the Ancient Order of United Workmen, the Maccabees, and the Modern Woodmen of the World). Beito’s (2000) work suggests that while the poor, non-whites and immigrants were not usually members of the larger fraternal orders’ memberships, they had their own mutual aid organizations.

Friendly Insurance: Modest Benefits at Low Cost

Friendly society sick benefits exemplified classic features of working-class insurance: a low cost and a small, fixed benefit amount equal to part of the wages of a worker with average wages. By contrast, commercial policies for middle-class clients offered insurance in variable amounts up to full-income replacement, at a cost beyond the reach of most workers. The affiliated orders established Constitutions which standardized rules and arrangements for sick benefit provision. For most of the friendly societies, local lodges or courts paid the sick claims of its members. Subject to requirements of higher bodies, the local lodge set the amounts of its weekly benefit, joining fees, and membership dues. The affiliation of lodges across locations also resulted in members having portable sickness insurance. If a member moved from one location to another, he could transfer his membership from one lodge to another within the organization.

Claiming Benefits

To claim benefits in the IOOF, a member had to provide his lodge with notice of sickness or disability within a week of its commencement. On receiving notice of a brother’s illness, the member of the visiting committee was to visit the brother within twenty-four hours to render him aid and confirm his sickness. Subsequently, the lodge visitors reported weekly on the brother’s condition until he recovered.

Strengths of Friendly Society’s Insurance: Low Overhead, Effective Monitoring

The local lodge or court system of the affiliated friendly societies like the IOOF and the Ancient Order of Foresters had important strengths for the sickness-insurance market. First, it had low overhead costs. Lodge members, not paid agents, recruited clients. Nominally-paid or unpaid lodge officers did the administrative work. Second, the intrusive methods of monitoring within the lodge system helped friendly societies to respond effectively to two classic problems in sickness insurance: adverse selection and moral hazard.

Overcoming the Adverse Selection Problem

An adverse selection of customers for sickness insurers refers to the fact that when the insurance is priced to reflect the average risk of a specified population, unhealthy persons (above average risk of sickness) have more incentive than healthy persons to purchase sickness insurance. Adverse selection in fraternal memberships was potentially a large problem as many orders had membership dues that were not scaled according to age despite the reality that the risk of sickness increased with age. To keep claims and costs manageable, an insurer needs ways to screen out poor risks. To this end, many organizations scaled initiation fees by the age of an initiate to discourage applications from older males, who had above-average sickness risk. In other cases, fraternal lodges or courts scaled the membership dues by the age at which the member was initiated. In addition, lodge-approved physicians often examined the physical conditions and health histories of applicants for membership. Lodge committees investigated the “moral character” of applicants.

Overcoming the Moral Hazard Problem

Sickness insurers also faced the problem of moral hazard (malingering) — an insured person has an incentive to claim to be disabled when he is not and an incentive to not take due care in avoiding injury or illness. The moral hazard problem was small for accident insurance as disability from accident is definite as to time and cause, and external symptoms are usually self-evident (Osborn, 1958). Disability from sickness, by contrast, is subjective and variable in definition. Friendly societies defined sickness, or disability, as the inability to work at one’s usual occupation. Relatively minor complaints disabled some individuals, while serious complaints failed to incapacitate others. The very possession of sickness insurance may have increased a worker’s willingness to consider himself disabled. The friendly society benefit contract dealt with this problem in several ways. First, by having one to two week waiting periods, and much less than full earnings replacement, self-help benefits required the disabled member to co-insure the loss which reduces the incentive to make a claim. In many fraternal orders, members receiving benefits could not drink or gamble and in some cases were not allowed to be away from their residence after dark. The activities of the lodge visiting committee helped to ward off false claims. In addition, fraternal ideology emphasized a member’s moral responsibility for not making a false claim and for reporting on brothers who were falsely claiming benefits.

Problem with Lack of Risk Diversification

On the negative side, the fraternal-lodge system made little provision for risk diversification. In the IOOF, the Knights of Pythias and the Ancient Order of Foresters, each subordinate lodge (or Court) was responsible for the sick claims of its members. Thus in principle, a high local rate of sick claims in a given year could shock a lodge’s financial condition. Certain commercial practices might have reduced the problem. For example, a grand lodge could have pooled the risks from all lodges in a central fund. Alternatively, it could have initiated a scheme of reinsurance, whereby each lodge assumed a portion of the claims in other lodges. Yet any centralization stood to weaken a friendly society’s management of adverse selection and the moral hazard. The behaviour of lodge members was observed to be a function of the structure of the benefit system. In 1908, for example, when the IOOF, Manchester Unity, in New South Wales, Australia established central funds for sick and funeral benefits, the effect was to turn the lodges into “mere collection agencies.” Participation in lodge affairs fell off, and members developed a more selfish attitude to claims. “When the lodges administered sick pay,” Green and Cromwell observed, “the members knew who was paying — it was the members themselves. But once ‘head office’ took over, the illusion that someone else was paying made its entry” (Green and Cromwell, 1984, pp. 59-60).

Commercial Insurers Couldn’t Match Friendly Societies in the Working-Class Sickness Insurance Market

On balance friendly societies provided an efficient delivery of working-class sickness insurance that commercial insurers could not match. Without the intrusive screening methods and low overhead of the decentralized lodge system, commercial insurers could not as easily solve the problems of moral hazard and adverse selection. “The assurance of a stipulated sum during sickness,” the president of the Prudential Insurance Company conceded in 1909, “can only safely be transacted ? by fraternal organizations having a perfect knowledge of and complete supervision over the individual members.”2

The Decline of Fraternal Sickness Insurance

By the 1890s, friendly societies in North America were withdrawing from the sickness insurance field. The IOOF imposed limits on the length of time that full sick benefits had to be paid, and one or two week waiting periods before the payment of claims began. In 1894, the Knights of Pythias eliminated their constitutional requirement that all subordinate lodges be required to pay stated sick benefits. By the 1920s, the IOOF followed the Knights of Pythias and eliminated its compulsory requirement for the payment of stipulated sick benefits. In England, where friendly societies opposed government pension and insurance schemes in the 1890s, they did not stand in the way of the introduction of Old Age Pensions in 1908 and compulsory state health insurance in 1911. Thus, the decline of fraternal sickness insurance pre-dates the Depression of the 1930s and for many organizations dates from at least the 1890s.

Unsound Pricing Practices?

Why did sickness insurance provided by friendly societies decline? Perhaps friendly society sickness insurance was a casualty of unsound pricing practices in the presence of ageing memberships. To illustrate this argument, consider the IOOF benefit contract. On the one hand, the incidence and duration of sickness claims increased with a member’s age. On the other hand, most IOOF lodges set quarterly dues at a flat rate, rather than by the member’s age, or the member’s age at joining. As the IOOF lodge benefit arrangement was essentially insurance benefits provided on a pay-as-you-go basis (current revenues are used to meet current expenditures), this posed little problem during a lodge’s early years when its members were young and had low sick-claim rates. Over time, however, the members aged and their claim rates showed a rising trend. When revenues from level dues became insufficient to cover claims, the argument goes, the lodge’s insurance provision collapsed. Thus fraternal-insurance provision was essentially a failed, experimental phase in the development of sickness and health insurance.

Lodges Were Financially Sound Despite Non-Actuarial Pricing

By contrast with the above scenario, evidence for British Columbia showed that the IOOF lodges were financially sound, despite their non-actuarial pricing practices (Emery 1996). Typically a lodge accumulated assets during its first years of operation, when its members were young and had below-average sickness risk. In later years, as its membership aged and the cost of claims exceeded income from members’ dues and fees, income from investments made up the difference. Consequently none of British Columbia’s twenty lodge closures before 1929 resulted from the bankruptcy of lodge assets. Similarly none of the British Columbia lodges had a significant probability of ruin from high claims in a particular year.

Non-payment of dues also helped lodge finances. A member became ineligible for benefits if he fell behind in his dues. If he fell far enough behind on his dues, his lodge could suspend him from membership or declare him “ceased” (dropped from membership). A member’s unpaid dues continued to accumulate after suspension. Thus a suspended member had to pay the full, accumulated amount (or a maximum sum, if his grand lodge set one), to get reinstated. Lodges did not pay sick claims to members who were in arrears.

Turnover of Membership Explains How They Remained Financially Sound

When members did not pay their dues owing to be reinstated, their exit from membership relieved lodge financial pressures. Most men joined fraternal lodges when they were under age 35 and for the members who quit, they typically did so before age 40.3 Thus, a substantial proportion of initiates into fraternal memberships did not remain in the membership long enough for their rising risk of illness after age 40 to pose a problem for lodge finances. On average, they belonged when they were most likely net payers and quit before they were net recipients. These features of the substantial turnover in fraternal memberships helps to explain how fraternal lodges were actually going concerns when official actuarial valuations of lodge finances and reserves inevitably showed that the lodges had actuarial deficits at the prevailing levels of dues. These valuations assessed the adequacy of accumulated reserves and dues revenues expected over the remaining lifetimes of the membership at the time of the valuation for meeting the expected benefits of the membership over the remainder of the members’ lifetimes. The assumption that all current members would remain in the membership until death always resulted in valuations that showed the sick benefits were inadequately, if not hazardously, priced. The fact that many members were not lifetime members meant that the pricing was not so hazardous.

Competition from Other Insurers

If poor finances cannot explain the decline of friendly society sickness benefits, then perhaps increasing competition from government and commercial insurance arrangements can explain the decline. Trends for competition do not provide strong support for this explanation for the decline of friendly society sickness-insurance. Competition for friendly societies came from commercial-group plans, government workmen’s compensation programs, trade unions and industrial unions, company-sponsored mutual benefit societies, and other fraternal orders that provided life insurance, or non-stipulated (discretionary) relief.

Group Insurance

Group insurance used the employer’s mass-purchasing power to provide low-cost insurance without a medical examination (Ilse, 1953, chapter 1). Often the employer paid the premium. Otherwise employees paid part of the cost through payroll deductions, a practice that kept the insurer’s overhead costs low. The insurance company made the group-plan contract with the employer, who then issued certificates to individuals in the plan. Group plans compared favourably with IOOF benefits in terms of cost and the amount of the benefit. They also gave a viable commercial solution to the problems of adverse selection and moral hazard.

During the 1920s, however, group plans were available to few workers. In the United States, they missed men who were self-employed or employed in firms with less than fifty workers. The employee’s coverage ceased if he left the company. It also stopped if either the insurer or the employer did not renew the contract at the end of its standard one-year term. When coverage ceased, the employee might find himself too old or unhealthy to obtain insurance elsewhere. More importantly, the challenge of commercial-group insurance was just beginning during the 1920s. By 1929 Americans and Canadians in group plans were less numerous than the number of Odd Fellows alone.

Government Programs

Government programs such as compulsory sickness insurance dated from 1883 in Germany and 1911 in Britain. Between 1914 and 1920, eight state commissions, two national conferences, and several state legislatures attended to the issue in the United States (see Armstrong, 1932, Beito 2000, Hoffman 2001). Despite these initiatives, no American or Canadian government — national, state, or provincial — adopted compulsory sickness insurance until the 1940s (Osborn, 1958, chapter 4; Ilse, 1953, chapter 8).

Workmen’s compensation was another matter. During the years 1911-25, forty-two of the forty-eight American states and six of Canada’s nine provinces passed workmen’s compensation laws (Weis, 1935; Leacy, 1983). Nevertheless, half of all state laws in 1917, and a fifth of them in 1932, applied only to persons in hazardous occupations. None of the various state laws covered employees of interstate railways. In twenty-four states, the law exempted small businesses; in five it exempted public employees. In some states the law was so hedged with restrictions that the scale of benefits was uncertain. Although comprehensive by American standards, Ontario’s law omitted persons in farming, wholesale and retail establishments, and domestic service (Guest, 1980).

Overall, government programs provided negligible competition for friendly society sick benefits during the 1920s. No state or province provided for compulsory sickness insurance. Workmen’s compensation laws were commonplace, but missed important parts of the workforce. More importantly, industrial accidents accounted for just ten percent of all disability (Armstrong, 1932, pp. 284ff; Osborn, 1958, chapter 1).

Labor Unions

Labor unions traditionally used benefits to attract members and hold the loyalty of existing members. During the 1890s miners’ unions in the American west and British Columbia reportedly devoted more time to mutual aid than to collective bargaining (Derickson, 1988, chapter 3). By 1907 nineteen unions, accounting for 25 per cent of organized labor in the United States, offered sick benefits (Rubinow, 1913, chapter 18). During the 1920s, however, the friendly society competition from unions followed a declining trend. After years of steady growth, for example, the membership of American trade unions dropped by 32 per cent between 1920 and 1929.4 Similarly, the membership of Canadian trade unions fell by 23 per cent between 1919 and 1926. In an unprecedented development in 1926, the street railway workers’ union in Newburgh, New York, obtained commercial group-sickness coverage through a collective bargaining agreement with the employer (Ilse, 1953, ch. 13). Although rare during the 1920s, this marked the start of collective bargaining for sick benefits rather than direct union provision.

Company-sponsored Sick-Benefit Societies

Company-sponsored sick-benefit societies, often known as Mutual Benefit Associations, originated in a tradition of corporate paternalism during the 1870s (Brandes, 1976; Brody, 1980; Zahavi, 1988; McCallum, 1990). The United States had more than 500 such societies by 1908. Typically these societies obtained most or all of their funds from employee dues, not company funds, ostensibly to encourage the workers to be self-reliant.

Participation was voluntary in 85 per cent of 461 American societies surveyed on the eve of the First World War. Eligibility for membership commonly required a waiting period (a minimum period of permanent employment). A major disadvantage, compared to fraternal order sickness benefits, was that coverage ceased when the employee left the firm. In the amount and cost of the benefit (benefits of $5 to 6 per week for up to thirteen weeks for annual dues of $2.50 to $6 per year) the societies were similar to fraternal lodges.

The institutions were part of a larger program of corporate welfarism that had developed during the First World War in conditions of labor scarcity, labor unrest, rising union membership, and government management of capital-labor relations. At the war’s end, however, the economy slumped, the supply of labor became abundant, unions became cooperative and were losing members, and wartime government-economic management ended. In the new circumstances, the pressure on businessmen to promote welfare programs abated, and the membership of company-sponsored sick-benefit societies entered a flat trend.5 By 1929 the societies were still a minority phenomenon. They existed in 30 percent of large firms (250 or more employees), but in just 4.5 percent of small firms, which accounted for half the industrial work force (Jacoby, 1985, ch.6).

Competition from Insurance Orders

Friendly societies (orders with sick and funeral benefits) also competed with the insurance orders (orders with life and/or annuity benefits in small amounts) that offered an optional sick benefit. The Maccabees, Woodmen of the World, Independent Order of Foresters, and the Royal Arcanum were some main rivals in the insurance-order group for the friendly societies.

The insurance-order sick benefit had several features of commercial insurance and compared poorly with the friendly-society benefit. In many cases, these orders paid sick claims from a centrally-administered “sick and funeral fund,” not local lodge funds. They financed sick claims by requiring monthly premiums, paid in advance, not quarterly dues. Their central authority could cancel the member’s sickness insurance by giving him notice; in the IOOF, by contrast, the member retained his coverage as long as his dues were paid up. A member could draw benefits for a maximum of twenty-six weeks in the Maccabees and a maximum of twelve weeks in the IOF. During the 1920s, competition from fraternal life insurance orders showed a flat or declining trend. In terms of membership size, the largest friendly society, the IOOF, gained ground on all competitors in the insurance-order group.

Broader Economic and Social Trends in the 1920s

Another popular explanation for the decline of friendly society sick benefits is one of “changing times” where friendly societies provided an outdated social arrangement. Here fraternal orders were multiple-function organizations that offered their members a variety of social and indirect economic benefits, as well as insurance. Thus in principle, the declining trend for IOOF sickness insurance could have been a by-product of social changes during the 1920s that were undermining the popularity of fraternal lodges (Dumenil, 1984; Brody, 1980; Carnes, 1989; Charles, 1993; Clawson, 1989; Rotundo, 1989; Burley, 1994; Tucker, 1990). For example, the fraternal-lodge meeting faced competition from new forms of entertainment (radio, cinema, automobile travel). The development of installment buying and consumerism undermined fraternal culture and working-class institutional life. Trends in sex relations sapped the appeal of all-male social activities and fraternal ritual of lodge meetings. The rising popularity of luncheon-club organizations (Kiwanis, Lions, Kinsmen) expressed a popular shift to a community-service orientation, as opposed to the fraternal tradition of services to members. The luncheon clubs also exemplified a popular shift to class-specific organizations, at the expense of fraternal orders, which had a cross-class appeal. Finally, with the waning popularity of lodge meetings, lodge nights became less useful occasions for making business contacts.

Rising Health-Care Costs

The decade also gave rise to two important insurance-related developments. The one, described above, was the diffusion of commercial-group plans for income-replacement insurance. The other was the emergence of health-care services as the principal cost of sickness (Starr, 1982). In 1914 lost wages had been between two and four times the medical costs of a worker’s sickness, or about equal if one included the worker’s family. During the 1920’s, however, the medical costs soared, by 20 per cent for families with less than $1,200 income and 85 per cent for families with incomes between $1,200 and $2,500. The medical costs were highly variable as well as rising. Effectively, a serious hospitalized illness could consume a third to a half of a family’s annual income.

External Changes and Competition Don’t Explain the Decline of Fraternal Sickness Insurance Well

Changes during the 1920s, however, provide a poor explanation for the declining trend for the friendly-society sick benefit in North America. First, the timing was wrong. On the one hand, the declining trend dated from the 1890s, not the 1920s. On the other hand, key developments during the decade were at an early stage. By 1929 commercial-group insurance was established, but not widespread. Similarly, health insurance scarcely existed, despite the rising trend for the health-care costs. As Starr explains, health insurance presented an extreme problem of moral hazard that insurers did not solve until the 1930s.6 Second, we lack a theory to explain why the waning of interest in lodge meetings would have caused a declining trend for the sick benefit. Finally, the “changing times” explanation, on its own, incorrectly portrays the sick benefit as a static product that became less relevant in an exogenously changing society and economy.

Young Men Value Sickness Insurance

If external pressure did not cause the decline of the friendly society sick benefits, then why did friendly society sickness insurance decline? Emery and Emery (1999) argue that the sick benefit was primarily in demand amongst men who lacked alternatives to market insurance. For example, at the start of their working lives, male breadwinners had no older children to earn secondary incomes (family insurance). They also lacked savings to cover the disability risk (self-insurance). Thus men joined the Odd Fellows when they were “young”. They then quit after a few years as family and self-insurance alternatives to market insurance opened up to them. Further, as the friendly society sick benefit was a form of precautionary saving, demand for it would have declined as a household accumulated wealth.

Aging Membership and the Declining Demand for Sickness Insurance

Over time, fraternal memberships were ageing as rates of initiation slowed and suspensions from membership continued on at steady rates. Initiates and suspended members were disproportionately from the lower age groups in the memberships thus slower membership growth in the friendly societies represented ageing memberships. In this context of the demand for the sick benefit over the life-cycle, ageing fraternal memberships became less attached to the sick benefit. Thus, as the memberships aged, their collective preferences changed. Older members had priorities and objectives other than sickness insurance.

Friendly Societies and Compulsory State Insurance

Despite the similarity of organizations and the high rates of participation in them in the late nineteenth and early twentieth centuries, the role of voluntary self-help organizations like the friendly societies, diverged on either side of the Atlantic. In England, the “administrative machinery” of friendly societies was the vehicle for introducing and delivering compulsory government sickness/health insurance under the Approved Societies system that prevailed from 1911 to 1944 at which time the government centralized the provision of health insurance (Gosden 1973). In North America the friendly society sickness insurance arrangement declined from at least the 1890s despite growing memberships in the organizations up to the 1920s. While the friendly society sickness insurance declined, government showed little activity in the health/sickness insurance field. Only through the 1930s did commercial and non-profit group health and hospital insurance plans and government social programs rise to primacy in the sickness and health insurance field.7

Critics of Friendly Societies’ Voluntary Self-Help

Critics of voluntary self-help arrangements for insuring the costs of sickness argue that voluntary self-help was a failed system and its obvious short-comings and financial difficulties were the impetus for government involvement in social insurance arrangements. (Smiles 1876, Moffrey 1910, Peebles 1936, Gosden 1961, Gilbert 1965, Hopkins 1995, Horrell and Oxley 2000, Hoffman 2001). Horrell and Oxley (2000) argue that friendly society benefits were too paltry to offer true relief. Hopkins (1995) argues that for those workers who could afford it, self-help through friendly society membership worked well but too much of the working population remained outside the safety net due to low incomes. At best, the critics applaud the intent of individuals taking the initiative to protect themselves and for friendly societies in pioneering the preparation of actuarial data on morbidity and sickness duration that aided commercial insurers in insuring the sickness risk in a financially sound way.

Positive Assessments of Friendly Societies’ Roles

In contrast, Beito (2000) presents a positive assessment of fraternal mutual aid in the United States, and hence working-class self-help, for dealing with the economic consequences of poor health. Beito argues that fraternal societies in America extended social welfare service, such as insurance, to the poor (notably immigrants and blacks) and working class Americans who otherwise would not have had access to such coverage. Far from being an inadequate form of safety net, fraternal mutual aid sustained needy Americans from cradle to grave and over time, extended the range of benefits provided to include hospitals and homes for the aged as the needs in society arose. Beito suggests that changing cultural attitudes and the expanding scale and scope of a paternalistic welfare state undermined an efficient and viable fraternal social insurance arrangement.

Government’s Role in “Crowding Out” Self-Help

Similarly, Green and Cromwell (1984) argue that state paternalism crowded out efficient fraternal methods of social insurance in Australia. Hopkins (1995) suggests that while friendly societies were effective for aiding a sizable portion of the working class, working class self-help “had been weighed in the balance and found wanting” since it failed to provide income protection for the working classes as a whole. Hopkins concludes that compulsory state aid inevitably had to replace voluntary self-help to “spread the net over the abyss” to protect the poorest of the working class. Similar to Beito’s view, Hopkins suggests that equity considerations were the reason for undermining otherwise efficient voluntary self-help arrangements. Beveridge (1948) expresses dismay over the crowding out of friendly societies as social insurers in England following the centralization of compulsory government health insurance arrangements in 1944.

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Van der Linden, Marcel. “Introduction.” In Social Security Mutualism: The Comparative History of Mutual Benefit Societies, edited by Marcel Van der Linden, 11-38. Bern: Peter Lang, 1996.

Vondracek, Felix John. “The Rise of Fraternal Organizations in the United States, 1868-1900.” Social Science 47 (1972): 26-33.

Weis, Harry. “Employers’ Liability and Workmen’s Compensation.” In History of Labor in the United States, 1896-1932, Vol. III, edited by Don D. Lescohier

Footnotes

1 See Gosden (1961), Hopkins (1995) and Riley (1997) for excellent discussions of the evolution of friendly societies in England.

2 Cited in Starr (1982, p. 242). British industrial-life companies did not offer sickness insurance until 1911, when government allowed them qualify as approved societies under the National Health Act. In acting as approved societies, their motive was not to write sickness insurance, but rather to protect their interest in burial insurance. See Beveridge, 1948, p. 81; Gilbert, 1966, p. 323.

3 Emery and Emery (1999). Riley (1997) shows that British men in their twenties were the majority of initiates and members who exited did so within “a few years of joining”.

4 Data for unions are from Wolman, 1936, pp. 16, 239 and Leacy, 1983, series E175. By 1931 just 10 per cent of non-agricultural workers in the United States were unionized, down from 19 per cent in 1919 (Bernstein, 1960, chapter 2). Unions affiliated with the American Federation of Labor accounted for approximately 80 per cent of the total membership of American labor unions (Wolman, p.7). The reported AFL membership statistics are high. Unions paid per capita tax on more than their actual paid-up memberships for prestige and to maintain their voting strength at AFL meetings. In 1929, the United Mine Workers, an extreme case, reported 400,000 members, but probably had just 262,000 members, including 169,000 paid-up members and 93,000 “exonerated” members (kept on the books because they were unemployed or on strike).

5 Brandes (1976, chapter 10) places their membership at 749,000 in 1916 and 825,000 in 1931.

6 The probable costs of health-care claims were hard to predict (Starr, 1982, pp. 290-1). As with income-replacement insurance, sickness was not a well-defined condition. In addition, the treatment costs were within the insured’s control. They also were within the control of the physician and hospital, both of which could profit from additional services and raise prices as the patient’s ability to pay increased.

7 Employer-purchased/provided group plans came to be the most common source of the health insurance coverage in the United States (Applebaum, 1961; Follmann, 1965; Davis, 1989). In Canada, provincial government health insurance plans, with universal coverage, replaced the work-place based arrangements in the 1960s.

Citation: Emery, Herb. “Fraternal Sickness Insurance”. EH.Net Encyclopedia, edited by Robert Whaples. March 26, 2008. URL http://eh.net/encyclopedia/fraternal-sickness-insurance/

An Economic History of Finland

Riitta Hjerppe, University of Helsinki

Finland in the early 2000s is a small industrialized country with a standard of living ranked among the top twenty in the world. At the beginning of the twentieth century it was a poor agrarian country with a gross domestic product per capita less than half of that of the United Kingdom and the United States, world leaders at the time in this respect. Finland was part of Sweden until 1809, and a Grand Duchy of Russia from 1809 to 1917, with relatively broad autonomy in its economic and many internal affairs. It became an independent republic in 1917. While not directly involved in the fighting in World War I, the country went through a civil war during the years of early independence in 1918, and fought against the Soviet Union during World War II. Participation in Western trade liberalization and bilateral trade with the Soviet Union required careful balancing of foreign policy, but also enhanced the welfare of the population. Finland has been a member of the European Union since 1995, and has belonged to the European Economic and Monetary Union since 1999, when it adopted the euro as its currency.

Gross Domestic Product per capita in Finland and in EU 15, 1860-2004, index 2004 = 100

Sources: Eurostat (2001–2005)

Finland has large forest areas of coniferous trees, and forests have been and still are an important natural resource in its economic development. Other natural resources are scarce: there is no coal or oil, and relatively few minerals. Outokumpu, the biggest copper mine in Europe in its time, was depleted in the 1980s. Even water power is scarce, despite the large number of lakes, because of the small height differences. The country is among the larger ones in Europe in area, but it is sparsely populated with 44 people per square mile, 5.3 million people altogether. The population is very homogeneous. There are a small number of people of foreign origin, about two percent, and for historical reasons there are two official language groups, the Finnish-speaking majority and a Swedish-speaking minority. In recent years population has grown at about 0.3 percent per year.

The Beginnings of Industrialization and Accelerating Growth

Finland was an agrarian country in the 1800s, despite poor climatic conditions for efficient grain growing. Seventy percent of the population was engaged in agriculture and forestry, and half of the value of production came from these primary industries in 1900. Slash and burn cultivation finally gave way to field cultivation during the nineteenth century, even in the eastern parts of the country.

Some iron works were founded in the southwestern part of the country in order to process Swedish iron ore as early as in the seventeenth century. Significant tar burning, sawmilling and fur trading brought cash with which to buy a few imported items such as salt, and some luxuries – coffee, sugar, wines and fine cloths. The small towns in the coastal areas flourished through the shipping of these items, even if restrictive legislation in the eighteenth century required transport via Stockholm. The income from tar and timber shipping accumulated capital for the first industrial plants.

The nineteenth century saw the modest beginnings of industrialization, clearly later than in Western Europe. The first modern cotton factories started up in the 1830s and 1840s, as did the first machine shops. The first steam machines were introduced in the cotton factories and the first rag paper machine in the 1840s. The first steam sawmills were allowed to start only in 1860. The first railroad shortened the traveling time from the inland towns to the coast in 1862, and the first telegraphs came at around the same time. Some new inventions, such as electrical power and the telephone, came into use early in the 1880s, but generally the diffusion of new technology to everyday use took a long time.

The export of various industrial and artisan products to Russia from the 1840s on, as well as the opening up of British markets to Finnish sawmill products in the 1860s were important triggers of industrial development. From the 1870s on pulp and paper based on wood fiber became major export items to the Russian market, and before World War I one-third of the demand of the vast Russian empire was satisfied with Finnish paper. Finland became a very open economy after the 1860s and 1870s, with an export share equaling one-fifth of GDP and an import share of one-fourth. A happy coincidence was the considerable improvement in the terms of trade (export prices/import prices) from the late 1860s to 1900, when timber and other export prices improved in relation to the international prices of grain and industrial products.

Openness of the economies (exports+imports of goods/GDP, percent) in Finland and EU 15, 1960-2005

Sources: Heikkinen and van Zanden 2004; Hjerppe 1989.

Finland participated fully in the global economy of the first gold-standard era, importing much of its grain tariff-free and a lot of other foodstuffs. Half of the imports consisted of food, beverages and tobacco. Agriculture turned to dairy farming, as in Denmark, but with poorer results. The Finnish currency, the markka from 1865, was tied to gold in 1878 and the Finnish Senate borrowed money from Western banking houses in order to build railways and schools.

GDP grew at a slightly accelerating average rate of 2.6 percent per annum, and GDP per capita rose 1.5 percent per year on average between 1860 and 1913. The population was also growing rapidly, and from two million in the 1860s it reached three million on the eve of World War I. Only about ten percent of the population lived in towns. The investment rate was a little over 10 percent of GDP between the 1860s and 1913 and labor productivity was low compared to the leading nations. Accordingly, economic growth depended mostly on added labor inputs, as well as a growing cultivated area.

Catching up in the Interwar Years

The revolution of 1917 in Russia and Finland’s independence cut off Russian trade, which was devastating for Finland’s economy. The food situation was particularly difficult as 60 percent of grain required had been imported.

Postwar reconstruction in Europe and the consequent demand for timber soon put the economy on a swift growth path. The gap between the Finnish economy and Western economies narrowed dramatically in the interwar period, although it remained the same among the Scandinavian countries, which also experienced fast growth: GDP grew by 4.7 percent per annum and GDP per capita by 3.8 percent in 1920–1938. The investment rate rose to new heights, which also improved labor productivity. The 1930s depression was milder than in many other European countries because of the continued demand for pulp and paper. On the other hand, Finnish industries went into depression at different times, which made the downturn milder than it would have been if all the industries had experienced their troughs simultaneously. The Depression, however, had serious and long-drawn-out consequences for poor people.

The land reform of 1918 secured land for tenant farmers and farm workers. A large number of new, small farms were established, which could only support families if they had extra income from forest work. The country remained largely agrarian. On the eve of World War II, almost half of the labor force and one-third of the production were still in the primary industries. Small-scale agriculture used horses and horse-drawn machines, lumberjacks went into the forest with axes and saws, and logs were transported from the forest by horses or by floating. Tariff protection and other policy measures helped to raise the domestic grain production to 80–90 percent of consumption by 1939.

Soon after the end of World War I, Finnish sawmill products, pulp and paper found old and new markets in the Western world. The structure of exports became more one-sided, however. Textiles and metal products found no markets in the West and had to compete hard with imports on the domestic market. More than four-fifths of exports were based on wood, and one-third of industrial production was in sawmilling, other wood products, pulp and paper. Other growing industries included mining, basic metal industries and machine production, but they operated on the domestic market, protected by the customs barriers that were typical of Europe at that time.

The Postwar Boom until the 1970s

Finland came out of World War II crippled by the loss of a full tenth of its territory, and with 400.000 evacuees from Karelia. Productive units were dilapidated and the raw material situation was poor. The huge war reparations to the Soviet Union were the priority problem of the decision makers. The favorable development of the domestic machinery and shipbuilding industries, which was based on domestic demand during the interwar period and arms deliveries to the army during the War made war-reparations deliveries possible. They were paid on time and according to the agreements. At the same time, timber exports to the West started again. Gradually the productive capacity was modernized and the whole industry was reformed. Evacuees and soldiers were given land on which to settle, and this contributed to the decrease in farm size.

Finland became part of the Western European trade-liberalization movement by joining the World Bank, the International Monetary Fund (IMF) and the Bretton Woods agreement in 1948, becoming a member of the General Agreement on Tariffs and Trade (GATT) two years later, and joining Finnefta (an agreement between the European Free Trade Area (EFTA) and Finland) in 1961. The government chose not to receive Marshall Aid because of the world political situation. Bilateral trade agreements with the Soviet Union started in 1947 and continued until 1991. Tariffs were eased and imports from market economies liberated from 1957. Exports and imports, which had stayed at internationally high levels during the interwar years, only slowly returned to the earlier relative levels.

The investment rate climbed to new levels soon after War World II under a government policy favoring investments and it remained on this very high level until the end of the 1980s. The labor-force growth stopped in the early 1960s, and economic growth has since depended on increases in productivity rather than increased labor inputs. GDP growth was 4.9 percent and GDP per capita 4.3 percent in 1950–1973 – matching the rapid pace of many other European countries.

Exports and, accordingly, the structure of the manufacturing industry were diversified by Soviet and, later, on Western orders for machinery products including paper machines, cranes, elevators, and special ships such as icebreakers. The vast Soviet Union provided good markets for clothing and footwear, while Finnish wool and cotton factories slowly disappeared because of competition from low-wage countries. The modern chemical industry started to develop in the early twentieth century, often led by foreign entrepreneurs, and the first small oil refinery was built by the government in the 1950s. The government became actively involved in industrial activities in the early twentieth century, with investments in mining, basic industries, energy production and transmission, and the construction of infrastructure, and this continued in the postwar period.

The new agricultural policy, the aim of which was to secure reasonable incomes and favorable loans to the farmers and the availability of domestic agricultural products for the population, soon led to overproduction in several product groups, and further to government-subsidized dumping on the international markets. The first limitations on agricultural production were introduced at the end of the 1960s.

The population reached four million in 1950, and the postwar baby boom put extra pressure on the educational system. The educational level of the Finnish population was low in Western European terms in the 1950s, even if everybody could read and write. The underdeveloped educational system was expanded and renewed as new universities and vocational schools were founded, and the number of years of basic, compulsory education increased. Education has been government run since the 1960s and 1970s, and is free at all levels. Finland started to follow the so-called Nordic welfare model, and similar improvements in health and social care have been introduced, normally somewhat later than in the other Nordic countries. Public child-health centers, cash allowances for children, and maternity leave were established in the 1940s, and pension plans have covered the whole population since the 1950s. National unemployment programs had their beginnings in the 1930s and were gradually expanded. A public health-care system was introduced in 1970, and national health insurance also covers some of the cost of private health care. During the 1980s the income distribution became one of the most even in the world.

Slower Growth from the 1970s

The oil crises of the 1970s put the Finnish economy under pressure. Although the oil reserves of the main supplier, the Soviet Union, showed no signs of running out, the price increased in line with world market prices. This was a source of devastating inflation in Finland. On the other hand, it was possible to increase exports under the terms of the bilateral trade agreement with the Soviet Union. This boosted export demand and helped Finland to avoid the high and sustained unemployment that plagued Western Europe.

Economic growth in the 1980s was somewhat better than in most Western economies, and at the end of the 1980s Finland caught up with the sluggishly-growing Swedish GDP per capita for the first time. In the early 1990s the collapse of the Soviet trade, Western European recession and problems in adjusting to the new liberal order of international capital movement led the Finnish economy into a depression that was worse than that of the 1930s. GDP fell by over 10 percent in three years, and unemployment rose to 18 percent. The banking crisis triggered a profound structural change in the Finnish financial sector. The economy revived again to a brisk growth rate of 3.6 percent in 1994-2005: GDP growth was 2.5 percent and GDP per capita 2.1 percent between 1973 and 2005.

Electronics started its spectacular rise in the 1980s and it is now the largest single manufacturing industry with a 25 percent share of all manufacturing. Nokia is the world’s largest producer of mobile phones and a major transmission-station constructor. Connected to this development was the increase in the research-and- development outlay to three percent of GDP, one of the highest in the world. The Finnish paper companies UPM-Kymmene and M-real and the Finnish-Swedish Stora-Enso are among the largest paper producers in the world, although paper production now accounts for only 10 percent of manufacturing output. The recent discussion on the future of the industry is alarming, however. The position of the Nordic paper industry, which is based on expensive, slowly-growing timber, is threatened by new paper factories founded near the expanding consumption areas in Asia and South America, which use local, fast-growing tropical timber. The formerly significant sawmilling operations now constitute a very small percentage of the activities, although the production volumes have been growing. The textile and clothing industries have shrunk into insignificance.

What has typified the last couple of decades is the globalization that has spread to all areas. Exports and imports have increased as a result of export-favoring policies. Some 80 percent of the stocks of Finnish public companies are now in foreign hands: foreign ownership was limited and controlled until the early 1990s. A quarter of the companies operating in Finland are foreign-owned, and Finnish companies have even bigger investments abroad. Most big companies are truly international nowadays. Migration to Finland has increased, and since the collapse of the eastern bloc Russian immigrants have become the largest single foreign group. The number of foreigners is still lower than in many other countries – there are about 120.000 people with foreign background out of a population of 5.3 million.

The directions of foreign trade have been changing because trade with the rising Asian economies has been gaining in importance and Russian trade has fluctuated. Otherwise, almost the same country distribution prevails as has been common for over a century. Western Europe has a share of three-fifths, which has been typical. The United Kingdom was for long Finland’s biggest trading partner, with a share of one-third, but this started to diminish in the 1960s. Russia accounted for one-third of Finnish foreign trade in the early 1900s, but the Soviet Union had minimal trade with the West at first, and its share of the Finnish foreign trade was just a few percentage points. After World War II Soviet-Finnish trade increased gradually until it reached 25 percent of Finnish foreign trade in the 1970s and early 1980s. Trade with Russia is now gradually gaining ground again from the low point of the early 1990s, and had risen to about ten percent in 2006. This makes Russia one of Finland’s three biggest trading partners, Sweden and Germany being the other two with a ten percent share each.

The balance of payments was a continuing problem in the Finnish economy until the 1990s. Particularly in the post-World War II period inflation repeatedly eroded the competitive capacity of the economy and led to numerous devaluations of the currency. An economic policy favoring exports helped the country out of the depression of the 1990s and improved the balance of payments.

Agriculture continued its problematic development of overproduction and high subsidies, which finally became very unpopular. The number of farms has shrunk since the 1960s and the average size has recently risen to average European levels. The share of agricultural production and labor are also on the Western European levels nowadays. Finnish agriculture is incorporated into the Common Agricultural Policy of the European Union and shares its problems, even if Finnish overproduction has been virtually eliminated.

The share of forestry is equally low, even if it supplies four-fifths of the wood used in Finnish sawmills and paper factories: the remaining fifth is imported mainly from the northwestern parts of Russia. The share of manufacturing is somewhat above Western European levels and, accordingly, that of services is high but slightly lower than in the old industrialized countries.

Recent discussion on the state of the economy mainly focuses on two issues. The very open economy of Finland is very much influenced by the rather sluggish economic development of the European Union. Accordingly, not very high growth rates are to be expected in Finland either. Since the 1990s depression, the investment rate has remained at a lower level than was common in the postwar period, and this is cause for concern.

The other issue concerns the prominent role of the public sector in the economy. The Nordic welfare model is basically approved of, but the costs create tensions. High taxation is one consequence of this and political parties discuss whether or not the high public-sector share slows down economic growth.

The aging population, high unemployment and the decreasing numbers of taxpayers in the rural areas of eastern and central Finland place a burden on the local governments. There is also continuing discussion about tax competition inside the European Union: how does the high taxation in some member countries affect the location decisions of companies?

Development of Finland’s exports by commodity group 1900-2005, percent

Source: Finnish National Board of Customs, Statistics Unit

Note on classification: Metal industry products SITC 28, 67, 68, 7, 87; Chemical products SITC 27, 32, 33, 34, 5, 66; Textiles SITC 26, 61, 65, 84, 85; Wood, paper and printed products SITC 24, 25, 63, 64, 82; Food, beverages, tobacco SITC 0, 1, 4.

Development of Finland’s imports by commodity group 1900-2005, percent

Source: Finnish National Board of Customs, Statistics Unit

Note on classification: Metal industry products SITC 28, 67, 68, 7, 87; Chemical products SITC 27, 32, 33, 34, 5, 66; Textiles SITC 26, 61, 65, 84, 85; Wood, paper and printed products SITC 24, 25, 63, 64, 82; Food, beverages, tobacco SITC 0, 1, 4.

References:

Heikkinen, S. and J.L van Zanden, eds. Explorations in Economic Growth. Amsterdam: Aksant, 2004.

Heikkinen, S. Labour and the Market: Workers, Wages and Living Standards in Finland, 1850–1913. Commentationes Scientiarum Socialium 51 (1997).

Hjerppe, R. The Finnish Economy 1860–1985: Growth and Structural Change. Studies on Finland’s Economic Growth XIII. Helsinki: Bank of Finland Publications, 1989.

Jalava, J., S. Heikkinen and R. Hjerppe. “Technology and Structural Change: Productivity in the Finnish Manufacturing Industries, 1925-2000.” Transformation, Integration and Globalization Economic Research (TIGER), Working Paper No. 34, December 2002.

Kaukiainen, Yrjö. A History of Finnish Shipping. London: Routledge, 1993.

Myllyntaus, Timo. Electrification of Finland: The Transfer of a New Technology into a Late Industrializing Economy. Worcester, MA: Macmillan, Worcester, 1991.

Ojala, J., J. Eloranta and J. Jalava, editors. The Road to Prosperity: An Economic History of Finland. Helsinki: Suomalaisen Kirjallisuuden Seura, 2006.

Pekkarinen, J. and J. Vartiainen. Finlands ekonomiska politik: den långa linjen 1918–2000, Stockholm: Stiftelsen Fackföreningsrörelsens institut för ekonomisk forskning FIEF, 2001.

Citation: Hjerppe, Riitta. “An Economic History of Finland”. EH.Net Encyclopedia, edited by Robert Whaples. February 10, 2008. URL http://eh.net/encyclopedia/an-economic-history-of-finland/

The Economics of American Farm Unrest, 1865-1900

James I. Stewart, Reed College

American farmers have often expressed dissatisfaction with their lot but the decades after the Civil War were extraordinary in this regard. The period was one of persistent and acute political unrest. The specific concerns of farmers were varied, but at their core was what farmers perceived to be their deteriorating political and economic status.

The defining feature of farm unrest was the efforts of farmers to join together for mutual gain. Farmers formed cooperatives, interest groups, and political parties to protest their declining fortunes and to increase their political and economic power. The first such group to appear was The Grange or Patrons of Husbandry, founded in the 1860s to address farmers’ grievances against the railroads and desire for greater cooperation in business matters. The agrarian-dominated Greenback Party followed in the 1870s. Its main goal was to increase the amount of money in circulation and thus to lower the costs of credit to farmers. The Farmers’ Alliance appeared in the 1880s. Its members practiced cooperative marketing and lobbied the government for various kinds of business and banking regulation. In the 1890s, aggrieved farmers took their most ambitious steps yet, forming the independent People’s or Populist Party to challenge the dominance of the unsympathetic Republican and Democratic parties.

Although farmers in every region of the country had cause for agitation, unrest was probably greatest in the northern prairie and Plains states. A series of droughts there between 1870 and 1900 created recurring hardships, and Midwestern grain farmers faced growing price competition from producers abroad. Farmers in the South also revolted, but their protests were muted by racism. Black farmers were excluded from most farm groups, and many white farmers were reluctant to join the attack on established politics and business for fear of undermining the system of social control that kept blacks inferior to whites (Goodwyn, 1978).

The Debate about the Causes of Farm Unrest

For a long time, a debate raged about the causes of farm unrest. Historians could not reconcile the complaints of farmers with evidence about the agricultural terms of trade— the prices farmers received for their output, especially relative to the prices of other goods and services farmers purchased such as transportation, credit, and manufactures. Now, however, there appears to be some consensus. Before exploring the basis for this consensus, it will be useful to examine briefly the complaints of farmers. What were farmers so upset about? Why did they feel so threatened?

The Complaints of Farmers

The complaints of farmers are well documented (Buck, 1913; Hicks, 1931) and relatively uncontroversial. They concerned farmers’ declining incomes and fractious business relationships primarily. First, farmers claimed that farm prices were falling and, as a consequence, so were their incomes. They generally blamed low prices on over-production. Second, farmers alleged that monopolistic railroads and grain elevators charged unfair prices for their services. Government regulation was the farmers’ solution to the problem of monopoly. Third, there was a perceived shortage of credit and money. Farmers believed that interest rates were too high because of monopolistic lenders, and the money supply was inadequate, producing deflation. A falling price level increased the real burden of debt, as farmers repaid loans with dollars worth significantly more than those they had borrowed. Farmers demanded ceilings on interest rates, public boards to mediate foreclosure proceedings, and the U.S. Treasury to coin silver freely to increase the money supply. Finally, farmers complained about the political influence of the railroads, big business, and money lenders. These interests had undue influence over policy making in the state legislatures and U.S. Congress. In short, farmers felt their economic and political interests were being shortchanged by a gang of greedy railroads, creditors, and industrialists.

The Puzzle of Farm Unrest

Economic historians have subjected the complaints of farmers to rigorous statistical testing. Each claim has been found inconsistent to some extent with the available evidence about the terms of trade.

First, consider farmers’ complaints about prices. Farm prices were falling, along with the prices of most other goods during this period. This does not imply, however, that farm incomes were also falling. First, real prices (farm prices relative to the general price level) are a better measure of the value that farmers were receiving for their output. When real prices over the post-Civil War period are examined, there is an approximately horizontal trend (North, 1974). Moreover, even if real farm prices had been falling, farmers were not necessarily worse off (Fogel and Rutner, 1972). Rising farm productivity could have offset the negative effects of falling real prices on incomes. Finally, direct evidence about the incomes of farmers is scarce, but estimates suggest that farm incomes were not falling (Bowman, 1965). Some regions experienced periods of distress—Iowa and Illinois in the 1870s and Kansas and Nebraska in the 1890s, for instance—but there was no general agricultural depression. If anything, data on wages, land rents, and returns to capital suggest that land in the West was opened to settlement too slowly (Fogel and Rutner, 1972).

Next, consider farmers’ claims about interest rates and mortgage debt. It is true that interest rates on the frontier were high, averaging two to three percentage points more than those in the Northeast. Naturally, frontier farmers complained bitterly about paying so much for credit. Lenders, however, may have been well justified in the rates they charged. The susceptibility of the frontier to drought and the financial insecurity of many settlers created above average lending risks for which creditors had to be compensated (Bogue, 1955). For instance, borrowers often defaulted, leaving land worth only a fraction of the loan as security. This story casts doubt on the exploitation hypothesis. Furthermore, when the claims of farmers were subjected to rigorous statistical testing, there was little evidence to substantiate the monopoly hypothesis (Eichengreen, 1984). Instead, consistent with the unique features of the frontier mortgage market, high rates of interest appear to have been compensation for the inherent risks of lending to frontier farmers. Finally, regarding the burden on borrowers of a falling price level, deflation may have been not as onerous as farmers alleged. The typical mortgage had a short term, less than five years, implying that lenders and borrowers could often anticipate changes in the price level (North, 1974).

Last, consider farmers’ complaints about the railroads. These appear to have the most merit. Nevertheless, for a long time, most historians dismissed farmers’ grievances, assuming that the real cost to farmers of shipping their produce to market must have been steadily falling because of productivity improvements in the railroad sector. As Robert Higgs (1970) shows, however, gains in productivity in rail shipping did not necessarily translate into lower rates for farmers and thus higher farm gate prices. Real rates (railroad rates relative to the prices farmers received for their output) were highly variable between 1865 and 1900. More important, over the whole period, there was little decrease in rail rates relative to farm prices. Only in the 1890s did the terms of trade begin to improve in farmers’ favor. Employing different data, Aldrich (1985) finds a downward trend in railroad rates before 1880 but then no trend or an increasing trend thereafter.

The Causes of Farm Unrest

Many of the complaints of farmers are weakly supported or even contradicted by the available evidence, leaving questions about the true causes of farm unrest. If the monopoly power of the railroads and creditors was not responsible for farmers’ woes, what or who was?

Most economic historians now believe that agrarian unrest reflected the growing risks and uncertainties of agriculture after the Civil War. Uncertainty or risk can be thought of as an economic force that reduces welfare. Today, farmers use sophisticated production technologies and agricultural futures markets to reduce their exposure to environmental and economic uncertainty at little cost. In the late 1800s, the avoidance of risk was much more costly. As a result, increases in risk and uncertainty made farmers worse off. These uncertainties and risks appear to have been particularly severe for farmers on the frontier.

What were the sources of risk? First, agriculture had become more commercial after the Civil War (Mayhew, 1972). Formerly self-sufficient farmers were now dependent on creditors, merchants, and railroads for their livelihoods. These relationships created opportunities for economic gain but also obligations, hardships, and risks that many farmers did not welcome. Second, world grain markets were becoming ever more integrated, creating competition in markets abroad once dominated by U.S. producers and greater price uncertainty (North, 1974). Third, agriculture was now occurring in the semi-arid region of the United States. In Kansas, Nebraska, and the Dakotas, farmers encountered unfamiliar and adverse growing conditions. Recurring but unpredictable droughts caused economic hardship for many Plains farmers. Their plights were made worse because of the greater price elasticity (responsiveness) of world agricultural supply (North, 1974). Drought-stricken farmers with diminished harvests could no longer count on higher domestic prices for their crops.

A growing body of research now supports the hypothesis that discontent was caused by increasing risks and uncertainties in U.S. agriculture. First, there are strong correlations between different measures of economic risk and uncertainty and the geographic distribution of unrest in fourteen northern states between 1866 and 1909 (McGuire, 1981; 1982). Farm unrest was closely tied to the variability in farm prices, yields, and incomes across the northern states. Second, unrest was highest in states with high rates of farm foreclosures (Stock, 1986). On the frontier, the typical farmer would have had a neighbor whose farm was seized by creditors and thus cause to worry about his own future financial security. Third, Populist agitation in Kansas in the 1890s coincided with unexpected variability in crop prices that resulted in lost profits and lower incomes (DeCanio, 1980). Finally, as mentioned already, high interest rates were not a sign of monopoly but rather compensation to creditors for the greater risks of frontier lending (Eichengreen, 1984).

The Historical Significance of Farm Unrest

Farm unrest had profound and lasting consequences for American economic development. Above all, it ushered in fundamental and lasting institutional change (Hughes, 1991; Libecap, 1992).

The change began in the 1870s. In response to the complaints of farmers, Midwestern state legislatures enacted a series of laws regulating the prices and practices of railroads, grain elevators, and warehouses. The “Grange” laws were a turning point because they reversed a longstanding trend of decreasing government regulation of the private sector. They also prompted a series of landmark court rulings affirming the regulatory prerogatives of government (Hughes, 1991). In Munn v. Illinois (1877), the U.S. Supreme Court rejected a challenge to the legality of the Granger laws, famously ruling that government had the legal right to regulate any commerce “affected with the public interest.”

Farmers also sought redress of their grievances at the federal level. In 1886, the U.S. Supreme Court had ruled in Wabash, St. Louis, and Pacific Railway v. Illinois that only the federal government had the right to regulate commerce between the states. This meant the states could not regulate many matters of concern to farmers. In 1887, Congress passed the Interstate Commerce Act, which gave the Interstate Commerce Commission regulatory oversight over long distance rail shipping. This legislation was followed by the Sherman Antitrust Act of 1890, which prohibited monopolies and certain conspiracies, combinations, and restraints of trade. Midwestern cattle farmers urged the passage of an antitrust law, alleging that the notorious Chicago meat packers had conspired to keep cattle prices artificially low (Libecap, 1992). Both laws marked the beginning of growing federal involvement in private economic activity (Hughes, 1991; Ulen, 1987).

Not all agrarian proposals were acted upon, but even demands that fell on deaf ears in Congress and the state legislatures had lasting impacts (Hicks, 1931). For instance, many Alliance and Populist demands such as the graduated income tax and the direct election of U.S. Senators became law during the Progressive Era.

Historians disagree about the legacy of the late nineteenth century farm movements. Some view their contributions to U.S. institutional development positively (Hicks, 1931), while others do not (Hughes, 1991). Nonetheless, few would dispute their impact. In fact, it is possible to see much institutional change in the U.S. over the last century as the logical consequence of political and legal developments initiated by farmers during the late 1800s (Hughes, 1991).

The Sources of Cooperation in the Farm Protest Movement

Nineteenth century farmers were remarkably successful at joining together to increase their economic and political power. Nevertheless, one aspect of farm unrest that has largely been neglected by scholars is the sources of cooperation in promoting agrarian interests. According to Olson (1965), large lobbying or interest groups like the Grange and the Farmers’ Alliance should have been plagued by free-riding: the incentives for individuals not to contribute to the collective production of public goods—those goods for which it is impossible or very costly to exclude others from enjoying. A rational and self-interested farmer would not join a lobbying group because he could enjoy the benefits of its work without incurring any of the costs.

Judging by their political power, most farm interest groups were, however, able to curb free-riding. Stewart (2006) studies how the Dakota Farmers’ Alliance did this between 1885 and 1890. First, the Dakota Farmers’ Alliance provided valuable goods and services to its members that were not available to outsiders, creating economic incentives for membership. These goods and services included better terms of trade through cooperative marketing and the sharing of productivity-enhancing information about agriculture. Second, the structure of the Dakota Farmers’ Alliance as a federation of township chapters enabled the group to monitor and sanction free-riders. Within townships, Alliance members were able to pressure others to join the group. This strategy appears to have succeeded among German and Norwegian immigrants, who were much more likely than others to join the Dakota Farmers’ Alliance and whose probability of joining was increasing in the share of their nativity group in the township population. This is consistent with long-standing social norms of cooperation in Germany and Norway and economic theory about the use of social norms to elicit cooperation in collective action.

References

Aldrich, Mark. “A Note on Railroad Rates and the Populist Uprising.” Agricultural History 41 (1985): 835-52.

Bogue, Allan G. Money at Interest: The Farm Mortgage on the Middle Border. Ithaca, NY: Cornell University Press, 1955.

Bowman, John. “An Economic Analysis of Midwestern Farm Values and Farm Land Income, 1860-1900.” Yale Economic Essays 5 (1965): 317-52.

Buck, Solon J. The Granger Movement: A Study of Agricultural Organization and Its Political, Economic, and Social Manifestations, 1870-1880. Cambridge: Harvard University Press. 1913.

DeCanio, Stephen J. “Economic Losses from Forecasting Error in Agriculture.” Journal of Political Economy 88 (1980): 234-57.

Eichengreen, Barry. “Mortgage Interest Rates in the Populist Era.” American Economic Review 74 (1984): 995-1015.

Fogel, Robert W. and Jack L. Rutner. “The Efficiency Effects of Federal Land Policy, 1850-1900: A Report of Some Provisional Findings.” In The Dimensions of Quantitative Research in History, edited by Wayne O. Aydelotte, Allan G. Bogue and Robert W. Fogel. Princeton, N.: Princeton University Press, 1972.

Goodwyn, Lawrence. The Populist Moment: A Short History of the Agrarian Revolt in America. New York: Oxford University Press, 1978.

Hicks, John D. The Populist Revolt: A History of the Farmers’ Alliance and the People’s Party. Minneapolis: University of Minnesota Press, 1931.

Higgs, Robert. “Railroad Rates and the Populist Uprising.” Agricultural History 44 (1970): 291-97.

Hughes, Jonathan T. The Government Habit Redux: Economic Controls from Colonial Times to the Present. Princeton, NJ: Princeton University Press, 1991.

Libecap, Gary D. “The Rise of the Chicago Packers and the Origins of Meat Inspection and Antitrust.” Economic Inquiry 30 (1992): 242-62.

Mayhew, Anne. “A Reappraisal of the Causes of the Farm Protest Movement in the United States, 1870-1900.” Journal of Economic History 32 (1972): 464-75.

McGuire, Robert A. “Economic Causes of Late Nineteenth Century Agrarian Unrest: New Evidence.” Journal of Economic History 41 (1981): 835-52.

McGuire, Robert A. “Economic Causes of Late Nineteenth Century Agrarian Unrest: Reply.” Journal of Economic History 42 (1981): 697-99.

North, Douglass. Growth and Welfare in the American Past: A New Economic History. Englewood Cliffs, NJ: Prentice Hall, 1974.

Olson, Mancur. The Logic of Collective Action: Public Goods and the Theory of Groups. Cambridge, MA: Harvard University Press, 1965.

Stewart, James I. “Free-riding, Collective Action, and Farm Interest Group Membership.” Reed College Working Paper, 2006. Available at http://www.reed.edu/~stewartj.

Stock, James H. “Real Estate Mortgages, Foreclosures, and Midwestern Agrarian Unrest, 1865-1920.” Journal of Economic History 44 (1983): 89-105.

Ulen, Thomas C. “The Market for Regulation: The ICC from 1887 to 1920.” American Economic Review 70 (1980): 306-10.

Citation: Stewart, James. “The Economics of American Farm Unrest, 1865-1900″. EH.Net Encyclopedia, edited by Robert Whaples. February 10, 2008. URL http://eh.net/encyclopedia/the-economics-of-american-farm-unrest-1865-1900/

The U.S. Economy in the 1920s

Gene Smiley, Marquette University

Introduction

The interwar period in the United States, and in the rest of the world, is a most interesting era. The decade of the 1930s marks the most severe depression in our history and ushered in sweeping changes in the role of government. Economists and historians have rightly given much attention to that decade. However, with all of this concern about the growing and developing role of government in economic activity in the 1930s, the decade of the 1920s often tends to get overlooked. This is unfortunate because the 1920s are a period of vigorous, vital economic growth. It marks the first truly modern decade and dramatic economic developments are found in those years. There is a rapid adoption of the automobile to the detriment of passenger rail travel. Though suburbs had been growing since the late nineteenth century their growth had been tied to rail or trolley access and this was limited to the largest cities. The flexibility of car access changed this and the growth of suburbs began to accelerate. The demands of trucks and cars led to a rapid growth in the construction of all-weather surfaced roads to facilitate their movement. The rapidly expanding electric utility networks led to new consumer appliances and new types of lighting and heating for homes and businesses. The introduction of the radio, radio stations, and commercial radio networks began to break up rural isolation, as did the expansion of local and long-distance telephone communications. Recreational activities such as traveling, going to movies, and professional sports became major businesses. The period saw major innovations in business organization and manufacturing technology. The Federal Reserve System first tested its powers and the United States moved to a dominant position in international trade and global business. These things make the 1920s a period of considerable importance independent of what happened in the 1930s.

National Product and Income and Prices

We begin the survey of the 1920s with an examination of the overall production in the economy, GNP, the most comprehensive measure of aggregate economic activity. Real GNP growth during the 1920s was relatively rapid, 4.2 percent a year from 1920 to 1929 according to the most widely used estimates. (Historical Statistics of the United States, or HSUS, 1976) Real GNP per capita grew 2.7 percent per year between 1920 and 1929. By both nineteenth and twentieth century standards these were relatively rapid rates of real economic growth and they would be considered rapid even today.

There were several interruptions to this growth. In mid-1920 the American economy began to contract and the 1920-1921 depression lasted about a year, but a rapid recovery reestablished full-employment by 1923. As will be discussed below, the Federal Reserve System’s monetary policy was a major factor in initiating the 1920-1921 depression. From 1923 through 1929 growth was much smoother. There was a very mild recession in 1924 and another mild recession in 1927 both of which may be related to oil price shocks (McMillin and Parker, 1994). The 1927 recession was also associated with Henry Ford’s shut-down of all his factories for six months in order to changeover from the Model T to the new Model A automobile. Though the Model T’s market share was declining after 1924, in 1926 Ford’s Model T still made up nearly 40 percent of all the new cars produced and sold in the United States. The Great Depression began in the summer of 1929, possibly as early as June. The initial downturn was relatively mild but the contraction accelerated after the crash of the stock market at the end of October. Real total GNP fell 10.2 percent from 1929 to 1930 while real GNP per capita fell 11.5 percent from 1929 to 1930.

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Price changes during the 1920s are shown in Figure 2. The Consumer Price Index, CPI, is a better measure of changes in the prices of commodities and services that a typical consumer would purchase, while the Wholesale Price Index, WPI, is a better measure in the changes in the cost of inputs for businesses. As the figure shows the 1920-1921 depression was marked by extraordinarily large price decreases. Consumer prices fell 11.3 percent from 1920 to 1921 and fell another 6.6 percent from 1921 to 1922. After that consumer prices were relatively constant and actually fell slightly from 1926 to 1927 and from 1927 to 1928. Wholesale prices show greater variation. The 1920-1921 depression hit farmers very hard. Prices had been bid up with the increasing foreign demand during the First World War. As European production began to recover after the war prices began to fall. Though the prices of agricultural products fell from 1919 to 1920, the depression brought on dramatic declines in the prices of raw agricultural produce as well as many other inputs that firms employ. In the scramble to beat price increases during 1919 firms had built up large inventories of raw materials and purchased inputs and this temporary increase in demand led to even larger price increases. With the depression firms began to draw down those inventories. The result was that the prices of raw materials and manufactured inputs fell rapidly along with the prices of agricultural produce—the WPI dropped 45.9 percent between 1920 and 1921. The price changes probably tend to overstate the severity of the 1920-1921 depression. Romer’s recent work (1988) suggests that prices changed much more easily in that depression reducing the drop in production and employment. Wholesale prices in the rest of the 1920s were relatively stable though they were more likely to fall than to rise.

Economic Growth in the 1920s

Despite the 1920-1921 depression and the minor interruptions in 1924 and 1927, the American economy exhibited impressive economic growth during the 1920s. Though some commentators in later years thought that the existence of some slow growing or declining sectors in the twenties suggested weaknesses that might have helped bring on the Great Depression, few now argue this. Economic growth never occurs in all sectors at the same time and at the same rate. Growth reallocates resources from declining or slower growing sectors to the more rapidly expanding sectors in accordance with new technologies, new products and services, and changing consumer tastes.

Economic growth in the 1920s was impressive. Ownership of cars, new household appliances, and housing was spread widely through the population. New products and processes of producing those products drove this growth. The combination of the widening use of electricity in production and the growing adoption of the moving assembly line in manufacturing combined to bring on a continuing rise in the productivity of labor and capital. Though the average workweek in most manufacturing remained essentially constant throughout the 1920s, in a few industries, such as railroads and coal production, it declined. (Whaples 2001) New products and services created new markets such as the markets for radios, electric iceboxes, electric irons, fans, electric lighting, vacuum cleaners, and other laborsaving household appliances. This electricity was distributed by the growing electric utilities. The stocks of those companies helped create the stock market boom of the late twenties. RCA, one of the glamour stocks of the era, paid no dividends but its value appreciated because of expectations for the new company. Like the Internet boom of the late 1990s, the electricity boom of the 1920s fed a rapid expansion in the stock market.

Fed by continuing productivity advances and new products and services and facilitated by an environment of stable prices that encouraged production and risk taking, the American economy embarked on a sustained expansion in the 1920s.

Population and Labor in the 1920s

At the same time that overall production was growing, population growth was declining. As can be seen in Figure 3, from an annual rate of increase of 1.85 and 1.93 percent in 1920 and 1921, respectively, population growth rates fell to 1.23 percent in 1928 and 1.04 percent in 1929.

These changes in the overall growth rate were linked to the birth and death rates of the resident population and a decrease in foreign immigration. Though the crude death rate changed little during the period, the crude birth rate fell sharply into the early 1930s. (Figure 4) There are several explanations for the decline in the birth rate during this period. First, there was an accelerated rural-to-urban migration. Urban families have tended to have fewer children than rural families because urban children do not augment family incomes through their work as unpaid workers as rural children do. Second, the period also saw continued improvement in women’s job opportunities and a rise in their labor force participation rates.

Immigration also fell sharply. In 1917 the federal government began to limit immigration and in 1921 an immigration act limited the number of prospective citizens of any nationality entering the United States each year to no more than 3 percent of that nationality’s resident population as of the 1910 census. A new act in 1924 lowered this to 2 percent of the resident population at the 1890 census and more firmly blocked entry for people from central, southern, and eastern European nations. The limits were relaxed slightly in 1929.

The American population also continued to move during the interwar period. Two regions experienced the largest losses in population shares, New England and the Plains. For New England this was a continuation of a long-term trend. The population share for the Plains region had been rising through the nineteenth century. In the interwar period its agricultural base, combined with the continuing shift from agriculture to industry, led to a sharp decline in its share. The regions gaining population were the Southwest and, particularly, the far West.— California began its rapid growth at this time.

 Real Average Weekly or Daily Earnings for Selected=During the 1920s the labor force grew at a more rapid rate than population. This somewhat more rapid growth came from the declining share of the population less than 14 years old and therefore not in the labor force. In contrast, the labor force participation rates, or fraction of the population aged 14 and over that was in the labor force, declined during the twenties from 57.7 percent to 56.3 percent. This was entirely due to a fall in the male labor force participation rate from 89.6 percent to 86.8 percent as the female labor force participation rate rose from 24.3 percent to 25.1 percent. The primary source of the fall in male labor force participation rates was a rising retirement rate. Employment rates for males who were 65 or older fell from 60.1 percent in 1920 to 58.0 percent in 1930.

With the depression of 1920-1921 the unemployment rate rose rapidly from 5.2 to 8.7 percent. The recovery reduced unemployment to an average rate of 4.8 percent in 1923. The unemployment rate rose to 5.8 percent in the recession of 1924 and to 5.0 percent with the slowdown in 1927. Otherwise unemployment remained relatively low. The onset of the Great Depression from the summer of 1929 on brought the unemployment rate from 4.6 percent in 1929 to 8.9 percent in 1930. (Figure 5)

Earnings for laborers varied during the twenties. Table 1 presents average weekly earnings for 25 manufacturing industries. For these industries male skilled and semi-skilled laborers generally commanded a premium of 35 percent over the earnings of unskilled male laborers in the twenties. Unskilled males received on average 35 percent more than females during the twenties. Real average weekly earnings for these 25 manufacturing industries rose somewhat during the 1920s. For skilled and semi-skilled male workers real average weekly earnings rose 5.3 percent between 1923 and 1929, while real average weekly earnings for unskilled males rose 8.7 percent between 1923 and 1929. Real average weekly earnings for females rose on 1.7 percent between 1923 and 1929. Real weekly earnings for bituminous and lignite coal miners fell as the coal industry encountered difficult times in the late twenties and the real daily wage rate for farmworkers in the twenties, reflecting the ongoing difficulties in agriculture, fell after the recovery from the 1920-1921 depression.

The 1920s were not kind to labor unions even though the First World War had solidified the dominance of the American Federation of Labor among labor unions in the United States. The rapid growth in union membership fostered by federal government policies during the war ended in 1919. A committee of AFL craft unions undertook a successful membership drive in the steel industry in that year. When U.S. Steel refused to bargain, the committee called a strike, the failure of which was a sharp blow to the unionization drive. (Brody, 1965) In the same year, the United Mine Workers undertook a large strike and also lost. These two lost strikes and the 1920-21 depression took the impetus out of the union movement and led to severe membership losses that continued through the twenties. (Figure 6)

Under Samuel Gompers’s leadership, the AFL’s “business unionism” had attempted to promote the union and collective bargaining as the primary answer to the workers’ concerns with wages, hours, and working conditions. The AFL officially opposed any government actions that would have diminished worker attachment to unions by providing competing benefits, such as government sponsored unemployment insurance, minimum wage proposals, maximum hours proposals and social security programs. As Lloyd Ulman (1961) points out, the AFL, under Gompers’ direction, differentiated on the basis of whether the statute would or would not aid collective bargaining. After Gompers’ death, William Green led the AFL in a policy change as the AFL promoted the idea of union-management cooperation to improve output and promote greater employer acceptance of unions. But Irving Bernstein (1965) concludes that, on the whole, union-management cooperation in the twenties was a failure.

To combat the appeal of unions in the twenties, firms used the “yellow-dog” contract requiring employees to swear they were not union members and would not join one; the “American Plan” promoting the open shop and contending that the closed shop was un-American; and welfare capitalism. The most common aspects of welfare capitalism included personnel management to handle employment issues and problems, the doctrine of “high wages,” company group life insurance, old-age pension plans, stock-purchase plans, and more. Some firms formed company unions to thwart independent unionization and the number of company-controlled unions grew from 145 to 432 between 1919 and 1926.

Until the late thirties the AFL was a voluntary association of independent national craft unions. Craft unions relied upon the particular skills the workers had acquired (their craft) to distinguish the workers and provide barriers to the entry of other workers. Most craft unions required a period of apprenticeship before a worker was fully accepted as a journeyman worker. The skills, and often lengthy apprenticeship, constituted the entry barrier that gave the union its bargaining power. There were only a few unions that were closer to today’s industrial unions where the required skills were much less (or nonexistent) making the entry of new workers much easier. The most important of these industrial unions was the United Mine Workers, UMW.

The AFL had been created on two principles: the autonomy of the national unions and the exclusive jurisdiction of the national union.—Individual union members were not, in fact, members of the AFL; rather, they were members of the local and national union, and the national was a member of the AFL. Representation in the AFL gave dominance to the national unions, and, as a result, the AFL had little effective power over them. The craft lines, however, had never been distinct and increasingly became blurred. The AFL was constantly mediating jurisdictional disputes between member national unions. Because the AFL and its individual unions were not set up to appeal to and work for the relatively less skilled industrial workers, union organizing and growth lagged in the twenties.

Agriculture

The onset of the First World War in Europe brought unprecedented prosperity to American farmers. As agricultural production in Europe declined, the demand for American agricultural exports rose, leading to rising farm product prices and incomes. In response to this, American farmers expanded production by moving onto marginal farmland, such as Wisconsin cutover property on the edge of the woods and hilly terrain in the Ozark and Appalachian regions. They also increased output by purchasing more machinery, such as tractors, plows, mowers, and threshers. The price of farmland, particularly marginal farmland, rose in response to the increased demand, and the debt of American farmers increased substantially.

This expansion of American agriculture continued past the end of the First World War as farm exports to Europe and farm prices initially remained high. However, agricultural production in Europe recovered much faster than most observers had anticipated. Even before the onset of the short depression in 1920, farm exports and farm product prices had begun to fall. During the depression, farm prices virtually collapsed. From 1920 to 1921, the consumer price index fell 11.3 percent, the wholesale price index fell 45.9 percent, and the farm products price index fell 53.3 percent. (HSUS, Series E40, E42, and E135)

Real average net income per farm fell over 72.6 percent between 1920 and 1921 and, though rising in the twenties, never recovered the relative levels of 1918 and 1919. (Figure 7) Farm mortgage foreclosures rose and stayed at historically high levels for the entire decade of the 1920s. (Figure 8) The value of farmland and buildings fell throughout the twenties and, for the first time in American history, the number of cultivated acres actually declined as farmers pulled back from the marginal farmland brought into production during the war. Rather than indicators of a general depression in agriculture in the twenties, these were the results of the financial commitments made by overoptimistic American farmers during and directly after the war. The foreclosures were generally on second mortgages rather than on first mortgages as they were in the early 1930s. (Johnson, 1973; Alston, 1983)

A Declining Sector

A major difficulty in analyzing the interwar agricultural sector lies in separating the effects of the 1920-21 and 1929-33 depressions from those that arose because agriculture was declining relative to the other sectors. A relatively very slow growing demand for basic agricultural products and significant increases in the productivity of labor, land, and machinery in agricultural production combined with a much more rapid extensive economic growth in the nonagricultural sectors of the economy required a shift of resources, particularly labor, out of agriculture. (Figure 9) The market induces labor to voluntarily move from one sector to another through income differentials, suggesting that even in the absence of the effects of the depressions, farm incomes would have been lower than nonfarm incomes so as to bring about this migration.

The continuous substitution of tractor power for horse and mule power released hay and oats acreage to grow crops for human consumption. Though cotton and tobacco continued as the primary crops in the south, the relative production of cotton continued to shift to the west as production in Arkansas, Missouri, Oklahoma, Texas, New Mexico, Arizona, and California increased. As quotas reduced immigration and incomes rose, the demand for cereal grains grew slowly—more slowly than the supply—and the demand for fruits, vegetables, and dairy products grew. Refrigeration and faster freight shipments expanded the milk sheds further from metropolitan areas. Wisconsin and other North Central states began to ship cream and cheeses to the Atlantic Coast. Due to transportation improvements, specialized truck farms and the citrus industry became more important in California and Florida. (Parker, 1972; Soule, 1947)

The relative decline of the agricultural sector in this period was closely related to the highly inelastic income elasticity of demand for many farm products, particularly cereal grains, pork, and cotton. As incomes grew, the demand for these staples grew much more slowly. At the same time, rising land and labor productivity were increasing the supplies of staples, causing real prices to fall.

Table 3 presents selected agricultural productivity statistics for these years. Those data indicate that there were greater gains in labor productivity than in land productivity (or per acre yields). Per acre yields in wheat and hay actually decreased between 1915-19 and 1935-39. These productivity increases, which released resources from the agricultural sector, were the result of technological improvements in agriculture.

Technological Improvements In Agricultural Production

In many ways the adoption of the tractor in the interwar period symbolizes the technological changes that occurred in the agricultural sector. This changeover in the power source that farmers used had far-reaching consequences and altered the organization of the farm and the farmers’ lifestyle. The adoption of the tractor was land saving (by releasing acreage previously used to produce crops for workstock) and labor saving. At the same time it increased the risks of farming because farmers were now much more exposed to the marketplace. They could not produce their own fuel for tractors as they had for the workstock. Rather, this had to be purchased from other suppliers. Repair and replacement parts also had to be purchased, and sometimes the repairs had to be undertaken by specialized mechanics. The purchase of a tractor also commonly required the purchase of new complementary machines; therefore, the decision to purchase a tractor was not an isolated one. (White, 2001; Ankli, 1980; Ankli and Olmstead, 1981; Musoke, 1981; Whatley, 1987). These changes resulted in more and more farmers purchasing and using tractors, but the rate of adoption varied sharply across the United States.

Technological innovations in plants and animals also raised productivity. Hybrid seed corn increased yields from an average of 40 bushels per acre to 100 to 120 bushels per acre. New varieties of wheat were developed from the hardy Russian and Turkish wheat varieties which had been imported. The U.S. Department of Agriculture’s Experiment Stations took the lead in developing wheat varieties for different regions. For example, in the Columbia River Basin new varieties raised yields from an average of 19.1 bushels per acre in 1913-22 to 23.1 bushels per acre in 1933-42. (Shepherd, 1980) New hog breeds produced more meat and new methods of swine sanitation sharply increased the survival rate of piglets. An effective serum for hog cholera was developed, and the federal government led the way in the testing and eradication of bovine tuberculosis and brucellosis. Prior to the Second World War, a number of pesticides to control animal disease were developed, including cattle dips and disinfectants. By the mid-1920s a vaccine for “blackleg,” an infectious, usually fatal disease that particularly struck young cattle, was completed. The cattle tick, which carried Texas Fever, was largely controlled through inspections. (Schlebecker, 1975; Bogue, 1983; Wood, 1980)

Federal Agricultural Programs in the 1920s

Though there was substantial agricultural discontent in the period from the Civil War to late 1890s, the period from then to the onset of the First World War was relatively free from overt farmers’ complaints. In later years farmers dubbed the 1910-14 period as agriculture’s “golden years” and used the prices of farm crops and farm inputs in that period as a standard by which to judge crop and input prices in later years. The problems that arose in the agricultural sector during the twenties once again led to insistent demands by farmers for government to alleviate their distress.

Though there were increasing calls for direct federal government intervention to limit production and raise farm prices, this was not used until Roosevelt took office. Rather, there was a reliance upon the traditional method to aid injured groups—tariffs, and upon the “sanctioning and promotion of cooperative marketing associations.” In 1921 Congress attempted to control the grain exchanges and compel merchants and stockyards to charge “reasonable rates,” with the Packers and Stockyards Act and the Grain Futures Act. In 1922 Congress passed the Capper-Volstead Act to promote agricultural cooperatives and the Fordney-McCumber Tariff to impose high duties on most agricultural imports.—The Cooperative Marketing Act of 1924 did not bolster failing cooperatives as it was supposed to do. (Hoffman and Liebcap, 1991)

Twice between 1924 and 1928 Congress passed “McNary-Haugan” bills, but President Calvin Coolidge vetoed both. The McNary-Haugan bills proposed to establish “fair” exchange values (based on the 1910-14 period) for each product and to maintain them through tariffs and a private corporation that would be chartered by the government and could buy enough of each commodity to keep its price up to the computed fair level. The revenues were to come from taxes imposed on farmers. The Hoover administration passed the Hawley-Smoot tariff in 1930 and an Agricultural Marketing Act in 1929. This act committed the federal government to a policy of stabilizing farm prices through several nongovernment institutions but these failed during the depression. Federal intervention in the agricultural sector really came of age during the New Deal era of the 1930s.

Manufacturing

Agriculture was not the only sector experiencing difficulties in the twenties. Other industries, such as textiles, boots and shoes, and coal mining, also experienced trying times. However, at the same time that these industries were declining, other industries, such as electrical appliances, automobiles, and construction, were growing rapidly. The simultaneous existence of growing and declining industries has been common to all eras because economic growth and technological progress never affect all sectors in the same way. In general, in manufacturing there was a rapid rate of growth of productivity during the twenties. The rise of real wages due to immigration restrictions and the slower growth of the resident population spurred this. Transportation improvements and communications advances were also responsible. These developments brought about differential growth in the various manufacturing sectors in the United States in the 1920s.

Because of the historic pattern of economic development in the United States, the northeast was the first area to really develop a manufacturing base. By the mid-nineteenth century the East North Central region was creating a manufacturing base and the other regions began to create manufacturing bases in the last half of the nineteenth century resulting in a relative westward and southern shift of manufacturing activity. This trend continued in the 1920s as the New England and Middle Atlantic regions’ shares of manufacturing employment fell while all of the other regions—excluding the West North Central region—gained. There was considerable variation in the growth of the industries and shifts in their ranking during the decade. The largest broadly defined industries were, not surprisingly, food and kindred products; textile mill products; those producing and fabricating primary metals; machinery production; and chemicals. When industries are more narrowly defined, the automobile industry, which ranked third in manufacturing value added in 1919, ranked first by the mid-1920s.

Productivity Developments

Gavin Wright (1990) has argued that one of the underappreciated characteristics of American industrial history has been its reliance on mineral resources. Wright argues that the growing American strength in industrial exports and industrialization in general relied on an increasing intensity in nonreproducible natural resources. The large American market was knit together as one large market without internal barriers through the development of widespread low-cost transportation. Many distinctively American developments, such as continuous-process, mass-production methods were associated with the “high throughput” of fuel and raw materials relative to labor and capital inputs. As a result the United States became the dominant industrial force in the world 1920s and 1930s. According to Wright, after World War II “the process by which the United States became a unified ‘economy’ in the nineteenth century has been extended to the world as a whole. To a degree, natural resources have become commodities rather than part of the ‘factor endowment’ of individual countries.” (Wright, 1990)

In addition to this growing intensity in the use of nonreproducible natural resources as a source of productivity gains in American manufacturing, other technological changes during the twenties and thirties tended to raise the productivity of the existing capital through the replacement of critical types of capital equipment with superior equipment and through changes in management methods. (Soule, 1947; Lorant, 1967; Devine, 1983; Oshima, 1984) Some changes, such as the standardization of parts and processes and the reduction of the number of styles and designs, raised the productivity of both capital and labor. Modern management techniques, first introduced by Frederick W. Taylor, were introduced on a wider scale.

One of the important forces contributing to mass production and increased productivity was the transfer to electric power. (Devine, 1983) By 1929 about 70 percent of manufacturing activity relied on electricity, compared to roughly 30 percent in 1914. Steam provided 80 percent of the mechanical drive capacity in manufacturing in 1900, but electricity provided over 50 percent by 1920 and 78 percent by 1929. An increasing number of factories were buying their power from electric utilities. In 1909, 64 percent of the electric motor capacity in manufacturing establishments used electricity generated on the factory site; by 1919, 57 percent of the electricity used in manufacturing was purchased from independent electric utilities.

The shift from coal to oil and natural gas and from raw unprocessed energy in the forms of coal and waterpower to processed energy in the form of internal combustion fuel and electricity increased thermal efficiency. After the First World War energy consumption relative to GNP fell, there was a sharp increase in the growth rate of output per labor-hour, and the output per unit of capital input once again began rising. These trends can be seen in the data in Table 3. Labor productivity grew much more rapidly during the 1920s than in the previous or following decade. Capital productivity had declined in the decade previous to the 1920s while it also increased sharply during the twenties and continued to rise in the following decade. Alexander Field (2003) has argued that the 1930s were the most technologically progressive decade of the twentieth century basing his argument on the growth of multi-factor productivity as well as the impressive array of technological developments during the thirties. However, the twenties also saw impressive increases in labor and capital productivity as, particularly, developments in energy and transportation accelerated.

 Average Annual Rates of Labor Productivity and Capital Productivity Growth.

Warren Devine, Jr. (1983) reports that in the twenties the most important result of the adoption of electricity was that it would be an indirect “lever to increase production.” There were a number of ways in which this occurred. Electricity brought about an increased flow of production by allowing new flexibility in the design of buildings and the arrangement of machines. In this way it maximized throughput. Electric cranes were an “inestimable boon” to production because with adequate headroom they could operate anywhere in a plant, something that mechanical power transmission to overhead cranes did not allow. Electricity made possible the use of portable power tools that could be taken anywhere in the factory. Electricity brought about improved illumination, ventilation, and cleanliness in the plants, dramatically improving working conditions. It improved the control of machines since there was no longer belt slippage with overhead line shafts and belt transmission, and there were less limitations on the operating speeds of machines. Finally, it made plant expansion much easier than when overhead shafts and belts had been relied upon for operating power.

The mechanization of American manufacturing accelerated in the 1920s, and this led to a much more rapid growth of productivity in manufacturing compared to earlier decades and to other sectors at that time. There were several forces that promoted mechanization. One was the rapidly expanding aggregate demand during the prosperous twenties. Another was the technological developments in new machines and processes, of which electrification played an important part. Finally, Harry Jerome (1934) and, later, Harry Oshima (1984) both suggest that the price of unskilled labor began to rise as immigration sharply declined with new immigration laws and falling population growth. This accelerated the mechanization of the nation’s factories.

Technological changes during this period can be documented for a number of individual industries. In bituminous coal mining, labor productivity rose when mechanical loading devices reduced the labor required from 24 to 50 percent. The burst of paved road construction in the twenties led to the development of a finishing machine to smooth the surface of cement highways, and this reduced the labor requirement from 40 to 60 percent. Mechanical pavers that spread centrally mixed materials further increased productivity in road construction. These replaced the roadside dump and wheelbarrow methods of spreading the cement. Jerome (1934) reports that the glass in electric light bulbs was made by new machines that cut the number of labor-hours required for their manufacture by nearly half. New machines to produce cigarettes and cigars, for warp-tying in textile production, and for pressing clothes in clothing shops also cut labor-hours. The Banbury mixer reduced the labor input in the production of automobile tires by half, and output per worker of inner tubes increased about four times with a new production method. However, as Daniel Nelson (1987) points out, the continuing advances were the “cumulative process resulting from a vast number of successive small changes.” Because of these continuing advances in the quality of the tires and in the manufacturing of tires, between 1910 and 1930 “tire costs per thousand miles of driving fell from $9.39 to $0.65.”

John Lorant (1967) has documented other technological advances that occurred in American manufacturing during the twenties. For example, the organic chemical industry developed rapidly due to the introduction of the Weizman fermentation process. In a similar fashion, nearly half of the productivity advances in the paper industry were due to the “increasingly sophisticated applications of electric power and paper manufacturing processes,” especially the fourdrinier paper-making machines. As Avi Cohen (1984) has shown, the continuing advances in these machines were the result of evolutionary changes to the basic machine. Mechanization in many types of mass-production industries raised the productivity of labor and capital. In the glass industry, automatic feeding and other types of fully automatic production raised the efficiency of the production of glass containers, window glass, and pressed glass. Giedion (1948) reported that the production of bread was “automatized” in all stages during the 1920s.

Though not directly bringing about productivity increases in manufacturing processes, developments in the management of manufacturing firms, particularly the largest ones, also significantly affected their structure and operation. Alfred D. Chandler, Jr. (1962) has argued that the structure of a firm must follow its strategy. Until the First World War most industrial firms were centralized, single-division firms even when becoming vertically integrated. When this began to change the management of the large industrial firms had to change accordingly.

Because of these changes in the size and structure of the firm during the First World War, E. I. du Pont de Nemours and Company was led to adopt a strategy of diversifying into the production of largely unrelated product lines. The firm found that the centralized, divisional structure that had served it so well was not suited to this strategy, and its poor business performance led its executives to develop between 1919 and 1921 a decentralized, multidivisional structure that boosted it to the first rank among American industrial firms.

General Motors had a somewhat different problem. By 1920 it was already decentralized into separate divisions. In fact, there was so much decentralization that those divisions essentially remained separate companies and there was little coordination between the operating divisions. A financial crisis at the end of 1920 ousted W. C. Durant and brought in the du Ponts and Alfred Sloan. Sloan, who had seen the problems at GM but had been unable to convince Durant to make changes, began reorganizing the management of the company. Over the next several years Sloan and other GM executives developed the general office for a decentralized, multidivisional firm.

Though facing related problems at nearly the same time, GM and du Pont developed their decentralized, multidivisional organizations separately. As other manufacturing firms began to diversify, GM and du Pont became the models for reorganizing the management of the firms. In many industrial firms these reorganizations were not completed until well after the Second World War.

Competition, Monopoly, and the Government

The rise of big businesses, which accelerated in the postbellum period and particularly during the first great turn-of-the-century merger wave, continued in the interwar period. Between 1925 and 1939 the share of manufacturing assets held by the 100 largest corporations rose from 34.5 to 41.9 percent. (Niemi, 1980) As a public policy, the concern with monopolies diminished in the 1920s even though firms were growing larger. But the growing size of businesses was one of the convenient scapegoats upon which to blame the Great Depression.

However, the rise of large manufacturing firms in the interwar period is not so easily interpreted as an attempt to monopolize their industries. Some of the growth came about through vertical integration by the more successful manufacturing firms. Backward integration was generally an attempt to ensure a smooth supply of raw materials where that supply was not plentiful and was dispersed and firms “feared that raw materials might become controlled by competitors or independent suppliers.” (Livesay and Porter, 1969) Forward integration was an offensive tactic employed when manufacturers found that the existing distribution network proved inadequate. Livesay and Porter suggested a number of reasons why firms chose to integrate forward. In some cases they had to provide the mass distribution facilities to handle their much larger outputs; especially when the product was a new one. The complexity of some new products required technical expertise that the existing distribution system could not provide. In other cases “the high unit costs of products required consumer credit which exceeded financial capabilities of independent distributors.” Forward integration into wholesaling was more common than forward integration into retailing. The producers of automobiles, petroleum, typewriters, sewing machines, and harvesters were typical of those manufacturers that integrated all the way into retailing.

In some cases, increases in industry concentration arose as a natural process of industrial maturation. In the automobile industry, Henry Ford’s invention in 1913 of the moving assembly line—a technological innovation that changed most manufacturing—lent itself to larger factories and firms. Of the several thousand companies that had produced cars prior to 1920, 120 were still doing so then, but Ford and General Motors were the clear leaders, together producing nearly 70 percent of the cars. During the twenties, several other companies, such as Durant, Willys, and Studebaker, missed their opportunity to become more important producers, and Chrysler, formed in early 1925, became the third most important producer by 1930. Many went out of business and by 1929 only 44 companies were still producing cars. The Great Depression decimated the industry. Dozens of minor firms went out of business. Ford struggled through by relying on its huge stockpile of cash accumulated prior to the mid-1920s, while Chrysler actually grew. By 1940, only eight companies still produced cars—GM, Ford, and Chrysler had about 85 percent of the market, while Willys, Studebaker, Nash, Hudson, and Packard shared the remainder. The rising concentration in this industry was not due to attempts to monopolize. As the industry matured, growing economies of scale in factory production and vertical integration, as well as the advantages of a widespread dealer network, led to a dramatic decrease in the number of viable firms. (Chandler, 1962 and 1964; Rae, 1984; Bernstein, 1987)

It was a similar story in the tire industry. The increasing concentration and growth of firms was driven by scale economies in production and retailing and by the devastating effects of the depression in the thirties. Although there were 190 firms in 1919, 5 firms dominated the industry—Goodyear, B. F. Goodrich, Firestone, U.S. Rubber, and Fisk, followed by Miller Rubber, General Tire and Rubber, and Kelly-Springfield. During the twenties, 166 firms left the industry while 66 entered. The share of the 5 largest firms rose from 50 percent in 1921 to 75 percent in 1937. During the depressed thirties, there was fierce price competition, and many firms exited the industry. By 1937 there were 30 firms, but the average employment per factory was 4.41 times as large as in 1921, and the average factory produced 6.87 times as many tires as in 1921. (French, 1986 and 1991; Nelson, 1987; Fricke, 1982)

The steel industry was already highly concentrated by 1920 as U.S. Steel had around 50 percent of the market. But U. S. Steel’s market share declined through the twenties and thirties as several smaller firms competed and grew to become known as Little Steel, the next six largest integrated producers after U. S. Steel. Jonathan Baker (1989) has argued that the evidence is consistent with “the assumption that competition was a dominant strategy for steel manufacturers” until the depression. However, the initiation of the National Recovery Administration (NRA) codes in 1933 required the firms to cooperate rather than compete, and Baker argues that this constituted a training period leading firms to cooperate in price and output policies after 1935. (McCraw and Reinhardt, 1989; Weiss, 1980; Adams, 1977)

Mergers

A number of the larger firms grew by merger during this period, and the second great merger wave in American industry occurred during the last half of the 1920s. Figure 10 shows two series on mergers during the interwar period. The FTC series included many of the smaller mergers. The series constructed by Carl Eis (1969) only includes the larger mergers and ends in 1930.

This second great merger wave coincided with the stock market boom of the twenties and has been called “merger for oligopoly” rather than merger for monopoly. (Stigler, 1950) This merger wave created many larger firms that ranked below the industry leaders. Much of the activity in occurred in the banking and public utilities industries. (Markham, 1955) In manufacturing and mining, the effects on industrial structure were less striking. Eis (1969) found that while mergers took place in almost all industries, they were concentrated in a smaller number of them, particularly petroleum, primary metals, and food products.

The federal government’s antitrust policies toward business varied sharply during the interwar period. In the 1920s there was relatively little activity by the Justice Department, but after the Great Depression the New Dealers tried to take advantage of big business to make business exempt from the antitrust laws and cartelize industries under government supervision.

With the passage of the FTC and Clayton Acts in 1914 to supplement the 1890 Sherman Act, the cornerstones of American antitrust law were complete. Though minor amendments were later enacted, the primary changes after that came in the enforcement of the laws and in swings in judicial decisions. Their two primary areas of application were in the areas of overt behavior, such as horizontal and vertical price-fixing, and in market structure, such as mergers and dominant firms. Horizontal price-fixing involves firms that would normally be competitors getting together to agree on stable and higher prices for their products. As long as most of the important competitors agree on the new, higher prices, substitution between products is eliminated and the demand becomes much less elastic. Thus, increasing the price increases the revenues and the profits of the firms who are fixing prices. Vertical price-fixing involves firms setting the prices of intermediate products purchased at different stages of production. It also tends to eliminate substitutes and makes the demand less elastic.

Price-fixing continued to be considered illegal throughout the period, but there was no major judicial activity regarding it in the 1920s other than the Trenton Potteries decision in 1927. In that decision 20 individuals and 23 corporations were found guilty of conspiring to fix the prices of bathroom bowls. The evidence in the case suggested that the firms were not very successful at doing so, but the court found that they were guilty nevertheless; their success, or lack thereof, was not held to be a factor in the decision. (Scherer and Ross, 1990) Though criticized by some, the decision was precedent setting in that it prohibited explicit pricing conspiracies per se.

The Justice Department had achieved success in dismantling Standard Oil and American Tobacco in 1911 through decisions that the firms had unreasonably restrained trade. These were essentially the same points used in court decisions against the Powder Trust in 1911, the thread trust in 1913, Eastman Kodak in 1915, the glucose and cornstarch trust in 1916, and the anthracite railroads in 1920. The criterion of an unreasonable restraint of trade was used in the 1916 and 1918 decisions that found the American Can Company and the United Shoe Machinery Company innocent of violating the Sherman Act; it was also clearly enunciated in the 1920 U. S. Steel decision. This became known as the rule of reason standard in antitrust policy.

Merger policy had been defined in the 1914 Clayton Act to prohibit only the acquisition of one corporation’s stock by another corporation. Firms then shifted to the outright purchase of a competitor’s assets. A series of court decisions in the twenties and thirties further reduced the possibilities of Justice Department actions against mergers. “Only fifteen mergers were ordered dissolved through antitrust actions between 1914 and 1950, and ten of the orders were accomplished under the Sherman Act rather than Clayton Act proceedings.”

Energy

The search for energy and new ways to translate it into heat, light, and motion has been one of the unending themes in history. From whale oil to coal oil to kerosene to electricity, the search for better and less costly ways to light our lives, heat our homes, and move our machines has consumed much time and effort. The energy industries responded to those demands and the consumption of energy materials (coal, oil, gas, and fuel wood) as a percent of GNP rose from about 2 percent in the latter part of the nineteenth century to about 3 percent in the twentieth.

Changes in the energy markets that had begun in the nineteenth century continued. Processed energy in the forms of petroleum derivatives and electricity continued to become more important than “raw” energy, such as that available from coal and water. The evolution of energy sources for lighting continued; at the end of the nineteenth century, natural gas and electricity, rather than liquid fuels began to provide more lighting for streets, businesses, and homes.

In the twentieth century the continuing shift to electricity and internal combustion fuels increased the efficiency with which the American economy used energy. These processed forms of energy resulted in a more rapid increase in the productivity of labor and capital in American manufacturing. From 1899 to 1919, output per labor-hour increased at an average annual rate of 1.2 percent, whereas from 1919 to 1937 the increase was 3.5 percent per year. The productivity of capital had fallen at an average annual rate of 1.8 percent per year in the 20 years prior to 1919, but it rose 3.1 percent a year in the 18 years after 1919. As discussed above, the adoption of electricity in American manufacturing initiated a rapid evolution in the organization of plants and rapid increases in productivity in all types of manufacturing.

The change in transportation was even more remarkable. Internal combustion engines running on gasoline or diesel fuel revolutionized transportation. Cars quickly grabbed the lion’s share of local and regional travel and began to eat into long distance passenger travel, just as the railroads had done to passenger traffic by water in the 1830s. Even before the First World War cities had begun passing laws to regulate and limit “jitney” services and to protect the investments in urban rail mass transit. Trucking began eating into the freight carried by the railroads.

These developments brought about changes in the energy industries. Coal mining became a declining industry. As Figure 11 shows, in 1925 the share of petroleum in the value of coal, gas, and petroleum output exceeded bituminous coal, and it continued to rise. Anthracite coal’s share was much smaller and it declined while natural gas and LP (or liquefied petroleum) gas were relatively unimportant. These changes, especially the declining coal industry, were the source of considerable worry in the twenties.

Coal

One of the industries considered to be “sick” in the twenties was coal, particularly bituminous, or soft, coal. Income in the industry declined, and bankruptcies were frequent. Strikes frequently interrupted production. The majority of the miners “lived in squalid and unsanitary houses, and the incidence of accidents and diseases was high.” (Soule, 1947) The number of operating bituminous coal mines declined sharply from 1923 through 1932. Anthracite (or hard) coal output was much smaller during the twenties. Real coal prices rose from 1919 to 1922, and bituminous coal prices fell sharply from then to 1925. (Figure 12) Coal mining employment plummeted during the twenties. Annual earnings, especially in bituminous coal mining, also fell because of dwindling hourly earnings and, from 1929 on, a shrinking workweek. (Figure 13)

The sources of these changes are to be found in the increasing supply due to productivity advances in coal production and in the decreasing demand for coal. The demand fell as industries began turning from coal to electricity and because of productivity advances in the use of coal to create energy in steel, railroads, and electric utilities. (Keller, 1973) In the generation of electricity, larger steam plants employing higher temperatures and steam pressures continued to reduce coal consumption per kilowatt hour. Similar reductions were found in the production of coke from coal for iron and steel production and in the use of coal by the steam railroad engines. (Rezneck, 1951) All of these factors reduced the demand for coal.

Productivity advances in coal mining tended to be labor saving. Mechanical cutting accounted for 60.7 percent of the coal mined in 1920 and 78.4 percent in 1929. By the middle of the twenties, the mechanical loading of coal began to be introduced. Between 1929 and 1939, output per labor-hour rose nearly one third in bituminous coal mining and nearly four fifths in anthracite as more mines adopted machine mining and mechanical loading and strip mining expanded.

The increasing supply and falling demand for coal led to the closure of mines that were too costly to operate. A mine could simply cease operations, let the equipment stand idle, and lay off employees. When bankruptcies occurred, the mines generally just turned up under new ownership with lower capital charges. When demand increased or strikes reduced the supply of coal, idle mines simply resumed production. As a result, the easily expanded supply largely eliminated economic profits.

The average daily employment in coal mining dropped by over 208,000 from its peak in 1923, but the sharply falling real wages suggests that the supply of labor did not fall as rapidly as the demand for labor. Soule (1947) notes that when employment fell in coal mining, it meant fewer days of work for the same number of men. Social and cultural characteristics tended to tie many to their home region. The local alternatives were few, and ignorance of alternatives outside the Appalachian rural areas, where most bituminous coal was mined, made it very costly to transfer out.

Petroleum

In contrast to the coal industry, the petroleum industry was growing throughout the interwar period. By the thirties, crude petroleum dominated the real value of the production of energy materials. As Figure 14 shows, the production of crude petroleum increased sharply between 1920 and 1930, while real petroleum prices, though highly variable, tended to decline.

The growing demand for petroleum was driven by the growth in demand for gasoline as America became a motorized society. The production of gasoline surpassed kerosene production in 1915. Kerosene’s market continued to contract as electric lighting replaced kerosene lighting. The development of oil burners in the twenties began a switch from coal toward fuel oil for home heating, and this further increased the growing demand for petroleum. The growth in the demand for fuel oil and diesel fuel for ship engines also increased petroleum demand. But it was the growth in the demand for gasoline that drove the petroleum market.

The decline in real prices in the latter part of the twenties shows that supply was growing even faster than demand. The discovery of new fields in the early twenties increased the supply of petroleum and led to falling prices as production capacity grew. The Santa Fe Springs, California strike in 1919 initiated a supply shock as did the discovery of the Long Beach, California field in 1921. New discoveries in Powell, Texas and Smackover Arkansas further increased the supply of petroleum in 1921. New supply increases occurred in 1926 to 1928 with petroleum strikes in Seminole, Oklahoma and Hendricks, Texas. The supply of oil increased sharply in 1930 to 1931 with new discoveries in Oklahoma City and East Texas. Each new discovery pushed down real oil prices, and the prices of petroleum derivatives, and the growing production capacity led to a general declining trend in petroleum prices. McMillin and Parker (1994) argue that supply shocks generated by these new discoveries were a factor in the business cycles during the 1920s.

The supply of gasoline increased more than the supply of crude petroleum. In 1913 a chemist at Standard Oil of Indiana introduced the cracking process to refine crude petroleum; until that time it had been refined by distillation or unpressurized heating. In the heating process, various refined products such as kerosene, gasoline, naphtha, and lubricating oils were produced at different temperatures. It was difficult to vary the amount of the different refined products produced from a barrel of crude. The cracking process used pressurized heating to break heavier components down into lighter crude derivatives; with cracking, it was possible to increase the amount of gasoline obtained from a barrel of crude from 15 to 45 percent. In the early twenties, chemists at Standard Oil of New Jersey improved the cracking process, and by 1927 it was possible to obtain twice as much gasoline from a barrel of crude petroleum as in 1917.

The petroleum companies also developed new ways to distribute gasoline to motorists that made it more convenient to purchase gasoline. Prior to the First World War, gasoline was commonly purchased in one- or five-gallon cans and the purchaser used a funnel to pour the gasoline from the can into the car. Then “filling stations” appeared, which specialized in filling cars’ tanks with gasoline. These spread rapidly, and by 1919 gasoline companies werebeginning to introduce their own filling stations or contract with independent stations to exclusively distribute their gasoline. Increasing competition and falling profits led filling station operators to expand into other activities such as oil changes and other mechanical repairs. The general name attached to such stations gradually changed to “service stations” to reflect these new functions.

Though the petroleum firms tended to be large, they were highly competitive, trying to pump as much petroleum as possible to increase their share of the fields. This, combined with the development of new fields, led to an industry with highly volatile prices and output. Firms desperately wanted to stabilize and reduce the production of crude petroleum so as to stabilize and raise the prices of crude petroleum and refined products. Unable to obtain voluntary agreement on output limitations by the firms and producers, governments began stepping in. Led by Texas, which created the Texas Railroad Commission in 1891, oil-producing states began to intervene to regulate production. Such laws were usually termed prorationing laws and were quotas designed to limit each well’s output to some fraction of its potential. The purpose was as much to stabilize and reduce production and raise prices as anything else, although generally such laws were passed under the guise of conservation. Although the federal government supported such attempts, not until the New Deal were federal laws passed to assist this.

Electricity

By the mid 1890s the debate over the method by which electricity was to be transmitted had been won by those who advocated alternating current. The reduced power losses and greater distance over which electricity could be transmitted more than offset the necessity for transforming the current back to direct current for general use. Widespread adoption of machines and appliances by industry and consumers then rested on an increase in the array of products using electricity as the source of power, heat, or light and the development of an efficient, lower cost method of generating electricity.

General Electric, Westinghouse, and other firms began producing the electrical appliances for homes and an increasing number of machines based on electricity began to appear in industry. The problem of lower cost production was solved by the introduction of centralized generating facilities that distributed the electric power through lines to many consumers and business firms.

Though initially several firms competed in generating and selling electricity to consumers and firms in a city or area, by the First World War many states and communities were awarding exclusive franchises to one firm to generate and distribute electricity to the customers in the franchise area. (Bright, 1947; Passer, 1953) The electric utility industry became an important growth industry and, as Figure 15 shows, electricity production and use grew rapidly.

The electric utilities increasingly were regulated by state commissions that were charged with setting rates so that the utilities could receive a “fair return” on their investments. Disagreements over what constituted a “fair return” and the calculation of the rate base led to a steady stream of cases before the commissions and a continuing series of court appeals. Generally these court decisions favored the reproduction cost basis. Because of the difficulty and cost in making these calculations, rates tended to be in the hands of the electric utilities that, it has been suggested, did not lower rates adequately to reflect the rising productivity and lowered costs of production. The utilities argued that a more rapid lowering of rates would have jeopardized their profits. Whether or not this increased their monopoly power is still an open question, but it should be noted, that electric utilities were hardly price-taking industries prior to regulation. (Mercer, 1973) In fact, as Figure 16 shows, the electric utilities began to systematically practice market segmentation charging users with less elastic demands, higher prices per kilowatt-hour.

Energy in the American Economy of the 1920s

The changes in the energy industries had far-reaching consequences. The coal industry faced a continuing decline in demand. Even in the growing petroleum industry, the periodic surges in the supply of petroleum caused great instability. In manufacturing, as described above, electrification contributed to a remarkable rise in productivity. The transportation revolution brought about by the rise of gasoline-powered trucks and cars changed the way businesses received their supplies and distributed their production as well as where they were located. The suburbanization of America and the beginnings of urban sprawl were largely brought about by the introduction of low-priced gasoline for cars.

Transportation

The American economy was forever altered by the dramatic changes in transportation after 1900. Following Henry Ford’s introduction of the moving assembly production line in 1914, automobile prices plummeted, and by the end of the 1920s about 60 percent of American families owned an automobile. The advent of low-cost personal transportation led to an accelerating movement of population out of the crowded cities to more spacious homes in the suburbs and the automobile set off a decline in intracity public passenger transportation that has yet to end. Massive road-building programs facilitated the intercity movement of people and goods. Trucks increasingly took over the movement of freight in competition with the railroads. New industries, such as gasoline service stations, motor hotels, and the rubber tire industry, arose to service the automobile and truck traffic. These developments were complicated by the turmoil caused by changes in the federal government’s policies toward transportation in the United States.

With the end of the First World War, a debate began as to whether the railroads, which had been taken over by the government, should be returned to private ownership or nationalized. The voices calling for a return to private ownership were much stronger, but doing so fomented great controversy. Many in Congress believed that careful planning and consolidation could restore the railroads and make them more efficient. There was continued concern about the near monopoly that the railroads had on the nation’s intercity freight and passenger transportation. The result of these deliberations was the Transportation Act of 1920, which was premised on the continued domination of the nation’s transportation by the railroads—an erroneous presumption.

The Transportation Act of 1920 presented a marked change in the Interstate Commerce Commission’s ability to control railroads. The ICC was allowed to prescribe exact rates that were to be set so as to allow the railroads to earn a fair return, defined as 5.5 percent, on the fair value of their property. The ICC was authorized to make an accounting of the fair value of each regulated railroad’s property; however, this was not completed until well into the 1930s, by which time the accounting and rate rules were out of date. To maintain fair competition between railroads in a region, all roads were to have the same rates for the same goods over the same distance. With the same rates, low-cost roads should have been able to earn higher rates of return than high-cost roads. To handle this, a recapture clause was inserted: any railroad earning a return of more than 6 percent on the fair value of its property was to turn the excess over to the ICC, which would place half of the money in a contingency fund for the railroad when it encountered financial problems and the other half in a contingency fund to provide loans to other railroads in need of assistance.

In order to address the problem of weak and strong railroads and to bring better coordination to the movement of rail traffic in the United States, the act was directed to encourage railroad consolidation, but little came of this in the 1920s. In order to facilitate its control of the railroads, the ICC was given two additional powers. The first was the control over the issuance or purchase of securities by railroads, and the second was the power to control changes in railroad service through the control of car supply and the extension and abandonment of track. The control of the supply of rail cars was turned over to the Association of American Railroads. Few extensions of track were proposed, but as time passed, abandonment requests grew. The ICC, however, trying to mediate between the conflicting demands of shippers, communities and railroads, generally refused to grant abandonments, and this became an extremely sensitive issue in the 1930s.

As indicated above, the premises of the Transportation Act of 1920 were wrong. Railroads experienced increasing competition during the 1920s, and both freight and passenger traffic were drawn off to competing transport forms. Passenger traffic exited from the railroads much more quickly. As the network of all weather surfaced roads increased, people quickly turned from the train to the car. Harmed even more by the move to automobile traffic were the electric interurban railways that had grown rapidly just prior to the First World War. (Hilton-Due, 1960) Not surprisingly, during the 1920s few railroads earned profits in excess of the fair rate of return.

The use of trucks to deliver freight began shortly after the turn of the century. Before the outbreak of war in Europe, White and Mack were producing trucks with as much as 7.5 tons of carrying capacity. Most of the truck freight was carried on a local basis, and it largely supplemented the longer distance freight transportation provided by the railroads. However, truck size was growing. In 1915 Trailmobile introduced the first four-wheel trailer designed to be pulled by a truck tractor unit. During the First World War, thousands of trucks were constructed for military purposes, and truck convoys showed that long distance truck travel was feasible and economical. The use of trucks to haul freight had been growing by over 18 percent per year since 1925, so that by 1929 intercity trucking accounted for more than one percent of the ton-miles of freight hauled.

The railroads argued that the trucks and buses provided “unfair” competition and believed that if they were also regulated, then the regulation could equalize the conditions under which they competed. As early as 1925, the National Association of Railroad and Utilities Commissioners issued a call for the regulation of motor carriers in general. In 1928 the ICC called for federal regulation of buses and in 1932 extended this call to federal regulation of trucks.

Most states had began regulating buses at the beginning of the 1920s in an attempt to reduce the diversion of urban passenger traffic from the electric trolley and railway systems. However, most of the regulation did not aim to control intercity passenger traffic by buses. As the network of surfaced roads expanded during the twenties, so did the routes of the intercity buses. In 1929 a number of smaller bus companies were incorporated in the Greyhound Buslines, the carrier that has since dominated intercity bus transportation. (Walsh, 2000)

A complaint of the railroads was that interstate trucking competition was unfair because it was subsidized while railroads were not. All railroad property was privately owned and subject to property taxes, whereas truckers used the existing road system and therefore neither had to bear the costs of creating the road system nor pay taxes upon it. Beginning with the Federal Road-Aid Act of 1916, small amounts of money were provided as an incentive for states to construct rural post roads. (Dearing-Owen, 1949) However, through the First World War most of the funds for highway construction came from a combination of levies on the adjacent property owners and county and state taxes. The monies raised by the counties were commonly 60 percent of the total funds allocated, and these primarily came from property taxes. In 1919 Oregon pioneered the state gasoline tax, which then began to be adopted by more and more states. A highway system financed by property taxes and other levies can be construed as a subsidization of motor vehicles, and one study for the period up to 1920 found evidence of substantial subsidization of trucking. (Herbst-Wu, 1973) However, the use of gasoline taxes moved closer to the goal of users paying the costs of the highways. Neither did the trucks have to pay for all of the highway construction because automobiles jointly used the highways. Highways had to be constructed in more costly ways in order to accommodate the larger and heavier trucks. Ideally the gasoline taxes collected from trucks should have covered the extra (or marginal) costs of highway construction incurred because of the truck traffic. Gasoline taxes tended to do this.

The American economy occupies a vast geographic region. Because economic activity occurs over most of the country, falling transportation costs have been crucial to knitting American firms and consumers into a unified market. Throughout the nineteenth century the railroads played this crucial role. Because of the size of the railroad companies and their importance in the economic life of Americans, the federal government began to regulate them. But, by 1917 it appeared that the railroad system had achieved some stability, and it was generally assumed that the post-First World War era would be an extension of the era from 1900 to 1917. Nothing could have been further from the truth. Spurred by public investments in highways, cars and trucks voraciously ate into the railroad’s market, and, though the regulators failed to understand this at the time, the railroad’s monopoly on transportation quickly disappeared.

Communications

Communications had joined with transportation developments in the nineteenth century to tie the American economy together more completely. The telegraph had benefited by using the railroads’ right-of-ways, and the railroads used the telegraph to coordinate and organize their far-flung activities. As the cost of communications fell and information transfers sped, the development of firms with multiple plants at distant locations was facilitated. The interwar era saw a continuation of these developments as the telephone continued to supplant the telegraph and the new medium of radio arose to transmit news and provide a new entertainment source.

Telegraph domination of business and personal communications had given way to the telephone as long distance telephone calls between the east and west coasts with the new electronic amplifiers became possible in 1915. The number of telegraph messages handled grew 60.4 percent in the twenties. The number of local telephone conversations grew 46.8 percent between 1920 and 1930, while the number of long distance conversations grew 71.8 percent over the same period. There were 5 times as many long distance telephone calls as telegraph messages handled in 1920, and 5.7 times as many in 1930.

The twenties were a prosperous period for AT&T and its 18 major operating companies. (Brooks, 1975; Temin, 1987; Garnet, 1985; Lipartito, 1989) Telephone usage rose and, as Figure 19 shows, the share of all households with a telephone rose from 35 percent to nearly 42 percent. In cities across the nation, AT&T consolidated its system, gained control of many operating companies, and virtually eliminated its competitors. It was able to do this because in 1921 Congress passed the Graham Act exempting AT&T from the Sherman Act in consolidating competing telephone companies. By 1940, the non-Bell operating companies were all small relative to the Bell operating companies.

Surprisingly there was a decline in telephone use on the farms during the twenties. (Hadwiger-Cochran, 1984; Fischer 1987) Rising telephone rates explain part of the decline in rural use. The imposition of connection fees during the First World War made it more costly for new farmers to hook up. As AT&T gained control of more and more operating systems, telephone rates were increased. AT&T also began requiring, as a condition of interconnection, that independent companies upgrade their systems to meet AT&T standards. Most of the small mutual companies that had provided service to farmers had operated on a shoestring—wires were often strung along fenceposts, and phones were inexpensive “whoop and holler” magneto units. Upgrading to AT&T’s standards raised costs, forcing these companies to raise rates.

However, it also seems likely that during the 1920s there was a general decline in the rural demand for telephone services. One important factor in this was the dramatic decline in farm incomes in the early twenties. The second reason was a change in the farmers’ environment. Prior to the First World War, the telephone eased farm isolation and provided news and weather information that was otherwise hard to obtain. After 1920 automobiles, surfaced roads, movies, and the radio loosened the isolation and the telephone was no longer as crucial.

Othmar Merganthaler’s development of the linotype machine in the late nineteenth century had irrevocably altered printing and publishing. This machine, which quickly created a line of soft, lead-based metal type that could be printed, melted down and then recast as a new line of type, dramatically lowered the costs of printing. Previously, all type had to be painstakingly set by hand, with individual cast letter matrices picked out from compartments in drawers to construct words, lines, and paragraphs. After printing, each line of type on the page had to be broken down and each individual letter matrix placed back into its compartment in its drawer for use in the next printing job. Newspapers often were not published every day and did not contain many pages, resulting in many newspapers in most cities. In contrast to this laborious process, the linotype used a keyboard upon which the operator typed the words in one of the lines in a news column. Matrices for each letter dropped down from a magazine of matrices as the operator typed each letter and were assembled into a line of type with automatic spacers to justify the line (fill out the column width). When the line was completed the machine mechanically cast the line of matrices into a line of lead type. The line of lead type was ejected into a tray and the letter matrices mechanically returned to the magazine while the operator continued typing the next line in the news story. The first Merganthaler linotype machine was installed in the New York Tribune in 1886. The linotype machine dramatically lowered the costs of printing newspapers (as well as books and magazines). Prior to the linotype a typical newspaper averaged no more than 11 pages and many were published only a few times a week. The linotype machine allowed newspapers to grow in size and they began to be published more regularly. A process of consolidation of daily and Sunday newspapers began that continues to this day. Many have termed the Merganthaler linotype machine the most significant printing invention since the introduction of movable type 400 years earlier.

For city families as well as farm families, radio became the new source of news and entertainment. (Barnouw, 1966; Rosen, 1980 and 1987; Chester-Garrison, 1950) It soon took over as the prime advertising medium and in the process revolutionized advertising. By 1930 more homes had radio sets than had telephones. The radio networks sent news and entertainment broadcasts all over the country. The isolation of rural life, particularly in many areas of the plains, was forever broken by the intrusion of the “black box,” as radio receivers were often called. The radio began a process of breaking down regionalism and creating a common culture in the United States.

The potential demand for radio became clear with the first regular broadcast of Westinghouse’s KDKA in Pittsburgh in the fall of 1920. Because the Department of Commerce could not deny a license application there was an explosion of stations all broadcasting at the same frequency and signal jamming and interference became a serious problem. By 1923 the Department of Commerce had gained control of radio from the Post Office and the Navy and began to arbitrarily disperse stations on the radio dial and deny licenses creating the first market in commercial broadcast licenses. In 1926 a U.S. District Court decided that under the Radio Law of 1912 Herbert Hoover, the secretary of commerce, did not have this power. New stations appeared and the logjam and interference of signals worsened. A Radio Act was passed in January of 1927 creating the Federal Radio Commission (FRC) as a temporary licensing authority. Licenses were to be issued in the public interest, convenience, and necessity. A number of broadcasting licenses were revoked; stations were assigned frequencies, dial locations, and power levels. The FRC created 24 clear-channel stations with as much as 50,000 watts of broadcasting power, of which 21 ended up being affiliated with the new national radio networks. The Communications Act of 1934 essentially repeated the 1927 act except that it created a permanent, seven-person Federal Communications Commission (FCC).

Local stations initially created and broadcast the radio programs. The expenses were modest, and stores and companies operating radio stations wrote this off as indirect, goodwill advertising. Several forces changed all this. In 1922, AT&T opened up a radio station in New York City, WEAF (later to become WNBC). AT&T envisioned this station as the center of a radio toll system where individuals could purchase time to broadcast a message transmitted to other stations in the toll network using AT&T’s long distance lines and an August 1922 broadcast by a Long Island realty company became the first conscious use of direct advertising.

Though advertising continued to be condemned, the fiscal pressures on radio stations to accept advertising began rising. In 1923 the American Society of Composers and Publishers (ASCAP), began demanding a performance fee anytime ASCAP-copyrighted music was performed on the radio, either live or on record. By 1924 the issue was settled, and most stations began paying performance fees to ASCAP. AT&T decided that all stations broadcasting with non AT&T transmitters were violating their patent rights and began asking for annual fees from such stations based on the station’s power. By the end of 1924, most stations were paying the fees. All of this drained the coffers of the radio stations, and more and more of them began discreetly accepting advertising.

RCA became upset at AT&T’s creation of a chain of radio stations and set up its own toll network using the inferior lines of Western Union and Postal Telegraph, because AT&T, not surprisingly, did not allow any toll (or network) broadcasting on its lines except by its own stations. AT&T began to worry that its actions might threaten its federal monopoly in long distance telephone communications. In 1926 a new firm was created, the National Broadcasting Company (NBC), which took over all broadcasting activities from AT&T and RCA as AT&T left broadcasting. When NBC debuted in November of 1926, it had two networks: the Red, which was the old AT&T network, and the Blue, which was the old RCA network. Radio networks allowed advertisers to direct advertising at a national audience at a lower cost. Network programs allowed local stations to broadcast superior programs that captured a larger listening audience and in return received a share of the fees the national advertiser paid to the network. In 1927 a new network, the Columbia Broadcasting System (CBS) financed by the Paley family began operation and other new networks entered or tried to enter the industry in the 1930s.

Communications developments in the interwar era present something of a mixed picture. By 1920 long distance telephone service was in place, but rising rates slowed the rate of adoption in the period, and telephone use in rural areas declined sharply. Though direct dialing was first tried in the twenties, its general implementation would not come until the postwar era, when other changes, such as microwave transmission of signals and touch-tone dialing, would also appear. Though the number of newspapers declined, newspaper circulation generally held up. The number of competing newspapers in larger cities began declining, a trend that also would accelerate in the postwar American economy.

Banking and Securities Markets

In the twenties commercial banks became “department stores of finance.”— Banks opened up installment (or personal) loan departments, expanded their mortgage lending, opened up trust departments, undertook securities underwriting activities, and offered safe deposit boxes. These changes were a response to growing competition from other financial intermediaries. Businesses, stung by bankers’ control and reduced lending during the 1920-21 depression, began relying more on retained earnings and stock and bond issues to raise investment and, sometimes, working capital. This reduced loan demand. The thrift institutions also experienced good growth in the twenties as they helped fuel the housing construction boom of the decade. The securities markets boomed in the twenties only to see a dramatic crash of the stock market in late 1929.

There were two broad classes of commercial banks; those that were nationally chartered and those that were chartered by the states. Only the national banks were required to be members of the Federal Reserve System. (Figure 21) Most banks were unit banks because national regulators and most state regulators prohibited branching. However, in the twenties a few states began to permit limited branching; California even allowed statewide branching.—The Federal Reserve member banks held the bulk of the assets of all commercial banks, even though most banks were not members. A high bank failure rate in the 1920s has usually been explained by “overbanking” or too many banks located in an area, but H. Thomas Johnson (1973-74) makes a strong argument against this. (Figure 22)— If there were overbanking, on average each bank would have been underutilized resulting in intense competition for deposits and higher costs and lower earnings. One common reason would have been the free entry of banks as long as they achieved the minimum requirements then in force. However, the twenties saw changes that led to the demise of many smaller rural banks that would likely have been profitable if these changes had not occurred. Improved transportation led to a movement of business activities, including banking, into the larger towns and cities. Rural banks that relied on loans to farmers suffered just as farmers did during the twenties, especially in the first half of the twenties. The number of bank suspensions and the suspension rate fell after 1926. The sharp rise in bank suspensions in 1930 occurred because of the first banking crisis during the Great Depression.

Prior to the twenties, the main assets of commercial banks were short-term business loans, made by creating a demand deposit or increasing an existing one for a borrowing firm. As business lending declined in the 1920s commercial banks vigorously moved into new types of financial activities. As banks purchased more securities for their earning asset portfolios and gained expertise in the securities markets, larger ones established investment departments and by the late twenties were an important force in the underwriting of new securities issued by nonfinancial corporations.

The securities market exhibited perhaps the most dramatic growth of the noncommercial bank financial intermediaries during the twenties, but others also grew rapidly. (Figure 23) The assets of life insurance companies increased by 10 percent a year from 1921 to 1929; by the late twenties they were a very important source of funds for construction investment. Mutual savings banks and savings and loan associations (thrifts) operated in essentially the same types of markets. The Mutual savings banks were concentrated in the northeastern United States. As incomes rose, personal savings increased, and housing construction expanded in the twenties, there was an increasing demand for the thrifts’ interest earning time deposits and mortgage lending.

But the dramatic expansion in the financial sector came in new corporate securities issues in the twenties—especially common and preferred stock—and in the trading of existing shares of those securities. (Figure 24) The late twenties boom in the American economy was rapid, highly visible, and dramatic. Skyscrapers were being erected in most major cities, the automobile manufacturers produced over four and a half million new cars in 1929; and the stock market, like a barometer of this prosperity, was on a dizzying ride to higher and higher prices. “Playing the market” seemed to become a national pastime.

The Dow-Jones index hit its peak of 381 on September 3 and then slid to 320 on October 21. In the following week the stock market “crashed,” with a record number of shares being traded on several days. At the end of Tuesday, October, 29th, the index stood at 230, 96 points less than one week before. On November 13, 1929, the Dow-Jones index reached its lowest point for the year at 198—183 points less than the September 3 peak.

The path of the stock market boom of the twenties can be seen in Figure 25. Sharp price breaks occurred several times during the boom, and each of these gave rise to dark predictions of the end of the bull market and speculation. Until late October of 1929, these predictions turned out to be wrong. Between those price breaks and prior to the October crash, stock prices continued to surge upward. In March of 1928, 3,875,910 shares were traded in one day, establishing a record. By late 1928, five million shares being traded in a day was a common occurrence.

New securities, from rising merger activity and the formation of holding companies, were issued to take advantage of the rising stock prices.—Stock pools, which were not illegal until the 1934 Securities and Exchange Act, took advantage of the boom to temporarily drive up the price of selected stocks and reap large gains for the members of the pool. In stock pools a group of speculators would pool large amounts of their funds and then begin purchasing large amounts of shares of a stock. This increased demand led to rising prices for that stock. Frequently pool insiders would “churn” the stock by repeatedly buying and selling the same shares among themselves, but at rising prices. Outsiders, seeing the price rising, would decide to purchase the stock whose price was rising. At a predetermined higher price the pool members would, within a short period, sell their shares and pull out of the market for that stock. Without the additional demand from the pool, the stock’s price usually fell quickly bringing large losses for the unsuspecting outside investors while reaping large gains for the pool insiders.

Another factor commonly used to explain both the speculative boom and the October crash was the purchase of stocks on small margins. However, contrary to popular perception, margin requirements through most of the twenties were essentially the same as in previous decades. Brokers, recognizing the problems with margin lending in the rapidly changing market, began raising margin requirements in late 1928, and by the fall of 1929, margin requirements were the highest in the history of the New York Stock Exchange. In the 1920s, as was the case for decades prior to that, the usual margin requirements were 10 to 15 percent of the purchase price, and, apparently, more often around 10 percent. There were increases in this percentage by 1928 and by the fall of 1928, well before the crash and at the urging of a special New York Clearinghouse committee, margin requirements had been raised to some of the highest levels in New York Stock Exchange history. One brokerage house required the following of its clients. Securities with a selling price below $10 could only be purchased for cash. Securities with a selling price of $10 to $20 had to have a 50 percent margin; for securities of $20 to $30 a margin requirement of 40 percent; and, for securities with a price above $30 the margin was 30 percent of the purchase price. In the first half of 1929 margin requirements on customers’ accounts averaged a 40 percent margin, and some houses raised their margins to 50 percent a few months before the crash. These were, historically, very high margin requirements. (Smiley and Keehn, 1988)—Even so, during the crash when additional margin calls were issued, those investors who could not provide additional margin saw the brokers’ sell their stock at whatever the market price was at the time and these forced sales helped drive prices even lower.

The crash began on Monday, October 21, as the index of stock prices fell 3 points on the third-largest volume in the history of the New York Stock Exchange. After a slight rally on Tuesday, prices began declining on Wednesday and fell 21 points by the end of the day bringing on the third call for more margin in that week. On Black Thursday, October 24, prices initially fell sharply, but rallied somewhat in the afternoon so that the net loss was only 7 points, but the volume of thirteen million shares set a NYSE record. Friday brought a small gain that was wiped out on Saturday. On Monday, October 28, the Dow Jones index fell 38 points on a volume of nine million shares—three million in the final hour of trading. Black Tuesday, October 29, brought declines in virtually every stock price. Manufacturing firms, which had been lending large sums to brokers for margin loans, had been calling in these loans and this accelerated on Monday and Tuesday. The big Wall Street banks increased their lending on call loans to offset some of this loss of loanable funds. The Dow Jones Index fell 30 points on a record volume of nearly sixteen and a half million shares exchanged. Black Thursday and Black Tuesday wiped out entire fortunes.

Though the worst was over, prices continued to decline until November 13, 1929, as brokers cleaned up their accounts and sold off the stocks of clients who could not supply additional margin. After that, prices began to slowly rise and by April of 1930 had increased 96 points from the low of November 13,— “only” 87 points less than the peak of September 3, 1929. From that point, stock prices resumed their depressing decline until the low point was reached in the summer of 1932.

 

—There is a long tradition that insists that the Great Bull Market of the late twenties was an orgy of speculation that bid the prices of stocks far above any sustainable or economically justifiable level creating a bubble in the stock market. John Kenneth Galbraith (1954) observed, “The collapse in the stock market in the autumn of 1929 was implicit in the speculation that went before.”—But not everyone has agreed with this.

In 1930 Irving Fisher argued that the stock prices of 1928 and 1929 were based on fundamental expectations that future corporate earnings would be high.— More recently, Murray Rothbard (1963), Gerald Gunderson (1976), and Jude Wanniski (1978) have argued that stock prices were not too high prior to the crash.—Gunderson suggested that prior to 1929, stock prices were where they should have been and that when corporate profits in the summer and fall of 1929 failed to meet expectations, stock prices were written down.— Wanniski argued that political events brought on the crash. The market broke each time news arrived of advances in congressional consideration of the Hawley-Smoot tariff. However, the virtually perfect foresight that Wanniski’s explanation requires is unrealistic.— Charles Kindleberger (1973) and Peter Temin (1976) examined common stock yields and price-earnings ratios and found that the relative constancy did not suggest that stock prices were bid up unrealistically high in the late twenties.—Gary Santoni and Gerald Dwyer (1990) also failed to find evidence of a bubble in stock prices in 1928 and 1929.—Gerald Sirkin (1975) found that the implied growth rates of dividends required to justify stock prices in 1928 and 1929 were quite conservative and lower than post-Second World War dividend growth rates.

However, examination of after-the-fact common stock yields and price-earning ratios can do no more than provide some ex post justification for suggesting that there was not excessive speculation during the Great Bull Market.— Each individual investor was motivated by that person’s subjective expectations of each firm’s future earnings and dividends and the future prices of shares of each firm’s stock. Because of this element of subjectivity, not only can we never accurately know those values, but also we can never know how they varied among individuals. The market price we observe will be the end result of all of the actions of the market participants, and the observed price may be different from the price almost all of the participants expected.

In fact, there are some indications that there were differences in 1928 and 1929. Yields on common stocks were somewhat lower in 1928 and 1929. In October of 1928, brokers generally began raising margin requirements, and by the beginning of the fall of 1929, margin requirements were, on average, the highest in the history of the New York Stock Exchange. Though the discount and commercial paper rates had moved closely with the call and time rates on brokers’ loans through 1927, the rates on brokers’ loans increased much more sharply in 1928 and 1929.— This pulled in funds from corporations, private investors, and foreign banks as New York City banks sharply reduced their lending. These facts suggest that brokers and New York City bankers may have come to believe that stock prices had been bid above a sustainable level by late 1928 and early 1929. White (1990) created a quarterly index of dividends for firms in the Dow-Jones index and related this to the DJI. Through 1927 the two track closely, but in 1928 and 1929 the index of stock prices grows much more rapidly than the index of dividends.

The qualitative evidence for a bubble in the stock market in 1928 and 1929 that White assembled was strengthened by the findings of J. Bradford De Long and Andre Shleifer (1991). They examined closed-end mutual funds, a type of fund where investors wishing to liquidate must sell their shares to other individual investors allowing its fundamental value to be exactly measurable.— Using evidence from these funds, De Long and Shleifer estimated that in the summer of 1929, the Standard and Poor’s composite stock price index was overvalued about 30 percent due to excessive investor optimism. Rappoport and White (1993 and 1994) found other evidence that supported a bubble in the stock market in 1928 and 1929. There was a sharp divergence between the growth of stock prices and dividends; there were increasing premiums on call and time brokers’ loans in 1928 and 1929; margin requirements rose; and stock market volatility rose in the wake of the 1929 stock market crash.

There are several reasons for the creation of such a bubble. First, the fundamental values of earnings and dividends become difficult to assess when there are major industrial changes, such as the rapid changes in the automobile industry, the new electric utilities, and the new radio industry.— Eugene White (1990) suggests that “While investors had every reason to expect earnings to grow, they lacked the means to evaluate easily the future path of dividends.” As a result investors bid up prices as they were swept up in the ongoing stock market boom. Second, participation in the stock market widened noticeably in the twenties. The new investors were relatively unsophisticated, and they were more likely to be caught up in the euphoria of the boom and bid prices upward.— New, inexperienced commission sales personnel were hired to sell stocks and they promised glowing returns on stocks they knew little about.

These observations were strengthened by the experimental work of economist Vernon Smith. (Bishop, 1987) In a number of experiments over a three-year period using students and Tucson businessmen and businesswomen, bubbles developed as inexperienced investors valued stocks differently and engaged in price speculation. As these investors in the experiments began to realize that speculative profits were unsustainable and uncertain, their dividend expectations changed, the market crashed, and ultimately stocks began trading at their fundamental dividend values. These bubbles and crashes occurred repeatedly, leading Smith to conjecture that there are few regulatory steps that can be taken to prevent a crash.

Though the bubble of 1928 and 1929 made some downward adjustment in stock prices inevitable, as Barsky and De Long have shown, changes in fundamentals govern the overall movements. And the end of the long bull market was almost certainly governed by this. In late 1928 and early 1929 there was a striking rise in economic activity, but a decline began somewhere between May and July of that year and was clearly evident by August of 1929. By the middle of August, the rise in stock prices had slowed down as better information on the contraction was received. There were repeated statements by leading figures that stocks were “overpriced” and the Federal Reserve System sharply increased the discount rate in August 1929 was well as continuing its call for banks to reduce their margin lending. As this information was assessed, the number of speculators selling stocks increased, and the number buying decreased. With the decreased demand, stock prices began to fall, and as more accurate information on the nature and extent of the decline was received, stock prices fell more. The late October crash made the decline occur much more rapidly, and the margin purchases and consequent forced selling of many of those stocks contributed to a more severe price fall. The recovery of stock prices from November 13 into April of 1930 suggests that stock prices may have been driven somewhat too low during the crash.

There is now widespread agreement that the 1929 stock market crash did not cause the Great Depression. Instead, the initial downturn in economic activity was a primary determinant of the ending of the 1928-29 stock market bubble. The stock market crash did make the downturn become more severe beginning in November 1929. It reduced discretionary consumption spending (Romer, 1990) and created greater income uncertainty helping to bring on the contraction (Flacco and Parker, 1992). Though stock market prices reached a bottom and began to recover following November 13, 1929, the continuing decline in economic activity took its toll and by May 1930 stock prices resumed their decline and continued to fall through the summer of 1932.

Domestic Trade

In the nineteenth century, a complex array of wholesalers, jobbers, and retailers had developed, but changes in the postbellum period reduced the role of the wholesalers and jobbers and strengthened the importance of the retailers in domestic trade. (Cochran, 1977; Chandler, 1977; Marburg, 1951; Clewett, 1951) The appearance of the department store in the major cities and the rise of mail order firms in the postbellum period changed the retailing market.

Department Stores

A department store is a combination of specialty stores organized as departments within one general store. A. T. Stewart’s huge 1846 dry goods store in New York City is often referred to as the first department store. (Resseguie, 1965; Sobel-Sicilia, 1986) R. H. Macy started his dry goods store in 1858 and Wanamaker’s in Philadelphia opened in 1876. By the end of the nineteenth century, every city of any size had at least one major department store. (Appel, 1930; Benson, 1986; Hendrickson, 1979; Hower, 1946; Sobel, 1974) Until the late twenties, the department store field was dominated by independent stores, though some department stores in the largest cities had opened a few suburban branches and stores in other cities. In the interwar period department stores accounted for about 8 percent of retail sales.

The department stores relied on a “one-price” policy, which Stewart is credited with beginning. In the antebellum period and into the postbellum period, it was common not to post a specific price on an item; rather, each purchaser haggled with a sales clerk over what the price would be. Stewart posted fixed prices on the various dry goods sold, and the customer could either decide to buy or not buy at the fixed price. The policy dramatically lowered transactions costs for both the retailer and the purchaser. Prices were reduced with a smaller markup over the wholesale price, and a large sales volume and a quicker turnover of the store’s inventory generated profits.

Mail Order Firms

What changed the department store field in the twenties was the entrance of Sears Roebuck and Montgomery Ward, the two dominant mail order firms in the United States. (Emmet-Jeuck, 1950; Chandler, 1962, 1977) Both firms had begun in the late nineteenth century and by 1914 the younger Sears Roebuck had surpassed Montgomery Ward. Both located in Chicago due to its central location in the nation’s rail network and both had benefited from the advent of Rural Free Delivery in 1896 and low cost Parcel Post Service in 1912.

In 1924 Sears hired Robert C. Wood, who was able to convince Sears Roebuck to open retail stores. Wood believed that the declining rural population and the growing urban population forecast the gradual demise of the mail order business; survival of the mail order firms required a move into retail sales. By 1925 Sears Roebuck had opened 8 retail stores, and by 1929 it had 324 stores. Montgomery Ward quickly followed suit. Rather than locating these in the central business district (CBD), Wood located many on major streets closer to the residential areas. These moves of Sears Roebuck and Montgomery Ward expanded department store retailing and provided a new type of chain store.

Chain Stores

Though chain stores grew rapidly in the first two decades of the twentieth century, they date back to the 1860s when George F. Gilman and George Huntington Hartford opened a string of New York City A&P (Atlantic and Pacific) stores exclusively to sell tea. (Beckman-Nolen, 1938; Lebhar, 1963; Bullock, 1933) Stores were opened in other regions and in 1912 their first “cash-and-carry” full-range grocery was opened. Soon they were opening 50 of these stores each week and by the 1920s A&P had 14,000 stores. They then phased out the small stores to reduce the chain to 4,000 full-range, supermarket-type stores. A&P’s success led to new grocery store chains such as Kroger, Jewel Tea, and Safeway.

Prior to A&P’s cash-and-carry policy, it was common for grocery stores, produce (or green) grocers, and meat markets to provide home delivery and credit, both of which were costly. As a result, retail prices were generally marked up well above the wholesale prices. In cash-and-carry stores, items were sold only for cash; no credit was extended, and no expensive home deliveries were provided. Markups on prices could be much lower because other costs were much lower. Consumers liked the lower prices and were willing to pay cash and carry their groceries, and the policy became common by the twenties.

Chains also developed in other retail product lines. In 1879 Frank W. Woolworth developed a “5 and 10 Cent Store,” or dime store, and there were over 1,000 F. W. Woolworth stores by the mid-1920s. (Winkler, 1940) Other firms such as Kresge, Kress, and McCrory successfully imitated Woolworth’s dime store chain. J.C. Penney’s dry goods chain store began in 1901 (Beasley, 1948), Walgreen’s drug store chain began in 1909, and shoes, jewelry, cigars, and other lines of merchandise also began to be sold through chain stores.

Self-Service Policies

In 1916 Clarence Saunders, a grocer in Memphis, Tennessee, built upon the one-price policy and began offering self-service at his Piggly Wiggly store. Previously, customers handed a clerk a list or asked for the items desired, which the clerk then collected and the customer paid for. With self-service, items for sale were placed on open shelves among which the customers could walk, carrying a shopping bag or pushing a shopping cart. Each customer could then browse as he or she pleased, picking out whatever was desired. Saunders and other retailers who adopted the self-service method of retail selling found that customers often purchased more because of exposure to the array of products on the shelves; as well, self-service lowered the labor required for retail sales and therefore lowered costs.

Shopping Centers

Shopping Centers, another innovation in retailing that began in the twenties, was not destined to become a major force in retail development until after the Second World War. The ultimate cause of this innovation was the widening ownership and use of the automobile. By the 1920s, as the ownership and use of the car began expanding, population began to move out of the crowded central cities toward the more open suburbs. When General Robert Wood set Sears off on its development of urban stores, he located these not in the central business district, CBD, but as free-standing stores on major arteries away from the CBD with sufficient space for parking.

At about the same time, a few entrepreneurs began to develop shopping centers. Yehoshua Cohen (1972) says, “The owner of such a center was responsible for maintenance of the center, its parking lot, as well as other services to consumers and retailers in the center.” Perhaps the earliest such shopping center was the Country Club Plaza built in 1922 by the J. C. Nichols Company in Kansas City, Missouri. Other early shopping centers appeared in Baltimore and Dallas. By the mid-1930s the concept of a planned shopping center was well known and was expected to be the means to capture the trade of the growing number of suburban consumers.

International Trade and Finance

In the twenties a gold exchange standard was developed to replace the gold standard of the prewar world. Under a gold standard, each country’s currency carried a fixed exchange rate with gold, and the currency had to be backed up by gold. As a result, all countries on the gold standard had fixed exchange rates with all other countries. Adjustments to balance international trade flows were made by gold flows. If a country had a deficit in its trade balance, gold would leave the country, forcing the money stock to decline and prices to fall. Falling prices made the deficit countries’ exports more attractive and imports more costly, reducing the deficit. Countries with a surplus imported gold, which increased the money stock and caused prices to rise. This made the surplus countries’ exports less attractive and imports more attractive, decreasing the surplus. Most economists who have studied the prewar gold standard contend that it did not work as the conventional textbook model says, because capital flows frequently reduced or eliminated the need for gold flows for long periods of time. However, there is no consensus on whether fortuitous circumstances, rather than the gold standard, saved the international economy from periodic convulsions or whether the gold standard as it did work was sufficient to promote stability and growth in international transactions.

After the First World War it was argued that there was a “shortage” of fluid monetary gold to use for the gold standard, so some method of “economizing” on gold had to be found. To do this, two basic changes were made. First, most nations, other than the United States, stopped domestic circulation of gold. Second, the “gold exchange” system was created. Most countries held their international reserves in the form of U.S. dollars or British pounds and international transactions used dollars or pounds, as long as the United States and Great Britain stood ready to exchange their currencies for gold at fixed exchange rates. However, the overvaluation of the pound and the undervaluation of the franc threatened these arrangements. The British trade deficit led to a capital outflow, higher interest rates, and a weak economy. In the late twenties, the French trade surplus led to the importation of gold that they did not allow to expand the money supply.

Economizing on gold by no longer allowing its domestic circulation and by using key currencies as international monetary reserves was really an attempt to place the domestic economies under the control of the nations’ politicians and make them independent of international events. Unfortunately, in doing this politicians eliminated the equilibrating mechanism of the gold standard but had nothing with which to replace it. The new international monetary arrangements of the twenties were potentially destabilizing because they were not allowed to operate as a price mechanism promoting equilibrating adjustments.

There were other problems with international economic activity in the twenties. Because of the war, the United States was abruptly transformed from a debtor to a creditor on international accounts. Though the United States did not want reparations payments from Germany, it did insist that Allied governments repay American loans. The Allied governments then insisted on war reparations from Germany. These initial reparations assessments were quite large. The Allied Reparations Commission collected the charges by supervising Germany’s foreign trade and by internal controls on the German economy, and it was authorized to increase the reparations if it was felt that Germany could pay more. The treaty allowed France to occupy the Ruhr after Germany defaulted in 1923.

Ultimately, this tangled web of debts and reparations, which was a major factor in the course of international trade, depended upon two principal actions. First, the United States had to run an import surplus or, on net, export capital out of the United States to provide a pool of dollars overseas. Germany then had either to have an export surplus or else import American capital so as to build up dollar reserves—that is, the dollars the United States was exporting. In effect, these dollars were paid by Germany to Great Britain, France, and other countries that then shipped them back to the United States as payment on their U.S. debts. If these conditions did not occur, (and note that the “new” gold standard of the twenties had lost its flexibility because the price adjustment mechanism had been eliminated) disruption in international activity could easily occur and be transmitted to the domestic economies.

In the wake of the 1920-21 depression Congress passed the Emergency Tariff Act, which raised tariffs, particularly on manufactured goods. (Figures 26 and 27) The Fordney-McCumber Tariff of 1922 continued the Emergency Tariff of 1921, and its protection on many items was extremely high, ranging from 60 to 100 percent ad valorem (or as a percent of the price of the item). The increases in the Fordney-McCumber tariff were as large and sometimes larger than the more famous (or “infamous”) Smoot-Hawley tariff of 1930. As farm product prices fell at the end of the decade presidential candidate Herbert Hoover proposed, as part of his platform, tariff increases and other changes to aid the farmers. In January 1929, after Hoover’s election, but before he took office, a tariff bill was introduced into Congress. Special interests succeeded in gaining additional (or new) protection for most domestically produced commodities and the goal of greater protection for the farmers tended to get lost in the increased protection for multitudes of American manufactured products. In spite of widespread condemnation by economists, President Hoover signed the Smoot-Hawley Tariff in June 1930 and rates rose sharply.

Following the First World War, the U.S. government actively promoted American exports, and in each of the postwar years through 1929, the United States recorded a surplus in its balance of trade. (Figure 28) However, the surplus declined in the 1930s as both exports and imports fell sharply after 1929. From the mid-1920s on finished manufactures were the most important exports, while agricultural products dominated American imports.

The majority of the funds that allowed Germany to make its reparations payments to France and Great Britain and hence allowed those countries to pay their debts to the United States came from the net flow of capital out of the United States in the form of direct investment in real assets and investments in long- and short-term foreign financial assets. After the devastating German hyperinflation of 1922 and 1923, the Dawes Plan reformed the German economy and currency and accelerated the U.S. capital outflow. American investors began to actively and aggressively pursue foreign investments, particularly loans (Lewis, 1938) and in the late twenties there was a marked deterioration in the quality of foreign bonds sold in the United States. (Mintz, 1951)

The system, then, worked well as long as there was a net outflow of American capital, but this did not continue. In the middle of 1928, the flow of short-term capital began to decline. In 1928 the flow of “other long-term” capital out of the United States was 752 million dollars, but in 1929 it was only 34 million dollars. Though arguments now exist as to whether the booming stock market in the United States was to blame for this, it had far-reaching effects on the international economic system and the various domestic economies.

The Start of the Depression

The United States had the majority of the world’s monetary gold, about 40 percent, by 1920. In the latter part of the twenties, France also began accumulating gold as its share of the world’s monetary gold rose from 9 percent in 1927 to 17 percent in 1929 and 22 percent by 1931. In 1927 the Federal Reserve System had reduced discount rates (the interest rate at which they lent reserves to member commercial banks) and engaged in open market purchases (purchasing U.S. government securities on the open market to increase the reserves of the banking system) to push down interest rates and assist Great Britain in staying on the gold standard. By early 1928 the Federal Reserve System was worried about its loss of gold due to this policy as well as the ongoing boom in the stock market. It began to raise the discount rate to stop these outflows. Gold was also entering the United States so that foreigners could obtain dollars to invest in stocks and bonds. As the United States and France accumulated more and more of the world’s monetary gold, other countries’ central banks took contractionary steps to stem the loss of gold. In country after country these deflationary strategies began contracting economic activity and by 1928 some countries in Europe, Asia, and South America had entered into a depression. More countries’ economies began to decline in 1929, including the United States, and by 1930 a depression was in force for almost all of the world’s market economies. (Temin, 1989; Eichengreen, 1992)

Monetary and Fiscal Policies in the 1920s

Fiscal Policies

As a tool to promote stability in aggregate economic activity, fiscal policy is largely a post-Second World War phenomenon. Prior to 1930 the federal government’s spending and taxing decisions were largely, but not completely, based on the perceived “need” for government-provided public goods and services.

Though the fiscal policy concept had not been developed, this does not mean that during the twenties no concept of the government’s role in stimulating economic activity existed. Herbert Stein (1990) points out that in the twenties Herbert Hoover and some of his contemporaries shared two ideas about the proper role of the federal government. The first was that federal spending on public works could be an important force in reducin Smiley and Keehn, 1995.  investment. Both concepts fit the ideas held by Hoover and others of his persuasion that the U.S. economy of the twenties was not the result of laissez-faire workings but of “deliberate social engineering.”

The federal personal income tax was enacted in 1913. Though mildly progressive, its rates were low and topped out at 7 percent on taxable income in excess of $750,000. (Table 4) As the United States prepared for war in 1916, rates were increased and reached a maximum marginal rate of 12 percent. With the onset of the First World War, the rates were dramatically increased. To obtain additional revenue in 1918, marginal rates were again increased. The share of federal revenue generated by income taxes rose from 11 percent in 1914 to 69 percent in 1920. The tax rates had been extended downward so that more than 30 percent of the nation’s income recipients were subject to income taxes by 1918. However, through the purchase of tax exempt state and local securities and through steps taken by corporations to avoid the cash distribution of profits, the number of high income taxpayers and their share of total taxes paid declined as Congress kept increasing the tax rates. The normal (or base) tax rate was reduced slightly for 1919 but the surtax rates, which made the income tax highly progressive, were retained. (Smiley-Keehn, 1995)

President Harding’s new Secretary of the Treasury, Andrew Mellon, proposed cutting the tax rates, arguing that the rates in the higher brackets had “passed the point of productivity” and rates in excess of 70 percent simply could not be collected. Though most agreed that the rates were too high, there was sharp disagreement on how the rates should be cut. Democrats and  Smiley and Keehn, 1995.  Progressive Republicans argued for rate cuts targeted for the lower income taxpayers while maintaining most of the steep progressivity of the tax rates. They believed that remedies could be found to change the tax laws to stop the legal avoidance of federal income taxes. Republicans argued for sharper cuts that reduced the progressivity of the rates. Mellon proposed a maximum rate of 25 percent.

Though the federal income tax rates were reduced and made less progressive, it took three tax rate cuts in 1921, 1924, and 1925 before Mellon’s goal was finally achieved. The highest marginal tax rate was reduced from 73 percent to 58 percent to 46 percent and finally to 25 percent for the 1925 tax year. All of the other rates were also reduced and exemptions increased. By 1926, only about the top 10 percent of income recipients were subject to federal income taxes. As tax rates were reduced, the number of high income tax returns increased and the share of total federal personal income taxes paid rose. (Tables 5 and 6) Even with the dramatic income tax rate cuts and reductions in the number of low income taxpayers, federal personal income tax revenue continued to rise during the 1920s. Though early estimates of the distribution of personal income showed sharp increases in income inequality during the 1920s (Kuznets, 1953; Holt, 1977), more recent estimates have found that the increases in inequality were considerably less and these appear largely to be related to the sharp rise in capital gains due to the booming stock market in the late twenties. (Smiley, 1998 and 2000)

Each year in the twenties the federal government generated a surplus, in some years as much as 1 percent of GNP. The surpluses were used to reduce the federal deficit and it declined by 25 percent between 1920 and 1930. Contrary to simple macroeconomic models that argue a federal government budget surplus must be contractionary and tend to stop an economy from reaching full employment, the American economy operated at full-employment or close to it throughout the twenties and saw significant economic growth. In this case, the surpluses were not contractionary because the dollars were circulated back into the economy through the purchase of outstanding federal debt rather than pulled out as currency and held in a vault somewhere.

Monetary Policies

In 1913 fear of the “money trust” and their monopoly power led Congress to create 12 central banks when they created the Federal Reserve System. The new central banks were to control money and credit and act as lenders of last resort to end banking panics. The role of the Federal Reserve Board, located in Washington, D.C., was to coordinate the policies of the 12 district banks; it was composed of five presidential appointees and the current secretary of the treasury and comptroller of the currency. All national banks had to become members of the Federal Reserve System, the Fed, and any state bank meeting the qualifications could elect to do so.

The act specified fixed reserve requirements on demand and time deposits, all of which had to be on deposit in the district bank. Commercial banks were allowed to rediscount commercial paper and given Federal Reserve currency. Initially, each district bank set its own rediscount rate. To provide additional income when there was little rediscounting, the district banks were allowed to engage in open market operations that involved the purchasing and selling of federal government securities, short-term securities of state and local governments issued in anticipation of taxes, foreign exchange, and domestic bills of exchange. The district banks were also designated to act as fiscal agents for the federal government. Finally, the Federal Reserve System provided a central check clearinghouse for the entire banking system.

When the Federal Reserve System was originally set up, it was believed that its primary role was to be a lender of last resort to prevent banking panics and become a check-clearing mechanism for the nation’s banks. Both the Federal Reserve Board and the Governors of the District Banks were bodies established to jointly exercise these activities. The division of functions was not clear, and a struggle for power ensued, mainly between the New York Federal Reserve Bank, which was led by J. P. Morgan’s protege, Benjamin Strong, through 1928, and the Federal Reserve Board. By the thirties the Federal Reserve Board had achieved dominance.

There were really two conflicting criteria upon which monetary actions were ostensibly based: the Gold Standard and the Real Bills Doctrine. The Gold Standard was supposed to be quasi-automatic, with an effective limit to the quantity of money. However, the Real Bills Doctrine (which required that all loans be made on short-term, self-liquidating commercial paper) had no effective limit on the quantity of money. The rediscounting of eligible commercial paper was supposed to lead to the required “elasticity” of the stock of money to “accommodate” the needs of industry and business. Actually the rediscounting of commercial paper, open market purchases, and gold inflows all had the same effects on the money stock.

The 1920-21 Depression

During the First World War, the Fed kept discount rates low and granted discounts on banks’ customer loans used to purchase V-bonds in order to help finance the war. The final Victory Loan had not been floated when the Armistice was signed in November of 1918: in fact, it took until October of 1919 for the government to fully sell this last loan issue. The Treasury, with the secretary of the treasury sitting on the Federal Reserve Board, persuaded the Federal Reserve System to maintain low interest rates and discount the Victory bonds necessary to keep bond prices high until this last issue had been floated. As a result, during this period the money supply grew rapidly and prices rose sharply.

A shift from a federal deficit to a surplus and supply disruptions due to steel and coal strikes in 1919 and a railroad strike in early 1920 contributed to the end of the boom. But the most—common view is that the Fed’s monetary policy was the main determinant of the end of the expansion and inflation and the beginning of the subsequent contraction and severe deflation. When the Fed was released from its informal agreement with the Treasury in November of 1919, it raised the discount rate from 4 to 4.75 percent. Benjamin Strong (the governor of the New York bank) was beginning to believe that the time for strong action was past and that the Federal Reserve System’s actions should be moderate. However, with Strong out of the country, the Federal Reserve Board increased the discount rate from 4.75 to 6 percent in late January of 1920 and to 7 percent on June 1, 1920. By the middle of 1920, economic activity and employment were rapidly falling, and prices had begun their downward spiral in one of the sharpest price declines in American history. The Federal Reserve System kept the discount rate at 7 percent until May 5, 1921, when it was lowered to 6.5 percent. By June of 1922, the rate had been lowered yet again to 4 percent. (Friedman and Schwartz, 1963)

The Federal Reserve System authorities received considerable criticism then and later for their actions. Milton Friedman and Anna Schwartz (1963) contend that the discount rate was raised too much too late and then kept too high for too long, causing the decline to be more severe and the price deflation to be greater. In their opinion the Fed acted in this manner due to the necessity of meeting the legal reserve requirement with a safe margin of gold reserves. Elmus Wicker (1966), however, argues that the gold reserve ratio was not the main factor determining the Federal Reserve policy in the episode. Rather, the Fed knowingly pursued a deflationary policy because it felt that the money supply was simply too large and prices too high. To return to the prewar parity for gold required lowering the price level, and there was an excessive stock of money because the additional money had been used to finance the war, not to produce consumer goods. Finally, the outstanding indebtedness was too large due to the creation of Fed credit.

Whether statutory gold reserve requirements to maintain the gold standard or domestic credit conditions were the most important determinant of Fed policy is still an open question, though both certainly had some influence. Regardless of the answer to that question, the Federal Reserve System’s first major undertaking in the years immediately following the First World War demonstrated poor policy formulation.

Federal Reserve Policies from 1922 to 1930

By 1921 the district banks began to recognize that their open market purchases had effects on interest rates, the money stock, and economic activity. For the next several years, economists in the Federal Reserve System discussed how this worked and how it could be related to discounting by member banks. A committee was created to coordinate the open market purchases of the district banks.

The recovery from the 1920-1921 depression had proceeded smoothly with moderate price increases. In early 1923 the Fed sold some securities and increased the discount rate from 4 percent as they believed the recovery was too rapid. However, by the fall of 1923 there were some signs of a business slump. McMillin and Parker (1994) argue that this contraction, as well as the 1927 contraction, were related to oil price shocks. By October of 1923 Benjamin Strong was advocating securities purchases to counter this. Between then and September 1924 the Federal Reserve System increased its securities holdings by over $500 million. Between April and August of 1924 the Fed reduced the discount rate to 3 percent in a series of three separate steps. In addition to moderating the mild business slump, the expansionary policy was also intended to reduce American interest rates relative to British interest rates. This reversed the gold flow back toward Great Britain allowing Britain to return to the gold standard in 1925. At the time it appeared that the Fed’s monetary policy had successfully accomplished its goals.

By the summer of 1924 the business slump was over and the economy again began to grow rapidly. By the mid-1920s real estate speculation had arisen in many urban areas in the United States and especially in Southeastern Florida. Land prices were rising sharply. Stock market prices had also begun rising more rapidly. The Fed expressed some worry about these developments and in 1926 sold some securities to gently slow the real estate and stock market boom. Amid hurricanes and supply bottlenecks the Florida real estate boom collapsed but the stock market boom continued.

The American economy entered into another mild business recession in the fall of 1926 that lasted until the fall of 1927. One of the factors in this was Henry’s Ford’s shut down of all of his factories to changeover from the Model T to the Model A. His employees were left without a job and without income for over six months. International concerns also reappeared. France, which was preparing to return to the gold standard, had begun accumulating gold and gold continued to flow into the United States. Some of this gold came from Great Britain making it difficult for the British to remain on the gold standard. This occasioned a new experiment in central bank cooperation. In July 1927 Benjamin Strong arranged a conference with Governor Montagu Norman of the Bank of England, Governor Hjalmar Schacht of the Reichsbank, and Deputy Governor Charles Ritt of the Bank of France in an attempt to promote cooperation among the world’s central bankers. By the time the conference began the Fed had already taken steps to counteract the business slump and reduce the gold inflow. In early 1927 the Fed reduced discount rates and made large securities purchases. One result of this was that the gold stock fell from $4.3 billion in mid-1927 to $3.8 billion in mid-1928. Some of the gold exports went to France and France returned to the gold standard with its undervalued currency. The loss of gold from Britain eased allowing it to maintain the gold standard.

By early 1928 the Fed was again becoming worried. Stock market prices were rising even faster and the apparent speculative bubble in the stock market was of some concern to Fed authorities. The Fed was also concerned about the loss of gold and wanted to bring that to an end. To do this they sold securities and, in three steps, raised the discount rate to 5 percent by July 1928. To this point the Federal Reserve Board had largely agreed with district Bank policy changes. However, problems began to develop.

During the stock market boom of the late 1920s the Federal Reserve Board preferred to use “moral suasion” rather than increases in discount rates to lessen member bank borrowing. The New York City bank insisted that moral suasion would not work unless backed up by literal credit rationing on a bank by bank basis which they, and the other district banks, were unwilling to do. They insisted that discount rates had to be increased. The Federal Reserve Board countered that this general policy change would slow down economic activity in general rather than be specifically targeted to stock market speculation. The result was that little was done for a year. Rates were not raised but no open market purchases were undertaken. Rates were finally raised to 6 percent in August of 1929. By that time the contraction had already begun. In late October the stock market crashed, and America slid into the Great Depression.

In November, following the stock market crash the Fed reduced discount rates to 4.5 percent. In January they again decreased discount rates and began a series of discount rate decreases until the rate reached 2.5 percent at the end of 1930. No further open market operations were undertaken for the next six months. As banks reduced their discounting in 1930, the stock of money declined. There was a banking crisis in the southeast in November and December of 1930, and in its wake the public’s holding of currency relative to deposits and banks’ reserve ratios began to rise and continued to do so through the end of the Great Depression.

Conclusion

Though some disagree, there is growing evidence that the behavior of the American economy in the 1920s did not cause the Great Depression. The depressed 1930s were not “retribution” for the exuberant growth of the 1920s. The weakness of a few economic sectors in the 1920s did not forecast the contraction from 1929 to 1933. Rather it was the depression of the 1930s and the Second World War that interrupted the economic growth begun in the 1920s and resumed after the Second World War. Just as the construction of skyscrapers that began in the 1920s resumed in the 1950s, so did real economic growth and progress resume. In retrospect we can see that the introduction and expansion of new technologies and industries in the 1920s, such as autos, household electric appliances, radio, and electric utilities, are echoed in the 1990s in the effects of the expanding use and development of the personal computer and the rise of the internet. The 1920s have much to teach us about the growth and development of the American economy.

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Citation: Smiley, Gene. “US Economy in the 1920s”. EH.Net Encyclopedia, edited by Robert Whaples. June 29, 2004. URL http://eh.net/encyclopedia/the-u-s-economy-in-the-1920s/