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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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The Dutch Economy in the Golden Age (16th – 17th Centuries)

Donald J. Harreld, Brigham Young University

In just over one hundred years, the provinces of the Northern Netherlands went from relative obscurity as the poor cousins of the industrious and heavily urbanized Southern Netherlands provinces of Flanders and Brabant to the pinnacle of European commercial success. Taking advantage of a favorable agricultural base, the Dutch achieved success in the fishing industry and the Baltic and North Sea carrying trade during the fifteenth and sixteenth centuries before establishing a far-flung maritime empire in the seventeenth century.

The Economy of the Netherlands up to the Sixteenth Century

In many respects the seventeenth-century Dutch Republic inherited the economic successes of the Burgundian and Habsburg Netherlands. For centuries, Flanders and to a lesser extent Brabant had been at the forefront of the medieval European economy. An indigenous cloth industry was present throughout all areas of Europe in the early medieval period, but Flanders was the first to develop the industry with great intensity. A tradition of cloth manufacture in the Low Countries existed from antiquity when the Celts and then the Franks continued an active textile industry learned from the Romans.

As demand grew early textile production moved from its rural origins to the cities and had become, by the twelfth century, an essentially urban industry. Native wool could not keep up with demand, and the Flemings imported English wool in great quantities. The resulting high quality product was much in demand all over Europe, from Novgorod to the Mediterranean. Brabant also rose to an important position in textile industry, but only about a century after Flanders. By the thirteenth century the number of people engaged in some aspect of the textile industry in the Southern Netherlands had become more than the total engaged in all other crafts. It is possible that this emphasis on cloth manufacture was the reason that the Flemish towns ignored the emerging maritime shipping industry which was eventually dominated by others, first the German Hanseatic League, and later Holland and Zeeland.

By the end of the fifteenth century Antwerp in Brabant had become the commercial capital of the Low Countries as foreign merchants went to the city in great numbers in search of the high-value products offered at the city’s fairs. But the traditional cloths manufactured in Flanders had lost their allure for most European markets, particularly as the English began exporting high quality cloths rather than the raw materials the Flemish textile industry depended on. Many textile producers turned to the lighter weight and cheaper “new draperies.” Despite protectionist measures instituted in the mid-fifteenth century, English cloth found an outlet in Antwerp ‘s burgeoning markets. By the early years of the sixteenth century the Portuguese began using Antwerp as an outlet for their Asian pepper and spice imports, and the Germans continued to bring their metal products (copper and silver) there. For almost a hundred years Antwerp remained the commercial capital of northern Europe, until the religious and political events of the 1560s and 1570s intervened and the Dutch Revolt against Spanish rule toppled the commercial dominance of Antwerp and the southern provinces. Within just a few years of the Fall of Antwerp (1585), scores of merchants and mostly Calvinist craftsmen fled the south for the relative security of the Northern Netherlands.

The exodus from the south certainly added to the already growing population of the north. However, much like Flanders and Brabant, the northern provinces of Holland and Zeeland were already populous and heavily urbanized. The population of these maritime provinces had been steadily growing throughout the sixteenth century, perhaps tripling between the first years of the sixteenth century to about 1650. The inland provinces grew much more slowly during the same period. Not until the eighteenth century, when the Netherlands as a whole faced declining fortunes would the inland provinces begin to match the growth of the coastal core of the country.

Dutch Agriculture

During the fifteenth century, and most of the sixteenth century, the Northern Netherlands provinces were predominantly rural compared to the urbanized southern provinces. Agriculture and fishing formed the basis for the Dutch economy in the fifteenth and sixteenth centuries. One of the characteristics of Dutch agriculture during this period was its emphasis on intensive animal husbandry. Dutch cattle were exceptionally well cared for and dairy produce formed a significant segment of the agricultural sector. During the seventeenth century, as the Dutch urban population saw dramatic growth many farmers also turned to market gardening to supply the cities with vegetables.

Some of the impetus for animal production came from the trade in slaughter cattle from Denmark and Northern Germany. Holland was an ideal area for cattle feeding and fattening before eventual slaughter and export to the cities of the Southern provinces. The trade in slaughter cattle expanded from about 1500 to 1660, but protectionist measures on the part of Dutch authorities who wanted to encourage the fattening of home-bred cattle ensured a contraction of the international cattle trade between 1660 and 1750.

Although agriculture made up the largest segment of the Dutch economy, cereal production in the Netherlands could not keep up with demand particularly by the seventeenth century as migration from the southern provinces contributed to population increases. The provinces of the Low Countries traditionally had depended on imported grain from the south (France and the Walloon provinces) and when crop failures interrupted the flow of grain from the south, the Dutch began to import grain from the Baltic. Baltic grain imports experienced sustained growth from about the middle of the sixteenth century to roughly 1650 when depression and stagnation characterized the grain trade into the eighteenth century.

Indeed, the Baltic grain trade (see below), a major source of employment for the Dutch, not only in maritime transport but in handling and storage as well, was characterized as the “mother trade.” In her recent book on the Baltic grain trade, Mijla van Tielhof defined “mother trade” as the oldest and most substantial trade with respect to ships, sailors and commodities for the Northern provinces. Over the long term, the Baltic grain trade gave rise to shipping and trade on other routes as well as to manufacturing industries.

Dutch Fishing

Along with agriculture, the Dutch fishing industry formed part of the economic base of the northern Netherlands. Like the Baltic grain trade, it also contributed to the rise of Dutch the shipping industry.

The backbone of the fishing industry was the North Sea herring fishery, which was quite advanced and included a form of “factory” ship called the herring bus. The herring bus was developed in the fifteenth century in order to allow the herring catch to be processed with salt at sea. This permitted the herring ship to remain at sea longer and increased the range of the herring fishery. Herring was an important export product for the Netherlands particularly to inland areas, but also to the Baltic offsetting Baltic grain imports.

The herring fishery reached its zenith in the first half of the seventeenth century. Estimates put the size of the herring fleet at roughly 500 busses and the catch at about 20,000 to 25,000 lasts (roughly 33,000 metric tons) on average each year in the first decades of the seventeenth century. The herring catch as well as the number of busses began to decline in the second half of the seventeenth century, collapsing by about the mid-eighteenth century when the catch amounted to only about 6000 lasts. This decline was likely due to competition resulting from a reinvigoration of the Baltic fishing industry that succeeded in driving prices down, as well as competition within the North Sea by the Scottish fishing industry.

The Dutch Textile Industry

The heartland for textile manufacturing had been Flanders and Brabant until the onset of the Dutch Revolt around 1568. Years of warfare continued to devastate the already beaten down Flemish cloth industry. Even the cloth producing towns of the Northern Netherlands that had been focusing on producing the “new draperies” saw their output decline as a result of wartime interruptions. But textiles remained the most important industry for the Dutch Economy.

Despite the blow it suffered during the Dutch revolt, Leiden’s textile industry, for instance, rebounded in the early seventeenth century – thanks to the influx of textile workers from the Southern Netherlands who emigrated there in the face of religious persecution. But by the 1630s Leiden had abandoned the heavy traditional wool cloths in favor of a lighter traditional woolen (laken) as well as a variety of other textiles such as says, fustians, and camlets. Total textile production increased from 50,000 or 60,000 pieces per year in the first few years of the seventeenth century to as much as 130,000 pieces per year during the 1660s. Leiden’s wool cloth industry probably reached peak production by 1670. The city’s textile industry was successful because it found export markets for its inexpensive cloths in the Mediterranean, much to the detriment of Italian cloth producers.

Next to Lyons, Leiden may have been Europe’s largest industrial city at end of seventeenth century. Production was carried out through the “putting out” system, whereby weavers with their own looms and often with other dependent weavers working for them, obtained imported raw materials from merchants who paid the weavers by the piece for their work (the merchant retained ownership of the raw materials throughout the process). By the end of the seventeenth century foreign competition threatened the Dutch textile industry. Production in many of the new draperies (says, for example) decreased considerably throughout the eighteenth century; profits suffered as prices declined in all but the most expensive textiles. This left the production of traditional woolens to drive what was left of Leiden’s textile industry in the eighteenth century.

Although Leiden certainly led the Netherlands in the production of wool cloth, it was not the only textile producing city in the United Provinces. Amsterdam, Utrecht, Delft and Haarlem, among others, had vibrant textile industries. Haarlem, for example, was home to an important linen industry during the first half of the seventeenth century. Like Leiden’s cloth industry, Haarlem’s linen industry benefited from experienced linen weavers who migrated from the Southern Netherlands during the Dutch Revolt. Haarlem’s hold on linen production, however, was due more to its success in linen bleaching and finishing. Not only was locally produced linen finished in Haarlem, but linen merchants from other areas of Europe sent their products to Haarlem for bleaching and finishing. As linen production moved to more rural areas as producers sought to decrease costs in the second half of the seventeenth century, Haarlem’s industry went into decline.

Other Dutch Industries

Industries also developed as a result of overseas colonial trade, in particular Amsterdam’s sugar refining industry. During the sixteenth century, Antwerp had been Europe’s most important sugar refining city, a title it inherited from Venice once the Atlantic sugar islands began to surpass Mediterranean sugar production. Once Antwerp fell to Spanish troops during the Revolt, however, Amsterdam replaced it as Europe’s dominant sugar refiner. The number of sugar refineries in Amsterdam increased from about 3 around 1605 to about 50 by 1662, thanks in no small part to Portuguese investment. Dutch merchants purchased huge amounts of sugar from both the French and the English islands in the West Indies, along with a great deal of tobacco. Tobacco processing became an important Amsterdam industry in the seventeenth century employing large numbers of workers and leading to attempts to develop domestic tobacco cultivation.

With the exception of some of the “colonial” industries (sugar, for instance), Dutch industry experienced a period of stagnation after the 1660s and eventual decline beginning around the turn of the eighteenth century. It would seem that as far as industrial production is concerned, the Dutch Golden Age lasted from the 1580s until about 1670. This period was followed by roughly one hundred years of declining industrial production. De Vries and van der Woude concluded that Dutch industry experienced explosive growth after 1580s because of the migration of skilled labor and merchant capital from the southern Netherlands at roughly the time Antwerp fell to the Spanish and because of the relative advantage continued warfare in the south gave to the Northern Provinces. After the 1660s most Dutch industries experienced either steady or steep decline as many Dutch industries moved from the cities into the countryside, while some (particularly the colonial industries) remained successful well into the eighteenth century.

Dutch Shipping and Overseas Commerce

Dutch shipping began to emerge as a significant sector during the fifteenth century. Probably stemming from the inaction on the part of merchants from the Southern Netherlands to participate in seaborne transport, the towns of Zeeland and Holland began to serve the shipping needs of the commercial towns of Flanders and Brabant (particularly Antwerp ). The Dutch, who were already active in the North Sea as a result of the herring fishery, began to compete with the German Hanseatic League for Baltic markets by exporting their herring catches, salt, wine, and cloth in exchange for Baltic grain.

The Grain Trade

Baltic grain played an essential role for the rapidly expanding markets in western and southern Europe. By the beginning of the sixteenth century the urban populations had increased in the Low Countries fueling the market for imported grain. Grain and other Baltic products such as tar, hemp, flax, and wood were not only destined for the Low Countries, but also England and for Spain and Portugal via Amsterdam, the port that had succeeded in surpassing Lübeck and other Hanseatic towns as the primary transshipment point for Baltic goods. The grain trade sparked the development of a variety of industries. In addition to the shipbuilding industry, which was an obvious outgrowth of overseas trade relationships, the Dutch manufactured floor tiles, roof tiles, and bricks for export to the Baltic; the grain ships carried them as ballast on return voyages to the Baltic.

The importance of the Baltic markets to Amsterdam, and to Dutch commerce in general can be illustrated by recalling that when the Danish closed the Sound to Dutch ships in 1542, the Dutch faced financial ruin. But by the mid-sixteenth century, the Dutch had developed such a strong presence in the Baltic that they were able to exact transit rights from Denmark (Peace of Speyer, 1544) allowing them freer access to the Baltic via Danish waters. Despite the upheaval caused by the Dutch and the commercial crisis that hit Antwerp in the last quarter of the sixteenth century, the Baltic grain trade remained robust until the last years of the seventeenth century. That the Dutch referred to the Baltic trade as their “mother trade” is not surprising given the importance Baltic markets continued to hold for Dutch commerce throughout the Golden Age. Unfortunately for Dutch commerce, Europe ‘s population began to decline somewhat at the close of the seventeenth century and remained depressed for several decades. Increased grain production in Western Europe and the availability of non-Baltic substitutes (American and Italian rice, for example) further decreased demand for Baltic grain resulting in a downturn in Amsterdam ‘s grain market.

Expansion into African, American and Asian Markets – “World Primacy”

Building on the early successes of their Baltic trade, Dutch shippers expanded their sphere of influence east into Russia and south into the Mediterranean and the Levantine markets. By the turn of the seventeenth century, Dutch merchants had their eyes on the American and Asian markets that were dominated by Iberian merchants. The ability of Dutch shippers to effectively compete with entrenched merchants, like the Hanseatic League in the Baltic, or the Portuguese in Asia stemmed from their cost cutting strategies (what de Vries and van der Woude call “cost advantages and institutional efficiencies,” p. 374). Not encumbered by the costs and protective restrictions of most merchant groups of the sixteenth century, the Dutch trimmed their costs enough to undercut the competition, and eventually establish what Jonathan Israel has called “world primacy.”

Before Dutch shippers could even attempt to break in to the Asian markets they needed to first expand their presence in the Atlantic. This was left mostly to the émigré merchants from Antwerp, who had relocated to Zeeland following the Revolt. These merchants set up the so-called Guinea trade with West Africa, and initiated Dutch involvement in the Western Hemisphere. Dutch merchants involved in the Guinea trade ignored the slave trade that was firmly in the hands of the Portuguese in favor of the rich trade in gold, ivory, and sugar from São Tomé. Trade with West Africa grew slowly, but competition was stiff. By 1599, the various Guinea companies had agreed to the formation of a cartel to regulate trade. Continued competition from a slew of new companies, however, insured that the cartel would be only partially effective until the organization of the Dutch West India Company in 1621 that also held monopoly rights in the West Africa trade.

The Dutch at first focused their trade with the Americas on the Caribbean. By the mid-1590s only a few Dutch ships each year were making the voyage across the Atlantic. When the Spanish instituted an embargo against the Dutch in 1598, shortages in products traditionally obtained in Iberia (like salt) became common. Dutch shippers seized the chance to find new sources for products that had been supplied by the Spanish and soon fleets of Dutch ships sailed to the Americas. The Spanish and Portuguese had a much larger presence in the Americas than the Dutch could mount, despite the large number vessels they sent to the area. Dutch strategy was to avoid Iberian strongholds while penetrating markets where the products they desired could be found. For the most part, this strategy meant focusing on Venezuela, Guyana, and Brazil. Indeed, by the turn of the seventeenth century, the Dutch had established forts on the coasts of Guyana and Brazil.

While competition between rival companies from the towns of Zeeland marked Dutch trade with the Americas in the first years of the seventeenth century, by the time the West India Company finally received its charter in 1621 troubles with Spain once again threatened to disrupt trade. Funding for the new joint-stock company came slowly, and oddly enough came mostly from inland towns like Leiden rather than coastal towns. The West India Company was hit with setbacks in the Americas from the very start. The Portuguese began to drive the Dutch out of Brazil in 1624 and by 1625 the Dutch were loosing their position in the Caribbean as well. Dutch shippers in the Americas soon found raiding (directed at the Spanish and Portuguese) to be their most profitable activity until the Company was able to establish forts in Brazil again in the 1630s and begin sugar cultivation. Sugar remained the most lucrative activity for the Dutch in Brazil, and once the revolt of Portuguese Catholic planters against the Dutch plantation owners broke out the late 1640s, the fortunes of the Dutch declined steadily.

The Dutch faced the prospect of stiff Portuguese competition in Asia as well. But, breaking into the lucrative Asian markets was not just a simple matter of undercutting less efficient Portuguese shippers. The Portuguese closely guarded the route around Africa. Not until roughly one hundred years after the first Portuguese voyage to Asia were the Dutch in a position to mount their own expedition. Thanks to the travelogue of Jan Huyghen van Linschoten, which was published in 1596, the Dutch gained the information they needed to make the voyage. Linschoten had been in the service of the Bishop of Goa, and kept excellent records of the voyage and his observations in Asia.

The United East India Company (VOC)

The first few Dutch voyages to Asia were not particularly successful. These early enterprises managed to make only enough to cover the costs of the voyage, but by 1600 dozens of Dutch merchant ships made the trip. This intense competition among various Dutch merchants had a destabilizing effect on prices driving the government to insist on consolidation in order to avoid commercial ruin. The United East India Company (usually referred to by its Dutch initials, VOC) received a charter from the States General in 1602 conferring upon it monopoly trading rights in Asia. This joint stock company attracted roughly 6.5 million florins in initial capitalization from over 1,800 investors, most of whom were merchants. Management of the company was vested in 17 directors (Heren XVII) chosen from among the largest shareholders.

In practice, the VOC became virtually a “country” unto itself outside of Europe, particularly after about 1620 when the company’s governor-general in Asia, Jan Pieterszoon Coen, founded Batavia (the company factory) on Java. While Coen and later governors-general set about expanding the territorial and political reach of the VOC in Asia, the Heren XVII were most concerned about profits, which they repeatedly reinvested in the company much to the chagrin of investors. In Asia, the strategy of the VOC was to insert itself into the intra-Asian trade (much like the Portuguese had done in the sixteenth century) in order to amass enough capital to pay for the spices shipped back to the Netherlands. This often meant displacing the Portuguese by waging war in Asia, while trying to maintain peaceful relations within Europe.

Over the long term, the VOC was very profitable during the seventeenth century despite the company’s reluctance to pay cash dividends in first few decades (the company paid dividends in kind until about 1644). As the English and French began to institute mercantilist strategies (for instance, the Navigation Acts of 1551 and 1660 in England, and import restrictions and high tariffs in the case of France ) Dutch dominance in foreign trade came under attack. Rather than experience a decline like domestic industry did at the end of the seventeenth century, the Dutch Asia trade continued to ship goods at steady volumes well into the eighteenth century. Dutch dominance, however, was met with stiff competition by rival India companies as the Asia trade grew. As the eighteenth century wore on, the VOC’s share of the Asia trade declined significantly compared to its rivals, the most important of which was the English East India Company.

Dutch Finance

The last sector that we need to highlight is finance, perhaps the most important sector for the development of the early modern Dutch economy. The most visible manifestation of Dutch capitalism was the exchange bank founded in Amsterdam in 1609; only two years after the city council approved the construction of a bourse (additional exchange banks were founded in other Dutch commercial cities). The activities of the bank were limited to exchange and deposit banking. A lending bank, founded in Amsterdam in 1614, rounded out the financial services in the commercial capital of the Netherlands.

The ability to manage the wealth generated by trade and industry (accumulated capital) in new ways was one of the hallmarks of the economy during the Golden Age. As early as the fourteenth century, Italian merchants had been experimenting with ways to decrease the use of cash in long-distance trade. The resulting instrument was the bill of exchange developed as a way to for a seller to extend credit to a buyer. The bill of exchange required the debtor to pay the debt at a specified place and time. But the creditor rarely held on to the bill of exchange until maturity preferring to sell it or otherwise use it to pay off debts. These bills of exchange were not routinely used in commerce in the Low Countries until the sixteenth century when Antwerp was still the dominant commercial city in the region. In Antwerp the bill of exchange could be assigned to another, and eventually became a negotiable instrument with the practice of discounting the bill.

The idea of the flexibility of bills of exchange moved to the Northern Netherlands with the large numbers of Antwerp merchants who brought with them their commercial practices. In an effort to standardize the practices surrounding bills of exchange, the Amsterdam government restricted payment of bills of exchange to the new exchange bank. The bank was wildly popular with merchants; deposits increasing from just less than one million guilders in 1611 to over sixteen million by 1700. Amsterdam ‘s exchange bank flourished because of its ability to handle deposits and transfers, and to settle international debts.

By the second half of the seventeenth century many wealthy merchant families had turned away from foreign trade and began engaging in speculative activities on a much larger scale. They traded in commodity values (futures), shares in joint-stock companies, and dabbled in insurance and currency exchanges to name only a few of the most important ventures.

Conclusion

Building on its fifteenth- and sixteenth-century successes in agricultural productivity, and in North Sea and Baltic shipping, the Northern Netherlands inherited the economic legacy of the southern provinces as the Revolt tore the Low Countries apart. The Dutch Golden Age lasted from roughly 1580, when the Dutch proved themselves successful in their fight with the Spanish, to about 1670, when the Republic’s economy experienced a down-turn. Economic growth was very fast during until about 1620 when it slowed, but continued to grow steadily until the end of the Golden Age. The last decades of the seventeenth century were marked by declining production and loss of market dominance overseas.

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Citation: Harreld, Donald. “Dutch Economy in the “Golden Age” (16th-17th Centuries)”. EH.Net Encyclopedia, edited by Robert Whaples. August 12, 2004. URL http://eh.net/encyclopedia/the-dutch-economy-in-the-golden-age-16th-17th-centuries/

An Economic History of Denmark

Ingrid Henriksen, University of Copenhagen

Denmark is located in Northern Europe between the North Sea and the Baltic. Today Denmark consists of the Jutland Peninsula bordering Germany and the Danish Isles and covers 43,069 square kilometers (16,629 square miles). 1 The present nation is the result of several cessions of territory throughout history. The last of the former Danish territories in southern Sweden were lost to Sweden in 1658, following one of the numerous wars between the two nations, which especially marred the sixteenth and seventeenth centuries. Following defeat in the Napoleonic Wars, Norway was separated from Denmark in 1814. After the last major war, the Second Schleswig War in 1864, Danish territory was further reduced by a third when Schleswig and Holstein were ceded to Germany. After a regional referendum in 1920 only North-Schleswig returned to Denmark. Finally, Iceland, withdrew from the union with Denmark in 1944. The following will deal with the geographical unit of today’s Denmark.

Prerequisites of Growth

Throughout history a number of advantageous factors have shaped the Danish economy. From this perspective it may not be surprising to find today’s Denmark among the richest societies in the world. According to the OECD, it ranked seventh in 2004, with income of $29.231 per capita (PPP). Although we can identify a number of turning points and breaks, for the time period over which we have quantitative evidence this long-run position has changed little. Thus Maddison (2001) in his estimate of GDP per capita around 1600 places Denmark as number six. One interpretation could be that favorable circumstances, rather than ingenious institutions or policies, have determined Danish economic development. Nevertheless, this article also deals with time periods in which the Danish economy was either diverging from or converging towards the leading economies.

Table 1:
Average Annual GDP Growth (at factor costs)
Total Per capita
1870-1880 1.9% 0.9%
1880-1890 2.5% 1.5%
1890-1900 2.9% 1.8%
1900-1913 3.2% 2.0%
1913-1929 3.0% 1.6%
1929-1938 2.2% 1.4%
1938-1950 2.4% 1.4%
1950-1960 3.4% 2.6%
1960-1973 4.6% 3.8%
1973-1982 1.5% 1.3%
1982-1993 1.6% 1.5%
1993-2004 2.2% 2.0%

Sources: Johansen (1985) and Statistics Denmark ‘Statistikbanken’ online.

Denmark’s geographical location in close proximity of the most dynamic nations of sixteenth-century Europe, the Netherlands and the United Kingdom, no doubt exerted a positive influence on the Danish economy and Danish institutions. The North German area influenced Denmark both through long-term economic links and through the Lutheran Protestant Reformation which the Danes embraced in 1536.

The Danish economy traditionally specialized in agriculture like most other small and medium-sized European countries. It is, however, rather unique to find a rich European country in the late-nineteenth and mid-twentieth century which retained such a strong agrarian bias. Only in the late 1950s did the workforce of manufacturing industry overtake that of agriculture. Thus an economic history of Denmark must take its point of departure in agricultural development for quite a long stretch of time.

Looking at resource endowments, Denmark enjoyed a relatively high agricultural land-to-labor ratio compared to other European countries, with the exception of the UK. This was significant for several reasons since it, in this case, was accompanied by a comparatively wealthy peasantry.

Denmark had no mineral resources to speak of until the exploitation of oil and gas in the North Sea began in 1972 and 1984, respectively. From 1991 on Denmark has been a net exporter of energy although on a very modest scale compared to neighboring Norway and Britain. The small deposits are currently projected to be depleted by the end of the second decade of the twenty-first century.

Figure 1. Percent of GDP in selected=

Source: Johansen (1985) and Statistics Denmark ’Nationalregnskaber’

Good logistic can be regarded as a resource in pre-industrial economies. The Danish coast line of 7,314 km and the fact that no point is more than 50 km from the sea were advantages in an age in which transport by sea was more economical than land transport.

Decline and Transformation, 1500-1750

The year of the Lutheran Reformation (1536) conventionally marks the end of the Middle Ages in Danish historiography. Only around 1500 did population growth begin to pick up after the devastating effect of the Black Death. Growth thereafter was modest and at times probably stagnant with large fluctuations in mortality following major wars, particularly during the seventeenth century, and years of bad harvests. About 80-85 percent of the population lived from subsistence agriculture in small rural communities and this did not change. Exports are estimated to have been about 5 percent of GDP between 1550 and 1650. The main export products were oxen and grain. The period after 1650 was characterized by a long lasting slump with a marked decline in exports to the neighboring countries, the Netherlands in particular.

The institutional development after the Black Death showed a return to more archaic forms. Unlike other parts of northwestern Europe, the peasantry on the Danish Isles afterwards became a victim of a process of re-feudalization during the last decades of the fifteenth century. A likely explanation is the low population density that encouraged large landowners to hold on to their labor by all means. Freehold tenure among peasants effectively disappeared during the seventeenth century. Institutions like bonded labor that forced peasants to stay on the estate where they were born, and labor services on the demesne as part of the land rent bring to mind similar arrangements in Europe east of the Elbe River. One exception to the East European model was crucial, however. The demesne land, that is the land worked directly under the estate, never made up more than nine percent of total land by the mid eighteenth century. Although some estate owners saw an interest in encroaching on peasant land, the state protected the latter as production units and, more importantly, as a tax base. Bonded labor was codified in the all-encompassing Danish Law of Christian V in 1683. It was further intensified by being extended, though under another label, to all Denmark during 1733-88, as a means for the state to tide the large landlords over an agrarian crisis. One explanation for the long life of such an authoritarian institution could be that the tenants were relatively well off, with 25-50 acres of land on average. Another reason could be that reality differed from the formal rigor of the institutions.

Following the Protestant Reformation in 1536, the Crown took over all church land, thereby making it the owner of 50 percent of all land. The costs of warfare during most of the sixteenth century could still be covered by the revenue of these substantial possessions. Around 1600 the income from taxation and customs, mostly Sound Toll collected from ships that passed the narrow strait between Denmark and today’s Sweden, on the one hand and Crown land revenues on the other were equally large. About 50 years later, after a major fiscal crisis had led to the sale of about half of all Crown lands, the revenue from royal demesnes declined relatively to about one third, and after 1660 the full transition from domain state to tax state was completed.

The bulk of the former Crown land had been sold to nobles and a few common owners of estates. Consequently, although the Danish constitution of 1665 was the most stringent version of absolutism found anywhere in Europe at the time, the Crown depended heavily on estate owners to perform a number of important local tasks. Thus, conscription of troops for warfare, collection of land taxes and maintenance of law and order enhanced the landlords’ power over their tenants.

Reform and International Market Integration, 1750-1870

The driving force of Danish economic growth, which took off during the late eighteenth century was population growth at home and abroad – which triggered technological and institutional innovation. Whereas the Danish population during the previous hundred years grew by about 0.4 percent per annum, growth climbed to about 0.6 percent, accelerating after 1775 and especially from the second decade of the nineteenth century (Johansen 2002). Like elsewhere in Northern Europe, accelerating growth can be ascribed to a decline in mortality, mainly child mortality. Probably this development was initiated by fewer spells of epidemic diseases due to fewer wars and to greater inherited immunity against contagious diseases. Vaccination against smallpox and formal education of midwives from the early nineteenth century might have played a role (Banggård 2004). Land reforms that entailed some scattering of the farm population may also have had a positive influence. Prices rose from the late eighteenth century in response to the increase in populations in Northern Europe, but also following a number of international conflicts. This again caused a boom in Danish transit shipping and in grain exports.

Population growth rendered the old institutional set up obsolete. Landlords no longer needed to bind labor to their estate, as a new class of landless laborers or cottagers with little land emerged. The work of these day-laborers was to replace the labor services of tenant farmers on the demesnes. The old system of labor services obviously presented an incentive problem all the more since it was often carried by the live-in servants of the tenant farmers. Thus, the labor days on the demesnes represented a loss to both landlords and tenants (Henriksen 2003). Part of the land rent was originally paid in grain. Some of it had been converted to money which meant that real rents declined during the inflation. The solution to these problems was massive land sales both from the remaining crown lands and from private landlords to their tenants. As a result two-thirds of all Danish farmers became owner-occupiers compared to only ten percent in the mid-eighteenth century. This development was halted during the next two and a half decades but resumed as the business cycle picked up during the 1840s and 1850s. It was to become of vital importance to the modernization of Danish agriculture towards the end of the nineteenth century that 75 percent of all agricultural land was farmed by owners of middle-sized farms of about 50 acres. Population growth may also have put a pressure on common lands in the villages. At any rate enclosure begun in the 1760s, accelerated in the 1790s supported by legislation and was almost complete in the third decade of the nineteenth century.

The initiative for the sweeping land reforms from the 1780s is thought to have come from below – that is from the landlords and in some instances also from the peasantry. The absolute monarch and his counselors were, however, strongly supportive of these measures. The desire for peasant land as a tax base weighed heavily and the reforms were believed to enhance the efficiency of peasant farming. Besides, the central government was by now more powerful than in the preceding centuries and less dependent on landlords for local administrative tasks.

Production per capita rose modestly before the 1830s and more pronouncedly thereafter when a better allocation of labor and land followed the reforms and when some new crops like clover and potatoes were introduced at a larger scale. Most importantly, the Danes no longer lived at the margin of hunger. No longer do we find a correlation between demographic variables, deaths and births, and bad harvest years (Johansen 2002).

A liberalization of import tariffs in 1797 marked the end of a short spell of late mercantilism. Further liberalizations during the nineteenth and the beginning of the twentieth century established the Danish liberal tradition in international trade that was only to be broken by the protectionism of the 1930s.

Following the loss of the secured Norwegian market for grain in 1814, Danish exports began to target the British market. The great rush forward came as the British Corn Law was repealed in 1846. The export share of the production value in agriculture rose from roughly 10 to around 30 percent between 1800 and 1870.

In 1849 absolute monarchy was peacefully replaced by a free constitution. The long-term benefits of fundamental principles such as the inviolability of private property rights, the freedom of contracting and the freedom of association were probably essential to future growth though hard to quantify.

Modernization and Convergence, 1870-1914

During this period Danish economic growth outperformed that of most other European countries. A convergence in real wages towards the richest countries, Britain and the U.S., as shown by O’Rourke and Williamsson (1999), can only in part be explained by open economy forces. Denmark became a net importer of foreign capital from the 1890s and foreign debt was well above 40 percent of GDP on the eve of WWI. Overseas emigration reduced the potential workforce but as mortality declined population growth stayed around one percent per annum. The increase in foreign trade was substantial, as in many other economies during the heyday of the gold standard. Thus the export share of Danish agriculture surged to a 60 percent.

The background for the latter development has featured prominently in many international comparative analyses. Part of the explanation for the success, as in other Protestant parts of Northern Europe, was a high rate of literacy that allowed a fast spread of new ideas and new technology.

The driving force of growth was that of a small open economy, which responded effectively to a change in international product prices, in this instance caused by the invasion of cheap grain to Western Europe from North America and Eastern Europe. Like Britain, the Netherlands and Belgium, Denmark did not impose a tariff on grain, in spite of the strong agrarian dominance in society and politics.

Proposals to impose tariffs on grain, and later on cattle and butter, were turned down by Danish farmers. The majority seems to have realized the advantages accruing from the free imports of cheap animal feed during the ongoing process of transition from vegetable to animal production, at a time when the prices of animal products did not decline as much as grain prices. The dominant middle-sized farm was inefficient for wheat but had its comparative advantage in intensive animal farming with the given technology. O’Rourke (1997) found that the grain invasion only lowered Danish rents by 4-5 percent, while real wages rose (according to expectation) but more than in any other agrarian economy and more than in industrialized Britain.

The move from grain exports to exports of animal products, mainly butter and bacon, was to a great extent facilitated by the spread of agricultural cooperatives. This organization allowed the middle-sized and small farms that dominated Danish agriculture to benefit from the economy of scale in processing and marketing. The newly invented steam-driven continuous cream separator skimmed more cream from a kilo of milk than conventional methods and had the further advantage of allowing transported milk brought together from a number of suppliers to be skimmed. From the 1880s the majority of these creameries in Denmark were established as cooperatives and about 20 years later, in 1903, the owners of 81 percent of all milk cows supplied to a cooperative (Henriksen 1999). The Danish dairy industry captured over a third of the rapidly expanding British butter-import market, establishing a reputation for consistent quality that was reflected in high prices. Furthermore, the cooperatives played an active role in persuading the dairy farmers to expand production from summer to year-round dairying. The costs of intensive feeding during the wintertime were more than made up for by a winter price premium (Henriksen and O’Rourke 2005). Year-round dairying resulted in a higher rate of utilization of agrarian capital – that is of farm animals and of the modern cooperative creameries. Not least did this intensive production mean a higher utilization of hitherto underemployed labor. From the late 1890’s, in particular, labor productivity in agriculture rose at an unanticipated speed at par with productivity increase in the urban trades.

Industrialization in Denmark took its modest beginning in the 1870s with a temporary acceleration in the late 1890s. It may be a prime example of an industrialization process governed by domestic demand for industrial goods. Industry’s export never exceeded 10 percent of value added before 1914, compared to agriculture’s export share of 60 percent. The export drive of agriculture towards the end of the nineteenth century was a major force in developing other sectors of the economy not least transport, trade and finance.

Weathering War and Depression, 1914-1950

Denmark, as a neutral nation, escaped the devastating effects of World War I and was even allowed to carry on exports to both sides in the conflict. The ensuing trade surplus resulted in a trebling of the money supply. As the monetary authorities failed to contain the inflationary effects of this development, the value of the Danish currency slumped to about 60 percent of its pre-war value in 1920. The effects of monetary policy failure were aggravated by a decision to return to the gold standard at the 1913 level. When monetary policy was finally tightened in 1924, it resulted in fierce speculation in an appreciation of the Krone. During 1925-26 the currency returned quickly to its pre-war parity. As this was not counterbalanced by an equal decline in prices, the result was a sharp real appreciation and a subsequent deterioration in Denmark’s competitive position (Klovland 1997).

Figure 2. Indices of the Krone Real Exchange Rate and Terms Of Trade (1980=100; Real rates based on Wholesale Price Index

Source: Abildgren (2005)

Note: Trade with Germany is included in the calculation of the real effective exchange rate for the whole period, including 1921-23.

When, in September 1931, Britain decided to leave the gold standard again, Denmark, together with Sweden and Norway, followed only a week later. This move was beneficial as the large real depreciation lead to a long-lasting improvement in Denmark’s competitiveness in the 1930s. It was, no doubt, the single most important policy decision during the depression years. Keynesian demand management, even if it had been fully understood, was barred by a small public sector, only about 13 percent of GDP. As it was, fiscal orthodoxy ruled and policy was slightly procyclical as taxes were raised to cover the deficit created by crisis and unemployment (Topp 1995).

Structural development during the 1920s, surprisingly for a rich nation at this stage, was in favor of agriculture. The total labor force in Danish agriculture grew by 5 percent from 1920 to 1930. The number of employees in agriculture was stagnating whereas the number of self-employed farmers increased by a larger number. The development in relative incomes cannot account for this trend but part of the explanation must be found in a flawed Danish land policy, which actively supported a further parceling out of land into small holdings and restricted the consolidation into larger more viable farms. It took until the early 1960s before this policy began to be unwound.

When the world depression hit Denmark with a minor time lag, agriculture still employed one-third of the total workforce while its contribution to total GDP was a bit less than one-fifth. Perhaps more importantly, agricultural goods still made up 80 percent of total exports.

Denmark’s terms of trade, as a consequence, declined by 24 percent from 1930 to 1932. In 1933 and 1934 bilateral trade agreements were forced upon Denmark by Britain and Germany. In 1932 Denmark had adopted exchange control, a harsh measure even for its time, to stem the net flow of foreign exchange out of the country. By rationing imports exchange control also offered some protection of domestic industry. At the end of the decade manufacture’s GDP had surpassed that of agriculture. In spite of the protectionist policy, unemployment soared to 13-15 percent of the workforce.

The policy mistakes during World War I and its immediate aftermath served as a lesson for policymakers during World War II. The German occupation force (April 9, 1940 until May 5, 1945) drew the funds for its sustenance and for exports to Germany on the Danish central bank whereby the money supply more than doubled. In response the Danish authorities in 1943 launched a policy of absorbing money through open market operations and, for the first time in history, through a surplus on the state budget.

Economic reconstruction after World War II was swift, as again Denmark had been spared the worst consequences of a major war. In 1946 GDP recovered its highest pre-war level. In spite of this, Denmark received relatively generous support through the Marshall Plan of 1948-52, when measured in dollars per capita.

From Riches to Crisis, 1950-1973: Liberalizations and International Integration Once Again

The growth performance during 1950-1957 was markedly lower than the Western European average. The main reason was the high share of agricultural goods in Danish exports, 63 percent in 1950. International trade in agricultural products to a large extent remained regulated. Large deteriorations in the terms of trade caused by the British devaluation 1949, when Denmark followed suit, the outbreak of the Korean War in 1950, and the Suez-crisis of 1956 made matters worse. The ensuing deficits on the balance of payment led the government to contractionary policy measures which restrained growth.

The liberalization of the flow of goods and capital in Western Europe within the framework of the OEEC (the Organization for European Economic Cooperation) during the 1950s probably dealt a blow to some of the Danish manufacturing firms, especially in the textile industry, that had been sheltered through exchange control and wartime. Nevertheless, the export share of industrial production doubled from 10 percent to 20 percent before 1957, at the same time as employment in industry surpassed agricultural employment.

On the question of European economic integration Denmark linked up with its largest trading partner, Britain. After the establishment of the European Common Market in 1958 and when the attempts to create a large European free trade area failed, Denmark entered the European Free Trade Association (EFTA) created under British leadership in 1960. When Britain was finally able to join the European Economic Community (EEC) in 1973, Denmark followed, after a referendum on the issue. Long before admission to the EEC, the advantages to Danish agriculture from the Common Agricultural Policy (CAP) had been emphasized. The higher prices within the EEC were capitalized into higher land prices at the same time that investments were increased based on the expected gains from membership. As a result the most indebted farmers who had borrowed at fixed interests rates were hit hard by two developments from the early 1980s. The EEC started to reduce the producers’ benefits of the CAP because of overproduction and, after 1982, the Danish economy adjusted to a lower level of inflation, and therefore, nominal interest rates. According to Andersen (2001) Danish farmers were left with the highest interest burden of all European Union (EU) farmers in the 1990’s.

Denmark’s relations with the EU, while enthusiastic at the beginning, have since been characterized by a certain amount of reserve. A national referendum in 1992 turned down the treaty on the European Union, the Maastricht Treaty. The Danes, then, opted out of four areas, common citizenship, a common currency, common foreign and defense politics and a common policy on police and legal matters. Once more, in 2000, adoption of the common currency, the Euro, was turned down by the Danish electorate. In the debate leading up to the referendum the possible economic advantages of the Euro in the form of lower transaction costs were considered to be modest, compared to the existent regime of fixed exchange rates vis-à-vis the Euro. All the major political parties, nevertheless, are pro-European, with only the extreme Right and the extreme Left being against. It seems that there is a discrepancy between the general public and the politicians on this particular issue.

As far as domestic economic policy is concerned, the heritage from the 1940s was a new commitment to high employment modified by a balance of payment constraint. The Danish policy differed from that of some other parts of Europe in that the remains of the planned economy from the war and reconstruction period in the form of rationing and price control were dismantled around 1950 and that no nationalizations took place.

Instead of direct regulation, economic policy relied on demand management with fiscal policy as its main instrument. Monetary policy remained a bone of contention between politicians and economists. Coordination of policies was the buzzword but within that framework monetary policy was allotted a passive role. The major political parties for a long time were wary of letting the market rate of interest clear the loan market. Instead, some quantitative measures were carried out with the purpose of dampening the demand for loans.

From Agricultural Society to Service Society: The Growth of the Welfare State

Structural problems in foreign trade extended into the high growth period of 1958-73, as Danish agricultural exports were met with constraints both from the then EEC-member countries and most EFTA countries, as well. During the same decade, the 1960s, as the importance of agriculture was declining the share of employment in the public sector grew rapidly until 1983. Building and construction also took a growing share of the workforce until 1970. These developments left manufacturing industry with a secondary position. Consequently, as pointed out by Pedersen (1995) the sheltered sectors in the economy crowded out the sectors that were exposed to international competition, that is mostly industry and agriculture, by putting a pressure on labor and other costs during the years of strong expansion.

Perhaps the most conspicuous feature of the Danish economy during the Golden Age was the steep increase in welfare-related costs from the mid 1960s and not least the corresponding increases in the number of public employees. Although the seeds of the modern Scandinavian welfare state were sown at a much earlier date, the 1960s was the time when public expenditure as a share of GDP exceeded that of most other countries.

As in other modern welfare states, important elements in the growth of the public sector during the 1960s were the expansion in public health care and education, both free for all citizens. The background for much of the increase in the number of public employees from the late 1960s was the rise in labor participation by married women from the late 1960s until about 1990, partly at least as a consequence. In response, the public day care facilities for young children and old people were expanded. Whereas in 1965 7 percent of 0-6 year olds were in a day nursery or kindergarten, this share rose to 77 per cent in 2000. This again spawned more employment opportunities for women in the public sector. Today the labor participation for women, around 75 percent of 16-66 year olds, is among the highest in the world.

Originally social welfare programs targeted low income earners who were encouraged to take out insurance against sickness (1892), unemployment (1907) and disability (1922). The public subsidized these schemes and initiated a program for the poor among old people (1891). The high unemployment period in the 1930s inspired some temporary relief and some administrative reform, but little fundamental change.

Welfare policy in the first four decades following World War II is commonly believed to have been strongly influenced by the Social Democrat party which held around 30 percent of the votes in general elections and was the party in power for long periods of time. One of the distinctive features of the Danish welfare state has been its focus on the needs of the individual person rather than on the family context. Another important characteristic is the universal nature of a number of benefits starting with a basic old age pension for all in 1956. The compensation rates in a number of schedules are high in international comparison, particularly for low income earners. Public transfers gained a larger share in total public outlays both because standards were raised – that is benefits became higher – and because the number of recipients increased dramatically following the high unemployment regime from the mid 1970s to the mid 1990s. To pay for the high transfers and the large public sector – around 30 percent of the work force – the tax load is also high in international perspective. The share public sector and social expenditure has risen to above 50 percent of GDP, only second to the share in Sweden.

Figure 3. Unemployment, Denmark (percent of total labor force)

Source: Statistics Denmark ‘50 års-oversigten’ and ADAM’s databank

The Danish labor market model has recently attracted favorable international attention (OECD 2005). It has been declared successful in fighting unemployment – especially compared to the policies of countries like Germany and France. The so-called Flexicurity model rests on three pillars. The first is low employment protection, the second is relatively high compensation rates for the unemployed and the third is the requirement for active participation by the unemployed. Low employment protection has a long tradition in Denmark and there is no change in this factor when comparing the twenty years of high unemployment – 8-12 per cent of the labor force – from the mid 1970s to the mid 1990s, to the past ten years when unemployment has declined to a mere 4.5 percent in 2006. The rules governing compensation to the unemployed were tightened from 1994, limiting the number of years the unemployed could receive benefits from 7 to 4. Most noticeably labor market policy in 1994 turned from ‘passive’ measures – besides unemployment benefits, an early retirement scheme and a temporary paid leave scheme – toward ‘active’ measures that were devoted to getting people back to work by providing training and jobs. It is commonly supposed that the strengthening of economic incentives helped to lower unemployment. However, as Andersen and Svarer (2006) point out, while unemployment has declined substantially a large and growing share of Danes of employable age receives transfers other than unemployment benefit – that is benefits related to sickness or social problems of various kinds, early retirement benefits, etc. This makes it hazardous to compare the Danish labor market model with that of many other countries.

Exchange Rates and Macroeconomic Policy

Denmark has traditionally adhered to a fixed exchange rate regime. The belief is that for a small and open economy, a floating exchange rate could lead to very volatile exchange rates which would harm foreign trade. After having abandoned the gold standard in 1931, the Danish currency (the Krone) was, for a while, pegged to the British pound, only to join the IMF system of fixed but adjustable exchange rates, the so-called Bretton Woods system after World War II. The close link with the British economy still manifested itself when the Danish currency was devaluated along with the pound in 1949 and, half way, in 1967. The devaluation also reflected that after 1960, Denmark’s international competitiveness had gradually been eroded by rising real wages, corresponding to a 30 percent real appreciation of the currency (Pedersen 1996).

When the Bretton Woods system broke down in the early 1970s, Denmark joined the European exchange rate cooperation, the “Snake” arrangement, set up in 1972, an arrangement that was to be continued in the form of the Exchange Rate Mechanism within the European Monetary System from 1979. The Deutschmark was effectively the nominal anchor in European currency cooperation until the launch of the Euro in 1999, a fact that put Danish competitiveness under severe pressure because of markedly higher inflation in Denmark compared to Germany. In the end the Danish government gave way before the pressure and undertook four discrete devaluations from 1979 to 1982. Since compensatory increases in wages were held back, the balance of trade improved perceptibly.

This improvement could, however, not make up for the soaring costs of old loans at a time when the international real rates of interests were high. The Danish devaluation strategy exacerbated this problem. The anticipation of further devaluations was mirrored in a steep increase in the long-term rate of interest. It peaked at 22 percent in nominal terms in 1982, with an interest spread to Germany of 10 percent. Combined with the effects of the second oil crisis on the Danish terms of trade, unemployment rose to 10 percent of the labor force. Given the relatively high compensation ratios for the unemployed, the public deficit increased rapidly and public debt grew to about 70 percent of GDP.

Figure 4. Current Account and Foreign Debt (Denmark)

Source: Statistics Denmark Statistical Yearbooks and ADAM’s Databank

In September 1982 the Social Democrat minority government resigned without a general election and was relieved by a Conservative-Liberal minority government. The new government launched a program to improve the competitiveness of the private sector and to rebalance public finances. An important element was a disinflationary economic policy based on fixed exchange rates pegging the Krone to the participants of the EMS and, from 1999, to the Euro. Furthermore, automatic wage indexation that had occurred, with short interruptions since 1920 (with a short lag and high coverage), was abolished. Fiscal policy was tightened, thus bringing an end to the real increases in public expenditure that had lasted since the 1960’s.

The stabilization policy was successful in bringing down inflation and long interest rates. Pedersen (1995) finds that this process, nevertheless, was slower than might have been expected. In view of former Danish exchange rate policy it took some time for the market to believe in the credible commitment to fixed exchange rates. From the late 1990s the interest spread to Germany/ Euroland has been negligible, however.

The initial success of the stabilization policy brought a boom to the Danish economy that, once again, caused overheating in the form of high wage increases (in 1987) and a deterioration of the current account. The solution to this was a number of reforms in 1986-87 aiming at encouraging private savings that had by then fallen to an historical low. Most notable was the reform that reduced tax deductibility of private interest on debts. These measures resulted in a hard landing to the economy caused by the collapse of the housing market.

The period of low growth was further prolonged by the international recession in 1992. In 1993 yet another shift of regime occurred in Danish economic policy. A new Social Democrat government decided to ‘kick start’ the economy by means of a moderate fiscal expansion whereas, in 1994, the same government tightened labor market policies substantially, as we have seen. Mainly as a consequence of these measures the Danish economy from 1994 entered a period of moderate growth with unemployment steadily falling to the level of the 1970s. A new feature that still puzzles Danish economists is that the decline in unemployment over these years has not yet resulted in any increase in wage inflation.

Denmark at the beginning of the twenty-first century in many ways fits the description of a Small Successful European Economy according to Mokyr (2006). Unlike in most of the other small economies, however, Danish exports are broad based and have no “niche” in the world market. Like some other small European countries, Ireland, Finland and Sweden, the short term economic fluctuations as described above have not followed the European business cycle very closely for the past thirty years (Andersen 2001). Domestic demand and domestic economic policy has, after all, played a crucial role even in a very small and very open economy.

References

Abildgren, Kim. “Real Effective Exchange Rates and Purchasing-Power-parity Convergence: Empirical Evidence for Denmark, 1875-2002.” Scandinavian Economic History Review 53, no. 3 (2005): 58-70.

Andersen, Torben M. et al. The Danish Economy: An international Perspective. Copenhagen: DJØF Publishing, 2001.

Andersen, Torben M. and Michael Svarer. “Flexicurity: den danska arbetsmarknadsmodellen.” Ekonomisk debatt 34, no. 1 (2006): 17-29.

Banggaard, Grethe. Befolkningsfremmende foranstaltninger og faldende børnedødelighed. Danmark, ca. 1750-1850. Odense: Syddansk Universitetsforlag, 2004

Hansen, Sv. Aage. Økonomisk vækst i Danmark: Volume I: 1720-1914 and Volume II: 1914-1983. København: Akademisk Forlag, 1984.

Henriksen, Ingrid. “Avoiding Lock-in: Cooperative Creameries in Denmark, 1882-1903.” European Review of Economic History 3, no. 1 (1999): 57-78

Henriksen, Ingrid. “Freehold Tenure in Late Eighteenth-Century Denmark.” Advances in Agricultural Economic History 2 (2003): 21-40.

Henriksen, Ingrid and Kevin H. O’Rourke. “Incentives, Technology and the Shift to Year-round Dairying in Late Nineteenth-century Denmark.” Economic History Review 58, no. 3 (2005):.520-54.

Johansen, Hans Chr. Danish Population History, 1600-1939. Odense: University Press of Southern Denmark, 2002.

Johansen, Hans Chr. Dansk historisk statistik, 1814-1980. København: Gyldendal, 1985.

Klovland, Jan T. “Monetary Policy and Business Cycles in the Interwar Years: The Scandinavian Experience.” European Review of Economic History 2, no. 3 (1998): 309-44.

Maddison, Angus. The World Economy: A Millennial Perspective. Paris: OECD, 2001

Mokyr, Joel. “Successful Small Open Economies and the Importance of Good Institutions.” In The Road to Prosperity. An Economic History of Finland, edited by Jari Ojala, Jari Eloranta and Jukka Jalava, 8-14. Helsinki: SKS, 2006.

Pedersen, Peder J. “Postwar Growth of the Danish Economy.” In Economic Growth in Europe since 1945, edited by Nicholas Crafts and Gianni Toniolo. Cambridge: Cambridge University Press, 1995.

OECD, Employment Outlook, 2005.

O’Rourke, Kevin H. “The European Grain Invasion, 1870-1913.” Journal of Economic History 57, no. 4 (1997): 775-99.

O’Rourke, Kevin H. and Jeffrey G. Williamson. Globalization and History: The Evolution of a Nineteenth-century Atlantic Economy. Cambridge, MA: MIT Press, 1999

Topp, Niels-Henrik. “Influence of the Public Sector on Activity in Denmark, 1929-39.” Scandinavian Economic History Review 43, no. 3 (1995): 339-56.


Footnotes

1 Denmark also includes the Faeroe Islands, with home rule since 1948, and Greenland, with home rule since 1979, both in the North Atlantic. These territories are left out of this account.

Citation: Henriksen, Ingrid. “An Economic History of Denmark”. EH.Net Encyclopedia, edited by Robert Whaples. October 6, 2006. URL http://eh.net/encyclopedia/an-economic-history-of-denmark/

Credit in the Colonial American Economy

David T Flynn, University of North Dakota

Overview of Credit versus Barter and Cash

Credit was vital to the economy of colonial America and much of the individual prosperity and success in the colonies was due to credit. Networks of credit stretched across the Atlantic from Britain to the major port cities and into the interior of the country allowing exchange to occur (Bridenbaugh, 1990, 154). Colonists made purchases by credit, cash and barter. Barter and cash were spot exchanges, goods and services were given in exchange for immediate payment. Credit, however, delayed the payment until a later date. Understanding the role of credit in the eighteenth century requires a brief discussion of all payment options as well as the nature of the repayment of credit.

Barter

Barter is an exchange of goods and services for other goods and services and can be a very difficult method of exchange due to the double coincidence of wants. For exchange to occur in a barter situation each party must have the good desired by its trading partner. Suppose John Hancock has paper supplies and wants corn while Paul Revere has silver spoons and wants paper products. Even though Revere wants the goods available from Hancock no exchange occurs because Hancock does not want the good Revere has to offer. The double coincidence of wants can make barter very costly because of time spent searching for a trading partner. This time could otherwise be used for consumption, production, leisure, or any number of other activities. The principle advantage of any form of money over barter is obvious: money satisfies the double coincidence of wants, that is, money functions as a medium of exchange.

Money’s advantages

Money also has other functions that make it a superior method of exchange to barter including acting as the unit of account (the unit in which prices are quoted) in the economy (e.g. the dollar in the United States and the pound in England). A barter economy uses a large number of prices because every good must have a price in terms of each other good available in the economy. An economy with n different goods would have n(n-1)/2 prices in total, not an enormous burden for small values of n, but as n grows it quickly becomes unmanageable. A unit of account reduces the number of prices from the barter situation to n, or the number of goods. The colonists had a unit of account, the colonial pound (£), which removed this burden of barter.

Several forms of money circulated in the colonies over the course of the seventeenth and eighteenth centuries, such as specie, commodity money and paper currency. Specie is gold or silver minted into coins and is a special form of commodity money, a good that has an exchange value separate from the market value of the good. Tobacco, and later tobacco warehouse receipts, acted as a form of money in many of the colonies. Despite multiple money options some colonists complained of an inability to keep money in circulation, or at least in the hands of those wanting to use it for exchange (Baxter, 1945, 11-17; Bridenbaugh, 153).1

Credit’s advantages

When you acquire goods with credit you delay payment to a later time, be it one day or one year. A basic credit transaction today is essentially the same as in the eighteenth century, only the form is different.2 Extending credit presents risks, most notably default, or the failure of the borrower to repay the amount borrowed. Sellers also needed to worry about the total volume of credit they extended because it threatened their solvency in the case of default. Consumers benefited from credit by the ability to consume beyond current financial resources, as well as security from theft and other advantages. Sellers gained by faster sales of goods and interest charges, often hidden in a higher price for the goods.3

Uncertainty about the scope of credit

The frequency of credit versus barter and cash is not well quantified because surviving account books and transaction records generally only report cash or goods payments made after the merchant allowed credit, not spot cash or barter transactions (Baxter, 19n). Martin (1939, 150) concurs, “The entries represent transactions with those customers who did not pay at once on purchasing goods for [the seller] either made no record of immediate cash purchases, or else there were almost no such transactions.” The results of Flynn’s (2001) study using merchant account books from Connecticut and Massachusetts found also that most purchases recorded in the account books were credit purchases (see Table 1 below).4 Scholars are forced to make general statements about credit as a standard tool in transactions in port cities and rural villages without reference to specific numbers (Perkins, 1980, 123-124).

Table 1

Percentage of Purchases by Type

Purchases by Credit Purchases by Cash Purchases by Barter
Connecticut 98.6 1.1 0.3
Massachusetts 98.5 1.0 0.4
Combined 98.6 1.0 0.4

Source: Adapted from Table 3.2 in Flynn (2001), p. 54.

Indications of the importance of credit

In some regions, the institution of credit was so accepted that many employers, including merchants, paid their employees by providing them credit at a store on the business’s account (Martin, 94). Probate inventories evidence the frequency of credit through the large amount of accounts receivable recorded for traders and merchant in Connecticut, sometimes over £1,000 (Main, 1985, 302-303). Accounts receivable are an asset of the business representing amounts owed to the business by other parties. Almost 30 percent of the estates of Connecticut “traders” contained £100 or more of receivables as part of their estate (Main, 316). More than this, accounts receivable averaged one-eighth of personal wealth throughout most of the colonial period, and more than one-fifth at the end (Main, 36). While there is no evidence that enables us to determine the relative frequencies of payments, the available information supports the idea that the different forms of payment co-existed.

The Different Types of Credit

There are three different types of credit to discuss: international credit, book credit, and promissory notes and each facilitated exchange and payments. Colonial importers and wholesalers relied on credit from British suppliers while rural merchants received credit from importers and wholesalers in the port cities and, finally, consumers received credit from the retailers. A discussion starts logically with international credit from British suppliers to colonial merchants because it allowed colonial merchants to extend credit to their customers (McCusker and Menard, 1985, 80n; Martin, 1939, 19; Perkins, 1980, 24).

Overseas credit

Research on colonial growth attaches importance to several items including foreign funds, capital improvements and productivity gains. The majority of foreign funds transferred were in the form of mercantile credit (Egnal, 1998, 12-20). British merchants shipped goods to colonial merchants on credit for between six months and one year before demanding payment or charging interest (Egnal, 55; Perkins, 1994, 65; Shepherd and Walton, 1972, 131-132; Thomson, 1955, 15). Other examples show a minimum of one year’s credit given before suppliers assessed five percent interest charges (Martin, 122-123). Factors such as interest and duration determined for how long colonial merchants could extend credit to their own customers and at what level of markup. Some merchants sold goods on commission, where the goods remained the property of the British merchant until sold. After the sale the colonial merchant remitted the funds, less his fee, to the British merchant.

Relationships between colonial and British merchants exhibited regional differences. Virginia merchants’ system of exchange, known as the consignment system, depended on the credit arrangements between planters and “factors” – middlemen who accepted colonial goods and acquired British or other products desired by colonists (Thomson, 28). A relationship with a British merchant was important for success in business because it provided the tobacco growers and factors access to supplies of credit sufficient to maintain business (Thomson, 211). Independent Virginia merchants, those without a British connection, ordered their supplies of goods on credit and paid with locally produced goods (Thomson, 15). Virginia and other Southern colonies could rely on credit because of their production of a staple crop desired by British merchants. New England merchants such as Thomas Hancock, uncle of the famous patriot John Hancock, could not rely on this to the same extent. New England merchants sometimes engaged in additional exchanges with other colonies and countries because they lacked goods desired by British merchants (Baxter, 46-47). Without the willingness of British merchant houses to wait for payment it would have been difficult for many colonial merchants to extend credit to their customers.

Domestic credit: book credit and promissory notes

Domestic credit was primarily of two forms, book credit and promissory notes. Merchants recorded book credit in the account books of the business. These entries were debits for an individual’s account and were set against payments, credits in the merchant’s ledger. Promissory notes detailed a debt, including typically the date of issue, the date of redemption, the amount owed, possibly the form of repayment and an interest rate. Book credit and promissory notes were substitutes and complements. Both represented a delay of payment and could be used to acquire goods but book accounts were also a large source of personal notes. Merchants who felt payment was either too slow in coming or the risks of default too high could insist the buyer provide a note. The note was a more secure form of credit as it could be exchanged and, despite the likely loss on the note’s face value if the debtor was in financial trouble, would not represent a continuing worry of the merchant (Martin, 158-159).5

Figure 1

Accounts of Samuell Maxey, Customer, and Jonathan Parker, Massachusetts Merchant

Date Transaction Debt (£) Date Transaction Credit (£)
5/28/1748 To Maxey earthenware by Brock 62.00 5/30/1748 By cash & Leather 45.00
10/21/1748 To ditto by Cap’n Long 13.75 8/20/1748 By 2 quintals of fish @6-0-0 [per quintal] 12.00
5/25/1749 To ditto 61.75 11/15/1748 By cash received of Mr. Suttin 5.00
6/26/1749 To ditto 27.35 5/26/1749 By sundrys 74.75
10/1749 By cash of Mr. Kettel 9.75
12/1749 By ditto 18.35

Source: John Parker Account Book. Baker Library, Harvard Business School, Mss: 605 1747-1764 P241, p.7.

The settlement of debt obligations incorporated many forms of payment. Figure 1 details the activity between Samuell Maxey and Jonathan Parker, a Massachusetts merchant. Included are several purchases of earthenware by Maxey and others and several payments, including some in cash and goods as well as from third parties. Baxter (1945, 21) describes similar experiences when he says,

…the accounts over and over again tell of the creditor’s weary efforts to get his dues by accepting a tardy and halting series of odds and ends; and (as prices were often soaring, especially in 1740-64) the longer a debtor could put off payment, the fewer goods might he need to hand over to square a liability for so much money.

Repayment means and examples

The “odds and ends” included goods and commodity money as well as other cash, bills of exchange, and third party settlements (Baxter, 17-32). Merchants accepted goods such as pork beef, fish and grains for their store goods (Martin, 94). Flynn (2001) shows several items offered as payment, including goods, cash, notes and others, shown in Table 2.

Table 2

Percentage of Payments by Category

Repayment in Cash Repayment in Goods Repayment by note Repayment by Reckoning Repayment by third- party note Repayment by Bond Repayment by Labor

Conn.

27.5 45.9 3.3 7.5 6.9 0.0 8.9
Mass. 24.2 47.6 2.8 7.5 13.7 0.2 2.3
Combined 25.6 46.9 3.0 7.5 10.9 0.1 5.0

Source: Adapted from Table 3.4 in Flynn (2001), p. 54.

Cash, goods and notes require no further explanation, but Table 2 shows other items used in payment as well. Colonists used labor to repay their tabs, working in their creditor’s field or lending the labor services of a child or yoke of oxen. Some accounts also list “reckoning,” which occurred typically between two merchants or traders that made purchases on credit from each other. Before the two merchants settled their accounts it was convenient to determine the net position of their accounts with each other. After making the determination the merchant in debt possibly made a payment that brought the balance to zero, but at other times the merchants proceeded without a payment but a better sense of the account position. Third parties also made payments that employed goods, money and credit. When the merchant did not want the particular goods offered in payment he could hope to pass them on, ideally to his own creditors. Such exchange satisfied both the merchant’s debts and the consumer’s (Baxter, 24-25). Figure 1 above and Figure 2 below illustrate this.

Figure 2

Accounts of Mr. Clark, Customer, and Jonathan Parker, Massachusetts Merchant

Date Transaction Debt (£) Date Transaction Credit (£)
9/27/1749 To Clark earthenware 10.85 11/30/1749 By cash 3.00
4/14/1750 By ditto 1.00
?/1762 By rum in full of Mr. Blanchard 6.35

Source: John Parker Account Book. Baker Library, Harvard Business School, Mss: 605 1747-1764 P241, p.2.

The accounts of Parker and his customer, Mr. Clark, show another purchase of earthenware and three payments. The purchase is clearly on credit as Parker recorded the first payment occurring over two months after the purchase. Clark provided two cash payments and then a third person Mr. Blanchard settled Clark’s account in full with rum. What do these third party payments represent? For answers to this we need to step back from the specifics of the account and generalize.

Figures 1 and 2 show credits from third parties in cash and goods. If we think in terms of three-way trade the answer becomes obvious. In Figure 1 where a Mr. Suttin pays £5.00 cash to Parker on the account of Samuell Maxey, Suttin is settling a debt with Maxey (in part or in full we do not know). To settle the debt he owes Parker, Maxey directs those who owe him money to pay Parker, and thus reduce his debt. Figure 2 displays the same type of activity, except Blanchard pays with rum. Though not depicted here, private debts between customers could be settled on the merchant’s books. Rather than offering payment in cash or goods, private parties could swap debt on the merchant’s account book, ordering a transfer from one account to another. The merchant’s final approval for the exchange implied something about the added risk from a third party exchange. The new person did not pose a greater default risk in the creditor’s opinion, otherwise (we would suspect) they refused the exchange.6

Complexity of the credit system

The payment system in the colonies was complex and dynamic with creditors allowing debtors to settle accounts in several fashions. Goods and money satisfied outstanding debts and other credit obligations deferred or transferred debts. Debtors and creditors employed the numerous forms of payment in regular and third party transactions, making merchants’ account books a clearinghouse for debts. Although the lack of technology leaves casual observers thinking payments at this time were primitive, such was clearly not the case. With only pen and paper eighteenth century merchants developed a sophisticated payment system, of which book credit and personal notes were an important part.

The Duration of Credit

The length of time outstanding for credit, its duration, is an important characteristic. Duration represents the amount of time a creditor awaited payment and anecdotal and statistical evidence provide some insights into the duration of book credit and promissory notes.

The calculation of the duration of book credit, or any similar type of instrument, is relatively straightforward when the merchant recorded dates in his account book conscientiously. Consider the following example.

Figure 3

Accounts of David Forthingham, Customer, and Jonathan Parker, Massachusetts Merchant

Date Transaction Debt (£) Date Transaction Credit (£)
10/1/1748 To Forthingham earthenware 7.75 10/1/1748 By cash 3.00
4/1749 By Indian corn 4.75

Source: John Parker Account Book. Baker Library, Harvard Business School, Mss: 605 1747-1764 P241, p.2.

The exchanges between Frothingham and Jonathan Parker show one purchase and two payments. Frothingham provides a partial payment for the earthenware at the time of purchase, in cash. However, £4.75 of debt remains outstanding, and is not repaid until April of 1749. It is possible to calculate a range of values for the final settlement of this account, using the first day of April to give a lower bound estimate and the last day to give an upper bound estimate. Counting the number of days shows that it took at least 182 days and at most 211 days to settle the debt. Alternatively the debt lasted between 6 and 7 months.

Figure 4

Accounts of Joseph Adams, Customer, and Jonathan Parker, Massachusetts Merchant

Date Transaction Debt (£) Date Transaction Credit (£)
9/7/1747 to Adams earthenware -30.65 11/9/1747 by cash 30.65
7/22/1748 to ditto -22.40 7/22/1748 by ditto 12.40
No Date7 by ditto 10.00

Source: John Parker Account Book. Baker Library, Harvard Business School, Mss: 605 1747-1764 P241, p.4.

Not all merchants were meticulous record keepers and sometimes they failed to record a particular date with the rest of an account book entry.8 Figure 4 illustrates this problem well and also provides an example of multiple purchases along with multiple payments. The first purchase of earthenware is repaid with one “cash” payment sixty-three days (2.1 months) later.9 Computation of the term of the second loan is more complicated. The last two payments satisfy the purchase amount, so Adams repaid the loan completely. Unfortunately, Parker left out the date for the second payment. The second payment occurred on or after July 22, 1748, so this date is the lower end of the interval. The minimum time between purchase and second payment is zero days, but computation of a maximum time, or upper bound, is not possible due to the lack of information.10

With a sufficient number of debts some generalization is possible. If we interpret the data as the length of a debt’s life we can use demographic methods, in particular the life table.11 For a sample of Connecticut and Massachusetts account books the average duration looks like the following.12

Table 3

Expected Duration for Connecticut Debts, Lower and Upper Bound

(a) (b) (c) (d) (e)
Size of debt in £ eo lower bound (months) Median lower bound (interval) eo upper bound (months) Median upper bound (interval)
All Values 14.79 6-12 15.87 6-12
0.0-0.25 15.22 6-12 15.99 6-12
0.25-0.50 14.28 6-12 15.51 6-12
0.50-0.75 15.24 6-12 18.01 6-12
0.75-1.00 14.25 6-12 15.94 6-12
1.00-10.00 13.95 6-12 15.07 6-12
10.00+ 7.95 0-6 10.73 6-12

Table 4

Expectation Duration for Massachusetts Debts, Lower and Upper Bound

(a) (b) (c) (d) (e)
Size of debt in £ eo lower bound (months) Lower bound median (interval) eo upper bound (months) Upper bound median (interval)
All Values 13.22 6-12 14.87 6-12
0.0-0.25 14.74 6-12 17.55 12-18
0.25-0.50 12.08 6-12 12.80 6-12
0.50-0.75 11.73 6-12 13.08 6-12
0.75-1.00 11.01 6-12 12.43 6-12
1.00-10.00 13.08 6-12 13.88 6-12
10.00+ 14.28 12-18 17.02 12-18

Source: Adapted from Tables 4.1 and 4.2 in Flynn (2001), p. 80.

For all debts in the sample from Connecticut, the expected length of time the debt is outstanding from its inception is estimated between 14.78 and 15.86 months. For Massachusetts the range is somewhat shorter, from 13.22 to 14.87 months. Tables 3 and 4 break the data into categories based on the value of the credit transaction as well. An important question to ask is whether this represents a long- term or a short-term debt? There is no standard yardstick for comparison in this case. The best comparison is likely the international credit granted to colonial merchants. The colonial merchants needed to repay these amounts and had to sell the goods to make remittances. The estimates of that credit duration, listed earlier, center around one year, which means that colonial merchants in New England needed to repay their British suppliers before they could expect to receive full payment from their customers. From the colonial merchants’ perspective book credit was certainly long-term.

Other estimates of duration of book credit

Other estimates of book credit’s duration vary. Consumers paying their credit purchases in kind took as little time as a few months or as long as several years (Martin, 153). Some accounting records show book credit remaining unsettled for nearly thirty years (Baxter, 161). Thomas Hancock often noted expected payment dates, such as “to pay in 6 months” along with a purchase, though frequently this was not enough time for the buyer. Thomas blamed the law, which allowed twelve months for people to make repayments, complaining to his suppliers that he often provided credit to country residents of “one two & more years” (Baxter, 192). Surely such a situation is the exception and not the rule, though it does serve to remind us that many of these arrangements were open, lacking definite endpoints. Some merchants allowed accounts to last as long as two years before examining the position of the account, allowing one year’s book credit without charge, and thereafter assessing interest (Martin, 157).

Duration of promissory notes

The duration of promissory notes is also important. Priest (1999) examines a form of duration for these credit instruments, estimating the time between a debtor’s signing of the note and the creditor’s filing of suit to collect payment. Of course this only measures the duration for notes that go into default and require legal recourse. Typically, a suit originated some 6 to 9 months after default (Priest, 2417-18). Results for the period 1724 to 1750 show 14.5% of cases occurred within 6 months after the initial contraction date, the execution of the debt. Merchants brought suit in more than 60% of the cases between 6 months and 3 years from execution, 21.4% from six to twelve months, 27.4% from one to two years and 14.1% from two to three years. Finally, more than 20% of the cases occurred more than three years from the execution of the debt. The median interval between execution and suit was 17.5 months (Priest, 2436, Table 3).

The duration of promissory notes provides an important complement to estimates of book credit’s term. Median estimates of 17.5 months make promissory notes, more than likely, a long-term credit instrument when balanced against the one year credit term given colonial importers. The estimates for book credit range between three months and several years in the literature to between 13 and 16 months in Flynn (2001) study. Duration results show that merchants waited significant amounts of time for payment, raising the issue of the time value of money and interest rates.

The Interest Practices of Merchants

In some cases credit was outstanding for a long period of time, but the accounts make no mention of any interest charges, as in Figures 1 through 4. Such an omission is difficult to reconcile with the fairly sophisticated business practices for the merchants of the day. Accounting research and manuals from the time demonstrate clearly an understanding of the time value of money. The business community understood the concept of compound interest. Account books allowed merchants to charge higher and variable prices for goods sold on book credit (Martin, 94). While in some cases interest charges entered the account book as an explicit entry in many others interest was an added or implicit charge contained in the good’s price.

Advertisements from the time make it clear that merchants charged less for goods

purchased by cash, and accounts paid promptly received a discount on the price,

One general pricing policy seems to have been that goods for cash were sold at a lower price than when they were charged. Cabel[sic] Bull advertised beaver hats at 27/ cash and 30/ country produce in hand. Daniel Butler of Northampton offered dyes, and “a few Cwt. of Redwood and Logwood cheaper than ever for ready money.” Many other advertisements carried allusions to the practice but gave no definite data. A daybook of the Ely store contained this entry for October 21, 1757: “William Jones, Dr to 6 yds Towcloth at 1/6—if paid in a month at 1/4. (Martin, 1939, 144-145)

Other advertisements also evidence a price difference, offering cash prices for certain grains they desired. Connecticut merchants likely offered good prices for products they thought would sell well as they sought remittances for their British creditors. Hartford merchants charged interest rates ranging from four and one-half to six and one-half percent in the 1750s and 1760s, though Flynn (2001) arrives at different rates from a different sample of New England account books (Martin, 158). Many promissory notes in South Carolina specified interest, though not an exact rate, usually just the term “lawful interest” (Woods, 364).

Estimates of interest rates

Simple regression analysis can help determine if interest was implicit in the price of goods sold on credit though there are numerous technical issues, such as borrower characteristics, market conditions and the quality of the good that make a discussion here inappropriate.13 In general, there seems to be a positive correlation, with the annual interest rates falling between 3.75% and 7%, which seem consistent with the results from interest entries made in account books. There is some tendency for the price of a good to increase with the time waited for repayment, though many other technical matters need resolution.

Most annual interest rates in Flynn’s (2001) study, explicit and implicit, fall in the range of 4 to 6.5 percent making them similar to those Martin found in her examination of accounts and roughly consistent with the Massachusetts lawful rate of 6 percent at the time, though some entries assess interest as high as 10 percent (Martin, 158; Rothenberg, 1992, 124). Despite this, the explicit rates are insufficient on their own to form a conclusion about the interest rate charged on book credit; there are too few entries, and many involve promissory notes or third parties, factors expected to alter the interest rate. Other factors such as borrower characteristics likely changed the assessed rate of interest too, with more prominent and wealthy individuals charged lower rates, either due to their status and a perceived lower risk, or possibly due to longer merchant-buyer relationships. Most account books do not contain information sufficient to judge the effects of these characteristics.

Merchants gained from credit use by charging higher prices; credit required a premium over cash sales and so the merchant collected interest and at the same time minimized the necessary amount of payments media (Martin, 94). Interest was distinct from the normal markups for insurance, freight, wharfage, etc. that were often significant additions to the overall price and represented an attempt to account for risk and the time value of money (Baxter, 192; Thomson, 239).14

Conclusions

Credit was significant as a form of payment in colonial America. Direct comparisons of the number of credit purchases versus barter or cash are not possible, but an examination of accounting records demonstrates credit’s widespread use. Credit was present in all forms of trade including international trade between England and her colonies. The domestic forms of credit were relatively long-term instruments that allowed individuals to consume beyond current means. In addition, book credit allowed colonists to economize on cash and other means of payment through transfers of credit, “reckoning,” and other means such as paying workers with store credit. Merchants also understood the time value of money, entering interest charges explicitly in the account books and implicitly as part of the price. The use of credit, the duration of credit instruments, and the methods of incorporating interest show credit as an important method of exchange and the economy of colonial America to be very complex and sophisticated.

References

Baxter, W.T. The House of Hancock: Business in Boston, 1724-1775. Cambridge: Harvard University Press, 1945.

Bridenbaugh, Carl. The Colonial Craftsman. Dover Publications: New York, 1990.

Egnal, Marc. New World Economies: The Growth of the Thirteen Colonies and Early Canada. Oxford: Oxford University Press, 1998.

Flynn, David T. “Credit and the Economy of Colonial New England.” Ph.D. dissertation, Indiana University, 2001.

McCusker, John J., and Russel R. Menard. The Economy of British America, 1607-1789. Chapel Hill: University of North Carolina Press, 1985.

Main, Jackson Turner. Society and Economy in Colonial Connecticut. Princeton: Princeton University Press, 1985.

Martin, Margaret. “Merchants and Trade of the Connecticut River Valley, 1750-1820.” Smith College Studies in History. Department of History, Smith College: Northampton, Mass. 1939.

Parker, Jonathan. Account Book, 1747-1764. Mss:605 1747-1815. Baker Library Historical Collections, Harvard Business School; Cambridge, Massachusetts

Perkins, Edwin J. The Economy of Colonial America. New York: Columbia University Press, 1980.

Perkins, Edwin J. American Public Finance and Financial Services, 1700-1815. Columbus: Ohio State University Press, 1994.

Price, Jacob M. Capital and Credit in British Overseas Trade: The View from the Chesapeake, 1700-1776. Cambridge: Harvard University Press, 1980.

Priest, Claire. “Colonial Courts and Secured Credit: Early American Commercial Litigation and Shays’ Rebellion.” Yale Law Journal 108, no. 8 (June, 1999): 2412-2450.

Rothenberg, Winifred. From Market-Places to a Market Economy: The Transformation of Rural Massachusetts, 1750-1850. Chicago: University of Chicago Press, 1992.

Shepherd, James F. and Gary Walton. Shipping, Maritime Trade, and the Economic Development of Colonial North America. Cambridge: University Press 1972.

Thomson, Robert Polk. The Merchant in Virginia, 1700-1775. Ph.D. dissertation, University of Wisconsin, 1955.

Further Reading:

For a good introduction to credit’s importance across different professions, merchant practices and the development of business practices over time I suggest:

Bailyn, Bernard. The New England Merchants in the Seventeenth-Century. Cambridge: Harvard University Press, 1979.

Schlesinger, Arthur. The Colonial Merchants and the American Revolution: 1763-1776. New York: Facsimile Library Inc., 1939.

For an introduction to issues relating to money supply, the unit of account in the economy, and price and exchange rate data I recommend:

Brock, Leslie V. The Currency of the American Colonies, 1700-1764: A Study in Colonial Finance and Imperial Relations. New York: Arno Press, 1975.

McCusker, John J. Money and Exchange in Europe and America, 1600-1775: A Handbook. Chapel Hill: University of North Carolina Press, 1978.

McCusker, John J. How Much Is That in Real Money? A Historical Commodity Price Index for Use as a Deflator of Money Values in the Economy of the United States, Second Edition. Worcester, MA: American Antiquarian Society, 2001.

1 Some authors note a small amount of cash purchases as well as small numbers of cash payments for debts as evidence of a lack of money (Bridenbaugh, 153; Baxter, 19n).

2 Presently, credit cards are a common form of payment. While such technology did not exist in the past, the merchant’s account book provided a means of recording credit purchases.

3 Price (1980, pp.16-17) provides an excellent summary of the advantages and risks of credit to different types of consumers and to merchants in both Britain and the colonies.

4 Please note that this table consists of transactions mostly between colonial retail merchants and colonial consumers in New England. Flynn (2001) uses account books that collectively span from approximately 1704 to 1770.

5 In some cases with the extension of book credit came a requirement to provide a note too. When the solvency of the debtor came into question the creditor, could sell the note and pass the risk of default on to another.

6 I offer a detailed example of such an exchange going sour for the merchant below.

7 “No date” is Flynn’s entry to show that a date is not recorded in the account book.

8 It seems that this frequently occurs at the end of a list of entries, particularly when the credit fully satisfies an outstanding purchase as in Figure 4.

9 To calculate months, divide days by 30. The term “cash” is placed in quotation marks as it is woefully nondescript. Some merchants and researchers using account books group several different items under the heading cash.

10 Students interested in historical research of this type should be prepared to encounter many situations of missing information. There are ways to deal with this censoring problem, but a technical discussion is not appropriate here.

11 Colin Newell’s Methods and Models in Demography (Guilford Press, 1988) is an excellent introduction for these techniques.

12 Note that either merchants recorded amounts in the lawful money standard or Flynn (2001) converted amounts into this standard for these purposes.

13 The premise behind the regression is quite simple: we look for a correlation between the amount of time an amount was outstanding and the per unit price of the good. If credit purchases contained implicit interest charges there would be a positive relationship. Note that this test implies forward looking merchants, that is, merchants factored the perceived or agreed upon time to repayment into the price of the good.

14 The advance varied by colony, good and time period,

In 1783, a Boston correspondent wrote Wadsworth that dry goods in Boston were selling at a twenty to twenty-five percent ‘advance’ from the ‘real Sterling Cost by Wholesale.’ The ‘advances’ occasionally mentioned in John Ely’s Day Book were far higher, seventy to seventy-five per cent on dry goods. Dry goods sold well at one hundred and fifty per cent ‘advance’ in New York in 1750… (Martin, 136).

In the 1720s a typical advance on piece goods in Boston was eighty per cent, seventy-five with cash (Martin, 136n). It should be noted that others find open account balances were commonly kept interest free (Rothenberg, 1992, 123).

13

Citation: Flynn, David. “Credit in the Colonial American Economy”. EH.Net Encyclopedia, edited by Robert Whaples. March 16, 2008. URL http://eh.net/encyclopedia/credit-in-the-colonial-american-economy/

Economic Interests and the Adoption of the United States Constitution

Robert A. McGuire, University of Akron

The adoption of the Constitution greatly strengthened the national government at the expense of the states. This article examines how our Founding Fathers designed the Constitution, examining findings on the political and economic factors behind the provisions included in the Constitution and its ratification. The article discusses the views of Charles Beard and his critics and focuses on recent quantitative findings that explain the making of the Constitution. These findings suggest that personal interests of the Founding Fathers, as well as constituents’ interests, played an important role in drafting the Constitution. They also suggest that economic and other interests played important roles at the ratifying conventions.

The Adoption of the Constitution

During the summer of 1787, fifty-five men attended the constitutional convention in Philadelphia that drafted the Constitution of the United States. In less than a year after the convention finished, New Hampshire, on June 21, 1788, became the ninth state to have ratified the Constitution that was drafted. As a result, Congress declared the Constitution to be in force beginning March 4, 1789, because ratification by only nine of the thirteen states was required for the Constitution to be considered adopted by the ratifying states. The Constitution thus replaced the Articles of Confederation and Perpetual Union as the law of the land. Under the Articles, which had been in effect only since 1781, the American political system consisted of a loose confederation of largely independent states with a very weak central government. Under the Constitution, the Articles were replaced with a political system that consisted of a powerful central government with, ultimately, little state sovereignty.

Fiscal and Economic Problems under the Articles of Confederation

Under the Articles of Confederation, the central (federal) government had little or no power to raise revenues and had difficulty repaying its domestic and foreign debt. The fiscal problems under the Articles were twofold. First, the primary source of revenues to fund the federal government was requisitions to the state governments asking them to send to the federal government state-collected tax revenues. Yet the Articles did not include any enforcement mechanism to ensure that the state governments would send in the full amount of the funds requested of them, which they never did. Second, each state had a single vote in the federal Congress and the unanimous consent of the thirteen states was required for the Congress to enact any federal taxes. A single state could thus block federal tax legislation. This de facto veto power on the part of each state created substantial decision-making costs for Congress and prevented proposed federal imposts (import duties) from being enacted under the Articles. The central government also lacked the legal power to enforce uniform commercial or trade regulations – either at home or abroad – that might have been conducive to the development of a common economic trading area. Likewise, the Confederation government possessed uncertain authority to deal with foreign powers. Its problems raising revenues and repaying existing debts created uncertainty about the financial viability of the federal government. Although state and local interference in trade was not a major problem at the time, many commercial interests apparently feared that local and state barriers to trade could develop in the future under the Articles of Confederation. Western landowners also were often impatient with the federal government because of its inability to establish order on the frontiers.

How the Constitution Strengthened the Power of the Central Government

Under the Constitution, the power to tax, along with the authority to settle past federal debts, was firmly delegated to the central (national) government, improving the central government’s financial future as well as improving capital markets (the markets for funds). The Constitution, unlike the Articles, required only a simple majority vote of the representatives in both chambers of the national Congress to enact tax legislation. There were, and are, checks on simple majority voting though. The president can veto congressional legislation and a two-thirds vote in Congress can override the presidential veto. But neither of these constraints on majority voting creates the magnitude of decision-making costs that unanimous voting under the Articles created. The assignment of the sole right “To coin money, [and] regulate the value thereof,” to the national government and the prohibition on states from emitting “bills of credit” (paper money) also were expected to improve capital markets. A national judiciary was created under the Constitution and the power to make treaties with foreign nations was firmly delegated to the central government.

How a Strong Central Government Affected the Economy

With respect to interstate trade, Gary M. Walton and James F. Shepherd (1979) suggest “the possibility of such barriers [to interstate commerce] loomed as a threat until the Constitution specifically granted the regulation of interstate commerce to the federal government” (pp. 187-88). Walton and Shepherd conclude that the most important changes associated with the Constitution “were those changes that strengthened the framework for protection of private property and enforcement of contracts” (pp. 187-88). These changes were most important because they increased the benefits of exchange (the cornerstone of a market economy) and created incentives for individuals to specialize in economic activities in which they had a particular advantage and then engage in mutually advantageous exchange (trade) with individuals specializing in other economic activities. Specific provisions in the Constitution that helped to increase the benefits of exchange were those that prohibited the national and state governments from enacting ex-post-facto laws (retroactive laws) and a provision that prohibited the state governments from passing any “law impairing the obligation of contracts.” These prohibitions were important to the development of a market economy because they constrained governments from interfering in economic exchange, making the returns to economic activity more secure.

Because the economies of the thirteen states were not highly interconnected in the 1780s, the immediate consequences for the nation of adopting the Constitution were not at all large. But the change in our fundamental political institution was ultimately to have a profound influence on our nation’s history, because the Constitution over time became the foundation of the supremacy of the national government in the United States.

The “Important Question”: How Did Constitutional Change Come About?

How did this fundamental change come about? Why did our nation’s Founding Fathers replace the Articles of Confederation, our first “constitution,” with the United States Constitution? In defending the Constitution in late 1787, Alexander Hamilton observed “It has been frequently remarked that it seems to have been reserved to the people of this country . . . to decide the important question, whether societies of men are really capable or not of establishing good government from reflection and choice, or whether they are forever destined to depend for their political constitutions on accident and force” (Hamilton, Jay and Madison, 1937, No. 1, p. 3). To paraphrase Hamilton: How did “this country” decide “the important question”?

Since the middle of the nineteenth century, hundreds of scholars have studied and debated the possible explanations for such an important change in the fundamental political institution of our nation. Many historians have concluded that the Constitution was drafted and adopted as a result of a consensus that the Articles of Confederation were fatally flawed. Other scholars have argued that the limitations of the Articles could have been eliminated without fundamentally altering the balance of power between the states and the central government. Others have suggested that the adoption of the Constitution was the product of conflict between various economic and financial interests within the nation, a conflict between those who, because of their interests, wanted a strengthened, more powerful national government and those who, because of their interests, did not.

Charles Beard’s “Economic” Interpretation

In 1913, Charles A. Beard (1913 [1935]) consolidated various scholarly views of the Constitution and, in the process, offered what became identified as “the” economic interpretation of the Constitution. Beard (pp. 16-18) argued that the formation of the Constitution was a conflict based upon competing economic interests – interests of both the proponents and opponents. In his view, the Federalists, the founders who supported a strong, centralized government and favored the Constitution during its drafting and ratification, were individuals whose primary economic interests were tied to personal property. They were mainly merchants, shippers, bankers, speculators, and private and public securities holders, according to Beard (pp. 31-51). The Anti-federalists, the opponents of the Constitution and supporters of a more decentralized government, were individuals whose primary economic interests were tied to real property. Beard (pp. 26-30) contended these opponents consisted primarily of more isolated, less-commercial farmers, who often were also debtors, and northern manorial planters along the Hudson River. However, Beard (pp. 29-30) maintained that many southern slaveowning planters, who held much of their wealth in personal property, had much in common with northern merchants and financiers, and should be included as supporters of the Constitution.

Beard (pp. 31-51) claimed that support for his argument could be found in the economic conditions prevailing during the 1780s. As a result, he suggested that the primary beneficiaries under the Constitution would have been individuals with commercial and financial interests – particularly, those with public securities holdings who, according to Beard, had a clause included in the Constitution requiring the assumption of existing federal debt by the new national government. Commercial and financial interests also would benefit because of more certainty in the rules of commerce, trade, and credit markets under the Constitution. More isolated less-commercial farmers, debtors, paper money advocates, and the northern planters along the Hudson would be the primary beneficiaries under the status quo. They would have had greater ability at the state level with decentralized government to avoid heavy land taxation – levied to pay off the public debt – and to promote paper money and debt moratorium issues that advanced their interests. Consequently, they opposed the Constitution.

Criticisms of Beard’s View: Brown and McDonald

Beard’s thesis soon emerged as the standard historical interpretation and remained so until the 1950s, when it began to face serious scholarly challenges. The most influential and lasting of the challenges were those by Robert E. Brown (1956) and Forrest McDonald (1958). Robert E. Brown’s (1956) critique dismisses an economic interpretation as utterly without merit, attacking Beard’s conclusions in their entirety. Brown counters Beard’s views that eighteenth-century America was not very democratic, that the wealthy were strong supporters of the Constitution, and that those without personal property generally opposed the Constitution. Brown examines the support for the Constitution among various economic and social classes, the democratic nature of the nation, and the franchise within the states in eighteenth-century America. He maintains that Beard was plain wrong, eighteenth-century America was democratic, the franchise was common, and there was widespread support for the Constitution.

In contrast, Forrest McDonald’s (1958) study empirically examines the wealth, economic interests, and the votes of the delegates to the constitutional convention in Philadelphia that drafted the Constitution in 1787 and of the delegates to the thirteen ratifying conventions that considered its adoption afterward. McDonald’s primary interest is in testing Charles A. Beard’s thesis. Based on his evidence collected from the Philadelphia convention, McDonald (1958, p. 110) concludes, “anyone wishing to rewrite the history of those proceedings largely or exclusively in terms of the economic interests represented there would find the facts to be insurmountable obstacles.” With respect to the ratification of the Constitution, McDonald (1958. p. 357) likewise concludes, “On all counts, then, Beard’s thesis is entirely incompatible with the facts.”

Neither Brown nor McDonald, however, offered any modern rigor (no formal or statistical analysis of any type) in testing the behavior of the Founding Fathers during the drafting or ratification of the Constitution. Yet Brown and McDonald are still credited by many with delivering the fatal blows to Beard’s economic interpretation of the Constitution. (Examples of economists, historians, political scientists, and legal scholars who credit Brown and McDonald, or both, with proving Beard incorrect include Buchanan and Tullock (1962), Wood (1969), Riker (1987), and Ackerman (1991).

The New Quantitative Approach

Recently economic historians have begun to reexamine the behavior of our Founding Fathers concerning the Constitution. This reexamination, which employs formal economics and modern statistical techniques, involves the application of an economic model of voting behavior during the drafting and ratification processes and the collection and processing of large amounts of data on the economic and financial interests and other characteristics of the men who drafted and ratified the Constitution. The findings of this reexamination, which have become the accepted view among quantitative economic historians today (Robert Whaples, 1995), provide answers to many heretofore-unresolved issues involving the adoption of the Constitution.

What factors explain the behavior of George Washington, James Madison, Alexander Hamilton, and the other Founding Fathers regarding the Constitution? Why did they include a prohibition on state paper-money issues in the Constitution? Why did they decide to allow for duties (taxes) on imports but not on exports? Why did they fail to adopt a clause giving the national government an absolute veto over state laws? Were the economic, financial, and other interests of the founders significant factors in their support for the Constitution, or their support for specific clauses in it, or their support for ratification? Were, for example, the slaveholdings of the founders a significant factor in their behavior? Were the founders’ commercial activities significant factors? Were the private or public securities holdings significant factors?

The Rational Choice Model

The critical reexamination of the adoption of the Constitution, which began in the mid-1980s (Robert A. McGuire and Robert L. Ohsfeldt, 1984), offers an economic model of the founders that is based on rational choice and methodological individualism, and employs formal statistical techniques. Methodologically, such an approach analyzes the choices of the individuals involved in the drafting and ratification of the Constitution. The object of analysis is the behavior of the individual Founding Fathers not the behavior of some social class or group. The economic model presumes that a founder was motivated by self-interest to maximize the satisfaction he received from the choices he made at the constitutional convention attended. But neither self-interest nor economic rationality implies that a founder was concerned only with his financial or material well-being. The economic model indicates that a founder weighed the benefits (the satisfaction) and the costs (the sacrifice) to himself of his actions, making those choices that were in his self-interest, broadly defined to include any pecuniary and non-pecuniary benefits and costs of his choices. This is the presumption of rational choice.

Personal and Constituent Interests

More precisely, the economic model is that a founder acted individually to maximize the net benefit he received from his votes. A founder would have voted in favor of a particular issue at Philadelphia, or in favor of ratification, if he expected the net benefit he would receive would have been greater if the issue, or the Constitution, was adopted. Because a founder was from a particular state or locality, the founder represented the citizens (the constituents) of the state or locality in which he resided as well as represented his own personal interests at Philadelphia or a ratifying convention. The benefit of a founder’s vote was affected directly by the anticipated impact of his vote on his personal interests and indirectly by the anticipated impact of his vote on his constituents’ interests. A founder’s personal interests depended on his own economic interests and ideology and his constituent interests depended on the economic interests and ideologies of his constituents. The interests may have been purely economic (pecuniary interests, such as the ownership or value of specific economic assets) or ideological (non-pecuniary interests, such as beliefs about the moral correctness of a particular form of government). The potential effect of personal interests on a founder’s vote is straightforward; the founder would have benefited or been harmed directly. The potential effect of constituents’ interests on a founder’s vote is through the impact of his vote on the potential for maintaining his decision-making authority, continuing to represent his constituents.

Statistical Tests

To quantitatively test the economic model, the founders’ observed votes on a particular issue at Philadelphia or on ratification are statistically related to measures of the economic interests and ideologies of the founders and their constituents. The statistical technique employed is called multivariate logistic regression. Estimation of a logistic regression model is designed to determine the marginal or incremental impact of each explanatory variable – the measures of the economic interests and ideologies – on the dependent variable – the “yes” or “no” votes on a particular issue at Philadelphia or ratification. The estimated logistic regression produces for each explanatory variable an estimated coefficient that captures the influence (its direction and magnitude) of the explanatory variable on the probability of a founder voting in favor of the issue being estimated, holding the influence of all other explanatory variables constant. The benefit of this approach is that each potential factor, each explanatory variable, affecting a vote is examined separately from the influence of the other factors, while at the same time, controlling for the influence of the other factors. This reduces to a minimum the incidence of spurious relationships between any particular factor and a vote. For example, if the relationship between the vote on an issue and the founders’ slaveholdings is examined in isolation, a positive correlation may be indicated. But if other interests are taken into account (for example, the founders’ public securities holdings), the correlation with slaveholdings could change and, in fact, be negative.

The modern economic history of the Constitution indicates that Charles Beard’s economic interpretation has not yet been refuted. The issues, in fact, have not been heretofore tested. Earlier historical studies did not have the benefit of modern economic methodology and systematic statistical analysis. As such, their conclusions cannot pass scientific scrutiny. Major advances in both economic thinking about political behavior and statistical techniques have taken place in the last thirty or so years. These modern methods allow for a systematic quantitative analysis of the voting behavior of the founders employing, among other data and evidence, the types of non-quantitative data about the founders that historians collected decades ago but never systematically analyzed. They failed to systematically analyze such data and evidence because the necessary techniques did not exist and because they generally were not trained in quantitative analysis.

Findings of the Quantitative Approach: A New Economic Interpretation of the Constitution

One unambiguous conclusion can be drawn from the recent quantitative studies: There is a valid economic interpretation of the Constitution. The idea of self-interest can explain the design and adoption of the Constitution. This does not mean that either the framers or the ratifiers of the Constitution were motivated by a greedy desire to “line their own pockets” or by some dialectic concept of “class interests.” Nor does it mean that some “conspiracy among the founders” or some fatalistic concept of “economic determinism” explains the Constitution. Nor does it mean that the founders were completely selfish in a purely financial or material sense. It does mean that the pursuit of one’s “interests” both in a narrow, pecuniary (financial) sense and a broader, non-pecuniary sense can explain the drafting and ratification of the Constitution. (See McGuire (2001).)

The recent quantitative studies contend that the Constitution was neither drafted nor ratified by a group of disinterested and nonpartisan demigods motivated only, or even primarily, by high-minded political principles to promote the nation’s interest. The fifty-five delegates to the Philadelphia convention that drafted the Constitution during the summer of 1787 were motivated by self-interest, in a broad sense, in choosing its design. Quantitative research suggests that these framers of the Constitution can be seen as rational individuals who were making choices in designing the fundamental rules of governance for the nation. In doing so, they rationally weighed the expected costs and benefits of each clause they considered. They included a particular clause in the Constitution only if they expected the benefits from its inclusion to exceed the costs they expected to result from inclusion. Likewise, the more than 1,600 delegates who participated in the thirteen state ratifying conventions, which took place between 1787 and 1790 to consider adopting the Constitution, can be viewed as rational individuals who were making the choice to adopt the set of rules embodied in the Constitution as drafted at the Philadelphia Constitutional Convention. In doing so, they rationally weighed the expected costs and benefits of their decision to ratify. They voted to ratify only if the benefits they expected from adoption of the set of rules embodied in the Constitution exceeded the costs they expected to result from that set of rules. If not, they voted against ratification.

Contrary to earlier views that the founders’ specific economic or financial interests cannot be principally identified with one side or the other of an issue, the modern evidence indicates that their economic and financial interests can be so identified. When specific issues arose at the Philadelphia convention that had a direct impact on important economic interests of the founders, their economic interests, even narrowly defined, significantly influenced the specific design of the Constitution, and the magnitudes of the influences were often quite large. The types of economic interests that mattered for the choice of specific issues were those that were likely to have accounted for a substantial portion of the overall wealth or represent the primary livelihood of the founders.

Even when the founders were deciding on the general issue of the basic design of the Constitution to strengthen the national government, economic and other interests significantly influenced them. In terms used in constitutional political economics, even when the founders were making fundamental “constitutional” choices rather than more specific-interest “operational” choices, the modern evidence indicates their choices were still consistent with self-interested and partisan behavior. In terms used among legal scholars, even when the founders were involved in the “higher lawmaking” of the “constitutional founding,” they were still self-interested and partisan. Partisan behavior explains even this “constitutional moment.” However, the modern evidence does indicate that fewer economic and financial interests mattered for the basic design of the Constitution than for specific-interest aspects of it.

Specific Empirical Findings from the Constitutional Convention and the Ratifying Conventions

Financial Securities

The financial securities holdings of the founders often had a significantly large influence on their behavior and founders with such financial assets were often aligned with each other on the same issue. These findings are in contrast to a strongly held view among many historical scholars that the founders’ financial securities holdings had little or no influence on their behavior or that these founders were not aligned on common issues. For a small number of the issues considered at the Philadelphia convention, the founders’ financial securities holdings mattered. Moreover, during the ratification process, the financial securities holdings had a major influence. Specifically, delegates with private securities holdings (private creditors) or public securities holdings (public creditors), and especially delegates with large amounts of public securities holdings (generally, Revolutionary War debt), were significantly more likely to vote in favor of ratification.

This does not mean that all securities-holding delegates voted together at the constitutional conventions. What it does mean is that the holdings of financial securities, controlling for other influences, significantly increased the probability of supporting some of the issues at the Philadelphia convention, particularly those issues that strengthened the central government (or weakened the state governments). For example, one issue that the securities holders were more likely to have supported was a proposal to absolutely prohibit state governments from issuing paper money. This means that the securities holders (creditors) at the convention desired to constrain the states’ ability to inflate away the value of their financial holdings through expansion of the supply of state paper money. Not surprisingly, the twelve founders at Philadelphia with private securities holdings voted unanimously in favor of the prohibition. Likewise, those with public securities holdings were significantly more likely to have favored it. The evidence indicates that a founder at Philadelphia with any public securities holdings, who at the same time possessed the average values of all other interests represented at the convention, was 26.5 percent more likely to vote yes than was an otherwise average delegate with no public securities holdings. With respect to the ratification process, a delegate’s financial securities holdings, controlling for other influences, significantly increased his probability of voting in favor of ratification at his state convention. An implication that can be drawn from this evidence is that to the extent some delegates with financial securities holdings did not support strengthening the central government, or did not vote for ratification, it was the effects of their other interests that influenced them to vote “no.”

Slaveowners

The view of many historical scholars is that delegates who were slaveowners and those who represented slave areas generally supported strengthening the central government and supported ratifying the Constitution. While this may be correct as far as it goes, the issue of the influence of slaveholdings on the behavior of the Founding Fathers, as is the influence of any factor, is actually more complex. The quantitative evidence indicates that, although a majority of the slaveowners and a majority of the delegates from slave areas, may have, in fact, voted for issues strengthening the central government or voted for ratification, the actual influence of slaveholdings or representing slave areas per se was to significantly decrease a delegate’s likelihood of voting for strengthening the central government or voting for ratification.

As with the findings for financial securities holdings, this does not mean that all slaveholding delegates or all delegates from slave areas voted together at the various constitutional conventions. What it does mean for the Philadelphia constitutional convention is that slaveholdings, controlling for other influences, decreased the probability of voting at the convention for issues that would have strengthened the central government. For example, one issue that slaveholders at Philadelphia were less likely to have supported was a proposal that would have given the national legislature an absolute veto over state laws, which would have greatly strengthened the central government. This means that if the national veto had been put into the Constitution at Philadelphia, which it was not, the national Congress, especially if it had a majority of non-slaveholding representatives, could have vetoed state laws concerning slavery, for example. This would have given the national Congress the power to limit the economic viability of slavery, if it so chose. Not surprisingly, the evidence suggests that a delegate at Philadelphia who owned the most slaves at the convention, for example, and had average values of all other interests, was one-twelfth as likely to have voted yes on the national veto than an otherwise average delegate with no slaveholdings. Likewise, during the ratification process, slaveholdings, controlling for other influences, significantly decreased the probability of voting in favor of ratification at the state ratifying conventions. An implication from this evidence is that in the case of the slaveholding delegates and the delegates from slave areas, who did vote to strengthen the central government or did vote for ratification, it was the effects of their other interests that influenced them to vote “yes.”

Commercial Interests

The modern evidence confirms that the framers and the ratifiers of the Constitution, who were from the more commercial areas of their states, were likely to have voted differently from individuals from the less commercial areas. Delegates who were from the more commercial areas were significantly more likely to have voted for clauses in the Constitution that strengthened the central government and were significantly more likely to have voted for ratification in the ratifying conventions. The Founding Fathers who were from the more isolated, less commercial areas of their states were significantly less likely to support strengthening the central government and significantly less likely to vote for ratification.

Local and State Office Holders

But surprisingly, the findings for the ratification of the Constitution strongly conflict with the nearly unanimous prevailing scholarly view that the localism and parochialism of local and state officeholders were major factors in the opposition to the Constitution’s ratification. The modern quantitative evidence, in fact, indicates that there were no significant relationships whatsoever between any measure of local or state office holding and the ratification vote in any ratifying convention for which the data on officeholders were collected.

The Founders Mattered: How the Constitution Would Have Been Different If Men with Different Interests Had Written It

One of the more important findings of the modern approach to the adoption of the Constitution is that it makes evident the importance to historical outcomes of the specific individuals involved in any historical process. The modern evidence attests to the paramount importance of the specific political actors involved in the American constitutional founding. The estimated magnitudes of the influences of many of the economic, financial, and other interests on the founders’ behavior are large enough that the findings suggest the product of the constitutional founding most likely would have been dramatically different had men with dramatically different interests been involved.

For example, had all the founders at Philadelphia represented a state with a population the size of the most populous state, and possessed the average values of all other interests represented at Philadelphia, the Constitution most certainly would have contained a clause giving the national government an absolute veto over all state laws. If the national veto had been put into the Constitution, which it was not, and representation in the national Congress was based on the population of a state, which it was and is in the House of Representatives, rather than each state possessing an equal vote as under the Articles, representatives from the most populous states could have controlled legislative outcomes. This would have given “large” states potential control over the “small” states. As might be expected, the modern findings indicate that the predicted probability of voting yes on the national veto for a founder at Philadelphia who represented the most populous state and possessed the average values of all other interests is 0.837. But the predicted probability for an “average” delegate, one with the average values of all measured interests including state population, is only 0.379.

Or, had all the founders at Philadelphia represented a state with the heaviest concentration of slaves of all states, and possessed the average values of all other interests, the Constitution likely would have contained a clause requiring a two-thirds majority of the national legislature to enact any commercial laws. If the two-thirds majority requirement had been put into the Constitution, which it was not, it would have been more difficult to enact commercial laws, laws that could have regulated the slave-based export economies of the southern states. The two-thirds requirement would have made it much more difficult for a future northern majority to impact negatively on the southern economy through commercial regulation. Again, as might be expected, the modern findings indicate that the predicted probability of a yes vote on the two-thirds issue for an otherwise “average” founder who represented a state with the heaviest concentration of slaves is 0.914; but it is only 0.206 for an “average” founder. The Constitution also might not have contained a clause prohibiting the national legislature from enacting export duties (taxes) had there been no delegates with merchant interests at the Philadelphia convention; there might have been only a fifty-fifty chance of passing the prohibition. The predicted probability of a yes vote to prohibit national-level export duties for an otherwise “average” delegate without merchant interests is 0.505. But it is 0.790 for an otherwise “average” delegate with merchant interests, and nine of the Founding Fathers at the Philadelphia convention had merchant interests.

Interests of the Ratifiers Mattered

With respect to ratification, the quantitative evidence indicates that the magnitudes of the influences of the economic and other interests on the ratification votes were even more considerable than for the Philadelphia convention. The outcome of ratification appears to have depended even more on the specific individuals involved. The estimated influences were considerable enough that they suggest the outcome of ratification almost certainly would have been different had men with different interests attended the ratifying conventions. Had there been, among the ratifiers, fewer merchants, more debtors, more slaveowners, more delegates from the less-commercial areas, or more delegates belonging to dissenting religions, there would have been no ratification of the Constitution, at least no ratification as the Constitution was written. For example, at the Massachusetts ratifying convention, the predicted probability of a yes vote on ratification for an otherwise “average” delegate who was a debtor is only 0.175 but if the same delegate was not a debtor it is 0.624. For an otherwise “average” Baptist, the predicted probability of a yes vote is only 0.162 but if the Massachusetts delegate was not a Baptist it is 0.657. At the North Carolina ratifying convention, the predicted probability of a yes vote for an otherwise “average” delegate who was not a merchant is 0.175 but if the same delegate was a merchant it is 0.924. For an otherwise “average” North Carolina delegate from the least commercial areas in the state, the predicted probability of a yes vote is a trivial 0.002 but if the delegate was from the most commercial areas in the state it is 0.753. At the Virginia ratifying convention, the predicted probability of a yes vote for an otherwise “average” slaveowner is 0.451 but if the otherwise “average” delegate was not a slaveowner it is 0.837. Differences of these magnitudes suggest that ratification of the Constitution strongly depended on the specific economic, financial, and other interests of the specific individuals who attended the state conventions.

Broader Implications for Constitution Making

Overall, the modern approach to explaining the design and adoption of the Constitution suggests that it is unlikely that any real world constitution would ever be drafted or ratified through a disinterested and nonpartisan process. Because actual constitutional settings will always involve political actors who possess partisan interests and who likely will be able to predict the consequences of their decisions; partisan interests will influence constitutional choice. The economic history of the drafting and ratification of our nation’s Constitution makes it hard to envision any actual constitutional setting, including any setting to reform existing constitutions, in which self-interested and partisan behavior would not dominate. The modern evidence suggests that constitutions are the products of the interests of those who design and adopt them.

The Statistical Approach versus the Traditional Approach

Much of the differences between the modern evidence and the evidence found in the traditional historical literature is a matter of the approach taken, as well as the questions asked, rather than a matter of arriving at fundamentally different answers to identical questions. Many studies in the traditional literature question an economic interpretation of the Constitution because they question whether the Constitution is strictly an economic document designed solely to promote specific economic interests. Of course, it was not designed merely to promote economic interests. Many others question an economic interpretation because they question whether the founders were really attempting to solely, or even to principally, enhance their personal wealth, or the wealth of those they represented, as a result of adopting the Constitution. Of course, the founders were not. Others question an economic interpretation because they question whether the founders were really involved in a conspiracy to promote specific economic interests. Of course, they were not. Others question an economic interpretation because they question whether political principles, philosophies, and beliefs can be ignored in an attempt to understand the design of the Constitution. Of course, they cannot. In contrast, the modern economic history of the Constitution does not take any of these positions.

Yet the conclusions drawn from the modern evidence on the role of the economic, financial, and other interests of the founders are fundamentally different from the conclusions found in the traditional literature. The primary reason is that the statistical technique employed in the modern reexamination yields estimates of the separate influence of a particular economic interest or other factor on the founders’ behavior (how they voted) taking into account, and controlling for, the influence of other interests and factors on the founders’ behavior. The traditional literature nearly always draws conclusions about how the majority of the delegates with a particular interest – for example, how the majority of public securities holding delegates – voted on a particular issue, without regard to the influence of other interests and factors on behavior and without any formal statistical analysis. Prior studies, consequently, do not control for the confounding influences of other factors when drawing conclusions about any particular factor. As a result, the modern reexamination and the prior studies will often reach different conclusions about the influence of the same economic interest or other factor on the founders’ behavior. The conclusions differ because in a sense the studies are asking different questions. The modern economic history of the Constitution asks: How did a particular economic interest (for example, slaveholdings) per se influence the founders’ voting behavior taking into account all the influences of other factors on those founders’ voting behavior (for example, the slaveholding founders)? Prior historical studies more simply ask: How many of the founders with a particular economic interest (for example, founders with slaveholdings) voted the same on a particular issue?

The modern approach to the adoption of the Constitution may be disquieting to individuals of all political persuasions. It may be personally difficult for many to embrace. The evidence suggests motivating factors and intent on the part of our Founding Fathers that may be distasteful to conservatives, moderates, and liberals alike, to those on the left, in the middle, and on the right. The methodology employed, rational choice and methodological individualism, will be acceptable to some. But methodological individualism and a presumption of rational choice are likely to be troublesome to others. Some may have difficulty because an economic approach to the adoption of the Constitution appears “too calculating.” To some, it may appear “too deterministic” or “too economic.” Yet it actually is a dispassionate, almost antiseptic, view of the founders. It does not offer a special approach to the behavior of the founders because of the unique position reserved for them in our nation’s history. It treats them as it would any political actor. The modern approach represents an impartial, disinterested explanation of the behavior of our Founding Fathers, employing what are today commonly accepted techniques of economic and statistical analysis. Yet many individuals tend to look at our Founding Fathers through rose-colored glasses. They often place the founders on a pedestal and treat them as demigods. Many contend that the founders were motivated primarily, if not solely, by high-minded political principles “To Form a More Perfect Union.” The modern approach takes a broader view.

Annotated References

Ackerman, Bruce. We the People, two volumes. Cambridge, MA: The Belknap Press of Harvard University Press, 1991.

A view of the American constitutional founding by an eminent legal scholar. Ackerman offers a “dualist” theory of the founders’ politics in an attempt to recover the “true” revolutionary character of the founders, contending they were “dualist democrats.” Given this dualism, it is claimed that the founders behaved differently during “constitutional politics” than during “normal politics.” The founders thus were able to suspend their self-interests during the framing of the Constitution and promote instead the “rights of citizens and the permanent interests of the community.” Dismisses an economic interpretation as not serious. Indicates how a modern legal scholar thinks about the issues. Not a quantitative study.

Beard, Charles A. An Economic Interpretation of the Constitution of the United States. New York, NY: Macmillan Publishing Company, 1913 (1935).

A must read. The classic study of economics and the Constitution. Beard consolidated existing scholarly views and, in the process, his study became identified as “the” economic interpretation of the Constitution. Argues that the adoption of the Constitution was based on a conflict among competing economic interests. Contends that the founders who supported the strong, centralized government in the Constitution were merchants, shippers, bankers, land speculators, or private and/or public securities holders. Contends that the opponents, who supported a more decentralized government, represented agrarian interests and were less-commercial farmers, who often were also debtors, and/or northern planters along the Hudson. Contains little empirical evidence. Offers no formal or quantitative analysis.

Brown, Robert E. Charles Beard and the Constitution: A Critical Analysis of An Economic Interpretation of the Constitution. Princeton, NJ: Princeton University Press, 1956.

The first significant blow to Beard after nearly a half-century of acceptance. Dismisses an economic interpretation as utterly without merit, attacking its conclusions in their entirety. Brown maintains that eighteenth-century America was democratic, the franchise was common, and there was widespread support for the Constitution, claiming that his evidence counters Beard’s contention about the lack of democracy and the narrow support for the Constitution. Brown accuses Beard of taking the Philadelphia debates out of context, falsely editing The Federalist, and misstating facts. Not an empirical study per se. Offers no formal or quantitative analysis of the economic or financial interests of the founders.

Buchanan, James M., and Gordon Tullock. The Calculus of Consent: Logical Foundations of Constitutional Democracy. Ann Arbor, MI: University of Michigan Press, 1962.

An important read. The first modern attempt by economists to develop an economic theory of constitutions. The premise is that citizens rationally devise constitutions, which contain the fundamental rules of governance to be used for future collective decisions in a society. As constitutions specify the constraints placed on governments and individuals, they establish the incentive structure for the future. Buchanan and Tullock maintain that it is in the self-interest of rational citizens to adopt a constitution that contains economically “efficient” rules that promote the interests of the society as a whole rather than the interests of any particular group. Suggests that the theory is applicable to the American founding. No empirical evidence is presented, however.

Elliot, Jonathan, editor. The Debates in the Several State Conventions on the Adoption of the Federal Constitution as Recommended by the General Convention at Philadelphia, in 1787, 5 volumes. Philadelphia, PA: J. B. Lippincott, 1836 (1888).

Worth perusing. Contains a record of the speeches and debates during the ratification process at most of the state ratifying conventions, as well as numerous other documents and correspondence pertaining to the Constitution’s ratification and drafting. The original source of information on what was said at the constitutional conventions. Elliot’s “Debates” are a most illuminating source of information concerning the views of both the supporters and opponents of the Constitution. Contains a record of the debates over ratification in the ratifying conventions in Massachusetts, New York, Pennsylvania, Virginia, South Carolina, and North Carolina. Contains only small fragments of the debates in the ratifying conventions in Connecticut, New Hampshire, and Maryland. No debates from the other four state ratifying conventions are included.

Farrand, Max, editor. The Records of the Federal Convention of 1787, 3 volumes. New Haven, CT: Yale University Press, 1911.

Worth perusing. Reputably the best source of information concerning what took place at the Philadelphia Constitutional Convention in 1787. Contains copies of the official journal of the convention; James Madison’s highly respected notes of the entire proceedings; the diaries, notes, and memoranda of seven others (Alexander Hamilton, Rufus King, George Mason, James McHenry, William Pierce, William Paterson, and Robert Yates); the Virginia and the New Jersey plans of government presented at the convention; several documents recording the work of the Committee of Detail that wrote the first draft of the Constitution; a list of the framers, their attendance records, whether they signed the Constitution, and for thirteen of the sixteen non-signing framers whether the debates indicated they favored or opposed the Constitution; and hundreds of letters and correspondence of many of the framers and their contemporaries.

Hamilton, Alexander, John Jay, and James Madison. The Federalist: A Commentary on the Constitution of the United States, Being a Collection of Essays written in Support of the Constitution agreed upon September 17, 1787, by the Federal Convention. New York, NY: The Modern Library, 1937.

A must read to understand the arguments put forth by the contemporary supporters of the Constitution. Commonly referred to today as The Federalist Papers, a collection of eighty-five essays written, between October 1787 and May 1788, under the pseudonym “Publius,” in support of the Constitution during the ratification debate in New York, seventy-seven of which originally appeared in the New York press. They appeared in book form in the spring of 1788 and it was soon after revealed that Alexander Hamilton, James Madison, and John Jay collectively wrote them. Given the “Papers” were part of a political campaign to win ratification, they should not be considered unbiased interpretations of the Constitution. Yet because Hamilton and, especially, Madison, the “Father” of the Constitution, were both at the Philadelphia convention that drafted the Constitution and Jay was a renowned lawyer, The Federalist soon became the authoritative interpretation of the intention of the framers as well as the meaning of the Constitution. Still viewed as such today by many but some scholars readily acknowledge the biased political nature of their conception.

Jensen, Merrill. The Making of the Constitution. New York, NY: Van Nostrand, 1964.

A culmination of more than two decades of scholarship on constitutional history and the Confederation period. Presents an interesting view of the issues. Concludes that many of the framers “who agreed on ultimate goals differed as to the means of achieving them, and they tended to reflect the interests of their states and their sections when those seemed in conflict with such goals.” Suggests that throughout the Philadelphia convention the framers expressed their common belief that men conducting public business must be restrained from using their influence to further their private interests. Jensen’s conclusion about the controversy over Charles Beard is especially revealing, as he maintains that the founders would have been bewildered because they “took for granted the existence of a direct relationship between the economic life of a state or nation and its government.” Not a study of economic interests, however.

Jillson, Calvin C. Constitution Making: Conflict and Consensus in the Federal Convention of 1787. New York, NY: Agathon Press, 1988.

An argument for the importance of economic and other interests by a respected political scientist. Employs modern statistical techniques to describe the voting alignments among the states at the Philadelphia convention. The findings indicate that many of the long recognized voting alignments existed over many of the issues considered at Philadelphia. Concludes that issues of basic constitutional design were decided on the basis of principle, whereas specific economic and political interests decided votes involving more specific issues. Is limited though because it does not use explicit data to measure economic or other interests. Employs the historical literature to categorize the interests of the states represented at the convention and then tests whether the states voted together on particular issues, concluding that when they did, economic or political interests mattered. Employs fairly sophisticated statistical techniques. Concerns issues of interest mainly to political scientists, voting alignments and coalition formation.

McDonald, Forrest. We the People: The Economic Origins of the Constitution. Chicago, IL: University of Chicago Press, 1958.

An important read to understand the scholarly opinion of an “economic interpretation of the Constitution” among many. The most important and lasting blow to Beard after nearly a half-century of acceptance. Empirically examines the wealth and economic interests of the framers of the Constitution and ratifiers at the thirteen state conventions. Several economic interests are reported for nearly 1,300 (about three-quarters) of the founders. The votes on several issues at the Philadelphia convention and the votes at the ratifying conventions also are reported. Concludes that for the Philadelphia convention and the ratifying conventions the facts do not support an interpretation of the Constitution based on the economic interests represented. Further concludes there is no measurable relationship between specific economic interests and specific voting at the Philadelphia convention nor generally between specific economic interests and the votes at most of the ratifying conventions. Argues that an economic interpretation is more complex than that offered by Beard. Contains much empirical evidence but offers no formal or quantitative analysis. Many of its conclusions are overturned in McGuire’s To Form A More Perfect Union.

McGuire, Robert A. To Form A More Perfect Union: A New Economic Interpretation of the United States Constitution. New York, NY: Oxford University Press, (2002, in press).

Should be read by anyone interested in the modern “economic interpretation of the Constitution” and what the evidence indicates formally. The culmination of more than a decade and a half of modern research critically reexamining the adoption of the Constitution that seriously challenges the prevailing interpretation of our constitutional founding. Based on large amounts of new data on the economic, financial, and other interests of the Founding Fathers, an economic model of their voting behavior, and formal statistical analysis. The votes of the founders on selected issues at the Philadelphia convention and the votes during ratification are statistically related to measures of the founders and their constituents’ interests. The findings indicate that the economic and other interests significantly influenced the drafting and ratification of the Constitution. The magnitudes of the influences are shown to be substantial in many cases. Indicates how the Constitution would have been different had different interests been present at Philadelphia and how ratification would have been different had different interests been represented at the ratifying conventions. Attests to the importance of the specific individuals involved in historical events to historical outcomes.

McGuire, Robert A., and Robert L. Ohsfeldt. “Economic Interests and the American Constitution: A Quantitative Rehabilitation of Charles A. Beard.” Journal of Economic History 44 (1984): 509-519.

Quite readable. A useful preliminary study, reexamining the adoption of the Constitution employing the methods of modern economic history. Discusses the issues in a straightforward fashion with a minimum of technical jargon. Develops an economic model of the behavior of the Founding Fathers, discusses the data and evidence collected on the economic and other interests, and reports preliminary statistical findings on the role of economic interests in the drafting and ratification of the Constitution. The findings are dated though because of their preliminary nature. The findings have been superceded by those reported in McGuire’s To Form A More Perfect Union.

Riker, William H. “The Lessons of 1787.” Public Choice 55 (1987): 5-34.

Quite readable. Written with a minimum of technical jargon by an eminent political scientist and constitutional expert. While emphasizing a rational choice view of the founders, it places little weight on the importance of economic interests per se. Riker maintains that military threats to the status quo during the 1780s explain the adoption of a strengthened central government. Presumes the framers of the Constitution were different from modern day politicians. Their achievements could not be duplicated today because, according to Riker, they were not constrained, as so many contemporaries are, by the foolish views of their constituencies. Maintains that the framers were less partisan and more disinterested than politicians are today. The approach presumes there was near unanimity among the framers. Indicates how an important political scientist thinks about the issues. Not a quantitative study.

Rossiter, Clinton. 1787: The Grand Convention. New York, NY: Macmillan Publishing Company, 1966.

An influential study of the Philadelphia convention that maintains economic interests motivated the founders throughout their deliberations. Contends, however, that the founders were essentially “like-minded gentlemen” whose interests and political ideologies were similar. Openly rejects an economic interpretation during ratification, claiming that “Virginia ratified the Constitution . . . because of a whole series of accidents and incidents that mock the crudely economic interpretation of the Great Happening of 1787-1788.” Further concludes “the evidence we now have leads most historians to conclude that no sharp economic or social line can be drawn on a nationwide basis.” Offers no formal or quantitative analysis of the role of any economic, financial, or other interests, however.

Storing, Herbert J. The Complete Anti-Federalist, volumes 1 through 7. Chicago, IL: University of Chicago Press, 1981.

A must read for anyone seriously interested in our nation’s founding. Places the essays in The Federalist in perspective. It is not at all necessary to read the volumes in their entirety. The seven volumes are the magnum opus for the arguments of the contemporary opponents of the Constitution. Given the success of the supporters of the Constitution and the esteem given their arguments presented in The Federalist, the opponents have often been denigrated and ignored. Yet many prominent Americans in the 1780s did oppose the Constitution. Among some of the better know Anti-Federalists, and opponents of the Constitution, are Patrick Henry and George Mason of Virginia, and Melancton Smith of New York. The Complete Anti-Federalist is a superb attempt, in Storing’s words, “to make available for the first time all of the substantial Anti-Federal writings in their complete original form and in an accurate text, together with appropriate annotation.” See, especially, the introduction, contained in volume one, which gives valuable coherence to Anti-Federalist thought.

Whaples, Robert. “Where Is There Consensus among American Economic Historians? The Results of a Survey on Forty Propositions.” Journal of Economic History, 55 (1995): 139-154.

The title of this article says it all. Whaples surveyed economists and historians whose specialty is American economic history to determine whether, and where, there is consensus among economic historians on forty important historical issues concerning the American economy. Reports the findings of the survey so that they indicate whether there are differences in the consensus on various issues among scholars trained in economics versus scholars trained in history.

Wood, Gordon S. The Creation of the American Republic 1776-1787. Chapel Hill, NC: University of North Carolina Press, 1969.

An important read. A widely acclaimed, and monumentally influential, study of the American founding by an eminent historian. Contends it is nearly impossible to identify the supporters or opponents of the Constitution with specific economic interests. Argues that the founding can be better understood in terms of the fundamental social forces underlying the ideological positions of the founders. Wood maintains the Constitution was founded on these larger sociological and ideological forces, which are the primary interests of the book. Concludes, “The quarrel was fundamentally one between aristocracy and democracy.” Offers no formal or quantitative analysis of the role of any economic, financial, or other interests.

Walton, Gary M., and James F. Shepherd. The Economic Rise of Early America. New York, NY: Cambridge University Press, 1979.

Quite readable. A concise presentation of the economic history of early America from the colonial period through the early national period by two eminent economic historians of early America. In addition to the material on the colonial period, contains a discussion of general economic conditions in the United States in the 1780s, a discussion of the Articles of Confederation, and the immediate and longer-term influences on the American economy brought about by the adoption of the Constitution. A nice starting point for a general understanding of the economic history of early America. It is somewhat dated though, as there has been new scholarship on the early American economy in the last twenty years.

Citation: McGuire, Robert. “Economic Interests and the Adoption of the United States Consitution”. EH.Net Encyclopedia, edited by Robert Whaples. August 14, 2001.
URL http://eh.net/encyclopedia/economic-interests-and-the-adoption-of-the-united-states-constitution/

Common Agricultural Policy

David R. Stead, University College Dublin

Europe’s Common Agricultural Policy (CAP) has been one of the most controversial, and complex, farm policies of all time. The CAP was a cornerstone of the European Economic Community (EEC) established by the 1957 Treaty of Rome, which aimed to progressively create a common market and harmonize the economic policies of the then six member states. France, West Germany, Italy, the Netherlands, Belgium and Luxembourg were the original signatories. The objectives of the CAP for “the six” as stated in Article 39 of the Treaty were to (i) increase agricultural productivity; (ii) ensure a fair standard of living for the agricultural community; (iii) stabilize markets; (iv) provide certainty of food supplies; and (v) ensure that those supplies reached consumers at reasonable prices.

To attempt to achieve these objectives (some of which were potentially conflicting), two main mechanisms were used. First, a generous EEC-wide common “target price” was set for each of the major farm products. Foodstuffs entering the EEC from non-member countries were subject to “variable levies” (tariffs), which prevented target prices from being undercut by cheaper imports. Second, if a commodity’s market price within the Community fell to an appointed “intervention price” – usually set ten to twenty percent below its target price – then national intervention agencies would purchase all produce that could not otherwise be sold at that price, artificially removing supply and thereby preventing a further fall in price. Thus the CAP effectively set a “price floor” for agricultural commodities produced in the EEC. Other countries subsequently adopted the CAP when they joined what became the European Community (EC) and is now the European Union (EU), beginning with Denmark, Ireland and the United Kingdom in 1973 and Greece in 1981.

Throughout its lifetime, the CAP has come under heavy criticism. The policy’s financial cost has been very substantial. In the 1970s and 1980s, the CAP absorbed about two-thirds of the EC’s entire annual budget on average. European taxpayers have paid higher taxes than would have been the case in the absence of farm support, while the setting of target and intervention prices substantially above the prices prevailing on world markets raised the cost of food for European consumers. Estimates of the CAP’s total expense vary widely due to differences in the methods employed and movements in world commodity prices; one ballpark figure for the late 1990s was a cost to each EU citizen of about British pounds 250 per year.

The key problem was that stabilizing agricultural prices at high levels encouraged Europe’s farmers to increase output. Importantly, this met a number of the CAP’s original objectives, but by the early 1980s as domestic production consistently ran ahead of domestic consumption the EC was compelled to purchase and store large amounts of surplus commodities, producing so-called “butter mountains” and “wine lakes” which often had to be resold at a loss on world markets; or else the EC had to entice traders to sell overseas by paying them export “refunds” (export subsidies) equal to the difference between the Community intervention prices and the lower world prices. Moreover, the linking or “coupling” of support to the farmer’s current volume of production ensured that, inequitably, the largest producers received most of the benefits (in 1991 a European Commission document said that eighty percent of CAP assistance went to just twenty percent of farmers), and also contributed to environmental damage by encouraging farmers to increase output through intensive practices such as the application of chemical pesticides and the removal of hedgerows. Outside the EC, agricultural producers in developed and developing nations have been denied commercial opportunities on account of the EC’s import levies and the subsidized “dumping” of excess European produce on world markets.

Radical proposals for policy reform were made as early as 1968 with the Mansholt Plan to provide financial incentives to encourage about half of the farming population to leave the sector during the 1970s and to take at least five million hectares of land out of production. But this and subsequent reform attempts were substantially watered down by the politicians who make the policy choices. Thus today the CAP still absorbs more than two-fifths of the EU budget. The failure of these more radical reform recommendations can be principally attributed to the influence of the agricultural lobby, particularly in France. While the costs of the CAP are widely dispersed among millions of EU taxpayers and consumers, its sizeable benefits are concentrated on a relatively small number of farmers. Europe’s agriculturists therefore have had a strong economic incentive to apply political pressure for the continuation of current policy, while the individual taxpayer/consumer has a far weaker pecuniary incentive to lobby for change. Hence there is a bias towards the status quo, and for many years the challenges of solving the problem of overproduction and curbing the CAP’s cost were only addressed through a number of somewhat minor policy adjustments. For example, production quotas in the milk sector were introduced in 1984, and since 1988 arable farmers have been given money if they “set-aside” from production part of their land.

International complaints about the CAP in the Uruguay Round of world trade talks helped to trigger the MacSharry reforms of 1992, named after the European Commissioner for Agriculture at the time. Again representing a compromise from originally more far-reaching proposals, the policy changes made included the extension of milk quotas and set-aside, and much more importantly, for the first time significant reductions in the level of institutional prices for cereals and beef. In compensation for these cutbacks in price support, farmers were given direct payments (“cheques in the post”) per head of livestock and hectare under crops, more-or-less up to a maximum of their pre-reform quantities. Economists regard these direct payments as a less unsatisfactory type of subsidy than price support because they were partially “decoupled” (partially independent) from the current volume of the farmer’s production, thereby reducing his or her incentive to overproduce using intensive methods. Funds were also made available for programs to assist the development of rural areas (such as subsidies for afforestation) and for schemes where farmers pursue environmentally-friendly agricultural practices in return for additional payments. This change in policy direction, then, started to ameliorate the CAP’s impact on the environment. The Agenda 2000 reform – agreed in 1999 – extended the MacSharry reforms, with additional compensated cuts in institutional prices and reinforced rural development/agri-environmental schemes becoming the “second pillar” of the CAP.

The latest major policy reform was the Mid-Term Review of Agenda 2000 (or Fischler reforms), agreed in 2003. (Subsequent CAP reforms have been sector-specific, such as the changes to the hitherto unreformed sugar regime in 2005 and the 2007 reform of the measures operating in the fruit and vegetable sector.) Pressures arose from the agreed entry to the EU of ten central and eastern European countries with large farming industries (this enlargement occurred in 2004), and especially from demands for further liberalization of the protectionist CAP from Europe’s trading partners in the World Trade Organisation’s Doha Development Agenda negotiations. The most fundamental alteration was the introduction of the “single farm payment,” an annual lump sum grant which replaced the area and headage direct payments historically received on each farm. Crucially, unlike the previous system, the single farm payment can be claimed more-or-less regardless of changes in the scale and type of farm production (although member states were given limited flexibility over the extent to which they undertook this additional “decoupling”). EU farmers, then, should generally now be making their production decisions based on market demand and production costs, rather than “farming for subsidies,” and this should cause less distortion to international trade. Receipt of the single farm payment, though, is conditional on farmers meeting “cross-compliance” requirements which ensure a high standard of environmental protection and animal welfare. In short, a consensus has now emerged in Europe around granting farmers financial assistance in exchange for undertaking rural stewardship activities such as environmentally-friendly farming, instead of subsidizing commodity production. This “European model of agriculture” therefore aligns farm support with the public’s concerns about the environment, food safety and animal welfare.

Yet many criticisms of the “new CAP” remain, for instance, over its continued inequity since the biggest single farm payments are distributed to the largest (and typically richest) farm owners. At the time of writing, further substantive reform is being mooted in the Doha Development Round and in the lead up to the CAP “Health Check” in 2008. Probable reforms in the latter include the abolition of arable set-aside to allow this land to be utilized to produce biomass for biofuels, and additional allocation of funds from the (now fixed) CAP budget to help to finance rural development programs such as local tourism initiatives. If a breakthrough is finally achieved, a Doha Round Agreement on Agriculture is likely to include the elimination of CAP export subsidies by about 2013 and an overall average cut in its import levies of a little over 50 percent, which would further reduce the CAP’s adverse impact on non-EU producers.

Bibliography

Ackrill, Robert.The Common Agricultural Policy. Sheffield: Sheffield Academic Press, 2000.

Baldwin, Richard and Charles Wyplosz. The Economics of European Integration. London: McGraw-Hill (second edition), 2006. Chapter 9 on “The Common Agricultural Policy.”

EuroChoices, passim.

Fennell, Rosemary. The Common Agricultural Policy: Continuity and Change. Oxford: Clarendon Press, 1997.

“Reforming the CAP.” Symposium in Economic Affairs 20 (June 2000): 2-48.

Ritson, Christopher and David Harvey, editors. The Common Agricultural Policy. Wallingford: CAB International (second edition), 1997.

Swinbank, Alan and Carsten Daugbjerg. “The 2003 CAP Reform: Accommodating WTO Pressures.” Comparative European Politics 4 (2006): 47-64.

Websites:

EUROPA [European Union’s web site] Agriculture and Rural Development pages, http://ec.europa.eu/agriculture/index_en.htm

Wyn Grant’s CAP blog,

http://commonagpolicy.blogspot.com/

Online Learning Center of Baldwin and Wyplosz (2006),

http://highered.mcgraw-hill.com/sites/0077111192/student_view0/chapter9/

Citation: Stead, David. “Common Agricultural Policy”. EH.Net Encyclopedia, edited by Robert Whaples. June 21, 2007. URL http://eh.net/encyclopedia/common-agricultural-policy/

Oscar Douglas Skelton and Canada’s Economic History

Terry Crowley, University of Guelph

Oscar Douglas Skelton (1878-1941) provided the essential bridge between the founding of Canadian economic history by Adam Shortt in the late nineteenth century and its larger development by Harold Innis from the 1920s to the 1950s. More than Shortt, Skelton was the first to identify the parameters of the economic history of the northern dominion. Long before Canada became officially independent of Britain in 1931, Skelton’s writings hypothesized a nation that he saw coming into existence on the basis of colonial economic activities. These ventures were forged in both private and public spheres in defiance of a vast geography that otherwise would have prohibited the formation of a national identity.

As one of the earliest professionally trained political economists, Oscar Skelton turned to history after acquiring a distaste for intellectual attempts to make the world conform to theoretical paper sketches purporting to elucidate immutable laws. The diachronic methods of historical study appeared to him to provide knowledge with more satisfying richness and complexity than the synchronic approaches of the more theoretically minded. As a scholar who was also a public intellectual intimately involved in the political and economic currents of his time and place, Skelton taught at Queen’s University in Kingston (Ontario), published extensively in a variety of media, and eventually became Undersecretary of State for foreign affairs and the closest advisor of two Canadian prime ministers, William Lyon Mackenzie King and Richard Bedford Bennett.

Born into Anglo-Irish stock in Shelbourne, Ontario, Oscar Skelton received his earliest education locally and in neighboring Orangeville, north of Toronto. At Queen’s University he studied Classics and went on to graduate work in the subject at the University of Chicago, but finding the program unsatisfactory, he returned to Kingston to take more courses in political economy from Adam Shortt. Having already developed a fine writing style that communicated with verve and color, Skelton returned to Chicago in 1905 where he prepared a thesis in its department of political economy on Marxism. Department chair James Laurence Laughlin, who had founded the Journal of Political Economy, served as his advisor, but by the time he graduated in 1908 he regretted that he had not studied with Robert Hoxie, a labor economist. Work in political economy at Chicago proved formative to the young man by introducing him to such great thinkers as Thorstein Veblen. With this intellectual formation Oscar Skelton was soon able to surpass Adam Shortt whose academic preparation had been in philosophy and science before he had turned to economic history. Skelton’s doctoral dissertation about socialism (largely Marxism) led to his disenchantment with formalized theory and his turn to historical study. By the time the thesis was published as book in 1911 – acclaimed by Vladimir Lenin and British guild scholar G.D.H. Cole – Oscar Skelton not only accurately predicted the command economy that would ensue under communism but he also arrived at a position that sided fully with the historicists within the emerging discipline of economics rather than with the marginalists.

Employed at Queen’s University, Skelton held the Sir John A. Macdonald Chair, became chair of the Department of Political and Economic Science as the two disciplines progressively disentangled themselves, and then Dean of Arts before he was appointed to the federal government in 1924. During this time he published seven books of history and economic history, as well as innumerable scholarly and popular articles. More than any of his other works, Skelton’s volumes on the economic history of Canada from Confederation in 1867 to 1912, his studies of banking, and his volume on railroad builders gave shape to an emerging subject. In these writings Skelton reinvented a colony of the United Kingdom as the North American nation that he wanted to see come about.

As a liberal nationalist Skelton was concerned with collective identities as they expressed themselves in both political and economic spheres. His economic history of Canada since Confederation was the first to examine consistently how markets were organized and economic space was shaped by public and private sectors. Concerns about structures, evolution, and state policy were interwoven with a keen eye to external developments over which the country had little control. Canadians were viewed as restless people striving for material betterment within a context that was only partially of their own making. As a trading nation and as a colony, Canada was dependent on the vagaries of strangers; the talents of Canadians rested in being able to make the best of changing conditions in the United Kingdom or the United States. The country’s nineteenth-century regional economies based on fishing, farming, lumbering, mining, and manufacturing had moved increasingly into national and international markets through the force of technological change and commercial policies. Reciprocity between the British North American colonies and the United States from 1854 to 1866 had extended the possibility of increased trade, but after it failed, both countries pursued protectionist policies despite Canadian efforts to break the juggernaut. This trend reached its apogee in 1879 with John A. Macdonald’s national policy tariffs, but in Skelton’s view protection had been waged at a price to consumers and the country as a whole. Economic stagnation in the 1880s and the return of depression between 1893 and 1896 increased emigration to the United States.

Canada’s fate was only partially determined by her geographical proximity to the burgeoning republic; Canadian ingenuity and ties to the United Kingdom were equally important. Willingness to grasp opportunities provided by technology allowed the creation of a country that might otherwise have been little more than remotely scattered regions pursuing desperate policies. “The railway found Canada scarcely a geographical expression and made it a nation,” Skelton exclaimed. This bold stroke bordered on technological determinism and flew in the face of Canadian imperialists who saw the country as only British North America. It also countered Toronto historian Goldwin Smith’s view that rampant anti-Americanism alone seemed to hold the country together. While carefully delineating how Canadian interest in railroads developed, and not ignoring its seedier side as a corrupting influence in political life, Skelton pursued his argument, reserving the most fulsome praise for the Canadian Pacific Railway completed to British Columbia in 1886. Prior to its construction, Skelton thought, Canada “covered half a continent, but in reality it stopped at the Great Lakes. There was little national spirit, little diversity of commercial enterprise. Hundreds of thousands of our best born had been drawn by the greater attraction of the United States’ cities and farms, until one-fourth of the whole people were living in the republic.”

There was also a larger conclusion to be drawn. If Canadians had managed to construct the largest railroad in the world before the Russian Trans-Siberian, and since the ratio of people to railroad kilometers was also the highest, the C.P.R. carried even greater significance. “Here, again,” Skelton thought, “if railways were Canada’s politics it was not only because Canadians were materialists, but because they were idealists. They were determined in spite of geography and diplomacy, in spite of Rocky Mountains and Lake Superior wilderness, Laurentian plateaus and Maine intrusions, that Canada would be one and independent.” Skelton’s principal contentions about the role of geography and historical links to Europe in Canadian history were not far from the mind of a young Harold Innis when, two years after Skelton’s The Railway Builders appeared in 1916, he embarked on a doctoral program in political economy at the University of Chicago to write a dissertation on the Canadian Pacific Railway.

Skelton also struck another theme in Canada’s economic history that proved enduring. What, Skelton asked, was the country’s fate: “to link our commercial destinies with Great Britain or the United States – or neither?” Maintaining that Canadians sought advantage where they could, his question proposed the context within which he saw national history evolving. Oscar Skelton portrayed Canada as having existed precariously not just within a colonial relationship but between two poles on either side of the Atlantic. Sometimes, as his statistical studies of World War One finances showed, Canada moved closer to the United States, other times it stood more aloof despite the advantages he believed that freer trade would bring, especially in stemming emigration to south of the border.

If Adam Shortt was the father of economic history in Canada as Harold Innis said, then Oscar Skelton was the vital spur who combined Shortt’s rigorous methodology with far reaching interpretations challenging the imagination. Shortt had been so entranced by the new methodology of documentary evidence that his output was highly fragmented and displayed little coherence. Skelton, in contrast, had the ideas, flare for writing, and dedication and discipline, although his political histories were unabashedly whiggish in their present-mindedness and Liberal bias. Oscar Skelton made his most original contributions in economic history where his connection of state policy and market logic in economic development was suggestive to Innis and his work influenced other economic historians such as William A. Macintosh. Innis’ studies in the economic history of Canada, and later of communications, also assumed the same determinist bent that had appeared in Skelton’s work. Oscar Skelton proved to be a formative influence in the development of economic history in Canada.

References

Berger, Carl. The Writing of Canadian History: Aspects of English-Canadian Historical Writing since 1900. Toronto: University of Toronto Press, 1986.

Crowley, Terry. Marriage of Minds: Isabel and Oscar Skelton Reinventing Canada. Toronto: University of Toronto Press, 2003.

Ferguson, Barry. Remaking Liberalism: The Intellectual Legacy of Adam Shortt, O.D. Skelton, W.C. Clark and W.A. Mackintosh, 1890-1925. Montreal: McGill-Queen’s University Press, 1993.

Innis, Harold. Staples, Markets, and Cultural Change: Selected Essays. Daniel Drache, editor. Montreal: McGill-Queen’s University Press, 1995.

Skelton, Oscar. Socialism: A Critical Analysis. Boston and New York: Houghton Mifflin, 1919; London: Constable & Co., 1911.

Skelton, Oscar. General Economic History of the Dominion, 1867-1912. Toronto: Publishers’ Association of Canada, 1913. Prepared for Canada and Its Provinces, vol. 9: 95-276.

Skelton, Oscar. “Early Banking in Upper and Lower Canada”; “The Merchant’s Bank of Prince Edward Island”; “The Bank of British Columbia.” In A History of the Canadian Bank of Commerce, edited by Victor Ross, vol. 1. Toronto, 1920.

[Skelton, Oscar]. “Historical Sketch.” In Fifty Years of Banking Service, 1871-1921: The Dominion Bank. Toronto: Dominion Bank, 1922.

Watson, A. John. Marginal Man: The Dark Vision of Harold Innis. Toronto: University of Toronto Press, 2006.

Citation: Crowley, Terry. “Oscar Douglas Skelton and Canada’s Economic History”. EH.Net Encyclopedia, edited by Robert Whaples. January 16, 2007. URL
http://eh.net/encyclopedia/oscar-douglas-skelton-and-canadas-economic-history/

The Use of Quantitative Micro-data in Canadian Economic History: A Brief Survey

Livio Di Matteo, Lakehead University

Introduction1

From a macro perspective, Canadian quantitative economic history is concerned with the collection and construction of historical time series data as well as the study of the performance of broad economic aggregates over time.2 The micro dimension of quantitative economic history focuses on individual and sector responses to economic phenomena.3 In particular, micro economic history is marked by the collection and analysis of data sets rooted in individual economic and social behavior. This approach uses primary historical records like census rolls, probate records, assessment rolls, land records, parish records and company records, to construct sets of socio-economic data used to examine the social and economic characteristics and behavior of those individuals and their society, both cross-sectionally and over time.

The expansion of historical micro-data studies in Canada has been a function of academic demand and supply factors. On the demand side, there has been a desire for more explicit use of economic and social theory in history and micro-data studies that make use of available records on individuals appeal to historians interested in understanding aggregate trends and reaching the micro-underpinnings of the larger macroeconomic and social relationships. For example, in Canada, the late nineteenth century was a period of intermittent economic growth and analyzing how that growth record affected different groups in society requires studies that disaggregate the population into sub-groups. One way of doing this that became attractive in the 1960’s was to collect micro-data samples from relevant census, assessment or probate records.

On the supply side, computers have lowered research costs, making the analysis of large data sets feasible and cost-effective. The proliferation of low cost personal computers, statistical packages and data spread-sheets has led to another revolution in micro-data analysis, as computers are now routinely taken into archives so that data collection, input and analysis can proceed even more efficiently.

In addition, studies using historical micro-data are an area where economic historians trained either as economists or historians have been able to find common ground.4 Many of the pioneering micro-data projects in Canada were conducted by historians with some training in quantitative techniques, much of which was acquired “on the job” by intellectual interest and excitement, rather than as graduate school training. Historians and economists are united by their common analysis of primary micro-data sources and their choice of sophisticated computer equipment, linkage software and statistical packages.

Background to Historical Micro-data Studies in Canadian Economic History

The early stage of historical micro-data projects in Canada attempted to systematically collect and analyze data on a large scale. Many of these micro-data projects crossed the lines between social and economic history, as well as demographic history in the case of French Canada. Path-breaking work by American scholars such as Lee Soltow (1971), Stephan Thernstrom (1973) and Alice Hanson Jones (1980) was an important influence on Canadian work. Their work on wealth and social structure and mobility using census and probate data drew attention to the extent of mobility — geographic, economic and social — that existed in pre-twentieth-century America.

However, Canadian historical micro-data work has been quite distinct from that of the United States, reflecting its separate tradition in economic history. Canada’s history is one of centralized penetration from the east via the Great Lakes-St. Lawrence waterway and the presence of two founding “nations” of European settlers – English and French – which led to strong Protestant and Roman Catholic traditions. Indeed, there was nearly 100 percent membership in the Roman Catholic Church for francophone Quebeckers for much of Canada’s history. As well, there is an economic reliance on natural resources, and a sparse population spread along an east-west corridor in isolated regions that have made Canada’s economic history, politics and institutions quite different from the United States.

The United States, from its early natural resource staples origins, developed a large, integrated internal market that was relatively independent of external economic forces, at least compared with Canada, and this shifted research topics away from trade and towards domestic resource allocation issues. At the level of historical micro-data, American scholars have had access to national micro-data samples for some time, which has not been the case in Canada until recently. Most of the early studies in Canadian micro-data were regional or urban samples drawn from manuscript sources and there has been little work since at a national level using micro-data sources. However, the strong role of the state in Canada has meant a particular richness to those sources that can be accessed and even the Census contains some personal details not available in the U.S. Census, such as religious affiliation. Moreover, earnings data are available in the Canadian census starting some forty years earlier than the United States.

Canadian micro-data studies have examined industry, fertility, urban and rural life, wages and labor markets, women’s work and roles in the economy, immigration and wealth. The data sources include census, probate records, assessment rolls, legal records and contracts, and are used by historians, economists, geographers, sociologists and demographers to study economic history.5 Very often, the primary sources are untapped and there can be substantial gaps in their coverage due to uneven preservation.

A Survey of Micro-data Studies

Early Years in English Canada

The fruits of early work in English Canada were books and papers by Frank Denton and Peter George (1970, 1973), Michael Katz (1975) and David Gagan (1981), among others.6 The Denton and George paper examined the influences on family size and school attendance in Wentworth County, Ontario, using the 1871 Census of Canada manuscripts. But it was Katz and Gagan’s work that generated greater attention among historians. Katz’s Hamilton Project used census, assessment rolls, city directories and other assorted micro-records to describe patterns of life in mid-nineteenth century Hamilton. Gagan’s Peel County Project was a comprehensive social and economic study of Peel County, Ontario, again using a variety of individual records including probate. These studies stimulated discussion and controversy about nineteenth-century wealth, inheritance patterns, and family size and structure.

The Demographic Tradition in French Canada

In French Canada, the pioneering work was the Saguenay Project organized by Gerard Bouchard (1977, 1983, 1992, 1993, 1996, 1998). Beginning in the 1970’s, a large effort has been expended to create a computerized genealogical and demographic data base for the Saguenay and Charlevoix regions of Quebec going back well into the nineteenth century. This data set, known now as the Balsac Register, contains data on 600,000 individuals (140,000 couples) and 2.4 million events (e.g. births, deaths, gender, etc…) with enormous social scientific and human genetic possibilities. The material gathered has been used to examine fertility, marriage patterns, inheritance, agricultural production and literacy, as well as genetic predisposition towards disease and formed the basis for a book spanning the history of population and families in the Saguenay over the period 1858 to 1971.

French Canada has a strong tradition of historical micro-data research rooted in demographic analysis.7 Another project underway since 1969 and associated with Bertrand Desjardins, Hubert Charbonneau, Jacques Légaré and Yves Landry is Le Programme de recherche en démographie historique (P.R.D.H) at the University of Montréal (Charbonneau, 1988; Landry, 1993; Desjardins, 1993). The database will eventually contain details on a million persons and their life events in Quebec between 1608 and 1850.

Industrial Studies

Only for the 1871 census have all of the schedules survived and the industrial schedules of that census have been made machine-readable (Bloomfield, 1986; Borsa and Inwood, 1993). Kris Inwood and Phyllis Wagg (1993) have used the census manuscript industrial schedules to examine the survival of handloom weaving in rural Canada circa 1870 (Inwood and Wagg, 1993). A total of 2,830 records were examined and data on average product, capital and month’s activity utilized. The results show that the demand for woolen homespun was income sensitive and that patterns of weaving by men and women differed with male-headed firms working a greater number of months during the year and more likely to have a second worker.

More recently, using a combination of aggregate capital market data and firm-level data for a sample of Canadian and American steel producers, Ian Keay and Angela Redish (2004) analyze the relationships between capital costs, financial structure, and domestic capital market characteristics. They find that national capital market characteristics and firm specific characteristics were important determinants of twentieth-century U.S. and Canadian steel firms’ financing decisions. Keay (2000) uses information from firms’ balance sheets and income accounts, and industry-specific prices to calculate labor, capital, intermediate input and total factor productivities for a sample of 39 Canadian and 39 American manufacturing firms in nine industries. The firm-level data also allow for the construction of nation, industry and time consistent series, including capital and value added. Inwood and Keay (2005) use establishment-level data describing manufacturers located in 128 border and near-border counties in Michigan, New York, Ohio, Pennsylvania, and Ontario to calculate Canadian relative to U.S. total factor productivity ratios for 25 industries. Their results illustrate that the average U.S. establishment was approximately 7% more efficient than its Canadian counterpart in 1870/71.

Population, Demographics & Fertility

Marvin McInnis (1977) assembled a body of census data on childbearing and other aspects of Upper Canadian households in 1861 and produced a sample of 1200 farm households that was used to examine the relationship between child-bearing and land availability. He found that an abundance of nearby uncultivated land did affect the probability of there being young children in the household but the magnitude of the influence was small. Moreover, the strongest result was that fertility fell as larger cities developed sufficiently close by for there to be a real influence by urban life and culture.

Eric Moore and Brian Osborne (1987) have examined the socio-economic differentials of marital fertility in Kingston. They related religion, birthplace, and age of mother, ethnic origin and occupational status to changes in fertility between 1861and 1881, using a data set of approximately 3000 observations taken from the manuscript census. Their choice of variables allows for the examination of the impact of both economic factors, as well as the importance of cultural attributes. William Marr (1992) took the first reasonably large sample of farm households (2,656) from the 1851-52 Census of Canada West and examined the determinants of fertility. He found fertility differences between older and more newly settled regions were influenced by land availability at the farm level but farm location, with respect to the extent of agricultural development, did not affect fertility when age, birthplace and religion were held constant. Michael Wayne (1998) uses the 1861 Census of Canada to look at the black population of Canada on the eve of the American Civil War. Meanwhile, George Emery (1993) helps provide an assessment of the comprehensiveness and accuracy of aggregate vital statistics in Ontario between 1869 and 1952 by looking at the process of recording vital statistics. Emery and Kevin McQuillan (1988) use case studies to examine mortality in nineteenth-century Ingersoll, Ontario.

Urban and Rural Life

A number of studies have examined urban and rural life. Bettina Bradbury (1984) has analyzed the census manuscripts of two working class Montreal wards, Ste. Anne and St. Jacques, for the years 1861, 1871 and 1881. Random samples of 1/10 of the households in these parts of Montreal were taken for a sample of nearly 11,000 individuals over three decades. The data were used to examine women and wage labor in Montreal. The evidence is that men were the primary wage earners but the wife’s contribution to the family economy was not so much her own wage labor, which was infrequent, but in organizing the economic life of the household and finding alternate sources of support.

Bettina Bradbury, Peter Gossage, Evelyn Kolish and Alan Stewart (1993) and Gossage (1991) have examined marriage contracts in Montreal over the period 1820-1840 and found that, over time, the use of marriage contracts changed, becoming a tool of a propertied minority. As well, a growing proportion of contract signers chose to keep the property of spouses separate rather than “in community.” The movement towards separation was most likely to be found among the wealthy where separate property offered advantages, especially to those engaged in commerce during harsh economic times. Gillian Hamilton (1999) looks at prenuptial contracting behavior in early nineteenth-century Quebec to explore property rights within families and finds that couples signing contracts tended to choose joint ownership of property when wives were particularly important to the household.

Chad Gaffield (1979, 1983, 1987) has examined social, family and economic life in the Eastern Ontario counties of Prescott-Russell, Alfred and Caledonia using aggregate census, as well as manuscript data for the period 1851-1881.8 He has applied the material to studying rural schooling and the economic structure of farm families and found systematic differences between the marriage patterns of Anglophones and Francophone with Francophone tending to marry at a younger average age. Also, land shortages and the diminishing forest frontier created economic difficulties that led to reduced family sizes by 1881. Gaffield’s most significant current research project is his leadership of the Canadian Century Research Infrastructure (CCRI) initiative, one of the country’s largest research projects. The CCRI is creating cross-indexed databases from a century’s worth of national census information, enabling unprecedented understanding of the making of modern Canada. This effort will eventually lead to an integrated set of micro-data resources at a national level comparable to what currently exist for the United States.9

Business Records

Company and business records have also been used as a source of micro-data and insight into economic history. Gillian Hamilton has conducted a number of studies examining contracts, property rights and labor markets in pre-twentieth century Canada. Hamilton (1996, 2000) examines the nature of apprenticing arrangements in Montreal around the turn of the nineteenth century, using apprenticeship contracts from a larger body of notarial records found in Quebec. The principal question addressed is what determined apprenticeship length and when the decline of the institution began? Hamilton finds that the characteristics of both masters and their boys were important and that masters often relied on probationary periods to better gauge a boy’s worth before signing a contract. Probations, all else equal, were associated with shorter contracts.

Ann Carlos and Frank Lewis (1998, 1999, 2001, 2002) access Hudson Bay Company fur trading records to study property rights, competition, and depletion in the eighteenth-century Canadian fur trade and their work represents an important foray into Canadian aboriginal economic history by studying role of aboriginals as consumers. Doug McCalla (2005, 2005, 2001) uses store records from Upper Canada to examine and understand consumer purchases in the early nineteenth century and gain insight into material culture. Barton Hamilton and Mary MacKinnon (1996) use the Canadian Pacific Railway records to study changes between 1903 and 1938 in the composition of job separations, and the probability of separation. The proportion of voluntary departures fell by more than half after World War I. Independent competing risk, piecewise-constant hazard functions for the probabilities of quits and layoffs are estimated. Changes in workforce composition lengthened the average worker’s spell, but a worker with any given set of characteristics was much more likely to be laid off after 1921, although many of these layoffs were only temporary.

MacKinnon (1997) taps into the CPR data again with a constructed sample of 9000 employees hired before 1945 that includes 700 pensioners and finds features of the CPR pension plan are consistent with economic explanations regarding the role of pensions. Long, continuous periods of service were likely to be rewarded and employees in the most responsible positions generally had higher pensions.

MacKinnon (1996) complements published Canadian nominal wage data by constructing a new hourly wage series, developed from firm records, for machinists, helpers, and laborers employed by the Canadian Pacific Railway between 1900 and 1930. This new evidence suggests that real wage growth in Canada was faster than previously believed, and that there were substantial changes in wage inequality. In another contribution, MacKinnon (1990) studies unemployment relief in Canada by examining relief policies and recipients and contrasting the Canadian situation with unemployment insurance in Britain. She finds demographic factors important in explaining who went on relief, with older workers, and those with large families most likely to be on relief for sustained periods. Another unique contribution to historical labor studies is Michael Huberman and Denise Young (1999). They examine a set of individual strike data of 1554 strikes for Canada from 1901 to 1914 and conclude that having international unions did not weaken Canada’s union movement and that they became part of Canada’s industrial relations framework.

The 1891 and 1901 Census

An ongoing project is the 1891 Census of Canada Project at the University of Guelph under Director Kris Inwood, which is making the information of this census available to the research public in a digitized sample of individual records from the 1891 census. The project is hosted by the University of Guelph, with support from the Canadian Foundation for Innovation, the Ontario Innovation Trust and private sector partners. Phase 1 (Ontario) of the project began during the winter of 2003 in association with the College of Arts Canada Research Chair in Rural History. The Ontario project continues until 2007. Phase II began in 2005; it extends data collection to the rest of the country and also creates an integrated national sample. The database includes information returned on a randomly selected 5% of the enumerators’ manuscript pages with each page containing information describing twenty-five people. An additional 5% of census pages for western Canada and several large cities augment the basic sample. Ultimately the database will contain records for more than 350,000 people, bearing in mind that the population of Canada in 1891 was 3.8 million.

The release of the 1901 Census of Canada manuscript census has also spawned numerous micro-data studies. Peter Baskerville and Eric Sager (1995, 1998) have used the 1901 Census to examine unemployment and the work force in late Victorian Canada.10 Baskerville (2001a,b) uses the 1901 census to examine the practice of boarding in Victorian Canada while in another study he uses the 1901 census to examine wealth and religion. Kenneth Sylvester (2001) uses the 1901 census to examine ethnicity and landholding. Alan Green and Mary MacKinnon (2001) use a new sample of individual-level data compiled from the manuscript returns of the 1901 Census of Canada to examine the assimilation of male wage-earning immigrants (mainly from the UK) in Montreal and Toronto. Unlike studies of post-World War II immigrants to Canada, and some recent studies of nineteenth-century immigration to the United States, they find slow assimilation to the earnings levels of native-born English mother-tongue Canadians. Green, MacKinnon and Chris Minns (2005) use 1901 census data to demonstrate that Anglophones and Francophone had very different personal characteristics, so that movement to the west was rarely economically attractive for Francophone. However, large-scale migration into New England fitted French Canadians’ demographic and human capital profile.

Wealth and Inequality

Recent years have also seen the emergence of a body of literature by several contributors on wealth accumulation and distribution in nineteenth-century Canada. This work has provided quantitative measurements of the degree of inequality in wealth holding, as well as its evolution over time. Gilles Paquet and Jean-Pierre Wallot (1976, 1986) have examined the net personal wealth of wealth holders using “les inventaires après déces” (inventories taken after death) in Quebec during the late eighteenth and early nineteenth century. They have suggested that the habitant was indeed a rational economic agent who chose land as a form of wealth not because of inherent conservatism but because information and transactions costs hindered the accumulation of financial assets.

A. Gordon Darroch (1983a, 1983b) has utilized municipal assessment rolls to study wealth inequality in Toronto during the late nineteenth century. Darroch found that inequality among assessed families was such that the top one-fifth of assessed families held at least 65% of all assessed wealth and the poorest 40% never more than 8%, even though inequality did decline between 1871 and 1899. Darroch and Michael Ornstein (1980, 1984) used the 1871 Census to examine ethnicity, occupational structure and family life cycles in Canada. Darroch and Soltow (1992, 1994) research property holding in Ontario using 5,669 individuals the 1871 census manuscripts and find “deep and abiding structures of inequality” accompanied by opportunities for mobility.

Lars Osberg and Fazley Siddiq (1988, 1993) and Siddiq (1988) have examined wealth inequality in Nova Scotia using probated estates from 1871 and 1899. They found a slight shift towards greater inequality in wealth over time and concluded that the prosperity of the 1850-1875 period in Nova Scotia benefited primarily the Halifax- based merchant class. Higher levels of wealth were associated with being a merchant and with living in Halifax, as opposed to the rest of the province. Siddiq and Julian Gwyn (1992) used probate inventories from 1851 and 1871 to study wealth over the period. They again document a greater trend towards inequality, accompanied by rising wealth. In addition, Peter Wardhas collected a set of 196 Nova Scotia probate records for Lunenburg County spanning 1808-1922, as well as a set of poll tax records for the same location between 1791 and 1795.11

Livio Di Matteo and Peter George (1992, 1998) have examined wealth distribution in late nineteenth century Ontario using probate records and assessment roll data for Wentworth County for the years 1872, 1882, 1892 and 1902. They find a rise in average wealth levels up until 1892 and a decline from 1892 to 1902. Whereas the rise in wealth from 1872 to 1892 appears to have accompanied by a trend towards greater equality in wealth distribution, the period 1892 to 1902 marked a return to greater inequality. Di Matteo (1996, 1997, 1998, 2001) uses a set of 3,515 probated decedents for all of Ontario in 1892 to examine the determinants of wealth holding, the wealth of the Irish, inequality and life cycle accumulation. Di Matteo and Herb Emery (2002) use the 1892 Ontario data to examine life insurance holding and the extent of self-insurance as wealth rises. Di Matteo (2004, 2006) uses a newly constructed micro-data set for the Thunder Bay District from 1885-1920 consisting of 1,293 probated decedents to examine wealth and inequality during Canada’s wheat boom era. Di Matteo is currently using Ontario probated decedents from 1902 linked to the 1901 census and combined with previous data from 1892 to examine the impact of religious affiliation on wealth holding.

Wealth and property holding among women has also been a specific topic of research.12 Peter Baskerville (1999) uses probate data to examine wealth holding by women in the cities of Victoria and Hamilton between 1880 and 1901 and finds that they were substantial property owners. The holding of wealth by women in the wake of property legislation is studied by Inwood and Sue Ingram (2000) and Inwood and Sarah Van Sligtenhorst (2004). Their work chronicles the increase in female property holding in the wake of Canadian property law changes in the late nineteenth-century, Inwood and Richard Reid (2001) also use the Canadian Census to examine the relationship between gender and occupational identity.

Conclusion

The flurry of recent activity in Canadian quantitative economic history using census and probate data bodes well for the future. Even the National Archives of Canada has now made digital images of census forms available online as well as other primary records.13 Moreover, projects such as the CCRI and the 1891 Census Project hold the promise of new, integrated data sources for future research on national as opposed to regional micro-data questions. We will be able to see the extent of regional economic development, earnings and convergence at a regional level and from a national perspective. Access to the 1911 and future access to the 1921 Census of Canada will also provide fertile areas for research and discovery. The period between 1900 and 1921, spanning the wheat boom and the First World War, is particularly important as it coincides with Canadian industrialization, rapid economic growth and the further expansion of wealth and income at the individual level. Moreover, the access to new samples of micro data may also help shed light on aboriginal economic history during the nineteenth and early twentieth century, as well as the economic progress of women.14 In particular, the economic history of Canada’s aboriginal peoples after the decline of the fur trade and during Canada’s industrialization is an area where micro-data might be useful in illustrating economic trends and conditions.15

References:

Baskerville, Peter A. “Familiar Strangers: Urban Families with Boarders in Canada, 1901.” Social Science History 25, no. 3 (2001): 321-46.

Baskerville, Peter. “Did Religion Matter? Religion and Wealth in Urban Canada at the Turn of the Twentieth Century: An Exploratory Study.” Histoire sociale-Social History XXXIV, no. 67 (2001): 61-96.

Baskerville, Peter A. and Eric W. Sager. “Finding the Work Force in the 1901 Census of Canada.” Histoire sociale-Social History XXVIII, no. 56 (1995): 521-40.

Baskerville, Peter A., and Eric W. Sager. Unwilling Idlers: The Urban Unemployed and Their Families in Late Victorian Canada. Toronto: University of Toronto Press, 1998

Baskerville, Peter A. “Women and Investment in Late-Nineteenth Century Urban Canada: Victoria and Hamilton, 1880-1901.” Canadian Historical Review 80, no. 2 (1999): 191-218.

Borsa, Joan, and Kris Inwood. Codebook and Interpretation Manual for the 1870-71 Canadian Industrial Database. Guelph, 1993.

Bouchard, Gerard. “Introduction à l’étude de la société saguenayenne aux XIXe et XXe siècles.” Revue d’histoire de l’Amérique française 31, no. 1 (1977): 3-27.

Bouchard, Gerard. “Les systèmes de transmission des avoirs familiaux et le cycle de la société rurale au Québec, du XVIIe au XXe siècle.” Histoire sociale-Social History XVI, no. 31 (1983): 35-60.

Bouchard, Gerard. “Les fichiers-réseaux de population: Un retour à l’individualité.” Histoire sociale-Social History XXI, no. 42 (1988): 287-94.

Bouchard, Gerard and Regis Thibeault. “Change and Continuity in Saguenay Agriculture: The Evolution of Production and Yields (1852-1971).” In Canadian Papers in Rural History, Vol. VIII, edited Donald H. Akenson, 231-59. Gananoque, ON: Langdale Press, 1992.

Bouchard, Gerard. “Computerized Family Reconstitution and the Measure of Literacy. Presentation of a New Index.” History and Computing 5, no 1 (1993): 12-24.

Bouchard, Gerard. Quelques arpents d’Amérique: Population, économie, famille au Saguenay, 1838-1971. Montreal: Boréal, 1996.

Bouchard, Gerard. “Economic Inequalities in Saguenay Society, 1879-1949: A Descriptive Analysis.” Canadian Historical Review 79, no. 4 (1998): 660-90.

Bourbeau, Robert, and Jacques Légaré. Évolution de la mortalité au Canada et au Québec 1831-1931. Montreal: Les Presses de l’Université de Montréal, 1982.

Bradbury, Bettina. “Women and Wage Labour in a Period of Transition: Montreal, 1861-1881.” Histoire sociale-Social History XVII (1984): 115-31.

Bradbury, Bettina, Peter Gossage, Evelyn Kolish, and Alan Stewart. “Property and Marriage: The Law and the Practice in Early Nineteenth-Century Montreal.” Histoire sociale-Social History XXVI, no. 51 (1993): 9-40.

Carlos, Ann, and Frank Lewis. “Property Rights and Competition in the Depletion of the Beaver: Native Americans and the Hudson’s Bay Company, 1700-1763.” In The Other Side of the Frontier: Economic Explanations into Native American History, edited by Linda Barrington. Boulder, CO: Westview Press, 1998.

Carlos, Ann, and Frank Lewis. “Property Rights, Competition, and Depletion in the Eighteenth-century Canadian Fur Trade: The Role of the European Market.” Canadian Journal of Economics 32, no. 3 (1999): 705-28.

Carlos, Ann, and Frank Lewis. “Marketing in the Land of Hudson Bay: Indian Consumers and the Hudson’s Bay Company, 1670-1770.” Enterprise and Society 3 (2002): 285-317.

Carlos, Ann and Frank Lewis. “Trade, Consumption, and the Native Economy: Lessons from York Factory, Hudson Bay.” Journal of Economic History 61, no. 4 (2001): 1037-64.

Charbonneau, Hubert. “Le registre de population du Québec ancien Bilan de vingt annés de recherches.” Histoire sociale-Social History XXI, no. 42 (1988): 295-99.

Darroch, A. Gordon. “Occupational Structure, Assessed Wealth and Homeowning during Toronto’s Early Industrialization, 1861-1899.” Histoire sociale-Social History XVI (1983): 381-419.

Darroch, A. Gordon. “Early Industrialization and Inequality in Toronto, 1861-1899.” Labour/Le Travailleur 11 (1983): 31-61.

Darroch, A. Gordon. “A Study of Census Manuscript Data for Central Ontario, 1861-1871: Reflections on a Project and On Historical Archives.” Histoire sociale-Social History XXI, no. 42 (1988): 304-11.

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Footnotes

1 The helpful comments of Herb Emery, Mary MacKinnon and Kris Inwood on earlier drafts are acknowledged.

2 See especially Mac Urquhart’s spearheading of the major efforts in national income and output estimates. (Urquhart, 1986, 1993)

3 “Individual response” means by individuals, households and firms.

4 See Gaffield (1988) and Igartua (1988).

5 The Conference on the Use of Census Manuscripts for Historical Research held at Guelph in March 1993 was an example of the interdisciplinary nature of historical micro-data research. The conference was sponsored by the Canadian Committee on History and Computing, the Social Sciences and Humanities Research Council of Canada and the University of Guelph. The conference was organized by economist Kris Inwood and historian Richard Reid and featured presentations by historians, economists, demographers, sociologists and anthropologists.

6 The Denton/George project had its origins in a proposal to the Second Conference on Quantitative Research in Canadian Economic History in 1967 that a sampling of the Canadian census be undertaken. Denton and George drew a sample from the manuscript census returns for individuals for 1871 that had recently been made available, and reported their preliminary findings to the Fourth Conference in March, 1970 in a paper that was published shortly afterwards in Histoire sociale/Social History (1970). Mac Urquhart’s role here must be acknowledged. He and Ken Buckley were insistent that a sampling of Census manuscripts would be an important venture for the conference members to initiate.

7 Also, sources such as the aggregate census have been used to examine fertility by Henripin (1968) and mortality by Bourbeau and Legaré (1982)).

8 Chad Gaffield, Peter Baskerville and Alan Artibise were also involved in the creation of a machine-readable listing of archival sources on Vancouver Island known as the Vancouver Islands Project (Gaffield, 1988, 313).

9 See Chad Gaffield, “Ethics, Technology and Confidential Research Data: The Case of the Canadian Century Research Infrastructure Project,” paper presented to the World History Conference, Sydney, July 3-9, 2005.

10 Baskerville and Sager have been involved in the Canadian Families Project. See “The Canadian Families Project”, a special issue of the journal Historical Methods, 33 no. 4 (2000).

11 See Don Paterson’s Economic and Social History Data Base at the University of British Columbia at http://www2.arts.ubc.ca/econsochistory/data/data_list.html

12 Examples of other aspects of gender and economic status in a regional context ar e covered by Muise (1991), Myers (1994) and Seager and Perry (1997).

13 See http://www.collectionscanada.ca/genealogy/022-500-e.html

14 See for example the work by Gerhard Ens (1996) on the Red River Metis.

15 Hamilton and Inwood (2006) have begun research into identifying the aboriginal population in the 1891 Census of Canada.

Citation: Di Matteo, Livio. “The Use of Quantitative Micro-data in Canadian Economic History: A Brief Survey”. EH.Net Encyclopedia, edited by Robert Whaples. January 27, 2007. URL
http://eh.net/encyclopedia/the-use-of-quantitative-micro-data-in-canadian-economic-history-a-brief-survey/

Banking in the Western U.S.

Lynne Pierson Doti, Chapman University

Banking in the western United States has had a distinctive history, marked by a great variety of banking arrangements and generally loose regulation.

California Banks in the Gold Rush Era

In the early frontier years, private individuals and outposts of the Hudson Bay Company and other trading companies provided banking services. As states west of the Mississippi began developing after the 1840s, capital flowed fairly readily from the east coast and also from foreign sources. This is particularly true of California. Gold was discovered in early 1848, and the population exploded. San Francisco and Sacramento quickly became cities. By 1852, numerous banks representing investors from St. Louis, Boston, New York and even other countries were operating in San Francisco. Lazard Freres, a French bank, has remained there to the present time. St. Louis, an earlier financial center of the west, and New York banks were well represented until the mid-1850s, when a bank panic forced the reevaluation of distant branches or subsidiaries. As California grew, spurred at first by gold production and then by the Nevada silver discoveries in the1860s, San Francisco became the financial center of the western states.

One of the largest banks in California in the 1850s was started by D.O. Mills, a young New York bank employee who came to California to mine gold. Soon tiring of mining, he opened a mercantile establishment in Sacramento. Mills began storing gold for the miners, and later began buying gold and issuing notes that circulated as money. Within a few years he changed the sign on his building from “store” to “bank.” The Bank of D.O. Mills survived into the 1920s. Merchants started many early western banks in just this manner, since the lack of regulation or enforcement meant that potential depositors needed the security of a trusted, widely respected individual. A previous business often was the route to this trust.

Although the character of the individuals in control was of foremost importance, housing the bank in a solid structure also reassured customers. Because depositors worried about “wildcat banks” which accepted deposits, then relocated far away to discourage withdrawals, it was hard to gather deposits without proof of stability. So the bank was often the most solid structure in town. Although there are a few spectacular instances of bankers leaving town with deposits, the system generally worked extremely well with minimal regulation.

Large Banks Come to Dominate in the Late 1800s

Just as a few New York banks dominated financial markets on the east coast, a few large San Francisco banks — created first by the “Silver Kings” made rich by the Virginia City, Nevada mines, then by the railroad barons — dominated the West Coast financial world in the late 1800s. For example, in 1865, William Ralston started the Bank of California, which quickly branched into Nevada, and then Oregon and other western states. As in the case of New York City’s large banks, correspondent relationships with smaller banks and direct deposits and loans in larger amounts from customers located far from the bank’s offices allowed the Bank of California to become important throughout the far west.

Although, the western bank network still had many ties to the East at the end of the nineteenth century, the lag between the east coast and west coast in financial crises was still a few years. For example, in 1893, New York experienced a panic where customers rushed to withdraw their funds, fearing that the banks would fail. The New York panic spread quickly to the other east coast banks, but reached San Francisco only in 1895.

A. P. Giannini and Branch Banking

By 1930, A.P. Giannini was the most powerful financier in the Western U.S. He had started his first bank, the Bank of Italy, in 1905 to appeal to the Italian immigrants of North Beach in San Francisco. Having many connections and having learned about customer service in the produce industry helped him turn the setback of the 1906 earthquake into an advantage. As the city burned, Giannini loaded the contents of his safe into a produce wagon and relocated. While some other bankers waited in frustration for their safes to cool enough to open, Giannini was making loans. Perhaps this impressed upon him the benefits of diverse locations. Diversification meant that if business was bad in one area, it might be better in another. He opened his first branch in 1907 in the Mission district of San Francisco. After 1915 he began to add new offices and buy other banks at a rate that became alarming to rival banks.

Giannini was a pioneer of branch banking, maneuvering around state and federal regulators to eventually establish over one thousand branches in California. He dreamed of a bank with branches around the world, but it did not occur in his lifetime. However, his banking system, consolidated in 1930 as Bank of America, N.T. and S.A., moved from California into neighboring states in the 1970s and (along with Citibank of New York) created the pressure that eventually lead to interstate branching in the 1990s. The 1994 Riegle-Neal Interstate Banking and Branching Efficiency Act allowed banks to combine across state lines. Bank of America was purchased by Nationsbank of North Carolina in 1999, creating a truly national bank using the name “Bank of America.”

Restrictions on Branch Banking

Although California regulators, undoubtedly spurred on by rival bankers, tried to confine Giannini’s operations to a small geographic area in the 1920s, they never actually banned branch banking for state-chartered banks. This was atypical, even in the less regulated west. National banks were banned from opening branches under the National Banking Act of 1864, confirming the general attitude, carefully cultivated by local monopolist bankers, that branching only existed to drain funds from the countryside to finance growth in the cities.

Among the western states Texas, Oregon, Washington, Utah, Colorado, New Mexico and Idaho had severe restrictions on branching and only reduced or removed these limits during the Depression, when acquisition by a stronger bank became the only alternative to failure for many rural banks. Also, it became clear that the banks with branches were surviving much better than the unit banks (those with only one location). Nevada, Idaho, Oregon and Washington removed most of their onerous restrictions on branching during the 1930s, but Texas, Wyoming, Montana, New Mexico and Colorado remained almost entirely branchless until late in the twentieth century. Colorado was the last of the fifty states to allow branch banking. In the states where branch banking was limited, the number of small banks grew as the economy grew, but many failed in bad times.

Methods of Avoiding Branch Banking Restrictions

Mergers and chain banking were substitutes for branch banking and their formation came in waves generated by economic or technological change. The first merger movement came in the mid-1890s in Portland, Denver, Seattle and Salt Lake City, when many banks experienced problems due to the panic. Another wave of mergers came in the 1920s, inspired by Giannini’s expansion (though still limited in unit banking states). Chain banking — common ownership of several legally independent banks — was another way to achieve diversification without branching. In Nevada, George Wingfield built a chain of twelve banks starting in 1908 as part of his business empire. However, low prices for wool put a majority of his customers in trouble and the banks were permanently closed in 1933. The chain system survived, however. The three Walker brothers started chain banks in Utah in 1859, which survived until their acquisition by another chain system in the1950s. First Interstate Bank, in spite of the common name for all its banks, was a chain of twenty-one banks in eleven western states, all owned by First Interstate Bancorporation. Joe Pinola, chairman of the chain, created the appearance of one bank operating in several states fifteen years before it became legal to actually have a single bank operating across state lines.

Developments after World War II

World War II brought population increases for the western states and many of the military personnel and workers in war industries settled permanently in the west after the war. The increases in population occurred disproportionately in the suburbs. A rash of new banks, and new branches, followed. Deposit insurance enacted in the 1930s now replaced the need for reassuring edifices and bank buildings acquired a new, often inexpensive demeanor. Drive-in banking facilities became common. Treats provided for the children and, sometimes, the dogs confined to the car were almost a requirement.

During the Depression and World War II, Giannini continued his expansion. To facilitate diversification he created Transamerica Corporation as a holding company for Bank of America, several insurance companies and about two hundred other banks. In 1948, the Securities and Exchange Commission and the Federal Reserve Board charged Transamerica with monopolizing western banking. In 1952, Transamerica won the case, but the attention precipitated the Bank Holding Company Act of 1956, which made bank holding companies subject to the same restrictions in crossing state lines as individual banks. Transamerica sold off its banks and remained a powerhouse in the insurance industry into the twenty-first century.

Savings and Loan Failures

In the mid 1980s into the mid 1990s, a large number of savings and loan institutions failed, and because California and Texas were among the states with the largest numbers of these institutions, they produced some notable disasters. Sharply rising interest rates and changing regulations brought on this national phenomenon. Established institutions with large long-term loans on the books at low interest rates could not attract deposits without paying high interest rates. As the real estate market had escalated in the west in the postwar period, the western banks and savings and loans had proportionately larger amounts of the low interest loans. They became desperate to find a way to increase their earnings. Many of them ventured into unfamiliar territory, including auto loans, business lending and real estate development. California’s Columbia Savings and Loan, for example, tried investing in high-interest, high-risk (junk) bonds in a spectacularly unsuccessful quest for high earnings. Unscrupulous businessmen, who manipulated insurance guarantees to make large profits at little risk to themselves, purchased some weak banks. One of the most notorious of the villains of the disaster, Charles Keating, purchased California’s Lincoln Savings & Loan. He expanded the bank by offering high interest rates on large deposits, and later by selling bonds to confused retirees to replace these deposits. The funds were invested in several of Keating’s own projects, including an extravagant hotel in Arizona. Contributions to several Congressmen and taxpayer insured losses that totaled about $2 billion made Keating a notorious national figure.

California had the most losses in the savings and loan industry of any state, but Arizona and Colorado were also high. The problem worsened as troubled banks tried to unload repossessed real estate. The federal government ultimately paid the bill to bail out depositors, and established the Resolution Trust Corporation (RTC) to absorb the real estate holdings of failed institutions.

Conclusions

Banking in the American west has often been innovative. The more varied, but generally lower, level of regulation has allowed various banking experiments to run in the west. These innovations have often shaped national legislation and produced models eventually followed by many eastern states. The less stringent legal environment has produced the best and the worst banking in the nation, but has also shaped banking in the rest of the country and in the rest of the world.

References

Doti, Lynne Pierson. “Banking in California: Some Evidence on Structure 1878-1905.” Ph.D. dissertation, University of California, Riverside, 1978.

Doti, Lynne Pierson. “Banking in California: The First Branching Era.” Journal of the West 23, no. 2 (April 1984): 65-71.

Doti, Lynne Pierson and Larry Schweikart. Banking in the American West: From Gold Rush to Deregulation. Norman, OK: University of Oklahoma Press, 1991.

Doti, Lynne Pierson. “Nationwide Branching: Some Lessons from California.” Essays in Economic and Business History 9 (May 1991): 141 -161.

Doti, Lynne Pierson and Larry Schweikart. California Bankers, 1848-1993. Needham Heights, MA: Ginn Press, 1994.

Schweikart, Larry. A History of Banking in Arizona. Tucson: University of Arizona Press, 1982.

Schweikart, Larry, editor. Encyclopedia of American Business History and Biography.: Banking and Finance, 1913-1989. New York: Facts on File, 1990.

Citation: Doti, Lynne. “Banking in the Western US”. EH.Net Encyclopedia, edited by Robert Whaples. June 10, 2003. URL http://eh.net/encyclopedia/banking-in-the-western-u-s/

Antebellum Banking in the United States

Howard Bodenhorn, Lafayette College

The first legitimate commercial bank in the United States was the Bank of North America founded in 1781. Encouraged by Alexander Hamilton, Robert Morris persuaded the Continental Congress to charter the bank, which loaned to the cash-strapped Revolutionary government as well as private citizens, mostly Philadelphia merchants. The possibilities of commercial banking had been widely recognized by many colonists, but British law forbade the establishment of commercial, limited-liability banks in the colonies. Given that many of the colonists’ grievances against Parliament centered on economic and monetary issues, it is not surprising that one of the earliest acts of the Continental Congress was the establishment of a bank.

The introduction of banking to the U.S. was viewed as an important first step in forming an independent nation because banks supplied a medium of exchange (banknotes1 and deposits) in an economy perpetually strangled by shortages of specie money and credit, because they animated industry, and because they fostered wealth creation and promoted well-being. In the last case, contemporaries typically viewed banks as an integral part of a wider system of government-sponsored commercial infrastructure. Like schools, bridges, road, canals, river clearing and harbor improvements, the benefits of banks were expected to accrue to everyone even if dividends accrued only to shareholders.

Financial Sector Growth

By 1800 each major U.S. port city had at least one commercial bank serving the local mercantile community. As city banks proved themselves, banking spread into smaller cities and towns and expanded their clientele. Although most banks specialized in mercantile lending, others served artisans and farmers. In 1820 there were 327 commercial banks and several mutual savings banks that promoted thrift among the poor. Thus, at the onset of the antebellum period (defined here as the period between 1820 and 1860), urban residents were familiar with the intermediary function of banks and used bank-supplied currencies (deposits and banknotes) for most transactions. Table 1 reports the number of banks and the value of loans outstanding at year end between 1820 and 1860. During the era, the number of banks increased from 327 to 1,562 and total loans increased from just over $55.1 million to $691.9 million. Bank-supplied credit in the U.S. economy increased at a remarkable annual average rate of 6.3 percent. Growth in the financial sector, then outpaced growth in aggregate economic activity. Nominal gross domestic product increased an average annual rate of about 4.3 percent over the same interval. This essay discusses how regional regulatory structures evolved as the banking sector grew and radiated out from northeastern cities to the hinterlands.

Table 1
Number of Banks and Total Loans, 1820-1860

Year Banks Loans ($ millions)
1820 327 55.1
1821 273 71.9
1822 267 56.0
1823 274 75.9
1824 300 73.8
1825 330 88.7
1826 331 104.8
1827 333 90.5
1828 355 100.3
1829 369 103.0
1830 381 115.3
1831 424 149.0
1832 464 152.5
1833 517 222.9
1834 506 324.1
1835 704 365.1
1836 713 457.5
1837 788 525.1
1838 829 485.6
1839 840 492.3
1840 901 462.9
1841 784 386.5
1842 692 324.0
1843 691 254.5
1844 696 264.9
1845 707 288.6
1846 707 312.1
1847 715 310.3
1848 751 344.5
1849 782 332.3
1850 824 364.2
1851 879 413.8
1852 913 429.8
1853 750 408.9
1854 1208 557.4
1855 1307 576.1
1856 1398 634.2
1857 1416 684.5
1858 1422 583.2
1859 1476 657.2
1860 1562 691.9

Sources: Fenstermaker (1965); U.S. Comptroller of the Currency (1931).

Adaptability

As important as early American banks were in the process of capital accumulation, perhaps their most notable feature was their adaptability. Kuznets (1958) argues that one measure of the financial sector’s value is how and to what extent it evolves with changing economic conditions. Put in place to perform certain functions under one set of economic circumstances, how did it alter its behavior and service the needs of borrowers as circumstances changed. One benefit of the federalist U.S. political system was that states were given the freedom to establish systems reflecting local needs and preferences. While the political structure deserves credit in promoting regional adaptations, North (1994) credits the adaptability of America’s formal rules and informal constraints that rewarded adventurism in the economic, as well as the noneconomic, sphere. Differences in geography, climate, crop mix, manufacturing activity, population density and a host of other variables were reflected in different state banking systems. Rhode Island’s banks bore little resemblance to those in far away Louisiana or Missouri, or even those in neighboring Connecticut. Each state’s banks took a different form, but their purpose was the same; namely, to provide the state’s citizens with monetary and intermediary services and to promote the general economic welfare. This section provides a sketch of regional differences. A more detailed discussion can be found in Bodenhorn (2002).

State Banking in New England

New England’s banks most resemble the common conception of the antebellum bank. They were relatively small, unit banks; their stock was closely held; they granted loans to local farmers, merchants and artisans with whom the bank’s managers had more than a passing familiarity; and the state took little direct interest in their daily operations.

Of the banking systems put in place in the antebellum era, New England’s is typically viewed as the most stable and conservative. Friedman and Schwartz (1986) attribute their stability to an Old World concern with business reputations, familial ties, and personal legacies. New England was long settled, its society well established, and its business community mature and respected throughout the Atlantic trading network. Wealthy businessmen and bankers with strong ties to the community — like the Browns of Providence or the Bowdoins of Boston — emphasized stability not just because doing so benefited and reflected well on them, but because they realized that bad banking was bad for everyone’s business.

Besides their reputation for soundness, the two defining characteristics of New England’s early banks were their insider nature and their small size. The typical New England bank was small compared to banks in other regions. Table 2 shows that in 1820 the average Massachusetts country bank was about the same size as a Pennsylvania country bank, but both were only about half the size of a Virginia bank. A Rhode Island bank was about one-third the size of a Massachusetts or Pennsylvania bank and a mere one-sixth as large as Virginia’s banks. By 1850 the average Massachusetts bank declined relatively, operating on about two-thirds the paid-in capital of a Pennsylvania country bank. Rhode Island’s banks also shrank relative to Pennsylvania’s and were tiny compared to the large branch banks in the South and West.

Table 2
Average Bank Size by Capital and Lending in 1820 and 1850 Selected States and Cities
(in $ thousands)

1820
Capital
Loans 1850 Capital Loans
Massachusetts $374.5 $480.4 $293.5 $494.0
except Boston 176.6 230.8 170.3 281.9
Rhode Island 95.7 103.2 186.0 246.2
except Providence 60.6 72.0 79.5 108.5
New York na na 246.8 516.3
except NYC na na 126.7 240.1
Pennsylvania 221.8 262.9 340.2 674.6
except Philadelphia 162.6 195.2 246.0 420.7
Virginia1,2 351.5 340.0 270.3 504.5
South Carolina2 na na 938.5 1,471.5
Kentucky2 na na 439.4 727.3

Notes: 1 Virginia figures for 1822. 2 Figures represent branch averages.

Source: Bodenhorn (2002).

Explanations for New England Banks’ Relatively Small Size

Several explanations have been offered for the relatively small size of New England’s banks. Contemporaries attributed it to the New England states’ propensity to tax bank capital, which was thought to work to the detriment of large banks. They argued that large banks circulated fewer banknotes per dollar of capital. The result was a progressive tax that fell disproportionately on large banks. Data compiled from Massachusetts’s bank reports suggest that large banks were not disadvantaged by the capital tax. It was a fact, as contemporaries believed, that large banks paid higher taxes per dollar of circulating banknotes, but a potentially better benchmark is the tax to loan ratio because large banks made more use of deposits than small banks. The tax to loan ratio was remarkably constant across both bank size and time, averaging just 0.6 percent between 1834 and 1855. Moreover, there is evidence of constant to modestly increasing returns to scale in New England banking. Large banks were generally at least as profitable as small banks in all years between 1834 and 1860, and slightly more so in many.

Lamoreaux (1993) offers a different explanation for the modest size of the region’s banks. New England’s banks, she argues, were not impersonal financial intermediaries. Rather, they acted as the financial arms of extended kinship trading networks. Throughout the antebellum era banks catered to insiders: directors, officers, shareholders, or business partners and kin of directors, officers, shareholders and business partners. Such preferences toward insiders represented the perpetuation of the eighteenth-century custom of pooling capital to finance family enterprises. In the nineteenth century the practice continued under corporate auspices. The corporate form, in fact, facilitated raising capital in greater amounts than the family unit could raise on its own. But because the banks kept their loans within a relatively small circle of business connections, it was not until the late nineteenth century that bank size increased.2

Once the kinship orientation of the region’s banks was established it perpetuated itself. When outsiders could not obtain loans from existing insider organizations, they formed their own insider bank. In doing so the promoters assured themselves of a steady supply of credit and created engines of economic mobility for kinship networks formerly closed off from many sources of credit. State legislatures accommodated the practice through their liberal chartering policies. By 1860, Rhode Island had 91 banks, Maine had 68, New Hampshire 51, Vermont 44, Connecticut 74 and Massachusetts 178.

The Suffolk System

One of the most commented on characteristic of New England’s banking system was its unique regional banknote redemption and clearing mechanism. Established by the Suffolk Bank of Boston in the early 1820s, the system became known as the Suffolk System. With so many banks in New England, each issuing it own form of currency, it was sometimes difficult for merchants, farmers, artisans, and even other bankers, to discriminate between real and bogus banknotes, or to discriminate between good and bad bankers. Moreover, the rural-urban terms of trade pulled most banknotes toward the region’s port cities. Because country merchants and farmers were typically indebted to city merchants, country banknotes tended to flow toward the cities, Boston more so than any other. By the second decade of the nineteenth century, country banknotes became a constant irritant for city bankers. City bankers believed that country issues displaced Boston banknotes in local transactions. More irritating though was the constant demand by the city banks’ customers to accept country banknotes on deposit, which placed the burden of interbank clearing on the city banks.3

In 1803 the city banks embarked on a first attempt to deal with country banknotes. They joined together, bought up a large quantity of country banknotes, and returned them to the country banks for redemption into specie. This effort to reduce country banknote circulation encountered so many obstacles that it was quickly abandoned. Several other schemes were hatched in the next two decades, but none proved any more successful than the 1803 plan.

The Suffolk Bank was chartered in 1818 and within a year embarked on a novel scheme to deal with the influx of country banknotes. The Suffolk sponsored a consortium of Boston bank in which each member appointed the Suffolk as its lone agent in the collection and redemption of country banknotes. In addition, each city bank contributed to a fund used to purchase and redeem country banknotes. When the Suffolk collected a large quantity of a country bank’s notes, it presented them for immediate redemption with an ultimatum: Join in a regular and organized redemption system or be subject to further unannounced redemption calls.4 Country banks objected to the Suffolk’s proposal, because it required them to keep noninterest-earning assets on deposit with the Suffolk in amounts equal to their average weekly redemptions at the city banks. Most country banks initially refused to join the redemption network, but after the Suffolk made good on a few redemption threats, the system achieved near universal membership.

Early interpretations of the Suffolk system, like those of Redlich (1949) and Hammond (1957), portray the Suffolk as a proto-central bank, which acted as a restraining influence that exercised some control over the region’s banking system and money supply. Recent studies are less quick to pronounce the Suffolk a successful experiment in early central banking. Mullineaux (1987) argues that the Suffolk’s redemption system was actually self-defeating. Instead of making country banknotes less desirable in Boston, the fact that they became readily redeemable there made them perfect substitutes for banknotes issued by Boston’s prestigious banks. This policy made country banknotes more desirable, which made it more, not less, difficult for Boston’s banks to keep their own notes in circulation.

Fenstermaker and Filer (1986) also contest the long-held view that the Suffolk exercised control over the region’s money supply (banknotes and deposits). Indeed, the Suffolk’s system was self-defeating in this regard as well. By increasing confidence in the value of a randomly encountered banknote, people were willing to hold increases in banknotes issues. In an interesting twist on the traditional interpretation, a possible outcome of the Suffolk system is that New England may have grown increasingly financial backward as a direct result of the region’s unique clearing system. Because banknotes were viewed as relatively safe and easily redeemed, the next big financial innovation — deposit banking — in New England lagged far behind other regions. With such wide acceptance of banknotes, there was no reason for banks to encourage the use of deposits and little reason for consumers to switch over.

Summary: New England Banks

New England’s banking system can be summarized as follows: Small unit banks predominated; many banks catered to small groups of capitalists bound by personal and familial ties; banking was becoming increasingly interconnected with other lines of business, such as insurance, shipping and manufacturing; the state took little direct interest in the daily operations of the banks and its supervisory role amounted to little more than a demand that every bank submit an unaudited balance sheet at year’s end; and that the Suffolk developed an interbank clearing system that facilitated the use of banknotes throughout the region, but had little effective control over the region’s money supply.

Banking in the Middle Atlantic Region

Pennsylvania

After 1810 or so, many bank charters were granted in New England, but not because of the presumption that the bank would promote the commonweal. Charters were granted for the personal gain of the promoter and the shareholders and in proportion to the personal, political and economic influence of the bank’s founders. No New England state took a significant financial stake in its banks. In both respects, New England differed markedly from states in other regions. From the beginning of state-chartered commercial banking in Pennsylvania, the state took a direct interest in the operations and profits of its banks. The Bank of North America was the obvious case: chartered to provide support to the colonial belligerents and the fledgling nation. Because the bank was popularly perceived to be dominated by Philadelphia’s Federalist merchants, who rarely loaned to outsiders, support for the bank waned.5 After a pitched political battle in which the Bank of North America’s charter was revoked and reinstated, the legislature chartered the Bank of Pennsylvania in 1793. As its name implies, this bank became the financial arm of the state. Pennsylvania subscribed $1 million of the bank’s capital, giving it the right to appoint six of thirteen directors and a $500,000 line of credit. The bank benefited by becoming the state’s fiscal agent, which guaranteed a constant inflow of deposits from regular treasury operations as well as western land sales.

By 1803 the demand for loans outstripped the existing banks’ supply and a plan for a new bank, the Philadelphia Bank, was hatched and its promoters petitioned the legislature for a charter. The existing banks lobbied against the charter, and nearly sank the new bank’s chances until it established a precedent that lasted throughout the antebellum era. Its promoters bribed the legislature with a payment of $135,000 in return for the charter, handed over one-sixth of its shares, and opened a line of credit for the state.

Between 1803 and 1814, the only other bank chartered in Pennsylvania was the Farmers and Mechanics Bank of Philadelphia, which established a second substantive precedent that persisted throughout the era. Existing banks followed a strict real-bills lending policy, restricting lending to merchants at very short terms of 30 to 90 days.6 Their adherence to a real-bills philosophy left a growing community of artisans, manufacturers and farmers on the outside looking in. The Farmers and Mechanics Bank was chartered to serve excluded groups. At least seven of its thirteen directors had to be farmers, artisans or manufacturers and the bank was required to lend the equivalent of 10 percent of its capital to farmers on mortgage for at least one year. In later years, banks were established to provide services to even more narrowly defined groups. Within a decade or two, most substantial port cities had banks with names like Merchants Bank, Planters Bank, Farmers Bank, and Mechanics Bank. By 1860 it was common to find banks with names like Leather Manufacturers Bank, Grocers Bank, Drovers Bank, and Importers Bank. Indeed, the Emigrant Savings Bank in New York City served Irish immigrants almost exclusively. In the other instances, it is not known how much of a bank’s lending was directed toward the occupational group included in its name. The adoption of such names may have been marketing ploys as much as mission statements. Only further research will reveal the answer.

New York

State-chartered banking in New York arrived less auspiciously than it had in Philadelphia or Boston. The Bank of New York opened in 1784, but operated without a charter and in open violation of state law until 1791 when the legislature finally sanctioned it. The city’s second bank obtained its charter surreptitiously. Alexander Hamilton was one of the driving forces behind the Bank of New York, and his long-time nemesis, Aaron Burr, was determined to establish a competing bank. Unable to get a charter from a Federalist legislature, Burr and his colleagues petitioned to incorporate a company to supply fresh water to the inhabitants of Manhattan Island. Burr tucked a clause into the charter of the Manhattan Company (the predecessor to today’s Chase Manhattan Bank) granting the water company the right to employ any excess capital in financial transactions. Once chartered, the company’s directors announced that $500,000 of its capital would be invested in banking.7 Thereafter, banking grew more quickly in New York than in Philadelphia, so that by 1812 New York had seven banks compared to the three operating in Philadelphia.

Deposit Insurance

Despite its inauspicious banking beginnings, New York introduced two innovations that influenced American banking down to the present. The Safety Fund system, introduced in 1829, was the nation’s first experiment in bank liability insurance (similar to that provided by the Federal Deposit Insurance Corporation today). The 1829 act authorized the appointment of bank regulators charged with regular inspections of member banks. An equally novel aspect was that it established an insurance fund insuring holders of banknotes and deposits against loss from bank failure. Ultimately, the insurance fund was insufficient to protect all bank creditors from loss during the panic of 1837 when eleven failures in rapid succession all but bankrupted the insurance fund, which delayed noteholder and depositor recoveries for months, even years. Even though the Safety Fund failed to provide its promised protections, it was an important episode in the subsequent evolution of American banking. Several Midwestern states instituted deposit insurance in the early twentieth century, and the federal government adopted it after the banking panics in the 1930s resulted in the failure of thousands of banks in which millions of depositors lost money.

“Free Banking”

Although the Safety Fund was nearly bankrupted in the late 1830s, it continued to insure a number of banks up to the mid 1860s when it was finally closed. No new banks joined the Safety Fund system after 1838 with the introduction of free banking — New York’s second significant banking innovation. Free banking represented a compromise between those most concerned with the underlying safety and stability of the currency and those most concerned with competition and freeing the country’s entrepreneurs from unduly harsh and anticompetitive restraints. Under free banking, a prospective banker could start a bank anywhere he saw fit, provided he met a few regulatory requirements. Each free bank’s capital was invested in state or federal bonds that were turned over to the state’s treasurer. If a bank failed to redeem even a single note into specie, the treasurer initiated bankruptcy proceedings and banknote holders were reimbursed from the sale of the bonds.

Actually Michigan preempted New York’s claim to be the first free-banking state, but Michigan’s 1837 law was modeled closely after a bill then under debate in New York’s legislature. Ultimately, New York’s influence was profound in this as well, because free banking became one of the century’s most widely copied financial innovations. By 1860 eighteen states adopted free banking laws closely resembling New York’s law. Three other states introduced watered-down variants. Eventually, the post-Civil War system of national banking adopted many of the substantive provisions of New York’s 1838 act.

Both the Safety Fund system and free banking were attempts to protect society from losses resulting from bank failures and to entice people to hold financial assets. Banks and bank-supplied currency were novel developments in the hinterlands in the early nineteenth century and many rural inhabitants were skeptical about the value of small pieces of paper. They were more familiar with gold and silver. Getting them to exchange one for the other was a slow process, and one that relied heavily on trust. But trust was built slowly and destroyed quickly. The failure of a single bank could, in a week, destroy the confidence in a system built up over a decade. New York’s experiments were designed to mitigate, if not eliminate, the negative consequences of bank failures. New York’s Safety Fund, then, differed in the details but not in intent, from New England’s Suffolk system. Bankers and legislators in each region grappled with the difficult issue of protecting a fragile but vital sector of the economy. Each region responded to the problem differently. The South and West settled on yet another solution.

Banking in the South and West

One distinguishing characteristic of southern and western banks was their extensive branch networks. Pennsylvania provided for branch banking in the early nineteenth century and two banks jointly opened about ten branches. In both instances, however, the branches became a net liability. The Philadelphia Bank opened four branches in 1809 and by 1811 was forced to pass on its semi-annual dividends because losses at the branches offset profits at the Philadelphia office. At bottom, branch losses resulted from a combination of ineffective central office oversight and unrealistic expectations about the scale and scope of hinterland lending. Philadelphia’s bank directors instructed branch managers to invest in high-grade commercial paper or real bills. Rural banks found a limited number of such lending opportunities and quickly turned to mortgage-based lending. Many of these loans fell into arrears and were ultimately written when land sales faltered.

Branch Banking

Unlike Pennsylvania, where branch banking failed, branch banks throughout the South and West thrived. The Bank of Virginia, founded in 1804, was the first state-chartered branch bank and up to the Civil War branch banks served the state’s financial needs. Several small, independent banks were chartered in the 1850s, but they never threatened the dominance of Virginia’s “Big Six” banks. Virginia’s branch banks, unlike Pennsylvania’s, were profitable. In 1821, for example, the net return to capital at the Farmers Bank of Virginia’s home office in Richmond was 5.4 percent. Returns at its branches ranged from a low of 3 percent at Norfolk (which was consistently the low-profit branch) to 9 percent in Winchester. In 1835, the last year the bank reported separate branch statistics, net returns to capital at the Farmers Bank’s branches ranged from 2.9 and 11.7 percent, with an average of 7.9 percent.

The low profits at the Norfolk branch represent a net subsidy from the state’s banking sector to the political system, which was not immune to the same kind of infrastructure boosterism that erupted in New York, Pennsylvania, Maryland and elsewhere. In the immediate post-Revolutionary era, the value of exports shipped from Virginia’s ports (Norfolk and Alexandria) slightly exceeded the value shipped from Baltimore. In the 1790s the numbers turned sharply in Baltimore’s favor and Virginia entered the internal-improvements craze and the battle for western shipments. Banks represented the first phase of the state’s internal improvements plan in that many believed that Baltimore’s new-found advantage resulted from easier credit supplied by the city’s banks. If Norfolk, with one of the best natural harbors on the North American Atlantic coast, was to compete with other port cities, it needed banks and the state required three of the state’s Big Six branch banks to operate branches there. Despite its natural advantages, Norfolk never became an important entrepot and it probably had more bank capital than it required. This pattern was repeated elsewhere. Other states required their branch banks to serve markets such as Memphis, Louisville, Natchez and Mobile that might, with the proper infrastructure grow into important ports.

State Involvement and Intervention in Banking

The second distinguishing characteristic of southern and western banking was sweeping state involvement and intervention. Virginia, for example, interjected the state into the banking system by taking significant stakes in its first chartered banks (providing an implicit subsidy) and by requiring them, once they established themselves, to subsidize the state’s continuing internal improvements programs of the 1820s and 1830s. Indiana followed such a strategy. So, too, did Kentucky, Louisiana, Mississippi, Illinois, Kentucky, Tennessee and Georgia in different degrees. South Carolina followed a wholly different strategy. On one hand, it chartered several banks in which it took no financial interest. On the other, it chartered the Bank of the State of South Carolina, a bank wholly owned by the state and designed to lend to planters and farmers who complained constantly that the state’s existing banks served only the urban mercantile community. The state-owned bank eventually divided its lending between merchants, farmers and artisans and dominated South Carolina’s financial sector.

The 1820s and 1830s witnessed a deluge of new banks in the South and West, with a corresponding increase in state involvement. No state matched Louisiana’s breadth of involvement in the 1830s when it chartered three distinct types of banks: commercial banks that served merchants and manufacturers; improvement banks that financed various internal improvements projects; and property banks that extended long-term mortgage credit to planters and other property holders. Louisiana’s improvement banks included the New Orleans Canal and Banking Company that built a canal connecting Lake Ponchartrain to the Mississippi River. The Exchange and Banking Company and the New Orleans Improvement and Banking Company were required to build and operate hotels. The New Orleans Gas Light and Banking Company constructed and operated gas streetlights in New Orleans and five other cities. Finally, the Carrollton Railroad and Banking Company and the Atchafalaya Railroad and Banking Company were rail construction companies whose bank subsidiaries subsidized railroad construction.

“Commonwealth Ideal” and Inflationary Banking

Louisiana’s 1830s banking exuberance reflected what some historians label the “commonwealth ideal” of banking; that is, the promotion of the general welfare through the promotion of banks. Legislatures in the South and West, however, never demonstrated a greater commitment to the commonwealth ideal than during the tough times of the early 1820s. With the collapse of the post-war land boom in 1819, a political coalition of debt-strapped landowners lobbied legislatures throughout the region for relief and its focus was banking. Relief advocates lobbied for inflationary banking that would reduce the real burden of debts taken on during prior flush times.

Several western states responded to these calls and chartered state-subsidized and state-managed banks designed to reinflate their embattled economies. Chartered in 1821, the Bank of the Commonwealth of Kentucky loaned on mortgages at longer than customary periods and all Kentucky landowners were eligible for $1,000 loans. The loans allowed landowners to discharge their existing debts without being forced to liquidate their property at ruinously low prices. Although the bank’s notes were not redeemable into specie, they were given currency in two ways. First, they were accepted at the state treasury in tax payments. Second, the state passed a law that forced creditors to accept the notes in payment of existing debts or agree to delay collection for two years.

The commonwealth ideal was not unique to Kentucky. During the depression of the 1820s, Tennessee chartered the State Bank of Tennessee, Illinois chartered the State Bank of Illinois and Louisiana chartered the Louisiana State Bank. Although they took slightly different forms, they all had the same intent; namely, to relieve distressed and embarrassed farmers, planters and land owners. What all these banks shared in common was the notion that the state should promote the general welfare and economic growth. In this instance, and again during the depression of the 1840s, state-owned banks were organized to minimize the transfer of property when economic conditions demanded wholesale liquidation. Such liquidation would have been inefficient and imposed unnecessary hardship on a large fraction of the population. To the extent that hastily chartered relief banks forestalled inefficient liquidation, they served their purpose. Although most of these banks eventually became insolvent, requiring taxpayer bailouts, we cannot label them unsuccessful. They reinflated economies and allowed for an orderly disposal of property. Determining if the net benefits were positive or negative requires more research, but for the moment we are forced to accept the possibility that the region’s state-owned banks of the 1820s and 1840s advanced the commonweal.

Conclusion: Banks and Economic Growth

Despite notable differences in the specific form and structure of each region’s banking system, they were all aimed squarely at a common goal; namely, realizing that region’s economic potential. Banks helped achieve the goal in two ways. First, banks monetized economies, which reduced the costs of transacting and helped smooth consumption and production across time. It was no longer necessary for every farm family to inventory their entire harvest. They could sell most of it, and expend the proceeds on consumption goods as the need arose until the next harvest brought a new cash infusion. Crop and livestock inventories are prone to substantial losses and an increased use of money reduced them significantly. Second, banks provided credit, which unleashed entrepreneurial spirits and talents. A complete appreciation of early American banking recognizes the banks’ contribution to antebellum America’s economic growth.

Bibliographic Essay

Because of the large number of sources used to construct the essay, the essay was more readable and less cluttered by including a brief bibliographic essay. A full bibliography is included at the end.

Good general histories of antebellum banking include Dewey (1910), Fenstermaker (1965), Gouge (1833), Hammond (1957), Knox (1903), Redlich (1949), and Trescott (1963). If only one book is read on antebellum banking, Hammond’s (1957) Pulitzer-Prize winning book remains the best choice.

The literature on New England banking is not particularly large, and the more important historical interpretations of state-wide systems include Chadbourne (1936), Hasse (1946, 1957), Simonton (1971), Spencer (1949), and Stokes (1902). Gras (1937) does an excellent job of placing the history of a single bank within the larger regional and national context. In a recent book and a number of articles Lamoreaux (1994 and sources therein) provides a compelling and eminently readable reinterpretation of the region’s banking structure. Nathan Appleton (1831, 1856) provides a contemporary observer’s interpretation, while Walker (1857) provides an entertaining if perverse and satirical history of a fictional New England bank. Martin (1969) provides details of bank share prices and dividend payments from the establishment of the first banks in Boston through the end of the nineteenth century. Less technical studies of the Suffolk system include Lake (1947), Trivoli (1979) and Whitney (1878); more technical interpretations include Calomiris and Kahn (1996), Mullineaux (1987), and Rolnick, Smith and Weber (1998).

The literature on Middle Atlantic banking is huge, but the better state-level histories include Bryan (1899), Daniels (1976), and Holdsworth (1928). The better studies of individual banks include Adams (1978), Lewis (1882), Nevins (1934), and Wainwright (1953). Chaddock (1910) provides a general history of the Safety Fund system. Golembe (1960) places it in the context of modern deposit insurance, while Bodenhorn (1996) and Calomiris (1989) provide modern analyses. A recent revival of interest in free banking has brought about a veritable explosion in the number of studies on the subject, but the better introductory ones remain Rockoff (1974, 1985), Rolnick and Weber (1982, 1983), and Dwyer (1996).

The literature on southern and western banking is large and of highly variable quality, but I have found the following to be the most readable and useful general sources: Caldwell (1935), Duke (1895), Esary (1912), Golembe (1978), Huntington (1915), Green (1972), Lesesne (1970), Royalty (1979), Schweikart (1987) and Starnes (1931).

References and Further Reading

Adams, Donald R., Jr. Finance and Enterprise in Early America: A Study of Stephen Girard’s Bank, 1812-1831. Philadelphia: University of Pennsylvania Press, 1978.

Alter, George, Claudia Goldin and Elyce Rotella. “The Savings of Ordinary Americans: The Philadelphia Saving Fund Society in the Mid-Nineteenth-Century.” Journal of Economic History 54, no. 4 (December 1994): 735-67.

Appleton, Nathan. A Defence of Country Banks: Being a Reply to a Pamphlet Entitled ‘An Examination of the Banking System of Massachusetts, in Reference to the Renewal of the Bank Charters.’ Boston: Stimpson & Clapp, 1831.

Appleton, Nathan. Bank Bills or Paper Currency and the Banking System of Massachusetts with Remarks on Present High Prices. Boston: Little, Brown and Company, 1856.

Berry, Thomas Senior. Revised Annual Estimates of American Gross National Product: Preliminary Estimates of Four Major Components of Demand, 1789-1889. Richmond: University of Richmond Bostwick Paper No. 3, 1978.

Bodenhorn, Howard. “Zombie Banks and the Demise of New York’s Safety Fund.” Eastern Economic Journal 22, no. 1 (1996): 21-34.

Bodenhorn, Howard. “Private Banking in Antebellum Virginia: Thomas Branch & Sons of Petersburg.” Business History Review 71, no. 4 (1997): 513-42.

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

Bodenhorn, Howard. State Banking in Early America: A New Economic History. New York: Oxford University Press, 2002.

Bryan, Alfred C. A History of State Banking in Maryland. Baltimore: Johns Hopkins University Press, 1899.

Caldwell, Stephen A. A Banking History of Louisiana. Baton Rouge: Louisiana State University Press, 1935.

Calomiris, Charles W. “Deposit Insurance: Lessons from the Record.” Federal Reserve Bank of Chicago Economic Perspectives 13 (1989): 10-30.

Calomiris, Charles W., and Charles Kahn. “The Efficiency of Self-Regulated Payments Systems: Learnings from the Suffolk System.” Journal of Money, Credit, and Banking 28, no. 4 (1996): 766-97.

Chadbourne, Walter W. A History of Banking in Maine, 1799-1930. Orono: University of Maine Press, 1936.

Chaddock, Robert E. The Safety Fund Banking System in New York, 1829-1866. Washington, D.C.: Government Printing Office, 1910.

Daniels, Belden L. Pennsylvania: Birthplace of Banking in America. Harrisburg: Pennsylvania Bankers Association, 1976.

Davis, Lance, and Robert E. Gallman. “Capital Formation in the United States during the Nineteenth Century.” In Cambridge Economic History of Europe (Vol. 7, Part 2), edited by Peter Mathias and M.M. Postan, 1-69. Cambridge: Cambridge University Press, 1978.

Davis, Lance, and Robert E. Gallman. “Savings, Investment, and Economic Growth: The United States in the Nineteenth Century.” In Capitalism in Context: Essays on Economic Development and Cultural Change in Honor of R.M. Hartwell, edited by John A. James and Mark Thomas, 202-29. Chicago: University of Chicago Press, 1994.

Dewey, Davis R. State Banking before the Civil War. Washington, D.C.: Government Printing Office, 1910.

Duke, Basil W. History of the Bank of Kentucky, 1792-1895. Louisville: J.P. Morton, 1895.

Dwyer, Gerald P., Jr. “Wildcat Banking, Banking Panics, and Free Banking in the United States.” Federal Reserve Bank of Atlanta Economic Review 81, no. 3 (1996): 1-20.

Engerman, Stanley L., and Robert E. Gallman. “U.S. Economic Growth, 1783-1860.” Research in Economic History 8 (1983): 1-46.

Esary, Logan. State Banking in Indiana, 1814-1873. Indiana University Studies No. 15. Bloomington: Indiana University Press, 1912.

Fenstermaker, J. Van. The Development of American Commercial Banking, 1782-1837. Kent, Ohio: Kent State University, 1965.

Fenstermaker, J. Van, and John E. Filer. “Impact of the First and Second Banks of the United States and the Suffolk System on New England Bank Money, 1791-1837.” Journal of Money, Credit, and Banking 18, no. 1 (1986): 28-40.

Friedman, Milton, and Anna J. Schwartz. “Has the Government Any Role in Money?” Journal of Monetary Economics 17, no. 1 (1986): 37-62.

Gallman, Robert E. “American Economic Growth before the Civil War: The Testimony of the Capital Stock Estimates.” In American Economic Growth and Standards of Living before the Civil War, edited by Robert E. Gallman and John Joseph Wallis, 79-115. Chicago: University of Chicago Press, 1992.

Goldsmith, Raymond. Financial Structure and Development. New Haven: Yale University Press, 1969.

Golembe, Carter H. “The Deposit Insurance Legislation of 1933: An Examination of its Antecedents and Purposes.” Political Science Quarterly 76, no. 2 (1960): 181-200.

Golembe, Carter H. State Banks and the Economic Development of the West. New York: Arno Press, 1978.

Gouge, William M. A Short History of Paper Money and Banking in the United States. Philadelphia: T.W. Ustick, 1833.

Gras, N.S.B. The Massachusetts First National Bank of Boston, 1784-1934. Cambridge, MA: Harvard University Press, 1937.

Green, George D. Finance and Economic Development in the Old South: Louisiana Banking, 1804-1861. Stanford: Stanford University Press, 1972.

Hammond, Bray. Banks and Politics in America from the Revolution to the Civil War. Princeton: Princeton University Press, 1957.

Hasse, William F., Jr. A History of Banking in New Haven, Connecticut. New Haven: privately printed, 1946.

Hasse, William F., Jr. A History of Money and Banking in Connecticut. New Haven: privately printed, 1957.

Holdsworth, John Thom. Financing an Empire: History of Banking in Pennsylvania. Chicago: S.J. Clarke Publishing Company, 1928.

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1 Banknotes were small demonination IOUs printed by banks and circulated as currency. Modern U.S. money are simply banknotes issued by the Federal Reserve Bank, which has a monopoly privilege in the issue of legal tender currency. In antebellum American, when a bank made a loan, the borrower was typically handed banknotes with a face value equal to the dollar value of the loan. The borrower then spent these banknotes in purchasing goods and services, putting them into circulation. Contemporary law held that banks were required to redeem banknotes into gold and silver legal tender on demand. Banks found it profitable to issue notes because they typically held about 30 percent of the total value of banknotes in circulation as reserves. Thus, banks were able to leverage $30 in gold and silver into $100 in loans that returned about 7 percent interest on average.

2 Paul Lockard (2000) challenges Lamoreaux’s interpretation. In a study of 4 banks in the Connecticut River valley, Lockard finds that insiders did not dominate these banks’ resources. As provocative as Lockard’s findings are, he draws conclusions from a small and unrepresentative sample. Two of his four sample banks were savings banks, which were designed as quasi-charitable organizations designed to encourage savings by the working classes and provide small loans. Thus, Lockard’s sample is effectively reduced to two banks. At these two banks, he identifies about 10 percent of loans as insider loans, but readily admits that he cannot always distinguish between insiders and outsiders. For a recent study of how early Americans used savings banks, see Alter, Goldin and Rotella (1994). The literature on savings banks is so large that it cannot be be given its due here.

3 Interbank clearing involves the settling of balances between banks. Modern banks cash checks drawn on other banks and credit the funds to the depositor. The Federal Reserve system provides clearing services between banks. The accepting bank sends the checks to the Federal Reserve, who credits the sending bank’s accounts and sends the checks back to the bank on which they were drawn for reimbursement. In the antebellum era, interbank clearing involved sending banknotes back to issuing banks. Because New England had so many small and scattered banks, the costs of returning banknotes to their issuers were large and sometimes avoided by recirculating notes of distant banks rather than returning them. Regular clearings and redemptions served an important purpose, however, because they kept banks in touch with the current market conditions. A massive redemption of notes was indicative of a declining demand for money and credit. Because the bank’s reserves were drawn down with the redemptions, it was forced to reduce its volume of loans in accord with changing demand conditions.

4 The law held that banknotes were redeemable on demand into gold or silver coin or bullion. If a bank refused to redeem even a single $1 banknote, the banknote holder could have the bank closed and liquidated to recover his or her claim against it.

5 Rappaport (1996) found that the bank’s loans were about equally divided between insiders (shareholders and shareholders’ family and business associates) and outsiders, but nonshareholders received loans about 30 percent smaller than shareholders. The issue remains about whether this bank was an “insider” bank, and depends largely on one’s definition. Any modern bank which made half of its loans to shareholders and their families would be viewed as an “insider” bank. It is less clear where the line can be usefully drawn for antebellum banks.

6 Real-bills lending followed from a nineteenth-century banking philosophy, which held that bank lending should be used to finance the warehousing or wholesaling of already-produced goods. Loans made on these bases were thought to be self-liquidating in that the loan was made against readily sold collateral actually in the hands of a merchant. Under the real-bills doctrine, the banks’ proper functions were to bridge the gap between production and retail sale of goods. A strict adherence to real-bills tenets excluded loans on property (mortgages), loans on goods in process (trade credit), or loans to start-up firms (venture capital). Thus, real-bills lending prescribed a limited role for banks and bank credit. Few banks were strict adherents to the doctrine, but many followed it in large part.

7 Robert E. Wright (1998) offers a different interpretation, but notes that Burr pushed the bill through at the end of a busy legislative session so that many legislators voted on the bill without having read it thoroughly

Citation: Bodenhorn, Howard. “Antebellum Banking in the United States”. EH.Net Encyclopedia, edited by Robert Whaples. March 26, 2008. URL http://eh.net/encyclopedia/antebellum-banking-in-the-united-states/