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MODERN ECONOMIC PROBLEMS

BY FRANK A. FETTER, PH.D., LL.D. ROFESSOR OF ECONOMICS, PRINCETON UNIVERSITY 1916


            

TABLE OF CONTENTS


PART I. RESOURCES AND ECONOMIC ORGANIZATION.

  1. Material resources of the nation

  2. The present economic system


PART II. MONEY AND PRICES.

  3. Nature, use, and coinage of money

  4. The value of money

  5. Fiduciary money, metal and paper

  6. The standard of deferred payments


PART III. BANKING AND INSURANCE.

  7. The functions of banks

  8. Banking in the United States before 1914

  9. The Federal Reserve Act

  10. Crises and industrial depressions

  11. Institutions for saving and investment

  12. Principles of insurance


PART IV. TARIFF AND TAXATION.

  13. International trade

  14. The policy of a protective tariff

  15. American tariff history

  16. Objects and principles of taxation

  17. Property and corporation taxes

  18. Personal taxes


PART V. PROBLEMS OF THE WAGE SYSTEM.

  19. Methods of industrial remuneration

  20. Organized labor

  21. Public regulation of hours and wages

  22. Other protective labor and social legislation

  23. Social insurance

  24. Population and immigration


PART VI. PROBLEMS OF INDUSTRIAL ORGANIZATION.

  25. Agricultural and rural population

  26. Problems of agricultural economics

  27. The railroad problem

  28. The problem of industrial monopoly

  29. Public policy in respect to monopoly

  30. Public ownership

  31. Some aspects of socialism

  Index




FOREWORD


The present volume deals with various practical problems in economics,
as a volume published a year earlier dealt with the broader economic
principles of value and distribution. To the student beginning
economics and to the general reader the study of principles is likely
to appear more difficult than does that of concrete questions. In
fact, the difficulty of the latter, tho less obvious, is equally
great. The study of principles makes demands upon thought that are
open and unmistakable; its conclusions, drawn in the cold light of
reason, are uncolored by feeling, and are acceptable of all men so
long as the precise application that may justly be made of them is
not foreseen. But conclusions regarding practical questions of public
policy, tho they may appear to be simple, usually are biased and
complicated by assumptions, prejudices, selfish interests, and
feelings, deep-rooted and often unsuspected.

No practical problem in the field of economics can be solved as if
it were solely and purely an economic problem. It is always in some
measure also a political, moral, and social problem. The task of the
economist "as such" is the analysis of the economic valuation-aspects
of these problems. We may recall Francis A. Walker's comparison of the
economist's task with that of the chemist, which task, in a certain
case, was to analyze the contents of a vial of prussic acid, not to
give advice as to the use to make of it. Accordingly, in the following
pages, the author has endeavored primarily to develop the economic
aspects of each problem, and has repeatedly given warning when the
discussion or the conclusions began to transcend strict economic
limits. In many questions feeling is nine-tenths of reason. If the
reader has different social sympathies he may prefer to draw different
conclusions from the economic analysis.

The outlook and sympathies that are expressed or tacitly assumed
throughout this work are not so much those personal to the author as
they are those of our present day American democratic society,
taken at about its center of gravity. When the people generally feel
differently as to the ends to be attained, a different public policy
must be formulated, tho the economic analysis may not need to be
changed. Therefore, in some cases, the author has discussed merely the
economic aspect, or has referred to the general principles treated in
volume one, and has purposely refrained from expressing his personal
judgment as to "the best" policy for the moment.

The present volume was planned some years ago as a revision of a part
of the author's earlier text, "The Principles of Economics" (1904).
The intervening years have, however, been so replete with notable
economic and social legislation and have witnessed the growth of a
wider public interest in so many economic subjects, that both in
range and in treatment this work necessarily grew to be more than
a revision. Except in a few chapters, occasional sentences and
paragraphs are all of the specific features of the older text that
remain. Suggestive of the rapid changes occurring in the economic
field is the fact that a number of statements made in the manuscript a
few months or a few weeks ago had to be amended in the proof sheets to
accord with recent events.

The author's debt for information, inspiration, and assistance in
various phases of the work is a large one. The debt is owing to
many,--authors, colleagues, and students. A few of the sources that
have been drawn upon will be indicated in a pamphlet following the
plan of the "Manual of References and Exercises in Economics," already
published for use in connection with Volume I; but the limits of space
will prevent a complete enumeration. I wish, however, in particular,
to acknowledge gratefully the aid and friendly criticisms given in
connection with the chapters on money and banking, on labor problems,
and on the principles of insurance, respectively, by my colleagues,
E.W. Kemmerer, D.A. McCabe, and N. Carothers.

In completing, at least provisionally, the present work, the author
cherishes the hope that it will be of assistance not only to teachers
and to students in American colleges, but also to citizen-readers
seeking to gain a better and a non-partisan insight into the great
economic problems now claiming the nation's conscience and thought.

F.A.F.

Princeton, N.J., October, 1916.





MODERN ECONOMIC PROBLEMS

PART I RESOURCES AND ECONOMIC ORGANIZATION




CHAPTER I

MATERIAL RESOURCES OF THE NATION

  § 1. Politico-economic problems. § 2. American economic problems
  in the past. § 3. Present-day problems: main subjects. § 4. Attempts
  to summarize the nation's wealth. § 5. Average wealth and the problem
  of distribution. § 6. Changes in the price-standard. § 7. A sum of
  capital, not of wealth. § 8. Sources of food supply. § 9. The sources
  of heat, light, and power. § 10. Transportation agencies. § 11. Raw
  materials for clothing, shelter, machinery, etc.


§ 1. #Politico-economic problems.# The word "problem" is often on our
tongues. Life itself is and always has been a problem. In every time
and place in the world there have been questions of industrial
policy that challenged men for an answer, and new and puzzling social
problems that called for a solution. And yet, when institutions,
beliefs, and industrial processes were changing slowly from one
generation to another and men's lives were ruled by tradition,
authority, and custom, few problems of social organization forced
themselves upon attention, and the immediate struggle for existence
absorbed the energies and the interests of men. But our time of rapid
change seems to be peculiarly the age of problems. The movement of
the world has been more rapid in the last century than ever before--in
population, in natural science, in invention, in the changes of
political and economic institutions; in intellectual, religious,
moral, and social opinions and beliefs.

Some human problems are for the individual to solve, as, whether it is
better to go to school or to go to work, to choose this occupation or
that, to emigrate or to stay at home. Other problems of wider bearing
concern the whole family group; others, still wider, concern the local
community, the state, or the nation. In each of these there are more
or less mingled economic, political and ethical aspects. Economics
in the broad sense includes the problems of individual economy, of
domestic economy, of corporate economy, and of national economy. In
this volume, however, we are to approach the subject from the public
point of view, to consider primarily the problems of "political
economy," considering the private, domestic, and corporate problems
only insomuch as they are connected with those of the nation or of
the community as a whole. Our field comprises the problems of national
wealth and of communal welfare.

What then are our politico-economic problems in America? They are
problems that are economic in nature because they concern the way that
wealth shall be used and that citizens are enabled to make a living;
but that are likewise political, because they can be solved only
collectively by political action.

§ 2. #American economic problems in the past.# With the first
settlements of colonists on this continent politico-economic problems
appeared. Take, for example, the land policy. Each group of colonists
and each proprietary landholder had to adopt some method of land
tenure whether by free grant or by sale of separate holdings or by
leasing to settlers. In one way and another these questions were
answered, but rapidly changing conditions soon forced upon men the
reconsideration of the problem as the old solution ceased to be
satisfactory.

In large part our political history is but the reflection of the
economic motives and economic changes in the national life. Thus
the American Revolution arose out of resistance to England's trade
regulations, commercial restrictions, and attempted taxation of the
colonies. The War of 1812 was brought on by interference with American
commerce on the high seas. The Mexican War was the result of the
colonization of Texan territory by American settlers and the desire
of powerful interests to extend the area of land open to slavery. The
Civil War arose more immediately out of a difference of opinion as to
the rights of states to be supreme in certain fields of legislation,
but back of this political issue was the economic problem of
slave labor. Illustrations of this kind, which may be indefinitely
multiplied, do not prove that the material, economic changes are the
cause of all other changes, political, scientific, and ethical; for in
many cases the economic changes themselves appear to be the results
of changes of the other kinds. There is a constant action and reaction
between economic forces and other forces and interests in human
society, and the needs of economic adjustment are constantly changing
in nature.

§ 3. #Present-day problems: main subjects#. The particular economic
problems in America at this time are determined by the whole complex
economic and social situation. Two main factors in this may be
distinguished: the objective and the subjective, or the material
environment and the population composing the nation. The one is what
we have, the other is what we are, as a people. These factors are
closely related; for what we are as a people (our tastes, interests,
capacities, achievements) depends largely on what we have, and what we
have (our wealth and incomes) depends largely on what we are. We may
consider the following phases; the first two of the objective factor,
and the last two of the subjective factor.

(a) The basic material resources, consisting of the materials of the
earth's surface and the natural climatic conditions which together
provide the physical conditions necessary for human existence, and
which furnish the stuff out of which men can create new forms of
wealth.

(b) The industrial equipment, consisting of all those artificial
adaptations and improvements of the original resources by which men
fit nature better to do their will. These two (a and b) become
more and more difficult to distinguish in settled and civilized
communities, and become blended into one mass of valuable objects, the
wealth of the nation.

(c) The social system under which men live together, make use of
wealth and of their own services, and exchange economic goods.

(d) The people, considered with reference to their number, race,
intelligence, education, and moral, political, and economic capacity.

The particular economic problems which are presented to each
generation of our people are the resultant of all these factors taken
together. A change in any one of them alters to some extent the
nature of the problem. The problems change, for example, (a) with the
discovery or the exhaustion (or the increase or decrease) of any
kind of basic material resources; (b) with the multiplication or
the improvement of tools and machinery or the invention of better
industrial equipment; (c) with changes in the ideals, education, and
capacities of any portion of the people whether or not due to changes
in the race composition of the population; (d) with the increase or
decrease of the total number of people, and the consequent shift in
the relation of population to resources. Many examples of such changes
may be found in American history, and some knowledge of them is
necessary for an appreciation of the genesis and true relation of our
present-day problems.

§ 4. #Attempts to summarize the nation's wealth.# If we seek to
compare the material resources of the nation at one period in our
history with those at another period, we find that it is impossible
to find a single satisfactory expression for them. Let us examine
the figures for the (so-called) "wealth of the people of the United
States",[1] as it has been calculated by the census officials.

                                              Average
                                total       per capita
          Population.         "wealth."       wealth.

  1850    23,200,000     $7,136,000,000[a]     $308
  1860    31,400,000     16,160,000,000[a]      514
  1870    38,600,000     24,055,000,000[a b]    624
  1880    50,200,000     43,642,000,000         870
  1890    62,900,000     65,037,000,000       1,036
  1900    76,000,000     88,517,000,000       1,165
  1904    82,500,000    107,104,000,000       1,318
  1912    95,400,000    187,739,000,000       1,965

  [Footnote a: Taxable only; all other figures include exempt.]

  [Footnote b: Estimated on a gold basis.]

A detailed comparison of the classes of concrete things making up the
totals is possible only in the last three sets of figures (1900 to
1912), and they are here given (omitting 000,000).

                                     1900.  1904.   1912.
  1. Real property (excepting
  some items below)                52,538  62,331  110,700
  2. Irrigation enterprises            [a]     [a]     360
  3. Agricultural equipment
  (livestock, tools, etc.)          3,822   4,919    7,706
  4. Manufacturing equipment        2,541   3,298    6,069
  5. Transportation agencies       11,249  14,434   22,360
  6. Telegraph and telephones         612     813    1,304
  7. Waterworks (privately owned)     263     275      290
  8. Electric lighting plants         403     563    2,099
  9. Products (still in trade)[b]   8,294  10,212   21,577
  10. Direct goods in use[c]        6,880   8,250   12,758
  11. Gold and silver               1,677   1,999    2,617

  [Footnote a: No figures for these years.]

  [Footnote b: The main items are agricultural and mining products and
  imported merchandise.]

  [Footnote c: The main items are clothing, personal adornment, furniture,
  and carriages.]

§ 5. #Average wealth and the problem of distribution#. The foregoing
figures make a most satisfactory showing, and appear to indicate
that mere economic problems are rapidly being solved by the growth
of national wealth. But unfortunately these figures have little
significance in connection with such an inquiry, if indeed they are
not badly misleading.

In the first place, the final figures of "per capita wealth" are
merely averages; a per capita increase, therefore, may appear when
total wealth increases, altho the total may be due to the growth of
comparatively few very large fortunes. The fact is evident that vast
numbers of individuals and families are nearly propertyless and in
so far as this is true there is involved one of the greatest of our
socio-economic problems, that of the distribution of wealth and income
among the people. The more unequal the distribution, the greater, in
all likelihood, is the discontent; and the greater the effort of many
men to find some methods by which greater equality may be attained.

§ 6. #Changes in the price-standard#. These figures, moreover, are
expressed in terms of the monetary price-unit, in dollars of the
gold standard, and therefore the increasing total figure (and
correspondingly, the increasing per capita) may be but the reflection
of a change in the value of the monetary unit. It is well known that
the gold dollar has now less purchasing power than in 1880, and less
also than at any intervening time.[2] To the extent that this is true
the increase in the figures of wealth (total and per capita) is only
nominal and does not indicate increase in the quantity and betterment
in the quality of real wealth. This fact is so evident that it would
seem unnecessary to call attention to it, if it were not constantly
overlooked in citing these figures.

§ 7. #A sum of capital, not of wealth#. Consider further, that the
figures here given for wealth really express but the sum of capitals
of the individuals (or private corporations) of the nation. These
do not constitute a sum of social wealth in any proper sense of the
term.[3] Arithmetically it is a fallacious kind of a total, for the
sum of the individual capitals contains some items that should
be canceled to find the sum of wealth. Moreover, capital is an
acquisitive concept. It is an expression of the value of a man's
possessions, and not of the utility[4] of them. It measures intensity
of desire for goods and not necessarily the degree of welfare. Such a
total, therefore, embodies the difficulties of the paradox of value;
in some cases increased value reflects a growing scarcity and not
greater abundance.[5]

For example, between 1900 and 1915, with the growth of population, the
total number of improved acres in farms in the United States increased
but little, and the per capita number diminished. At least in part
as a result of this fact, the prices of nearly all kinds of food rose
rapidly, as did also the price of farm land. The prices (and estimated
values) of farm lands are the expression of the individual capitals,
which formed each year an increasing statistical total of so-called
wealth. The people had less land per capita, and were poorer per
capita as respects this item of landed-wealth, had less meat per
capita, and had to give more labor in exchange for food, at the same
time that the statistical per capita of land values increased.

So it may be as respects forests, coal, cotton, and eventually iron,
copper, and many other things. When forests were plentiful, lumber and
fire wood were free goods in many neighborhoods. Forests entered into
the total of national "wealth" in 1850 and 1860 at a comparatively
small sum. But in 1910 when the forests had been half used up they
appeared as a greater total and probably as a greater per capita
item of "wealth" than in 1850. The figures reflect changes in the
paradoxical section of the scale of values, and express scarcity
rather than wealth.

Altho the wealth of a nation may not be expressed as a single sum of
values that accurately reflects the weal-bringing things composing its
environment, some conception of the situation is to be gained by an
enumeration of goods in their kinds and quantities and by studying
their relations to the life of the people. Objects of wealth may be
grouped in various ways. The following may serve our purpose of a
general survey of our present resources.

§ 8. #Sources of food supply#. The land area of the country in 1910
was about 1,900,000,000 acres, of which 879,000,000 acres were in
farms, this being 46 per cent of the total area. A very small part
of the remainder is used for residential and commercial purposes,
the rest being barren mountains, deserts, swamps, and forests. Of the
total in farms a little more than one-half was improved, 478,000,000
acres altogether, a per capita average of 5.2 acres; and a little
less than one-half was unimproved, 400,000,000 acres altogether, a
per capita average of 4.3 acres. The improved land produced not merely
food but many kinds of materials, such as cotton, wool, hides,
and lumber, while much of the unimproved land was either in farm
wood-lots, or in rough range pasture. Of course the kinds and amounts
of produce per acre vary with the climate, particularly with sunshine
and rainfall; possibly the proportion of the area of the United States
that is true desert and infertile mountain land is greater than that
of any other equal area in the temperate zones. The actual productive
capacity per acre of the lands of America cannot be expressed in a
very helpful way as a general average per acre, but each area must be
carefully studied in respect to its climate, rainfall, and possibility
of irrigation and drainage. It is evident that a very large number of
economic problems must arise in connection with the land supply
for food: such as problems of land-ownership, taxation, irrigation,
drainage, forestry, and encouragement or limitation of population. We
are just beginning to awaken to the needs in this direction.

The rivers, lakes, and ocean waters near our coasts are other great
sources of food, but no statistics are available to show adequately
their yield. Few of them are in private possession and they do not
appear at all in a total of "capitals," yet they are more important to
the nation than a large part of the land area. They are only beginning
to be developed artificially by the propagation of oysters, clams, and
fish. The development of a proper policy in this matter is one of our
economic problems.

There were in 1910 (mostly on farms) about 64,000,000 beef and dairy
cattle, 60,000,000 swine, 56,000,000 sheep and goats, and there were
raised in the one year nearly 500,000,000 fowls of all kinds.

§ 9. #The sources of heat, light, and power#. The law of the
conservation of energy expresses the fundamental likeness of heat,
light, and power. The principal sources from which man derives these
agencies are coal and falling waters, tho wood is of importance as
fuel in some localities. About 500,000 square miles of land (about 13
per cent of the area of the country) are underlaid with coal. These
deposits are widely distributed, so that nearly every part of the
country is within 500 miles of a mine. The enormous deposits if used
at the present amounts per year would last probably 2,000 to 4,000
years, but if used at the present increasing rate (doubling the
product every ten years) they would, it has been estimated, last but
150 years. What shall be the actual rate as between these extremes
is a question whose answer depends on our economic legislation as
to ownership, exploitation, prices, use, and substitution. This is
another of our important socio-economic problems.

The one great available substitute for coal as a source of heat and
light and power is water power. It is estimated that in 1908 but
5,400,000 horse power was being developed from water falls, whereas
about 37,000,000 primary horse power[6] was available; but, by
the storage of flood waters so as to equalize the flow, at least
100,000,000 horse power, and possibly double that amount, could be
developed. As it requires ten tons of coal to develop one horse power
a year in a steam engine by present methods, there is here a potential
substitute for coal equal to two to four times our present annual use
of coal (about 500,000,000 tons in 1912).

But this does not mean that it would be economical, at present costs
of mining coal and of building reservoirs, to make this substitution
now. To determine when, how far, and by what methods to develop this
water power from lakes and rivers for the use of the people and to
make this substitution, is another of our great economic problems.

Petroleum and natural gas, of which our original reservoirs were
perhaps the richest in the world, are being rapidly exhausted. These
may be merely mentioned as being related to coal in the source
of their supply, in the nature of their uses, and in the economic
problems to which they give rise.

§ 10. #Transportation agencies#. First to mention among the means of
transportation are the navigable waters--oceans, lakes, rivers, and
canals, with the necessary equipment of dredged inlets, harbors,
docks, locks, and lighthouses. Few of these appear in the total of
"capitals," for they are not in private possession. Yet a good system
of natural waterways may be greater wealth to one nation than costly
additional railroads are to another. Good natural harbors on the
waterways leading out to the oceans are a most important kind
of national wealth, as are the navigable great lakes within the
boundaries or on the borders of a country. Just in proportion as these
natural means of transportation are lacking, is the need to build
costly artificial means of transportation.

Both in natural and in artificial means of transportation, America
is well provided. The straight coast line is 5700 miles long, and the
line following indentations of the coast is about 64,000 miles. The
Great Lakes with a straight shore line of 2760 miles are the most
important inland waterways in the world. The 295 navigable rivers in
the country have a length of 26,400 miles of navigable water. About
2000 miles of canals are still in operation. On the waterways some
27,000 American vessels are in use, with a capacity of 8,000,000 gross
tons.[7]

There are about 250,000 route miles of steam railroads, or with
additional tracks, yard tracks, and sidings, a total of about 370,000
miles. On these are over 63,000 locomotives, 52,000 passenger cars,
and 2,400,000 freight and company cars. Besides these are 45,000 track
miles of electric railways and nearly 100,000 cars. These railroads
include an enormous aggregate of works and structures in the form of
tunnels, cuts, banks, bridges, stations, and shops.

There are in the country (1914) about 2,228,000 miles of public
roads, of which 10 per cent are "surfaced" roads. No figures are now
available of the number of wagons, horses, automobiles, and
other vehicles in use on the roads and streets for purposes of
transportation.

Many of our economic problems are presented by these transportation
agencies, from the question of opening a new dirt road in a rural
township to that of building an inter-oceanic canal, from the question
whether to have free public roads or toll roads to that of regulating
the railroad rates on the whole railroad system of the country.

§ 11. #Raw materials for clothing, shelter, machinery, etc.# The farm
lands supply, besides food, a large part of the raw materials for many
other goods, such materials as cotton, flax, wool, hides, feathers,
lumber, and firewood. The farm woodlots compose about 200,000,000
acres, and the large forests, public and private, about 350,000,000
acres, a total of about one-fourth the area of the country in
forests, containing about one-half of the lumber that the country once
possessed. The economic problem of a sound forestry policy is one of
the largest we have to solve.

The most important other sources of raw materials for industry are
the mineral deposits in the earth's surface.[8] This country is stored
more bountifully, probably, than is any other country, with the metal
ores of iron, copper, lead, zinc, gold, and silver. Aluminum is the
most abundant metal, composing about 8 per cent of the crust of the
earth, but by present methods it can be extracted only at considerable
cost from certain compounds that are limited in amount. The details as
to our metal stores are too complex for fuller treatment here, and may
be found in treatises on economic geology or on industrial geography.
The determination of wise policies as to the use of these stores
involves many economic problems, private and public.

Another great class of material wealth is in the form of tools,
machinery, and other agencies for carrying on the industrial
processes of farming and of manufacturing. These are sometimes called
instrumental goods, or the industrial equipment. Still another class
consists of the great mass of completed direct goods, such as houses
to live in, libraries, museums, school buildings, theaters, all kinds
of buildings and equipment for pleasure and entertainment, parks, and
pleasure resorts in mountains, at lakes or sea shore. The possession
and use of these forms of wealth give rise to some economic problems
of public ownership and to others connected with the institution of
private property in general, as sketched in the following chapter.


[Footnote 1: It is to be observed that these figures appear under
the general title of Part I, "Estimated valuation of national wealth:
1850-1912," and the tables are spoken of (volume on Wealth, Debt, and
Taxation, p. 20) as "estimates of the aggregate wealth of the nation
as prepared by the United States censuses," but the tables themselves
are described (pp. 23-25) as the "estimated true valuation of all
property," this phrase being used as equivalent to "wealth." For the
definitions of wealth and property see Vol. I, pp. 264-265.]

[Footnote 2: This change will be described below in ch. 6, in treating
of the standard of deferred payments.]

[Footnote 3: See Vol. I, pp. 265, 278, 508 for the distinction between
wealth and capital.]

[Footnote 4: See Vol. I, p. 25, for the definition of utility.]

[Footnote 5: See Vol. I, p. 510 on the paradox of value.]

[Footnote 6: That is, "the amount which can be developed upon the
basis of the flowage of the streams for a period of two weeks in which
the flow is the least," all the rest being allowed to escape unused.
Van Hise, "Conservation of Natural Resources," p. 119.]

[Footnote 7: These and other figures in this section relate to the
year 1913.]

[Footnote 8: Coal has been mentioned above, sec. 9.]




CHAPTER 2

THE PRESENT ECONOMIC SYSTEM

  § 1. The place of private property. § 2. Nature of property. § 3.
  Relation of wealth, property, and capital. § 4. Some theories of
  private property. § 5. Origin vs. justification. § 6. Limitations of
  private property. § 7. Limitations of bequest and inheritance. § 8.
  Social expediency of private property. § 9. The monetary economy.
  § 10. The competitive system. § 11. Limitation of competition by
  custom. § 12. Effect of modern forces upon custom. § 13. Adam
  Smith's influence. § 14. The wage-system.


§ 1. #The place of private property#. Of fully equal importance with
material wealth in determining the economic power of a people is the
_social system_ under which the nation lives. This is the term applied
to the whole complex of institutions and arrangements in which and
by which people live together in society. It is the embodiment of the
opinions, ideas, and habits of life inherited by each generation from
its forbears. It is, indeed, a people's whole state of civilization
with its political, economic, intellectual, scientific, religious, and
esthetic aspects.

The most important economic aspect of the existing system is, broadly
speaking, the institution of private property. So closely connected
with this that they are hardly more than different phases of the same
thing, are the use of money (the monetary economy), the wage system,
and competition as a mode of distribution. "The institution of private
property" is the general expression for the way in which men in the
modern state make use of their own energies and of material wealth
within the nation. Nearly all the total of the things mentioned in the
table in Chapter 2, section 4, are owned by private citizens.[1] We
live in a régime of private property, and all our economic problems
are affected by that fact. The determination of the exact boundaries
of private property makes up a large part of the politico-economic
problems which the people in each generation have to solve. A large
share, possibly, in a certain sense, every one of the economic
problems that are discussed involve change, limitation, definition,
or, more radically, abolition of present laws of property. Broadly
understood, as above, therefore, determination of the nature of
private property is _the essential_ economic problem.

§ 2. #Nature of property#. Property means ownership, and "ownership"
is the abstract noun expressing the quality of possessing a
thing. Correspondingly, "owner" is the Anglo-Saxon equivalent of
"proprietor." Property thus, fundamentally, means not an object held,
or possessed, but the right in or belonging to a person to control
something that he owns. Ownership is a legal right to control under
certain conditions.[2] Physical, possession of an object is not
necessarily ownership.

There are different kinds of ownership. It may be private, as that
of individuals, families, partnerships, or corporations; or it may be
public, as that of nations, states, counties, cities and towns, owning
such things as public buildings, parks, highways, the Adirondack
forest-reserve, or the Erie Canal. These two kinds are equally
effective as against the claims of outsiders, but the rights of those
inside the circle of ownership differ. For example, the rights of one
shareholder against another, or the rights of one member of a family
as against another, are not the same as the rights against outsiders.
Private property is the characteristic feature of our present
industrial society, but it exists side by side with public property
and with many intermediate grades between private and common property.

Tho property meant originally and essentially the intangible right to
a thing, the word came to be applied also to the object of the right.
This is done both in common speech and in judicial decisions, with
inevitable ambiguity. This may be readily seen by trying to substitute
the word ownership for property, a thing quite simple in some cases
but impossible in others. One would not point to a house and say,
"This is my ownership," but either, "This is my property," or "I
exercise ownership over it." It is well recognized that a man may have
a property right in this abstract sense in or over his own services,
as to practise a trade or in the "good will" of a business or in
an intangible patent or a copyright, quite as well as in a material
object.

§ 3. #Relation of wealth, property, and capital#. A failure to see
this distinction and to keep it clearly in mind has led to confusion,
even on the part of legislatures, learned judges, and able economists.
If property is said to be (for example) a house and lot and at
the same time the right to that house and lot, then there are two
properties at once for each economic good, viz.: the object itself and
the right to it.[3]

This difficulty could be avoided by the consistent definition and use
of terms. A material economic object is a good, is a form of wealth.
The usance of wealth and the service of laborers at the moment
rendered constitute forms of income. The right of ownership, i.e., the
right to control, use, or direct the use of wealth and services, is
property, which is therefore the right to receive incomes. The value
of the incomes of an individual constitute his capital. Goods, rights
to goods, value of rights to goods: these three things are clearly
distinguishable.

§ 4. #Some theories of private property#. Various theories have been
framed to explain the origin and to justify the existence of private
property. The occupation theory is that property is based upon
the priority of claim of one who finds wealth without an owner and
appropriates it. This is not an explanation of the property rights
that are arising every moment, nor does it give a logical reason for
the continuance of ancient property rights. It is a statement applying
to a case that has rarely happened, the settlement of an unoccupied
territory.

More adequate to explain many cases is the conquest theory, that
property is based on force; for nearly all lands to-day are occupied
by the descendants of conquering invaders who took the lands and
natural resources from the former inhabitants, who in turn had taken
them from other occupants, many centuries before. The conquest theory
applies, for example, to the invasion of the Roman provinces by
barbarian tribes who divided the country and developed the feudal
system based on land tenure. But it hardly applies to present-day
happenings, and at its best it cannot, to modern minds, "justify"
present property rights.

The labor theory, meeting some queries where others fail, is that
ownership is based on the act of production. It is declared that
every man has a right to that to which his brain and his muscle
have imparted value. It is evident that this test leaves without
explanation or justification a great number of things that do exist
and have existed as property. Usually the basis of the labor theory
of property is declared to be each individual's natural right to the
results of his own labor, which claim is assumed to be an ultimate,
undebatable, axiomatic fact. However, that type of natural-right
doctrine, which makes no appeal to experience and results, is now
quite discredited in political science.

Another form of natural-rights theory is that property is necessary
for the realization of the dignity of human nature and every
individual has the natural right to self-realization. This theory
is, in a way, based on an appeal to experience, as to the effect of
property on human character, and it has the virtue of expressing one
of the ideals of modern democracy. Altho, in common with various other
"natural-rights" theories, it must be deemed too absolute and too
individualistic, it contains a far-reaching truth, of which due
account must be taken in our social philosophy.

The legal theory is that property exists because the law says it
shall. This expresses a truth, but is no more than a truism. The law
determines the limits of property, but what determines the limits of
the law? What practical or social justification is there for passing
and continuing such law? The legal theory does not contain a final
explanation. Each of these theories has its defects, but each points
to some fact important and significant, at certain times and places,
in the explanation of this widespread institution.

§ 5. #Origin vs. justification#. The question of the origin is not the
same as that of the present justification of the existing system of
private property. The institution of private property has evolved
under diverse conditions. In early societies individual property
rights were not very clearly marked. Every tribe asserted against
other tribes, and tried to uphold by war, its claims upon its
customary hunting grounds; but the claims of the individual hunters
on land within the tribe did not often come into conflict. Private
property at the outset was in personal possessions, ornaments,
weapons, utensils, which were very meager in that primitive society
in which it was the custom "to go calling with a club instead of a
card-case." Only later came individual property in land. A few years
ago it was generally believed that the organization of the old German
tribes was politically an almost perfect democracy, and economically
a communism in which all had equal claims upon the land. To-day this
opinion is very seriously questioned. It seems probable that there was
a goodly measure of communism in the control and use of lands (tho not
in other things), but this was largely confined to an oligarchy of the
favored; whereas the masses lived in subjection, cut off from all but
a meager share in the common lands. However that may have been, strong
forces within historic times have put an end to the common ownership
and tillage of land as it existed among the peasants of Europe. That
system was shown by experience to be wasteful. Competition tended to
bring the economic agents into more efficient hands, and the movement
was furthered by many acts of injustice and violence on the part of
those in power.

Inquiries into the origin and development of any social institution
are interesting and helpful in forming an estimate of its present
significance, but the problems of the past are not those of to-day.
Whether or not the ancient beginning of property in Europe was in
violence and evil has but a remote bearing on the question as to the
present working of it. Social conditions and needs have not changed
more than have the forms and limits of property itself. Each
generation has its own problems to solve, and ignoring for the most
part the evils of the distant past, each generation must test existing
institutions by their present results.

§ 6. #Limitations of private property#. It is well, in discussing
private property, to rid the mind at once of the idea that it is an
absolute and unchanging thing. Few realize the manifold ways in which
property rights are limited. Unmodified private control of property is
unknown; the public makes many reservations in its own interest. There
is, first, a whole set of limitations to prevent nuisances. An owner
in many situations is not free to build a slaughter-house or to start
a glue-factory on his land. Property is governed by general public
utility, and anything that threatens to become a nuisance or a danger
may be excluded. Under the right of "eminent domain," the state or the
railroad takes the old homestead from the owner who would live and die
there.

Altho pecuniary damages are paid to him, this is a limitation of his
property rights. Rights of way on property exist either by contract
or by prescription permitting its public use. Most important of all
limitations is the right of taxation, by which society takes more or
less of private incomes for purposes of which the individual owners
may not approve.

The law enforces a multitude of private claims by some persons against
others. A variety of rights called easements or servitudes may attach
to private property, modifying its exclusive use. Leases for any
period are a limitation of the owner's control. Both the holder of
the lease and the owner of the property have certain rights before the
law. The lender of money secured by mortgage has a legally recognized
and enforceable interest in the mortgaged wealth. Property is left in
trust for the benefit of persons or of institutions or of the public,
and is administered by trustees who are strictly bound to execute the
terms of their instructions. Contracts of many sorts are entered
into by owners, limiting their control in manifold ways, and the
law enforces these contracts. These all form a complex of equitable
claims, which together equal in value one undivided property right,
which in turn equals the value of the wealth.[4]

§ 7. #Limitations of bequest and inheritance#. The term bequest
implies a will, usually a written will in which the person, in
anticipation of death, expresses his wishes as to the disposition of
his property. It is said sometimes that bequest is a "logical" result
of private property, but the law does not treat it as such. The
right of bequest, or of gift at death, is limited in various ways
in different countries. In countries where hereditary aristocracies
exist, primogeniture is in some cases required by law, in others
so strongly favored by public opinion that it is practically always
followed. Custom limits bequests in England to members of the family,
and wills given outside the family are rare, and are almost always
broken in the courts. John Stuart Mill contrasted this with the
practice in America, frequent even in his day and still more frequent
now, of rich men giving for public purposes. In France the right of
bequest outside the family is legally limited; only the share of one
child can be willed away by the father, and the rest must be equally
divided among the children. Settlements and _fidei commissa_ are
limited in many countries, because of the recognized social evils
resulting from the tying up of estates for generations. Throughout the
history of England, Parliament has given attention to the question of
mortmain, which chiefly concerned the drifting of great estates into
the hands of the church or of corporations, as the result of bequests
by the pious. In England, of late (and to a less extent in this
country), the policy of permitting unlimited endowments to charitable
institutions has been seriously questioned, and by legislation some
of the old endowments have been diverted from their original purposes
when these have ceased to be of social utility. Inheritance, in
contrast with bequest, usually means succession to the property of
one who has died intestate, that is, has made no will. The law of
inheritance likewise varies greatly with time and place.

§ 8. #Social expediency of private property#. In the light of present
political philosophy the explanation and justification of private
property must be on grounds of social expediency. This is a broad
explanation and it has the fault of a broad explanation, that it needs
to be further explained. Under it can be brought the many varying
conditions. Even if private property works hardship to individuals in
many cases, yet it may be justified if, on the whole, it is best for
the progress of society. Laws must be judged by their average working,
not by exceptional cases. In general, the system of private property
must be judged by this test: Does it further the welfare of the nation
better than would any alternative plan for the control of economic
wealth? The question is not whether it is faultless, for no human
institution is so. Nor must it be assumed that the rule of property
needs to be uniform in respect to all kinds of wealth. There are
many kinds of property, and the test may be applied separately to the
different forms and to the varying degrees of property rights. The
varied and often strict limitations of property mentioned above are
all determined by some thought, wise or foolish, of social expediency.
Different parts of wealth may be treated in different ways: there may
be private property in wagons, and public property in roads; private
property in houses, and public property in forests; private property
in automobiles, and public property in railway carriages. But any rule
of property, like any other workable human law, must be applicable to
all individuals that meet the conditions.

The very acceptance of the theory of social expediency implies the
need of frequent readjustment of the institution of private property.
The essential thought in the various attacks on the institution of
property is that, because it either causes or makes possible the
inequality of incomes, it is not socially expedient. Private property,
as it is found to-day, is complicated by many historical accidents.
Survivals of ancient injustice and relics of feudal institutions that
rest on no vital reason remain in our new country as well as in the
older ones. The limits of property in many respects are determined not
according to the logic of expediency, but by the social inertia which
often governs successive generations.

The question is raised in many minds: If private property is not an
absolute right, what shall be its limits? What changes should be made
in it? These questions put the greatest economico-political problem of
our day, one that contains within it, indeed, many minor problems. A
number of these will receive attention in the following pages.

§ 9. #The monetary economy#. So greatly does the use of money
facilitate the transfer, buying, and selling of private property and
so closely are property and pecuniary trade connected in practice and
in the thoughts of men, that every radical proposal to abolish private
property has included a plan to do away with money also. But money and
private property are not essentially and logically bound up together,
for a certain measure of private property always has been found where
money was little or not at all used. True, if there were absolutely no
private property, there would be little use for money, altho it might
still be used as a form of counter by the communistic state. We have
already seen[5] how a monetary unit comes into use, and we shall treat
more fully of the nature of money in later chapters. We may note here
merely that the use of money is an outstanding feature of the present
economic system and gives rise to many of the problems of political
economy.

§ 10. #The competitive system#. The existing system is likewise
characterized by competition[6] in the buying and selling of wealth
and of the usances and services of economic agents. By competition we
mean here the condition of political freedom on the part of each man
to trade his property (goods, uses, or services) as he chooses, and
this combined with the disposition on his part to get what he
values most highly for himself and his family. Whenever any one else
(official or citizen) forbids and prevents a man from getting all he
can, in so far competition is limited. Whenever any one is deterred by
fear of, or by affection for, some other trader, from getting all he
can, in so far competition is limited. Whenever any one conspires with
another trader to act together with him to withdraw or to alter his
bid, in so far competition is limited. Private property and economic
competition do not merely happen to exist side by side, forming more
or less favored conditions each for the other; they are essentially
connected.[7]

It is not our task at this point to present the advantages and
disadvantages of competition, but merely to indicate its important
place in the actual economic world. Like private property, competition
is not the universal feature of our present system, but it is the most
general and characteristic method of valuation, of price fixing, and
of trade.

§ 11. #Limitation of competition by custom.#[8] The relatively large
influence of competition in present society appears more plainly in
comparing the present system with that of an earlier state of society
or with that of a present savage tribe. A member of the lowest human
societies is subject to law; tho he is a savage he is not "untutored."
On the contrary he is bound in many ways to follow customary lines
of conduct, and a large part of his time is given to learning the
traditions and then to observing the ceremonials of the tribe.
Primitive customs always take on a religious sanction, and every
member of the tribe is piously bound to do as his fathers have done
and as his neighbors are doing. This limitation applies to the choice
of food to eat, clothes to wear, time to hunt, plant, and harvest,
weapons and tools to use, where and how to trade, how much to give or
take, and to countless other details of economic choice. So, in early
society, economic relations were complex and but slowly changing from
generation to generation. Custom, rather than competition, ruled in
manifold ways the economic actions of men.

Custom continued to rule a large share of the individual life of the
peoples of northern Europe through barbarian and feudal times. Its
force has gradually decreased, but even yet is not entirely set aside.
Political and economic interests were not clearly distinct in the
Middle Ages. Land was the all-important kind of wealth. Military
and other public services were performed by the higher landlords (as
vassals of their overlords) who in this way paid at the same time what
we to-day would call rent and taxes. The landlord in turn received
from his underlings services and goods in kind (food and supplies) and
so (in modern eyes) was both a collector of taxes and a receiver of
rent. The rent, however, was not a competitive price, but consisted
of the dues and services which the forefathers had been accustomed to
pay. In many ways also in the towns, close organizations of craftsmen
and of merchants regulated prices and kept others out of their
industries. Industrial privilege pervaded the life of that time.

Yet through all the Middle Ages ran the forces of competition. The
inefficiency of customary services and the high prices charged
by selfish privilege were constant invitations to men to become
competitors. Men strove to break over the barriers of custom and of
prejudice. Their efforts to attain freedom to compete was the vital
force of the time. The industrial history of the Middle Ages was
largely the story of the struggle of the forces of competition against
the bonds of custom and privilege.

§ 12. #Effect of modern forces upon custom#. The industrial events
following the discovery of America strengthened the forces making for
economic freedom. Discoveries in the Western hemisphere opened up a
wide field for the adventure and enterprise of Europe. Commerce is the
strongest enemy of custom, and new opportunities gave a rude shock to
the conservatism both of the manor and of the village. With the rapid
growth of industry and manufactures, old methods broke down. In an
open market custom declines; it flourishes best in sheltered places.
Further, the movement of thought in the Reformation, and the spirit
of the times which expressed the principle of personal liberty
and allowed the individual to follow his own opinions and take the
consequences, were favorable to competition. Despite these facts, the
restraints of the national governments on trade continued great,
in some respects increasing during the seventeenth and eighteenth
centuries, in France, Holland, and England. The regulation before
attempted by towns and villages was employed on a larger scale by
national governments with their industrial systems. The colonies in
America were used for the economic ends of the "mother country"
and for the selfish interests of the home merchants in Europe. The
American Revolution was one of the bitter fruits of the English policy
of trade restriction.

§ 13. #Adam Smith's influence#. "The Wealth of Nations," the first
great work on political economy, was published in the year 1776. That
was the "psychological moment" for its appearance, as public thought
was so prepared for it that it had its maximum possible influence.
The year of the American Declaration of Independence gave the most
striking object lesson on the evils of a selfish colonial policy that
interfered on a grand scale with economic freedom. The old customs had
become ill fitted to life, ill adapted to the rapid industrial changes
that were going on. What was needed in many directions, both
in politics and in industry, was merely negative action by the
government, the repeal of the old laws, the overthrow of old abuses.
The French Revolution, following a few years later, emphasized this
thought in the political field. The philosophers of the time believed
in a "natural law" in industry and politics. The reformers of the
time wished to throw off the trammels of the past and to give men
opportunity to exert themselves "naturally." In America the old abuses
never had taken deep root, as the conditions of a new continent were
not favorable to monopoly and privilege. Altho the movement for the
repeal of medieval laws has continued in Europe from 1776 till the
present time, yet custom still is stronger to-day in Europe than
in America. Serfdom was not abolished until the first half of the
nineteenth century in Austria and southeastern Europe, and not until
the last half in Russia. Many economic and cultured forces furthered
this movement, but the most powerful intellectual force in its favor
was the work of Adam Smith. So strong an impression did Smith's book
make, that in the minds of men "free trade" became almost identical
in thought with political economy, whereas that was but the temporary
economic problem of the eighteenth century.

Many men then thought that in "free and unlimited competition" had
been found a solution of all economic problems for all time. But soon,
it was apparent that it was no such simple and absolute solution.
Indeed many of the present economic problems--in one sense all of
them--center around this one: to determine the proper forms and limits
of competition. The varied aspects that this problem takes will appear
in every portion of the following pages.

§ 14. #The wage-system.# Viewed in another aspect the present economic
and social order is called the wage-system.[9] The wage-contract, like
the use of money, is not essential to the existence of a system of
private property. Communities such as the American colonies and as
many of the newly settled states, may consist almost entirely of
self-employed owners of land. Bulgaria, before the Balkan wars called
the peasant state, presented this organization (tho of course with
some wage-payment), as did also its neighbor Serbia. But given the
institution of private property with competition (freedom to buy
and sell), let manufactures and commerce develop to any extent,
and inequalities of fortunes increase while an increasing number of
persons work for wages. It is noteworthy that as this goes on (as
it has done in America at an increasing rate since the middle of the
nineteenth century) it is the agricultural and rural hand industries
that continue to be mainly worked by owner-managers and workers,
while it is the manufacturing, transporting, and large commercial
enterprises in which the labor is done for wages. The acceptance of
the wage-system thus far has been the inevitable price to be paid
for manufacturing and industrial development; and one of our economic
problems is to determine whether this must continue, and if so,
whether in the same measure as in the past.


[Footnote 1: The exceptions are probably unstated amounts of exempt
real estate (owned by municipalities, state, and nation), some of the
irrigation plants, part of the canals, and that part of the gold and
silver which is in the public treasury.]

[Footnote 2: See Vol. I, pp. 264-267. The law makes between property
rights and equitable rights some subtle distinctions, which have their
reason in the history, if not in the logic, of the law but which are
not essential to economic discussion. In some states this distinction
has been in large measure abolished. What interests us are the rights
(claims) that men have to the control of wealth and services, whether
by technical law these are called legal or equitable, and this right
is what is meant by "property" in our discussion of it.]

[Footnote: 3 This confusion has had important practical consequences
in the field of taxation. See Vol. I, pp. 265-267, and below, ch. 17.]

[Footnote 4: These claims mutually delimit each other (whether they be
called equitable claims, or liens, or property rights), and wealth
is not multiplied by multiplying the claims, as is unfortunately
sometimes assumed to be the case. See above, sec. 3.]

[Footnote 5: See Vol. I, p. 51.]

[Footnote 6: See Vol. I, p. 73.]

[Footnote 7: This will appear in comparing the competitive method of
distribution with other methods in ch. 31.]

[Footnote 8: See Vol. I, p. 143, on medieval land tenures; p. 158, on
customary rents; p. 190, on the effect of caste.]

[Footnote 9: See Vol. I, p. 227.]




PART II


MONEY AND PRICES




CHAPTER 3

NATURE, USE, AND COINAGE OF MONEY

  § 1. Origin of money. § 2. Qualities of the original money-goods.
  § 3. Industrial changes and the forms of money. § 4. The precious
  metals as money. § 5. Gold-using countries. § 6. Varying extent of
  the use of money. § 7. Money defined and reviewed. § 8. Metal money
  without or with coinage. § 9. Technical features of coinage. § 10.
  Seigniorage defined.


§ 1. #Origin of money#. Everywhere in the world where the beginnings
of regular trade have appeared, some one of the articles of trade soon
has come to be taken by many traders who did not expect to keep or use
it themselves, but to pass it along in another trade.[1] This made it
money, for money is whatever comes to be used as a general price-good.
The character of a _general_ price good clearly distinguishes money
from goods bought and sold by a particular class of merchants, such
as grain, cattle, etc., to be sold again. It is only in so far as a
particular good comes to be taken by persons not specially dealing in
it, taken for the purpose of using it as a price-good to get something
else which they desire, that a thing has the character of money. The
thing called money thus is a durative good passing from hand to hand
in a community, and completing its use in turn to each possessor of it
only as he parts with it.

The use of money is of such social importance, that it would be
impossible for modern industrial society to exist without it. The
discussion of money touches many interests, it raises many questions
of a political and of an ethical nature. There are perhaps more
popular errors on this than on any other one subject in economics, but
the general principles of money are as fully understood and as firmly
established as are any parts of economics.

§ 2. #Qualities of the original money-good#. The selection of any
money-commodity has not been mere chance, but has been the result of
that object being better fitted than others to serve as a medium of
exchange. The main qualities that affected the selection of primitive
form of money were as follows: 1. Marketability (or saleability); that
is, it must be easy to sell. The first forms of money had to be things
which every one desired at some time and many people desired at any
time. That was the essential quality that made any one ready to take
it even when he did not wish to use it himself. Many kinds of food and
of clothing are very generally desired goods. But few of these classes
of goods have in a high measure certain other important qualities, now
to be named.

2. Transportability; that is, the money material must be easy to
carry, it must have a large value in small bulk and weight. To carry
a bag of wheat on one's back a few miles requires as great an effort
ordinarily as does the raising of the wheat, and the cost of carriage
for fifty miles even by wagon will often equal the whole value of the
wheat. Cattle, while not comparatively very valuable in proportion to
weight, and not possessing the other qualities of money in the highest
degree, have the advantage that they can be made to carry themselves
long distances, and therefore they have been much used as money in
simpler economic conditions.

3. Cognizability; that is, the money-good must be easy to know, and
to judge as to quality. If expert knowledge or special apparatus are
needed to test it in order to avoid counterfeits, few could be ready
to take it and trading would be a costly process.

4. Durability; that is, the money-good must be easy to keep without
much loss in amount or in quality, perhaps for long periods, until it
can be passed on in trade. Few kinds of food answer very well to this
last requirement, being organic and perishable. But all four qualities
above named were pretty well embodied in primitive times in rock salt,
in rare flints and bits of copper suitable for tools and weapons,
in furs in northern countries, and in many articles of personal
adornment, such as beads, feathers, jewels, and metal ornaments.

5. Divisibility; that is, the quality in the monetary material that
permits it to be divided easily into smaller amounts and then to be
united again into larger masses at little cost and without loss in
amount or in quality. This quality is present only when the material
is quite homogeneous throughout the whole mass, a condition fulfilled
more completely by the metals than by any other goods. This quality
makes it possible to put the governmental stamp upon the money
material, and to produce pieces, some of which are exact duplicates
and some exact multiples, of others. In this manner pieces of money
are provided suitable for transactions of different magnitudes, down
to small fractional amounts. A monetary system of this kind aids
greatly the development of the sense and habit of exact estimation of
price.

§ 3. #Industrial changes and the forms of money#. The money use, as
has just been shown, is a resultant of a number of different motives
in men. The changing material and industrial conditions of society
change the kind of money that is used. Things that have the highest
claim to fitness for money with a people at one stage of development
have a low claim at another. The final choice of the money-good
depends on the resultant of all the advantages. Shells are used for
ornament in poor communities but cease to be so used in a higher state
of advancement, and thus their saleability ceases. Furs cease to be
generally marketable in northern climes, when the fur-bearing animals
are nearly killed off and the fur trade declines. When tobacco was the
great staple of export from Virginia, everybody was willing to take
it, and its market price was known by all. It served well then as the
chief money, but, as it ceased to be the almost exclusive product
of the province, it lost the knowableness and marketability it had
before. In agricultural and pastoral communities where every one had
a share in the pasture, cattle were a fairly convenient form of money,
but in the city trade of to-day their use as money is impossible.
Thus, in a sense, different commodities compete, each trying to prove
its fitness to be a medium of trade; but only one, or two, or three at
the most, can at one time hold such a place.

While industrial changes and conditions affect the choice of money, in
turn money reacts upon the other industrial conditions. If a new and
more convenient material is found or the value of the money metal
changes to a degree that affects the generalness of its use, industry
is greatly affected. The discovery of mines in America brought into
Europe in the sixteenth century a great supply of the precious metals,
and this change in the use of money reacted powerfully upon industry.
Money, being itself one of the most important of the industrial
conditions, is affected by and in turn affects all others.

§ 4. #The precious metals as money#. Certain of the metals early began
to show their superior fitness to perform the monetary function. The
metals first used as money were copper, bronze (an alloy of copper
with nickel), and iron. These were truly precious metals in
early times for they were found only in small quantities in a few
localities. They, therefore, were widely sought and highly valued as
ornaments and for use as tools and weapons. But as the great ancient
nations emerged into history, these materials were already being
displaced in large measure. Their value fell greatly as a result of
greater production due to somewhat regular mining. As wealth grew, as
trade increased, as the use of money developed, as commerce extended
to more distant lands, the heavier, less precious metals failed
to serve the growing monetary need, especially in the larger
transactions. Silver and gold, step by step, often making little
progress in a century, became the staple and dominant forms of money
in the world, while copper and nickel still continued to be used for
the smaller monetary pieces. Every community has witnessed some stages
of this evolution. In this contest silver had proved itself a few
centuries ago to be on the whole the fittest medium of exchange for
most purposes, though gold was at the same time in use in larger
transactions and in international trade.

§ 5. #Gold-using countries#. At the beginning of the nineteenth
century nations were divided, in accordance with the metals they used
as standards, into two great groups, silver- and gold-using. Since
that time, and more rapidly after 1850, gold has displaced silver as
the standard money. In a higher degree than any other one material,
gold has the qualities of a good standard for rich and industrially
developed communities. England for a long period practically has had
gold as its standard money; the United States since 1834 (except for
the period of paper money from 1862 to 1879); France since about 1879,
having shifted gradually from silver, after 1855, under the working
of the bimetallic law; Germany since 1873; and Japan since the later
nineties. Other countries have been striving to attain it. Since
about 1890 some states (including Mexico) and some of the colonial
possessions of the great nations (including India and the Philippines)
have adopted the plan of "the gold-exchange standard." By this plan
gold is the standard price unit, while silver continues to be used
all but exclusively as the material in circulation, its amount being
controlled and its value regulated on principles to be explained below
under coinage, seigniorage, and foreign exchange. There are now left
but a few silver-standard countries, the most important being China.
There are, however, numerous countries, notably in South America and
Central America, which have fiduciary paper-money standards.[2]

§ 6.# Varying extent of the use of money#. Trade by the use of money
at no time has become the exclusive method. Barter still lingers
to-day.[3] The extent to which, on an average, money is used in
different parts of the world differs widely. The use of money in
Siberia is less than in European Russia, and its use is less there
than in western Europe. The use of money as compared with barter is
generally much greater in the cities than in the rural districts. In
the cities of Mexico not only money, but banks and credit agencies are
in general use; whereas the rural districts are more backward and make
far more use of barter than is the case in the United States. At the
ports in the cities of China, India, and South America the use of
money may be very like that in European cities; but go a little way
into the interior of these countries and conditions as to the use of
money change greatly.

However, the comparative per capita amounts of money (in terms of
American dollars) in circulation in different countries is far
from being a true index of their industrial development or of their
commercial activity. Indeed, beyond a certain point the larger average
amount of money in circulation in a country may indicate backwardness
in the development of banks and other credit agencies rather than
greater amount of wealth or of business. Notice, for example, the
medium position of the great commercial countries, Germany and the
United Kingdom, as compared with other countries above and below them
in the following list.

PER CAPITA CIRCULATION OF MONEY IN LEADING COUNTRIES DECEMBER 31,
1912.

  France..................$48.91  America (U.S.)..........$32.98

  Australia............... 38.45  Portugal................ 29.46

  Canada.................. 33.57  Netherlands............. 26.86

  Switzerland............. 24.32  Mexico..................  9.17

  Germany................. 21.36  Finland.................  8.38

  United Kingdom.......... 21.21  Chile...................  8.24

  Spain................... 19.96  Turkey..................  7.09

  Brazil.................. 18.79  Russia..................  6.45

  Denmark................. 17.73  Japan...................  5.68

  Belgium................. 15.83  Bulgaria................  5.57

  Austria-Hungary......... 14.68  Serbia..................  5.49

  Rumania................. 13.24  Venezuela...............  5.51

  Italy................... 13.09  India (British).........  5.19

  South Africa............ 12.93  Ecuador.................  4.62

  Norway.................. 12.50  Peru....................  3.17

  Sweden.................. 11.59  Colombia................  2.32

  Greece.................. 11.02  Paraguay................   .57

7. #Money defined and reviewed#. Money may be defined as a material
means of payment and medium of trade, generally accepted as the
price-good and passing from hand to hand. The definition contains
several ideas. The words "generally accepted" imply that money has a
peculiar social character, is not an ordinary good. As a price-good,
money itself must be a thing having value, otherwise it could not be
accepted. Trade means the taking and giving of things of value. Money
is, therefore, not merely an order for goods, as a card or paper
requesting payment; it is itself a thing of value (tho this value may
be due partly or solely to its possessing the money function). Such
things as a telegram when transferring an order for the payment of
money, as the spoken word, and as a mere promise to pay, are not
money. Even checks and drafts are merely substitutes for money. Money
passes from hand to hand, is a thing that can be handled, and is or
can be bodily transported.

The application of the definition is not always easy, for money shades
off into other things that serve the same purpose and are related in
nature. In many problems money appears to be at the same time like
and unlike other things of value, and just wherein lies the difference
often is difficult to determine. Even special students differ as to
the border-line of the concept, but as to the general nature of money
there is essential agreement.

8.# Metal money without or with coinage#. In antiquity the metals
were used as money in bulk; that is, the amount was weighed at each
transaction and the quality was tested whenever there was doubt.[4]
In countries industrially backward, payments are still made in this
manner. For some time after the discovery of gold in California, gold
dust was roughly measured out on the thumb-nail. In shipments of gold
to-day by bankers to settle international balances, metal may be in
the form of bars that bear the mark of some well-known banking house.
In all of the cases of this kind the gold is money in fact, but not by
virtue of any act of government. The metal is simply a valuable good,
the receiver of which values it according to its weight and fineness.
This is true even when the government mint, for a small charge, tests
and stamps the bars at the request of citizens.

Very early it became the practice of governments to shape and stamp
pieces of metal to be used as money, so as to indicate their weight
and fineness. The act of shaping and marking metal for this purpose is
called coinage.[5] The coinage by government had notable advantages in
giving to the monetary units uniformity of size, fineness, and value,
with the stamp that was readily recognized. But in its simplest form
coinage in no way changed the value of the money, and any other mark
equally plain put upon it would have served equally well, if only it
had carried with it equal assurance of the quality and weight of the
metal.

9. #Technical features of coinage#. For each kind of metal money there
is an established _ratio of fineness_ for the more precious material,
which is mixed with baser metals used as alloys. In the United States
all gold and silver coins are made nine-tenths fine; in Great Britain,
eleven-twelfths. The established weight of the gold dollar in the
United States is 25.8 grains of standard gold which contain 23.22
grains of fine gold. The _limit of tolerance_ is the variation either
above or below the standard weight or fineness that a coin is allowed
to have when it leaves the mint. This is different for each of the
principal coins, being about one-fifth of one per cent on a gold
eagle. The _par of exchange_ between standard coins of different
countries is the expression of the ratio of fine metal in them.
Thus the par of exchange between the American dollar and the English
sovereign (the "pound") is 4.866; that is, that number of dollars
contains the same amount of fine gold as an English gold sovereign.
The embossed design is merely to make the coins easily recognizable
and difficult to counterfeit; and milled or lettered edges are to
prevent clipping and otherwise abstracting metal from the coins.

10. #Seigniorage defined#. Coinage, as practised by early governments
and rulers, came to be a function of great importance politically as
well as economically. The right to issue money came to be one of
the most essential prerogatives of sovereignty. The prince, king, or
emperor stamped his own device or portrait upon the coin; hence the
term seigniorage from _seignior_ (meaning lord or ruler). Seigniorage
meant primarily the right the ruler, or the estate, has to charge
for coinage, and hence it has come to mean also the charge made for
coinage, and often, in a still broader sense, the profit made by the
government in issuing any kind of money with a value higher than that
of the materials (whether metal or paper) composing it. Coinage is
rarely without charge, and often has been a source of revenue to the
ruler. In antiquity and in the Middle Ages this right was frequently
exercised by princes for their selfish advantage to the injury and
unsettling of trade. This introduced a very great problem of value
into the use of money.

The coinage is said to be _gratuitous_ when no charge is made for
coinage. Coinage is said to be _free_ if the subject or citizen
may take bullion to the mint whenever he pleases, paying the
usual seigniorage. Coinage is _limited_ if the government or ruler
determines when coinage is to take place. Thus, coinage may be both
free and gratuitous, when citizens are allowed to bring bullion
whenever they please and have it converted into coins without charge
or deduction. But coinage is free without being gratuitous when any
citizen may bring metal to the mint, whenever he chooses, to be coined
subject to the seigniorage charge.


[Footnote 1: See Vol. I, pp. 15-16 and 50-53 for an introductory
statement of the origin of money in connection with markets.]

[Footnote 2: See ch. 5.]

[Footnote 3: See Vol. I, p. 43, on the decline of barter.]

[Footnote 4: "I will ... refine them as silver is refined, and will
try them as gold is tried." Zech. xiii, 9. "I bought the field ...
and weighed him the money, even seventeen shekels of silver. And I ...
weighed him the money in the balances." Jer. xxxii, 9, 10. A shekel
was 224 grains, troy weight, which is about equal to six-tenths of the
pure metal in a silver dollar to-day and worth now about twenty-four
cents in gold. At that time, however, the purchasing power of silver
was many times greater than it now is.]

[Footnote 5: From the French _coin_, in turn from Latin _cuneus_,
wedge, suggestive either of an earlier wedge-shaped piece, or of a
wedge-shaped mark on the piece. The German word _Münze_ is from the
Latin _moneta_ (as is the English _mint_, the place where coins are
made), which meant money, that name being taken from the temple of
Juno, called _Moneta_, where coins were made.]




CHAPTER 4

THE VALUE OF MONEY

  § 1. Standard-commodity money. § 2. Alternative uses of the money-good.
  § 3. Money as a valuable tool. § 4. Relative importance of
  money. § 5. Concept of the individual monetary demand. § 6. Concept
  of the community's monetary demand. § 7. The money-material in
  its commodity uses. § 8. The general level of prices. § 9. Effect of
  increasing gold production. § 10. The quantity theory of money. § 11.
  Interpretation of the quantity theory. § 12. Practical application of
  the quantity theory.


§ 1. #Standard-commodity money#. The actual money in use in almost
every country to-day consists of a wide and confusing variety: gold,
silver, nickel, copper, paper in various forms, issued by various
authorities under various conditions as to amount and as to
seigniorage. But among all the kinds, in each country some one kind
is found standing preëminent and in a peculiar position, as the
_standard_ money to which the value of all the other kinds of money is
in some manner adjusted. Usually this standard money is composed of
a material (gold or silver) which is a commodity; but there are
many examples of paper money being for the time the standard. The
difficulties of the money problem must be attacked at the point
of standard-commodity money, where it is nearest to ordinary value
problems and is less complicated than when the various other kinds of
money and the various money substitutes are included.

We mean by standard money that kind, no matter what its form, which
serves in any country as the unit in which the value of other kinds of
money is expressed. The standard usually is a quantity of metal of a
certain weight and fineness, which, as a commodity, has a value also
in industrial uses. Coins of this standard are called full, or real,
money by some writers that deny the title of money to everything else.

§ 2. #Alternative uses of the money-good.# Let us consider the
problem of money-value as it would present itself if only one kind of
commodity money were in use. This doubtless was in large measure,
if not entirely, the case for a time in early societies after one
material had proved itself to be the best suited for the purpose. The
history of many kinds of money may, we have seen, be traced back to
a point where they were not money, but commodities with a direct
value-in-use. Such were ornaments, shells, furs, feathers, salt,
cattle, fish, game, and tobacco. Each of these materials has, in each
situation, a value which is the reflection of its power to appeal
to choice. Now, if to the commodity-use is added the money-use, this
increases the demand for that good. No new theory is required to
explain the value of a commodity as it gradually acquires the added
use of a medium of trade. The money use is one that works no physical
or visible change in goods except a slight unavoidable abrasion, and
at any time a person receiving a piece of commodity money may retain
it for its use-value, as food, ornament, tool, or weapon, or may
retain it for a time and then spend it as money. This case of value is
no more difficult than that of anything else having two or more uses.
For example, cattle are used for milk, for meat, and as beasts of
burden. Each of these uses is logically independent as a cause
of value, yet all are mutually related, the value of cattle to a
particular person being determined by the consideration of all the
uses united into one scale of varying gratification.

§ 3. #Money as a valuable tool.# Money is often, by a figure of
speech, called a tool. A tool is a piece of material taken into the
hand to apply force to other things, to shape them or move them.
Figuratively, this is what money does. A man takes it not to get
enjoyment out of it directly, but to apply force, to move something,
and that which he moves is the other commodity. Money thus (as money)
is always an indirect agent. Adam Smith aptly likened money to the
roads and wagons that transport goods, thus gratifying desires by
putting goods into more convenient places. The fundamental use that
money serves is to apportion one's income conveniently as it accrues
and as it is spent. The use of money increases the value of goods by
increasing the ease with which trade takes place. Like any tool or
agent, money is valued for what it does or helps to do. It enhances
the value of the goods that it buys and sells by dividing them into
quantities convenient for use and by making them available at
the right times. In the light of the principles of diminishing
gratification and of time-preference it is clear that the amounts in
which, and the times at which, goods are available have an essential
bearing on their values. Money is the most successful device ever
discovered for distributing the supplies of a journey along its
course, and the goods of daily need over a period of time. The use of
money as a storehouse of value by hoarding it is merely a more extreme
case of keeping income until a time when it will have a greater value
to the owner than it has in the present.[1]

§ 4. #Relative importance of money.# Because money is the general
expression of purchasing power, and comes to symbolize all other
wealth, it often assumes undue and exaggerated importance in men's
eyes. Money is but one of many forms of wealth. It constitutes but a
small percentage of the total wealth of a country, and it is far from
being the most indispensable to human welfare. Yet its importance,
as a whole, in determining the form of industrial organization is
enormous. In a society without money, industrial processes would be
very different, and trade would be hampered in manifold ways.

A poor community has little money because it cannot afford more; it
gets along with less money than is convenient just as it gets along
with fewer agents of every other kind that it could use. Pioneers in a
poor community where the average wealth is low cannot afford to keep
a large number of wagons, plows, good roads, or schoolhouses. If the
members of the community were wealthy enough each would have more
of these and of other things, and the sum total of money would be
greater. Great as is the convenience of money, poorer communities have
to do with little of it. It is, therefore, a confusion of cause and
effect when poor communities imagine that their poverty is due to lack
of money.

§ 5. #Concept of the individual monetary demand.# Let us now seek
to get in mind the idea of an _individual monetary demand,_ as that
amount of money which at any time is required by an individual to make
his purchases in expending his income. Every man may be thought of
as having an average monetary demand, or his average individual cash
reserve, throughout a period. A man with a salary of $50 a month
paid monthly has ordinarily a maximum monetary demand of $50. If his
expenditures are made in two equal parts, the one on pay-day, the
other thirty days later, his average monetary demand during the month
is a little over $25. If most of his purchasing is done in the first
week of the month, his average monetary demand may be perhaps $10.
Many a workman purchases on credit, running accounts at the stores for
a month. Then on pay day he spends his entire month's wages the day
he receives it, and goes without money for the rest of the month. His
average monetary demand throughout the month would then be about
equal to one day's wages. Evidently any person's cash reserve may
be expressed as that proportion of his income that is to him of more
value retained in money form for any period than if at once expended.

In this conception of the individual monetary demand, must, however,
be included not merely the demands of retail purchasers, made by
themselves, but also those of all agencies such as merchants, bankers,
and transportation companies, serving the needs of ultimate consumers
of goods. The use of money may be necessary several times before a
commodity completes its journey from producer to consumer.

Of two persons whose expenditures of money are of the same kind and
made at the same rate, the one having the larger amount of purchases
to make has the larger monetary demand. But the amount of purchases
does not always vary directly with the amount of real income[2]; for
example, a farmer and a village mechanic may have at their disposal
incomes equal in the quantities of goods, such as food, fuel,
clothing, and house-uses (worth, let us say, $1000 for each), but the
farmer would be getting a larger part of his goods directly from his
farm and by his own labor, while the mechanic would be getting first
a money income to be expended afterward for food, clothing, and rent.
The mechanic would in this case have an average monetary demand much
larger than the farmer.

We see thus that a person's monetary demand at any time is that amount
of money which rests in his possession as the necessary condition to
making his purchases as he desires. Individual monetary demand varies
in proportion directly to the delay, and inversely to the rapidity
with which the individual passes the money on; and directly to
the amount of the person's income that is received and expended in
monetary form.

§ 6. #Concept of the community's monetary demand.# The monetary demand
of a community at a given time is the sum of the monetary demands of
the various individuals and enterprises. It is that stock of money
which is necessarily present to effect the exchanges of the community
in the prevailing manner at the existing price level. A single
dollar as it circulates helps to supply the monetary demand of many
individuals in turn: the more quickly each person spends the piece
of money he receives, the greater its rapidity of circulation. Let us
suppose that every piece of money passed from one person to another
once each day. Then a dollar would, in the course of a business year
(about 300 days), serve to buy (and at the same time to sell) $300
worth of goods. If the average purchases of each individual amounted
to $1000 a year, the average monetary demand of each would be about
3-1/3 dollars.

But every moment beyond the average time that any one kept money would
increase his monetary demand. If he delayed a day, a week, or a
month in spending the money, waiting until he could buy in some other
market, or until a better time to buy, he would thus increase insomuch
the amount of money needed to make the trade (on that scale of
prices). It requires more slow dollars than swift dollars to make a
given volume of purchases.

Evidently the times of maximum monetary demand of the different
individuals do not coincide; rather they alternate with each other,
and the community's total monetary demand at a given time is a
composite of the many individual variations. The amount of money that
will remain in circulation in a community depends on several factors,
the chief among them being the amount of goods to exchange, the
methods of exchange, and the prevailing scale of prices. The amount
of goods to be exchanged may change even when the amount produced is
unaltered (e.g., a change from agricultural to industrial conditions).
The methods of exchange may alter so as to require either more money
(e.g., cash instead of credit business), or less money (e.g., use of
bank checks displacing use of money by individuals). Or, apart from
the other factors, the scale of prices may change as the conditions of
gold and silver production are altered. The interrelations of gold
and silver production, paper money issues, banking growth, and
money-inflow and outflow in foreign exchanges give rise to the most
interesting and important problems in the field of monetary theory.

§ 7. #The money-material in its commodity uses#. We are now prepared
to take up the question: What determines the ratio at which money
exchanges for other goods? And, as money comes to be the unit in which
prices are generally expressed, the question becomes: What determines
the general level of monetary prices? We have this problem in its
simplest form in the case of a commodity-money such as gold. It may be
looked upon merely as so much precious metal. The problem of its value
as bullion is the same as that of the value of pig iron or of zinc,
of meat or of potatoes. There is here no special monetary problem.
The value of gold as bullion and its value as money are kept in
equilibrium by choice and by substitution. The several uses of gold
are constantly competing for it: its uses for rings, pens, ornaments,
championship cups, photography, dentistry, delicate instruments, and
as a circulating medium. If the metal becomes worth more in any one
use, its amount is increased there and is correspondingly diminished
in other uses.[3]

When coinage is free and gratuitous[4] the standard money is a
commodity. Such coinage is essentially but the stamp and certificate
that the coin contains a certain weight and fineness of metal. Where
coinage is free and gratuitous each coin will be worth the same as the
bullion that is in it so far as the citizens exercise their choice.
They will not long keep uncoined metal in their possession when it is
worth more in the form of money, nor will they long keep money from
the melting-pot when it is worth more as bullion. Yet there may be
a slight disparity between the bullion value and the monetary value
before the metal is converted into coin or the coin melted down into
metal.

This adjustment of the value of commodity-money to other things is
made also on the side of supply, in the use of labor and material
agents to produce the precious metals and to produce other things.
Gold-mining, for example, is one among various industries to which men
may apply their labor and their available material agents. Some mines
are superior, others medium, others marginal which it barely pays
to work. There is, therefore, a rise and fall of the margin of
gold production with changes in prices and changes in the cost of
production. Large new deposits of gold are discovered from time to
time and new methods of extracting gold are invented. If, when it
barely pays to work a mine, such changes occur, gold becomes worth
less, and the poorer mines eventually must go out of use. As gold
rises in value some abandoned mines again come into use. A similar
variation may be noted in the utilization of marginal land, marginal
factories, marginal forges, and marginal agents of every kind.[5]

§ 8. #The general level of prices#. We come now to a more peculiar
aspect of the monetary value problem. In performing its function
as general medium of trade, money determines the general level
of monetary prices. We have the idea of a general level of prices
whenever we contrast the price ratio of money to other commodities at
one time with its ratio at another time. Now the monetary prices
of the various commodities are constantly changing, and in somewhat
different degrees, but on the average there may be a general trend
upward or downward, and this is called a change in the general scale
(or level) of prices, as contrasted with changes in the values of any
two commodities in terms of each other. The general price level will
be more fully discussed below (Chapter 6, section 3) in connection
with the method of measuring by index numbers its changes. This brief
explanation may, perhaps, be enough for our present purpose. Our
question now is: What is the effect of changes in the quantity of
money (considered apart from chance accompanying changes) upon the
general level of prices?

§ 9. #Effect of increasing gold production#. Let us take a case where
gold is in general use as money, and where for some time there has
been no noticeable change in the amount of business, the methods of
trade, and the general scale of prices. What would happen when new
gold mines were found that were much easier to operate, and gold began
to be produced at a much more rapid rate than formerly? The amount
of gold as compared with other forms of wealth evidently would be
increased. What if all the increase went into the industrial arts? The
value of gold in its industrial uses would fall. Then a part of the
increase must be diverted to monetary uses. When any man, by reason of
the increasing gold supplies, gets a larger stock of money than he had
before, the proportion formerly existing between his use for money
and his monetary stock is altered. He has more money than meets his
monetary demand at the existing prices. As he seeks to reduce his
stock of money to due proportions by buying more goods, he thereby
distributes a part of the excess of money to others. This bids up the
prices of goods further until the total value of goods exchanged again
bears the same ratio as before to the average monetary demand of each
individual.

Take an extreme case: if twice as many dollars get into circulation
in a community, either some few men may have far more dollars than
before, while others have nearly the same number; or every man may
have his due proportion of the new supplies, just twice as many as
before in proportion to his income. The latter result, "other things
being equal," is the logical one after equilibrium has been restored.
If prices of goods remained the same as before, there would be twice
as many pieces of money available to effect the same number of trades
at the same prices. There is no reason why each person should tie up
twice as large a proportion of his income in the form of money. If,
however, there is a concerted movement to spend the surplus money,
there results a general bidding down of the value of money, a general
bidding up of the prices of goods. At what point will this movement
stop? The rational conclusion must be that, other things being equal,
the new equilibrium will be established when the ratio between the
value of money and the price of the goods which each individual is
purchasing becomes the same as before. The money being doubled, prices
must be doubled, and likewise for any other change in quantity.

§ 10. #The quantity theory of money.# This explanation of the effect
of changes in the quantity of money in a country upon prices (the
general scale of prices) is known as the quantity theory of money.
This theory has, for a century, been very generally accepted by
competent students of the money problem. It may be summed up thus:
other things being equal, the value of the monetary unit, expressed
in terms of all other commodities, falls as the quantity of money
increases, and _vice versa_. That is, prices rise and fall in
direct proportion to changes in the total quantity. This is a simple
explanation of a complex and difficult set of conditions. The phrase,
"other things being equal," betokens the statement of a tendency where
there are several factors. The quantity theory explains what happens
when there is a change in one of the factors--the number of pieces
of money. There are three large sets of facts to be brought into
relationship with each other in the quantity theory: (1) the amount
of business, or the number of trades effected; (2) the rapidity of
circulation, depending on the methods by which business is done; (3)
the amount of money available. According to the quantity theory we
must expect that, when conditions (1) and (2) remain fixed, the value
of money will vary inversely as its quantity. This quantity theory may
be expressed in the formula P = MR/N when P is the symbol for price,
or the general price level, N is (1) above, R is (2), and M is (3).
P, therefore, changes directly with either M or R, or inversely with
N.[6]

§ 11. #Interpretation of the quantity theory.# The quantity theory
must be carefully interpreted to avoid various misunderstandings of it
that have appeared again and again in economic discussion.

(1) It does not mean that the price level changes with the absolute
quantity of money, independently of growth of population and of the
corresponding growth in the volume of exchanges.

(2) It is not a mere per capita rule to be applied at a certain moment
to different countries. For example, Mexico may have $9 per capita and
the United States $35, while average prices may not differ in anything
like that proportion. But in these two countries not only the amounts
of exchanges per capita but the methods of exchange and the rapidity
of the circulation of money differ greatly.[7]

(3) It cannot be applied as a per capita rule to the same country
through a series of years, without taking account of the many changing
factors. It is estimated that in 1800 the money stock was about $5
per capita in the United States, and in 1914 about $35[8], but average
prices have not necessarily changed in the same ratio. In a period of
years a country may change in a multitude of ways, in complexity of
industry, modes of exchange, transportation, wealth, and income. These
changes require, some larger, others smaller, per capita amounts
of money to maintain the same level of prices. For example, the
substitution of cash payments for book-credit in retail trade calls
for a larger per capita stock of money; whereas an increased use of
banks and checking accounts, by economizing the use of money, enables
a smaller amount of money to maintain the same level.[9]

(4) Tho applied originally to standard money, the quantity theory
applies to all other kinds of money circulating side by side and at
a parity of value, so far as these fulfil the definition of money and
are not merely supplementary aids of money. These substitutes for, or
supplements to, money enable each dollar to do more work, to circulate
more rapidly. If the standard money alone were doubled in quantity,
while the various forms of fiduciary money (smaller coins, bank notes,
government notes) remained unchanged, the quantity of money as a whole
would not be doubled. Indeed, in such a case, the method of exchange
would be greatly altered. According to the quantity theory, therefore,
prices would not be expected to double.

§ 12. #Practical application of the quantity theory#. Despite the
number of changing factors affecting the methods of exchange and
the amount of business, the quantity theory is a rule unable at any
moment. These various factors change slowly, and the quantity theory
answers the question: What general change occurs in prices as a result
of the increase or decrease of the money in a given community at a
given moment? Like the law of gravitation and the law of projectiles,
the theory must be interpreted with relation to actual conditions.

The quantity theory makes intelligible the great and rapid changes in
prices which have followed sudden changes in the quantity of money.
Inductive demonstration of broadly stated economic principles is
usually difficult, but there have been many "monetary experiments"
to teach their lessons. Many inflations and contractions of the
circulating medium have occurred, now in a single country, again
in the whole world; and the local or general results have helped
to exemplify richly the working of the quantity principle. With the
scanty yield of silver and gold mines during the Middle Ages, prices
were low. After the discovery of America, especially in the sixteenth
century, quantities of silver flowed into Europe. The great rise of
prices that occurred was explained by the keenest thinkers of that day
along the essential lines of the quantity theory, tho there were many
monetary fallacies current at that time. The experience in England
during the Napoleonic wars, when the money of England was inflated (by
the forced issue of large amounts of bank notes) and prices rose above
those of the Continent, led to the modern formulation of the theory by
Ricardo and others about 1810. The discovery of gold in California
and Australia in 1848-50 greatly increased the gold supply, and gold
prices rose throughout the world. Between 1870 and 1890 the production
of gold fell off while its use as money increased greatly, and prices
fell. A great increase of gold production has occurred in the period
since 1890. In part the rising prices since 1897 are explicable as the
periodic upswing of confidence and credit, but in the main doubtless
they are due to the stimulus of increasing gold supplies.[10] These
are but a few of many instances in monetary history, which, taken
together, make an argument of probability in favor of the quantity
theory so strong as to constitute practically an inductive proof.


[Footnote 1: The old-fashioned miser, however, withdraws his hoarded
gold for the time from its usual monetary function as an indirect
agent and treats it as a direct good yielding to him psychic income by
its mere possession.]

[Footnote 2: See on kinds of income, Vol. I, p. 26 ff.]

[Footnote 3: See secs. 1 and 2 of this chapter; also Vol. 1,
especially pp. 31-38 and 353-355.]

[Footnote 4: This means actually gratuitous, for any real difficulty
in getting metal to or from the mint operates as a cost in the
conversion of bullion into money, or _vice versa_; e.g., the gold may
be in Australia and the mint in London.]

[Footnote 5: See Vol. I, pp. 138 ff. and 361 ff.

FIG. 1. GOLD PRODUCTION OF THE WORLD, 1493-1914.

The changes in gold production here shown have bearings not only
upon problems of money, but in some respects upon nearly every modern
economic problem. Compare in the present connection this figure with
Figure 3, in Chapter 6, Section 4, showing changes in index numbers of
prices.

[Illustration: FIG. 1. GOLD PRODUCTION OF THE WORLD. 1493-1710.
AVERAGES FOR PERIODS BEFORE 1870]]

[Footnote 6: This formula is presented by E.W. Kemmerer in "Money and
Prices" (2d ed., 1909), p. 15 ff.]

[Footnote 7: See above, ch. 3, sec. 6, table.]

[Footnote 8:

  PER CAPITA CIRCULATION OF MONEY (ESTIMATED) IN THE UNITED
  STATES IN VARIOUS YEARS.

  1800......$4.99 1850......$12.02 1890......$22.82
  1810...... 7.60 1860...... 13.85 1900...... 26.93
  1820...... 6.96 1870...... 17.51 1910...... 34.33
  1830...... 6.78 1880...... 19.41 1915...... 35.44
  1840......10.91
]

[Footnote 9: On the function of deposits, see below, ch. 7, sec. 11.]

[Footnote 10: Consult Figure 1 in ch. 4 and Figure 2 in ch. 6 for the
graphic presentation of these and related facts.]




CHAPTER 5

FIDUCIARY MONEY, METAL AND PAPER

  § 1. Commodity and fiduciary defined. § 2. Present monetary system
  of the United States. § 3. Saturation point of fractional money. § 4.
  Light-weight fractional coins. § 5. Worn coins and Gresham's law.
  § 6. A general seigniorage charge on standard money. § 7. Coinage on
  governmental account. § 8. The gold-exchange standard. § 9. Nature
  of governmental paper money. § 10. Irredeemable paper money. § 11.
  Theories of political money.


§ 1. #Commodity and fiduciary defined#. The actual moneys in
circulation in every modern country consist of a wide variety of
pieces, differing in denomination, physical size, shape and materials,
mode of issue, source or authority of issue, and legal character.
Among these kinds, one is the standard and is a commodity-money.[1] In
such cases the coinage is free and nearly gratuitous, and the value
of the money is kept close to parity with its value as bullion by
changing bullion into coin, or coin back into bullion, whenever there
is an appreciable difference between the values in the two uses. This
adjustment is brought about by the free action of the people. The
government, having declared what is the standard money unit, and
having provided a mint to make coins, leaves it to citizens, acting
from the ordinary competitive motives, to decide when they will reduce
or increase the number of coins in circulation.

The other kinds of money are not commodity-money and the materials of
which they are made, whatever they be, are not worth as much in any
other uses as they are in their present monetary form. Their value is
always referred to, and adjusted to, that of the commodity-money, so
long as any of it is in circulation. In contrast with commodity-money,
these other kinds may be called fiduciary money. By fiduciary money
we mean money that has not a commodity value equal to its money value,
but which is generally accepted because each receiver has faith that
others in turn will take it in the same way.[2]

§ 2. #Present monetary system of the United States.# Here is given a
summary of the main features marking the present monetary system of
the United States (in 1915).

Not all this variety is essential to an efficient monetary system and
several of the kinds survive as the result of historical accidents
(political and legislative). But all are now kept in accord with the
value of the gold coin which, it will be observed, is the only kind
the amount of which is not artificially limited. Silver dollars are
no longer coined, subsidiary silver and minor coins are issued only
in exchange for other money, as are gold and silver certificates in
exchange for gold or for silver, which they merely represent while in
circulation.

§ 3. #Saturation point of fractional money.# Fiduciary money is that
on which regularly the issuer makes a seigniorage charge.[3] Let us
consider now the effect of seigniorage on the value of money.

Fractional coins are those of smaller denominations than the standard
unit of money, as shillings and pence in England, and half dollars,
quarter dollars, dimes, nickels, and cents in America. Money to serve
well a variety of uses must be of different denominations, and "small
change" is necessary to make small purchases and for exact settlement
in larger payments that are not multiples of the standard unit. The
amount required (or most convenient to use) in each denomination
of fractional coins is thus a more or less certain portion of each
person's monetary demand, shaped by experience and fixed by habit. For
example, within certain elastic limits of convenience quarters may be
used for halves, and dimes for nickels (and _vice versa_); but each
person has a point of preference. The total demand for each kind of
change is the sum of the individual demands. This point where the
amount of coins of any denomination (in relation to the whole monetary
system) is most convenient may be called the saturation point of that
kind of small change, up to which point the people prefer a share
of their money in that form, and beyond which they will, if free
to choose, exchange that kind for other denominations (smaller or
larger). Each kind of money, as the cent, nickel, dime, has its own
peculiar demand and its saturation point.

  MONETARY SYSTEM OF THE UNITED STATES, 1915

        Metals          | Weight, grains | Fineness |Ratio to gold
  1. Gold coins         |   25.8         |   .90    |   100
  2. Silver dollar      |  412.5         |   .90    |  15.988 to 1
  3. Silver, subsidiary |  385.8         |   .90    |  14.953 to 1
  4. Nickel (5 cents)   |   77.0         |   .25    |  ...........
  5. Copper (1 cent)    |   48.0         |   .95    |  ...........
  ----------------------------------------------------------------
       Metal          |Limit of issue | Legal tender for|Receivable for
                      |               |  private debts  |public dues
  1. Gold coins       | Unlimited.    | Unlimited.      |For all
  2. Silver   dollar  |Ceased in 1905 | Unlimited.      |For all
  3. Silver,          | Needs of the  |  $10            |$10
     subsidiary       |   people      |                 |
  4. Nickel (5 cts.)  |     Do.       | 25 cts.         |25 cts.
  5. Copper (1 ct.)   |     Do.       | 25 cts.         |25 cts.
                      |                \                |
     _Paper_     |                |                |
  6. Gold certificates|Unlimited in ex-| No             |For all
                      |change for gold |                |
  7. Silver           |In exchange for | No             |For all
     certificates     | silver $       |                |
  8. US notes         | No new issues. |Unlimited.      |Except customs
  9. Treasury notes   | No new issues. |Unlimited       |For all
      of 1890         |                |                |
  10. National bank   |Capital of banks|No              |Except customs
      notes.          |                |                |
  11. Federal reserve |Per cent. of    |At banks of     |For all
      notes.          | gold reserves  |reserve system  |
  ----------------------------------------------------------------------
       Metal          |Exchangeable at  |Redeemable at  |In circulation
                      |treasury  for    | treasury in   |Oct 1, 1915
  1. Gold coins       |Gold certificates|               |616,000,000
                      |U.S., Treas., or |               |
                      |Fed, res. notes  |               |
  2. Silver dollar    |Silver           |               |65,000,000
                      |certificates     |               |
  3. Silver,          |Minor coins      |Lawful money[a]|
     subsidiary       |                 |in sums or mul-|162,000,000
                      |                 |tiples of $20  |
  4. Nickel           |                 |     Do.       \
                                                         > 62,000,000[d]
  5. Copper           |                 |     Do.       /

           Paper      |                 |               |
  6. Gold certificates| Subsidiary and  |Gold coin      |1,172,000,000
                      | minor coins     |               |[e]
  7. Silver           | Silver and      |Silver dollars | 482,000,000[f]
     certificates     | minor coins     |               |
  8. US notes         | Subsidiary and  |Gold           | 337,000,000
                      | minor coins     |               |
  9. Treasury notes of| Silver and      |Gold           | 2,200,000
     1890             |  minor coins    |               |
  10. National bank   |Subsidiary silver|Lawful money[b]|761,000,000
      notes           |and minor coins  |               |
  11. Federal reserve | Gold[c]         |Gold[c]        |133,000,000
      notes           |                 |               |
  -------------------------------------------------------------------
      Total[g]...........................................3,792,200,000

  [Footnote a: "Lawful money" includes gold coin, silver dollars, U.S.
  notes, and Treasury notes.]

  [Footnote b: Redeemable also in lawful money at bank of issue.]

  [Footnote c: Redeemable also at Federal reserve banks in gold.]

  [Footnote d: Not usually included in the estimates of total money
  in circulation.]

  [Footnote e: Represented dollar for dollar by gold kept in the U.S.
  treasury.]

  [Footnote f: Represented dollar for dollar by silver kept in the U.S.
  treasury.]

  [Footnote g: Besides, there were about $312,000,000 in the U.S.
  Treasury not offset by outstanding paper. The total money stock (in
  circulation and in the Treasury, eliminating certificates representing
  gold and silver), was about $4,233,000,000, of which 70 per cent was
  metal (largely represented in circulation by paper certificates) and
  30 per cent was paper. Of the 70 per cent 50 was gold, 18 was silver,
  and 2 was copper and nickel.]

§ 4. #Light-weight fractional coins.# The standard metal is usually
too valuable to be suitable for coins of the smaller denominations.
Therefore, when gold is the standard, copper, nickel, and silver
remain in restricted use. But when coins of these metals are issued
at weights corresponding with their bullion value, difficulties arise.
Not only are they too heavy for convenience, but with every slight
rise in their bullion value as compared with that of the standard
metal, they become worth more as bullion than as coin and begin to
disappear from circulation. This happened often throughout the Middle
Ages and until the nineteenth century. The attempt was generally made
to coin gold and silver at a ratio of weight corresponding exactly
to their market values at a given moment and, every time the market
conditions varied, the best full-weight coins of one of the two metals
were taken out of circulation. [4]The country thus suffered for lack
either of the larger gold coins or of fractional coins. At length, to
remedy this difficulty, fractional silver coins, often called
"token coins," were issued, in limited numbers, of less than full
proportionate weight and bullion value.

This plan, having been partially tried, was generally adopted by the
United States in 1853 at a time when the silver dollar of 371.25 fine
grains was legally rated at the same value as the gold dollars of
23.22 grains, and was freely coined. The fractional coins were made
a little over 6 per cent lighter per dollar than the dollar coin; two
half-dollars or four quarters or ten dimes contained 93.52 cents worth
of silver. Since then silver bullion has become worth much less in
terms of gold, and for years past the bullion value of the silver in
a dollar of silver small change has been between 40 and 60 cents. Why
then has the fractional coinage a monetary value equal to the standard
money, dollar for dollar?

The answer is, because it is artificially limited in quantity, so that
it does not pass the point of saturation in the field of its use. Its
value rests on its monetary use; it is fiduciary money, not commodity
money. It is limited simply by letting "the needs of the people"
determine its amount. This is done by issuing it only in exchange for
other money of the larger denominations, and by redeeming it in other
money on demand. Fractional coins are issued on the request of banks
in exchange for standard money. One needing "change" gets it at the
bank; when the bank finds its supply falling short it gets more from
the government mints. As business increased in 1898, the demand for
nickels, dimes, and quarters became unprecedented, and the mints
worked night and day to supply them. If these coins were made in
great quantities and forced into circulation by the government through
paying them out to creditors and officials, their quantity would
become excessive and they would fall in value (be at a discount)
compared with standard money. But as this is not done, and as,
moreover, they are redeemed on demand at the treasury (and practically
at every bank and post office) in other money, any slight tendency
to depreciation in any locality is at once corrected. As it is, the
government makes a seigniorage profit on the fiduciary coinage, as
shown in the following table. [5] The fractional coinage is maintained
at a parity with the standard money in accordance with the monopoly
principle, expressed in the limitation of the amount.

  _Receipts:_

      Earnings (charges for refining, assaying, manufacture
        for other countries, etc.).........................  $392,000
      Bullion recovered, by-products, old materials, etc...   143,000
      Profits on seigniorage, subsidiary silver............ 3,013,000
      Profits on seigniorage minor coinage and recoinage... 2,387,000
                                                           ----------
      Total receipts.......................................$5,935,000

  _Expenditures_:
      All kinds............................................$1,138,000
                                                           ----------
        Net revenues from mint service.....................$4,797,000

§ 5. #Worn coins and Gresham's law.# Coins may be light-weight as the
result of another cause--namely, the abrasion (wearing off) of the
coins in circulation. Nearly always when this has occurred the worn
coins have still been accepted as money,[6] and ordinarily without any
depreciation. That is to say, they have a value as money greater than
the value of the bullion that is in them. Everybody takes them without
hesitation as readily as if they were full weight. If, however, at
this point, new full-weight coins are put into circulation, these at
once disappear while the old ones remain in circulation--a fact that
has always been somewhat mystifying.

In explanation of the phenomenon was formulated "Gresham's law" of
the circulation side by side of coins of different bullion value: bad
money drives out good money. Sir Thomas Gresham (whose name has but
recently been given to this so-called law), explained the principle
to Queen Elizabeth when counseling her regarding the recoinage of the
debased money of the realm as was done in 1560. He showed that when
old, worn coins were in circulation and the mint began putting out
full-weight coins, the old lighter ones remained as money, while the
new ones, being heavier, were picked out by jewelers and by those
needing to send money abroad.

Gresham's law has a paradoxical wording and is frequently
misunderstood. "Bad" money means not counterfeit money, but merely
money that has not as great a bullion value compared with its money
value as some other kind of money then in circulation. But not every
piece of such money will drive out every piece of good money. The law
applies only under certain conditions, and within certain limitations.
The "good" will be driven out only if the total amount of money in
circulation is in excess of what would be needed if all were of full
weight and of best quality. Paradoxically speaking, if there is not
too much of the bad money, it is just as good as the good money. But
even if good money is driven out, it may not leave the country. It
may be hoarded, or be picked out by banks and savings-institutions to
retain as their reserves, or be melted for use in the arts. Gresham's
"law" becomes thus a practical precept. As applied to the plan of
recoinage it is: Withdraw the worn coins as rapidly (in equal numbers)
as you put new coins into circulation.

The continued circulation of "bad" money along side of "good" money
(light-weight along side of full-weight coins), so long as the total
number of coins is not in excess of the money demand for full-weight
coins, is explained thus on just the same principle as is the
circulation at parity of a light-weight fractional coinage, in the
preceding section.

§ 6. #A general seigniorage charge on standard money.# The fiduciary
coinage problem presents itself under a some-what different guise in
case a seigniorage charge is made on all coinage, even of that metal
used as the standard unit. In this case coinage is free but not
gratuitous. In this case no bullion is brought to the mint unless the
coined pieces the owners receive have a value equal to the bullion
value plus the seigniorage charge. The power to impose a seigniorage
charge is a monopoly power. Artificial limitation is present.
Evidently, the number of coins that can be issued without depreciation
is limited to that number which would circulate if they were made
full weight without a seigniorage charge.[7] This number of pieces of
full-weight metal is the saturation point of the money demand of the
country. If more than that could in any way be put into circulation it
would become worth less as money than as bullion, and would be melted
or exported.

Assume that this full supply of money at a given moment is 100,000
pieces or dollars; then consider the effect of imposing a seigniorage
charge of ten per cent on further coinage. The government alone having
the right of coinage, the need of money would give the circulating
medium a monopoly value. The value of the money would rise. When
it had risen until the coin would buy any more than one-ninth more
bullion than was in it, the citizens would begin to take metal to the
mint. After the ten per cent charge was taken out they would receive a
coin which, the containing one-tenth less bullion, would be worth
very nearly the same as the metal taken to the mint. No considerable
depreciation could take place unless the volume of business fell off
so that less money was needed than before. In that case there would
be no outlet for the excess of coins until they fell to their bullion
value, i.e., till they lost the entire value of the seigniorage, the
monopoly element in them. Melting or exporting them before that point
was reached would cause to the owner the loss of whatever element of
seigniorage value they contained. We thus have arrived at the general
principle of seigniorage: when the number of coins issued is limited
to the saturation point, a seigniorage charge does not reduce their
money value; they are worth more as money than as bullion. And this
holds good of a large seigniorage charge as well as of a small one,
even up to the extreme limit of a charge of 100 per cent. In this last
case the government would retain the whole of the bullion brought to
it and would give in return a piece of money made of material (metal
or paper) with a negligible value.

§ 7. #Coinage on governmental account.# The fiduciary coinage problem
may be presented also when coinage is not free, and the times and
amount of coinage are determined by law or by legally authorized
officials. In this case the bullion must be obtained by purchase
in the open market (and paid for by some form of legal money, or by
bonds). Coinage is then said to be "on governmental account."

Now, assuming that the normal money-demand (the volume of business, or
sum of exchanges) remains unchanged, let us consider what will result
if the government begins to issue money in this way, when, as in the
preceding case, 100,000 units of full-weight money are in circulation.
This action might be taken most simply by recoining all the
full-weight pieces that came into the treasury, making them contain
1/10 less precious metal, and paying out 1111 pieces for every 1000
received. Every time this was done there would be an excess of 111
pieces above the normal money-demand, and 111 full-weight pieces would
be exported or melted (Gresham's law). The process (in strict theory)
may be repeated 90 times, at which point 90,000 full-weight coins have
been received, 100,000 light-weight coins have been issued to take
their place and 10,000 full-weight coins have gone out of circulation.
The total seigniorage charge would be 1-10 of 90,000, or 9000 units.
No depreciation has taken place, and the pieces, by reason of their
limitation, bear a money value in excess of the bullion that is in
them.

Now the government, with the next 1000 pieces collected by taxation,
could buy enough bullion (in the open market) to make another 1111.
The excess of 111 pieces could not now be promptly removed by the
melting down or exporting of 111 coins, for all those remaining in
circulation have a bullion value 1/10 below their money value. As this
process is repeated the excess must continue to grow from 100,000 to
111,111, and the value of the money piece in terms of bullion continue
to fall from 10 to 9. At this point the 111,111 pieces would contain
just the same amount of bullion and have just the same value as the
100,000 pieces did before. Thereafter no further profit would accrue
to the government from issuing coins of that weight. To make a further
profit it must again reduce the amount of pure metal in the coin.

This process was often repeated in the Middle Ages. A ruler, either by
making a higher seigniorage charge or by coining on his own account,
debased the quality or reduced the weight of the money of his realm.
For a time the new coins, having the same monetary use, circulated at
par with the old coins. The ruler, pleased with this almost magical
power of getting a revenue with little trouble, continued to issue
coins until suddenly the heavier coins began to be exported or melted,
and the value of the other money fell, to the mystification alike of
the prince and of his people. The reason is now perfectly plain: the
number of coins was not kept within the proper limits and they went
down to their bullion value. The only way a further profit could be
made in this way was to debase the coin again. By successive steps the
coinage came to consist almost entirely of cheaper alloy.

§ 8. #The gold-exchange standard.# In a number of silver-using
countries and colonial dependencies near the end of the nineteenth
century, the fluctuations of the value of silver in terms of gold was
a constant source of difficulty in the payment of foreign obligations
to gold standard countries. Yet there were strong reasons in the
habits of the people and in the industrial conditions of the country
to forbid the adoption of gold and the disuse of silver as the actual
money in circulation. The method adopted, that of the gold-exchange
standard, involved these features.

(1) Closing the mints of the country to the free coinage of silver, as
was done most notably in India in 1893 and in Mexico in 1904.

(2) Adoption of a fixed ratio of exchange between the silver coins in
circulation and some gold coin which is made the standard of value in
all transactions (as the dollar or the pound sterling), the money in
circulation thus being all or nearly all of a fiduciary nature.

(3) Regulation and limitation of the amount of money in circulation so
that a fixed parity between it and gold may be maintained (a) by the
limited issue of coins only on governmental account, (b) by the sale,
at a fixed rate, of foreign exchange bills payable abroad in the
standard unit, the money paid for the bills being withheld from
circulation in a special reserve, (c) by the purchase of foreign bills
of exchange at a fixed rate, thus paying out and putting again into
circulation some of the fiduciary money in the special reserve.

These monetary changes furnish numerous illustrations and
demonstrations of the quantity theory of money as applied to the
entire circulating medium of a country.[8]

§9. #Nature of governmental paper money.# The problem of seigniorage
presents itself in its most extreme form when money is made of paper.
Paper money is issued either by a government or by a bank. We will
consider governmental notes here, reserving until Chapter 7 the case
of bank notes.

The issue of paper money in some cases grew out of the practice of
debasing metal. However this may have been, governmental paper money
may be looked upon as money for which a seigniorage of one hundred per
cent is charged. The gain of seigniorage from paper money is greater
and is just as easily secured as that from coinage of metals.
Governmental paper money is called "political money," in contrast
with commodity money. However, all coins that contain an element of
seigniorage, or monopoly value, are to that degree "political money."
The typical paper money is irredeemable; that is, it cannot be turned
into bullion money on demand. It is simply put into circulation,
usually with the "legal-tender" quality. Money has the _legal-tender_
quality (as the term is used in the United States) when, according to
law, it must be accepted by citizens as a legal discharge for debts
due them, unless otherwise provided in the contract. The prime purpose
of making money legal tender is to reduce the danger of dispute as to
payments; but another purpose often has been to force people to use a
depreciated money whether they would or not. The purpose of the issue
of political money is usually to gain the profit of seigniorage for
the public treasury, and often it has been the desperate expedient
of nearly bankrupt governments. Governmental paper money differs
from bank notes in that its value does not necessarily depend on the
promise of redemption by the issuer. It differs from promissory notes
and bonds in that its value is not based on the interest it yields,
but mainly on its monetary uses. The issue of paper money may save the
government the payment of interest on an equal amount of bonds. The
promise to receive paper in payment for taxes or for public lands may
help to maintain its value by reducing its quantity, but nothing short
of its prompt redemption in standard coins makes it truly redeemable.

§ 10. #Irredeemable paper money.# The most notable examples of paper
money in the eighteenth century were the American colonial currencies,
the continental notes, and the French assignats. In all the American
colonies before the Revolution, notes or bills of credit were issued
which were in most cases legal tender. Parliament forbade the issues,
but to no effect. Without exception they were issued in large amounts
and without exception they depreciated. The continental notes were
issued by the Continental Congress in the first year of the war
(1775), and for the next five years. The object at first was to
anticipate taxes, and it was expected that the states would redeem and
destroy the notes, but this was not done. The notes passed at par for
a time, but depreciated rapidly as their number increased. It has been
estimated that the country had less than $10,000,000 of coin before
the war, and when, in 1780, over $200,000,000 of notes were in
circulation they were completely discredited: hence the phrase "not
worth a continental." Specie then quickly came back into use. A few
years later the leaders of the French Revolution, failing to learn the
lesson of the American experience, issued, on the security of land,
notes called assignats in such enormous quantities that they became
worth no more than the paper on which they were printed. The paper
money issued under the English bank restriction act of 1797-1820 is
especially notable because it gave rise to the controversy which did
much to develop the modern theory of the subject. Parliament forbade
the Bank of England to redeem its notes in coin because the government
wished to borrow the coin the bank held. The result was the issue of
a large amount of bank money not subject to the ordinary rule of
redemption on demand. It was virtually governmental paper money. The
notes depreciated and drove gold out of circulation, and it was not
until 1821 that specie payments were definitely resumed.

The United States, under the Constitution, did not try legal-tender
paper money till 1862 when paper notes (called greenbacks, because of
the color of ink with which the reverse side was printed) were first
issued, later increased to a total of about $450,000,000. Other
interest-bearing notes were issued with the legal-tender quality and
circulated as money to some extent. Greenbacks depreciated in terms
of gold, and gold rose in price in terms of greenbacks until, in June,
1864, it sold at 280 a hundred. Fourteen years elapsed after the war
before these notes rose to par, in terms of gold (in December, 1878),
and they became legally redeemable in gold January 1, 1879. This was
called "the resumption of specie payments."

Almost every nation has at some time issued political money. During
the Franco-Prussian War in 1870, France, through the medium of its
great state bank, made forced issues of notes of a political nature,
which only slightly depreciated. Many countries--Russia, Austria,
Portugal, Italy, and most of the South and Central American
republics--have had or still have depreciated paper currencies.

At once, at the outbreak of the great war in 1914, the governments of
the warring nations began to exercise a strict control over the issue
of paper money, sought to gather into the public treasury all the
specie, and to give paper (either governmental notes or bank
notes) practically a forced circulation, making it almost the sole
circulating medium. The values of the paper moneys have fallen in all
the countries, especially in Germany and Russia. In such cases the
money partakes somewhat of the characters both of bank notes and of
political money. Resorted to in desperate extremities, political
money has usually proved to be a costly experiment. A result usually
unintended is the derangement of business and of the existing
distribution of incomes. The rapid and unpredictable changes in prices
gives opportunity for speculative profits, but injure legitimate
business. This incidental effect on debts and industry offers the main
motive to some citizens for advocating the issue of paper money. It
is peculiarly liable to be the subject of political intrigue and of
popular misunderstanding. It is this danger, more than anything else,
which makes political money in general a poor kind of money.

§ 11. #Theories of political money.# There are two extreme views
regarding the nature of paper money, and a third which endeavors
to find the truth between these two. First is that of the
cost-of-production theorists, who declare that government is powerless
to influence value, or to impart value to paper by law. They deny that
there is any other basis for the value of money than the cost of the
material that is in it. Money made of paper, on a printing press, has
a cost almost negligibly small, and, therefore, they say it can have
no value. The facts that it does circulate and that it is treated as
if it had value are explained by the cost-of-production theorists as
follows: while the paper note is a mere promise to pay, with no value
in itself, it is accepted because of the hope of its redemption, just
as any private note. Depreciation, according to this view, is due
to loss of confidence; the rise toward par measures the hope of
repayment.

Taking a very different view, the extreme fiat-theorists assert that
the government has unlimited power to maintain the value of paper
money by conferring upon it the legal-tender quality. The meaning of
_fiat_ is "let there be," and the fiat-money advocates believe that
the government has but to say, "Let there be money," to impart value
to a piece of paper. The typical fiat-money advocates in the United
States were the "Greenbackers," who wished to retain the greenbacks
issued in the Civil War and to increase the amount greatly. They saw
in paper money an unlimited source of income to the government.
They proposed the payment of the national debt, the support of the
government without taxes, and the loan of money without interest to
citizens. All might live in luxury if the extreme fiat-money theorists
could realize their dreams. The depreciation that has taken place
in nearly every case where government notes have been issued, the
fiat-theorists declare to be due to a mild enforcement of the law of
legal tender. To them the fact that paper money may circulate for
a time at par appears a reason why it always should. They do not
recognize that there is a saturation point in the use of money, and
that its use is still further limited by the fear of larger issues.

The almost universally accepted opinion among economists rejects both
of these views, tho recognizing in each a certain limited aspect of
the truth. The cost-of-production view quite overlooks the features
in which paper money differs from ordinary credit paper. The value of
one's promises to pay depends on his reputation and his resources; the
resources constitute the basis of value. Bonds have value because they
yield interest and are payable at a definite time in standard money.
But paper money, lacking this basis for its value, has another basis
in its money use, in its power to buy goods.

The theory of paper money here outlined makes the value of paper money
a special case of monopoly value. As the power of any private monopoly
over price is relative, not absolute, so is that of the government
over the value of political money. The money use is the source
of value of the paper notes. It is this which gives the economic
condition for value in paper money and strictly limits the power of
the government--a fact overlooked by the fiat-theorists. Business
conditions remaining unchanged, the limit of possible issue without
depreciation is the number of units in circulation before the paper
money was issued, the saturation point of full-weight and full-value
coins. Whenever governments have failed to stop at that point,
paper money has depreciated. But under wise and honest control and
regulation political paper money might serve the monetary function
very effectively.


[Footnote 1: The problem of a legally authorized double standard,
bimetallism, is treated in the next chapter. An irredeemable paper
money may be, for a time, the standard money.]

[Footnote 2: The faith _(fides)_ is not always that the issuer of the
money (whether it be a bank or the government) will redeem the money
on demand at any future time; for fiduciary money may circulate while
irredeemable, that is, either carrying no promise of redemption in the
standard money or in fact not being redeemed. Yet undoubtedly actual
redemption on demand or a good prospect of future redemption is one
of the circumstances stimulating the faith and the readiness of each
person in turn to receive fiduciary money.]

[Footnote 3: In the broad sense as above defined, ch. 3, sec. 10.]

[Footnote 4: See next section on worn coins.]

[Footnote 5: Receipts and Expenditures of Mint Service in 1914:]

[Footnote 6: It makes no difference what may be deemed the cause of
their acceptance; whether it be habit, public opinion in business
circles, or the act of law making them a legal tender; the essential
thing is that they continue to be accepted as money.]

[Footnote 7: In this and following numerical examples no account is
taken of the possibility that the standard metal may depreciate in the
world market in terms of all other goods as a result of its diminished
use as money in one or more countries. This properly belongs in a
complete theoretical treatment of the subject.]

[Footnote 8: See "Modern Currency Reforms" (1916), by E.W. Kemmerer,
professor of Economics and Finance in Princeton University, for a
detailed treatment of this remarkable series of monetary changes,
probably unequaled in instructiveness to the student of monetary
theory.]




CHAPTER 6

THE STANDARD OF DEFERRED PAYMENTS

  § 1. Relative positions of gold and silver; historical. § 2. Gold
  production, first half of nineteenth century. § 3. Concept of the general
  price level. § 4. Index numbers. § 5. Gold production and monetary
  legislation, 1850 to 1879. § 6. Definition of the standard of deferred
  payments. § 7. Increasing importance of the standard. § 8. Fluctuating
  standard and the interest-rate. § 9. Notable changes in prices.
  § 10. Nature and object of bimetallism. § 11. The movement for
  national bimetallism in America. § 12. Rising prices after 1896. § 13.
  Defectiveness of the gold standard. § 14. Various ideal standards
  suggested. § 15. The tabular standard.


§ 1. #Relative positions of gold and silver: historical.# It is not
possible within the limits of our space to enter here into the details
of the world's monetary history. It must suffice for our purpose to
sketch briefly the period preceding the nineteenth century. Both
gold and silver were used as moneys in Europe in the Middle Ages, tho
silver was much the more common. The two metals continued to be used
side by side in Europe and in the new settlements in America, silver
for the smaller and gold for many of the larger transactions.
Both were made legalized forms of money (and standards of deferred
payments) in units of specified weights and fineness, the weights
bearing a certain ratio to each other. Thus it was possible for a
debtor to discharge his obligations with that one of the two metals
that at the moment was the cheaper at the legal ratio. Fluctuations in
the prices of gold in terms of silver were at times such as to cause a
large part of the full-weight coins of one or the other metal to leave
circulation (in accordance with Gresham's law). So from time to time
the ratio was slightly changed by law in the various countries to
permit the circulation or to bring back the kind of money that had
been undervalued in terms of the other. But it is a very remarkable
fact that from the time of Xenophon until the discovery of America
(a period of nearly 2000 years), the market ratio of silver to
gold bullion in Europe remained pretty close to 10 to 1, being only
temporarily altered by sudden and unusual occurrences. From 1492 to
1660 the ratio changed to 15 to 1, where it remained with remarkable
stability until about the year 1800. At the establishment of the mint
of the United States in 1792 that ratio was found to exist. Men
had come to look upon the ratio of 15 to 1 as the natural order,
determined (it was sometimes said) providentially by the deposit of
the two metals in due proportion in the earth's surface. But as we
now see it, this in part was mere chance and in part was due to the
equalizing effect of the wide use of both metals so that the one could
be easily substituted for the other in case of a divergence of the
market ratio from the legal ratio as money. From the year 1500 until
1800 the Western hemisphere was the main source of the precious
metals, the alluvial deposits were widely scattered, were gradually
discovered, were usually found in small quantities, and were
extracted in primitive ways. The existing stock of precious metals,
gold and silver, more than other products of mine and field, is at any
time the accumulation of many years' production, and is changed very
little, proportionally, by a large change of output in any year or
short period. It changes in volume as does a glacier fed by the snows
of many years, not as does a river, filled by a single rainfall. For
a short time after the discovery of America (from 1493 to about 1544)
the average coining value[1] of the world's production of gold,
nearly all found in America, was about 1-1/2 times as great as that of
silver; but thereafter for three centuries from about 1545, the annual
value of silver produced was between 1-1/2 to 4 times as great as that
of gold, averaging about twice as great. Silver was the money chiefly
in use in the ordinary transactions in all of the principal countries
of the world.

§ 2. #Gold production, first half of nineteenth century.# We have now
to note some great changes in the production of gold in the nineteenth
century, changes both absolute and relative to that of silver. The
market ratio of the two metals had been gradually changing before 1792
and continued to change. Gold was slowly becoming more valuable in
terms of silver and the legal ratio of 15 to 1 in the United States
(at which both metals were admitted free to the mint) proved to have
undervalued gold. Gold largely left circulation and silver and bank
notes formed the greater part of our circulating medium. Then, in
1834, soon after the production of gold had begun to increase somewhat
more rapidly than that of silver, the legal ratio of the United States
was changed to 16 to 1. This brought a good deal of gold back into
circulation and gradually drove out most of the silver (the heavier
coins disappearing first).

In the decade 1841-50 the average annual value of the gold production
had, for the first time since the early sixteenth century, exceeded
that of silver. Then, from 1848 to 1850, came the great gold
discoveries in California and in Australia. In 1851 the value of gold
produced was one and one-half times that of silver; in 1852 was three
times, and in 1853 four times as great; and then slowly declined, but
continued every year as late as 1870 to be over twice as great.
This caused the displacement of silver by gold and drove out a large
proportion of the silver coins of smaller denominations. This led to
the law of 1853, authorizing subsidiary coinage (on government account
only) of lighter weight.[2] Let us observe the effect on prices that
was brought about by the discoveries of 1848-49, and, first, we
must consider briefly the method of measuring and expressing general
changes in prices.

§ 3. #Concept of the general price level.# The price of any good
is some other good or group of goods given for it in trade.[3] The
standard unit of money coming to be the most convenient expression for
price (whether or not money be actually passed from hand to hand in
that particular trade), prices usually are monetary prices, and
more specifically are prices in gold, or in silver, or in whatever
constitutes the standard money unit. But the price of each good is
a definite, separate fact, which expresses the ratio at which that
commodity is sold. The price of any particular kind of goods may
fluctuate in either direction as compared with the prices of other
goods at the same time. For example, iron and many other goods
may rise while wheat and many other goods fall in price. There is,
therefore, no such thing as an actual _general_ change in the prices
of goods in terms of money, but it may be seen that the prices of
large classes of goods, often of nearly all goods, change upward or
downward at the same time and in the same general direction. We
thus have need to distinguish between changes in the valuations of
particular kinds of goods in terms of each other and general changes
in the valuation of a number of different goods in terms of the
monetary unit.

To get some idea of whether such a general trend occurs, the algebraic
sum of all the changes in the particular prices of a selected group
of goods may be taken, and for convenience this may be reduced to an
average price (by dividing the sum by the number of articles). Such
an average is called a general price and, when comparing it with
the general price of another time, we speak of changes up or down
in _general prices,_ or in the _general scale of prices,_ or in the
_price level._

When gold is the standard unit, its value is the converse of general
prices; as prices go up the value of gold goes down, and gold is said
to _depreciate_. As prices go down, the value of gold goes up and gold
is said to _appreciate_. Rising prices mean falling value of gold (and
at the same time falling purchasing power), and _vice versa._

[Illustration: FIG. 2. INDEX NUMBERS OF PRICES. The four series of
prices here shown begin at different periods; the American in 1840
(Aldrich report 1840-1889 and Bureau of Labor from 1890 on); the
English in 1846; the German in 1851; the French in 1857. We have
adjusted each of these series to a base of the average prices for
1890-1899, in accord with the basic period used by the American Bureau
of Labor.

The reader must be on his guard against misunderstanding the diagram.
It does not represent the heights of the prices of the different
countries compared with each other either at any one date or for the
entire period. For example, the heights of the lines at the year
1860, do not indicate that American prices were lowest and French the
highest at that date, or, indeed, tell anything whatever directly
on that point. The various series of prices are compared within
themselves, every year with the average of the prices for 1890-1899 in
each country, respectively. The only comparison allowable, therefore,
between the several lines, is that between the fluctuations, both as
to their times and as to their directions, both as to the larger tidal
movements and as to the lesser wave-like movements within the business
cycles. The Figure does indicate that both American and German prices
have risen somewhat as compared with the English and French prices,
since the period before 1860.

This figure should be studied in connection with Figure 1, in ch.
4, sec. 9, on gold production. The Figures indicate that the rapidly
growing monetary use of gold offset a large part of the effects of
increasing gold production between 1840-1860 and 1884-1914. Between
1884 and 1896 prices actually continued to fall after gold production
had begun to climb. Likewise the growing monetary use of gold
accentuated strongly the effects, between 1873 and 1883 of a
comparatively small decrease in gold production.]

§ 4. #Index numbers.# The process of calculating general prices and
changes in them has in it, inevitably, something of arbitrariness and
incompleteness. For not all prices can be included, but only those
of articles of somewhat standardized grades and those that are pretty
regularly sold in markets where prices are publicly quoted. Any list
of articles that can be selected is of unequal importance to different
persons and classes of persons, at different places, at different
times, and for different purposes. And yet the study of general prices
as shown by any broadly selected list reveals changes which in some
measure affect the interests of every member of the community.

General prices are conveniently compared from one time to another
through the use of index numbers. An _index number_ of any article is
the per cent which its price at any certain date is of its price at
another date (or of the average for a series of prices) taken as a
base or standard. Thus if the average price of cotton in the base year
were 10 cents (taken as 100) and the price rose to 12 cents, the index
number would be 120. _A tabular index number_ is the per cent which
the price of a selected group of articles at any certain date is of
the price of the same group of articles at a date which has been taken
as the base.[4]

The principal index numbers of the leading countries are here shown.
The fact that from 1862 to 1879 inclusive prices in the United States
were expressed in an irredeemable paper standard makes comparisons for
that period misleading. A better idea is obtained by using as the base
for each of the several series, the average of prices in each country
for the years 1890 to 1899.

§ 5. #Gold production and monetary legislation, 1850 to 1879#. The
unprecedented increase in gold production between 1849 and 1853, and
the continuance of production in volume about four-fold as great as
that of the decade 1840-49 was reflected at once in a rise of prices.
This was a period of prosperity in business culminating in the
crisis of 1857 (felt more or less in all the leading countries). This
prosperity accelerated the effect of increasing quantities of the
standard money. Credit was stimulated and the rate of circulation and
the efficiency of money were increased. Prices rose to a temporary
maximum in 1857 and then fell as a great international financial
crisis occurred. The great new supplies of gold had been readily taken
("absorbed") into the monetary circulation of the world, to meet
the needs of rapidly growing commerce and industry. In the European
countries,[5] prices in terms of gold, tho fluctuating somewhat, kept
at about the same level from 1860 to 1870. The years 1871 and 1872
were very prosperous and showed rapidly rising prices which reached a
maximum in 1873, when a financial panic occurred.

In that very year, just as the gold production for the first time
since 1851 had fallen below $100,000,000, several notable changes in
monetary legislation were made which made gold more important in the
circulation of a number of countries.

In 1873 Germany made gold the standard throughout the new German
Empire (having prepared the way by legislation in 1871 which made
gold a legal tender alongside of silver), and provided that silver was
thenceforth to be used only in the subsidiary coinage. The same year
Belgium, and the next year the other countries of the Latin Union
(France, Switzerland, and Italy) took steps which resulted in
demonetizing silver; that is, in limiting its coinage to governmental
account, and in making gold their one standard money.

The United States at that time had neither gold nor silver regularly
in circulation (except in California), and there was a long-continued
discussion of "a return to specie payments," which meant the return
to a metallic standard, and the redemption of greenbacks on demand.
Meantime in 1873 a law was passed making the gold dollar "the unit of
value," and dropping out the standard silver dollar from the list of
coins authorized to be issued at the mint.[6] From 1873 until 1879,
prices (in greenbacks) were falling in this country very rapidly
because the country with the increase in population, wealth, and
business, was "growing up to" its unchanging currency supply. For a
like reason at the same time gold prices throughout the world were
falling. While this country was lowering its level of prices from an
inflated paper money to a gold commodity basis, the gold basis itself
was sinking to a lower level. The very demand of our treasury and
banks for gold caused the retention of our own gold product (which
between 1864 and 1876 had been nearly all exported) and required an
enormous net importation of gold between 1878 and 1888. This
reduced suddenly by one-half the amount available each year from our
production for the rest of the world.

§ 6. #Definition of the standard of deferred payments.# These various
changes in the purchasing power of the standard money had great
effects upon industrial conditions. Particularly had they shifted the
positions and claims of debtors and creditors, because of the enormous
importance of money as "the standard of deferred payments," Let us now
get a more definite understanding of that term.

As a medium of exchange, money comes to be the unit in which most
prices are expressed and compared; in other words, it becomes
the common denominator of prices.[7] This makes it also the most
convenient unit in which to express the amount of credit transactions
and of existing debts.[8] A credit transaction is a trade lengthened
in time; one party fulfils his part of the contract, the other party
promises to give an equivalent at a later date. The equivalent may be
in any kind of goods; for example, in barter one may part with a horse
on the promise of a cow to be received later; or a small horse on
the promise of a large one; or a flock of sheep on the promise of
its return at the end of the year with a part of the increase of the
flock. A simple standard in which to express the debt is the thing
borrowed, as horse, sheep, wheat, house. Again, the thing to which
the value of debts is referred may be a thing quite different from the
goods borrowed and, with the growth of the monetary economy and the
use of the interest contract, money comes more and more to be used as
the standard. At length the law declares that, in the absence of any
other agreement, the amount of a debt is to be payable in terms of the
unit of standard money, which thus is made legal tender as well as
the customary standard of deferred payments. A _standard of deferred
payments_ is the thing of value in which, by law or by contract, the
amount of a debt is expressed and payable.

§ 7. # Increasing importance of the standard.# Until the use of money
develops, the use of credit is difficult and limited; it becomes
easy when the value of all things is expressed in terms of a common
circulating medium. It therefore generally is true that the importance
of money as the standard of deferred payments increases with the
use of money as a medium of trade. The volume of outstanding debts
expressed in terms of money now very greatly exceeds the total value
of the circulating medium. Changes in the general level of prices
have, therefore, great effects upon all existing debts. The value of
all debts changes in the same proportion as does that of the standard
unit of money; when this rises or falls in value, it means increase
or reduction, in the same ratio, of the purchasing power of every
creditor. It is as if he had in his possession metal dollars equal
in amount to the face of the debt, and they had changed by so much
in purchasing power. The debtor's interests in such changes are, of
course, just the reverse of the creditor's interests.

Outstanding contract debts may be roughly divided into two classes:
short-time loans, running less than a year; and long-time loans,
running for a year or more.[9] Fluctuations are rarely rapid and great
enough to affect appreciably the debtors and creditors in the case
of short-time loans. The results are appreciable in the case of loans
running from one to five years, and may be very great in the case of
loans made for still longer periods, such as the bonded indebtedness
of nations, states, municipalities, and business corporations, and
as mortgages given by farmers on their land or by owners of city real
estate. A multitude of interests are thus affected by a change in the
value of money. When money rises in purchasing power, receivers of
fixed incomes are gainers. When it falls in purchasing power, they
lose. Receivers of fixed incomes from loans include not merely private
investors, but also many educational and charitable institutions which
dispense their incomes for public purposes. Wages and salaries of many
kinds go up and down less rapidly than do other prices, and thus
to some extent wage-earners are in the position of passive
capitalists[10] as regards changes in the monetary standard. In a
capitalistic age, therefore, almost every individual is affected in
some way by a change in the value of money.

§ 8. #Fluctuating standard and the interest-rate.# In connection with
the standard of deferred payments there is presented a problem of
the effect that fluctuations of the standard may have upon the
interest-rate.[11] As the general price-level falls or rises, the
monetary standard conversely appreciates or depreciates.[12] If these
changes are slight in amount and imperceptible in their direction
they may not affect considerably the motives of borrowers and lenders.
Therefore, the rate of interest this year in long-time loans would be
just that resulting in the expectation, on all hands, of a stationary
level of general prices. Suppose that rate to be 5 per cent on the
standard investment (such as real-estate loans and good bonds). Then
the lender of $1000 will receive each year a $50 income and at the end
of the investment period $1000 principal, each dollar of which will
purchase the same composite quantum of goods that a dollar would have
purchased at the time the loan was made. Likewise, the borrower would
pay interest and principal in a standard that reflected an unchanging
general level of prices. But, now, if the general level of prices
unexpectedly falls 1 per cent within the year, the creditor of a loan
maturing at the end of the year would receive (principal and interest)
$1050 which will purchase 1 per cent more goods per dollar than the
sum he loaned, or (approximately) $1060 worth of goods. Hence, he
has received, in quantum of goods, a yield of 6 per cent on his
investment. If this change continues for five years, the lender of a
five-year loan would receive each year $50 having a purchasing power
successively 1, 2, 3, 4, and 5 per cent greater than the same sum
had at the making of the loan; and at the end of the five years would
collect the principal, having a purchasing power 5 per cent greater.
The lender, on his part, would have to pay interest and repay the
principal in a money that is to be obtained only in exchange for a
larger sum of goods than that which could be bought with each dollar
that he borrowed. This means that, with individual exceptions,
creditors generally gain and debtors lose by falling prices.

But this is fully true only in respect to loans already made. For just
to the extent that such a movement of prices comes to be more or less
regularly in the same direction, both borrowers and lenders are able
to take it into account, and as experience shows, do take it into
account.[13] When prices fall men become more eager to sell wealth, to
lend the proceeds, and more reluctant to borrow for investment at the
prevailing rate of interest and at the prevailing prices. There is an
incentive to divest one's self of ownership (e.g., by selling stocks)
and to become a lender (e.g., by buying bonds). This whole situation
is reversed in a period of rising prices. The result is that the rate
of interest in any long continued period of falling prices (such as
from 1873 to 1896) has a trend downward and in a period of rising
prices (such as from 1897 to 1915) has a trend upward. This movement
of readjustment would not go on indefinitely, even if the same
trend of prices continued; for in the strict theory of the case the
adjustment would be complete when the interest rate had changed by
just the amount of the annual change in the level of prices. For
example, if 5 per cent is the static normal rate of interest, then
when prices are falling 1 per cent each year, the adjusted rate of
interest would be 4 per cent; and when prices were rising 1 per cent
each year, the adjusted rate of interest would be 6 per cent. Such
adjustments serve to some extent to neutralize the effects of changes
in the standard of deferred payments so far as concerns new loans made
in view of just such a change and in expectation of its continuance.
But no one can foresee exactly, and most persons take little account
of, such a change until it has continued for several years in the
same direction. The adjustment is therefore never very prompt or very
exact. In some years the general level of prices has risen more than
5 per cent, or more than enough to offset the entire interest received
by most lenders. A man with dollars to invest would have been as well
off if he had kept them buried during that period.[14]

§ 9. #Notable changes in prices#. In most cases the true effects of
monetary changes escape recognition. In a few cases, however, the
change has been so great as to cause an economic revolution. Such
was the change in prices following the discovery of America, which
occurred soon after the old feudal dues had come to be generally
expressed in terms of money instead of labor services. In modern
times, since the mass of debts has become greater than ever before,
such changes bring even graver economic consequence. The increase in
the output of gold in 1849-57,[15] caused what was the most rapid, if
not the greatest money inflation that had occurred since the sixteenth
century. The substitution of gold for silver by some countries at that
time, by making a great additional market for gold, helped to check
the fall in its value. Indeed, a considerable decline in the output
of gold after 1870 combined with its widening use to cause in 1873 the
beginning of a great fall of gold prices. The resulting increase
in the burden of outstanding debts was felt by all debtors, but
particularly by great numbers of the agricultural classes both in
Europe and in America. Their tribulations were aggravated by the fact
that at that time (especially from about 1873 to 1896) the prices
of their products were falling much more rapidly than were general
prices, as a result of the very rapid extension of the agricultural
land supply.[16] There was complaint, agitation, and demand for relief
on the part of many interests in France, Germany, England, and the
United States. As a result, the money question became in this country
a leading political issue and continued to be such between 1873 and
1900.

§ 10. #Nature and object of bimetallism.# First came "the greenback
movement," which, lasted until after 1880.[17] This then gave way to
an agitation for bimetallism. _Bimetallism_ is the plan of using two
metals as standard moneys. Bimetallism is legally authorized when both
metals are admitted to the mints for free coinage at an established
ratio of weight. Bimetallism may be legally authorized, but not
actually working, for, if the market-value long continues to vary
appreciably from the legal ratio, only one of the metals may in fact
be left in circulation. This situation is called _limping_ bimetallism
(or the halting double standard), tho this is a contradiction of
terms. National bimetallism is confined to a single country, as was
the case in the United States before the Civil War, or in France
before 1867. International bimetallism is that resulting from an
agreement among several nations to use two metals on the same terms.

The theory of bimetallism is that the government can act on the value
of the two metals through the principle of substitution. The metal
tending to become dearer will not be coined, the other will be coined
in greater quantities. The degree of influence that can thus be
exerted on the value of the two metals depends on the size of the
reservoir of the metal that is rising in value. When it all leaves
circulation, the law on the statute book permitting it to be coined
becomes a mere phrase. In such a case there is bimetallism _de jure,_
but monometallism _de facto._ The greater the league of states the
greater is the likelihood that the plan will continue to work. The
only notable historical instance of international bimetallism is
that of the Latin Union, which united France, Belgium, Italy, and
Switzerland in an agreement remaining actually in force from 1866 to
1874. A strong movement developed between 1878 and 1892 in favor of
forming a great international bimetallic union of states.

One object of the movement was to put an end to the great fluctuations
in the rates of exchange of money between the silver-using and
gold-using countries, fluctuations which occasioned much uncertainty
and loss to individuals engaged in foreign trade. The rise in the
price of gold-exchange in the silver-using countries (notably India)
meant also an increase in their burden of taxation. These countries
collected their revenues in silver, but they had to pay their debts,
principal and interest, in gold. Another object of this movement was
to prevent the burden of individual debts from increasing by reason
of the rise in the value of the single standard, gold. It was, indeed,
hoped that by bringing silver much more into use, the value of gold
would be reduced, thus bringing relief to the debtor classes. Still
another object of the bimetallic movement was to aid the silver miners
and silver-producing districts by creating a larger market for silver.

Several international conferences were held which were taken part
in by some of the leading financiers of the world representing their
respective governments. The United States was foremost in advocating
the policy, France at first favored it, as did in large measure the
British Indian administration, tho England was in the main opposed.
The movement came to nothing.

§ 11. #The movement for national bimetallism in America#. When all
hope of international bimetallism failed, the efforts of many of its
advocates were turned to the plan of legalizing national bimetallism
in the United States at a ratio of 16 to 1. This was very different
from the market ratio. Gold had become before 1860, in fact, the
standard of our money system, and after 1873 it was the only metal
admitted to free coinage. Silver, little by little, had been losing
purchasing power in terms of gold, until from being worth, in 1873,
one-sixteenth as much, ounce for ounce, it became, in 1896, worth but
one-thirtieth as much as gold. The power of silver to purchase general
commodities fell much less than the change in its ratio to gold would
indicate, gold having risen in terms of most other goods as well as
of silver. Nevertheless, the proposal to open the mints to the free
coinage of silver at the ratio of 16 to 1 in the year 1896 threatened
a sudden and marked cheapening of money.[18] Probably gold would have
been entirely driven out as money and silver would have taken
its place as the standard. In any event "free silver" would have
accomplished the purpose of making the standard of deferred payments
cheaper. It was at first a debtors' movement, but to succeed it had
to enlist the support of other large classes of voters. And thus
it developed into the more sweeping theory that wages, welfare, and
prosperity were favored by a larger supply of money quite apart from
the effect it would have upon debts.

In its extreme form the free-silver plan was a fiat scheme, for some
of its supporters believed that by the mere passage of the law the two
metals could be made to bear to each other any ratio desired. But its
most intelligent advocates recognized that the force of the law was
limited by economic conditions. The victory of the gold standard in
the campaign of 1896 was, it would seem, due more to the well-founded
fear that a sudden change of the money standard would cause a panic
than to a popular understanding of the question.

The free-silver advocates got what they desired, a reversal of
the movement of general prices, through an occurrence for which no
political party could claim the credit. In 1883 the gold production of
the world was less than $100,000,000. From that date, with the opening
of newer gold-yielding territory in South Africa and in the Klondike,
the annual output of gold had been increasing rapidly and almost
steadily. The methods of extracting gold theretofore had still been in
large part of a primitive sort. But intricate machinery was taking the
place of crude tools, chemical processes had been introduced (notably,
the cyanide process), and the principal product began to come from
the regular and certain working of deep mines rather than from chance
surface discoveries. In many parts of the world were enormous deposits
of low-grade ores, before useless, that could be worked economically
by the new methods.

The general price level fluctuated, but on the whole tended downward
between 1884 and 1893 (the year of panic), and reached a minimum in
the year 1895 in Germany, 1896 in England, and 1897 in America. It
is noteworthy that the very year 1896, which marked the height of the
political agitation to abandon the gold standard for silver, saw the
gold production for the first time in all history surpass the two
hundred million dollar mark. The gold output had caught up with, and
began to surpass, the normal monetary demands of the world, meaning by
that phrase, the amount of gold needed to maintain a stationary level
of prices.

§ 12. #Rising prices after 1896#. The whole character of the monetary
problem then changed. A period of rising prices set in, which has
continued to the present time. By 1913 prices had risen just about 50
per cent above the low level of 1896. The rise has been, and still
is, at the average rate of nearly 3 per cent each year. This caused a
reversal of the former positions of advantage and disadvantage on the
part of debtor and creditor respectively. The purchasing power of a
3 per cent annual interest on notes and bonds has been offset by the
decrease in the purchasing power of the principal of the debt. The
burden of the average debt began relatively to decrease. A wide field
for enterpriser's profits was opened up by the rapid displacement of
prevailing prices in all quarters of the industrial world. The price
of manufacturer's products rose in advance of the rise of costs of
many raw materials and especially of the labor costs of manufacture.
The average enterpriser's gain was the average wage-worker's loss.
Wages (and salaries), as nearly always in the case of a change of
price levels, moved more slowly than did the prices of most of the
commodities which are bought with wages, thus causing great hardship
to large classes living on comparatively slowly moving incomes.[19]
Extremes meet, and these classes include both those living on
passive investments, and those dependent on their daily labor for a
livelihood.

Thus we escape the evils of a rising standard of deferred payments,
only to meet those of a falling standard. And as long as we have so
fluctuating a standard these difficulties must arise again and
again, continually repeated, causing unmerited gains and losses
to individuals. Let us conclude with a brief consideration of the
fundamental principles involved in this problem.

§ 13. #Defectiveness of the gold standard#. Money is, in general, for
both borrowers and lenders the most convenient standard of deferred
payments. But from the usage of speaking of all things in terms of
gold, arises the popular notion that the value of gold is always
the same, while the value of other things changes. In truth, a fixed
objective standard of value is not possible of attainment. Altho the
value of gold is stable as compared with most things, it rests on the
estimates made by men and is constantly changing with conditions. The
current new supplies of gold are comparatively regular. For centuries
at a time there was little change in the methods of mining gold and
there were no radical changes in its output. The nature of the use of
gold, likewise, is such as to made changes in the amount of it needed,
under ordinary conditions, more stable than is that of most other
goods. Moreover, the stock of gold in monetary uses is but slowly
worn out; it is, therefore, a large reservoir into which flows a
comparatively small stream of annual production; the existing stock
is twenty or thirty times the annual output. Yet the value of gold
expressed in other things is never quite stable, and sometimes
several influences combine to affect it greatly and suddenly. Recent
inventions, chemical and mechanical, moreover, have considerably
altered the conditions of production. While, therefore, it is the
best standard yet devised and put into actual practice, it is very
imperfect. A standard better than a single metal, more stable than a
single commodity, is desirable if it can be found.

§ 14. #Various ideal standards suggested.# It may, perhaps, be agreed
that the ideal standard of deferred payments is one that would insure
justice between borrower and lender. Yet different views may be and
have been taken as to what constitutes justice in this matter. The
suggestion is attractive that repayment should involve the return of
enjoyment equal to that which could be purchased with the sum at the
time of the loan. Such a standard is impossible of perfect realization
in any general way, for men's circumstances are constantly changing.
To insure even to the average man the same amount of enjoyment is only
roughly possible. The same goods do not afford the same enjoyment
when conditions, either subjective or objective, have changed. Another
suggestion is that the goods returned should represent the same
sacrifice as those loaned. Here again the difficulty is in the lack of
a standard applicable to all men. Whose sacrifice? That of the lender,
who may be rich, or that of the borrower, who may be poor? Some have
supposed that the condition of equal sacrifices was met by the labor
standard, according to which the sum returned should purchase the same
number of days of labor as when borrowed. But what kind of labor is to
be taken, that of the lender or that of the borrower or that of some
one else? Labor is of many different qualities, which can be exactly
compared only through their objective value in terms of some one
good.[20]

It must be recognized that any possible concrete standard of deferred
payments will sometimes work hardship in individual cases. The best
average results for justice and social welfare will be secured by
measuring debts in some standard that will change least often, and
least rapidly, in relation to the great majority of people of all
classes in the community.

§ 15. #The tabular standard.# Apart from the difficulties of its
practical operation, a standard better than a single metal and
more stable than a single commodity would be a _tabular standard_,
consisting of a number of leading commodities in fixed proportions,
such as is used in calculating index numbers expressing the general
scale of prices. Such a standard averages the fluctuations of
particular goods and would give a fair approximation in practice to
the ideals of equal sacrifice and equal enjoyment (on the average tho
not in individual cases). While some natural materials are growing
more scarce and call for more sacrifice, other products are by
industrial progress becoming more plentiful. This kind of standard has
been viewed with favor by many monetary authorities, and despite the
administrative difficulties ways may yet be found for putting it into
practice.

After determining the tabular standard, the actual regulation of the
quantity of money to make prices conform to the standard might be
accomplished in one of several ways. It might be done by letting the
value of the gold dollar fluctuate as it does now, while requiring
a greater or less number of dollars to be given in fulfilment of all
outstanding contracts. For example, if prices by the tabular standard
fell from 100 to 95 in the time between the origin of a debt of $100
and its payment, the debt would be discharged by paying $95; if prices
rose to $110, the debt would be discharged only by the payment of
$110.

By the plan of a "compensated gold dollar" the legal weight of the
gold coins would be increased or decreased from time to time to
conform with the tabular standard. Still a third method would be to
regulate the issue of standard paper money, contracting and expanding
its amount by issue and redemption, by deposit in and withdrawal from
depository banks, at regular intervals to bring prices into conformity
with the tabular standard. These are as yet but distant possibilities,
and for some time to come gold will continue to serve as the standard
money in the same manner as in the past.


[Footnote 1: The amount of silver is here expressed at its coining
value; this is not the commercial value, but rather the number of
silver dollars 371.25 fine grains weight that could be made out of
the silver produced. Silver and gold of equal coining value are,
therefore, as to weight always in the ratio of 16 to 1.]

[Footnote 2: See above, ch. 5, sec. 4.]

[Footnote 3: See Vol. I, p. 45 ff. See also above, ch. 4, sec. 8.]

[Footnote 4: Numerous tabular index numbers have been worked out for
different countries and periods. The main results of the more recent
ones have been brought together with critical comments, by Professor
Wesley C. Mitchell, in Bulletin 173 of the U.S. Bureau of Labor
Statistics, July, 1915, from which the figures here used are quoted.]

[Footnote 5: The price movements in the United States between 1860 and
1879 must be left out of consideration here, for the excessive issues
of greenbacks drove gold out of circulation and made greenbacks the
standard money, except in California and elsewhere on the Pacific
Coast where, by public opinion, gold was retained as the circulating
medium.]

[Footnote 6: This change was what later was referred to in political
discussions as "the crime of '73." The dollar referred to was the
_standard_ silver dollar; at the same time the coinage of a _trade_
dollar was authorized (intended to be used only in foreign trade),
which, after 1876, was not legal tender in the United States.]

[Footnote 7: See Vol. I, p. 262.]

[Footnote 8: See Vol. I, p. 263, on credit transactions, and p. 302,
on the interest contract.]

[Footnote 9: See Vol. I, p. 304.]

[Footnote 10: See Vol. I, p. 319.]

[Footnote 11: This could not be treated in connection with the
interest-rate in Vol. I, Part IV, for the reason that even its
elementary treatment must presuppose the fuller study of the nature of
money and the study of changes in the level of prices, that has just
been given in this and the three preceding chapters. The theory of
interest in Vol. I, therefore, is a static theory in respect to the
standard of deferred payments, and requires adjustment to apply to a
condition of a changing price-level.]

[Footnote 12: See above, sec. 3.]

[Footnote 13: Mention was made in Vol. I of the prospect of profit
as affecting the motives of commercial borrowers; e.g., pp. 298, 335,
348, 495.]

[Footnote 14: The modern explanation of this phenomenon was worked out
in the period of falling prices before 1896 and hence was referred to
as the theory of "appreciation and interest" (meaning the relation of
the appreciating dollar to a falling rate of interest). More generally
the theory is that of the relation of a changing standard of deferred
payments and the rate of interest.]

[Footnote 15: See ch. 4, sec. 12, and above secs. 1, 2, 4, 5.]

[Footnote 16: See Vol. I, on agricultural leases, p. 159, wheat
prices, p. 436, and changes in the land supply, p. 442.]

[Footnote 17: See ch. 5, sec. 11.]

[Footnote 18: The advocacy of this proposal was called "the
free-silver movement" because it involved resuming the free coinage of
silver at the legal ratio of 16 to 1.]

[Footnote 19: This happened to coincide with a relative increase of
the price of food-products and of other necessities of daily life at
a greater rate than general prices. This aspect of the much discussed
rising cost of living must be carefully distinguished from that of
the change of the _general_ price level, and also from that of the
relatively slower change of wages. See Vol. I, pp. 437, 445-446 on
population and food supply.]

[Footnote 20: See on the labor theory of value, Vol. I, pp. 210,
228-229, 502.]




PART III


BANKING AND INSURANCE




CHAPTER 7

THE FUNCTIONS OF BANKS

  § 1. Nature and classes of banks. § 2. Functions of banks. § 3. The
  essential banking function. § 4. Time deposits. § 5. Demand deposits.
  § 6. Discount and deposit. § 7. Nature of banking reserves. § 8. Bills
  of exchange, domestic. § 9. Issue of notes. § 10. Divergent views of
  typical bank notes. § 11. Banking credit as a medium of trade. § 12.
  Productive services of banks. § 13. Income of banks.


§ 1. #Nature and classes of banks.# Banks perform a variety of useful
functions in every modern community. All these functions touch in some
way upon the use of money, and banking problems always are related to
money problems. It is our purpose now to understand the general nature
and work of banks in relation to the general business activity of the
community. A bank, as one first comes to know it, is a building (or
a room in some building) in which there is a fire- and burglar-proof
safe. In this room are men receiving and paying out money and acting
as bookkeepers. Gradually one comes to understand that the bank is
perhaps not the building but the business organization that is there
performing these transactions.

In the United States there were in 1913 about 26,000 banks
reported.[1] These may be classified first according to the source
from which they derive their charters or authority to do a banking
business as: national, state, and private. The last are unchartered
and act under the general state laws governing private contracts;
in general they are unsupervised.[2] Banks may be classified also
according to the two main types of business they perform, as banks
for savings and commercial banks. Most banks do mainly a general
commercial business; some are distinctly banks for savings; but in
truth this dividing line can be less and less sharply drawn between
banks as wholes; rather the distinction must be made between the
savings function and the commercial discount function, which are more
and more being performed by one and the same bank. The trust company
usually well exemplifies this union of functions. This will best be
explained in connection with the subject to which we now turn, the
analysis of the functions which banks perform.

§ 2. #Functions of banks.# Almost every bank performs various
functions useful to its customers, but some of which are not
essentially bound up with banking, and may be performed by
institutions that are not truly banks. Among these are:

(a) Maintaining a safe deposit vault, where space may be rented by an
individual to keep his valuable papers, jewels, etc. The customer
does not usually deliver to the bank possession of the valuables,
but himself retains the key to the box which the bank has no right
to open. In larger cities this work is often done by separate
institutions.

(b) Acting as money-changer to buy and sell moneys of different
nations. This function is of less importance in America than elsewhere
because of the great size of our country and of the small portion
of our boundaries touching those of other nations using different
monetary units. Moreover, the function is in large part performed for
Americans by ticket agencies at the ports of embarkation and by the
steamship companies en route.

(c) Selling bonds and other investments to customers. In smaller
communities the customers of a bank turn to it as the best source
of information for safe investments of personal or trust funds. This
opens to it a new possibility of service. Large investments, however,
are usually made through the agency of more specialized investment
brokers.

(d) Acting as trustee and business manager for passive investors, and
especially as executor and administrator of estates or as guardian of
a minor heir. This function has been taken up rapidly since about 1890
by the trust company[3] organized under state laws.

§ 3. #The essential banking function.# The one essential function of
a bank, however, is selling (lending) its credit to its customers in
some form which will conveniently serve the same function as money. A
bank is sometimes defined as a business whose income is derived from
lending its promises. The bank's credit is sold in the form of its
promises, the evidences of which are its receipts, depositors'
account books, drafts and checks on other banks, and bank notes. The
indispensable condition to the exercise of this function by a bank is
public confidence in its ability to fulfil its promise to pay whenever
it is due. This confidence is built upon the bank's paid-up capital;
its surplus and undivided profits: the further liability of the
stockholders to make good any losses up to an amount equal to the
capital stock each holds ("stockholder's double liability");
the financial prestige of the bank's officers, directors, and
stockholders; the bank's established reputation and "good will" in the
community after a period of successful operation; the character of
its loans and of the securities which it owns; and, finally, by the
reliance placed in the control and inspection by official examiners.
The bank may then sell its credit in any one or in all of the
following five ways: (1) by receiving time deposits; (2) by receiving
demand deposits; (3) by the method of discount and deposit; (4) by
selling exchange of funds to distant points; (5) by issuing bank
notes.

§ 4. #Time deposits.# Time deposits are funds to the credit of
customers which, by agreement, are to be left for some specified
minimum time or on condition that the bank may require notice in
advance of the depositor's intention to withdraw them. The notice that
may be required is usually thirty to ninety days; but only in times
of general financial crises or of runs on particular banks is this
requirement enforced. A sufficient deterrent to irregular withdrawal
of funds is usually found in the loss of interest if deposits are
withdrawn at other than stated times. The bank's right to require
notice makes prudent the investment of a much larger proportion of its
deposits and for a longer time; it reduces the proportion of deposits
needed for reserves, and yet reduces the danger of a "run" upon the
bank in time of financial distress. These are reasons why banks can
and usually do pay interest on time deposits (at from 2 to 4 per
cent), as until more recently they rarely did on demand deposits[4].
From the standpoint of the depositor a time deposit is, by its very
nature, an investment and not a demand credit available for current
monetary uses. Only that portion of a person's capital that for some
more or less considerable period is not likely to be needed for other
purposes ought to be put into time deposits. A bank, however, is
generally a much safer place in which to keep a fund of purchasing
power for the future than is the strongest private treasure box.
Receiving time deposits is the one essential function of savings
banks, but this function is increasingly performed by other banks[5].
Sometimes time deposits are cared for by a separate department and
kept separate from the general business of a commercial bank.

§ 5. #Demand deposits#. Demand deposits are those payable on demand,
the demand in practice being by means of personal checks requesting
the bank to pay to (or on the order of) a specified person, or to pay
to bearer. A customer's bank account consisting of demand deposits is
called a checking account. Since the turn of the century it has become
increasingly the practice to pay a low rate of interest (about 2 per
cent) on current balances, oftener to large depositors. Banks attract
demand deposits mainly by the convenience and economy which they offer
to their customers in the guarding of funds from theft and fire and
in saving the time, trouble, and expense of carrying money for making
payments. A deposit in a bank is to the depositor for most purposes
"just as good" as money in the pocket and for many purposes is
even better. Thus the banks have become the custodians of a large
proportion of the money (or funds) needed for current use by
individuals and business corporations.

§ 6. #Discount and deposit#. The process of discount and deposit is
the purchase of the promissory note of a customer,[6] the price being
a credit in the form of a demand deposit on the books of the bank.
This--the central and most characteristic banking operation--has
something of mystery in it at first view. The simplest idea of making
a deposit is that of bringing to a bank window bags and rolls of money
or other funds (credit papers such as checks and drafts, calling for
the payment of money). The bank in that case becomes the debtor and
the depositor becomes the creditor of the bank. But in discount and
deposit the depositor brings no money, and the credit paper that he
gives is his own promise to pay whereby he becomes the bank's debtor.
For example, when a bank discounts a thousand dollar note for three
months and credits its customer with the proceeds, its deposits are at
that moment increased (let us say) $985. Notice that hereby the bank
does not add a cent to the cash in its vaults while it has added to
its liabilities payable on demand. As an off-setting asset it holds
the note of its customer receivable at some future time.

§7. #Nature of banking reserves#. Banks would have nothing to gain by
receiving deposits or by issuing notes if they were obliged to keep
in the vaults actual money to the amount of their deposits and
outstanding notes (unless they were paid by depositors for taking care
of deposits). Banks have found it necessary in practice to keep on
hand money amounting to only a fraction of all their outstanding
obligations in order to be able to pay promptly all due demands,
excepting in periods of general financial distress. The sum thus kept
on hand is called the _reserve_ or the _reserves_ of the bank, and
this is frequently expressed as a percentage of reserves against
deposits or against note issues, respectively. Frequently, as in the
United States, a minimum percentage of reserves is fixed by law.[7]

A bank's reserves consist, first, of the lawful money which it
actually holds in its vaults at any moment and secondly, of certain
other credit items in other banks or with the government, of such
a nature that a bank is permitted to count them as tho immediately
available.

The explanation of the adequacy of a mere fractional reserve is
found in the nature of the individual monetary demand[8] and in the
effective way in which a checking account serves as a substitute for
actual money.[9] Every customer, if he would avoid overdrawing his
account, must at most times keep a goodly balance to his credit that
he does not immediately need. Many individuals and corporations must
at times keep very large balances. The times of maximum monetary need
of the customers of a bank never exactly coincide and many payments
are made among the customers of a single bank, requiring only
bookkeeping transfers. A fractional reserve is therefore ordinarily
fully adequate, altho with any less than a 100 per cent reserve
any bank would be insolvent if all of its demand obligations were
presented at the same instant. Such a contingency is made impossible
by business custom and public opinion especially among the larger
customers of banks, but the panic of small depositors often brings
about dangerous conditions.

§ 8. #Bills of exchange, domestic.# Foreign and domestic exchange
is the sale of orders for the payment of specified sums of money
at distant points. But for this, payments at distant points would
ordinarily have to be made by sending the money in some way. It must
often occur, for example, that hundreds of payments, aggregating
millions of dollars, must be made by persons in and near Chicago to
those in and near New York, while, at the same time, equally large
sums are due from New York to Chicago. The wasteful process of
shipping these sums back and forth is avoided by the cancellation of
indebtedness between the two localities. It has been the practice for
each small bank to keep a part of its legal reserves in correspondent
banks in one or more of the larger cities on which it draws bills
of exchange for its customers and to which in turn it remits for
collection drafts and checks which it has received. From time to
time, as balances of accounts increase on the one side or the other,
shipments of actual money become necessary, but these are only a small
fraction of the total amount of the bills of exchange. Similarly, the
settlement of accounts between any two localities can be made by
the shipment of comparatively small sums of money. Under the Federal
Reserve Act the reserve banks are in various ways assuming the
functions of the correspondent banks.

The wider use and acceptance of individual checks at long distances
from the banks upon which they are drawn limit by so much the
proportion of special bills of exchange drawn by the banks themselves.
Domestic exchange involves just the same principles as foreign
exchange of funds, except that in the latter, usually, two different
units of standard money are used. In connection with the discussion of
foreign trade below, foreign exchanges will be explained and further
light will be thrown upon the adjustment of the money supplies and
levels of prices of the various sections of a single country as well
as between different countries.

§ 9. #Issue of notes#. The issue of bank notes as a mode of lending a
bank's credit calls for consideration here. Yet it must be observed
at once that comparatively few banks in the world have now the legal
right to issue their own notes. In some cases the right has been
granted as a monopoly to certain banks in return for specified
payments and services. But in general the function of bank note
issue has come to be treated as so closely connected with that of
the coinage and regulation of the standard money that it has been
increasingly limited in each country to a central national bank,
or group of banks, which is in many respects practically if not
technically an organ of the government. This public nature of bank
note issues has been strikingly evident in Russia, England, France,
Germany, and other countries since the outbreak of the war in 1914.

No two countries have quite the same system and kind of bank notes.
It is well to consider first, therefore, the qualities of typical bank
money. This consists of notes issued by banks on the credit of their
general assets, without special regulation by law. With such a form of
note we have had until 1914 no experience in the United States since
1866, at which time a federal tax of 10 per cent on state bank notes
made their issue unprofitable. Since the passage of the Federal
Reserve Act we have temporarily two kinds of national-bank notes, the
old bond-secured notes, in use since 1863 (very different from the
typical form),[10] and the new kind of Federal reserve notes very
nearly typical in character but issued only by the Federal reserve
banks, not by individual banks.

A bank, by the issue of notes, puts into circulation as money its own
promises to pay. The customer, in borrowing money or in withdrawing
deposits or cashing checks and drafts from other banks, is paid with
the bank's notes instead of with standard money. These notes may be
returned to the issuing bank either to be redeemed in specie or to be
paid in some other form of credit, such as deposits or exchange. The
limit of the issue of such notes is the need of the community for that
form of money, and if they are promptly redeemed in standard money on
demand, they never can exceed that amount. A holder of a note (in the
absence of special regulations) has the same claim on the bank that
a depositor has. As it is to the interest of the bank to keep in
circulation as many notes as possible, there is a temptation to abuse
the power of note issue, to which many banks in America yielded in the
period of so-called "wild-cat" banking before the Civil War.

§ 10. #Divergent views of typical bank notes#. Some persons seeing in
bank notes but a form of ordinary commercial credit (like a promissory
note or an individual's check) have contended that their issue should
be entirely unlimited and unregulated except by the ordinary law of
contract which makes the bank liable to redeem the notes on demand.
Such bank notes would not be legal tender, and every one would be free
to take or refuse them as he pleased. Each bank would thus put into
circulation as many notes as it could, and as they would constantly
be returned for redemption when not needed as money their volume would
expand and contract with the needs of business.

It may be conceded that there is much truth in this view, but not the
whole truth. For, in reality, when bank notes are in common use, every
one is compelled to take the money that is current. This offers a
constant temptation to the reckless and unscrupulous promotion of
banking enterprises, as has been repeatedly shown (notably in America
in the days of "wild-cat" banking before 1860). The average citizen
cannot know the credit of distant banks, and thus has not the same
power of judging wisely in taking bank notes that he has even in
making deposits in the bank of his own neighborhood. Between bank
notes and ordinary promissory notes there are other differences. Bank
notes pass without endorsement and thus depend on the credit of the
bank alone, not, like checks, on the credit of the person, from whom
received. Unlike ordinary promissory notes, they yield no interest
to the holder. They go into circulation and remain in circulation for
considerable time by virtue of their monetary character in the hands
of the holders. Thus they approach political money in their nature,
and the banks are near to exercising the sovereign right of the issue
of money.

At the other extreme of view have been those who consider bank notes
to be essentially of the nature of political money. If they are so, it
is argued, the power of issue should not be exercised by any but the
sovereign state. In this view it is overlooked that bank notes, unlike
inconvertible paper money, depend for their value on the credit of the
bank, not on their legal-tender quality and on political power.[11]
They must be redeemed on penalty of insolvency; government notes need
not be, and yet will circulate at par if properly limited. Adequate
provision for the prompt return and redemption of bank notes makes
them "elastic" in their adaptation to monetary needs, which fluctuate
with changes in commerce and industry from season to season and even
from day to day.

The predominant opinion to-day is that in their economic nature bank
notes share to some extent the character both of private promissory
notes and of political paper money. They stand midway between the two.
Everywhere it has come to be held that the issue of paper money of any
kind is in its nature a public monopoly, and yet everywhere the
bank note policy has come to be that of permitting the issue only to
certain institutions, under strict public legislation and regulation,
and of requiring in return for this privilege some substantial
services or payments to the government.

§ 11. #Banking credit as a medium of trade.# The credit which, in five
ways, banks sell (see above, section 3) serves, in most cases, the
purposes of money to their customers. This is least true of time
deposits, for the motive of the depositor in such cases is usually to
_invest_ his funds for a time rather than to keep them available as
money. However, there are many cases in which persons save for some
moderately distant use--such as the purchase of furniture, of a piano,
of a house. The safety and convenience of time deposits, combined
with the reward of a small rate of interest, cause great sums, in the
aggregate, to be deposited as _temporary_ savings, which otherwise
would be hoarded in the form of money and thus withdrawn from
circulation. In all such cases the time deposit is serving both as
an investment and as a monetary fund for future use. This is a great
economy in the use of money, for experience shows that in the savings
banks of America the average reserves of actual money kept against
deposits are only about 1-1/2 per cent. In countries where banks are
little known, the amount of actual money hoarded is therefore vastly
greater than it is in the United States where there are $5,000,000,000
of individual deposits in _regular_ savings banks, besides large sums
in time deposits in commercial banks.

Demand deposits, while not money, clearly perform the function of a
reserve of purchasing power for depositors and reduce by so much the
amount of money each must keep at hand to meet his current needs of
purchasing power. If the depositor's credit balance bears no interest,
he has no motive to keep a balance greater than he would require
of actual money, and he has the motive to spend it or invest it in
income-bearing capital whenever his balance (plus his cash in hand)
exceeds his monetary needs.[12] Thus demand deposits are often spoken
of (somewhat inaccurately) as "deposit currency," being funds at
the command of depositors which are as disposable and as active and
current for the monetary function as so much actual money would be.
It is estimated that the rate of turnover of deposits in the United
States is about 50 times a year. We may view the demand deposits
subject to check as either a substitute for money or as a means by
which the rapidity of circulation and the monetary efficiency of
actual money held in bank reserves is multiplied many fold.[13]

The method of payment by bank drafts in domestic exchange reduces the
need for, or increases the efficiency of, money in just the same way
as does the use of checks. By the mutual credit of banks in different
parts of the country, very large payments may be made in both
directions with the movement of only the comparatively small amount
of physical money needed to pay the balance after the cancellation of
drafts, bills of exchange, and checks.

The use of bank notes reduces the amount needed of other kinds
of money more directly, tho not more effectively, than do deposit
accounts. Bank notes _are_ money, and so long as their amount is
limited by prompt redemption they circulate _instead of_ so much of
other kinds of money. Redemption is possible by the use of a reserve
of standard (or of legal tender) money very much smaller than the
amount of notes outstanding.

§ 12. #Productive services of banks.# There have always been some
erroneous ideas regarding the magic power of banks to multiply the
power of money. But there should be no more of mystery about
banking credit than about the nature of money itself. Banks are the
labor-saving machinery of finance. They gather loanable funds, reduce
hoarding, make money move more rapidly, and create a central market
between borrowers and lenders for the sale of credit. While not
creating more physical wealth directly, they add to the efficiency
of wealth; they simplify and quicken the movement of nearly all
commercial transactions. Banks perform incidentally a further service
in developing better business methods in the community. They enforce
promptness and exactitude in business dealings. In supplying credit to
enterprises, banks are constantly passing judgment on the collateral
security presented to them and on the soundness of the enterprises
that are seeking support. This gives to bankers great economic power,
capable at times of misuse in political and social affairs, especially
where a group of selfish men come to exercise a practical monopoly of
business credit in any community.

§ 13. #Income of banks.# The income of banks is drawn from different
sources, according to the size of the community and the nature of the
banks. While in the villages and smaller cities the commercial banks
perform a number of functions, in the larger cities they usually
specialize in a far greater degree. The trust companies, however, with
their greater versatility, are increasing in number. The income
of banks is derived from discounts, interest on their own capital,
charges for exchange and collection, dividends, interest and rents on
investments, and profit from their bank notes. The capital with which
a bank starts in business[14] could be loaned with less trouble and
more cheaply without starting a bank, but used as a banking capital it
can be loaned in part while still serving to attract deposits, which
are the main source of the income of banks to-day. Charging smaller
customers for exchange is a source of income to some banks, but in
many cases this service is freely performed for regular customers and
becomes a considerable expense. Banks make few investments in real
estate or other physical property; it is, in fact, their duty to keep
out of ordinary enterprises, but they are forced sometimes to take for
unpaid debts things that have been held as security. Profits on
bank notes have at times been the main, almost the sole, motive for
starting banks; but that is not the case to-day when the right of
issue is so strictly limited.

[Footnote 1: These are classified as follows:

                              _Number_       --_Per Cent_--
  _National charter_:                            28.56
    National banks             7,404    28.56
  _State charter_:                               67.52
    State banks               14,011    54.05
    Loan and trust companies   1,515     5.84
    Savings banks              1,978     7.63
  _Private_:                                      3.92
    Private banks              1,016     3.92
                              ------   ------   ------
                              25,924   100.00   100.00
]

[Footnote 2: Opinion favors prohibiting the use of the word bank
to any except regularly incorporated organizations, or at least
subjecting private banks to the same supervision as the chartered
banks.]

[Footnote 3: Not to be confused with a trust in the sense of a
monopolistic enterprise, with which it has no connection except by
mere verbal accident, through the word trust.]

[Footnote 4: See next sec.]

[Footnote 5: The Federal Reserve Act of 1913 has given encouragement
to this practice by reducing to 5 per cent the reserve required to be
kept against time deposits. See ch. 9, sec. 7.]

[Footnote 6: Usually with deduction of interest in advance; a process
called discount. See Vol. 1, pp. 275, 302.]

[Footnote 7: The legal requirements as to minimum reserves vary
greatly from no specific per cent to 40 or more in different
countries, for different classes of banks, and for different purposes.
Some examples of legal reserve requirements in the United States occur
in the two following chapters.]

[Footnote 8: See above, ch. 4, sec. 5.]

[Footnote 9: See below, sec. 10.]

[Footnote 10: Including, now, some Federal Reserve bank notes secured
by United States bonds.]

[Footnote 11: In some cases, as during the bank restriction in
England, 1797-1821, bank notes become inconvertible--practically
political money.]

[Footnote 12: Payment of interest on credit balances reduces the
motive to withdraw for investment elsewhere any such excess, and
mingles in the depositor's thought monetary and investment motives.]

[Footnote 13: In the United States in 1914 there were individual
deposits reported in banks other than savings banks to the amount of
about $13,400,000,000

  In national banks ..................................  $6,000,000,000

  In state banks .....................................   3,250,000,000

  In loan and trust companies .......................... 4,000,000,000

  In private banks .....................................   150,000,000

Nearly all these were doubtless demand deposits (what proportion were
time deposits we have no data for determining), and were available as
immediate purchasing power for the depositors. The total money (other
than bank notes) in the commercial banks of the country was hardly 11
per cent of this amount. In that year the total amount of money of all
kinds in circulation (and in banks) in the United States (outside the
Treasury), including gold and silver and certificates represented
by bullion in the treasury, United States notes of all kinds, and
national bank notes, was about one fourth of the amount of these
individual deposits in commercial banks. This may suggest the enormous
influence that banking has in determining the average efficiency of
the circulating medium of the country.]

[Footnote 14: See above, sec. 3.]




CHAPTER 8

BANKING IN THE UNITED STATES BEFORE 1914

  § 1. The First and Second Banks of the United States. § 2. Banking
  from 1836 to 1863. § 3. National Banking Associations, 1863-1913.
  § 4. Defects of our banking organization before 1913. § 5. Lack of
  system. § 6. Inelasticity of credit. § 7. Periodical local congestion of
  funds. § 8. Unequal territorial distribution of banking facilities.
  § 9. Lack of provision for foreign financial operations. § 10. The
  "Aldrich plan."


§ 1. #The First and Second banks of the United States.#

A knowledge of the history of banking is helpful to an understanding
of the present banking system in our country. The form of our present
banking system has been affected by various economic and political
events which will be sketched here in broad outline to give a
background for our present study.

Alexander Hamilton, the great first Secretary of the Treasury in
Washington's cabinet, advocated the charter of a central national
bank as one portion of his larger plan of national financiering. His
purpose was realized in the chartering, in 1791, of the First Bank of
the United States, for a period of twenty years. The capital for this
institution was in small part subscribed by the government, but mostly
by private capitalists. The management of the bank was left almost
entirely in private hands. The central bank established branches
in many parts of the country, issued bank notes which circulated
everywhere without depreciation, acted as the governmental depository
of funds and as governmental agency in various ways. It seems to
have been successful and useful as a banking institution until
the expiration of its charter in 1811, but it was touched by the
contemporary controversies over state rights and was from the first
opposed by those who feared the growth of a strong central government.
This opposition prevented the extension of its charter.

In 1816, however, after only a moderate discussion, the Second Bank
of the United States was chartered for a period of twenty years. This
also, in its purely banking aspects, seems to have been distinctly
successful, conducting numerous branches in various parts of
the country, maintaining at all times the parity of its notes,
facilitating domestic exchange throughout the country, and enjoying
unquestioned credit and solvency. However, this bank became, even in
a greater degree than did the First Bank, the creature of political
rivalries. In the period of rising democratic sentiment typified
and led by Andrew Jackson, the bank came to be looked upon as the
embodiment, or the stronghold, of plutocratic interests, and Congress
permitted its charter to expire by limitation in 1836, near the close
of Jackson's administration.

§ 2. #Banking from 1836 to 1863#. The Federal Government, which up to
that time had deposited its funds in the central bank and its branches
and in local state banks, established the "independent treasury," in
1840 (abolished in 1841 and re-established in 1846). By this plan the
government kept its money of all kinds in various depositories (or
sub-treasuries) in charge of public officials. While from 1792 to 1836
almost continuously a central banking system was in operation, other
banks, organized under state charters, were steadily increasing in
number. They received deposits, issued bank notes under state laws,
and cared for local commercial needs. The abolition of the central
national bank in 1836 left to the various state banks for twenty seven
years all the banking functions of the country. The banks of some
states (notably those of New England and New York), under careful
regulation and held to strict standards by public sentiment, for the
most part maintained a high credit; but many banks, under lax laws and
regulations, were guilty of great abuses of credit and of downright
dishonest practices. The evils were more especially evident in
connection with excessive issues of bank notes.

§ 3. #National Banking Associations, 1863-1913#. The next step in
federal legislation was taken in 1863 in the midst of the Civil War by
chartering local "national banking associations." The purpose was in
part to provide banks under national charters for banking purposes
(both of deposit and of issue), and in part it was to make a wider
market for United States bonds at a time when government credit was
at low ebb. The plan adopted followed the experience of New York state
(1829 on) with a system of bond-secured bank notes. Congress provided
that every bank taking out a national charter must purchase bonds of
the United States and deposit them with the treasurer of the United
States, in return for which it would receive bank notes to the amount
of 90 per cent of the denomination or of the market value of the
bonds.[1] Bank notes issued on this plan, being secured by the bonds,
rest ultimately on the credit of the government, not on the credit of
the bank. They are not promptly sent back for redemption to the banks
issuing them, as should be done if they were typical bank notes. They
may circulate thousands of miles away from the bank that issued them,
and for years after the bank has gone out of business. They are not
an "elastic currency," increasing or diminishing with the needs of
business. The changes in their amount depend upon the chance of the
banks to make more or less in this way than by any other use of their
capital, and this in turn depends largely on the price of bonds and on
the rate of interest they bear. From 1864 to 1870, fortunes were made
from this source, but thereafter banks could make little more from
note issues than they could by investing the same amount in other
ways. Many banks for a long period did not avail themselves in the
least of their privilege of issue. The notes were subject to a tax.[2]

A national bank (as the law now stands) may be organized, with $25,000
capital in towns not exceeding three thousand population, with $50,000
in towns not exceeding six thousand, with $100,000 in cities not
exceeding fifty thousand, and with $200,000 in large cities. Three
cities, New York, Chicago, and St. Louis, have long been designated as
central reserve cities, and some 47 other cities as reserve cities,
in which the reserves of banks were required to bear a considerably
larger proportion to their deposits than in other cities.[3] Other
banks might count as part of their legal reserves their deposits in
reserve city banks, up to a certain proportion. The national banks in
the larger cities thus became the great capital reservoirs of cash for
the whole country.

National banks have been subject to stricter inspection than have been
the banks in most of the states, a fact which has strengthened public
confidence in their stability. Except in this and the other respects
above mentioned, a national charter offered few, if any, attractions
to small banks, a majority of which have found it more advantageous to
operate under state charters because of less stringent regulations as
to amount of capital, reserves, and supervision.

§ 4. #Defects of our banking organization before 1913#. Taken
altogether, the banks in the United States since 1868 have represented
great banking power and very efficient service for the community in
times of normal business. But in several respects it long ago became
evident that our banks were operating less satisfactorily than those
of several other countries. American banking organization had failed
to keep pace with the increasing magnitude and difficulty of its
task. Especially at the recurring periods of financial stress, such as
occurred in 1893, 1903, and 1907, our banking machinery showed itself
to be wofully unequal to the strain put upon it. Financial panics
were more acute here than in any other land, and the evil clearly
was traceable in large part to defects in the banking situation. In
academic teaching and in public conferences of bankers, business men,
publicists, and students, the subject was continually discussed
after 1890. At length Congress in 1908 created a "National Monetary
Commission" to inquire into and report what changes were necessary and
desirable in the monetary system of the United States or in the laws
relative to banking and currency. After the most extended inquiry
and discussion that the subject had ever received, the commission
submitted its report in January, 1912. The defects to be remedied,
as enumerated in the report,[4] may be reduced to the following five
headings: (a) Lack of system, (b) Inelasticity of credit, (c) Periodic
local congestion of funds. (d) Unequal territorial distribution of
banking facilities. (e) Lack of provision for foreign banking.

§ 5. #Lack of system#. Only in a loose sense could the banks of the
United States be said (before 1914) to constitute a system at all.
Both national and state laws dealt with individual banks only. It was
not legal for a bank to establish branches in another city as is done
in most countries. The several national banks in one city were legally
quite separate. It was only by voluntary agreement that in some of
the larger cities they came together into clearing-house associations.
They made possible some measure of coöperation which, small as it
was, proved at times of stress to be of much service within a limited
sphere for the local communities. But even with the aid of these
organizations the banks were unable in times of emergency to avoid the
suspension of cash payments.

There was no provision whatever for the concentration of bank revenues
so that each bank would be supported by the strength of the other
banks, if a movement began to withdraw deposits in unusual amounts.
Each bank then was compelled for self-protection to call for any sums
it had deposited with other banks,[5] and to keep for its own use all
the reserves it might have in excess of its own immediate needs. This
threw a great strain upon the banks in the reserve cities, which
in normal times had become the depositories of a good part of the
reserves of the banks in other places. Thus developed a spirit of
panic, like the fright of theater-goers crowding toward the door at
the cry of fire.

The maintenance of the government's independent treasury contributed
to the difficulties by causing the irregular withdrawal of money from
circulation and thus depleting bank reserves in periods of excessive
government revenues and by returning these funds into circulation only
in periods of deficient revenues. Efforts to modify this system by
a partial distribution of the public moneys among national banks had
resulted, it was charged, in discrimination and favoritism in the
treatment of different banks and of different sections of the country.

§ 6. #Inelasticity of credit#. Our banks, considered both separately
and collectively, were unable to increase their loaning powers
quickly and easily to respond to business needs. The need of greater
elasticity of credit was felt in the more or less regular seasonal
variations within the year, and in the more irregular variations
in cycles of years from periods of prosperity to those of panic and
depression in business. The inelasticity was necessitated by illogical
federal and state laws restricting absolutely the further extension of
credit when the reserves fell below the percentage of deposits (15 or
25 per cent) fixed by law. Reserves thus could not legally be used to
meet demands for cash payments at the very time when most needed.
This feature has been likened to the rule of the liveryman who always
refused to allow the last horse to leave his stable so that he would
never be without a horse when a customer called for one. The refusal
of credit by the banks at such times when they still had large amounts
of cash in their vaults increased the need and eagerness of the public
to draw from the bank all the cash they could, and often precipitated
the insolvency of the banks. Clearly some means were needed to enable
the loaning power of the individual banks to be increased at such
times, so that no customer with good commercial paper need fear to
be refused a loan, even tho the rate of interest might have to be
somewhat higher for a few days or weeks than the normal rate.

Our bond-secured bank notes lacked almost entirely the quality of
elasticity needed to meet these changing business needs.[6] Their
value being dependent primarily upon the amount and price of United
States bonds, they might be most numerous just when least needed as a
part of our circulating medium.

§ 7. #Periodical local congestion of funds#. In times of general
confidence each bank finds it profitable, and is tempted, to extend
its credit to the extreme limit permitted by the law governing the
proportion of reserves to deposits. Of the 15 per cent reserves
required in most banks, three-fifths (9 per cent) might be kept in
banks in reserve cities, and of the 25 per cent in reserve city banks,
12-1/2 per cent might be kept in central reserve cities, where it
counted as part of the depositing banks' legal reserves, was a fund
upon which domestic exchanges could be drawn, and usually earned a
small rate of interest (usually 2 per cent). Very large reserves were
kept in New York city where they could be loaned "on call," and the
largest use for call loans was in stock-exchange speculation. Thus
every period of prosperity encouraged an unhealthy distribution of
reserves, gave an unhealthy stimulus to rising prices, and "promoted
dangerous speculation."

§ 8. #Unequal territorial distribution of banking facilities.# Another
aspect of this concentration of surplus money and available funds in
the larger cities was the comparatively ample provision of banking
facilities in the cities and in the manufacturing sections, and
imperfect provision in the agricultural districts. The whole financial
system seemed designed to induce the poorer country districts to lend
funds at low rates of interest to be used speculatively in cities,
instead of enabling the richer districts, the cities, to lend to the
rural districts for productive enterprise. The rates of bank
discount in different sections of our country have long been most
unequal--lowest in the largest cities, and highest in the rural South
and West--whereas in all parts of Canada, with a different system of
banking, the rates have long been much more approximately uniform.

Indeed, our national banking development has been predominantly urban
and commercial to the neglect of rural and agricultural interests.
National banks were (until 1913) forbidden to make loans on real
estate, and this greatly "restricted their power to serve farmers and
other borrowers in rural communities." There was "no effective
agency to meet the ordinary or unusual demands for credit or currency
necessary for moving crops or for other legitimate purposes." The lack
of uniform standards of regulation, examination, and publication of
reports in the different sections prevented the free extension of
credit where most needed. Finally, the methods and agencies for
making domestic exchange of funds were, compared with other countries,
imperfect and uneconomical even in normal times and could not "prevent
disastrous disruption of all such exchanges in times of serious
trouble."

§ 9. #Lack of provision for foreign financial operations.# Not without
its influence on public opinion was the consideration that we had "no
American banking institutions in foreign countries." Many bankers and
business men felt, as did the commission, that the time had come when
the organization of such banks was "necessary for the development of
our foreign trade." Foreign banks in South America and the Orient,
handling American trade, were believed to favor their own countrymen
rather than the interests of American merchants. In contrast with the
European nations with their centralized control of banking, we had "no
instrumentality that" could "deal effectively with the broad questions
which, from an international standpoint, affect the credit and status
of the United States as one of the great financial powers of the
world. In times of threatened trouble or of actual panic these
questions, which involve the course of foreign exchange and the
international movements of gold, are even more important to us from a
national than from an international standpoint."

§ 10. #The "Aldrich plan."# The National Monetary Commission submitted
with its report a plan which was known by the name of the commission's
chairman, Senator Aldrich. This plan was embodied in a bill for
a National Reserve Association, a bank for banks which bore some
likeness to the great central banks of Europe. In the many details
of the plan an effort has been made to remedy every one of the
difficulties above described and to supply all the needs indicated.
The plan was favored pretty generally by bankers, but called forth
many adverse opinions. In the year of a presidential election,
however, Congress took no action in the matter. All parties were
pledged to some kind of banking reform, but particular proposals were
not discussed in the campaign.


[Footnote 1: Whichever was the smaller. In 1900 this was changed so
that notes could be issued to the full amount of the denomination of
the bonds.]

[Footnote 2: In recent years this has been one half of 1 per cent when
2 per cent bonds, and 1 per cent when bonds bearing a higher interest,
were deposited.]

[Footnote 3: In reserve cities 25 per cent and in other cities 15 per
cent. The details of the regulations in the old law (given in part
below, sec. 7) were ll altered by the legislation of 1913.]

[Footnote 4: The expressions within quotation marks in the following
sections are taken from this report.]

[Footnote 5: See further on this in sec. 7 on periodical congestion of
funds.]

[Footnote 6: See above, sec. 3.]




Chapter 9

THE FEDERAL RESERVE ACT

  § 1. General banking organization. § 2. The Federal Reserve Board.
  § 3. Federal reserve banks. § 4. Federal reserve notes. § 5. Reserves
  against Federal reserve notes. § 6. Reserves against Federal reserve
  bank deposits. § 7. Reserves in member banks. § 8. Rediscount by
  Federal reserve banks. § 9. Changes in national banks.
  § 10. Operation of the Act.


§ 1. #General banking organization#. President Wilson and the newly
elected Congress with its Democratic majority made banking reform one
of the main objects on the program for the special session beginning
March 5, 1913. The result was the Glass-Owen bill, which became law
as the Federal Reserve Act December 23 of that year. The bill was
actively discussed within and without the halls of Congress, and
many of its features were attacked by bankers individually and acting
through the bankers' associations, at various stages of its progress.
As a result it underwent numerous amendments in details, and tho it
remained in most essentials as it was first proposed, it was at last
accepted even by its critics as on the whole a beneficent act of
legislation. Indeed, its strongest critics had been the friends of
the Aldrich plan, and the Federal Reserve Act embodies, in a greater
degree than its authors were ready to admit, the main features of the
Aldrich plan. In one important respect, however, it is different; it
provides for more decentralization of control and of reserves than did
the Aldrich plan. It created not one central banking reserve, but, in
the end, twelve regional, or district, banks each to keep the reserves
of its district. The Jacksonian tradition of opposition to a central
bank[1] in part helps to explain this; in part the contemporary
congressional investigation and discussion of the so-called
"money-trust" and the consequent desire to decrease the importance of
"Wall Street" and of New York city banking power.

On the accompanying map are given the outlines of the districts as
constituted and altered down to 1916.[2]

[Illustration: FEDERAL RESERVE BANK DISTRICTS]

§ 2. #The Federal Reserve Board#. At the head of the banking system
stands the Federal Reserve Board of seven members, five of them
appointed by the President and Senate of the United States for this
purpose, and two serving _ex-officio_--the Secretary of the Treasury
and the Comptroller of the Currency. One of the five shall be
designated by the President as Governor and one as Vice-Governor of
the Board, but the Secretary of the Treasury is _ex-officio_ chairman.
The term of the appointive members is ten years and the salary is
$12,000 a year.

The powers of the board are numerous and important. The board is made
the head of a real _system_ of banking, the twelve parts of which can,
in times of emergency, and at the board's discretion, be compelled
to combine their reserves by means of lending to each other
(rediscounting), to the very limit of their resources, at rates fixed
by the board. By this means the reserves of the several district banks
may be "piped together" and thus be practically made into one central
bank under governmental control, altho centralization was in outward
form avoided by the bill. Alongside of the Reserve Board, is placed a
Federal Advisory Council, consisting of one member from the board of
directors of each of the twelve district banks. This council has only
the power to confer with, make representations and recommendations to,
and call for information from, the Federal Reserve Board.

§ 3. #Federal reserve banks#. The twelve Federal reserve banks which
opened for business November 16, 1914, are of a type of institution
new in our financial history. They are "banks for banks" belonging to
the system in their respective districts. Every national bank must,
and any state bank or trust company may,[3] subscribe for stock to
the amount of 6 per cent of its capital and surplus, and thus become
a "member bank." The capital of each Federal reserve bank was to be
at least $4,000,000; in fact only two of those organized (Atlanta and
Minneapolis) had at their opening less than $5,000,000 capital; the
largest (New York) had $21,000,000, and the average was $9,000,000.
The member banks are to receive dividends of 6 per cent, cumulative,
on this stock, and net earnings above that amount are to be paid to
the Government as a franchise tax.[4]

Each reserve bank has nine directors, consisting of three classes of
three men each. Classes A and B are elected by the member banks by a
system of group and preferential voting designed to prevent the large
banks from outvoting the smaller ones. Directors of class A are chosen
by the banks to represent them, and are expected to be bankers; those
of class B, tho chosen by the banks and tho they may be stockholders,
shall not be officers of any bank, and shall at the time of their
election be actively engaged within the district in commerce,
agriculture, or some other industrial pursuit. Directors in class
C are appointed by the Federal Reserve Board, one of them being
designated as chairman of the board of directors and as Federal
reserve agent. They represent the public particularly, and may not be
stockholders of any bank.

Any Federal reserve bank may:

a. Receive deposits from member banks and from the United States.

b. Discount upon the indorsement of any of its member banks negotiable
papers, with maturity not more than ninety days, that have arisen
out of actual business transactions, but not drawn for the purpose of
trading in stock and other investment securities.

c. Purchase in the open market anywhere various kinds of negotiable
paper.

d. Deal anywhere in gold coin and bullion.

e. Buy and sell anywhere bills, notes, revenue bonds, and warrants of
the states and subdivisions in the continental United States.

f. Fix the rate of discount it shall charge on each class of paper
(subject to review by the Federal Reserve Board).

g. Establish accounts with other Federal reserve banks and with banks
in foreign countries or establish foreign branches.

h. Apply to the Federal Reserve Board for Federal reserve notes to be
issued in the manner below indicated.

§ 4. #Federal reserve notes#. In 1914 there were outstanding about
$750,000,000 of what we may now call the old-style bank notes
(bond-secured). These were by the new act not forcibly retired at
once; but, as the law is shaped, they probably will be retired at
the rate of about $25,000,000 a year, and will all disappear from
circulation in thirty years.[5]

Whenever the banks having old-style bank notes outstanding desire to
retire any of their circulating notes, the Federal reserve banks
are required[6] to purchase the bonds in due quota (not to exceed
$25,000,000 in any one year). On the deposit of these bonds with the
Treasurer of the United States, the Federal reserve banks may receive
other circulating notes (essentially of the old style) called Federal
reserve bank notes, or may receive 3 per cent bonds not bearing the
circulating privilege.

The new kind of notes provided by the act are called Federal reserve
notes. They are not secured by the deposit of government bonds, but
they are secured beyond all question in other ways. First, they are
obligations of the United States receivable for all taxes, customs,
and other public dues, and are redeemable in gold on demand at the
Treasury of the United States. Secondly they are receivable by all
member banks in the twelve districts and by all Federal reserve banks,
and redeemable by the latter in gold or lawful money (which includes
greenbacks and gold and silver certificates). Thirdly, their credit
and prompt redemption is insured by certain elastic rules as to
reserves in gold which must be kept for the redemption of outstanding
notes. Fourthly, they are secured by collateral, consisting of notes
and bills accepted for rediscount from member banks, which must be
deposited by a Federal reserve bank with the Federal reserve agent of
its district, dollar for dollar for every note it receives. Fifthly,
the notes become "a first and paramount lien on all the assets of the
bank." This is what gives the notes their character of asset currency.
It is evident that the notes unite in a manner without example
the characteristic of asset bank notes with the characteristics of
political paper money.[7]

No notes, it will be observed, are issued by or on request of the
member banks, but only on request of a Federal reserve bank. After the
notes have been issued, the bank may reduce its liability any day by
depositing lawful money with the Federal reserve agent who is right
there in the bank. The Federal reserve banks and the United States
Treasury must promptly return to the banks through which they were
issued all notes as fast as they are received, and "no Federal reserve
bank shall pay out notes issued through another on penalty of a tax of
ten per centum." The regulations do not apply to the member banks,
but their effect must be to keep notes from circulating long in any
district except that for which they were issued.

§ 5. #Reserves against Federal reserve notes.# The rule applying in
normal times to reserves against note issues is that each bank must
provide a reserve in gold equal to 40 per cent "against the Federal
reserve notes in actual circulation, and not offset by gold or lawful
money deposited with the Federal reserve agent." At least 5 per
cent is to be on deposit in the Treasury of the United States. The
proportion of reserves to the liability for note issues by any bank,
however, may be allowed to fall below 40 per cent, on condition that
the Federal Reserve Board shall establish a graduated tax of not more
than 1 per cent per annum (it evidently might be made less if the
board chose) upon such deficiency, until the reserves fall to 32-1/2
per cent and thereafter a graduated tax of not less than 1-1/2
per cent on each additional 2-1/2 per cent deficiency or fraction
thereof.[8]

This tax must be paid by the reserve bank, but it must add an amount
equal to the tax to the rates of interest and discount charged to
member banks. The effect of these rules is to give a power of note
issue in time of emergency without compelling the reserve banks to
lock up their reserves held against notes. Suppose for example that
the circulating notes were in normal times $1,000,000,000 and the
reserves, therefore, were $400,000,000 and the rate of discount 5 per
cent. Then the circulation might be doubled with the same reserves,
the proportion thus falling to 20 per cent of outstanding notes, and
the rate of discount to customers rising to 13.5 per cent (5 plus
8.5). Or, to take a most extreme supposition, suppose that the
withdrawal of gold had been so great as to reduce the reserves against
notes to $50,000,000; yet outstanding notes might be doubled (becoming
$2,000,000,000,) the proportion falling to 2.5 per cent, the rate of
discount rising to 24 (5 plus 19).

§ 6. #Reserves against Federal reserve bank deposits.# Every Federal
reserve bank shall, under normal conditions, maintain reserves in
lawful money of not less than 35 per cent against its deposits. But
the Federal Reserve Board may suspend any reserve requirement in the
Act for a period not exceeding 30 days and from time to time renew the
suspension for periods not exceeding 15 days; but in that case it
must establish a graduated tax upon the amounts by which the reserve
requirements may be permitted to fall below the levels specified as to
note issues. Altho the amount of the tax on the deficiency of reserves
against deposits is not indicated in the act (as it is in respect to
excess note issues) it is plainly the thought that the Board, to which
discretion is left, will follow somewhat the same rule in both cases.
The great discretionary power as to reserve requirements thus lodged
in the hands of the Board makes possible at times of emergency the
use of the reserves both of the reserve banks and of the member banks,
down to the last dollar, if need be, without violation of law. This
gives practically unlimited opportunity to expand credit both by
the issue of bank notes and by discount and deposit in periods of
financial crises.

§ 7. #Reserves in member banks.# A fundamental change is made in the
rules as to the reserves against deposits that must be maintained by
the member banks. A new distinction is made between time and demand
deposits. Time deposits are defined as those payable after thirty days
or subject to not less than thirty days' notice; and demand deposits
as those payable within thirty days. In every case the reserve
requirement against time deposits is only 5 per cent. This gives
encouragement to banks to maintain savings departments.

The requirements as to reserves against demand deposits are not
uniform, being the lowest for banks in smaller cities (the great
majority), larger for banks in the reserve cities, and largest for
banks in the three central reserve cities (New York, Chicago, St.
Louis). The act substitutes the new Federal reserve banks for the
banks in reserve and central reserve cities as the depositories of
funds that may[9] be counted as a part of the reserves of member
banks. The new rule requires that one-third must be in the bank's own
possession, a fraction slightly over a third must be in the Federal
reserve bank, and the remainder may be kept in either place. This may
be tabulated as follows:

                             _Not in    In reserve  In central
                            reserve cities  cities    reserve cities_

  Total reserves, per cent             12      15      18
  Must be in its own vaults           4/12    5/15    6/18
  May be either place                 3/12    4/15    5/18
  Must be in a Federal reserve bank   5/12    6/15    7/18

These requirements as to total reserves are, as compared with
requirements of national banks under the old law, a reduction
respectively of 20 per cent, 40 per cent, and 28 per cent. The total
decrease in the amount of reserves required for all three classes of
national banks was about $400,000,000 on the amount of deposits held
in September, 1914.

§ 8. #Rediscounts by Federal reserve banks.# More important than
any other single feature of the act is, however, that by which each
Federal reserve bank is to rediscount notes, drafts, and bills of
exchange arising out of actual commercial transactions, when indorsed
and presented by any of its member banks. This, quite apart from
the note issues, gives a power to the banks collectively, under
the general supervision and control of the board, to expand credits
indefinitely at any time for real business purposes. Any business man
able to offer any commercial paper of sound quality should now be able
to borrow on it at some rate of discount, even in the most stringent
times. And, in turn, every member bank will now be able at such times
to rediscount such paper and thus secure credit toward its reserve
requirement on the books of its Federal reserve bank. Suppose, for
example, that a member bank (in a central reserve city) saw its
reserve in the Federal bank fall below 7 per cent of its deposits. It
could by rediscounting $7000 worth of notes increase by $38,888 the
amount to which it might legally extend credit to its customers (i.e.,
$7000 is 18 per cent of that sum). The deposits of the Federal reserve
bank would then be increased $7000, against which it must have a
reserve of 35 per cent, or $2450. If the reserves of any Federal
reserve bank fall too low, it can in turn rediscount its paper with
the other Federal reserve banks.[10] If the time comes when no one of
the twelve banks can longer maintain a 35 per cent reserve, the
board may reduce or suspend the requirement, levying a tax graduated
according to the deficiency. The provision here for elasticity of
credit combined with union and solidarity of all the central banking
reserves of the country to meet unusual demands in emergencies,
exceeds any needs which can be expected to arise.

§ 9. #Changes in national banks.# There is here created a national
system of reserves, but it will be observed that membership in the new
system of the Federal reserve banks is not limited to national banks,
but is open on equal terms to banks organized under state laws. While
in most respects the general banking law remains as it was, certain
changes are of importance. The percentage of reserves henceforth
required of all member banks (as above indicated) is a substantial
reduction of the former requirement for national banks. In some other
respects the powers of national banks are enlarged. One with a capital
and surplus of $1,000,000 may with the approval of the Board establish
foreign branches, and one not situated in a central reserve city may
loan on farm lands for a term not longer than five years, but not to
exceed one third of its time deposits or 25 per cent of its capital
and surplus. National banks may now be granted permission by the board
to act as trustee, executor, administrator, or registrar of stocks and
bonds, thus having the rights that have proved in many cases to be of
advantage to trust companies organized under state laws.

§ 10. #Operation of the Act#. It was fortunate that this act was
nearly ready to be put into operation when, August 1, 1914, the great
European war broke out. The able appointees to the Federal Reserve
Board commanded the confidence of the bankers and of the public. The
knowledge that the reserve banks would early begin operations was
reassuring during the grave financial stress of the next three months,
and the opening of the district banks in November, 1914, at once made
possible the release for commercial uses of cash reserves and
credits to meet the needs of reviving business.[11] Only an extended
experience can show how this enormous new banking organization will
operate as a whole and in its details.

Because of the very wide discretionary powers given to the board
in the administration of the act much depends on the character and
ability of the members of the board as well as on a sound public
opinion that will keep this great power from use in partisan and
selfish ways. No doubt amendments of the act will appear necessary,
but there can be no question that the Federal Reserve Act has
inaugurated a new epoch in the banking and financial history of our
country.[12]


[Footnote 1: See ch. 8, sec. 1.]

[Footnote 2: The law provided that an organization committee should
designate not less than eight nor more than twelve cities as Federal
reserve cities and should divide the continental United States,
excluding Alaska, into districts each containing one such city. Twelve
districts were designated. Wherever, therefore, the act speaks of "not
less than eight nor more than twelve," or of "as many as there are
Federal reserve districts," we may, for convenience, speak of twelve.]

[Footnote 3: On agreeing to comply with reserve and capital
requirements of national banks and to submit to Federal examination.]

[Footnote 4: Except that until the surplus of any reserve bank amounts
to 40 per cent of its paid-in capital stock, one half of its net
earnings shall be paid into a surplus fund.]

[Footnote 5: These notes are all secured by the deposit of bonds of
the United States, a large share of them bearing interest at the very
low rate of 2 per cent. Two per cent is less than the market rate for
government loans, for 3 per cent bonds without this privilege
sell above par. Therefore these 2 per cent bonds were held almost
exclusively by banks, and would have lost a good share of their value
had the note-deposit privilege been withdrawn.]

[Footnote 6: Through the Federal Reserve Board or they may do it
voluntarily, sec. 4.]

[Footnote 7: The Act does not explicitly say by whom the notes are
issued: it says that they are "to be issued at the discretion of the
Federal Reserve Board"; that "the said notes shall be obligations of
the United States." Further on the notes are spoken of as "issued
to" a Federal reserve bank, and again as "issued through" a Federal
reserve bank, but not _by_ it. But the phrase occurs (sec. 16) "its
[i.e., the Federal reserve bank's] Federal reserve notes." The notes
thus are technically issued by the United States, but not as ordinary
political (fiat) money, for they are not given a forced circulation
by the Government in paying its indebtedness. But the banks "shall pay
such rate of interest on" the amounts of notes outstanding as may be
established by the Federal Reserve Board (i.e., to the Government of
the United States). Practically the notes (as respects choice of time
of issue, amounts, profits from them, commercial assets to secure them
and to redeem them) are asset currency issued by the several Federal
reserve banks.]

[Footnote 8: This may be shown in the following table:

  When reserves against notes are        the tax rate upon the total
     are--                               deficiency shall be--

  Below 40.0 to 32.5 per cent            1.0 per cent
  "     35.5 to 30.0 "    "              2.5  "   "
  "     30.0 to 27.5 "    "              4.0  "   "
  "     27.5 to 25.0 "    "              5.5  "   "
  "     25.0 to 22.5 "    "              7.0  "   "
  "     22.5 to 20.0 "    "              8.5  "   "
  "     20.0 to 17.5 "    "             10.0  "   "
  "     17.5 to 15.0 "    "             11.5  "   "
  "     15.0 to 12.5 "    "             13.0  "   "
  "     12.5 to 10.0 "    "             14.5  "   "
  "     10.0 to  7.5 "    "             16.0  "   "
  "      7.5 to  5.0 "    "             17.5  "   "
  "      5.0 to  2.5 "    "             19.0  "   "
  "      2.5 to  0.0 "    "             20.5  "   "
]

[Footnote 9: The complete application of the new rule is deferred for
a period of three years from the passage of the act.]

[Footnote 10: See on "piping" provision, sec. 2, above.]

[Footnote 11: See sec. 7 above.]

[Footnote 12: Several other features of the law well merit
description. Among these features are measures for developing bankers'
acceptances, open market operations, the gold clearing system of
the Federal Reserve Board, and the clearing of checks and parring of
exchange.]




CHAPTER 10

CRISES AND INDUSTRIAL DEPRESSIONS

  § 1. Mischance, special and general, in business. § 2. Definitions.
  § 3. A feature of a money economy. § 4. European crises. § 5. American
  crises. § 6. A business cycle. § 7. General features of a crisis.
  § 8. "Glut" theories of crises. § 9. Monetary theories of crises. § 10.
  Capitalization theory of crises. § 11. The use of credit. § 12. Interest
  rates in a crisis. § 13. Dynamic conditions and price readjustments.
  § 14. Tariff changes and business uncertainty. § 15. Rhythmic changes
  in weather and in crops. § 16. Remedies for crises.


§ 1. #Mischance, special and general, in business.# Every separate
business enterprise is subject to chances which suddenly decrease
its profits and the prosperity of its owners; such are fire, flood,
illness of its owners, unfavorable changes in prices of materials
or of the products.[1] The interests of many other persons in the
neighborhood may be so bound up with an enterprise that its losses may
mean unemployment, lower wages to workingmen, and bankruptcy to local
merchants and to banks. Sometimes misfortune and disaster affect whole
communities. The lack of cotton while the Civil War was in progress
compelled the factories of Manchester to close in 1864, and the
earthquake and fire in San Francisco in 1906 left a quarter of a
million people homeless.

But a change of business conditions is constantly occurring that is of
wider extent, that is of less accidental and of more rhythmic nature,
and that appears to be the effect of slowly working and more general
causes. The enterprise of a modern community, as a whole, "general
business," moves along, in a wavelike manner, going through a somewhat
regular series of changes that is called a business cycle. We are now
to study the nature of these cycles.

§ 2. #Definitions.# Crisis means, generally, a decisive moment or
turning point. The word crisis suggests a brief period, a moment,
something that is sudden, severe, and soon over. In medical usage
it is the period when the disease must take a turn for better or
for worse. As used in economics, the term, however, implies a sudden
change of business conditions for the worse, a collapse of prosperity.
What precedes has not the appearance of disease, but rather that
of exuberant health. Crises in economics may be distinguished as
industrial, speculative, and financial, according as one or another
influence seems to be more potent, but all are essentially financial.
The change that occurs always is connected in some way with the use of
money and credit.

A financial _crisis_ is the culmination of a period of rising prices,
and a sudden fall which shatters the credit of some banks, brokers,
merchants, and manufacturers. Every crisis is marked by much confusion
and loss and by hasty efforts of individuals and institutions to meet
their pressing obligations. Sometimes this process of liquidation goes
on quietly and in other cases it becomes a wild scramble, each one
trying to save himself, in which case it is a financial _panic_.
An _industrial depression_ is the period of hard times that usually
follows a financial crisis.

§ 3. #A feature of a money economy.# Financial crises, by their
very nature, are confined to communities in which the money economy
prevails and where there is a developed state of industry. The periods
of industrial hardship in the Middle Ages were connected usually not
with the collapse of prices, but with political oppression, famine,
wars, pestilence, and scourges of nature. Throughout the lands money
was little used and there was no development of credit and of credit
prices. The money economy began, as has been noted, in the cities.
As the use of money spread, as larger commercial enterprises were
undertaken, as borrowing and the payment of interest became common,
there began to appear in city trading circles, on a small scale, the
phenomena of the modern crisis.[2]

§ 4. #European crises.# In Europe financial crises date from 1763
and have occurred at more or less regular intervals since. The common
statement that the cycle of a crisis is run in a period of ten
years, finds only partial support in history. The chief crises of the
eighteenth century occurred in 1763, 1783, 1793, these dates marking
the close of wars of some magnitude. The crises were not widespread
or general, but were more marked in England, which was at that time
farther developed industrially and in its money economy than other
countries. Likewise, in the nineteenth century, the crises were of
unequal force in various countries, usually being severer in England.
They may be dated 1803, 1825, 1838, 1847, 1857, 1864-66, 1875, 1890,
1900, 1907, and 1914. These were attributed to various causes; that of
1825 to over-trading abroad; that of 1847 to railroad-building; while
that of 1866 followed the severe disturbance of trade in 1864 caused
by the interruption of the cotton trade and commerce by the Civil
War in America. While in many parts of England the crisis of 1864 was
unusually severe, in other countries it was of little moment. Germany,
after several years of great speculative prosperity, had a most
severe crisis in 1875; while France, although prostrated by the war
of 1870-71, losing a large amount of wealth, and paying a thousand
millions of dollars to Germany as a war indemnity, escaped a
commercial crisis almost entirely at that time.

§ 5. #American crises.# Since the beginning of the nineteenth century,
the financial connections of the United States with London, the
leading loan market of Europe, have been such that every crisis
in either England or America has extended its effects to the other
country. But the disturbances are so modified by the particular
conditions (of crops, politics, and speculation) that the phenomena
never correspond exactly in time of occurrence, in duration, or in
intensity. The first notable crisis in America occurred about 1817
in the very violent readjustment of trade after the resumption of
commerce with Europe in 1816.[3] In 1837-39 came in quick succession
two crises, not quite distinct from each other, the second similar
to the relapse of a fever patient. The conditions were rapid westward
expansion, over-speculation in lands, reckless state internal
improvements, great issues of state bank notes, and the financial
measures of Andrew Jackson, which included the dissolution of the
Second Bank of the United States in 1836.[4] The crisis of 1857
followed a period of great prosperity marked by rising gold production
and prices and a great increase in foreign trade. The crisis of 1873,
possibly the severest in our history, followed great speculation,
especially in the direction of railroad building on an unexampled
scale after the war. The blow, when it fell, was intensified by the
relative contraction of currency then in progress, leading to the
return to a specie basis and lower prices.[5] The crisis of 1884,
a comparatively slight one, occasioned (rather than caused) by the
discussion of the money question, was followed by some years of
noticeable depression. The years 1889 to 1892 witnessed prosperity,
only slightly interrupted in 1890, that culminated in a crisis in May,
1893 (likewise generally explained as due to the unsettled state of
our monetary system), followed by a period of great depression lasting
until 1897. A rapid growth of business was checked but little in 1900
when a crisis occurred in Europe, especially severe in Germany. In
November, 1902, began in America what has been called "the rich
man's panic" of 1903 in which for a year many securities were sold
by holders because European creditors were recalling their loans.
American business, however, slackened but little, altho building
operations were somewhat checked. General prices, which had been
moving upward since 1897, remained almost unchanged in 1903 and
1904, and then continued going upward until 1907. In the period from
September to November of that year occurred a severe crisis both in
Europe and in America. The industrial depression following this was
marked in 1908, slowly growing less. The crisis at the outbreak of the
war in August, 1914, was quite exceptional, being due to the sudden
demand of Europe upon New York for funds. Within a couple of months
it was over and soon prices were again rising as the result of large
exports of merchandise followed by gold imports.

§ 6. #A business cycle#. Let us now sketch in broad outline a business
cycle, bearing in mind that this series of changes does not repeat
itself with unvarying regularity, but that it is fairly typical in
the modern business world. The period leading up to a crisis is one
of relative prosperity; then occurs a crisis in which prices fall,
at first rapidly, and afterward for a while going slowly lower. When
prices are at the lowest point many factories are closed, and much
labor is unemployed. Let us start at that point. Conditions are worse
in some industries than in others. General economy and great caution
prevail; few new enterprises are undertaken. For those persons having
available funds this is a good time to buy, and property begins to
change hands. Then hoarded money begins to come out of its hiding
places. Money and credit flow in from other countries, particularly if
business conditions are better abroad than here, for when prices are
lower than they have been, relative to those of other countries, a
country is a good place in which to buy. At the same time that the
money in circulation thus increases, there is a general return of
confidence that increases credit. Not only are there more dollars, but
each does more work. Then old enterprises are resumed and new ones are
undertaken. The purchase of materials in larger quantities causes a
rapid rise in the prices of many raw materials and of all kinds of
industrial equipment. The less efficient laborers and others that have
been out of work, begin to find employment, and then, more tardily,
wages begin to rise. As a result, the costs of many products begin to
rise rapidly. The only classes not sharing in this improvement are the
receivers of fixed incomes. As prices rise, the purchasing power of
their incomes correspondingly falls.

At length prices begin to go up less rapidly, and the question arises
in many minds whether the movement can continue, and if not, when it
will cease. Men wish to hold on for the last profits, and are willing
to risk something to gain them. When prices rise not only as compared
with former domestic prices, but as compared with current foreign
prices, foreign imports are stimulated and exports fall. This calls
for a new equilibrium of money and requires at length large and
continued exportation of specie. This checks prices, and, reducing the
specie reserves of the banks, compels them to be more cautious. At the
same time the increase of costs in many industries begins to reduce
profits. The fall in the value of many stocks and securities held
by the banks forces many brokers and speculators to convert their
resources into ready money. This is the moment of danger; weak
enterprises find their foundations crumbling, and there are many
failures.[6] The falling prices, the shattered credit, and the
financial losses force many factories to close, and many workmen
are thrown out of employment. This moment of widespread loss is the
crisis, It is followed by another period of low prices and of small
output, and therefore of profits small or negative in many industries.
Business must again enter upon a period of retrenchment, for it has
completed another cycle.

§ 7. #General features of a crisis.# Altho irregular in time of
occurrence and unlike in their immediate occasions, financial crises
show certain general features. They are a part of the larger movement
here outlined as the business cycle. Some have thought this cycle to
be normally a period of ten years, divided into one year of crisis,
three years of depression, three years of recovery, and three years of
unusual prosperity. This succession of events occurs pretty regularly,
though not in the regular intervals of time. Crises are more severe in
countries with more extensive use of money and credit, but still more
severe where the credit system is more loosely administered and less
efficiently coördinated. They are harder in the United States and
England than in Germany, harder in Germany than in France, harder in
western Europe than in eastern Europe, harder in Christendom than in
heathendom. They are less severe in rural districts, where prosperity
depends more on crop conditions, and business has in it less of
financial speculation. Their effects are least felt in the staple
industries, for when hard times come people economize on the
less essential things. The glove-factory, the silk-factory, the
golf-club-factory are more likely to close than the flour-mill. In
a crisis wages and salaries are less affected than are profits, but
wageworkers suffer in the loss of employment. Those money lenders who
have eliminated chance as far as possible and have taken a low rate
of interest lose little; the risk-takers who draw their incomes from
dividends on stock or from bonds of a less stable kind, often lose
much.

§ 8. #"Glut" theories of crises#. Many explanations of the causes of
financial crises have been offered.[7] Nearly all of these belong to
the general group of "glut" theories, of which genus there are two
species, under-consumption and over-production theories. These are, in
truth, but two aspects of the same idea.[8] The one view is that too
many goods are produced, the other that too few are consumed. The
over-production theorist seeing that in a crisis warehouses are filled
with goods that cannot be disposed of for what they cost (or at best,
not so as to give a profit), and that factories are shut down and men
are out of employment for lack of demand, declares that productive
power has grown too great. The under-consumption theorist, seeing
the same facts, says that the trouble is lack of purchasing power. He
observes that there are some people who would like to buy more of some
of these things, but that such people lack income with which to buy.
Usually he asserts that this is because production grows faster
than wages, wages being fixed, as he believes, by the minimum
of subsistence--a theory akin to the iron law of wages. In both
over-production and under-consumption theories, the inequality of
demand and supply is looked upon as a general one. There is supposed
to be not merely an unequal and mistaken distribution of production,
but a general excess of productive power.

The wide vogue held by these views would justify a fuller discussion
and disproof of them here, did space permit. It must suffice to
indicate merely that they have the same taint of illogicalness as the
"fallacy of waste," and the "fallacy of luxury."[9] They overlook the
fact that an income, either of money or of other goods, coming even
to the wealthiest, will be used in some way. It may be used either
for immediate consumption or for further indirect use in durable
form. Through miscalculation there may be, at a given moment, too many
consumption goods of a particular kind, but the durable applications
can find no limit until the inconceivable day when the material world
is no longer capable of improvement. At the time of a crisis, there is
unquestionably a bad apportionment of productive agents, and a still
worse adjustment of their valuations, but these facts should not be
taken as proving that there is an excess of all kinds of economic
goods.

§ 9. #Monetary theories of crises.# Another group of theories explains
the crises as being due to money, either too much or too little. The
unregulated issue of bank notes has been assigned as the cause of
crises, especially under the circumstances accompanying such crises
as those of 1837 and 1857 in America, when bank note issues greatly
contributed to the unsound expansion of credit. The issue of
government paper money years before, leading to inflation and
speculation, was by many believed to be the cause of the crisis
of 1873. The reverse view is taken by the advocates of a cheap and
plentiful money. They say that these crises were caused, not by the
expansion, but by the contraction of the money stock; for example, not
by the inflation of prices through the issue of greenbacks in 1862 to
1865, but by the contraction of the currency from 1866 to 1873.

There is only a fragment of truth in these various views. It is always
lack of "money" at the moment of the crisis that causes any particular
failure, and in that sense it is always lack of "money" that causes
a crisis. The question is, whether in any reasonable sense it can be
said that it was lack of a circulating medium before the crisis that
brought it on. There is no support for this view, except in the rare
case when the money standard is undergoing a rapid change, as in the
United States from 1866 to 1873, and the statement then needs much
modification and explanation. The monetary theories of crises are a
bit nearer to the truth than are those of the over-production type,
for the crisis is always connected with prices and credit. But it
is clear that these rhythmic price changes occurring in the business
cycle are not due to the same causes as are the general movements of
the price level, due to an increasing or decreasing output of gold or
again to a paper money inflation. Statistics show that while a general
price level is slowly changing like a tidal movement, the effect
of the rhythmic business cycle appears now in hastening, now in
retarding, the changes in the price level.

§ 10. #Capitalization theory of crises#. Here we verge upon a
different type of explanation of the financial crisis--one of a
psychological nature. The quantity of money, we have seen, affects
prices more or less according as credit is more or less used in
connection with it. Money plus confidence has a larger power of
sustaining prices, than money without, or with less, confidence. And
throughout the business cycle the amount of confidence, expressed in
such ways as the readiness to grant credits and in the easy extension
of the time of collection, is constantly changing. Over-confidence at
one time is suddenly followed by widespread lack of confidence. This
has led some to say that lack of confidence is the cause of crises.
This is a truism, but it does not explain what is the real cause of
this lack of confidence, which, when the crisis comes, is not mere
unreasoning fear that needs only to ignore the danger to banish it.
Might it not just as truly, if not more truly, be said that the cause
is _over-confidence_ in the period preceding the crisis?

The essential characteristic of a crisis is the forcible and sudden
movement of readjustment in the mistaken capitalization of productive
agents. Capitalization runs through all industry. The value of
everything that lasts for more than a moment is built in part upon
incomes that are not actual, but expectative, whose amount, therefore,
is a matter of guesswork, or "speculation."[10] Many unknown factors
enter into the estimate of future incomes. The universal tendency
to rhythm in motion (material or psychic) manifests itself in an
overestimate or underestimate of incomes and of every other factor in
value. This is emphasized by a psychological factor called sometimes
the "hypnotism of the crowd," and sometimes, the "mob mind." Most
men follow a leader in investment as in other things. The spirit of
speculation grows till often it becomes almost a frenzy, and people
rush toward this or that investment, throwing capitalization in some
industries far out of equilibrium with that in others.

The cause of crises immediately back of the maladjusted capitalization
thus is seen to be a psychological factor; it is the rhythmic
miscalculation of incomes and of capital value, occurring to some
degree throughout industry, but particularly in certain lines. This
subjective cause in men is given an opportunity for action only when
certain favoring objective conditions are present.

§ 11. #The use of credit.# Most noteworthy of these objective
conditions is the general use of credit. The credit system greatly
enhances the rhythm of price. If the value of a thing that is fully
paid for falls, the owner alone loses; but if the value of a thing
only partly paid for falls so much that the owner is forced to default
in his payment, the loss may be transmitted along the line of credit
to every one in a long series of transactions. A credit system, highly
developed, is a house of cards at a time of financial stress. Demand
liabilities are at such a time the greatest danger, so that the banks,
ordinarily the pillars of financial strength, become at such a time
the points of greatest weakness in the financial situation. If many
of the customers were not restrained by their sense of personal
obligation to the banks, by the strong pressure which the banks can
bring to bear upon them, or by the force of public opinion among
business men, from withdrawing the balances to their credit in a time
of crisis, all commercial banks would become insolvent at once in a
crisis by the very nature of their business; for all their ordinary
deposits are nominally payable on demand.

§ 12. #Interest rates in a crisis.# In normal times there is always
outstanding a great mass of short-time, commercial loans.[11] The
motive of the borrower, in most cases has been to hire more labor and
to buy more materials for use in his business. Ordinarily these loans
can and are renewed without difficulty or are replaced by others,
based on the security of new business transactions in unbroken
succession. Now at the time of a crisis a general contraction of
credit occurs, and all borrowers with maturing obligations are faced
with bankruptcy. The effort of the business man at such a time is not
to make a positive profit, but to save what he can from the threatened
wreck. The demand for short-time loans, therefore, in such times
of stress, fluctuates rapidly, and exceedingly high interest rates
prevail in these loan markets for a few days or a few weeks, rates
which have only a remote relationship with the usual capitalization of
most agents.

The distress of the business man is magnified by the fact that it
is just at such times that both the equipment he has bought and the
products he has made become temporarily almost unsaleable at prices as
high as he paid for them when he bought them with the borrowed money.
He may know that prices will soon be higher, but he cannot wait.
Various courses are open to him in this emergency; he may borrow the
money at a very high rate of interest, holding the goods for better
prices; or he may sell the goods under the unfavorable conditions; or
he may sell other capital such as stocks and bonds. The end sought
is the same--to get ready money; and the methods are not essentially
unlike--the exchange of greater future values for smaller present
values. The sacrifice sale thus reveals the merchant's high estimate
of present goods in the form of money. The purchaser of some kinds
of property in times of depression is securing them at a lower
capitalization than they will later have. The rise in value may be
foreseen as well by seller as by buyer, but the low capitalization
reflects the high interest rate temporarily obtaining. A.T. Stewart,
once the most famous New York merchant, is said to have laid the
foundation of his fortune when, being out of debt himself, he bought
up the bankrupt stocks of his competitors in a great financial panic.
The high interest at such times is but the reflection of the high
premium on present purchasing power.

The worst of the evils of crises are confined to the markets where the
greatest numbers of short-time loans are made. Most of the long-time
loans do not fall due in such seasons of stress, and the great mass of
slowly exchanging wealth alters little and slowly in price. Such loans
as fall due can generally be renewed for long periods at rates little
higher than usual, the market for long-time and short-time loans being
in large measure independent of each other. But they are not quite
independent, and some lenders take whatever sums they can collect on
maturing long-time obligations and loan them on short terms at high
rates of interest, or buy goods, whole enterprises, bonds, and stocks,
at the unusually low prices temporarily prevailing. The effect of this
is to raise somewhat the interest rate on long-time paper to accord
with the new conditions.

§ 13. #Dynamic conditions and price readjustments.# Another condition
favorable to the rhythmic movement of capitalization is a dynamic
economic society. The past century has opened up new fields for
investment on an unexampled scale. Investment has advanced both
intensively and extensively in a series of great waves. New machinery
and processes have given undreamt of opportunities for enterprise in
the older countries, and the physical frontier of investment has moved
outward with the march of millions of immigrants to people the fertile
wilderness. Such factors disturb the equilibrium of prices both in
time and space, give a powerful impulse toward higher values in
the older lands, and stimulate the hopes of all investors. When the
balance between the capitalizations of various industries and between
the incomes of the various periods proves to be false, the inevitable
readjustment causes suffering and loss to many, but particularly in
the inflated industries. But, because of the mutual relations of men
in business, few even of those who have kept freest from speculation
can quite escape the evils.

Among the dynamic conditions in industry are changes in the general
price level whether due to changes in the production of the standard
money commodity (relative to population) or to changing methods of
doing business. If the price level is falling (i.e., the standard unit
is appreciating), the burden of the great mass of outstanding debts
is growing heavier upon the debtors.[12] Sooner or later some of them
break down under its weight. At such times many attempt to shift their
capital from active investments such as stocks, to passive investments
such as bonds. When the price level is rising, the opposite conditions
prevail. But such adjustments proceed uncertainly and unevenly in
different industries, with much speculation in shifting from one type
of business to another, and with much accompanying miscalculation.

§ 14. #Tariff changes and business uncertainty.# Another variable
influence in American business has been the tariff. Every tariff
revision, whether the rates go upward or downward, shifts somewhat
the relative opportunities and profitableness of different industries.
Some of these call for far-reaching readjustments of investments and
of productive forces. Some persons gain and some lose by every such
change. It is observed that a reduction of tariff rates seems to have
a more disturbing effect upon business than does an increase. This
probably is because the industries favored by protective tariffs in
America are those most fully within the circle affected by crises;
whereas most of the consumers adversely affected by a rise of tariff
rates are outside the commercial circles where short-time credit
is common and where the rapid readjustment of investment leads to a
financial crisis. It never has been convincingly shown, however,
that there is any large measure of correspondence in time (not to say
causal relation) between tariff revisions and crises.[13]

§ 15. #Rhythmic changes in weather and in crops#. A psychological
movement, once started, accumulates force and momentum up to a certain
point where a reaction begins. This rhythmic movement as it appears
in the capitalization of enterprises is favored and magnified, we
have seen, by the wide use of credit and by the constantly changing
technical and physical conditions of industry. These call for constant
revaluations of the sources of incomes, thus destroying customary
and habitual valuations. But why should the cycle begin or end at one
point of time rather than at another; and what determines the length
of the cycle? Some of the new dynamic forces such as inventions and
growth of population are distributed pretty regularly along the line,
so that their influences are nearly equalized. But occasionally
some large impulse may serve to start a swing and if this impulse
is somewhat regularly repeated, it may serve to keep up the rhythmic
motion. True, the lack of coincidence in the impact of various
influences which occur accidentally, such as political changes, wars,
and the rapid opening of new routes of transportation, would serve
to hasten or to retard, perhaps for a time quite to alter, what would
otherwise be the rhythm of the cycle. That there is nevertheless, a
noticeable degree of regularity in the recurrence of crises may be due
to the presence of one dominating factor.

Alternation of good and poor harvests has always seemed to be
favorable to business prosperity. In America since about 1865, farm
products have constituted the larger part of our exports, so that a
succession of large harvests has usually acted to stimulate exports
(one of the features of a period of prosperity), to give us a larger
credit balance in international trade, and to reduce the rate of
exchange. Large harvests of the staple agricultural crops in America
have been known to be closely related to the amount of rainfall in the
three most important growing months. Recently, it has been shown that
the rainfall of the Ohio Valley occurs in cycles of about eight years,
and in a larger cycle of thirty-three years. The cycle of yield per
acre of the nine principal crops is shown to correspond closely with
the cycle of pig iron production (one of the best single indices of
growing business) dated one to two years later.[14] As the cycles of
rainfall and of harvests are not coincident in different countries, it
will require further study to adjust to these observations the fact
of the world-wide extent of the great financial crises. But a better
understanding of objective conditions of this kind will give fuller
meaning to the psychological interpretation of crises.

§ 16. #Remedies for crises#. The financial crisis must be looked upon
as an economic disease which brings many evils in its train. The need
is not merely to mitigate the severity of the brief period of crisis,
but also to smooth out the curve of the business cycle so as to reduce
periodic unemployment, the lottery element in profits, and the number
of unmerited failures in business. Several measures may aid toward
this end. In the past the crisis has been more severe in America than
in Europe because of certain well-recognized defects which now have
been largely remedied in the Federal Reserve Act.[15] The provisions
whereby any one may get credit on good commercial assets should
make it impossible for a crisis to degenerate into a panic. This
legislation has provided springs to reduce the jolt of the change from
a higher to a lower level of prices.

Probably other improvements may be made in our banking laws. Competent
students of the subject have urged that the payment of interest
on deposits not subject to notice before withdrawal should be made
unlawful, because demand deposits constitute the greatest danger at
critical times. In principle this objection is sound, tho experience
may show that this evil has been practically remedied by other
features of the Federal Reserve Act. Moreover, bankers could, by
pursuing a more conservative policy, discourage speculative methods of
enterprise. The strong public disapproval of stock-market speculation
on margins may some day be able to express itself effectively in ways
that will not injure healthy business. Greater stability in our tariff
policy would remove a constantly disturbing factor in prices, as would
likewise the stabilizing of the standard of deferred payments. In
the attempt to remedy the great evil of unemployment, public works of
every kind might be planned and distributed in time so as to better
equalize the demand for labor and materials. Finally, much better
commercial statistics are needed, and for collecting them and
reporting the outlook, government organization is required comparable
in range and methods to the weather bureau.

It cannot be expected, however, that financial crises, in the sense of
general readjustments of prices downward from time to time, ever
can be completely abolished. There will always be changes in general
industrial conditions calling for reevaluation of the existing sources
of income; and in this process there will always be a tendency to
rhythmic swing like that of a river, which carries the stream
of prices now on this side of the valley, now on that. But this
fluctuation of general prices surely can be so greatly moderated in
magnitude and in evil results as to make the word "crisis" almost a
misnomer. It is toward the attainment of this irreducible minimum of
uncertainty and disaster in business that efforts should be directed.


[Footnote 1: On the way these affect private profits see Vol. I, pp.
340, 341 (and references there given in note), 348 ff. and 361 ff.
There are thus good reasons for discussing crises in connection with
profits, as well as with money and banking.]

[Footnote 2: See Vol. I, pp. 51, 154, 300-302.]

[Footnote 3: See below, ch. 15, sec. 5, on the tariff legislation at
this time.]

[Footnote 4: See ch. 8, sec. 1.]

[Footnote 5: See ch. 6, sec 5.]

[Footnote 6: See diagram of business failures 1890-1914, in Vol. I p.
364.]

[Footnote 7: In the first annual report of the United States
Commissioner of Labor is given a long catalog of theories that have
been suggested, many of them quite fantastic.]

[Footnote 8: See Vol. I, ch. 38, on Abstinence and Production.
Believers in the glut theory usually condemn efforts to encourage
frugality among the masses, calling it the "fallacy of saving."]

[Footnote 9: See Vol. I, ch. 37, secs, 6 and 9.]

[Footnote 10: See e.g., Vol. I, pp. 271. 335, 365 367.]

[Footnote 11: See Vol. I, p. 304.]

[Footnote 12: See above, ch. 6, on the standard of deferred payments.]

[Footnote 13: See note on tariff legislation and business crises, end
of ch. 15.]

[Footnote 14: In both cases there is what is called in statistics
a high degree of correlation (viz., .719 and .800), indicating that
there is that percentage of probability that there is some causal
relation between the two sets of figures.]

[Footnote 15: See above, ch. 9, secs. 5, 6, 8.]




CHAPTER 11

INSTITUTIONS FOR SAVING AND INVESTMENT

  § 1. The nature of saving. § 2. Economic limit of saving. § 3. Commercial
  bank deposits of an investment nature. § 4. Investment banking.
  § 5. Savings banks in the United States. § 6. Typical mutual
  savings banks. § 7. Postal savings plan.  § 8. Advantages of the postal
  savings plan. § 9. Collection of savings and education in thrift. § 10.
  Building and loan associations. § 11. The main features. § 12. The
  continuous plan. § 13. The distribution of earnings. § 14. Possible
  developments of savings institutions.


§ 1. #The nature of saving.# The motives actuating the different
classes of lenders may, for our present purpose, be reduced to two:
to postpone the consumption of income, and to obtain a net income
from wealth (or investment). Saving always is relative to a particular
period and is for more or less distant ends. The child saves its
pennies to go to the circus next week, the working girl saves her
dimes for a new hat next spring, the earnest high school pupil saves
to go to college next year, and the provident man saves for his
family's future needs and for his own old age. But always, to
constitute saving, there must be for the time a net result: the
excess of income over consumptive outgo in that period. This is easily
distinguishable from various forms of pseudo-saving of which many
persons that are really spending all their incomes are very proud.
Such forms are: planning to buy a particular thing and then deciding
not to do so, but buying something else; finding the price less than
was expected, and thereupon using this so-called saving for another
purpose; spending less than some one else for a particular purpose,
such as food, but off-setting this by larger outlay for another
purpose, such as clothing; spending all one's own income but less
than some one else with a larger income. We may define saving as the
conversion, into expenditure for consumptive use, of less than one's
net income within a given income period.

Saving goes on in a natural economy both by accumulation of indirect
agents and by elaboration so as to improve their quality.[1] It goes
on to-day by the replacement of perishable by durative agents, as in
replacing a wooden house by one of stone or concrete, and by producing
wealth without consuming it, as in increasing the number of cattle on
one's farm. But saving has come to be increasingly made in the form
of money (or of monetary funds), and in this chapter we shall consider
some of the ways in which this can now be done.

§ 2. #Economic limit of saving#. There is an economic limit to saving,
as judged from the standpoint of each individual.[2] The ultimate
purpose of every act of saving is the provision of future incomes,
either as total sums to be used later or as new (net) incomes to be
received at successive periods. The economic limit of saving in each
case is dependent upon the person's present needs in relation to
present income and conditions, as compared with the prospect of his
future needs in relation to his future income and conditions. Each
free economic subject must form a judgment and make his choice as
best he can and in the light of experience. There is no absolute and
infallible standard of judgment that can be applied by outsiders to
each case. Yet there is occasion to deplore the improvidence that is
fostered and that prevails, especially among those receiving their
incomes in the form of wage or salary. Considered with reference to
the possible maximum of welfare of the individuals themselves, the
apportionment of their incomes in time is frequently woful. It is
uneconomic for families of small income to save through buying
less food than is needed to keep them in health; but it is likewise
uneconomic to spend the income, when work is plentiful and wages good,
for expensive foods having little nutriment and then, for lack of
savings, to go badly underfed when work is slack and wages are small.
There is for each class of circumstances a golden mean of saving. The
saving habit may develop to irrational excess and become miserliness,
but this happens rarely compared with the many cases where men in the
period of their largest earnings spend up to the limit on a gay life
and make no provision for any of the mischances of life--business
reverses, loss of employment, accidents, temporary sickness, permanent
invalidity, or unprovided old age. Despite the development of late of
new agencies and opportunities for saving there is need of doing more
toward popular education in thrift.[3]

§ 3. #Commercial bank deposits of an investment nature.# If a
commercial bank pays no interest on demand deposits there is no motive
for the depositor to keep a balance larger than he needs as current
purchasing power. When his bank account increases beyond that point,
it becomes available for a more or less lasting investment to yield
financial income. If the sum is small or if the owner is at all
uncertain as to his plans or if he is not in a position to find
another attractive form of investment, the offer by the bank of a
small rate of interest on special time deposits (2 to 3 per cent is
not an unusual rate in such cases) will suffice to cause him to leave
such funds in the bank. Since about 1900 the practice has been greatly
extended of paying interest even on "current balances" of regular
checking accounts (demand deposits). If the new 5 per cent rule[4] as
to reserves against time deposits operates to cause commercial banks
generally to pay a rate ranging from 2-1/2 to 3-1/2 per cent on time
deposits, their amount will doubtless increase greatly. But still, in
the future as in the past, those depositors having funds that can be
invested for considerable periods will seek a higher rate of interest
than can be obtained from commercial banks.

In their loaning function the "commercial" banks (as the adjective
indicates) serve mainly the special needs of the _commercial_ elements
of the community--business men borrowing for short terms to carry out
particular transactions. Loans made on short-time commercial paper
(quick assets) are very suitable to the needs of a bank that has its
liabilities largely in the form of demand deposits. Time deposits can
be more safely loaned on the security of real estate and for longer
periods.

Despite their limitations in this respect, the commercial banks must
be recognized as of growing importance in the work of encouraging and
collecting small savings, which in many cases are better invested in
other ways. In 1916, the centenary of the beginning of savings banks
in this country, a nation-wide propaganda was undertaken by the
American Bankers' Association for the encouragement of savings.

§ 4. #Investment banking#. Enormous amounts of securities issued by
governments or by corporations (railroad or industrial) are now on
the market and to be bought conveniently by private investors. Through
special bond houses some bonds are to be had in denominations as small
as $100 and $500. The regular brokers on the stock exchanges buy and
sell, for a small commission, the regular bonds and investment stocks.
Several large statistical and financial expert agencies[5] in return
for an annual subscription, offer advice to investors regarding
general market conditions and special securities.

For a large number of investors the personal examination and selection
of sound securities is too difficult a task. To serve their needs many
bonds and trust companies have of late developed special departments
for investment banking. Through these agencies the banks are
constantly placing as relatively permanent investments securities
which they have bought or have aided "to float" or which they handle
only as commission agents. In any case the real investment banker
is bringing to his task special training and a high sense of
his professional obligations, and is employing the services of
statisticians, financial experts, and of practical engineers to
determine exactly the fundamental conditions of each investment.
Investment banking promises to increase steadily in amount and
importance.

§ 5. #Savings banks in the United States.# For the increasing
number of wage-earners, salaried employees, and persons following
professions, investment as active capitalists is impossible.[6] Their
savings must take the form of passive investments. But there are few
good opportunities for lending money in small amounts, without great
risk, and the requirement of skill, time, and labor to look after the
loans and to collect the interest is prohibitive to a small lender. To
provide a place where small sums could be kept with safety and so as
to yield a moderate rate of income, the first modern savings bank
in the United States was instituted in New York in 1816 after a plan
already developed in England.

In form these banks are mutual, having no capital stock on which
dividends are to be paid. The boards of trustees are self-perpetuating
and receive only fees for attending meetings. In their legal aspect
these banks have a philanthropic character. Their investments are
limited by law to specified, conservative classes of securities and
loans on real estate. The total increase from investments is,
after paying the expenses of operation and setting aside a surplus,
distributable to the depositors at regular periods. In the United
States the number of such institutions reported in 1914 was 2100.[7]
They have over 11,000,000 depositors, deposits to the amount of
$5,000,000,000, an average deposit of $444 per depositor, or of $50
per capita of the whole population. These figures are very unequally
distributed geographically, the divisions ranking as to total deposits
in the following order: the Eastern Middle, New England, Middle
Western, Pacific, Southern, and Western divisions. The first two of
these groups of states have about 75 per cent of all the deposits, the
Southern states hardly 2 per cent, and the Western (North Dakota to
Oklahoma) only 1/4 of 1 per cent.

§ 6. #Typical mutual savings banks#. About one third of these banks
are on the mutual plan, having no capital stock (most of them in the
East) and these contain about four fifths of all the deposits.
The stock savings banks have individual deposits of over a billion
dollars, and have outstanding capital stock to the amount of about
$90,000,000 (about 9 per cent of their deposits). These stock savings
banks to a much greater extent than do the mutual banks transact also
a commercial business.

The banks on the mutual plan are therefore the most important, the
typical savings banks. The average rate of interest they paid
to depositors in 1914 was 3.86 per cent. About one half of their
resources are invested in loans, mostly to small borrowers on the
security of real estate, and most of the remainder consists of bonds
and other securities of the safer kinds.

Savings banks are subject to the supervision and inspection of the
banking departments in the several states, a fact that exerts a
salutary effect though not insuring absolutely against either mistaken
judgment or dishonesty on the part of the bank officials.[8]

Savings banks seek to keep invested as large a part as possible of
their assets, keeping only in ready cash enough to meet a possible
temporary excess of withdrawals over deposits. In contrast with the
policy of commercial banks with their demand deposits, the sound
policy for savings banks is to reserve the right to require notice of
intention to withdraw. The period of such notice varies from a
minimum of ten days to a maximum of about sixty days. In ordinary
circumstances it is not needful or usual for a bank to exercise this
right, but it is a needful safeguard in times of commercial crises.
This requirement of notice is greatly to the advantage of depositors
collectively and thus of the community as a whole. It is not an undue
limitation of the rights of the individual depositor. It is unfair
for the individual, in a period of financial stress, to seek his own
safety in a manner which is impossible for all, and thus to endanger
the interests of all.[9]

The mutual savings banks in 1914 had (on the average) but six tenths
of a cent of actual cash (and "checks and cash items") in their tills
for every dollar of deposits, but in addition they had for every
dollar of deposits four cents due on demand from state and national
(commercial) banks. In the aggregate these demand deposits amounted to
the large sum of $172,000,000, a large part of which bore a low rate
of interest.

The depositors in savings banks have a direct legal claim on the bank
as a corporation. The bank's only means of payment are its assets,
consisting of claims upon the owners of such wealth as houses,
factories, railroads, electric light plants, good roads, and school
buildings. Thus virtually the depositors have by their savings made
possible the building and equipping of these actual forms of wealth,
and have an equitable claim upon the usance of them, which claim is
met by the payment of interest and dividends to the savings banks.
Viewed in this way the great social importance of the savings function
appears, and the importance of developing the savings institutions.

§ 7. #Postal savings plan.# In many countries of the world the
governments have not only authorized private, corporate, and trustee
savings banks, but have provided public agencies where it is possible
for the citizens to deposit small amounts. Thus municipal, and what
are called communal, savings banks are operated by many European
cities; but the most effective and widely used agencies for the
purpose are the national post-offices. Postal savings banks, or postal
savings systems as divisions of the postal service, are now found in
all the larger countries of the world, and in many smaller ones. The
United States of America was almost the last civilized country to
establish such a system, which was authorized by act of Congress in
1910, and went into operation in a few designated cities in January,
1911. The number of offices at which it was in operation was rapidly
increased, and the number in 1914 was about 10,000.

Any one ten years of age may become a depositor. Deposit must be made
always in multiples of one dollar. Not more than $100 will be accepted
for deposit in any one calendar month, and nothing after the total
balance to the depositor's credit is as much as $1000, exclusive of
accumulated interest. However, amounts less than one dollar may be
saved for deposit by purchasing a ten-cent postal savings card and
affixing ten-cent postal savings stamps until the nine blank spaces
are filled. Such a filled card will be accepted as a deposit of
one dollar either in opening an account or in adding to an existing
account.

Deposits are not entered in a depositor's book, as is the usual
practice of savings banks, but are evidenced by certificates issued in
fixed denominations of $1, $2, $5, $10, $20, $50, and $100. These bear
interest, from the first day of the month next following that in which
the deposit is made, at the rate of 2 per cent per annum for a whole
year (interest is not paid for any fraction of a year). Interest
is not compounded, unless the depositor withdraws the interest and
redeposits it, but simple interest continues to accrue annually on
a certificate so long as it is outstanding, without limitation as to
time.

By the end of the first year (1911) of operation the savings system
held a balance to the credit of depositors of nearly $11,000,000; in
the next year (1912) there was added to this about $17,000,000; in
the next year (1913) about $12,000,000; and this average rate of one
million dollars a month net addition to deposits has continued to the
present (1916). These funds are deposited in banks belonging to the
federal reserve system, which must deposit with the Treasurer of
the United States designated kinds of bonds (national, state, and
municipal) as security and pay interest at the rate of 2-1/2 per
cent on the amount of the deposits. The one-half per cent difference
between this rate and that paid to individuals goes far toward paying
the expense of operating the system.

Provision is made for the issue of postal savings bonds in exchange
for certificates issued in sums of $20 or multiples thereof up to
$500. These bonds bear interest at the rate of 2-1/2 per cent payable
in semi-annual instalments, January 1 and July 1. These bonds are
not counted as a part of the $500 maximum of deposits allowed to one
person, and there is no limit to the amount of bonds which may be
acquired by one depositor. Postal savings bonds are exempt from all
kinds of taxes, federal and local. These bonds are issued only on the
surrender of postal savings deposits, but may be sold by the owner
at any time. Three years after the law went into effect, there were
$4,635,820 of postal savings bonds outstanding.

§ 8. #Advantages of the postal savings plan.# As compared with
corporate savings banks the postal savings system has certain
advantages.

(a) It protects the small depositors from the danger of dishonest
private bankers who have preyed upon the immigrants in the larger
cities. To foreigners, accustomed to the postal savings plan in their
home countries, it is especially useful.

(b) It gives to every depositor the greatest safety possible, as "the
faith of the United States is solemnly pledged" for the repayment of
depositors.

(c) It brings a savings institution to many a small town and rural
place formerly entirely lacking in facilities for small depositors.
The benefit of this has not immediately appeared to be great, but may
in time prove to be.

(d) It pays interest from the first of the month following the date of
deposit whereas the usual practice of savings and commercial banks is
to pay only from the beginning of the quarter year or half year.

(e) It provides for the exchange of deposits for bonds bearing a
higher rate of interest--a unique feature greatly simplifying for the
small saver the process of buying bonds for more lasting investment.

In some respects, however, the postal savings system falls short of
the advantages of the regular savings banks. These usually accept
for deposit as small an amount as ten cents; they pay interest either
quarterly or semi-annually; they pay on the average (at present)
almost double the rate of interest, and the interest is credited
to the depositor's account at stated intervals and automatically
compounded. The postal savings system, as the law now stands, may be
looked upon, therefore, as supplementing the regular savings banks
rather than competing with them.

§ 9. #Collection of savings and education in thrift.# Small savings
have been encouraged in many places by penny provident funds, dime
savings banks, and school savings funds, which have been conducted at
public schools, social settlements, and factories, by school officers
and by charitable and educational societies acting through canvassers.
These plans all call for much personal effort and cost, which must be
provided by volunteer services and private gifts. These plans being
undertaken mainly as a means of education in thrift and in the
related moralities, their results are not to be measured merely by the
magnitude of the sums collected. They are not rivals of the ordinary
savings banks, but rather auxiliary methods of encouraging their use.
The funds collected by these agencies are usually deposited in local
savings banks, and depositors are encouraged to open individual
accounts there, whenever they have considerable sums saved.

In Germany the public schools have been furnished with automatic stamp
vending machines, from which savings stamps in as small denominations
as ten pfennigs (2-1/2 cents) may be had by dropping a coin into a
slot.[10] This method could be used very effectively in connection
either with the postal savings system or with a local savings bank. It
ought to be made easy to deposit funds at every school house, at every
post-office, at every factory counter on pay day, and wherever people
pass in numbers. Allurements to foolish expenditures meet old and
young at every turn; to spend the dime is made all too easy, whereas
to save it and deposit it in a safe place too often calls for wasteful
and discouraging efforts from the person of small means.

§ 10. #Building and loan associations.# Building and loan association
is the name applied to a coöperative organization of persons with
the purpose of collecting regularly from members small sums which
are loaned to some members for the purpose of building or paying
for homes.[11] The first association of this type was organized in
Frankford, Pennsylvania, in 1831. It and others of its kind have
made Philadelphia notable among all the larger cities as "the city of
homes." The number of such associations has almost steadily increased
in the United States. Pennsylvania continues to rank first in respect
to amount of total assets, with Ohio a close second, and New Jersey
third (the ranking first in proportion to population). Associations
of this type have been hardly second in importance in America to the
savings banks as institutions for savings for persons of moderate
means. The number of their members (nearly 3,000,000) is about
one-fourth of that of savings bank depositors, and the amount of
their assets (1-1/4 billion dollars) is about one-fourth that of the
reported savings banks. But their relative influence in educating and
encouraging to thrift is doubtless much greater than these figures
indicate. There are more than three times as many of them as of
reported savings banks, their management is much more democratic than
is that of the banks, and many of their members attend and participate
in the meetings and understand how they are conducted. Moreover, the
savings made through these associations are constantly passing on into
the houses that are fully paid for, and which continue to yield their
incomes to their owners. Each year these associations collect from
their members as dues and in repayment of loans (made to build houses)
the sum of over half a billion dollars, which is twice as much as the
annual increase in the deposits of the reported savings banks.[12]

§ 11. #The main features.# A building and loan association is
organized by a group of persons in a neighborhood, uniting to form a
corporation under the laws of the state, every member to subscribe
for one or more shares. The officers elected all serve without pay
excepting the secretary-treasurer, who receives a small fee for his
services. All official meetings are open to all members. The shares
vary in denomination from $25 to $200; the larger figure being common
under the serial plan and $100 being usual under the continuous (or
permanent) plan, described below. Whenever there is a sufficient
sum it is loaned to one of the members for the purpose of building a
house. The borrower must subscribe for shares to the par value of his
loan.

The receipts of the association are of several kinds.

(a) Interest is received from members, usually at the rate of 6
per cent, and from banks at a lower rate on the small working cash
balances kept on deposit. Usually the loans made are large enough to
cover a large proportion of the cost of the house, but the land on
which the house stands must be free from all incumbrance, and its
value gives a margin of safety to the association. Then by the method
of payment of dues the debt is, from the first month, steadily reduced
and the security for the loan therefore grows constantly better.

(b) Premiums are collected in addition, sometimes in the form of a
higher rate of interest, but the practice of charging premiums has
been mostly abandoned and the total amount of premiums now constitutes
less than 1 per cent of all payments from members.

(c) Fines for delinquency also are less commonly imposed now and
constitute a small fraction of 1 per cent of total payments.

(d) Deductions are made on account of withdrawal before the maturity
of the shares; under these circumstances it is usual to pay a portion
but not all of the accumulated profits, sometimes a proportion
increasing as the shares approach maturity.

Different plans have been and still are followed in respect to the
method of issuing the shares. Under the _terminating plan_ all
the shares begin and mature at the same time (for all members that
continue to the end). Whereupon the association dissolves or starts
anew. The chief difficulty in this plan is that the association has
too few funds to loan at the beginning of its career, and a surplus
of unloanable funds as it nears the maturity of the series. It is
therefore necessary to encourage or to compel the withdrawal of
non-borrowing members on the payment of estimated profits to date.

The better to remedy this difficulty the _serial plan_ was devised,
by which new series of stock are issued at intervals--yearly,
half-yearly, quarterly, and even oftener.

§ 12. #The continuous plan.# A further development is the continuous
plan (usually called the _permanent_ or the Dayton plan), by which
much greater flexibility is attained in the organization. Shares
of stock may be subscribed for at any time, each man's separate
subscription of shares being treated as a separate series, and
maturing each at its own time. There is thus, after an association has
been for some time in operation, a continuous stream of new members
(or new subscriptions) flowing into the association, and a continuous
outflow of shareholders whose shares have matured. The maturing shares
of borrowing members discharge their indebtedness to the association;
the maturing shares of non-borrowing members are paid in money, or
may (if the association has use for the funds) be left as an
interest-bearing loan.

Additional funds are obtained when needed by issuing paid-up stock to
non-borrowers. This is convenient at the beginning of an association
and when the movement in building is more active than usual. But if an
association has funds that cannot be loaned, outstanding paid-up stock
may be called in. In practice a large part of the paid-up stock as
well as of the running stock is subscribed for and held not by large
capitalists but by persons of small means, especially "the more frugal
element in the working classes." Non-borrowing members desiring
to withdraw may do so at any time under certain conditions; but to
safeguard the association, the laws usually require that thirty days'
notice of intention to withdraw shall be given, that not more than
one half of the funds received in any one month shall be paid on
withdrawals, and that withdrawing shareholders shall be paid in the
order of the notices of intention to withdraw.

The most intelligent and prudent workers were formerly deterred from
subscribing by the fear that sickness, unemployment, or other mishap
might make it impossible to keep up regular payments. Now, however,
fines for late payment have been almost entirely done away with. On
the other hand, extra payments may be made at any time by borrowing
members, to hasten the date when their shares mature and their debt
be discharged. These privileges are possible because of the method of
distributing earnings which will now be described.


§ 13. #The distribution of earnings.# Every six months is ascertained
the amount of the gross earnings which, under this plan, consist
almost entirely of interest paid on loans. From this amount are
deducted expenses (and in some states 5 per cent of the total is
placed in a "loss fund" to meet possible losses) and the rest is
divided in proportion to the amount standing to the credit of each
member, being credited to the account of running stock and paid in
cash to holders of paid-up stock.

The payment of dues is correspondingly simple. The dues at twenty-five
cents a week amount to $13 a year per share of $100. This is the whole
bill; there are no extras. The interest at 6 per cent (the usual rate)
is $6, and the rest, $7, is credited upon the stock. Thus at the end
of the first six months the member has $3.50 to his credit, and is
entitled to his share of the net earnings on that amount. Thus his
share of the earnings is steadily increased by compound interest, and
if he keeps up his regular payments the shares mature in about sixteen
years. This means in most cases that a prudent tenant can become the
owner of a house in sixteen years while paying no more than the rent
would be. As the active investor he becomes his own rent collector
and uses the house with less need of repairs, thus dispensing with
services and costs which are included in contractual rents.[13]

These associations are properly made subject to supervision and
examination by state officials, in the manner of that exercised over
banks. They have been favored by exempting the shares of members and
the mortgages held by the associations from all state and municipal
taxation. As the houses built or paid for are taxed, this is of course
but just, but it is an exception to the rule of the illogical general
property tax.[14]


§ 14. #Possible developments of savings institutions.# The social
importance of increasing and improving the agencies of savings for the
masses is being more fully recognized, but much more might be done in
these directions. Some possible changes have been suggested above, and
a few words more may be added.

Probably the greatest developments in the near future will be through
the savings departments of commercial banks (favored by the reserve
rules of the Federal Reserve Act) rather than by the increase in the
number of special banks for savings. The initial expense and risk of
starting a savings bank is considerable, and outside of cities of some
size this is prohibitive. Whereas a savings department, with its
funds and reserves separated, can be easily and cheaply operated in
connection with a general bank. It is much to be desired, however,
that a larger measure of popular coöperation might be made possible to
the depositors, both for its educational value and to reduce the real
evil of the autocratic or the plutocratic centralization of the money
power in the small communities.

Savings banks usually limit the amount of an account to $3000. It
is desirable that depositors should be able easily to convert their
savings-bank deposits over certain amounts into good bonds, bearing
a higher rate of interest (after the method of the issue of postal
savings bonds). There is need of a central market in each community
where such bonds can be bought and sold at any time; and the savings
banks might easily serve to buy and sell for their customers in this
way in the larger bond market. This would be of benefit also to the
states and municipalities which issue bonds for such purposes as
schools, roads, and public utilities, by creating a more open and
regular market to small investors than now is provided for such
securities. This might somewhat reduce the rate of interest and there
would be a gain divided between taxpayers and lenders.

The general plan and principles of local building and loan
associations might well be extended to groups of rural coöperators,
enabling them to make loans to their members; and to groups of small
investors, permitting them to hold real estate mortgages and bonds and
stocks of corporations, free from taxation other than that paid on the
wealth itself. Members of such organizations could get a higher income
on their investments than a savings bank could pay, and with greater
security than if each attempted to save and invest by himself.[15]

Savings institutions are necessarily also lending institutions. In
this chapter they have been looked at mainly from the saver's (the
lender's) standpoint, though their service to the borrower is of
coördinate importance. In the case of building and loan associations
this feature is most apparent. Later, the problem of the agricultural
borrower will receive further consideration.


[Footnote 1: See Vol. I, chs. 9 and 10.]

[Footnote 2: See Vol. I, pp. 285-290 for the analysis of saving from
the individual standpoint; and pp. 482-499 for its relation to general
economic conditions.]

[Footnote 3: See Vol. I, p. 484.]

[Footnote 4: See above, ch. 9, sec. 7.]

[Footnote 5: E.g., Babson Statistical Organization, Brookmire Economic
Service, Moody Manual Co., Moody Corporation Service.]

[Footnote 6: See Vol. I, p. 318.]

[Footnote 7: Report of the Comptroller of the Currency. Not all of
these are mutual. Statistics, moreover, include in some cases (e.g.,
California) the savings deposits of commercial banks but not the
number of such banks, and in other cases (Michigan) some banks that do
chiefly a commercial business. The line of demarcation between savings
banks and savings departments of commercial banks cannot be sharply
drawn. The Comptroller of the Currency reported in 1914 in a different
form the amount of savings deposits and of time certificates
of deposits in _all_ kinds of banks as the enormous sum of
$8,675,000,000.]

[Footnote 8: In the last twenty-three years, on the average, seven
savings banks a year have failed, the annual excess of liabilities
over assets being about $200,000, or about $30,000 for each failing
bank. The total loss has been about 1/5 of 1 per cent of total
deposits.]

[Footnote 9: The Federal Reserve Act, by making it possible for loans
to be had at any time (through member banks) on good security, should
reduce the danger of runs on savings banks.]

[Footnote 10: The author saw in operation a new machine of this kind
which had been installed in a German public school as early as 1910.]

[Footnote 11: See Vol. I, pp. 290, 297-298, 484, and 486.]

[Footnote 12: The figures here given and the description of methods
apply to the "local" building and loan associations. The success of
this kind led to the organization of other associations which took the
name "National" building and loan associations, to carry on a business
in a larger field. The number of these has always been comparatively
small, and their operation is less simple, democratic, and economical
than the local associations. They have borne more of the nature of
ordinary profit-making enterprises. They should not be confused with
the local associations.]

[Footnote 13: On these economies, see Vol. I, p. 298.]

[Footnote 14: See ch. 17, sec. 4.]

[Footnote 15: Since this was written the Federal Rural Credits Act has
been passed, embodying the main idea here described.]




CHAPTER 12

PRINCIPLES OF INSURANCE

  § 1. Chance, unavoidable and average. § 2. Uneconomic character of
  gambling. § 3. Borderland of gambling. § 4. Insurance: definition and
  kinds. § 5. Insurance viewed as a wager. § 6. Insurance as mutual
  protection. § 7. Conditions of sound insurance. § 8. Purpose of life
  insurance. § 9. Assessment plan. § 10. The reserve plan. § 11. The
  mortality table. § 12. The single premium for any term. § 13. Level
  annual premiums and reserves. § 14. Different features of policies.
  § 15. Insurance assets and investments as savings. § 16. Excessive
  costs of insurance operation.


§ 1. #Chance, unavoidable and average.# Every action and every
movement in life has in it some element of chance. There are what
may be called natural chances, arising from the uncertainties of the
seasons, or from rainfall, heat, hail, storm, flood, lightning, or
land-slides. Such chances must be taken both by the small enterpriser
and by the large. In earlier conditions of society natural chance
dominated industry, and it still remains and must always remain
important. There is the chance of unexpected political events, such
as war, riot, and legislation on money, tariffs, credit, and business
relations. These things are caused, it is true, by the action of men,
but it is a collective action out of the control of the individual.
There is the chance of human carelessness causing fire, explosions,
and wrecks on misplaced switches. There is the chance of physical or
mental collapse, as the sudden insanity or the sudden death of one
performing responsible duties. There is the chance of sickness that
often wrecks the plans and the fortunes of a whole family. There is
the chance of economic alterations in methods of production and of
transportation, in fashions and demand in this direction or for those
materials.

Some of these chances are more connected with money-lending, others
with manufacturing, some with agriculture, others with commerce; but
all are present in some degree in every industry. Some events are
unique in nature and seem unlikely ever to occur again; others are of
a kind occurring so irregularly that no reasonable prediction can be
made as to the time and frequency of their occurrences. Still others
occur frequently and to many different persons; but no individual can
tell when and how they will occur to him. A general average of chances
in different lines of business causes some to be called safe, others
extra-hazardous. Chance has its favorable as well as its unfavorable
aspects. Chances are averaged and added algebraically to the profit or
loss in an industry, for an extra-hazardous enterprise must in general
afford a higher average of profit in order to induce men to engage in
it. It is folly to take a risk without ascertaining its degree so far
as general experience enables one to choose. But inasmuch and in so
far as the gains and losses fall unequally upon different individuals,
income depends upon chance.

§ 2. #Uneconomic character of gambling.# This prevalence of chance
sometimes tempts men to say that business is "a gamble." But a
distinction in principle must be made between gambling and legitimate
risk-taking. The chances enumerated above are not sought, but avoided
as far as possible; yet they must be borne by some one if productive
enterprise is to continue, and the burden must somehow be distributed
throughout the community. Gambling is, however, a kind of risk-taking
which has a very different economic and moral quality. Gambling
creates the hazard, making the gain or loss of income depend on an
event that is not a necessary part of productive enterprise. Typical
gambling is the transfer of wealth on the outcome of events absolutely
unpredictable, so far as the two gamblers are concerned. Examples are
the shaking of unloaded dice or the honest dealing of a pack of cards,
and the betting on prices in so-called "bucket-shops" by persons
having no connection with the market of real things, and seeking to
get something for nothing as a result of mere chance.

Cheating is not a necessary mark of gambling, altho the cruder
forms of dishonesty, such as the loading of dice or the collusion of
horse-owners or of horse-jockeys to deceive the betting public, are
so common that they seem often to be an essential feature. Gamblers
recognize fair as opposed to unfair methods. Fair gambling is a kind
of minor morality within the immoral field of gambling, like the
honor found among thieves. The chance-taking in gambling has no useful
purpose or result outside itself. Betting and gambling do not produce
wealth, but merely shift the ownership of existing wealth. The
gamblers constitute themselves a little fictitious economic circle,
and they transfer gains and losses on the turn of events that have no
practical objective result within their circle except to determine the
direction of the transfer. Even when fairest, gambling must, in its
average results, be uneconomic. In any economic trade each trader
gains by getting goods that are, on the marginal principle, to him
more valuable than the other kinds of goods he gives up.[1] But in
gambling the winner gets all, the loser gets nothing. If two men of
like incomes gamble the additional desires that the winner is able
to gratify are (by the principle of decreasing gratification) less in
amount than the desires which the loser must forego. As a result the
loser is often depressed and seriously injured by the loss of his
income, the winner makes reckless and extravagant use of his winnings.
Easy come, easy go, is the rule of gamblers.

Moreover, gambling reduces the amount of wealth by relaxing the
motives of economic activity, diverting energy from productive
enterprise, tempting men into dishonesty to offset their losses, and
leading them into speculation and embezzlement.

§ 3. #Borderland of gambling.# Ranging between the extremes of
unavoidable risk-taking and of gambling are a number of cases of a
mixed nature. In nearly all wagers, judgment in some degree influences
the choice of sides. One man bets on a horse whose pedigree and
performances he knows thoroly; another judges by the horse's
appearance as it comes upon the track. The professional bookmakers
have the latest possible and most exact information on which to base
their bids.

In the bets made on one's own prowess, as on speed in running, the
chance-taking is still on the uneconomic side of the borderland,
certainly if the running is for the sake of the wager, not for
pleasure or for a useful purpose. A premium won by a runner for speed
in delivering a message of economic importance presents an essential
contrast to the winnings in a wager.

Finally, the very borderland of difficulty is reached in the purchase
and sale of goods in the market with a view of profiting by chance
changes in price. The purchasing and holding of land, lumber, grain,
cattle, and other tangible and useful things, that need to be stored,
held for buyers, or taken to market, must be judged liberally. The
quality of gambling depends somewhat on the motive as well as on the
ability of the trader. The enterpriser dealing with real wealth, and
fitted to take the risks both because of his resources and of his
exceptional knowledge, needs the motive of gain in such cases, and in
a sense can be said to earn socially what he gets. The motive of the
uninformed must be a blind trust in luck, and a hope to gain from a
rise in prices which they are quite unable to foresee or to explain.

§ 4. #Insurance: definition and kinds.# The large element of luck in
industry due to unavoidable chances has something of the same evil
character as gambling. It brings unearned prizes to some and to others
unmerited losses. It must therefore be a benefit to the community, if
this element of unavoidable chance cannot be reduced as a whole,
at least to regularize it and make it exactly calculable for any
individual. In this way each may be encouraged by the more certain
prospect of receiving a reward proportionate to his efforts and
abilities. This desirable condition has in many respects been
accomplished by means of insurance.

_Insurance_ is the act of providing a guarantee of indemnity against
a financial loss that will result if an event of a specified kind
occurs. The person seeking some surety against the possible loss is
the _insured_; the person contracting to indemnify against the loss is
the _insurer_; the written contract of insurance is the _policy_;
and the price paid by the insured in fulfillment of his part of
the contract is the _premium_; the amount paid when a loss has been
incurred is the _indemnity_; and the person to whom the indemnity is
paid is the _beneficiary_ (who may or may not be the insured).

The insurance with which we are here concerned is that which gives
financial indemnity. This is given for loss of expected net income,
when by chance either receipts are less or costs are more than
average. The two main classes as regards kinds of loss are property
insurance and personal insurance. _Property insurance_ is that which
indemnifies for loss of one's possession in specified ways, such as by
fire, by the elements at sea (marine), by hail, lightning, or cyclone,
by death (of valuable animals), by robbery, and by breakage (of window
glass). _Personal insurance_ is that which indemnifies the beneficiary
for loss of income as the result of various happenings to persons,
the chief being death, accident, sickness, invalidity, old age, and
unemployment. The principle of insurance is being constantly extended
to new subjects[2] and it is capable of further development in a
variety of directions.

§ 5. #Insurance viewed as a wager.# Insurance, without question a
highly useful thing, appears, paradoxically, to be in its outer form
a bet. The large merchant with many vessels used in many kinds of
business had in the days before marine insurance an advantage in
distributing his losses over a number of voyages. Antonio, the wealthy
merchant, is made thus to express his security:

  "My ventures are not in one bottom trusted
  Nor to one place; nor is my whole estate
  Upon the fortune of the present year.
  Therefore my merchandise makes me not sad."

In its early form marine insurance was the attempt of smaller
ship-owners to distribute their losses (as could the wealthy merchant)
over a number of undertakings, lucky and unlucky. It became customary
for a ship-owner to bet with a wealthy man that the ship would not
return. If it did come back, the owner could afford to pay the bet;
if it did not, he won his bet and thus recovered a part of his loss.
Gradually there came about a specialization of risk-taking by the men
most able to bear it. They could tell by experience about what was the
degree of uncertainty, and could lay their wagers accordingly. When
several insurers were in the same business, competition forced them to
insure the vessel and cargo of the ordinary trader for something near
the percentage of risk involved. The insurance thus tended to become a
mutual protection to the ship-owners; what had to be paid in premiums
to cover risk came to be counted as part of the cost of carrying on
that business.

Every legitimate form of insurance exhibits substantially the same
characteristics; it reduces loss at the margin where it is felt most
keenly. The difference between insurance and gambling, thus, lies
primarily in the purpose of insurance, which is not to increase
artificially the risk that any individual runs, but to neutralize or
offset an already existing chance. The insurance bet is what is called
a "hedge." The difference lies further in the collective method of
insurance, which combines the chances scattered among a number of
persons. Insurance does not increase the total of risks and of losses,
but merely combines, averages, and distributes them equally among all
the insured. This eliminates the chance element to the individual by
converting it into a regular cost.

§ 6. #Insurance as mutual protection.# Modern insurance is conducted
either by enterprisers for profit, or by mutual companies; but in any
case in large measure the losses in insurance are mutually shared,
as the premiums (plus interest earned) equal the total losses plus
operating expenses and profit, if any is made. Each insured gets a
contract of indemnity for the payment of a sum that will help cover
the losses of others. Such an exchange is mutually beneficial. The
premium comes from marginal income; the loss if it occurs would fall
upon the parts of income having higher value to the insured. The less
urgent needs of the present are sacrificed in order to protect
the income that gratifies the more urgent needs of the future. In
insurance each party gives a smaller value for a greater; each makes a
gain. The greater security in business stimulates effort. This effect
is quite the opposite of that of gambling.

§ 7. #Conditions of sound insurance.# To be economically sound,
insurance must have to do with real productive agents, and with
a group of occurrences which, as a whole, are approximately
ascertainable in advance--however irregularly they may fall upon
individuals. The beneficiary must have an _incurable interest_ in the
property or person insured; that is, the beneficiary must actually
suffer a loss by the occurrence insured against. Finally, the amount
of the indemnity must not be greater than the loss incurred. Some of
the greatest difficulties in insurance arise from the absence of these
essential conditions. When there is no insurable interest or when
the indemnity is greater than the loss that may be incurred, the
beneficiary may and sometimes does find it to his interest to bring
about the socially injurious event insured against. He artificially
increases the loss against which insurance was taken. When the insured
sets fire to his own buildings, he makes an illegitimate use of
insurance. Constant efforts are made by insurance companies to guard
against these "moral risks," the least calculable of any. Merchants
whose stocks have been mysteriously burned two or three times find
difficulty in getting further insurance. Formerly insurance was not
paid in case of death by suicide; but now usually no such limitation
is contained in a policy after a period of one or more years. As men
rarely plan suicide years in advance, death by one's own hand some
years after taking life insurance is regarded as coming under the
ordinary rules of chance. Yet it is to be feared that this
liberal policy serves as a temptation at times to crime and to
self-destruction.

§ 8. #Purpose of life insurance.# Property insurance is mainly an
aspect of enterpriser's cost, whereas personal insurance is more
closely connected with the object of saving.[3] We shall in the rest
of this chapter limit the discussion to the one most important form
of personal insurance, that called life insurance (sometimes called
survivors' insurance).

Life insurance is that form of insurance in which partial indemnity
is provided for survivors against the financial loss incurred by the
death of the insured. Usually the insured is the breadwinner of
the family and the beneficiary is a member of his family, but in an
increasing number of cases the beneficiary is the surviving business
partner, a creditor, or a business corporation with an insurable
interest in the life of one of its employees.

Life insurance has been much used by persons mainly dependent on labor
incomes[4] rather than on incomes from capital, by those receiving
salaries, professional fees, and by active business men. It has of
late been extended rapidly, as "industrial insurance" to wage earners,
in policies never exceeding $1000, but averaging very much less,
and often being for no more than enough to pay funeral expenses. The
premiums on such policies are usually collected weekly and by agents
making personal visits. The cost to the insured is, therefore,
necessarily very high in proportion to the amount of insurance.


§ 9. #Assessment plan.# Life insurance plans may be distinguished,
with reference to the time and method of collecting the premiums, as
assessment and reserve insurance.

In the simple form of assessment insurance originally the losses were
paid by contributions taken after the losses occurred, each member
paying an equal share without regard to age. In a slightly improved
plan the assessments are made at the beginning of the year, based upon
the expected mortality for the year. The sum just sufficient for this
purpose (omitting expenses) is called the _natural premium_. The
cost of such insurance is closely related to the average age of
the members. The rates are very low in a new organization with a
membership of young men; but each year the average age, and therefore
the mortality of the membership, rises and the annual assessments must
be increased. By constant additions of young members, this rise of
cost may be retarded. But when these members grow older, a still
larger addition of young members is required to keep down the average,
and the mathematically inevitable result is an increasing rate of
assessment. This keeps young men from entering, and finally results in
failure or in some form of "reorganization" that drives out the older
members. The assessment plan carries with it the seeds of its own
decay.

To meet these difficulties in part, various modifications of the
flat-rate assessment plan are employed, such as classification by age
at entry, so that each member pays a flat-rate according to age
at entry; or large initiation fees at entry which form a temporary
"reserve" to offset increasing mortality in late years. Finally,
the policies may be issued on the natural premium plan, by which the
members of each age class pay exactly what the insurance costs for the
year. Under this plan the company will remain solvent, but with this
and all the other expedients the surviving members are forced to drop
the insurance in later years.

Assessment insurance is sold by business companies organized
for profit, by fraternal orders, and by various types of mutual
organizations. The business companies have had a dismal history
of hardship to surviving members and of eventual failure. They are
disappearing under the influence of hostile legislation resulting
from a better popular knowledge of insurance principles. The fraternal
orders combine insurance with other objects of a benevolent and social
character. With good management, a favorable death rate, and very low
expenses, some of them have provided protection at very low rates for
many years. Others have failed with disappointment and disaster to
the older members. Still others are struggling with difficulties that
presage dissolution. Many now have some form of reserve accumulations,
and some have so improved their methods that they closely resemble
reserve companies. The assets of all the assessment companies are
now $1.37 per $100 of insurance in force, while the legal reserve
companies have $22.66. The assessment companies now get 10 per cent of
their total incomes from their funded investments, as against 24 per
cent for the old-line companies. Even with the favorable conditions
under which the fraternal orders conduct their insurance business they
are doomed to failure unless they adopt rates and policies based upon
adequate reserve accumulations. Many thousands of present members
are paying for insurance at rates which will not suffice to meet the
future losses. The assessment plan fails to eliminate the one great
risk, that of leaving the survivors without insurance in advancing
years.


§ 10. # The reserve plan.# The reserve plan, if honestly administered,
gives complete protection against the difficulties just indicated. The
essential purpose of the reserve plan is to collect during the earlier
years of the insurance policy when the mortality is less, a sum larger
than is needed to meet the current losses. This sum, the reserve, is
kept invested and accumulating an income, sufficient to offset the
increase in losses as years advance. In reserve insurance, therefore,
the premium never increases from year to year, altho it may be so
arranged as to diminish or to cease entirely sometime within the term
for which the insurance continues.

The premium must always be fixed in advance. The calculations for
determining the premiums on different kinds of insurance policies are
many and complex, but all conform to a few general principles. The
three factors assumed are an average mortality table, a rate of
interest (or yield on investments), and an expense rate in proportion
to the premiums or outstanding insurance. Insurance on the reserve
plan is often called "scientific insurance" because, upon the basis
of these assumptions resulting from experience, it makes exact
mathematical calculations of the premiums and reserves needed for
insurance of any particular kind in respect to age of insured,
number of payments, method of paying the beneficiary, and any other
conditions. The premium thus fixed is, however, only a maximum, and
usually is reduced as the result of conditions more favorable than
those assumed.

§ 11. #The mortality table.# When large numbers of men are taken as
a group, a certain proportion of those at each age may be expected to
die. A mortality table starts with a group of persons, as 100,000, at
a given age, as 10 years, and shows the number who die and the number
who survive at each year of age until all are dead. The table most
widely used in the United States is the American Experience Table of
Mortality, constructed by Sheppard Homans in 1868. The figures of this
table, at different years, are given below:

  Age         Number Living     Deaths each year    Death rate
                                                    per 1,000

  10            100,000                749           7.49
  20             92,637                723           7.80
  30             84,441                720           8.43
  35             81,822                732           8.95
  40             78,106                765           9.79
  50             69,804                962          13.78
  60             57,917              1,546          26.69
  70             38,569              2,391          61.99
  80             14,474              2,091         144.47
  90                847                385         454.54
  95                  3                  3       1,000.00

The actual number of deaths of any group of insured will not
correspond exactly with the figures of any mortality table. But this
is not an essential defect of a table so long as the figures of the
table are approximately correct and are at least as great in the
earlier years as the actual mortality. For any excess of premium thus
collected but increases the safety of the insurance and reduces later
payments. In fact the mortality in nearly all companies in the United
States is much below the figures of the American Experience Table,
partly because of the influence of medical selection on the recently
insured and partly because of the decided improvement in longevity
since the table was constructed.

§ 12. #The single premium for any term.# It is evident that the
natural assessment premium payable at the beginning of the year for
$1000 of insurance for that year is expressed by the death rate, e.g.,
at age 35, the payment of $8.95 by each of the 81,822 living at the
beginning of the year will provide the $732,000 needed to pay the
losses.[5]

In the same manner would be determined the natural assessment premium
for each year of insurance. Now, when it is possible to invest the
premiums so as to yield a minimum rate of income it is a simple matter
to determine the amount of a single premium, at any age, that is
adequate to pay for insurance covering any selected number of years
(term insurance) up to the entire period of each insured person's
life (full life). It is necessary only to apply the formula of present
worth and that of compound interest on investments.[6] Thus the
expected losses of any year according to the table of mortality,
divided by 1 + rate of yield on investments raised to the power of
years distant, equals the present worth of insuring the entire group
for that year. The sum of the discounted cost of insurance for all the
years of the term divided by the number living at the beginning of the
period, gives the single premium for each of the insured. Let P be the
present worth of all the policies for a group of the same age, p the
present worth of one policy, X the total insured at the beginning of
the period, f the natural assessment premium this year, or the natural
premium required for any year. Then

          f           f1          f2          fn
   P = __________ + _________ + ________ + _________
       (l + r)      (l + r)^2   (l + r)^3   (l + r)^n

           P
   p = _________
           X

The payment in advance of the single premium for any selected period
provides a reserve fund sufficient, on the assumptions made, to carry
all the insurance without further payments. Each year there is added
to the fund the income earned on investments, and there is subtracted
the amount of the losses for the year, until the death of the last
member of the insured group. If the deaths in the earlier years are
fewer than were expected in the mortality table, this will be offset
eventually by more deaths at the advanced years; but in the meantime a
reserve larger than was expected is yielding income, thus providing
a larger sum than is needed to pay all the policies at maturity. This
surplus might be distributed as so-called "dividends" from time to
time to those surviving, or be added pro-rata, at intervals, to the
amount of the policies as accumulated dividends.

§ 13. #Level annual premiums and reserves.# It is a matter of no very
abstruse mathematics (in principle) to find the equivalent of this
single premium in any one of many other forms of premium payment.
The processes are mainly but variations of present worth and compound
interest calculations. Such calculations, however, lead into many
complexities of practical detail difficult to explain in brief
compass, and are the special task of the actuary (the mathematical
expert dealing with such problems in the insurance business). The most
useful actuarial equivalent of the single premium is the level annual
premium for any period (term or life). Almost all policies now written
have the level annual premium as a feature. The amount of the level
annual premiums at first is greater than the losses; this causes for
a time the steady accumulation of a reserve which yields income. Then,
as the losses grow, they overtake and finally surpass the amount of
the annual premiums. Therefore, the total reserve for any group of
insured increases year by year to a maximum and then declines until
it reaches zero with the payment of the last claim. The individual
reserve for each policy not yet matured increases steadily the longer
it is in force. The total reserve is essential to the solvency of
the company and the payment of all the policies as they fall due. The
companies which issue policies on the level premium plan or reserve
plan are known as "old line" companies, or as "legal reserve"
companies, because the state laws require every company of this type
to maintain the reserves calculated on the basis of a certain rate
of yield. The growth of the legal reserve companies in recent times
constitutes one of the financial marvels of the age.

§ 14. #Different features of policies.# The premiums thus far
discussed are "net premiums" estimated as just sufficient to meet the
actual payments required by the contracts in the policies. To provide
for the expenses of management an addition is made to the net
premium called the "loading." The entire premium is called the "gross
premium."

Reserve insurance is still carried on by a few stock companies, but of
late some stock companies have been transformed into mutual companies,
which are the prevailing type. The mutual company legally belongs to
the policyholders. The gross premiums in reserve insurance are, for
the purpose of safety, fixed at a figure larger than the expected cost
of the insurance, and normally the earnings from interest are higher,
the mortality is lower, and expenses are less than those on which the
calculation of rates is based. From the excess of income resulting,
the company sets aside a surplus and then divides the rest among
the policyholders. These returns, virtually but the refund of excess
premiums, are called "dividends" (a somewhat misleading term, not
to be confused with dividends on corporate stock). The policies
that receive dividends are called "participating" and are said to
participate in the earnings. Formerly the majority of policies paid
"deferred" dividends after 5, 10, or 20 years, according to various
tontine and semi-tontine plans, the survivors to these periods
receiving their dividends plus those of the other policyholders who
had died or had withdrawn from the company. This form of payment
having been found objectionable, it was made illegal in New York and
other states, and in most cases dividends are now paid annually. The
stock company, organized for profit, frequently charges lower premiums
for "non-participating" policies, and then retains such profits as may
result from keeping expenses below receipts.

The most popular policies are term policies (usually for 5, 10, 15,
or 20 years); ordinary life policies with annual premiums; limited
payment life policies (the policy payable at death, with premiums
fully paid up after 10, 15, or 20 years); and endowment policies (the
face of the policy payable after 10, 15, or 20 years if the insured is
still living). An endowment policy must be understood to be a regular
term policy of insurance for the specified number of years, plus a
plan of regular annual savings, which at compound interest, accumulate
to the face of the policy. Many persons are attracted to endowment
insurance by the oft expressed thought that "you don't have to die to
beat it." But this is a mistaken thought. For the premium in endowment
insurance is much higher than that for life insurance alone during the
same period, so that the endowment is merely a pretty convenient but
somewhat costly plan of saving, hitched on to an insurance policy,
with which "actuarially," it has no essential connection. In "scientific"
insurance the insured pays its full actuarial cost for each additional
feature of the policy that he buys. The various policies issued by a
company are approximately equivalent actuarially, on the basis of the
assumptions made, but they are of very different degrees of desirability,
in view of the circumstances of the insuring individual. The choice of
policies deserves a more careful investigation than it usually received.
Moreover, carelessness and ignorance in the choice of a company is
responsible for widespread loss and suffering.

Policies differ in respect to the mode of payment. The payment usually
takes the form of a lump sum payment at death or at the maturity
of the endowment. In recent times there has been a growing use of
optional forms of payment which give to the beneficiary annual or
monthly installments for a definite number of years or for life.

§ 14. #Insurance assets and investments as savings.# The discussion of
savings institutions in the last chapter left unmentioned insurance,
which probably is destined to be the most important of all. The assets
of life insurance companies in the United States have already attained
the enormous sum of $5,000,000,000, a sum equal to the reported
savings bank deposits. In the last twenty years life insurance assets
have more than doubled in each decade, and are now increasing by about
a quarter of a billion dollars every year.[7] These great funds,
which in equity nearly all belong to the policyholders, form already
approximately one thirtieth of all the private capital of the country.
They are invested in many ways, in real estate, in loans secured
by mortgages on real estate, in bonds--municipal, railroad, and
industrial. The problem of wise legislation for these organizations,
of their competent and honest management, and of their relation to the
social, business, and political life of the nation, is certain to be
of ever-increasing importance. We are hardly more than emerging from
the experimental stage of life insurance, hardly more than at the
beginning of its development.

The premium in personal insurance (life, accident, sickness,
invalidity, old age pensions) is in almost all cases paid out of some
current income. The premium paid is just so much subtracted from the
amount available for present direct use and applied to the purchase of
future incomes for one's self or family. The insurance method differs
from the method of depositing savings by its contingent nature, the
resulting income of any individual being possibly much greater than
the amounts actually saved (e.g., when the insured dies or is injured
soon after taking insurance), and possibly less or nothing at all. A
very desirable kind of insurance which is yet little developed is
that for a term ending with the usual retirement age (say 65 years)
combined with an old-age pension for life thereafter.

It is probable that abstinence will more and more express itself not
in accumulating large capital sums to provide for one's old age or for
survivors, but in providing insurance for survivors, and invalidity
and old-age pensions for the insured and others, payable as terminable
annuities. In any case the results to be expected in the changing
forms and magnitude of private fortunes are certain to be great.

§ 15. #Excessive costs of insurance operation.# So beneficent is
insurance that the enormous cost of transacting the business under
present methods is much to be regretted. A very large part of the
premiums paid by the insured is retained by the companies.[8] In the
case of reserve life insurance a considerable part of what is not
returned is, however, set aside as reserve virtually held in trust for
the policyholders. In the case of the other kinds of insurance, nearly
all of the amount not returned is either cost of operation or profits,
tho it must be recognized that a part of the cost of some kinds
of insurance is for real services, such as inspection and fire
prevention. It is remarkable that the percentage returned by the life
insurance companies, accumulating, as they do, large reserves in trust
for the policyholders, is greater than it is for the other kinds of
companies (fire, marine, casualty, surety, liability, accident, and
health insurance).

It is a striking evidence of the importance of the marginal
principle[9] that insurance at such a cost should still be desired by
men. The use of insurance would be much wider and its benefits greater
if this "tare and tret" of doing the business could be reduced. It
seems a reasonable hope, now that the experimental stages are passed,
that this may be done. In the case of all kinds of insurance as yet a
large expense for agents has been necessary to educate men to see
the value of insurance and to purchase it, as well as for many other
competitive expenses. It has been found that much of this expense
can be saved by insurance in groups (for all employees in an
establishment), by compulsory insurance (as of all working men), and
by central state administration serving to regularize and unify the
organizations. This important question will be further considered in
connection with "social insurance" as a measure to benefit the working
classes.


[Footnote 1: See Vol. 1, ch. 5, sec. 7.]

[Footnote 2: The Jeffries-Johnson prize-fight was insured, against
rain, for $30,000. Frequently, race-horses, the fingers of pianists,
the lives of ball-players, and the throats of singers, are now
insured. Summer hotels in England regularly insure for large sums
against more than so many days of rain per season.]

[Footnote 3: On the former, see Vol. I, pp. 365 and 374; and on the
latter, below, sec. 14.]

[Footnote 4: See Vol. I, labor-incomes, in Index.]

[Footnote 5: There is an appearance of a slight discrepancy due to
the omission of fractions of cents. If premiums are collected at the
beginning of the year and losses are paid at the end of the year, and
if interest can be earned meantime at the rate of 3-1/2 per cent, the
natural premium for a one year term policy is about $8.64, that being
the present worth of $8.95 due a year hence, interest being 3-1/2 per
cent. In these calculations there is no allowance for expenses, the
necessary "loading," on which see below, sec. 14.]

[Footnote 6: See Vol. I, p. 279.]

[Footnote 7: The following are the chief statistical facts regarding
the life insurance business in the United States, Jan. 1, 1914,
showing separately legal reserve and assessment companies, and the total.
  ------------------------------------------------------------------
                  |   Number of  |  Policies     |   Insurance
                  | Companies    |  in force     |    in force
                  |              |               |
  Legal reserve ..|    260       | 38,206,000    | $20,256,000,000
  Assessment .....|    605       |  8,789,000    |  10,023,000,000
  Total ..........|    865       | 46,995,000    |  30,587,000,000
  -----------------------------------------------------------------
                  |   Premium    |   Total       |  Per cent income
                  | income       |   income      | from premiums
                  |              |               |
  Legal reserve ..| $715,000,000 | $946,000,000  |       75.6
  Assessment .....|  138,000,000 |  153,000,000  |       90.2
  Total ..........|  853,000,000 |1,099,000,000  |       77.6
  ----------------------------------------------------------------
                  |   Payments to|    Assets     | Assets for each
                  | policyholders|               | 100 insurance
                  |              |               |    in force
                  |              |               |
  Legal reserve   | $470,000,000 |$4,659,000,000 |      $22.66
  Assessment .... |  106,000,000 |   195,000,000 |        1.37
  Total   ....... |  576,000,000 | 4,854,000,000 |       15.87
]

[Footnote 8: In 1913 the total premiums collected by all kinds of
insurance companies reported (Statistical Abstract of the U.S., 1914,
pp. 549-557) were about $1,512,000,000, and the amount returned to
policy holders the same year was $918,000,000, or about 61 per cent
of all premiums, the amount not returned ($584,000,000) being 39 per
cent.

                    Premiums received   Returned to policyholders
                                              Amount      Percent

  Life insurance
   reserve companies  ..$715,000,000       $470,000,000     67
   assessment companies  138,000,000        106,000,000     76
  Other  kinds ......... 659,000,000        342,000,000     52
                        -------------       -----------     --
  Total   ........... $1,512,000,000       $918,000,000     61
]

[Footnote 9: See above, secs. 2 and 5.]




PART IV


TARIFF AND TAXATION




CHAPTER 13

INTERNATIONAL TRADE

  § 1. Political and trade boundaries. § 2. Benefits of international
  trade. § 3. Choice of the more advantageous occupations. § 4. Persistence
  of differences between nations. § 5. Doctrine of comparative
  advantages. § 6. Equation of international exchange. §7. Balance of
  merchandise movements. § 8. Cancellation of foreign indebtedness. § 9.
  Par of exchange. § 10. International monetary balance and price-levels.


§ 1. #Political and trade boundaries.# By international trade is
meant, in general, trade between persons resident in different
countries; comparatively rare is the case in which one of the two
parties to a trade is a whole nation acting through its government
as a unit (e.g., in the purchase of munitions of war in neutral
countries). Outside of a communistic group such as the family, trade
is a necessary accompaniment of division of labor. As territorial
division of labor began between neighboring tribes,[1] international
trade was the earliest kind of regular interchange of goods. Indeed
the very word "market" meant originally the boundary between tribes.
Thus, from primitive times when wandering savages gave bits of flint
or copper in return for salt or fish, individuals have sought to
adjust their goods to their desires through trade with men of other
political groups. With the progress of the world in the means of
communication and transportation, international trade has widened in
extent and grown in volume.

Economic relations never have been coextensive with political
relations. The economic groupings of men connected by a network of
trades never have and never will correspond very nearly with political
groupings of men bound together by common citizenship in particular
states. Indeed it is not uncommon for many of the residents in two
adjoining states to trade far more with each other than they do with
their own fellow citizens. Lawmakers and rulers from the beginnings of
formal governments have constantly tried to hinder this kind of trade.
They have done this chiefly because of their belief that they could
strengthen their states in political and economic ways, and could
favor some of their citizens, by confining economic relations within
political boundaries--if not exclusively, more closely than when trade
was left to take its natural course, guided by individual motives. The
regulation of international trade, therefore, has always constituted
an economic problem of great importance in the field of political
action.

§ 2. #Benefits of international trade#. Now, bearing in mind that
international trade is carried on by individual traders in any two
countries, we may ask what motive impels men to trade across the
political boundaries of a state. The simple answer is that each trader
has something to give and desires to get something in return. Each
is seeking to get something that has to him a greater value than the
thing he gives, and believes he can do this in trade with a foreigner
better than by trading at home. In any trade, both parties gain, or
think they are gaining.[2] In international trade there is the same
chance for mistake as in domestic trade, but no more. In a single
transaction in either domestic or foreign trade one party may be
cheated, but the continuance of trade relations is dependent upon
continued benefits. The once generally accepted maxim that the gain
of one in trade is the loss of another is now generally rejected,
but often still it is assumed to be true of international trade.
The starting point for the consideration of this subject is in
this proposition: Foreign trade is carried on by individuals, for
individual gain, with the same motives and for the same benefits as
are found in other trade.

The advantages of international trade are indeed but those of division
of labor in general, in the particular case where it happens to cross
political boundaries. The great territorial divisions of industry are
determined first and mainly by natural differences of climate, soil,
and material resources. Thus trade arises easily between North and
South, between warm and frigid climates, between new countries and
old, between regions sparsely and regions densely populated.[3]

Territorial divisions of industry are determined secondly by social
and economic differences such as those with respect to accumulation
of wealth, amount of loanable capital, invention, organization and
intelligence of the workers, and the grade of civilization.

Foreign trade normally imparts increased efficiency to the productive
forces of each country. In most cases it is apparent that labor is
more effective and gets a larger product when it is applied in those
ways for which the country is best fitted and for which it offers the
best and most bountiful materials; and that, further, when special
branches of industry have developed at one place, they make possible
the advantages of large production and of high specialization.

Certain erroneous explanations of the advantages of foreign trade may
be dismissed with brief mention. It is said to give vent for surplus
production and to give a wider market to what would otherwise go to
waste. This involves the same fallacy as the "lump of labor notion,"
the destruction of machinery, and the praise of waste and luxury.[4]
If it were true that sale to backward nations were now necessary
to give an outlet for products which would otherwise rot in the
warehouses, a time would come at length when the world would have
an enormous surplus unless neighboring planets could be successively
annexed. Again it is said that the great purpose of foreign trade is
to keep exports in excess of imports so that the money of the country
may constantly increase in amount. The ideal of such theorists is an
impossible condition where the country would constantly sell and never
buy.[5] In the narrow commercial view of the subject the sole object
of foreign trade is to afford a profit to the merchants, regardless of
the welfare of the mass of the citizens.

§ 3. #Choice of the more advantageous occupations#. Let us consider
the cases of two countries somewhat differently situated, such as an
old country like England and a newer country such as was the United
States in the nineteenth century. Now the relative advantages of
various industries in two such countries are very unlike. The newer
country excels in its broad area, its abundant rich lands, its
bountiful natural resources of forests and mines. These are the
superior opportunities which give the economic motives for settlement
and for continued immigration from the other lands. Most of the
newcomers find it to their advantage to develop the peculiar
opportunities of the new land, rather than to go on producing the same
things in the same way as they did in the old country.[6] Thus they
get a larger quantity of products per day's labor, and are able to
gain by trading a part of these for the products of the older country.
Thus the characteristic industries of the two countries must differ.
Without any government supervision, therefore, but simply through the
choice of enterprises, each seeking the best investment of capital for
himself, industries are developed in which each country is either
most markedly superior, or least inferior, to its neighbors. If
either laborers or capitalists in the new country were to turn to
the less-favored industries they would be forced to accept a smaller
reward than they can earn in the more favored.

§ 4. #Persistence of difference between nations#. If both men and
wealth interchanged between industries and between countries with
perfect readiness and without any outlay whatever for transportation,
these differences would soon disappear, and perfect equilibrium
of advantage would everywhere result. In every country, in every
occupation, labor and wealth of given quality and amount would receive
the same reward. But the interchange of labor and of products between
countries is never without friction.

The laborers, enterprisers, and investors in a naturally rich country
are thus in a position of more or less enduring advantage relative to
those of older and poorer countries. Differences of the same nature
appear as between different parts of the same country, as between the
Northern and the Southern states of the American union, between the
Eastern and the Western states, and even between neighboring countries
of the same state. The differences between two countries, however, are
likely to be more marked, the circulation of factors being so active
within a country that it is allowable to speak broadly of prevailing
national rates of wages and of interest. Altho, as Adam Smith said, "a
man is of all sorts of luggage the most difficult to be transported,"
the higher wages in a new country attract constantly from the older
lands a portion of their laborers. The higher rate of interest in new
countries constantly attracts investments from abroad; yet, despite
these forces working toward equalization, the inequality may remain
and, through the working of other influences, may even increase in the
course of years.

§ 5. #Doctrine of comparative advantages.# It may be that two
countries both possess the necessary technical conditions for making
both articles that are to be traded for each other. It may even be
that the people in one country would be able to make not only one of
the two objects of trade, but both of them, more easily and with less
sacrifice and effort than the people in the other. If, for example,
American labor can produce two bushels of wheat in a day and English
labor but one bushel a day; and American labor can produce just as
much iron in a day as English labor--or more--the question always
arises: Is it not foolish and wasteful not to produce both the wheat
and the iron?

Now, exactly the same case is presented in almost every simple
neighborhood trade. The proprietor may be able to keep his books
better than does the bookkeeper whom he employs. The merchant may be
able to sweep out the store better than the cheap boy does it. The
carpenter may be able to raise better vegetables than can the gardener
from whom he purchases. Yet the merchant does not turn to sweeping and
the carpenter to raising vegetables, because if they did they would
have to quit or limit by so much their present better-paying work, and
would lose far more than they would gain.

So whenever the people in one country have a greater advantage in one
article than in another, relative to another country, the foreigners,
like the low-paid man, will be willing to exchange at a ratio that
will make it profitable to specialize in the product wherein the
greater superiority lies.[7]

But this is always hard doctrine for the popular mind, and
particularly for the commercial mind endeavoring to carry on a
business that can not be made "to pay" in the face of foreign
competition. It is easy to believe that a country ought not to import
goods unless it is at an _absolute_ disadvantage in their production.
It is often declared that as our country can produce any kind of goods
"as well" as foreign countries (meaning with as few days' labor),
there is a loss on every unit imported. The fundamental principle of
trade as applied to such cases shows that not the advantage which
one country enjoys over the other as to a single product determines
whether it will gain by producing at home, but the comparative
advantages enjoyed in the production of the two articles in question.

As a simple example, suppose that a day's labor in country A will
secure two bushels of wheat (2x) and two hundred pounds of iron (2y),
whereas in B a day's labor will secure 1x or 2y. Then A's comparative
advantage in producing x becomes a reason for A's not trying to
produce y. Trade can take place (aside from transportation outlay)
at any ratio between 2x = 2x (A's minimum) and 2x = 4y (B's maximum).
Evidently at any rate between these two ratios each party would gain
something by the trade, e.g., at 2x = 3y A would get 3 instead of 2y
by a day's labor, and B would get 1-1/3x instead of 1x for a day's
labor (2x for 1-1/2 day's labor instead of for two days'). If,
however, A could produce exactly twice as much of everything as B
could, then there could be no motive on either side for trade. But
this never happens.

§ 6. #Equation of international exchange.# Foreign trade of course
can take place as barter, and in earlier times, particularly, very
commonly did so. But in the existing monetary economy nearly all
trades are expressed in terms of monetary prices. Both the prices
of all the particular objects of international trade and the general
levels of prices in any two trading countries come to be pretty
definitely interrelated. Changes in the one country at once compel
readjustments in the other. To understand in the most general way
how this occurs, a knowledge at least of the elementary principles of
foreign exchange is required, and to this we may now turn.

Let us begin with the proposition known as the equation of
international exchange, which is sometimes given thus: the value of
the imports of a country must in the long run equal the value of
the exports. But this proposition (especially the words imports and
exports) must be understood in a much broader sense than that of
the movements of merchandise merely. The proposition might better be
expressed: the total credits of a nation (including money actually
sent abroad) must just equal its total debits (including money
imported). Into the balance of accounts between any two nations enter
many items: the cash values of the imports and exports of merchandise;
freights, insurance premiums, and commissions; the expenses of
citizens while traveling abroad; money brought in or taken out by
immigrants; the cost of the governmental foreign services (such as the
salaries of consuls and of diplomatic representatives); subsidies
and war indemnities received from or paid to foreign nations; the
investments of foreign capital; and credit items of many kinds, on
both sides of the account.

The effect of loans upon the equation differs at different periods
according as they are just being made, are continuing, or are being
repaid. When foreign capital is first invested in a country, whether
it is loaned to the government or to individuals or to corporations,
either gold must be remitted to the borrowing country or goods be
sent. But later the interest payments and the eventual repayment of
the principal of the loan act in the opposite direction. Accruing
interest must be offset annually by exports from the debtor country
and the repayment of the principal requires that either money or goods
be exported equal in value to the original obligations. In popular
opinion an excess of exports of merchandise is an index, if not the
real cause, of national prosperity; but evidently it is no true index
whatever on this point. An excess of exports may at any given moment
indicate that the country is rich and is lending abroad, or that it is
in debt and is paying interest, or that it is repaying the principal.
On the other hand, an excess of imports may indicate either that a
country is poor, and is borrowing from abroad, or that it is rich,
with many foreign investments, and is receiving the income from them
in the form of a regular shipment of goods from the debtors.

The following statistics of the foreign commerce (merchandise imports
and exports) of the principal countries of the world are given in
significant groupings which call for various explanations.

Figures are in million dollars ($1,000,000) and are mostly for the
year 1908, (Stat. Abst. 1908, p. 769). At the present writing the war
has altered all the lines of commerce.

  COUNTRIES HAVING EXCESS OF IMPORTS OF MERCHANDISE

                    |Excess %|Imports.|Exports.|
  United  Kingdom ..|   57   |  2886  |  1835  |
  Germany ..........|   20   |  1824  |  1523  |
  Netherlands ......|   30   |  1130  |   873  |
  France ......     |   12   |  1089  |   975  |
  Belgium ..........|   33   |   642  |   484  |

  Italy ............|   68   |   562  |   334  |
  Aust.-Hung .......|    7   |   487  |   457  |
  Switzerland ......|   44   |   287  |   200  |
  Spain ............|   10   |   168  |   153  |
  Sweden ...........|   26   |   163  |   129  |
  Denmark ..........|   16   |   191  |   165  |
  Norway ...........|   58   |   101  |    64  |

  Canada ...........|   34   |   298  |   222  |
  China ............|   43   |   254  |   178  |
  Turkey ...........|   59   |   135  |    85  |

  COUNTRIES HAVING EXCESS OF EXPORTS OF MERCHANDISE

                    |Imports.|Exports.|Excess %|
  United States ....|  1312  |  1638  |   25   |
  Russia ...........|   436  |   542  |   24   |

  British Colonies .|   558  |   615  |    5   |
  British India ....|   418  |   486  |   16   |
  Australasia ......|   242  |   302  |   25   |
  Japan ............|   196  |   206  |    5   |
  Cuba .............|    84  |   116  |   40   |
  Mexico ...........|    78  |   115  |   42   |
  San Domingo ......|     5  |    10  |  100   |

  Argentina ........|   263  |   353  |   34   |
  Brazil ...........|   172  |   214  |   24   |
  Chile ............|    98  |   116  |   18   |
  Uruguay ..........|    35  |    37  |    6   |
  Bolivia ..........|    21  |    24  |   14   |
  Venezuela ....    |    10  |    15  |   50   |

#§ 7. Balance of merchandise movements.# The first group evidently
consists of the older, creditor countries which are drawing some of
the income of their investments from abroad each year in the form of
food and of raw materials of many kinds. The second group includes
countries of very diverse conditions, possibly all having some
investments abroad; Italy receives large imports in return for the
services of many Italians working in foreign countries, and the three
Scandinavian countries (especially Norway) carry on a large commerce
for other nations which is paid for in these ways. The excess of
imports in the third group probably is the result of new investments
that were being made in Canada by English and American capitalists, in
Turkey especially by Germans, and in China by Americans and Europeans.

The countries in the second column are doubtless on the whole debtors,
but in varying degrees. The excess exports of some are insufficient
even to pay all the current interest, and they are borrowing still
more (possibly the British colonies, Japan and several South American
countries); others have ceased to borrow and are simply paying
interest; whereas the United States at least with its excess of
exports was at this time both paying interest and getting out of debt.
With the outbreak of the war in 1914 the United States began rapidly
buying up its foreign-held securities, and events are fast making it
a creditor nation. Its imports must therefore in future more nearly
equal if not exceed its exports, the actual outcome being dependent
as well on various other items in the balance as on those here
considered.

§ 8. #Cancelation of foreign indebtedness.# In the international
business of any two important countries to-day, such as England and
America, the number of credit and debit transactions is enormous. If
each trader had to attend to the forwarding of the means of payment
for his purchases he would, of course, deduct from the amount of his
indebtedness the amount due him from his foreign correspondent, and
might from time to time "remit" the balance in the form of a shipment
of gold. This simple offsetting and cancelation of debits and credits
would greatly limit the amount of gold that would have to be shipped.
But still, under such conditions, there must be a very large number of
shipments of gold by different individuals, and a large proportion
of these shipments would be going in opposite directions at the same
time. Now a merchant in New York called M may have a balance to pay in
London to X and at the same time a merchant in London called Y have a
balance to pay in New York to a man called N. If M can buy from N his
claim in the form of an order, draft, or bill of exchange, and send it
to X, the latter may through his bank collect the sum from Y. In this
way a further cancelation of indebtedness would occur.

When all persons having either debits or credits to be paid in New
York and in London, respectively, are dealing with the banks in these
cities, and the banks and special exchange brokers are constantly
buying and selling these bills, a market is created for London
exchange in New York (and conversely in London), and a much easier and
more nearly complete cancelation of indebtedness results. In effect,
all the debits and credits between the two countries are merged into
one big ledger balance, and the international shipment of gold bullion
finally made is just the amount needed to balance the accounts payable
at the time. Industrial indebtedness is represented in various forms:
bills of lading for goods shipped, drafts made by the creditor on his
debtor for goods shipped or property sold, checks or letters of credit
for travelers, bonds and notes public and private. These are the
objects dealt in by the bankers who are the agents to carry on the
work of exchange.

The balance of foreign exchanges is of essentially the same nature as
the domestic cancelation of indebtedness. It is going on constantly
between the two merchants in the same town, between two banks in
the same town who represent groups of merchants, between men in
neighboring towns, and between distant states like New York and
California.[8] The price of exchange to the individual is reduced
by the specializing of the business in the hands of a few dealers,
permitting the cancelation of indebtedness or offsetting of exchange,
and greatly reducing the amount of bullion to be transported in making
the payments. The cost to the bank of providing this exchange for its
customers varies as conditions change, but in any case is not great,
so that in domestic business when any charge is made it is usually at
a fixed rate, and is mainly for the service.

§ 9. #Par of exchange.# Foreign exchange from America to Europe is,
however, in two features different from domestic exchange: (a) the
cost of shipment of gold is greater; (b) the monetary units of the two
countries usually differ in name, weight, and fineness, and sometimes
in materials. We may define foreign exchange as the purchase and
sale of the right to receive a given kind and weight of metal or its
monetary equivalent in current funds at a specified time and place.
_Par of exchange_ between two countries using the same metal as
a standard is the number of units of the standard coin of the one
country that contains the same amount of fine metal as the standard
coin of the other country. There is no fixed par of exchange between
gold-using and silver-using countries: par of exchange between them
fluctuates with changes in the comparative values of the two metals.
The _gold shipping points_ for importing or exporting gold are
respectively par of exchange plus or minus the cost of moving the
actual metal. These points vary with means of transportation and
communication. The par of exchange between New York and London being
nearly $4.866 and the cost of expressing and insuring a gold pound
between New York and London being approximately $.02,[9] the shipping
point for the export of gold from New York is $4.886 and for the
import of gold to New York is $4.846. At these upper and lower limits,
there is a motive for shipping gold as a commodity.

When large sales have been made to Europe and credits are accumulating
in New York and the importation of gold is imminent or already begun,
the claims are bought by bankers in New York at less than par. At such
a time one needing to remit a sum to London can buy exchange for less
than par, for every such draft remitted reduces London's indebtedness
and, by so much, the need of shipping gold to this country. As a
rule then, accumulating credits here mean a low rate of exchange,
accumulating debits a high rate of exchange from this to the foreign
country.

These are the merest rudiments of the subject. The many problems
arising, such as the adjustment of foreign credits to changing needs,
and such as arbitrage (the readjustment of the rates of exchange
prevailing among different financial centers) make foreign exchange
both a complex science and a difficult art.

§ 10. #International monetary balance and price-levels.# The balance
of all accounts for or against a country (including new loans, current
interest, and repayments) must thus eventually be settled in money.
This cannot fail to affect the general level of prices in both
countries, tho this is brought about often only in indirect and
gradual ways. The flow of money out of a country causes the loan
market of a country to tighten (interest and discount rates to rise)
in proportion as the reserves of the banks are reduced. Then "general
prices" begin to fall.[10] When prices fall, imports decline, as the
country is not so good a place in which to sell: when prices rise,
imports increase, as it is a better place in which to sell. The
opposite effect is produced on exports, and thus in a short time the
national credits and debits are again brought into equilibrium. A
slight movement of money in either direction is enough to influence
prices and set in motion forces to counteract a further flow of
money. Decade after decade the circulating medium of leading countries
changes very slightly in amount, and the fluctuations in its amounts
during periods of so-called "favorable balance of trade" and of
"unfavorable balance of trade" are only the smallest fraction of the
value of goods passing through the ports of the country.

It is therefore absurd to imagine, as is sometimes done, that a
country could, by continually importing goods, be drained of all its
money, or that by any possible set of devices it could forever have an
excess of exports to be paid for by a continual inflow of gold.
Long before either of such movements could go far, the automatic
readjustment of prices would inevitably check it, and secure and
retain for each country its due portion of the money.


[Footnote 1: See Vol. I, ch. 17, sec. 10.]

[Footnote 2: See Vol. I, ch. 5, secs. 1 and 7.]

[Footnote 3: See Vol. I, ch. 6, sec. 11, on the origin of markets.]

[Footnote 4: See Vol. I, chs. 36 and 37.]

[Footnote 5: Recall ch. 4, in general, on the nature of monetary
demand.]

[Footnote 6: See Vol. 1 for numerous statements of the effects of
varying quantities of agents upon the economy of utilization; e.g.,
pp. 138, 163, 164, 213, 228, and chs. 34 and 35 entire.]

[Footnote 7: This theory has usually been presented under the name
of "the doctrine of comparative costs." The word "costs" is very
misleading in this connection because it is now always applied to
enterpriser's outlay. It seems best, therefore, to replace it in this
phrase by the word "advantages." Of course, it _never_ can be true
that an article can be "profitably" imported when its monetary costs
(all things considered) are higher in the exporting than in the
importing country. Indeed, the importation of any article is proof
conclusive that the importer thinks that the monetary costs of
an article would be higher in the importing than in the exporting
country. See further, ch. 15, secs. 11 and 13 (note).]

[Footnote 8: See ch. 7, sec. 7.]

[Footnote 9: This varies also with conditions; after the outbreak of
the war in 1914 it was for a time as high as $.05 because of high war
rates of insurance.]

[Footnote 10: The connection between a high rate of interest and
falling price is a dynamic phenomenon of a very temporary nature.
In long-time static conditions the general level of prices and the
prevailing rate of interest are dependent on entirely different sets
of forces. See on the theory of interest, Vol. I, p. 308. In long-time
movements of prices, in contrast with brief changes due to foreign
trade such as are referred to above, high rates of interest are
connected with rising prices, and _vice versa._ See above, ch. 6, sec.
8, on fluctuating price-levels and the interest rate.]




CHAPTER 14

THE POLICY OF A PROTECTIVE TARIFF

  § 1. Military and political motives for interference with trade. § 2.
  Revenue and protective tariffs. § 3. Growth of a protective system.
  § 4. The infant-industry argument. § 5. The home-market argument.
  § 6. The "two-profits" argument. § 7. The balance-of-trade argument.
  § 8. The claim that protection raises wages. § 9. Tariffs and
  unemployment. § 10. Exports and exhaustion of the soil. § 11. Protection
  as a monopoly measure. § 12. Harm of sudden tariff reductions.


§ 1. #Military and political motives for interference with trade.#
The considerations set forth in the last chapter raise a strong
presumption in favor of the sovereign state permitting its citizens to
trade freely across its boundaries, as the best way to further their
own prosperity and, on the whole and in the long run, that of the
nation. Indeed, this presumption and belief has been held by
nearly all serious students of the question, with more or less of
modifications and qualifications, ever since Adam Smith published his
work on the "Wealth of Nations" in 1776.[1] But in conflict with this
belief has been the all but unanimous policy of nations from
early times, throughout the Middle Ages, and down to this day, of
interposing some special hindrances (of varying degrees and kinds) to
this kind of trade. Sometimes this has been done by prohibitions, but
more often by taxes imposed upon either imports or exports. Sometimes
the attempt is made to justify the policy of governmental interference
with foreign trade by arguments which crumble before the slightest
examination, and again it is admitted that free trade is true in
theory, but it is declared to be false in practice. The latter view
is not to be entertained for a moment. If free trade in theory (as an
explanation) is complete and true, it will in practice (as a plan of
action) be sound and workable. In truth, however, the practical policy
of governmental interference with foreign trade has always in part
rested on other than the simple economic grounds.

Interference with free trade with the foreigner has always been in
large measure due to political motives. In every petty medieval state
or self-governing city, the aim was to make the economic boundaries
coincide as nearly as possible with the political boundaries. Except
for the trade in a few articles of comparative luxury this aim was
at that time nearly attainable. The peasantry surrounding a fortified
town and enjoying its protection were compelled to trade there. Down
to our own time it has seemed to statesmen expedient to forbid or
discourage trade that might nourish the economic power of future
enemies. Sometimes governments have used embargoes, bounties, or
tariffs as weapons to injure the trade of other nations and to secure
diplomatic or commercial concessions. Often they have sought by
tariffs to encourage the building of ships and the manufacture of
armaments and of all kinds of munitions by private enterprise within
their own borders, even when the immediate cost of these products was
greater than if they were purchased abroad. In such cases it is
always a question whether an outright expenditure would not be better,
whether the government could not build its own arsenals and shipyards
more economically than it can foster private enterprise by means of a
protective tariff. However, the political (or military) argument for
protection recognizes that it is in itself a costly (not a profitable)
policy, and that the cost is only justified on the grounds that
military necessity warrants the outlay.

The military argument as applied to the preparation of ships and
munitions has no application to a tariff on those articles which have
no bearing upon military power. But the most recent application of
science and the mechanical arts to the uses of war has given new
significance to a larger policy of industrial preparedness for
military purposes. The year 1914 doubtless ushered in for the world
a new epoch of protective and discriminatory tariff legislation
determined by political rather than by direct economic considerations.

§ 2. #Revenue and protective tariffs.# An important distinction in
principle is to be made between a tariff for revenue and a tariff
for protection. A _revenue tariff_ is a schedule of duties on goods
entering or leaving a country, so arranged that the collection of
taxes causes the least possible disturbance to domestic industry.
Speaking generally, the duties may be on either imports or exports;
but, as export duties are unconstitutional in the United States, our
tariff discussions are concerned only with import duties. The most
completely revenue-yielding tariff is one touching only articles
which, even at the higher prices are not in the least to be produced
profitably in the home country. A _protective tariff_ is a schedule of
import duties so arranged as to give appreciably higher prices to some
domestic enterprises than they could obtain with free trade. It shuts
out some foreign goods which would otherwise enter, an in so far it
"protects" the domestic producer from the foreign competitors who
would sell at lower prices than those at which he can or will sell.
In other words, "protection" means governmental interference with the
freedom of trade.

The distinction between revenue and protective tariffs, thus clear in
principle, is not always easy to make in practice. It does not lie in
the intention of the taxing power, but in the actual effects produced.
Most tariffs combine the characteristics both of revenue and of
protective measures. A tariff that reduces imports but does not
cut them off entirely may be called either a revenue tariff with
incidental protection or a protective tariff with incidental revenue.
The difference is one of degree. But notice particularly that the two
features of protection and of revenue are mutually exclusive. To the
extent that one is present the other is impossible. A tariff rate
that in whole or in part excludes the foreign article to that
extent affords "protection" but does not yield revenue. Whenever the
government collects a cent of tariff taxes, the domestic producer in
so far and as respects that unit of goods is unprotected. Likewise,
whenever any domestic producer enjoys "protection" in respect to any
unit of goods, importation is in so far prohibited and the government
is deprived of any revenue whatever derived from the production and
sale of that unit of goods.

§ 3. #Growth of a protective system.# The protective policy developed
at first accidentally, as it were, out of the practice of levying
taxes for revenue only. Tolls, dues (or duties), customs (that is, in
former times the customary dues paid by merchants, now the dues fixed
by law), tariffs (that is, schedules or lists of rates of duties) were
at first intended to raise revenues for the sovereign, the city, or
the state. The unintended, and to some degree inevitable, result of
the taxation of goods in commerce, whether imports or exports, is
to prevent and discourage trade and to raise the prices of the goods
imported. Any change in tariff duties, therefore, at once alters
the previously existing adjustment of profits and of industries in a
country.

The first effect of the tariff is the same as that of any new factor
in enterpriser's cost; the same, for example, as that of a new
domestic tax on an article or as that of a rise of freight rates--the
domestic price of the taxed article tends to rise. Other results then
follow. If the article cannot, even at the higher price, be produced
within the country (as in the cases of oranges, spices, and coffee
in England, Norway, and Sweden), its consumption is reduced. The
lessening of demand may, however, depress somewhat the price in
the producing country. But as such a tariff does not increase home
production of the taxed article, it is therefore for revenue, not for
protection.

But if the article can be profitably produced in the importing
country at the new price, "home industries" will start. Where the
transportation charges are low, as on the coasts and on the main lines
of railways, some imported goods may be bought, while farther inland
where transportation charges are higher home production of some or all
grades of such goods may take place. If the whole demand at home is
supplied and all imports stop, therewith cease all revenues to
the government from that source. A completely protective tariff is
completely prohibitive.

Experience abundantly shows that, with a few exceptions, due to
climate and natural resources, it is impossible to put into effect the
most moderate schedule of duties without the increase in price at once
causing some men to shift their occupations, and to begin producing
articles of the kinds that have risen in price. At once appears a
group of "protected industries," the owners of which are dependent for
the safety and profits of their investments, and the workmen in which
are dependent for the security of their present jobs (possibly for
the chance to continue the pursuit of highly skilled trades) on the
continuance, if not the increase, of the existing tariff rates. A
tariff may be adopted mainly from stress of financial need (as in our
own history in 1789 or in 1861), but its modification or repeal cannot
be decided by fiscal considerations. The "incidental protection" it
affords has created a wealthy and influential group of employers and a
large body of employees who are irresistibly tempted to exercise their
influence in politics almost solely in favor of continuing and of
increasing the rates to the sacrifice of the higher civic life of
their communities. Of course the beneficiaries of the tariff usually
believe sincerely that it is indispensable for the prosperity of the
country as a whole, and they can do much to persuade others to
the same opinion. This commercial motive for maintaining existing
protective tariffs explains in large part their wide prevalence,
whatever other reasons may be adduced in their justification.

§ 4. #The infant-industry argument.# Most free-trade writers concede a
limited validity to the claim that protection may be used to encourage
infant industries and thus diversify the industries of the country. If
the natural resources of a land are adapted to an industry, it may be
called into being earlier by a fostering protective tariff. This is
merely anticipating and hastening the natural order of progress. In
the American colonies the manufactures of such goods as iron, cloth,
hats, ships, and furniture sprang up and continued not only without
"protection," but despite numerous harassing trade restrictions made
in the interest of English merchants. Can it be doubted that many
of these industries would have developed and flourished after the
adoption of the Constitution with no other favoring influences than
those of rich resources and of economy in freights? In the Mississippi
Valley since 1880 natural gas, abundant coal, ore, and timber have
made possible a great growth of industries without protection against
the Eastern states. Industries capable of eventual self-support must
in most cases naturally appear in due time. Economic forces will bring
them out. The protective system has often been likened to a hothouse,
anticipating the season by a few weeks and at great cost. The question
is whether the mere possession of the hothouse is a luxury worth the
price, if meantime the products can be got more cheaply by trade.
English manufactures flourished in the nineteenth century because they
were well established, had excellent coal supplies, great stores of
iron ore, and low-paid labor which did not have the opportunity of
better alternatives, as did the American workman. If America had
imported more (it would not have been all) of her iron and coal, the
English mines would have begun to shown signs of exhaustion earlier,
and America's advantage surely would have asserted itself in time. Her
iron manufactures undoubtedly were hastened--they cannot truly be said
to have been created--by the protective tariff.

The peculiar advantages of a new country attract labor and
enterprise into a few lines. Industries are forced into an earlier
diversification by tariffs. Which is the better economic situation?
Contrast Iowa, Dakota, and Minnesota, or Kansas, if you please, with
New York and Pennsylvania. Is it so certain that a dense population
congested in cities and crowded in factories and mines is a more ideal
social aggregation than is a community of prosperous farmers? The
smoky industrialism fostered by protection often puts a premium on a
low grade of immigrants, crowds then into city slums and into forlorn
mill towns, and keeps them aliens to the American spirit. It would be
surprising if Americanism on the Western plains were not as sound
as in the crowded cities. But the infant-industry argument appeals
strongly to the enterprise and the speculative spirit of Americans,
who like to do all things rapidly and on a large scale. Every village
aspires to be a great industrial center. Americans are impatient of
the suggestion that things "will come in time"; they like things to
come at once.

It must, however, be recognized that in a new country there is often
a certain monotony and poverty of life because of the lack of
diversified industries. There are not sufficiently varied avenues for
the expression and use of the manifold talents of the nation. There
are unused materials and opportunities, but the initial expense of
experimentation, the initial difficulties of gathering and training a
working force, are discouraging to individual enterprise, prices being
as they are. A protective tariff is not necessarily and always the
best way, but it is one way of helping private enterprise to establish
and conduct such industries through their initial period. But as has
been pointed out by many writers, the infant-industry argument is
self-limiting, and involves always the assumption that the industries
selected as fit for protection are such as ultimately, and within a
moderately short period, can grow into self-dependence. The infant
must sometime grow to be a man and stand on his own legs, or he is
either a chronic invalid or a degenerate.

#§ 5. The home-market argument.# The home-market argument seeks to
show a more permanent need for a tariff. At the same time it appeals
to the farmers, whom it has been hard to reconcile to a policy which
in America[2] has been peculiarly favorable to manufacturers. The
home-market argument extols the advantages of having near to the
farms customers for agricultural products, and dwells on the greater
steadiness of domestic trade. War or political changes, it is said,
may change the demand for products. This is true, but no other changes
have affected American agriculture so radically as the peaceful
development of domestic transportation and the opening of the West.

The main economic claim made in the home-market argument is that the
shipping of food to Europe and the importing of manufactures involve
a great cost for double freights which could be saved by manufacturing
at home. The farmer is supposed to pay this cost. The obvious defects
in this view are: first, there is nothing to show that the freight is
not partly or entirely paid by the European, either the manufacturer
or the food consumer; secondly, home trade "saves the freights" for
the farmer only in case he can buy goods under a tariff with less
of his own labor and products than under free trade. The payment of
freight charges is true economy when the goods can be bought at a
distance on more favorable terms than near home. The freight argument
attempts to prove too much for it condemns every trade within the
country, of goods produced a stone's throw away from the consumer.

The home-market appeal is strongest when addressed not to all farmers,
but to one class of farmers, those whose lands are situated nearer the
manufacturing cities. As city population grows, some land is converted
from the extensive cultivation of corn and wheat to dairying, fruit-
and market-gardening in the neighborhood of cities, and perhaps at
length is used for factory sites or as city lots. There is, thus, a
partial validity in the argument as applied to a comparatively small
number of farmers, who gain as landlords, not as tillers of the soil.
Even greater gains have sometimes been reaped by the owners of timber
lands, ore mines, coal lands, and other natural resources, the values
of which have been raised by tariff legislation. But unless these
gains come from truly productive additions due to the tariff, there is
no benefit to the community as a whole.

#§ 6. The "two-profits" argument.# Somewhat related to this idea of
the saving of two freights is the "two-profits" argument. It is said
that the tariff keeps "two profits" at home, foreign trade gives but
one. The word "profits" is here used in the popular sense of gain from
a single transaction. Both parties are said to profit and both profits
are thought to be secured at home when two citizens are forced to
trade with each other. The view that there are "two profits" in a
trade is an advance upon the notion that "one man's gain is another's
loss,"[3] but there is an error in elementary arithmetic here, both as
to the number and as to the aggregate amount of profits. The purpose
of a protective tariff is to compel two of the citizens of a country
to trade with each other instead of trading with two citizens of a
foreign state; the number of profits made by each country is therefore
not increased by substituting domestic for foreign trade.

What, then, as to individual size and aggregate amount of the profits?
The gain is not the same in all trades; the trade is made if there
is a gain to each party, no matter how small it is; but the generous
"profit" on one transaction where the conditions of the two parties
are very different may be greater than the total of petty gains on a
dozen trades between two traders of evenly matched powers. Indeed,
the greater the difference in the conditions and the capacities of two
groups of traders, the greater is the sum of the profits which they
may secure through the members of each group trading with those of
the other, rather than by the members of each group trading only among
themselves. Can it safely be assumed that every trade with a foreigner
is less advantageous than one with a fellow-citizen? Diamond cuts
diamond, but two Yankees left to themselves surely should not be
worsted in bargains with the universe. If they could exchange to
better advantage with each other they probably would discover it as
soon as the interested manufacturers and political orators who can
prove so eloquently that they know the other man's business better
than he knows it himself. Forcing the home trade by making our
citizens trade with each other whether both wish to or not may be
to the advantage of one citizen, but it is not likely to be to the
advantage of both citizens.

§ 7. #The balance-of-trade argument.# At the foundation of nearly
all belief in the virtues of a protective tariff will be found the
"favorable balance-of-trade" notion. The ideal of the more thorogoing
upholders of a protective policy is to keep merchandise consistently
flowing out of the country, and to have nothing come in--in any case,
nothing that by any fair amount of effort (whatever that be) could be
produced at home. This is called maintaining a "favorable balance of
trade." Sometimes the emphasis is more on the advantages of an excess
of exports of goods, sometimes more on the importance of the need "to
keep money at home." The simple error in these opinions is clearly
apparent in the explanation of foreign exchanges and of the principles
regulating the international flow of money.[4]

An interesting commentary on the opinion before us is the fact already
noted[5] that an excess of exports is the usual situation in poor
debtor countries having constant interest payments to meet; while, on
the contrary, rich creditor countries have an excess of merchandise
imports.

The "favorable balance-of-trade" argument, with the emphasis on money
rather than on goods, is that the protective tariff keeps money at
home which, if trade is free, will be sent abroad to buy foreign
goods, thus impoverishing the country. This doctrine as presented
in the seventeenth and eighteenth centuries in Europe, was known as
_mercantilism_. It had great influence upon the commercial policies
of all the great European nations. A superficial glance at the trade
relations of an old, rich country with a new province seems to give
evidence for such a belief. A richer country that is lending capital
(sent to the debtor country in the form of goods) has at the same time
a larger supply of money. The lack of money and the poverty of the
newer country are looked upon by the protectionist as due to the
importation of goods. The common cause of the imports to newly settled
districts and of their scanty stocks of money, it need hardly be
repeated here, is the comparative poverty of settlers and pioneers.[6]
Often these are paying for imports by means of loans, and in any case
their monetary stocks are not decreased either by their foreign trade
or by their domestic trade with the older and richer parts of the same
country. Europe and the United States, in their trade with China and
South America, usually do not get gold in exchange, but merchandise
of various sorts. It is true that in the trade of England and New York
with great gold-producing districts, such as California, South Africa,
and Alaska, gold is received in return for merchandise, for much of
the gold in gold-producing districts is merely merchandise, and its
export does not drain them of their due portion of money. There was
a time when the states of Kansas, Nebraska, Iowa, and their neighbors
were filled with resentment against the money-lenders of the Eastern
states. There was a widespread belief that hard times were due to an
insufficient currency.[7]

Attempted action took the form of the greenback and free silver
movements, which were defeated by the opposition of the East, but
there can be little doubt that if the Federal Constitution had
not forbidden it, the discontented states would have established a
protective tariff "to keep their money at home." Few advocates of
protective tariffs are ready to admit that the money stock of the
country is dependent on the general wealth of the country and on the
methods of doing business, rather than on a protective tariff.

§ 8. #The claim that protection raises wages.# The most effective
popular claim made for protection is that it raises, or maintains, the
general scale of wages in the country. This argument takes two forms:
first, when wages are low in a country it is claimed that a tariff is
needed to raise them; and, secondly, when wages are high it is argued
that a tariff alone can preserve them. In Germany the fear is of the
higher paid and more efficient labor of England. In America, where
general wages at all times have been higher than in England, it was
first argued (in the time of Henry Clay) that because of the greater
cost of production, due to high wages, the tariff was needed to start
certain industries; but after the tariff had long been established
and the old argument had been forgotten (ever since 1865), it has
been urged that the tariff, being the cause of high wages, must
be maintained to protect against the "pauper" labor of the older
countries. The higher wages in new countries where a tariff exists are
always claimed to be the fruits of a protective policy. The true
cause of the high general scale of wages in America is the greater
efficiency of industry under existing conditions.[8] Labor is
surrounded here with advantages in the forms of rich natural resources
and of mechanical appliances such as never before were combined.
Because of the scarcity of workers in particular protected industries,
wages may be temporarily higher in them than in some other industries;
but such workers form a small fraction of the population, and it is
impossible to show that the general scale of wages in all occupations
is raised by the tariff protecting this fraction.

There is, of course, no question that every tariff change affects
certain enterprises and classes of workmen. Enterprisers already
acquainted with and engaged in a business always may hope to gain by
the higher prices immediately following a rise in the tariff rates
on their particular products. Though they are granted no enduring
monopoly by the protection, they for a time enjoy the advantage of
being on the ground, and may reap the first fruits of the favoring
conditions. The enterpriser usually profits when the price of his
product suddenly rises. Usually skilled workmen are affected slowly by
competition when there is any considerable increase of prices in their
special industries. The important question is, Who bears the burden of
the higher prices that result from a tariff? The burden is very soon
distributed. A part of it may be for a short time borne by the retail
merchants, but ultimately nearly the whole of it must be borne by
their customers, the unfortunate, less favored citizens. The weight
falling on each is usually small, often unsuspected, always hard to
measure. The increased benefit is concentrated in a few industries and
accrues to a comparatively few producers. Here is a recipe for riches:
get everybody to give you a penny; it's so little that no one will
miss it, and it will mean a great deal to you. Something like this
happens in the case of many protected industries; every consumer
of the article pays a few cents more, a small group of wage-earners
temporarily gains, and a few enterprises wax wealthy.

§ 9. #Tariffs and unemployment#. The claim that a low tariff is bad
for the workers is made with peculiar success in any period when
unemployment is greater than usual. It is vain in reply to show that
again and again equally bad periods of unemployment have occurred when
a high tariff was in force, and that often the most highly protected
industries are most affected. It is vain to suggest that fluctuations
of unemployment are related rather to the rhythm of industrial cycles
and panics, than to any particular level of the tariff, whatever it
be.[9] The fact that at the moment is seen is that here are some men
for the time out of work, and here are some foreign goods coming in.
Of course, what is not seen is that if we stop importing goods we
thereby eventually will stop the exportation of goods of equal value
now being sent in payment and this must throw as many men out of jobs
as we helped into jobs by raising the tariff. But the view easy to
take is the short view, and the ulterior consequences seem to the
popular mind to be vain imaginings.

§ 10. #Exports and exhaustion of the soil#. It has been ingeniously
argued that a tariff may keep some of the natural agricultural
resources of a new country from becoming quickly exhausted. The export
of food takes out of the soil and out of the country fertile qualities
never to be returned. The shipment of several hundred million dollars
of food products year after year represented a tremendous drain from
the soil of the United States, but this has now largely ceased.
The assumption, however, that the use of the food in this country
preserves the fertility of our own fields is in the main mistaken. The
fertile material in the food for human consumption hauled to a town
five miles away from the field is almost as entirely lost as if it
were shipped to Europe. Engineering skill has as yet succeeded in
returning economically to the fields from which it comes hardly a
fraction as much fertile organic matter as that which flows into the
sewers, that is dumped into river and ocean, and that is buried in
heaps at the borders of our own cities. Artificial fertilizers are
increasingly used, to be sure, but they are obtained in other ways.
On the other hand, the increased use of iron, coal, and timber, as a
result of encouraging manufacturers, has very effectually hastened the
exhaustion of the natural resources of the country.

§ 11. #Protection as a monopoly measure#. It has rightly been observed
that a new country has a limited potential monopoly in certain kinds
of products and that a tariff may make it effective. The rapid opening
up of America with its rich natural resources greatly benefited
the average consumer in Western Europe, altho it caused a loss to a
special class of landowners.[10] Whether the citizens of the older
or of the newer country shall reap the greater benefit in the trade
depends on the reciprocal demand for the two classes of goods, as was
seen in discussing the equation of international demand. A wide margin
of advantage may go to one party and a narrow margin to the citizen
of the more favored land. To put it concretely: America, having great
natural resources for agriculture, might continue to trade food for
manufactured goods even tho England reaped most of the benefits of the
trade. An American tariff on manufactures from England would, under
such conditions, check the demand for English products and compel some
Americans to leave farming. This reduction of the American supply
of wheat or corn and of the American demand for English manufactures
compels a new ratio of trade (expressed in prices). It is conceivable
that trading fewer goods with a larger gain on each trade would give
a larger total of gain to the favored nation. Thus, foreigners may
conceivably be compelled to pay a part of the tariff duties to
enjoy the favored market. This is but a special case of the monopoly
principle; the government by law artificially limits the supply of
goods offered by its citizens.

This argument is somewhat subtle, but probably is the soundest one in
the theory of protection. The supposed conditions seldom occur in
a marked measure, but they may exist, and probably have existed
in America. When the great system of internal transportation was
developed in the United States before that of the other new countries
(say from 1840 to 1894), this country had such peculiar advantages for
the production of food that the quantity was enormously increased
and agricultural prices fell.[11] At such a time the tariff may have
worked toward checking the fall and earlier reestablishing a more
favorable ratio. It did this by making prices of manufactured goods in
this country artificially higher and thus tempting men from rural to
urban callings. But the limited application of the principle must be
recognized. The potential competition of undeveloped countries on all
sides, seeking to develop their resources, and profiting by the higher
prices of food in the world-market caused by our tariff, threatens
the peculiar advantages of the favored land. Russia, Argentina, and
Australia have rapidly taken the place of America in supplying food to
Western Europe, in part, no doubt, because we refused to take Europe's
goods in trade. A great nation with its manifold interests is not
eminently fitted to practise the gentle art of monopoly.

The period in America from about 1840 to 1890 shows certain absurd
contradictions in economic policy. By governmental action, national,
state, and municipal, enormous grants of money and lands were made in
aid of transportation. Canals, roads, and railways were built into
new agricultural territory far faster than was healthy and normal. A
prodigal land policy put a premium upon a wastefully rapid extension
of the farming area. These things were done to favor the agricultural
states, but agricultural prices fell so greatly that our farmers for
a long period were nowhere prosperous, and great numbers of them,
both in the East and in the West, were ruined. At the same time a
high tariff on nearly everything the farmers needed to buy was the
political spoil obtained by the Eastern and Middle states. This
further depressed the condition of the farmers and forced them or
their sons into urban industries. A slower development would have
occurred without the waste of national resources in such conflicting
policies of artificial stimulation.

§ 12. #Harm of sudden tariff reductions.# It is rarely appreciated how
great is the tactical advantage which the advocates of a high tariff
enjoy in popular political discussion. They can so easily impress the
popular judgment with the evident fruits of their own policy and
with the immediate dangers of the policy of their opponents. When
a protective rate is first applied or is increased, it calls into
existence something visible and tangible, which can be measured in
terms of factories built, men employed, and products turned out. The
increased cost of these results is diffused among many consumers and
reaches them in such indirect ways and in such small increments of
price that they are quite unaware of the way they are affected.[12]

On the other hand, reduction of the tariff works in a direction the
reverse of the enactment. It may cause local crises and may even bring
on general crises. The benefits of the lower prices are diffused and
lost to view; the immediate injury is concentrated and strikingly
evident. Factories are closed, investments depreciate, laborers are
thrown out of employment. The organic nature of local industry causes
these evils to be felt by many classes. Merchants, professional men,
servants, and skilled laborers, that are tributary to the depressed
industry, suffer. The effects are transmitted to commercial and
financial centres and often credit is much shaken. Then follows a slow
and painful process of readjustment.

The low-tariff advocates in America undoubtedly have underestimated
these immediate effects. They have been too abstractly doctrinaire,
have argued too absolutely for the merits of free trade to be applied
instantly regardless of the existing distribution of investments and
of occupations. They have opposed one extreme system by another, with
no thought of the inexpediency and injustice of sweeping changes.
There is a strong feeling among business men that any tariff, be
it high or low, is better than a shifting policy. Despite the great
preponderance of domestic production over foreign trade, it is
perhaps too much to say that the tariff is unimportant in our present
conditions. It can, however, be truly said that business can adjust
itself in large measure to any settled conditions and that radical
changes, especially sudden and large reductions, are fraught with
evils. Long before a new tariff law goes into effect, even months in
advance of its passage, while it is merely in prospect, the course
of trade is abnormally affected. If the rate is likely to be raised,
large importations take place under the lower rate, and for a
considerable time after the law goes into effect imports are small,
while prices rise and domestic production gradually increases. But if
the rate is likely to fall, importations are for months meager, stocks
of goods are reduced to the lowest point, and when the lower rate
goes into effect, large importations follow to the injury of domestic
producers. In many cases a year or two of notice, time given to
enterprisers to adjust their business, would probably do away with a
large part both of the serious losses and of the lottery-like gains
that otherwise occur.

The obvious measure of precaution and of justice would be to put
any new rate into effect gradually.[13] The difficulties are of a
political nature and in the desire of the party in power to "make a
showing" at once of the results of its campaign pledges, in the one
case by starting and stimulating industries through a higher tariff
and in the other by reducing prices to consumers through a lower
tariff. Under the new permanent tariff board, constituted to suggest
tariff changes and to administer the tariff laws, it would be possible
to apply some such feature.


[Footnote 1: See above, ch. 2, secs. 12, 13.]

[Footnote 2: In European countries, on the contrary, the rates that
have been mainly effective have been those levied upon food products,
and the agricultural landholders have been the "protected interests,"
such as the England "landed aristocracy," the German agrarian
"Junkertum," and the French peasant landowners.]

[Footnote 3: See above, ch. 13, sec. 2.]

[Footnote 4: See ch. 4, sec. 6 and ch. 13, secs. 6-10.]

[Footnote 5: In ch. 13, sec. 7.]

[Footnote 6: See ch. 4, secs. 4 and 9.]

[Footnote 7: That there is a certain measure of truth in this opinion
is recognized in our discussion of the standard of deferred payments,
ch. 6, sec. 9. But the relation of a world-wide appreciation of the
standard money commodity with the burden that this change puts upon
debtors has nothing to do with the question now before us, viz.:
Does a protective tariff enable a country to keep and increase its
proportion of the world's stock of gold; and if it could, would it be
a general benefit?]

[Footnote 8: See Vol. I, especially p. 228, and chs. 34 and 36.]

[Footnote 9: See on wages in times of crises, ch. 10, secs. 6 and 7;
and on tariff changes, ch. 10, sec. 14, and ch. 15, sec. 13.]

[Footnote 10: See Vol. 1, pp. 361 and 443.]

[Footnote 11: See Vol. 1, p. 436, for average wheat prices in England,
practically in the world-market.]

[Footnote 12: See above, sec, 8. On the next paragraph, see ch. 10,
sec. 14.]

[Footnote 13: For example, the maximum alteration in any year might be
limited to 3.65 per cent of the value of the goods and in any case not
to exceed one tenth of the old duty, this change to be applied day by
day. Thus, if, on a valuation of $1000, the duty collected under the
old rate has been $400, and under the new law is to be $290.50, three
years would be required for the full change to become effective, the
reduction each day being $.10 per $1000 valuation. The administration
of such a rule would be simple, and it has been favored by men of
practical commercial experience.]




CHAPTER 15

AMERICAN TARIFF HISTORY

  § 1. Prevalence of protective tariffs. § 2. Specific and _ad valorem_
  rates. § 3. Some technical features of the tariff. § 4. The tariff,
  1789-1815. §5. The tariff, 1816-1845. §6. The tariff, 1846-1860. §7. The
  tariff, 1861-1871. § 8. The tariff, 1872-1889. § 9. The tariff,
  1890-1896. § 10. The Dingley tariff, 1897-1909. § 11. Sentiment favoring
  lower rates. § 12. The Payne-Aldrich tariff, 1909-1913. § 13. The
  Underwood tariff, 1913. § 14. Some lessons from our tariff history.
  Note on Tariff legislation and business depressions.


§ 1. #Prevalence of protective tariffs.# For a century and a half
most serious students of economics have favored a larger measure of
freedom, if not absolute freedom, in foreign trade. But the actual
practice of most nations has never been in accord with the principles
laid down by the philosophers. Great Britain alone among the larger
countries has, since 1846, steadily pursued a low tariff policy for
revenue only, and her example has been most nearly followed by Holland
and Denmark. Germany, which had always had restrictive duties, adopted
still more protective measures under Bismarck in 1879. France,
Italy, and most of the other nations of Europe have strong protective
tariffs. The United States has followed a restrictive policy since
near the beginning of the last century. The explanation of this
contradiction between precept and practice is not entirely simple.
Great interests are affected by foreign trade and certain of these
interests are able to influence opinion and to dominate legislation.
Free trade is not the most desirable thing for every one. The general
policy of free trade between nations, as advocated by most English
economists since Adam Smith, has usually been rejected by the people
and the legislators of other countries.

In its details American policy in tariff legislation under the
Constitution has been varied and vacillating. The changes have been
determined in most cases by motives of temporary partisan advantage or
by the political activity of the immediate beneficiaries rather than
by clear knowledge and consistent purpose of the electorate as a
whole. Thus its lessons for the student are largely of a negative
nature, but they well repay serious study.

§ 2. #Specific and _ad valorem_ rates.# Before entering upon the
history of the American policy let us make clear the meaning of
certain technical terms and explain certain methods which are
frequently referred to.

Rates (and duties) may be by either specific or _ad valorem. Specific
duties_ are those that are calculated and levied according to some
physical test, as so much per pound, per yard, per hundred-weight, or
per ton. _Ad valorem_ duties are those that are calculated and levied
according to the value of the goods (usually as it was at the place of
shipment) determined by an assessor, by invoice of sale, by statement
of the importer under oath, etc. The actual duty collected on any
article may result from various combinations of the two rates (as, to
take an actual example, $4.50 a pound and 25 per cent _ad valorem_
on cigars and cigarettes) or _ad valorem_ with a minimum valuation so
that on the cheaper goods the rate is specific.

Specific rates are more easily applied in administration, not offering
the temptation to undervaluation and misrepresentation that _ad
valorem_ rates do; on the other hand, specific rates do not adjust
themselves to price changes as _ad valorem_ rates do. If the prices of
goods go up the specific rate is relatively less and affords less of
"protection" to the domestic producer; whereas if prices go down (as,
in general trend, the prices of manufactured goods have done most
of the time) the specific duties are relatively greater. To take a
historical example, the specific rate of 6-1/4 cents a yard on cotton
goods in 1816 which was at first in fact only about 25 per
cent, within a few years became about 75 per cent and absolutely
prohibitive. For this reason specific rates have most often been used
in acts intended to increase the "protective" duties and often as a
device for immediately raising rates; while _ad valorem_ rates have
been more often used in acts prompted by the desire for less drastic
exclusion and for a more adequate revenue; but there is no essential
connection between the protective policy and specific rates. Indeed,
in the period from 1897 to 1909, when most prices were rising, many
of the specific rates under the Dingley Act, intended to be strongly
protective, afforded less and less "protection."[1]

§ 3. Some technical features of the tariff. All goods not subject to
duties are said to be on the _free list_. It is customary to group
articles in _schedules_, of which there are fourteen in the law of
1913, designated from A to N (for chemicals, pottery, metals, wood,
etc.), but the rates are not uniform for all the articles in each
schedule. _Drawbacks_ are a certain amount, the whole or a part, of
the duties that have been paid on imported commodities, which is
paid back by the government on the reëxportation of the goods.
_Compensatory duties_ (or compensatory rates) are those levied on
certain manufactured articles with the purpose of raising their price
as much as domestic producers' costs are raised by a tariff on their
raw materials. Examples are a duty on woolen goods to offset a duty on
wool, or a duty on shoes to offset one on hides. They may be intended
to be partial or complete or more than sufficient, and are likely in
any case to work either more or less to the advantage of the domestic
producer than was intended. It may be that the conditions of supply
are such that the home price of the raw materials is raised little
or none by the tariff while the price of the finished product is
considerably raised, or _vice versa._

§ 4. #The tariff, 1789-1815.# The main difficulty of government in
1781-1789 under the Articles of Confederation was lack of the power
to obtain revenues by taxation. The separate states alone could levy
duties, and a good many tariff restrictions on freedom of trade
among them developed in this period. The Constitution established the
principle of entire freedom of trade among the states. The first act
of Congress under the Constitution levied a tariff, primarily for
revenue purposes, but clearly having a protective purpose, in the view
of some of the representatives. However, most of the separate rates,
as well as the general average rate, were the lowest ever levied by
Congress, except that there was no free list and that 5 per cent was
imposed upon all goods not otherwise enumerated. _Ad valorem_ duties
up to a maximum of 15 per cent (that on carriages) were laid upon
certain articles of luxury, and low specific duties on a few articles
such as glass, nails, iron manufactures, hemp, and cordage.

From 1789 until 1812, thirteen tariff laws, all told, were passed. One
after another many rates were raised to get larger revenues, but some
goods were put upon the free list. The foreign trade, in both imports
and exports, grew largely and with considerable regularity, rising
then rapidly to a maximum in 1807. Then followed troublous times,
with British Orders in Council and our embargo and nonintercourse
acts until 1812, and war until 1815, trade falling off at first to
one-half, and at last (in 1814) to less than one-twelfth of the
former maximum. Just as trade was, in the war period, sinking to the
vanishing point, the tariff rates were doubled in hopes of getting
increased revenues needed for the war, but in vain.

[Illustration: FIG. 3. IMPORTS INTO THE UNITED STATES. 1821-18565

Many statistics bearing upon tariff history are graphically brought
together here. This figure should be carefully studied in connection
with the following sections. Observe how invariably in the years
following a crisis, the amounts of dutiable imports and of duties
collected have diminished, whether the tariff meantime was changed or
not.]

§ 5. #The tariff, 1816-1845.# Tho rates had been rising, manufacturers
had been making efforts to secure higher rates for protection, even
as early as 1803. Effectual exclusion of foreign goods and consequent
stimulus to the establishment of manufactures in the eastern states
resulted, in the period 1808 and 1815, from the embargoes and the war.
On the return of peace imports were resumed on a large scale and the
call for a higher tariff was loud. In the revision of 1816, rates in
a number of cases were fixed higher than those before the war. Average
rates are said to have been about 20 per cent. The rate on both cotton
and woolen goods was 25 per cent (and the minimum on cotton goods was
a specific rate of 6-1/4 cents a yard). High rates were imposed on pig
iron (50 cents a hundred), hammered bar (75 cents a hundred), and
rolled bar ($1.50 a hundred, equivalent to about 100 per cent _ad
valorem_). Rates were raised on many other articles. The average _ad
valorem_ rates collected in 1821 attained the remarkably high figures
of 36 per cent on dutiable goods, and almost 35 per cent on free and
dutiable together.

In 1824 in response to the growing sentiment in favor of the so-called
"American policy of protection," many rates were still further
increased, as those on cotton goods and woolen goods (to 33-1/3 per
cent) and some kinds of iron. Cheap wool was now taxed 15 per cent and
that valued over 10 cents a pound at 20 per cent (to be 30 per cent
after 1826). In 1828, in the "tariff of abominations" which evoked
much bitter criticism, the rates on all these goods were again raised,
those on woolen goods being in some cases 100 per cent on the value,
and those on iron being from 40 to 100 per cent on the value, and
duties were levied on molasses, hemp, and flax. The results appear
in the statistics of 1830, showing the average _ad valorem_ rates on
dutiable imports to be nearly 49 per cent, and on free and dutiable
together to be over 45 per cent. This marks a temporary high point in
tariff rates. Revenues were then becoming excessive and that year the
rates on tea and coffee and some other goods were reduced.

Violent protests, especially from the South, were made against the
protective system, and the tariff became a more important political
issue. Then in 1832 a number of changes were made, mostly downward;
the iron tariff, for example, being reduced to about the level of
1824. Average rates were thus brought down to about 33 per cent on
dutiable goods. The compromise tariff act of 1833 provided for a
process of reduction during a period terminating in 1842, the cut to
be small at first, then to be made more rapidly to bring the maximum
rate on any article down to about 20 per cent.[2] These changes, while
as yet incompleted had, in 1840, brought the average rates on dutiable
goods down to but 30 per cent and on free and dutiable together to 15
per cent. The 20 per cent rate, however, remained in effect only two
months in 1842, when it was replaced by a tariff with higher rates
distinctly protective, passed by the Whig party and which remained in
force four years.

§ 6. #The tariff, 1846-1860.# The Democratic party coming into power,
passed the Act of 1846, called the Walker tariff, after the Secretary
of the Treasury. As he was a believer in free trade, this act is often
mistakenly described as a free-trade measure. It was, in truth, far
from that. Most of the rates were indeed lower than those that had
been in force between 1816 and 1846 (with the exception of those
between 1840 and 1842), but still some of the rates were high (a few
as high as 100 per cent) and many of them were strongly protective in
nature. The fact that tea and coffee were on the free list is marked
evidence that considerations of revenue did not dominate. The rate
on cotton goods was 25 per cent and the rates on many of the most
important other protected articles (iron, woolen goods, manufactures
of iron, leather, paper, glass, and wood) were 30 per cent. The
average rates under the act for its last eight years (to 1857) were
on dutiable 26 per cent, on free and dutiable 23 per cent. The country
prospered for eleven years under this tariff. In 1857, rates were
again reduced, the more important protective rates from 30 per cent
to a level of 24 per cent. This time partizan considerations played
no part in the discussion. The revenues of the government had been
excessive and the need of a reduction was admitted by nearly every
one. The average _ad valorem_ rates under the nearly four years of the
act of 1857 were about 20 per cent on dutiable and 16 per cent on free
and dutiable (the lowest in the century between 1812 and 1913).

§ 7. #The tariff, 1861-1871.# The reduction of rates in 1857 was
made just at the time when the country was at the height of a wave of
prosperity and of speculation which culminated in the financial crisis
of that year.[3] As always at such times, the government's revenues
fell greatly. The first purpose in the revision of the tariff in 1861
was simply to restore the rates in the act of 1846. But the Morrill
act which became a law just before Fort Sumter was fired upon,
contained many higher rates and its purpose was avowedly protective.
This necessarily involved a sacrifice of possible revenues for the
government.[4] Then from the beginning of the Civil War till its close
some rates were raised almost every month with little scrutiny or
debate. The average _ad valorem_ rate jumped from 19 per cent on
dutiable in 1861 (under the law of 1857) to an average of 35 per cent
in the three years, 1862-1865.

The most important tariff acts of the war were those of 1862 and 1864
by which large increases were made on many articles. These tariff
acts were passed in connection with far-reaching and burdensome
applications of internal revenue taxes on many kinds of manufactures.
The tariff rates were primarily intended to offset these taxes, "to
impose an additional duty on imports equal to the tax which had been
put on the domestic articles," as was said by the sponsors of the
bill. These rates were similar in purpose to compensatory rates, and
in many cases they were more than sufficient to offset the internal
taxes. Under the last of these acts the duties collected in the six
years from 1865 to 1870 averaged nearly 48 per cent on dutiable and
nearly 44 per cent on free and dutiable.

The remarkable fact was that soon after the war the internal revenue
taxes began to be repealed one after another, and by 1872 nearly
all those bearing upon general manufactures (apart from cigars and
alcoholic beverages) were gone. The tariff, however, remained almost
unaltered. This repeal of internal revenue taxation had the same
"protective" effect as raising the tariff rates by so much. As if
this were not enough for the protected interests, in 1867 the duty on
woolens was further raised and in 1870 numerous other increases were
made in the duties having a protective character. Some reductions were
made, but these were almost all on articles of a distinctly "revenue"
character such as tea, coffee, sugar, molasses, spices, wines.
Revenues were superabundant for current expenses of government, and
altho there was a large national debt, hardly any of it was redeemable
at the time. There was therefore need to reduce taxation, but the
attention of the consuming and tax-paying public was distracted by the
somewhat passionate political issues of the day. Besides, the public
had not the technical knowledge or the unified opinion on this subject
to protect itself against the greedy lobby in this process of tax
revision. And so, selfish commercial interests could get nearly what
they asked for in Congress, and the politicians at Washington, who had
come to have a well-nigh superstitious faith in the efficacy of very
high protective duties, could quietly use the opportunity to raise the
people's taxes for the people's good.

These virtual increases in the protective power of the rates in force
are not evident in the statistics of average _ad valorem_ rates,
because the higher rates in many cases were sufficient to exclude
relatively more of the foreign products to which they applied.[5] The
imports came, by a process of selection, to consist more largely of
goods subject to lower rates. So the year 1868 showed the highest
average rate on dutiable goods (48.6 per cent) of any year after the
act of 1828 until that of 1890, and the rate fell somewhat each year
until in the fiscal year 1872 it was 41.3 per cent.

§ 8. #The tariff, 1872-1889#. In 1872 the country was again, as in
1857, nearing the crest of a wave of prosperity and of speculation.
Imports and customs receipts attained new high points in our history,
and, despite the enormous reductions of internal revenue taxation,
the government's receipts continued to be excessive.[6] The important
revenue articles, tea and coffee, were then transferred to the free
list, as were also raw hides and paper stock and some other articles;
the rate on salt was reduced one-half and that on coal almost as much.
Many other specific rates were reduced and the _ad valorem_ rates on a
long list of articles were cut to "90 per cent of existing rates."
The effects of these reductions were mingled with those of the severe
financial panic occurring in 1873 and of the depression following,
which reduced especially the importation of luxuries bearing the
higher rates. The average rate of the three (fiscal) years 1873 to
1875 was 39 per cent on dutiable (a fall of 9) and 28 on free and
dutiable (a fall of 16). The ratio of imports entering free, which in
1872 was still only about 1 in 14, became the next year 1 in 4. But
government revenues falling short in 1874, advantage was soon taken
of the circumstance to repeal in 1875 with little discussion the
horizontal cut of tariff rates made in 1872. The specific rates that
had been reduced in 1872 were little changed, however. From 1876 to
1883 (8 fiscal years) nearly a third of the imports consisted of goods
on the free list. The average rate on dutiable was over 43 per cent,
and on free and dutiable was 30 per cent.

The tariff was a leading issue in the campaigns of 1876 and 1880. In
1876, the Democratic party's platform contained a plank for "a tariff
for revenue only." It was a time of great industrial depression, and
as is usual in such cases a large number of the electors held the
party in power responsible for business adversity (as in turn they
credit it with any more or less fortuitous prosperity). The Republican
candidate Hayes, after a long contest in Congress, was declared
elected by a margin of one electoral vote. His opponent, Tilden had
received a quarter of a million more votes in the country as a whole.
In 1880, when business prosperity was rapidly returning, the party
in power was successful by a goodly margin of votes in the electoral
college, tho having a bare plurality of the popular vote. Garfield,
the Republican candidate, was known as one of the more moderate
protectionists and his opponent, General Hancock, who was without any
political record, declared the tariff to be a "local issue," to be
determined in the Congressional districts. The tariff issue was thus
not very sharply drawn. The tragic death of President Garfield left
no clear leadership. The tariff question from 1876 to 1884 was
politically in the doldrums.

Yet there was undoubtedly a somewhat growing popular demand for some
moderation of the very high duties. To this demand the friends of
protection who were in power felt compelled to concede something--or
to appear to do so. Congress appointed a Tariff Commission of which
the Chairman was secretary of the wool manufacturers' association, and
after a report the tariff act of 1883 was passed. The net results were
almost nil. Some rates were lowered, while others were raised with a
definite protectionist purpose. The average rates for the next seven
years, 1884-1890, were 45 on dutiable (an increase of nearly 2 per
cent) and 30 on free and dutiable (unchanged as compared with the
period ending 1883). In 1884, the Democratic party elected its
presidential candidate (Cleveland) and a majority of the House, but
as it did not control the Senate it could not pass any of the various
proposed measures for a "reform" of the tariff. In 1888 the protective
principle was a leading issue in the campaign. Altho Cleveland
received a few ten thousands larger popular plurality than he had
obtained four years before, and held the electoral votes of 18 of the
states, he lost New York and Indiana by very narrow margins, a result
in which other issues played a large part. Harrison was elected and
the party favoring a high protective tariff came into power.

§ 9. #The tariff, 1890-1896#. The tariff act (known as the McKinley
act) of October, 1890, followed. This was a general extension of the
principle of protection. The rates on woolen goods were on the whole
increased and made in more cases prohibitive. The rates on wool were
increased. The rates on iron, which was already highly protected, were
little changed except by the increase of the duty on tin-plates. The
duty on sugar (in the main a revenue duty, yielding $55,000,000
a year) was removed and a bounty was granted to domestic sugar
producers. In the next three (fiscal) years, 1892-1894, the average
rate proved to be over 49 per cent on dutiable (4 per cent increase)
and 22 per cent on free and dutiable (the remission of sugar duties
accounting for the most of this fall of 8 per cent from the average
under the preceding law--4 per cent fall from the last year of its
operation). Particularly noticeable, however, was the increase in the
proportion of goods entering free, which was nearly 55 per cent of
all merchandise as contrasted with about 33 per cent between 1884 and
1890.

Again the political weather vane shifted. The month after the McKinley
bill became law, the Congressional elections (November, 1890) returned
an overwhelming Democratic majority in the House, altho this was a
period of business prosperity, a fact usually favoring the party in
power. In 1892, Cleveland, being again a candidate, was successful
over Harrison by a largely increased plurality of the popular vote,
and received almost double the electoral vote of his opponent.
The House was Democratic, and the Senate soon became so. Business
prosperity was rising again to a high level, but there were many
features of financial and speculative weakness in the situation,
intensified by growing fear of a cheap money (silver dollar) inflation
under the act of 1878 providing for the annual purchase of silver.
A financial panic occurred in September, 1893, six months after
Cleveland's inauguration.

Nevertheless Congress enacted the next year, Aug. 28, 1894, the Wilson
tariff act. The changes made by this legislation were not on the whole
very great, but were nearly all in the direction of the lowering of
the tariff. Most notable was the putting of raw wool upon the free
list. Some rates on woolen goods were reduced, but hardly more than
enough to offset the effects, upon manufacturers' costs, of the
reduction of the tariff on raw wool. Likewise small reductions were
made on cotton and silk goods, on pig iron, steel and tin plate
and many other articles; and larger reductions on coal, iron ore,
chinaware, and glassware. To make up for the expected reduction of
receipts from other sources, a duty was laid again upon raw sugar,
and an income tax law was passed (this soon, however, to be declared
unconstitutional).

Under this law, for three fiscal years (1894-1897) the average
rates were 41 per cent on dutiable and 21 per cent on free and
dutiable,--pretty high rates. The proportion entering free under this
act was actually less than under the McKinley act, partly because
of the sugar item, and partly, probably, because of general business
conditions.

§ 10. #The Dingley tariff, 1897-1909.# The campaign of 1896 was waged
almost solely on the issue of free silver. Undoubtedly great numbers
of voters supported William McKinley rather despite of, than because
of, his high protectionist beliefs. But his inauguration was promptly
followed by the passage of the Dingley act of July 24, 1897, which
embodied a marked increase of protective rates. A duty was again
levied on wool, and also on hides which had been untaxed since 1872.
High rates were made for woolens, linens, silks, chinaware, and the
rate on sugar was doubled. Provision was made for some reduction of
rates by reciprocity agreements, but the conditions were so complex
that the effect could not be great. This high protective tariff, thus
enacted without popular discussion, remained almost unchanged for
twelve years, the longest life, by one year, of any tariff act in our
history,[7] The rate under the first full fiscal year of the law's
operation, 1899, was the highest on dutiable in our history, 52 per
cent, and was nearly 30 per cent on free and dutiable. In practical
operation, however, the average rate steadily became more moderate
because of the rapid rise of the general price level that was in
progress throughout this period, amounting to 35 per cent from 1898
to 1909.[8] The average rate of duties collected for the period of
12 years was 47 per cent on dutiable and 26 per cent on free and
dutiable. It was steadily falling and the last year, 1909, was 43 per
cent on dutiable and 23 per cent on free and dutiable.

§ 11. #Sentiment favoring lower rates.# While the Dingley act was thus
in operation showing declining average rates, sentiment was developing
in every part of the country in favor of a further moderation of the
tariff. This was due partly to the discontent resulting from steadily
rising general prices, in which change the rise in the prices of food
and of many other necessities was not fully compensated by the rise
of the wages and incomes of the masses. Partly the growth of this
sentiment accompanied the agitation against trusts and the belief
that protective duties in some cases were an aid to the formation of
domestic monopolies. But more fundamentally, this changing sentiment
was the result of the changing industrial conditions in America. The
character of our foreign trade had altered greatly since the early
nineties. We were importing relatively less and less of manufactured
and finished products, and more of raw materials; and we were
exporting less and less of raw materials and more of finished
products. A growing number of manufacturers were feeling the need of
cheaper raw materials and were looking hopefully toward an enlargement
of their foreign trade.

The Republican platform in 1908, in view of the changing public
sentiment, formulated a new rule for maintaining "the true principle
of protection," namely, that it "is best maintained by the imposition
of such duties as will equal the difference between the cost of
production at home and abroad, together with a reasonable profit to
American industries." This rule is very attractive in its suggestion
at the same time of the idea of a moderation of the tariff and of an
exact practical (not to say scientific) standard for the determination
of the proper rate in every case.

The rule is, however, fallacious. "Costs of production" mean here
the monetary costs of the enterpriser. Now a first difficulty is that
costs are not uniform for all establishments in any one industry, and
a tariff high enough to protect some is entirely too low to protect
others. As long as a tariff rate is too low to exclude every unit of
the foreign product its importation is conclusive proof that for some
home producers the tariff rates fall short of the "true principle"
(better proof, indeed, than the most elaborate investigation by any
tariff board could be). The indubitable truth is that no trade ever
can take place (in a monetary régime) unless the monetary price is
lower in the exporting than it is in the importing country. This
virtually means that the product cannot be profitably exported unless
the monetary costs of production ("together with a fair profit") of
the article exported are for each party less than those of the other
party in the other country.[9] The so-called "true principle" would
lead thus to absolute prohibition of every article to which it was
applied.

§ 12. #The Payne-Aldrich tariff, 1909-1913#. In the campaign of 1908
the Republicans admitted that the protective tariff needed to be
revised, but they declared that it should be revised by its friends.
It was doubtless the general understanding that "revision" in this
promise meant revision downward, tho this was left somewhat unclear in
a campaign wherein the tariff played a somewhat minor part. The tariff
act of 1909 (the Payne-Aldrich act) was the attempt of the successful
party to redeem its promise in this regard. Many changes of rates were
made, both downwards and upwards. It was estimated that rates were
reduced in 584 instances, affecting 20 per cent of imports. These
changes included placing hides upon the free list (before taxed 15 per
cent), and cutting down the rate on leather, shoes, coal, lumber,
iron ore, pig iron, and steel-rails. But on the other hand rates
were increased in 300 instances (including many items in the cotton
schedule). The general belief that little reduction was effected, on
the whole, was confirmed by the experience under the act. As compared
with the last two years (1908-1909) of the Dingley tariff the first
two years of the Payne-Aldrich tariff showed a decline of 1.5 per
cent, and on free and dutiable a decline of less than 3 per cent.
These reductions in the statistical results are no greater than
occurred within like periods while the Dingley act continued in
operation without change.[10]

No other tariff since "the act of abominations" in 1828 has called
forth such widespread criticism as this one, and the tariff became
a leading issue in the campaign of 1912. After 1910, the House being
Democratic, many bills to reduce duties were presented, and some were
passed by both houses, but all were vetoed by President Taft mainly
on the ground that it would be best to await the report of the tariff
board which had been authorized and appointed for the purpose of
ascertaining the cost of production referred to in the "true principle
of protection."

§ 13. #The Underwood tariff, 1913#. After President Wilson was
inaugurated, March 4, 1913, the tariff was at once taken up by
Congress. The general features of the act that was passed were as
follows:

(a) Considerable additions to the free list of raw materials.

(b) Abolition of compensatory duties corresponding with the old rates
on raw materials.

(c) Replacement of specific by _ad valorem_ rates in many cases.

(d) Taxation of plain kinds of goods less than fancy kinds--luxuries
higher than necessities.

(e) Reduction of rates generally (most of the few increases being to
correct some evident error in the old law).

(f) Application of the so-called competitive principle to rates
intended to be protective, viz., to leave the rate just barely high
enough to keep out foreign products.[11]

Articles placed on the free list were raw wool (which had borne a rate
equivalent to about 44 per cent), metals, agricultural implements, raw
sugar (the lower rate to go into effect gradually), coal, lumber, many
agricultural products including live cattle, meats, wheat, corn,
flax, tea, and hemp, and numerous manufactures including boots, shoes,
gunpowder, wood pulp, and print paper.

Moderate reductions were made in the schedules for chemicals, earths,
cotton goods, and sundries, while rates on various luxuries were
either unchanged or raised. Left almost unchanged were the schedules
for tobacco, for spirits and wines, and for silks (already very high).

This act was signed October 3, 1913, and had been in operation about
nine months when the great war broke out in August, 1914. What its
effects would have been under normal conditions we can judge little
from the actual experience. The first eight months that the act was in
operation, the _ad valorem_ rate on dutiable goods proved to be 36 per
cent (about 4 per cent less than in the preceding year) and the rate
on free and dutiable together about 14 per cent (over 3 per cent less
than the preceding year). The first complete fiscal year (that of
1915) under the act, the average rate on dutiable goods was 33.5 per
cent and that on all imports was 12.5 per cent. Evidently this is far
from a "free trade tariff." The reduction in the average _ad valorem_
rate is less than was expected. Many of the reductions had little
effect, the former rate having been much higher than was needed to
exclude the goods. In other cases the old rates were but nominal
and inoperative because they were upon goods regularly exported,
not imported (e.g., farm products, cotton goods, and some other
manufactures). But some of the reductions doubtless will force the
less efficient plants in some industries touched to increase their
efficiency or go out of business. Time, in any normal period, is
needed for adjustment, but an adjustment of a most abnormal kind is
in progress during the war. Imports from Europe have fallen greatly,
while exports are enormously increased. Old industrial establishments
have been converted to different and temporary uses. The conclusion of
the war must bring a new readjustment that must cause a severe shock
to some enterprises--and this must have been so under any possible
variety of tariff.[12]

§ 14. #Some lessons from our tariff history.# Can we draw from the
checkered course of tariff history in America clear lessons of wisdom
for the future? At least certain negative conclusions may be safely
drawn. It is a history of a vacillating public opinion toward the
policy of protective duties. Always the policy has kept some hold
on public sentiment, but it has varied in strength, now waxing, now
waning. The time of revisions has been determined nearly always by
varying needs of revenue. When more income has had to be raised, this
has nearly always been made the occasion and pretext for increasing
the degree of protection for many industries. This is not at all a
necessary connection, for it would be possible to couple internal
revenue taxes and customs duties in such a way that the rates would go
up and down together and give the varying amounts of revenue
required for the government without appreciably altering the relative
profitableness of various private enterprises.

Our tariff history is too largely a record of special favors granted
to classes of citizens, to the citizens of certain localities, and to
particular enterprises. This is apparent even in a general survey, but
almost every more detailed examination of particular protective rates
reveals evidence of suspicious and sometimes scandalous personal
influences at work. The protective policy has always professedly
been advocated for the general welfare to raise wages or to make the
country prosperous, but the initiative has always been taken, and
the valiant work in contributing funds for campaign purposes and
in lobbying bills through Congress has been done, by the interested
manufacturers. Even if it were beyond question sound in principle to
exclude goods that can be bought more cheaply by trade, it is very
doubtful whether any net good could have resulted from this policy
as it has been in fact applied and followed. The frequent and
unpredictable changes have been a great evil, and have again and again
brought unmerited losses to the many in business and still greater
and unearned gains to a favored few. It is incredible that such a
hit-or-miss, in large part selfishly determined, policy could have
been an important cause of our national prosperity. The fundamental
causes of the general high wages and popular welfare that we have
enjoyed is to be found rather in our rich natural resources,
our capacity for self-government with free institutions, and the
industrial energies of our people.[13]

The revision of the tariff of 1913, viewed with non-partizan eyes,
appears to have been carried out, to say the least, as consistently
with regard to its professed doctrine, and as little influenced by the
malevolent arts of the old-time Congressional lobby, as any debated
tariff act in our history. It still contains on the whole a large
measure of protection. Under various pretexts such as the danger of a
flood of cheap goods after the close of the great war, attempts will
be made to make it still more prohibitive. But one lesson of our
tariff history is that such an act should be given a period of fair
trial before extensive changes are made in it. Even further reductions
should be cautiously undertaken and put into effect gradually. If the
attempt is made through temporary rates to reduce the shock of the
trade adjustments, of the "dumping" after the war, then the devising
and administration of such measures should be delegated to an
expert, disinterested, permanent tariff board. The task is to prevent
temporary "unfair competition" and sudden changes, rather than to
raise permanent barriers to fair trade.[14]


[Footnote 1: It is evident that it is only through _ad valorem_ rates
that it is possible to compare the average rate of duty for one tariff
act, with that for another. As, however, every tariff act is made up
of both specific and _ad valorem_ duties, it is only at the end of the
year that an average _ad valorem_ rate can be estimated by comparing
the total of duties collected with the total estimated value of the
goods imported. Average _ad valorem_ rates are estimated in this way
both on the dutiable goods alone, and on all goods, free and dutiable
combined. There may be an element of error, even of misrepresentation,
in such estimates. They do not give the simple test of the relative
height of duties, or of the degree of "protection" that we might at
first suppose. Just to the extent that a new and higher rate really
operates to exclude imports (and thus is protective in its effect) the
goods subject to that rate cease to form part of the total imports.
For example, if the average rate of duty were 25 per cent, and a
50 per cent rate on an article were increased to 75 per cent, it is
possible that this rate would prove to be absolutely prohibitive.
This raise of rate, therefore, would tend to reduce the average rates
collected on all dutiable articles. Changes in general conditions
of industry from causes quite apart from the tariff may result in
shifting the proportions of imports that are dutiable so that the
average rates go either up or down while the tariff law has remained
unchanged on the statute book. A failure to consider these and related
facts leads to much confusion in popular and political discussion of
the tariff.]

[Footnote 2: Usually given as 20 per cent. However a good many rates
under the full operation of the act worked out as 21-1/2 or 23 per
cent, and a few at 26 and at 29 per cent. Besides there were
numerous specific rates, the _ad valorem_ force of which cannot be
determined.]

[Footnote 3: The political argument that the small tariff reduction of
1857 caused the crisis of 1857 will not bear serious examination. See
below, sec. 13.]

[Footnote 4: See ch. 14, sec. 2.]

[Footnote 5: See above, sec. 2, note 1.]

[Footnote 6: Internal revenue receipts in 1866 had been $309,000,000;
in 1872 they had fallen to $131,000,000, yet the government's surplus
for the three years 1870-1872 was little less than $100,000,000 a
year. This was almost half of the total receipts from customs, which
were $216,000,000.]

[Footnote 7: Other issues absorbed public attention in this
period--the Spanish war, colonial policy, "imperialism," railway rate
regulation, corporation control, etc.]

[Footnote 8: See above, sec. 2.]

[Footnote 9: Compare with ch. 13, sec. 5.]

[Footnote 10: Probably resulting from the rising prices, as explained
above, sec. 2. For example, in one year, from 1899 to 1900, the
average _ad valorem_ rate collected on dutiable goods fell 3 per cent,
and that on all goods fell 2 per cent; in the two years from 1904 to
1906 the average rates on dutiable fell 4 per cent, and on all goods
fell 2 per cent.]

[Footnote 11: This "competitive principle" is essentially the same as
the so-called "true principle" of equalizing the cost of production
(see above, sec. 11). It is essentially a prohibitive, not a free
trade, principle. Strictly applied it would cause complete exclusion
of imports. But as applied to selected articles which it is desired
to exclude in order to "protect" the domestic producer, this principle
would simply prevent the rate being placed appreciably higher than
was needed to exclude them. Anything beyond that point but offers
temptation and opportunity for the formation of a monopoly by domestic
producers. Then, too, the rate may intentionally be fixed so as to
make just possible the survival of the most favorably located or most
efficiently operated establishments, while compelling the abandonment
of other establishments. See ch. 14, sec. 3.]

[Footnote 12: Such changes are logically related to the subject of
financial crises rather than to that of the tariff. See note at end of
the next section.]

[Footnote 13: See Vol. I, e.g., pp. 228, 431, 445ff, 466, 490, 506ff.]

[Footnote 14: #Tariff legislation and business depressions.# The
relation between new tariff legislation and the business conditions
following it has been the subject of much debate in political
campaigns. In the few cases where a relationship has been most often
asserted to exist, it is more probable that the tariff change was the
_result_ of business conditions preceding it, than that it was the
cause of the conditions following it. For usually a tariff has been
revised downward because a few years of prosperity with large imports
had so increased customs duties that the government has had surplus
revenues. Just when the tariff was reduced, the conditions were ripe
for a crisis. This happened in 1857 (already in 1856 there had been a
preliminary halt of business), again in 1872, and on a small scale in
1883. But the main reduction resulting from the compromise act of 1833
did not occur until after the crisis of 1837-39; the Walker act of
1846 was passed just as business was starting upward on a long wave
of prosperity; and the act of 1894 was passed a full year after the
severe crisis of 1893, when business had already entered upon a period
of depression. In none of these cases does it seem reasonable to
attribute business depression to the reduction of the tariff, as
is commonly done in protectionist arguments even to the point of
attributing the panic of 1893 to the reduction of the tariff a year
later!

At several times the tariff has been raised soon after a crisis when a
good occasion was presented by the need of larger revenues as in 1842,
1860, 1875, and 1897. Business at such times is just at the point
of the cycle when prosperity is due. The higher tariff of 1842 was
succeeded by the low tariff of 1846 without any check to business. The
war obscured the ordinary industrial effects of the tariff acts of the
sixties. The increase in the year 1875 was followed by four years
of hard times and slow recovery. The increase of the tariff in 1890
occurred as business was nearing the top of the cycle and was followed
by two years of prosperity culminating in the very severe crisis of
1893. The authors of the tariff of 1897 were peculiarly fortunate in
the time of their action, for the country was just fairly recovering
from the very severe crisis of 1893 and prosperity was to continue
(with brief hesitation in 1900 and 1903) until the severe crisis and
panic of 1907.

The advocates of higher rates are, of course, correct in declaring
that the great business prosperity of the years 1915 and 1916 resulted
from the unexpected demands in foreign trade growing out of the war,
and is not to be credited in large measure to the act of 1913. But
reason requires that the same restraint be exercised in crediting
to higher protective acts the prosperity which has in some--not
all--cases, followed their enactment; and requires further that the
present act be not held accountable for the next reaction in trade,
whenever it may occur, inasmuch as a reaction would be sure to occur
no matter what kind of tariff act we might chance to have at the
time.]




CHAPTER 16

OBJECTS AND PRINCIPLES OF TAXATION

  § 1. Public finance as a division of economics. § 2. The police function.
  § 3. Social and industrial functions. § 4. The enlarging sphere
  of the state. § 5. Industrial revenues of governments. § 6. Governmental
  receipts from loans. § 7. Nonrevenue character of receipts from
  loans. § 8. Revenues from taxation. § 9. Forms of taxation. §10.
  Defective tax "systems." §11. Various standards of justice suggested.
  § 12. Social welfare as the aim. § 13. Principles of administration.
  § 14. Shifting and incidence. § 15. Taxes as costs.


§ 1. #Public finance as a division of economics.# Men live together
in politically organized societies which employ public officials as
agents to carry on the functions of government. Every governmental
unit, large or small, may be viewed not only as a political body,
but as an economic enterprise. Each has its economic aspects, such
as receipts and expenditures, employer and employee, borrowing and
lending, etc. Each political unit is in this sense "an economy." The
study of the public economy, of the economic aspects of government as
distinguished from its political aspects, constitutes the science of
public finance, an important division, tho not the whole, of political
economy.

The primary fact determining the public finances is the extent of the
sphere of "the state," meaning by the state the totality of political
powers and functions in a community. There are two typical ideals of
a state, each with corresponding functions: the ideal of the police
state, and that of the social-industrial state. In fact every system
of government provides for the exercise of both functions in some
measure. The police function is primary. All governments alike
exercise it, but they differ most in respect to the degree in which
they exercise the social-industrial functions.

§ 2. #The police function.# The police function is that of public
defense and the maintenance of domestic order. In family or
patriarchal communities all share a common income and combine in the
common defense, but self-preservation often has compelled such small
communities to form a larger, stronger state for the common defense.
Public defense requires sacrifice of some independence on the part of
the family and of the individual. Personal service in the field gives
place later in some measure to the payment of taxes, so that a regular
income may permit the government to attain a more regular, continuing,
and perfect organization of military forces.

As political unity and power grow, the citizens need less often
protection against foreign foes, and they need more often, relatively,
defense against the aggressions of some of their own countrymen. The
preservation of domestic order requires police, courts of justice, and
other agencies. The ideal of the anarchist to do without government
is nowhere realized. Everywhere there must be government to preserve
peace and to protect property. Unfortunately, this need grows with the
growing density of population. Crime increases when men swarm in
great cities. The courts which settle disputes between men, and which
interpret their contracts, are agencies of peace, displacing physical
contests. To maintain and operate the various parts of the social
machinery requires ever increasing governmental revenues. From many
causes government has, in modern times, grown increasingly costly.

§ 3. #Social and industrial functions.# The social and industrial
functions of government seem naturally to grow out of the primary
ones just mentioned. In a democratic society, popular education is
a necessity, as it appears that domestic order is not possible in a
democratic state without intelligent citizens. The system of public
education has, in many states, expanded to include a publicly
supported university as the dominant educational and scientific organ
of the community. Some industrial functions are performed by the
government in connection with the primary needs. Lighthouses are
necessary to guide the navy, but they also serve to guide the merchant
marine and to aid industry. The post was established as an agent
of political and military government to connect the ruler with the
outposts (a fact the name post indicates), but the postal service has
grown in every country to be a great industrial and social agency.
The consular service, originating in the political need of keeping
official representatives in foreign lands, has become a valuable
economic agency; consuls are commercial agents, advancing the business
interests of their countries in all quarters of the globe.

§ 4. #The enlarging sphere of the state.# A mere police state would
leave to private initiative the provision of every kind of economic
agencies not needed for political government. The state might, for
example, even leave the provision of roads and bridges to private
individuals or to companies, permitting them to charge tolls to obtain
a return on their investment. Whenever a toll-road is made public and
a toll-bridge becomes free, and the state maintains the roads, it is
becoming less strictly a mere police state. Reacting from the ideal
of the police state which was most highly praised in the first half
of the nineteenth century, the functions of government have been
extending in many directions in the last half century. More and more
economic functions are performed through the agency of government. If
we think of an act as done by the government _for_ private citizens,
we call it paternalism; but if we think of an act as done _by_
citizens collectively _for_ themselves as the best way to get these
things done, we may call it, in a broad sense, socialism.[1]

Government is in one aspect a direct good to its citizens. In return
for its collective cost men collectively get the enjoyment of social
organization, markedly in contrast with the uncertain ties and hazards
of primitive communities. But government becomes also a mode of social
investment, an indirect agent, a productive enterprise. Wealth applied
through it secures in some cases a greater product than is possible by
individual action.

But when the government undertakes these various tasks the expense
falls unequally on individuals and affects differently their incomes.
When free schools take the place of private schools, the law compels
every one to contribute to education. To many individuals it is a
matter of indifference whether they pay tuition or taxes, but the
wealthy bachelor sometimes grumbles when forced to help in educating
the day-laborer's family. The average result of a certain social
policy may be right, but individuals diverge from the average and
thus have constantly a motive to attempt to change the limits of
governmental action. Happily the subject is not always viewed with
selfish eyes. The ethical and patriotic thought is not, "How will this
affect my interests?" but. "How will it affect the general interests?"
But as the question of value is always involved men are usually found
favoring or opposing the industrial and social activity of the state
according as it affects their own incomes. Thus the determination of
the sphere of the state is in large part an economic question.

§ 5. #Industrial revenues of governments#. The costs of government at
any stage are met in varying degrees in one of three ways: (1) from
industrial sources, (2) by borrowing and thus creating a public debt,
(3) from taxation.

(1) Receipts from industrial sources in the broad sense include all
rents from wealth owned, interest on loans made, and proceeds of sales
from enterprises conducted, by the government. In feudal times, these
were mostly obtained in the form of rents from the private domains of
kings and nobles. In many early and medieval states these sources of
receipts were adequate to the need of government; then they decreased
in many countries, both relatively and absolutely, because of the
sale of publicly owned wealth (lands and mines) and with the recent
extension of the functions of government have again increased very
rapidly. Now industrial revenues come not only from the rents of
forests, mines, docks, lands, and buildings, but from profits in the
operation of industrial enterprises such as waterworks, railways,
mines, and factories, and from interest on funds deposited in banks
or otherwise invested. At present the industrial revenues of the
aggregate governments of the United States (national, state, and
municipal) amount to about a fifth of all revenue receipts. Since
the middle of the nineteenth century the number and variety of the
industrial enterprises undertaken by governments has been steadily
increasing, and this increase has been most marked in the cities. The
change in this respect in the United States, great as it has been, has
been proceeding more slowly than in the European countries.

In 1913 the receipts of this nature (earnings of departments and of
public service enterprises) were nearly $500,000,000. The larger part
of this sum comes to the national government ($288,000,000), mostly
from the post-office department. Most of the remainder comes to the
minor divisions ($176,000,000), and but little to the states. The
total "earnings" (this means here receipts, not profits) of public
service enterprises in incorporated places were $120,000,000.

§ 6. #Governmental receipts from loans.# The funds to invest in these
commercial undertakings are originally obtained in nearly all cases
from public loans. Almost every unit or division of government may
become a borrower to provide for its citizens at once certain needed
advantages and improvements when the funds are not at hand and
immediate taxation is deemed too heavy a burden.[2]

The indebtedness (less funds available for payment of debt) of the
aggregate governments of the United States in 1913 was:

  Nation  .................................  $1,028,000,000
  States  .................................     346,000,000
  Minor divisions .........................   3,476,000,000
                                              -------------
  Total   .................................. $4,850,000,000

The larger part of nearly every national debt has been incurred for
purposes of war and preparation for war, while nearly all public
debt other than national has been created for the purpose of peaceful
social and industrial development. The debts of the American states
have partly been made necessary to meet deficits in current expenses,
but largely of late to erect public buildings, purchase forest lands,
improve roads, and construct canals. The minor divisions are counties,
cities, villages, boroughs, towns, townships, school districts,
drainage, irrigation, and levee districts, fire districts, poor-relief
districts, road districts, and various other subdivisions of states
and of counties. Every one of them has more or less legal power to
incur debts and to levy taxes for the purpose of paying the interest
and of repaying the principal. The purposes for which the debts are
incurred by specially organized districts are sometimes indicated in
the names (e.g., drainage, irrigation), while the regular political
divisions of counties, cities, villages, towns, townships, incur debts
for a large variety of objects, such as streets, sewage disposal,
water supply, electric light or gas plants, school houses, libraries,
and other public buildings. Large expenditures for these purposes are
necessary because the local governments are undertaking new functions,
and either existing equipment (such as waterworks systems, and street
railways) must be bought from private companies or new ones must
be built. They are necessary further because the rapid growth of
population calls for an immediate "capital investment," the payment of
which may be, through borrowing, more easily spread over a series
of years (e.g., in the extension of streets and paving, and in the
provision of school houses for the children).

§ 7. #Nonrevenue character of receipts from loans.# The proceeds
from loans (and certain other items of sales) are called nonrevenue
receipts, because they are but in anticipation of receipts from other
sources. The economic theory of such loans is essentially the same as
that of private loans, but it is the people of the political district
collectively that are the borrowers. To get the present uses of goods
they sell their promise to make future payments totaling a larger
amount. The loan is the present worth of those promises. In the case
of loans made for local purposes, provision is now usually made for
their complete repayment within a definite number of years,
usually 10, or 20, or 30. Meantime interest is payable annually or
semi-annually, and from some source an additional sum is collected
to repay a part of the loan, sometimes by redeeming a certain part
annually, sometimes by accumulating a sinking fund until that amounts
to the whole debt.

The minor divisions in the United States are thus constantly creating
debts at the rate of about $2,000,000,000 each year and at the same
time paying former debts in instalments, in a total amount somewhat
less than this. In the case of some municipal investments which are
commercial enterprises (such as those supplying gas, electricity, and
water), these annual payments can be made out of the profits; in the
case of others, the payments come from special assessments upon
the owners; and in most other cases they are collected by the usual
methods of taxation. In America, a large part of these costs are, by
the law of special assessments, placed upon the owners of adjacent
lands, whose outlays are usually more than offset by the increased
value of their lands as a result of the improvements. In this case
also, the present investment is in anticipation of the future incomes
which the owners of the improved lands will get.[3]

§ 8. #Revenues from taxation.# Much the largest part of the receipts
of most governments, apart from loans, and in many cases nearly all
such revenue receipts, come from taxation. Tax (as a verb) meant
originally to touch or handle, then to estimate or appraise, and then
to charge a burden upon some one, especially to impose a payment of
services, goods, or money upon persons or property for the support
of government.[4] _Taxation_ is the legal process of taking income,
services, or wealth from private persons for public uses.

Taxes are of various kinds, but they always are incomes, or wealth
representing future incomes, transferred from private ownership of the
taxpayers to the government. In rare cases, more than the net current
income of a certain kind may be taken for public uses. As economic
income has many sources, it may be intercepted at many different
points, and taxation may take various forms. The differences are
so manifold that it is difficult to classify particular taxes
satisfactorily.

§ 9. #Forms of taxation.# The following are the forms of taxation most
frequently referred to.

(a) The simplest form of tax is a _poll tax_, a uniform amount payable
by every person of the taxable class. This form of tax is being
less and less used in America and now amounts to little more than
$17,000,000,[5] this being only .6 of 1 per cent of the aggregate
taxes in the United States. The national government gets about
one-fourth of this amount from a tax on immigrants and the rest is
collected by (some of) the states, counties, and minor divisions.
Usually, if not always, the poll tax is imposed only upon voters, as a
condition to the right to vote.

(b) Taxes may be laid upon _incomes_, as they come into the possession
of the owner. Usually, only monetary incomes that arise in commercial
transactions are taxable, and no attempt is made to estimate the value
of psychic incomes. Commercial incomes are more easily measured, but
the omission of the other elements must cause many inequalities in the
burden of the tax as between two individuals controlling equal incomes
of real things.

(c) Taxes may be on _property_, either general upon all property in
the taxing district, or special, upon certain forms of property. A
property tax may be specific or _ad valorem_, in proportion to value,
as to the method of its determination. Since the value of material
wealth is the capitalization of the rentals at the prevailing rate of
interest, a general, _ad valorem_, property tax, so far as it applies
to material wealth, and if it were accurately assessed, would take
an approximately equal proportion of wealth-incomes. It does not, of
course, touch directly incomes derived from wages and salaries, but it
reduces their purchasing power in many cases. It is in some respects
more searching than a tax on actual rents, for it reaches the
prospective, or speculative, rental.

(d) Taxes may be on _expenditure_ (sometimes called taxes on
consumption). This is but another mode of attacking income, for in the
long run most income is spent, not always by the individual who earned
it, but by some one, and thus it is reached by a tax on expenditure.
Usually in the United States the tariff duties are accounted to be
taxes on expenditure, as also the internal revenues (also called
excises) of the national government. In time of war, internal revenues
are extended in the United States to a multitude of articles, but
usually they have been limited (with minor exceptions) to liquor and
tobacco. Most of these taxes are in fact levied not at the time of
purchase by the ultimate consumer, but upon the specific goods in
the hands of some merchant or business agency, and some of them are
essentially special property taxes and others are business taxes of
the kind next to be mentioned.

(e) Taxes may be levied on selected agencies of industry or on the
process of _business_; such are business taxes, licenses, taxes on
investment in business, and corporation taxes. These burdens are
diffused and rest eventually on some income, rarely to be ascertained
exactly.

§ 10. #Defective tax "systems."# The actual tax laws of each division
of government in a country combine the various forms in different
proportions. Most of the federal taxes are from tariff duties and from
internal revenues; the latter include a variety of special business
and property taxes and, since 1913, the federal income tax. The
largest receipts of states, of counties, and of minor divisions are
from property taxes, some special but most of them general in form.
Among the various states a wide diversity is found. Some use the
general property tax for all the divisions (state and local), while
others (several of the Northern states and California) have separated
the sources of state and local taxation, taxing corporations for state
purposes, and most other forms of wealth for local purposes. Some
states, particularly those of the South, make large use of licenses
and taxes on business both for state and local purposes. The tax
laws of many states have been much modified of late and are still in
process of change. It is only in a loose sense that one can speak of
the tax "system" of any state, made up as it is of so many diverse
elements, each used to tap in some independent way some source of
private income for public purposes. Every tax "system" has grown up
more or less accidentally, guided by no more of a general principle
than the advice of the cynical old statesman--so to pluck the
feathers of the goose that it will squawk as little as possible. Thus,
everywhere, the existing situation must be largely accounted for by
custom and ignorance, by the weakness of some classes and the undue
influence of other classes, rather than by clearly thought out
principles soundly administered.

§ 11. #Various standards of justice suggested.# There have not been
lacking earnest attempts to arrive at some general principles. Many
standards have been suggested to measure the distribution of the
burden of taxation, such as benefit, equality, and ability. Each of
these terms is capable of various interpretations which have changed
from time to time. The benefit derived by any citizen from most of
the public services evidently cannot be measured with exactness. The
standard of equality cannot be applied in any literal sense to strong
and weak, to rich and poor. It is possible, however, to interpret
equality with reference not to objective goods, but to the psychic
sacrifice occasioned by taxation. Ability is of many kinds and may
be differently understood. Some think ability to bear taxation is
"in exact proportion to the money income"; others believe that it
increases at a greater rate than money income, and favor, therefore,
progressive taxation, that is, higher rates on the larger incomes.

§ 12. #Social welfare as the aim.# The conflicting interests of
the various classes of taxpayers in each period are to some degree
softened by the prevailing public opinion, sometimes called the social
conscience, and taxes are adjusted according to a vaguely held
ideal of the social welfare. Social expediency, more or less broadly
interpreted, determines who shall be taxed and what social results are
to be sought. The exemptions from taxation in feudal times were great
and, viewed from our standpoint, were inequitable, for the upper
classes escaped while the peasants bore most of the burdens. The
landlords and nobility, who were assumed to be performing important
social functions, generally had outgrown their usefulness in the
period preceding the French Revolution, which swept away many of these
abuses.

Exemptions from taxation are granted liberally in most states to-day
on some kinds of wealth and to some classes of citizens, because
of their supposed relations to the public interest. Real estate and
equipment devoted to educational, religious, and charitable purposes,
the homes of priests and ministers, homesteads purchased with pension
money, as well as all public lands, buildings, and equipment are
exempt.

The social interest requires that taxes be both elastic and
productive, so that the needs of the government shall be amply
provided for. The harmonizing of these needs in the laws of taxation
requires a high degree of wisdom, of foresight, and of integrity
in the legislator and in the citizen. No hard-and-fast rule for the
apportioning of taxes can be laid down. The decision must be made in
each generation by the public opinion as to what is most expedient for
the general welfare.

§ 13. #Principles of administration.# Whatever forms of taxes are
adopted, whether on property or income, whether at proportional or
at progressive rates, their justice and expediency depend largely
on their administration. Principle and practice in this, as in most
affairs, may go far apart. The administration of taxation should
be economical, certain, and uniform. Some laws are more easily and
economically executed than others. The time of collection should be as
convenient as possible for the citizen, and the mode of payment should
be the most simple. The utmost certainty is desirable as to the time,
method of payment, and amount. Taxation that, in its principle, is
variable, shifting, or dependent on personal whim and favoritism,
is despotism. But the greatest evils, in practice, result from the
failures in assessment. The assessment of taxes has to be intrusted
to men with fallible judgment, imperfect knowledge, and selfish
interests. The assessor is as near a despot as any agent of popular
government to-day. Not infrequently men of proved incapacity in every
private business they have attempted are, for partizan or corrupt
reasons, selected as assessors, and are given the power of passing
judgment on the value of millions of dollars' worth of property. Under
the circumstances, evils are to be expected, and they occur. The small
owner often is crushed under the unequal assessment while the large
owner comes lightly off. Political friends are favored, political foes
are made to suffer. Even the most honest and capable of assessors find
in the imperfections of the tax laws[6] an insuperable obstacle to
even-handed justice.

§ 14. #Shifting and incidence.# The person paying a tax into the
public treasury is not always the one whose income is reduced in
the long run. This is most clearly seen in the case of taxes paid by
middlemen. In most cases the final and regular burden of the tax is
distributed over a number of incomes. The passing on of the burden is
called the _shifting_ of the tax; the final location of the burden is
called the _incidence_ of the tax. The lawmaker cannot tell exactly
where the weight will fall. The principles of value give some guidance
in the inquiry, but the workings of the principle are difficult to
follow.

Consider a situation where certain taxes have been for some time
levied. They have become a part of the general adjustment of prices.
If paid by any one in business they may be looked upon as a deduction
from the gross proceeds or product of the business, prior to cost, or
as a part of cost.[7] In either case every one choosing that business
does so in the light of this fact. Unless the business promises to
yield as good incomes (wages, profits) as other lines, the number
engaging in it, and the output, must diminish and thus the price of
the product rise, or the cost of the factors fall, or both in some
proportion. The tax on any durative agent or on any established
business thus becomes incorporated after a time in its price and in
the prices of the products, and any purchaser pays a price based on
the net income remaining to the owner of the wealth after the tax is
paid. Viewed in this way, taxes are seen to be borne to some extent
by every one, by those who do not as well as by those who do actually
meet the tax-collector face to face. The citizen with no taxable
property is affected, far more than he realizes, by extravagance of
government and by inequities in taxation, for the effects of most
taxes are diffused so that every self-sustaining member of the
community has some share in them.


§ 15. #Taxes as costs.# Now if a new tax is levied, or an old tax
changed in amount or in its incidence, it becomes a new influence in
industry. Some occupations are made more attractive, others less so.
Some places are made more, others less, desirable to live in.
Property thus fluctuates in value, and investments become more or less
remunerative. If the new tax reduces the net income of any productive
agent, it reduces likewise its value, which is but the capitalization
of its net rental. If taxes are taken off of factories and put upon
farm rents, factories rise and farms fall in value in the hands of
their owners. The immediate change in value is much greater than the
annual tax, for if five dollars is to be taken permanently from the
annual rental of the farm, nearly one hundred dollars is taken at once
from its selling value when the prevailing yield on investment is
5 per cent. The rate of adjustment varies greatly under different
conditions, and the inflow and the outflow of labor and capital are
more or less rapid in the various industries.

Taxes that enterprisers are unable to shift to others are reckoned by
them as a part of their costs of production whenever the conditions of
competition and of substitution make it possible to do so. Every new
tax that curtails the supply of any necessary agent must raise the
price of the products and cause more or less of the tax to fall upon
the consumers. In the Civil War an increase in the tax on whisky
increased its selling price, and distillers who owned stocks on which
a smaller tax had already been paid reaped profits of millions of
dollars. When the tax on tea was increased in England, all dealers
that had accumulated a stock before the law went into effect were
gainers. Every change in taxation inevitably affects, either favorably
or unfavorably, many interests. The chance to anticipate a change in
tax laws or to get, from those in power, information of a proposed
change, makes speculation possible and political corruption
profitable.

The fact that a change in taxation is a disturbing element in price is
not to be deemed insignificant merely because "all comes out right
in the end." Every change in taxation is an element of uncertainty
in business and increases the fortunes of some men at the expense
of others. Hence no considerable change should be made without good
reasons in its favor. The older taxes have the virtue of stability,
but in many cases they have grown out of harmony with the industrial
conditions. While, therefore, from time to time there is a real need
of a reform in the tax system, it should not be undertaken without
recognizing the many and complex interests involved.


[Footnote 1: Meaning here not a certain political party, but a
principle of social action.]

[Footnote 2: The total debts of the _national_ governments of the
world just before the outbreak of the great war in 1914 were estimated
at about $44,000,000,000. (These figures include the debts of the
separate states in the federal unions of Australia and the German
Empire, and the separate debts of European colonial governments, but
not those of the states of the United States, and in no case including
the debts of minor divisions, the total figures for which are not
to be had.) The new debts created by the war give already more than
double the foregoing total.]

[Footnote 3: The special assessment is thus in its nature, in part a
private investment. The plan, of special assessments could easily be
applied in many more cases than is done at present.]

[Footnote 4: There are border-line cases where it is difficult to
decide whether a particular payment to the government in the form of a
fee, price for service (as water rates, etc.), and special assessment
(as for street paving) is in the legal sense a tax or not. Some
courts have, for example, decided that for certain purposes a special
assessment is to be called a tax, and in certain other cases it is
not to be if this would defeat the evident and just intention of the
legislature.]

[Footnote 5: The figures do not include returns from incorporated
places having a population of less than 2500 where the poll taxes may
be a considerable sum.]

[Footnote 6: Particularly the difficulties noted in the next chapter,
sees. 2-5.]

[Footnote 7: See Vol. I, p. 374.]


CHAPTER 17

PROPERTY AND CORPORATION TAXES

  § 1. Importance of taxation as a public question. § 2. The general
  property tax; nature and difficulty. § 3. Ambiguity of the term
  "property." § 4. Various temporizing policies. § 5. A consistent policy
  of wealth-taxation. § 6. Needed reform of assessment. § 7. Separation of
  state and local taxation. § 8. Federal taxation of merchandise in
  commerce. § 9. The proposal of the single tax on land values. § 10.
  Various reforms in land taxation. § 11. Difficulties in taxing
  corporations. § 12. Special taxes on banks. § 13. Special taxes on
  insurance. § 14. Special taxes on transportation. § 15. Alternative
  policies of corporate taxation. § 16. General plan for corporate
  taxation.


§ 1. #Importance of taxation as a public question.# The discussion of
taxation has accompanied the growth of free government in England and
America from the time of Magna Charta. The control of the public purse
has been found to give the key to political power, and therefore it
has frequently become the occasion of conflict between the monarch and
the people. But in our own national history since the adoption of the
Constitution, taxation has not had a leading place in politics except
in the one aspect of the tariff. The constitutional question of
states' rights long absorbed most of the interest of citizens and
of legislators. But with the quickened attention of the public to
economic questions, the problem of taxation became of increasing
importance.

It has come to be recognized that taxation can be made to play, and
is bound to play, a leading part as an agency in the distribution of
wealth, and thus it is the center of much of the ardent controversy
regarding social reform. Ultimately, almost every proposal of social
change and betterment involves some cost. The question then must be
answered. Who is to receive the benefits and upon whom and how shall
new taxes be levied to pay the cost? Further, it is often urged that
this result of taxation in redistributing incomes is in itself (or can
be made) a virtue; and some even see in tax reform the answer to the
largest social questions of our time. We are now to take up a few of
the more important problems of taxation, to see the difficulties, and
to suggest the direction in which their solution is to be sought. The
tariff having been already separately considered, the chief kinds of
taxes we have here to treat are property taxes, general and special,
and inheritance and income taxes.

§ 2. #The general property tax; nature and difficulty.# The rates both
of assessment and of levy of the general property tax are uniform and
equal in proportion to the value of all (or nearly all) property in
the taxing district.[1] There are always some exceptions of certain
kinds of property, or of the property of certain persons, or of
property and things put to certain uses--public, educational,
religious, and charitable in their nature.

The federal government levies no general property tax, but the other
branches of government[2] receive about three-fifths of all their
revenues from it.

At first view nothing would seem to be simpler and juster in principle
than such a plan of taxation, but those who have most carefully
studied its practical operation, almost with one accord, pronounce it
to be "a dismal failure." The chief reason assigned for this failure
has been that the assessment of the tax is imperfect and incomplete.
The usual thought is that if all property could be assessed the plan
would be excellent. Undoubtedly the difficulty of just assessment has
its part in the weakness of the tax, but back of, and more important
than this, is an inherent fallacy in the apparently simple principle
of the tax.


§ 3. #Ambiguity of the term "property."# Unfortunately, the word
property is applied, even by the most competent courts, both to the
intangible right of ownership (the fundamental meaning) and to
the concrete thing that is owned, the source of the income.[3] But
evidently the value of the right to the income yielded by a house, for
example, is merely the value of the house. The value of the _property
in the one sense_ (the abstract ownership, the intangible right) is
merely a reflection of the value of the _property in the other sense_
(the concrete wealth). There are not here two independent bodies of
economic wealth. Whatever value belongs to the one is subtracted from
the other. Nor is it rational to take the paper document called a deed
(which is but the evidence of ownership) and call it tangible property
having a value in addition to the house itself. Yet, in fact, all
these confusions are constantly made in taxation. The term "intangible
personal property" is applied to such things as mercantile credits,
promissory notes, bonds--in general to the right to collect sums
from another person, whether these rights arise out of sales or of
loans--and all are treated as parts of taxable property. Sometimes
the evidences of indebtedness, the promissory notes or the mortgage
papers, are even called tangible property, the same term that
is applied to land, houses, and machinery. By universal practice
supported by a long line of court decisions, these rights (whether
evidenced by paper or not) are made subject to taxation, except as
by piecemeal legislation certain grudging exceptions have been made.
These views and this practice are supported by the popular desire to
tax money-lenders. The result is "double taxation" of many sources of
income. This involves a burden that is ruinous in some cases, both to
borrowers and to lenders, and that tempts in all cases to the evasion
of the tax.

Take, for example, a house assessed at $10,000 which is owned free of
debt and which has a rental value of $600. At the rate of 1.5 per cent
the tax paid would be $150. Now if the owner borrows $8000 he is still
taxable $150 on the full value of the house, and the lender nearly
everywhere is taxable $120 on the amount of his mortgage. The total
tax payable out of the one source of income, the house, is then $270.
The same analysis will show that any credit is but a contractual
claim upon some other source of income which is, or should have been,
already taxed.

If one person owns all the capital-value invested in a specific piece
of wealth, no attempt is made to tax both the capital and the wealth;
but if it happens that two or more persons share the capital-value
invested in the same wealth, the attempt is made to tax as a unit the
full value of the wealth and, in addition, some part of the capital
also. It is, however, easy in most cases to conceal this "intangible
property" from the assessor's eyes, and a comparatively small amount
of it is ever taxed. This means inequality and hardship in the
operation of the tax and, as a result, unceasing temptation to perjury
by the taxpayer and to favoritism and graft by public officials.

§ 4. #Various temporizing policies.# The general property tax in
practice is unjust and demoralizing. What, then, shall be done about
it? Various policies have been followed. One has been to declare that
the law would be good if it could be enforced, but that as in practice
it cannot be, the best thing is to go on as before, catching a few
"tax dodgers," and letting the rest go. Another policy is to hire
"tax ferrets," paying them large commissions to discover cases
where intangible property of this sort has been concealed from the
assessors. This method, no matter how stringently applied, has never
reached more than a small proportion of the cases, and becomes a
potent agency of political favoritism and corruption.

Another policy is to maintain the general principle, but to make
exceptions here and there. Usually the exceptions are made just at
those points where the law would with earnest effort be most easily
enforceable, and therefore where it has become most inconvenient. As
a result of these changes the state laws display a bewildering and
illogical variety. By constitutional interpretation, United States
notes and federal bonds are exempt from state and local taxation;
generally, by state law, building and loan association and
savings-bank loans are exempt as, in a majority of states, are state
and municipal bonds if held within the state. In at least eight
states, bonds of the state are exempt, but those of the municipalities
are taxable, while in a few states the reverse is the case. In several
states both kinds of bonds when issued after specified dates, are
exempt, but in Ohio state bonds are exempt only if issued prior to
1913. All but seven of the forty-eight states, however, attempt to tax
the resident holders of state and municipal bonds of other states;
but the exceptional states are those in which most of the investors
in this class of securities reside. In many cases private debts
receivable are allowed to be offset against debts payable. In some
states mortgages on real estate are exempted or (in Massachusetts)
treated as an interest in the real estate. Rarely mortgages are
exempted up to a certain amount (in Indiana, to $700, the purpose
being to tempt the borrower to reveal the name of the lender).
Sometimes a special mortgage registration tax, payable but once (in
New York 1/2 of 1 per cent) is levied, and otherwise mortgages
are free from taxation. Small as this rate is, the fiscal yield of
mortgage taxation under this plan exceeds that under the general
property tax.

By the overlapping of these laws, so contradictory in principle, it
may happen that securities held by taxpayers residing in other states
than those of the issue are taxable two or three or more times; but
few if any loans of this kind are made except by those evading all
taxation.

§ 5. #A consistent policy of wealth taxation.# These exceptions
still leave the law in its general principles as to the taxation of
intangible property illogical and unjust. A solution can be found only
by abandoning the ambiguous legal concept of property, and making use
of economic concepts. A consistent tax law might take either wealth
or capital as the basis of assessment, but not sometimes the one and
sometimes the other. Wealth is an impersonal basis of taxation;
each piece of wealth might be taxed once as a unit no matter how the
ownership were divided. Or the other alternative might be chosen.
Capital would be a personal basis of taxation; each person's capital
might be taxed no matter from what sources the incomes were derived
(the concrete wealth, of course, then being left untaxed).

The wealth basis is much nearer to the present general property tax as
actually administered. The assessment of general tangible wealth
would undoubtedly be more easily done than would that of individual
capitals, and likewise be both easier and juster than the present
inconsistent policy. Tangible things are comparatively easy to find,
measure, and evaluate where they are, and if they are all taxed it is
evidently the same as if all the capital values based upon them were
taxed in the owners' hands. The various equitable claims of different
owners in one source of income could be left to adjust themselves
through shifting, mainly in the choice of investments, once the plan
had become generally applied.

§ 6. #Needed reform of assessment.# The assessment of the present
general property tax is notoriously inefficient and unjust. The root
of most of the present evils (other than those above discussed) is the
method of local election of assessors, which usually is by townships,
but in some cases by counties. The local assessor's estimate of value
is used as a basis for taxation not only for his district but for the
larger units (county and state). Thus every local assessor is tempted
by the conflict of interests not only among the taxpayers in the
district which elects him, but by the conflict of interests between
his district as a whole and other districts. The lower the ratio of
assessment to true valuation in any township compared with that of the
other tax districts, the smaller the proportion of county and state
taxes that the people of the district have to pay. Willingness to
under-assess property often becomes thus the chief virtue of an
assessor in the eyes of his political constituents. This has led in
many cases to absurd underassessment, which boards of equalization
have proved powerless to remedy in any great measure. A sounder plan
would be general state assessment, with a permanent expert board of
commissioners employing a corps of state assessors under the merit
system of appointment. This plan has as yet been applied only to
assessment of railroads and some other public-service corporations.

§ 7. #Separation of state and local taxation.# For the reason just
indicated the failure of the general property tax has been most
conspicuous where it is used as a basis for state taxation. This has
led some financial students to advocate the plan of separation of
state and local taxation. This means the assignment of certain sources
of revenue (such as corporations and the liquor business) primarily
or exclusively to the state, leaving all real estate and the general
property of non-corporate persons to be taxed by the counties and
minor divisions under the general property tax. The plan has been
increasingly applied in New York, until, in 1906, it became almost
complete. In 1910 the plan was adopted in California; and it is
largely used in New Jersey, Connecticut, Delaware, and Pennsylvania,
and to a small extent in some other states. An efficient state
assessment of general wealth would accomplish most of the advantages
claimed for this plan, while avoiding some of its dangers.

§ 8. #Federal taxation of merchandise and acts in commerce.# Tariff
and internal revenue duties constitute the two chief revenues of the
federal government. Both of these are mainly taxes on wealth. Unlike
the general property taxes they are not levied upon the main body
of wealth held in possession, but almost entirely upon articles of
merchandise and upon acts in course of trade. Stamps on receipts,
checks, deeds, bills of sale, and licenses on the sale of liquor
and tobacco are taxes on business acts which are necessary to the
acquisition, use, or expenditure of wealth. Goods imported are taxed
at the time of entering the country; domestic products such as cigars,
spirituous or malt liquors, playing cards, and (at times) matches, pig
iron, and other products, are taxed usually at the time of exit from
the factory. It has already been shown that when the tariff duty
prevents the importation of foreign goods and by raising the price
encourages domestic manufacture of the article, there is virtually
taxation of the consumer to subsidize the private manufacturer. A
system of properly adjusted compensatory duties (tariffs and internal
duties combined) which would prevent tariff duties from having any
prohibitive effect whatever could, in a great country like ours, be
made to produce any revenues desired. Such a system, combined with the
federal income tax, seems destined to be the chief dependence for the
national government.

§ 9. #Proposal of the single tax on land values.# Besides the general
property tax there are found in the country as a whole a large number
of special property taxes. Some of these have been introduced as
substitutes for the general property tax; such is the special taxation
(above referred to) of mortgages, and bonds. Other special property
taxes have been introduced because they were believed to be good in
themselves; such are special franchise taxes on corporations and some
kinds of taxes on land.

The special taxation of land, or of land values, has been strongly
urged by Henry George and his followers since the publication of the
remarkable book "Progress and Poverty" in 1879. The doctrine there set
forth is that the state should "appropriate land rent by taxation,"
should "tax land values, irrespective of improvements." It is
maintained that "a single tax" of this kind would be quite sufficient
for all the purposes of government. The main arguments adduced
for this plan may be reduced to three propositions: first, private
property in land is essentially unjust, because land is made by
nature, not by men; second, the plan would make assessment simple and
certain by limiting it to the unimproved land, and making unnecessary
the more difficult assessment both of tangible improvements and of
intangible personal property; and third, it would work a marvelous
reform in social conditions, abolishing poverty and greatly increasing
production.

It is impossible within our limits of space to discuss this proposal
further than to indicate that: (1) It assumes an untenable theory of
property.[4] (2) It overlooks the difficulty of distinguishing the
value of the land "irrespective of improvements," from that of the
land as it actually is, a difficulty especially great in the case of
agricultural land.[5] The difficulty is present even in the case of
urban land when the improvements of filling, draining, and leveling
have become incorporated with the site.[6] (3) The plan ignores the
stimulus (motivating force) which private ownership has given and
still gives to the maintenance and fuller productive use of land.
Nowhere has production thriven where the state was the universal
landlord.

§ 10. #Various reforms in land taxation.# While the single tax plan
is defective in principle, its wide discussion has served to direct
attention toward the need of reform in the taxation of land. Some
proposals looking toward this end are widely favored by opponents as
well as by advocates of the single tax. Such are the following:

(a) The abandonment of the taxation of mortgages.[7]

(b) A more correct assessment, in accordance with the present laws,
of lots and lands held for speculative purposes, which in practice are
now greatly under-assessed.

(c) More adequate special franchise taxation upon corporations for
special privileges in the public highways.

(d) Exemption, in value equal to the costs, of improvements on land,
such as buildings, drains, fences, and fertilizers, for a limited time
after they are made, perhaps five years.

(e) The separate assessment of urban lands used as mere building sites
and of the buildings on them.

(f) Taxation of the increase ("increment") of urban land values,
periodically or on the occasion of transfer of ownership.

§ 11. #Difficulties in taxing corporations.#[8] Until near the second
quarter of the nineteenth century, business corporations (of which
there were few) were taxed just as was the general property of
individuals. This still continues to be the case in the main in most
of the states. The methods and machinery of assessment were (and still
are) essentially local and simple, and have proved to be inadequate
to reach or justly assess the larger and more complex corporate
enterprises when their equipment and business extend beyond town, then
county and, finally, state lines. Moreover, the corporate forms
of organization presented in complex and puzzling forms the dual
conception of property.[9] Here was the tangible wealth of the
corporation and there were the diffused rights of ownership, the
capital of individual stockholders and bondholders. Confused by this
ambiguity, the men of that time believed (as many still believe) that
there were here two separate and justly taxable funds of value. The
popular will declared (and still declares) that "all kinds of property
ought to bear their fair share of the burdens of taxation." Yet to
apply this principle would obviously be double taxation and result
in confiscation in many cases. Between this doubt and the practical
difficulty of assessment, it turned out that corporate wealth, far
from being doubly taxed, was largely escaping even its due single
burden.

§ 12. #Special taxes on banks.# Attempts to deal with the difficulty
without clear perception of its cause took the form of legislative
tinkering and patching. Taxes were gathered from corporations by any
device that seemed workable. The banks, being the earlier important
corporations, were first experimented upon. Taxes on capital stock and
on circulation were tried first (in 1805, by Georgia), then a tax on
dividends (in 1814, in Pennsylvania, and in 1815 in Ohio), examples
which were followed or modified by a number of states. After the
national banking system was started in 1864, attempts to tax both the
capital of the banks and the stock in the hands of individuals led to
federal court decisions and then to state legislation by which now in
many of the states the banks are separately taxed on their real estate
and the shares are assessed to the individual holders (by various
rules), but the taxes deducted from dividends and paid by the bank.
There are, besides, special franchise taxes and fees paid by banks in
various states.

§ 13. #Special taxes on insurance companies#. Insurance companies
present in a striking manner the complexities of the ambiguous
property concept. The assets of the insurance companies (we refer here
particularly to the reserve companies), which belong in equity to the
policy holders (less the claim of the stockholders in the case of
the stock companies), are nearly all invested in stocks and bonds of
corporations and in mortgages on real estate. Now under the general
property tax, strictly interpreted, the policies are assessable
at their surrender or reserve valuation in the hands of the policy
holders; secondly, the securities and credits which compose the assets
are assessable to the company; and, thirdly, the railroads, factories,
and houses, built with the outstanding loans made by the insurance
companies, are assessable as tangible wealth, to the owners. If such
an interpretation were practically enforced it would result in triple
taxation to be drawn from the same economic source, and would be
utterly prohibitive of the insurance business. The enforcement
has, however, been impossible in practice. Insurance companies
have comparatively little tangible wealth excepting real estate
for offices. This is taxed locally. Several methods have been tried
(beginning as early as 1824) to make insurance companies pay taxes
(usually for state purposes) on something besides tangible wealth. A
tax on receipts from premiums proved most workable, first as applied
to "foreign corporations" (that is, to those of other states) and
later, generally, to domestic companies also. Now, amid bewildering
variety and interstate rivalries in tax laws, the most usual rate is
two per cent on gross (in a few cases on net) premiums collected. The
taxes on premiums, with various licenses and fees, now amount to 2.15
per cent of the total receipts from life insurance premiums in the
United States. This is taxation not on an existing body of accumulated
wealth, but upon the process of accumulation, a tax directly on the
act of saving. A consistent policy of wealth taxation combined with
income taxation would require the abandonment of the present forms of
special insurance taxes.

§ 14. #Special taxes on transportation.# Another great group of
businesses whose taxation has been especially complex, because they
are distributed throughout different taxing districts, are agencies of
transportation and communication, especially railroad, sleeping car,
express, telegraph, and telephone companies. A state tax on railroad
tonnage (Pennsylvania, 1860) was declared unconstitutional by the
United States Supreme Court. But many other plans have been tried
to compel the railroads to contribute, the chief being by taxes on
dividends, gross earnings, equipment, and valuation of capital stock,
taxed either to the company or to the stock-holders, (Connecticut
since 1849). About a third of the states no longer make the physical
plant the basis of taxation, except that in most of them some part or
kinds of real estate are taxed locally.[10]

Telegraph companies are still locally assessed in most states, but in
over a third of the states are taxed either on gross receipts, or
on mileage of wire. Telephone companies are similarly taxed, but
sometimes on the number of transmitters, or of subscribers, or on each
plant, or otherwise. In a similar manner, express and sleeping car
companies are taxed, in the same group of states, on mileage, or on
capital stock proportional to mileage, or by license and privilege
taxes.

In the case of these corporations, and also of various other
miscellaneous kinds of companies, no clear-cut principles serve to
guide. The result is "a chaos in practice--a complete absence of
principle."[11]

§ 15. #Alternative policies as to corporate taxation.# If the taxation
of corporations is not to continue to be treated in a mere hit-or-miss
manner, with every possible kind of inconsistency among the various
states, some general principles must be recognized and some clear
policy be formulated. But there is no general agreement to-day among
jurists and economists upon a definite and consistent plan in this
matter.

Two alternative policies appear. The first is to make the scheme for
taxing corporations quite different in principle and plan from
that for taxing natural persons. The assumption in this is that the
"general property tax" is an irremediable failure, and is particularly
inapplicable to corporations. This plan goes along with the separation
of state and local taxation.[12] An unfortunate result of this is to
relieve the great mass of taxpayers of the state from, any apparent
and measurable part of the tax burden for state purposes and thus to
separate responsibility and power in state government. This policy
nevertheless is favored by some of the leading authorities on finance.

The other policy is to tax the wealth and business of corporations
(excepting those enjoying special privileges) in essentially the
same way as other wealth and business. The improvement of corporate
taxation would thus be but a part of the transformation of the
"general property tax" into a general tax on tangible wealth.[13]
If first there is recognized the error of assessing the equitable
ownership interests in addition to the body of wealth, and secondly
there is created an efficient agency of assessment, the taxation of
corporations can be logically and easily brought into accord with a
harmonious system of state and local taxation.[14]

§ 16. #General plan for corporate taxation.# The main features in such
a plan of reform would be as follows:

(a) Assessment of all wealth by a state agency, with expert nonlocal
assessors, appointed and serving only under the merit system.

(b) The assessment of the value of each enterprise and body of wealth
as a unit for the whole state, and apportioned to the minor divisions
as the basis for levying local taxes.

(c) Apportionment of the total value in the state among the localities
by general rule, in the case of transportation and transmission
companies, by mileage with due regard to the presence of local real
estate and of special industrial equipment such as repair shops and
power plants.

(d) Taxation of interstate enterprises only in due proportion to the
whole business, by mileage or other rules; inter-state comity to be
further developed in this matter.

(e) Account to be taken, in assessment, of various factors determining
the earning power, such as good will, patents, and other monopolistic
elements, pertaining to and helping to determine the value of the
tangible plant of the enterprise.

(f) Account to be taken of the market value of securities and notes
owned by a corporation, in determining the taxable value of the whole
business, but these not to be treated as a separately assessable
"property" (in addition to the tangible plant).

(g) Exemption of the holders of securities and evidences of
indebtedness of corporations.{15}

(h) Treatment of special privileges granted to public-service
corporations for the use of streets and public highways on the
principle of rent-payment to the community rather than by levying a
percentage on an assessment.


[Footnote 1: For example, the constitution of Alabama declares: "All
taxes levied on property in this state shall be assessed in exact
proportion to the value of such property," etc. And the constitution
of Indiana declares: "The general assembly shall provide, by law, for
a uniform and equal rate of assessment and taxation of all property,
both real and personal, excepting," etc. Similar statements occur in
most state constitutions.]

[Footnote 2: The general property tax in the United States
constitutes:

  Of the revenue receipts of the states 38 per cent.
  Of the revenue receipts of the counties 76 per cent.
  Of the revenue receipts of the incorporated places. 60 per cent.

The total amount collected in this way in 1913 was over
$1,083,000,000.]

[Footnote 3: See above, ch. 2, secs. 2, 3, and reference there to Vol.
I.]

[Footnote 4: See above, ch. 2.]

[Footnote 5: See Vol. I, pp. 116, 117, 145, 445-455.]

[Footnote 6: See Vol. I, pp. 117, 146, 453.]

[Footnote 7: See above, sec. 4.]

[Footnote 8: No reference is made in what follows to fees payable but
once for the incorporation of new companies or at times of increasing
the capital stock of an old one, variously called taxes on corporate
charters, license taxes, incorporation fees, organization fees, and
charter fees.]

[Footnote 9: See above, sec. 3.]

[Footnote 10: E.R.A. Seligman, "Essays on Taxation" (1895), p. 156.]

[Footnote 11: Seligman, op. cit. p. 136.]

[Footnote 12: See above, sec. 7.]

[Footnote 13: See above, sec. 5.]

[Footnote 14: The assessment feature of this proposal is exemplified
more nearly than anywhere else, tho still imperfectly, in the "Indiana
plan," in which, however, the true concept of property is recognized
only in so far as the shares of corporations of which all the wealth
is taxed are not assessed to the shareholders.]

[Footnote 15. This need not prevent a supplementary system of
graduated taxation on incomes. See below, ch. 18, sec. 10.]




CHAPTER 18

PERSONAL TAXES

  § 1. Inheritance tax laws. § 2. Fiscal importance of inheritance taxes.
  § 3. Income taxes; general nature. §4. Income taxation by the states.
  § 5. History of federal income taxation. § 6. Events leading up to the
  law of 1913. § 7. Main features of the law. § 8. Exemptions and
  stoppage at source. § 9. The graduation principle. § 10. A system of
  taxation.


§ 1. #Inheritance tax laws.# There remain to be considered at least
two important forms of taxation that are essentially _personal_ in
their unit of assessment, in contrast with the foregoing which are (or
should be, if consistent) essentially _impersonal_[1] These are the
inheritance and the income taxes.

Until 1916 little use had been made of inheritance taxation for
federal purposes. In that year, however. Congress passed a law which
was expected to obtain about $20,000,000 a year from inheritances.

Forty-one states in America have inheritance tax laws (in 1915)
which apply generally to property passing either by will or under the
intestate laws of the state. The tax is for state purposes. These laws
differ in many ways, but are nearly all alike in certain respects:

(1) In applying to the separate legacies rather than to the estate as
a whole.[2]

(2) In taxing legacies to relatives in the direct line at a lower
rate (or even exempting them entirely) than those to collateral
relatives.[3]

(3) In exempting legacies below a certain amount.[4]

(4) In having rates progressing with the size of the legacy; (this
feature is less general, but is prominent in most of the later laws).

§ 2. #Fiscal importance of inheritance taxes.# The fiscal importance
of inheritance taxes has been comparatively not very great (except in
New York State), but it has rapidly grown. In 1903 the receipts from
this source (in 27 states) were over $7,000,000; in 1913 they were (in
35 states) $26,000,000. The spread of inheritance taxes and the higher
and progressive rates applied are an expression in part of the need
of additional revenues and in part of the growing popular concern
regarding the concentration of wealth. Yet the actual legislation is
something of a compromise between fiscal policy (to get revenues) and
social policy (to reduce or to distribute the larger fortunes).[5] In
New York legacies of over $1,000,000 are now taxable at 4 per cent
to relatives in the direct line and to all others at 8 per cent. In
Washington the tax to relatives in the direct line is but 1 per
cent, but to others it may go as high as 12 per cent on legacies over
$100,000. In Wisconsin, somewhat similarly, the tax may rise to 15 per
cent on the excess above $500,000.

§ 3. #Income taxes; general nature.# All taxes, whether assessed upon
the capital value of goods or not, come out of (reduce) the incomes
now or later available for individuals. But there are various ways
of attacking incomes, i.e., of apportioning the tax burden. Income
taxation is that form in which the basis of the assessment and levy
is the income of the taxpayer as it arises (not accumulated wealth,
or capital, or business processes, or expenditures). Of the various
conceptions of income[6] the one mainly employed in income taxation
is monetary income arising in the course of business, supplemented
occasionally (but not consistently) by some items of material income
that are expected to come to the person. There is not in the long run
such a contrast between wealth taxation and income taxation in their
ultimate burden and effect as is usually supposed.

Indeed wealth (or capital) taxation as applied to accumulated wealth
is more far-reaching than income taxation, for it falls upon the
present worth alike of monetary and of psychic incomes (e.g., the
value of a house whether it is let to a tenant or occupied by the
owner). But, on the other hand, income taxation attacks directly the
monetary incomes from labor, coming as wages, salaries, fees, and
profits in business. This feature goes naturally with the fact that
the income tax is essentially a personal tax, grouping the items of
assessment about a person, whereas the "property" taxes are mainly
(tho not consistently) impersonal, making the piece of wealth the
primary object of assessment. This summation of each person's income
makes income taxation peculiarly suitable for progressive taxation
with the social-welfare motive of equalizing the distribution of
wealth. It is doubtless this technical assessment feature, rather than
any essential advantage as a mode of taxation, that has led to its
recent growth in popular favor.

§ 4. #Income taxation by the states#. Income taxes have been used
widely in European countries, but not so much in the United States.
Numerous attempts have been made by the states to tax incomes, but
with small results. Personal incomes, when sought by local assessors,
proved to be most elusive. There are (in 1913) but seven states with
anything resembling a personal income tax.[7] These are Virginia,
North Carolina, South Carolina, Mississippi, Oklahoma, Massachusetts,
and Wisconsin. Of these states Wisconsin has the most recent law, and
one the widest in its application and the most important fiscally. The
law applies a progressive rate to all incomes (with exemption of
$700 from wages and salaries) and contains elaborate provisions for
corporate taxation. The proceeds are distributed 10 per cent to the
state, 20 per cent to the county, and 70 per cent to the municipality
in which the tax is collected. In the six other states the tax is on
incomes only exceeding a certain amount (North Carolina, $1000, the
other states from $2000 to $3500 exemption); some apply to incomes
from any source but others do not apply to incomes from property
otherwise taxed. The total receipts from these state income taxes in
1913 were but $314,000.

§ 5. #History of federal income taxation.# The income tax seems
destined to play a more important part in the fiscal system of the
federal government. Until 1913, however, its part had been small. It
began to be used under the law of 1867 (when the law passed in 1861
was replaced before it went into effect). This was repeatedly amended
and finally repealed in 1870, to continue in force until the year
1872. The rate was 3 per cent on the excess of incomes over $600, and
5 per cent on the excess over $10,000. This law was repeatedly
upheld by the United States Supreme Court as not in conflict with
the Constitution. Its fiscal results were not large, as it was never
effectively administered.

The next income tax law was that of 1894, enacted in connection with
the tariff revision of that year. It was declared unconstitutional
before it had gone into effect. The main ground for the decision was
that a tax on incomes from rent of land as well as on incomes from
personal property is direct, and must therefore be apportioned among
the states according to population.

In the active discussion of social legislation in the years following
this decision public sentiment developed favoring a renewed attempt to
get such legislation by amending the Constitution. This was shown by
the remarkable fact that a bill for the sixteenth amendment to
the Constitution was passed unanimously by the Senate, and almost
unanimously by the House. It was ratified by three-fourths of the
states and became a law in 1913.[8]

§ 6. #Events leading up to the law of 1913.# Meantime, in 1909 and
excise tax law had been passed, applying to corporations in a manner
not open to the objections found by the Supreme Court to the law of
1894. The Democratic party, which had passed the law of 1894, was
pledged to the passage of an income tax law when it came into power
again in 1913. The reduction of the tariff, as well as growing
expenditures, moreover, made necessary the development of new sources
of revenue for the national government. In other countries the income
tax had been found to be a part of a system of taxation especially
valuable as "a balance wheel" to equalize the revenues and
expenditures. It was deemed by some to be an additional advantage of
an income tax that it would make the richer citizens better realize
the nature and burden of public expenditure. Most other federal
revenues, being derived from the tariff and from taxes on merchandise,
are borne mainly by the purchasers and consumers.

An income tax was opposed as sectional taxation by many in the Eastern
states where the owners of most of the larger fortunes reside. But to
this Senator Elihu Root replied that the states where there was
the greatest ownership of wealth pay the largest taxation under any
scheme, and ought to.

§ 7. #Main features of the law.# The law as enacted[9] imposes (a)
a "normal" tax of 1 per cent on the entire net income of every
corporation (engaged in business for profit);

(b) a "normal" tax of 1 per cent on the excess above $3000 of every
unmarried individual's income (or $4000 for husband and wife, as
indicated in the next section); (c) an "additional tax" (often called
a super-tax) ranging from 1 to 6 per cent on individual incomes of
larger amounts than $20,000. There are thus eight classes of persons,
those entirely exempt, those paying only at the normal tax rate, and
six different classes paying a super-tax.[10]

A person with an income of $1,000,000 thus pays $60,020, this being
the amount indicated, $25,020 for the first half million plus 7 per
cent on the second half million.

§ 8. #Exemptions and stoppage at source#. There are various
exemptions, the first being that of $3000 on every individual income
and of $4000 on the aggregate income of husband and wife living
together.[11] Among other exceptions are sums paid for taxes (except
assessments for local benefits), necessary business expenses, losses
sustained, and (for the normal tax only) those parts of individual
incomes derived from corporations which have paid the tax on them.

The difficulty of getting an honest and complete assessment of incomes
is great. All taxation is deemed by the taxpayer to be "inquisitorial"
in some degree, and this is particularly true of an income tax. In
England had been developed the plan called "stoppage at source." In
our law the taxation of corporations at the rate of the normal tax,
while requiring them to report the names of those receiving dividends
and interest payments, affords an ingenious way of checking up the
returns of individuals in respect to a class of investments which is
steadily increasing in importance.

§ 9. #The graduation principle#. The most disputed feature of the
income tax is the principle of graduation, or of progression. It is
upheld in part because in this case it but offsets _regression_, that
is relatively heavier taxation on the smaller incomes, in the case of
the other kinds of taxes (tariff, property taxes, etc.). It is urged
further that those of larger incomes, especially the largest, have
marked advantages over others in making investments. Further it is
urged that the higher the income the less does a certain rate cut into
"the amount necessary for good living" (as was said in Congressional
debate). This is in accord with the psychological principles of
choice, of value, and of diminishing gratification. Finally, there is
a widespread approval of the progressive rate just because it in so
far acts as a leveling influence upon fortunes. The "additional" tax
is already important fiscally, yielding over one-half of the total
paid by individuals and one-fourth of the total from corporations and
individuals.

The income tax returns for the first ten months of the law (March to
December, 1913) showed 356,598 taxable individual incomes, equal to
about 1 per cent of the taxable population (considering minors to be
usually not taxable). Even this proportion, small as it is, is much
larger than that of the European countries having a general income
tax.

The first ten months' yield (March 1, 1913, to December 31, 1913) was
over $60,000,000. A remarkable fact is that 21 per cent of all taxable
incomes (not persons) were in the single Borough of Manhattan (the
main part of New York City). The receipts from the income tax in
1913 were nearly 10 per cent of the ordinary receipts of the federal
government, and about 2 per cent of total revenue receipts of all
branches of government, the income taxes paid by individuals being
about 1 per cent of the same total, and the super-tax about 1/2 per
cent of the same.

The receipts from the income tax during the fiscal year ending
June 30, 1915, were $80,000,000, of which $39,000,000 was paid by
corporations and $41,000,000 by individuals. Of the latter sum, over
$24,000,000 was from the super-tax.

§ 10. #A system of taxation.# The task of reforming and developing the
various kinds of taxes and of uniting them into a just and consistent
plan for each of the divisions of government in the United States is
a vast and difficult one. There are many conflicting interests among
states, between states and nation, among the various minor political
divisions, and among individuals and classes. There are also
conflicting opinions regarding many features of the possible practical
plans. Because of these it is safe to predict that progress will not
be made quickly, steadily, nor always directed toward a clear ideal.
If progress is to be rapid, the public must, however, have consistent
principles by which its steps may be guided. In the foregoing kinds of
taxation are the various elements which may be united into a system of
taxation. It is useful to consider how this might be done.

At the basis of the whole tax structure is taxation, by value, of
concrete wealth at the place where it is situated (_in situ_). This
should be regardless of the distribution of ownership or of the
residence of the owner. The present misnamed "general property tax"
already presents the main outlines of this form of taxation and the
general changes necessary in law and method of assessment have been
indicated above.[12] Corporation taxation may be adjusted to this
either by separate treatment and assignment to state purposes only,
or more simply for most states, by assimilating it with the general
taxation of wealth and allotting due shares of the proceeds to the
various taxing divisions.[13] The national government can, because of
its exclusive power of levying tariff duties and also because of
its exclusive control over interstate commerce, reach the tax-paying
ability of the nation effectively by a combination of tariff and
internal revenue taxes. These become a part of business costs, and are
diffused over the whole population in general prices.[14]

This system of impersonal wealth taxation may then be supplemented by
personal taxation, applied through inheritance and income taxes. These
forms of taxation extend over and reach many of the same persons and
incomes as do ultimately the impersonal taxes. But the summation
of personal incomes gives the necessary condition for applying the
principle of progression so far as this is, by public opinion, deemed
desirable either for fiscal or for social reasons.


[Footnote 1: See above, ch.17, sec. 3, note, and sec. 5, on this
distinction. The poll tax also is personal: see ch. 16, sec. 9.]

[Footnote 2: In Utah the tax is 5 per cent on all estates over
$10,000.]

[Footnote 3. Exception, Utah.]

[Footnote 4: Exceptions are Missouri, New Hampshire, Vermont,
Virginia.]

[Footnote 5: It would be more consistent with the purpose of
equalizing fortunes to vary the rate not according to the size of the
legacy but according to the size of the fortune which the legatee has,
or would have, after receiving the legacy.]

[Footnote 6: See Vol. I, p. 26.]

[Footnote 7: In addition, certain items of receipts of companies
or incomes of individuals are arbitrarily defined as property for
purposes of taxation in a few cases in about fifteen other states. See
Wealth, Debt, and Taxation, Report of the Bureau of the Census, 1907,
p. 622.]

[Footnote 8: Article XVI. The Congress shall have power to lay and
collect taxes on incomes, from whatever source derived, without
apportionment among the several states, and without regard to any
census enumeration.]

[Footnote 9: It constitutes sec. 2 of the tariff act of 1913 entitled
"An act to reduce tariff duties and to provide revenue for the
government and for other purposes."]

[Footnote 10: This may be seen in the following table:
                        Normal   Rate on excess   Total
                        tax on   in next class    tax on
                        lower    Nor-  Addi-      upper   Total rate
                        limit    mal   tional     limit   per cent
  Under $3,000               0    0      0         0      0.00 to 0.00
  $3,000-$20,000             0    1      0         170    0.00 to 0.85
  $20,000-$50,000          170    1      1         770    0.85 to 1.54
  $50,000-$75,000          770    1      2       1,520    1.54 to 2.02
  $75,000-$100,000       1,520    1      3       2,520    2.02 to 2.52
  $100,000-$250,000      2,520    1      4      10,020    2.52 to 4.00
  $250,000-$500,000     10,020    1      5      25,020    4.00 to 5.00
  In excess of $500,00  25,020    1      6      upwards   5.00 to 7.00

By legislation in the summer of 1916, after the foregoing was in type,
the "normal" rate was doubled and the additional rates were raised.]

[Footnote 11: The exemption is $3000 for each if they are not living
together. Thus the law offers a reward of $20 to make marriage a
failure.]

[Footnote 12: See above, ch. 17, sec. 5.]

[Footnote 13: See above, ch. 17, secs. 15, 16.]

[Footnote 14: See above, ch. 15, sec. 14, first paragraph.]




PART V


PROBLEMS OF THE WAGE SYSTEM




CHAPTER 19

METHODS OF INDUSTRIAL REMUNERATION

  § 1. Workers subordinate in early societies. § 2. Workers in the Middle
  Ages. § 3. Growth of the wage system. § 4. Practicability of the
  wage system. § 5. Time work. § 6. Task work. § 7. Piece work.
  § 8. Premium plans. § 9. Aim of profit-sharing. § 10. Examples of
  profit-sharing. § 11. Difficulties in profit-sharing. § 12. Defective
  theory of profit-sharing. § 13. Purpose of producers' coöperation.
  § 14. Limited success of the plan. § 15. Its main difficulty.


§ 1. #Workers subordinate in early societies#. As far back as the
history of settled and populous communities can be traced, the masses
of workers have been subordinate. Civilization began with direction,
with obedience to superiors on the part of the mass of men. Even in
the rudest tribes, the women and children were subject to the will of
the stronger, the head of the family. Among the Aryan races the family
system was widened, and the patriarch of the tribe secured personal
obedience and economic services from all members of the community.
Chattel slavery, the typical form of industrial organization in early
tropical civilization, seems to have been one of the necessary steps
to progress from rude conditions; students to-day incline to view it
as an essential stage in the history of the race. But as conditions
changed with industrial development, chattel slavery became an
inefficient form of industrial organization and a hindrance to
progress.

§ 2. #Workers in the Middle Ages#. Serfdom for rural labor and many
limitations on the workman's freedom in the towns were the prevailing
conditions in medieval Europe. Serfdom was both a political and an
economic relation. The self was bound to the soil; the lord could
command and control him; but the serf's obligations were pretty
well defined. He had to give services, but in return for them he got
something definite in the form of protection and the use of land.
Between the lord and the serf there continued an implied contract,
which passed by inheritance from father to son, in the case both of
the master and of the serf. In the towns conditions were better for
the free master class of the artisans who owned their tools and often
a little shop where they both made and sold their products. But the
mass of the workers, shut out from special privileges, bore a heavy
burden. There were strict rules of apprenticeship; gild regulations
forbidding the free choice of a trade or a residence; laws against
migration into the town; settlement laws making it impossible for
poor men to remove from one place to another; arbitrary regulation of
wages, either by the gilds in the towns or by national councils and
parliaments, forbidding the workmen to take the competitive wages
that economic conditions would have forced the employers to pay;
combination laws forbidding laborers to combine in their own interest.
These conditions prevailed even in the periods and in the countries
often referred to as particularly favorable for the working classes
(such as England in the fifteenth century).

§ 3. #Growth of the wage system#. Throughout the Middle Ages these
conditions were gradually changing, and the changes were hastened
by the discovery of America, by the social unrest accompanying the
Reformation, and by other forces. Servile dues in the rural districts
were, by the sixteenth century, commuted for cash payments in England
and had begun to disappear in the other Western countries of Europe.
The agricultural work was done partly by the peasant landowners,
partly by yeomen farmers on their own land, and partly by laborers
hired by landowners or by tenant farmers (enterprisers with some
capital for equipment). The growth of commerce and of the mechanical
trades in the towns required larger ships, factories, and shops,
and increasing investments. This required in the towns an increasing
proportion of hired laborers having little or no capital invested
in industry, and living on wages. This change went on more and more
rapidly with the introduction of machinery in the eighteenth and
nineteenth centuries, and "the wage system" grew steadily to be a more
and more important part of the whole economic structure.[1]

§ 4. #Practicability of the wage system#. This change has brought with
it grave problems of social organization and social welfare, which it
is not the place here to discuss. But whatever be the difficulties of
the wage system it has certain practical merits of workableness which
account for its progress and dominance.[2] The larger the market and
the longer the waiting period in industry, the greater the element of
uncertainty and financial risk. Under the wage contract the employer,
as the one best prepared to do it, takes the risk as to the future
selling price of the product; the worker gets in a definite sum at
once the market value of his services. Wage payment, therefore, is
a form of insurance to the workingman; he gets something definite
instead of taking chances he is ill prepared to take. Wage payment is
a form of credit to the laborer whose labor is applied to producing
the goods for customers distant in time and in place. The employer
advances to the workman the present value of the future sale,
discounting it at the prevailing rate of interest.

Wage payment implies a contract by which the employee on his part
agrees to render service and the employer on his part agrees to pay
for it. The methods of determining and measuring the amount of service
of the employee are called "methods of industrial remuneration." The
many varieties may be grouped in two classes: time payment and piece
payment, corresponding with the two modes of measuring labor, time
work and piece work.

§ 5. #Time work.# Time work came first and was long almost the only
method. In time work the employee is paid by the hour, day, week,
month, or year, as the case may be. This is very satisfactory for
small enterprises, where the master works with his own hands alongside
of the employee, overseeing him, teaching him, and stimulating him by
his own presence and example of industry. This method prevails still
in nearly all farming work, in many kinds of manufacturing, in most
transportation, in clerical positions in trade, and in general where
the employee must perform a variety of tasks.

Considering a brief period, it might seem that in time work the worker
is paid by time regardless of his effort or performance. However,
in every industry there is a recognized, fairly definite standard of
accomplishment for those getting the regular market rates of wages,
so that the time-standard implies some performance- or piece-standard
also. But this is judged by the employer only in a general way, and
very commonly men of different degrees of efficiency continue for
some time to receive the same money wage. Still, where any differences
become noticeable to the employer in quantity of work, quality of
work, or personal qualities of honesty, reliability, and good temper,
the better workman is likely to obtain a better position, higher pay,
more regular employment, or some other form of reward. The employer is
more likely at the end of any period of employment, to discharge the
man who falls short either in quantity or quality of work, and to
retain and advance the better worker. The method of time-payment does
not directly tempt the workman to slight the quality of his work by
haste. It does not keep constantly before the worker the thought of
his own interest in rapid work, often with an accompanying nervous and
mental strain. In most occupations, therefore, the workers prefer time
work. It does not take exclusive account of the quantity of material
product, but leaves place for estimating various personal qualities of
the employee which are of value in a business.

§ 6. #Task work#. There are thus both advantages and disadvantages
in time work, and their relative importance varies in different
industries and industrial conditions. Especially is the difficulty
of supervising workers and of ensuring the performance of a certain
standard, or minimum, amount and quality of work great in larger
enterprises. Various methods of measuring the performance of the
worker directly by some other than the time-standards have been
developed. All of these, in a general way, involve the piece work
principle.

Task work is nominally time work, with a penalty if a certain amount
of product is not turned out within a given period. The agreement may
be that if the specified task is not done within the regular time,
it must be completed in overtime without additional pay. This is also
called "doing a stint." This method has been extensively used in
the ready-made clothing business in America, and is to some extent
involved in many cases of wage payment in manufacturing.

§ 7. #Piece work.# Piece work of the simpler, or ordinary kind, is
that where the payment varies just according to the amount of the
product, by some physical measurement, as yards of cloth woven, number
of pieces turned on a lathe, or amount of type set by a printer.
Usually careful inspection by some agent of the employer serves to
keep the quality up to a certain standard. The rejected pieces are not
paid for, and sometimes also the workmen are required to pay for the
materials wasted by their poor work. Piece payment is convenient for
home work, such as that of rural peasants weaving cloth for commission
merchants or as that of tenement workers in cities. It is also
employed very widely in the larger factories in textile and mechanical
industries. Selling on commission is a form of piece work.

In piece work the motive to activity is ever present to the worker,
and almost always the worker turns out a larger product when paid by
the piece than when paid by time. The employer benefits by the more
efficient use of his machinery and equipment even when the price per
piece is not reduced with the larger output per worker. The worker's
earnings may increase rapidly under this plan, but as the manual
dexterity acquired is usually of a very special kind which can be used
only on one particular machine, the worker has little opportunity to
resist a cut in his wages. For this reason and because of the undue
strain upon the worker that often occurs, piece work is in many trades
not favored by the workers.[3]

§ 8. #Premium plans.# Various modifications of piece work have been
developed of late, all involving the features of a minimum task and
of a premium for performance beyond that point. These plans are called
"premium plans," "progressive wage systems," and "gain sharing." One
of the first of these, Halsey's premium plan, fixes a standard time
for a job and if the worker falls short of, or merely attains to,
that standard he gets the regular pay; but if he takes less than the
standard time he receives a fixed premium per hour for the time saved.
For example, if the standard time is 10 hours for a $3.00 job and the
premium for speed is ten cents per hour, the worker would receive 20
cents premium if he did the work in 8 hours ($2.40 +.20, total $2.60),
and 50 cents premium if he did it in 5 hours ($1.50 + 50, total
$2.00). His average wage per hour thus rises as his speed increases;
it becomes 32.5 cents per hour when the job is done in 8 hours, and 40
cents per hour when the job is done in 5 hours. The reduction of cost
per job to the employer evidently would be 40 cents in the first case,
and $1.00 in the second. This is Halsey's plan, by which the worker
gets one-third and the employer two-thirds of the time saved.

The same plan has been applied (Weir's method) with a premium that
equally divides between the workman and the employer the time saved.
By Rowan's method the premium is not a fixed sum but a percentage of
the standard rate per hour equal to the percentage of reduction in
time consumed. For example, if in the foregoing example the time were
reduced 20 per cent (to 8 hours) the premium would be 20 per cent of
30 cents, and the workman would receive 36 cents per hour. By this
plan the premium becomes less for the later reductions than in either
of the other plans. The utmost possible wages would be double the
standard rate.

A number of other variations have been worked out by the promoters of
recent scientific management, and are known as Taylor's, Gantt's,
and Emerson's plans. The authors of all these plans agree as to
the importance of fixing the standard rate so that it will leave a
possibility of considerable improvement with unusual effort, and of
leaving the standard rate and premium unchanged as long as no new
process or new machinery is introduced into the business. If this is
not done the employees lose faith in the plan and refuse to make the
necessary effort to earn the premium. Most of these plans of
payment recently have been connected with experiments and studies in
scientific management to reduce the time and increase the ease of the
operations.

In a variety of ways a bonus or a premium may be paid for quality, or
for economy in the use of materials (as to a fireman for using less
coal), or for various other results. Every business has its peculiar
conditions, which make certain results especially desirable, and
certain methods of reward practicable. In some industries, for
example, the various plans of piece work and of premium payment are
applied to groups of workers (as in collective piece work), the total
payment being then divided among the members of the group in some
agreed proportion.

§ 9. #Aim of profit-sharing.# Profit-sharing is rewarding the laborer
with a share of the profits in addition to his usual contract wages.
Payments by the piece and premiums for output are solely dependent on
the efforts of the particular workman (or collective group), but
in the plan of profit-sharing a premium is given in addition to the
regular wage if, at the end of the year, the business as a whole has
yielded a profit above a certain amount. Profit-sharing is not merely
a gift; it is done usually in accordance with a definite promise in
advance. The employer adopting the plan does not intend to lose by it.
His purpose is to stimulate the industry of the workers, thus reducing
waste and cost of labor and supervision, and thereby increasing
profits. He offers to divide with the workman the additional profits
which are expected to result from their efforts. There is, in every
factory, greater or less waste of materials, destruction of tools, and
loss of time, that no rules or penalties can prevent. If the worker
can be made to take a strong enough personal interest he will use care
when the eye of the foreman is not upon him. The product also can
be slightly increased in many ways by the workman's exertions or
suggestions. In some cases the quality of the work cannot be insured
by the closest inspection as well as it can be by a small degree
of personal interest. Either responsibility for the fault cannot
be fixed, or the defect is one not measurable by any easily applied
standard. Strikes may be averted, good feeling promoted, and
contentment furthered if the interest of the worker can be made to
approach, and in large measure to become in harmony with, that of the
employer. The economic result of the plan, if it can be made to work,
should be to reduce the costs of these establishments below what
they are. The crucial question is whether profit-sharing alone in any
particular case will insure that the costs will be less than those of
competitors, thus giving a source out of which an increased amount,
really a wage, can be paid to the laborer. For the amount of profits
is affected not only by the amount of output, but also by a number of
other things that are quite outside the control of the workmen.

§ 10. #Examples of profit-sharing.# The profit-sharing plan seems
first to have been successfully tried in Paris, in 1842, by Leclaire,
a house-painter. In house-painting there is often a great waste
of materials and time by men working singly or in small groups in
different parts of the city. By this new method Leclaire enlisted the
aid of the workmen, reduced the costs, and increased the profits. It
is a remarkable fact that the plan has been continued successfully by
the same firm to the present time. It has been tried in many hundreds,
possibly thousands, of cases, and is operating in some form or another
in more than a hundred firms in Europe and America. The most notable
examples of profit-sharing in the United States are the Pillsbury
Mills in Minneapolis, Procter and Gamble's soap-factories, in
Ivorydale, Ohio, the Nelson Mfg. Co., in Leclaire, Ill., and the Ford
Automobile Works, in Detroit. In some cases both manufacturer and
workmen value the system highly. It probably has its greatest success
when applied in prosperous establishments where profits are regular
and large, and where a steady working force is especially desired.
The proportion of business done in this way is not large. One hundred
firms is a very small fraction of 1 per cent of the total number of
firms in Germany, France, England, and America. A still more important
fact is that true profit-sharing has spread little since 1890, tho
various practices have developed under that name. The most noteworthy
of these is the selling of stock, usually at a somewhat lower price,
to the employees of a corporation so that, as stockholders, they may
have a motive to work for the success of the company (e.g., the United
States Steel Corporation). This method as applied to a select few
of the employees, who are advanced to official positions in a
corporation, is very widely adopted.

§ 11. #Difficulties in profit-sharing.# It seems at first difficult to
explain this comparative failure of a plan that looks so attractive
in spirit and of which so much was hoped. Yet objections come from
the side both of the workman and of the employer. The workman lacks
knowledge of the business and is suspicious of the bookkeeping. If
at the end of the year the books show no profits, the workman loses
confidence, considers the plan to be mere deception, and rejects
it. The working of the plan remains in the employer's hands, and the
workman really is not a partner in the business. Moreover, the plan
puts a limitation upon the workman's freedom to compete for better
wages by changing his place of work. It is indispensable to make
length of service in some degree a condition to the sharing of
profits. Workmen, coming and going, cannot be allowed to share; the
percentage given to the others increases with length of employment.
Whenever men are thus practically subject to a fine (equal to the
amount of shared profits) if they accept a better position, there is
danger of a covert lowering of wages. The plan tends to break up the
trade-unions, which is one of the reasons that the employers like it,
and is the main reason that organized labor opposes it.

The employer on his part objects to the interference with his
management, the troublesome inspection of the books, and the constant
complaints of the workmen. He dislikes to have the profits known; if
they are large, the advertisement of success invites competition; if
they are small, publicity may injure credit and depress the value of
the enterprise. In view of all these difficulties it is not surprising
that while the plan often starts promisingly, it usually fails after a
short trial. Business methods are severely subject to the principle of
the survival of the fittest. Through competition and the survival
of the firms that adopt improvements, better methods must eventually
supplant poorer ones. If a method fails to spread when it has been
tried for seventy-five years and all are free to adopt it, the strong
probability is that it has serious defects inherent in it.

§ 12. #Defective theory of profit-sharing.# It is usually better
to make wages depend on the worker's efficiency rather than on the
profits of the whole business. The strongest motive to efficiency is
present when reward is connected immediately and directly with effort,
not with some result only slightly under the worker's control. Any
change in the amount of profits is only partially and indirectly
related to increased effort of the worker. The "profits" may be
nothing, tho all the manual workers may be exerting themselves to the
utmost. The wage bill is but one of the groups of costs. Profits are
the net result of many influences. Chief among these is the skill in
planning and conducting the business. This function of management is
either performed by the same person that is carrying the financial
risk, or by some salaried employee selected by him. It is this
management function the reward of which should, in theory, be made
to vary with the amount of profits; and in fact such an arrangement
(managerial profit-sharing, so to speak) is undoubtedly in operation
in thousands of cases, but is not included in the usual conception of
profit-sharing. Many salaried managers are in receipt of a share of
profits and are gradually acquiring an interest in partnerships or a
larger share of ownership in the enterprise for which they work. But
ordinary profit-sharing is not in accord with the general trend
toward the centralization of responsibility in the hands of competent
managers, ensuring to the worker a definite amount in advance, as
high as conditions make possible. The system of premiums, or bonus
payments, for output, where it can be safeguarded against abuses,
gives in most cases better results and is rapidly spreading. It is
sounder in conception and works better in practice as a method of
remuneration for most of the workers.

§ 13. #Purpose of producers' coöperation.# Since the early part of the
nineteenth century many well-wishers of humanity have cherished high
hopes that the whole wage system might gradually be replaced by
the plan of producers' coöperation among workingmen. Producers'
coöperation is the union of workers in a self-employing group,
performing for themselves the enterpriser's function. The workers hope
to get what seems to them to be a needless drain of profits into the
pockets of the employer and unnecessarily high salaries to managers.
To do this they must perform the enterpriser's function as to
investment and risk. Collectively or through their representatives
they must undertake to furnish capital and management as well
as hand-work. The capital may be supplied either by the members,
individually or collectively, or may be borrowed from outsiders,
who are thus merely passive investors. Usually the return to capital
invested by members is limited to 5 or 6 per cent, so that this part
of the capital likewise is treated as a passive investment, and all
the real variable profits are distributed to the members as wages. The
hope has been as in profit-sharing to increase the amount of profits
through the stimulus the plan might give to the workers and by saving
in friction, disputes, and strikes.

§ 14. #Limited success of the plan.# Practically the plan has been
made to work in a comparatively few simple industries. The most
notable example of successful coöperation in America was in the
cooper-shops in Minneapolis. There were few and uniform materials,
patterns, and qualities of product, few machines and much hand-labor,
simple well-known processes, a simple problem of costs, a sure local
market. After more than thirty years the main shop was still in
operation, but with a membership of the older men and with no growth,
A number of the less skilled workers receive ordinary wages. In
America a few of the productive coöperative companies are found
operating small factories. In England, there have been numerous
successful societies, but all in small enterprises, mostly connected
with agriculture. Within the whole field of industry, this method
of organization makes little if any progress. Most experiments have
failed and the successful ones have become or are tending to become
ordinary stock companies with most of the stock in the hands of a few
men. Therefore, whether losing or making money, they nearly all cease
to exist as coöperative enterprises. This result has disappointed the
hopes and prophecies of many well-wishers of the working classes.

§ 15. #Its main difficulty.# The main difficulty in producers'
coöperation is to get and retain managerial ability of a high order.
Failure to do this results in inability to maintain and keep in
repair the equipment and to pay the ordinary returns to the passive
investment, and financial failure follows. There is no touchstone for
business talent, no way of selecting it with any certainty in
advance of trial. This selection is made hard in coöperative shops
by jealousies and rivalries, and by politics among the workmen. A man
selected by his fellows finds it difficult to enforce discipline. In
coöperation there is occasionally developed good business ability
that might have remained dormant under the wage system; some
work-men showing unusual capacity cease to be handicraftsmen. But the
unwillingness on the part of the workers to pay high salaries results
in the loss of able managers. Having demonstrated their ability, the
leaders go to competing establishments where their function is not in
such bad repute, and where they are given higher salaries, or they
go into business independently, being able easily to get the needed
backing from passive capitalists.

Coöperative schemes thus suffer from the workers' inability to
appreciate the functions of enterprise and management. Most men make
a very imperfect analysis of the productive process. They see that
a large part of the product does not go to the workmen; they see the
gross amount going to the enterpriser, and they ignore the fact
that this contains the cost of materials, interest on capital, and
incidental expenses. Further, they fail to see that the investment
function is an essential one. The theory of exploitation, as
explaining profits, is very commonly held in a more or less vague
way by work-men. With a body of intelligent and thoroughly honest
work-men, keenly alive to the truth, the dangers, and the risks of the
enterprise, coöperation would be possible in many industries where
now it is not. Producers' coöperative schemes usually stumble into
unsuspected pitfalls. When a heedless and over-confident army ventures
into an enemy's country without a knowledge of its geography, without
a map, and without leaders that have been tested on the field of
battle, the result can easily be foreseen.

The coöperative principle has been embodied much more successfully
and on a larger scale in America in the form of producers' selling
organizations or of consumers' coöperative stores. As, however, both
of these forms of organization have been developed in America more
largely by farmers than by wageworkers, the discussion of them may
better be undertaken in connection with problems of rural organization
rather than with those of labor.


[Footnote 1: See Vol. 1, pp. 227, 318, 322; also above, ch. 2, sec.
14.]

[Footnote 2: See e.g., Vol. 1, p. 329, on selection of managed and of
managers.]

[Footnote 3: See below, ch. 20, sec. 6.]




CHAPTER 20

ORGANIZED LABOR

  § 1. Changing relations between employers and wage-workers. § 2.
  Need of common action among wage-workers. § 3. Functions of labor
  organizations. § 4. Types of labor organizations. § 5. Statistics of
  labor organizations. § 6. Collective bargaining. § 7. Limitation of
  competition among workers. § 8. Strikes in labor disputes. § 9. Frequency
  and causes of strikes. § 10. Picketing and the boycott. § 11. Effects
  of organization upon general wages. § 12. Competitive aspect of
  organization and particular wages. § 13. Monopolistic aspect of
  organization and particular wages. § 14. Open vs. closed shop. §15.
  Political and economic considerations. §16. The public's view of unions.
  § 17. Future role of organization.


§ 1. #Changing relations between employers and wage-workers.# The
"organization of labor," or the "labor movement," so striking a
feature of the world to-day, is of comparatively recent origin. It did
not begin and advance _pari passu_ with the beginning and early growth
of the wage-system as above briefly described.[1] In anything like
its modern form the labor movement dates from the early years of the
eighteenth century. Much of the largest part of its history in all
countries, excepting England, is after 1860. Why was organization
among the workers so long delayed after wage-payment became common,
and why when it once appeared did it spread so rapidly in some
directions, and why is it still limited in the main to certain fields
of industry? These three questions are but one question in three forms
and to answer one fully would be to answer all.

The modern trade union appeared in England shortly before the
industrial revolution,[2] and has extended as fast and as far as
the same stage of industrial development has been attained in other
countries. The effort of wage workers to organize themselves appears
everywhere to result from the separation of the economic and personal
interests of employers and workmen. As the control of industry became
more concentrated in larger units with the advent of power machinery,
the feeling of economic unity among the different ranks of industry
was further weakened. The average workman had less opportunity of
becoming a master, an employer. In the days of the old hand industry,
master, journeyman, and apprentice worked side by side at the same
bench. Almost every apprentice might hope to become some time a
master, and many a one did so. To-day most wage-workers in large
establishments have no hope of rising out of their positions. The mere
largeness of an establishment forbids also the personal acquaintance
of employer and workman. As a result of these changes, the workmen
become more "class-conscious" of their position as wage-workers and
the employers in many establishments take the attitude of buyers of
labor as a mere ware. When the employer then feels the pressure
of competition he is more likely to force the lowest wage that is
possible and to compel the workers to accept less favorable conditions
than if he were in more personal relations with them. Where the
immediate direction of an establishment is intrusted to paid managers
who are responsible to stockholders, the managers' success is judged
almost exclusively by the dividends they succeed in earning. Hence
they are under stronger and more persistent temptation than are active
owners to drive hard bargains with their employees. Many examples
might be found where managers and resident directors have wished to
pursue a more liberal policy than absentee shareholders would permit.

§ 2. #Need of common action among wage-workers.# These same industrial
changes caused employers, even earlier than it did employees, to have
something of a "class-conscious" feeling, which tempered the spirit
of their mutual competition, especially in bidding for the services
of workers. The smaller the number of employers the easier it is by an
understanding to suppress competition on their side. If there is only
one factory of a kind in a town the employer is able at times to drive
a harder bargain with his employees. Especially in times of industrial
depression is a change of employment difficult for the laborer,
involving for him much trouble and loss of time and money in moving.
But it is possible to exaggerate the degree to which competition among
employers of labor is weakened to-day. In the long run and at many
points competition must be felt in all such cases. The notoriously
unfair employer will find his workmen drifting away, his working-force
reduced in number and quality at times of greatest need, and his evil
reputation going abroad among workmen. A better realization of this
fact has led many employers to pursue a farther-sighted policy that
fosters a better understanding and a kindlier feeling on both sides of
the labor-contract.

Another effect of the growing size of business units is to give the
workers less personal acquaintance with each other. When they are
unorganized they have less unity, common opinion, and power than the
workers in the old-fashioned shop with its close personal acquaintance
and ready interchange of views. In the wilderness of a great modern
factory a worker may be unknown in name and interests to the man
touching elbows with him. Moreover, in America, differences in
nationality and in speech among immigrant workers often effectively
prevent a common feeling of their interests and assertion of them.
There is an analogy between these conditions and the political
conditions that early led simple democracies to give way to
representative governments. So long as a community is small and men
know each other personally, popular government may exist without
complex machinery, but when numbers become larger, public opinion can
be concentrated and made effective only by delegating the functions to
elected representatives.

§ 3. #Functions of labor organizations.# Out of these conditions have
grown the various kinds of labor organizations. Their first object
is to maintain and increase wages. Closely connected with this is
the remedying of various abuses in respect to methods of payment,
measurement of the output, and conditions of work. Almost coördinate
with the aim of higher wages of recent years has been that of the
shorter work day. Labor leaders have frequently asserted when the two
demands have been made together, that a reduction of hours is the more
desirable. Better conditions of safety and sanitation in their work
were not the first thought of laborers when they organized. As a
result of habit and ignorance (widely prevalent at that time) they
were remarkably unconcerned about this matter. Reforms in this
direction at the outset had to come largely from sympathetic
observers, the "philanthropists," often described as sentimentalists.
But the modern, more enlightened, labor movement has better ideals
and policies in respect to the safety, sanitation, and decency of the
working places.

Labor organizations have also secondary objects of very great
importance. They are nearly always in some measure mutual-benefit
associations, and provide in varying degrees insurance against
accident, sickness, death, or lack of employment. All unions in a
measure serve their members as employment bureaus, and some make this
am important feature. Through trade-papers, correspondence, traveling
members, and in meetings, information is exchanged regarding
conditions of employment in various parts of the country. Labor
organizations by means of their discussions and through their special
periodicals are a strong educational force in matters political and
economic. The local labor organizations often come to be the center of
the social activities and interests of many of their members, and even
of all the members of their families. The organizations thus serve the
functions of social clubs, of literary societies, and of civic centers
for their members.

§ 4. #Types of labor organizations.# Among the many organizations of
wage-earners three main types may be distinguished: the labor union,
the trade union, and the industrial union, tho often they are all
spoken of as trade unions without distinction. A labor union admits
all classes of wage-earners and even business and professional men
into the same local chapter. The "Knights of Labor" is the most
notable example that America has seen of this type. The national
organization was composed of local chapters, to membership in which
every one was eligible excepting bankers, lawyers, gamblers, and
saloon keepers. Organized as a single local chapter in 1869 it grew
very rapidly until it attained its maximum membership of 600,000 in
1886. From this point it rapidly declined in membership, and since
1900, altho its organization is still maintained, has been of very
little influence.

A trade union is an organization of wage-earners in the same
handicraft or occupation. Unions exist among workers in all the old
distinctive handicrafts, such as the printers, stone cutters, cigar
makers, carpenters and in many other groups such as musicians and
retail clerks. The local chapters in many cases have been long united
in national unions (often international, including the United States
and Canada).

An industrial union is one that seeks to unite all workers employed in
the same class of establishments regardless of their craft or the
kind of work they do. The most notable examples are the United Mine
Workers, the Brewery Workers, and the Industrial Workers of the World.

In 1881 a number of national trade unions united for certain purposes,
to form the American Federation of Labor with a membership of about a
quarter million workers, which has steadily increased since that date.
The American Federation of Labor now includes also some important
unions of the industrial type. Several strong national trade unions
(the most important being the brotherhoods of railroad employees) are
not affiliated with the American Federation of Labor.

§ 5. #Statistics of labor organization.# The ratio of organized
workers to the population is estimated (figures for 1910) to be
highest in the United Kingdom, being nearly 7 per cent; it is next
highest in the German Empire, being nearly 6 per cent; whereas, in the
United States, it is but 2.3 per cent. This difference is largely due
to the much greater relative importance of agriculture in the United
States.

The total membership of trade unions in the United States and Canada
is estimated to have been in 1910 about 2,200,000, of which only
about 100,000 were in Canada. This was 5.5 per cent of all persons
(38,130,000) gainfully employed, or 6.8 per cent of male employees,
and 9 per cent of female employees. Organization was very weak (less
than 1 per cent) among the workers in a group of industries occupying
nearly one-half of all workers, including agriculture, the hand
trades, oil and natural gas, salt, and rubber factories. Organization
was not of large extent (1 to 10 per cent) in other groups of
industries occupying more than one fourth of all workers, including
those engaged in producing quarried stone, food stuffs, iron and
steel, metal, paper and pulp, stationary engineers, in public,
professional, and domestic service, and in clerical work. Organization
was of much greater strength, including 10 per cent or more of the
workers, in the remaining industries and occupations.

If deduction be made of the employing and salaried classes, about
7.7 per cent of all persons occupied were organized. If, further,
deduction be made of agricultural, clerical, publicly employed,
commercial and domestic workers, about 16 per cent of the remaining
13,760,000 persons are organized (of women 3.7 per cent). Among the
occupations most highly organized are those of railway conductors (87
per cent) and engineers (74 per cent). In the building trades about 16
per cent are organized, of granite cutters 69 per cent, masons 39 per
cent, plasterers 32 per cent, carpenters 21 per cent, and painters 17
per cent. Similar striking differences appear among the occupations in
the printing industry; of stereotypers 90 per cent are organized
and of compositors only 35 per cent. These figures point to inherent
differences in the conditions favoring organization. Even in the same
craft a high degree of organization may be found in the cities and
little or none in the smaller towns (e.g., in the case of the printing
and building trades in general).[3]

§ 6. #Collective bargaining.# The fundamental policy of trade unions
is the substitution, for the individual wage bargain, of collective
bargaining between the delegated representatives of the working men
and the employer, or group of employers, or their representatives.
The wage-earners bargaining collectively may be those of a single
establishment, or of a group of establishments in the same locality,
or of a wider territory even national in extent. Accordingly, they are
represented in the negotiations by trade-union officials with
narrower or wider jurisdiction. Employers in some cases had tacit
understandings with each other before laborers were organized. But in
many cases the individual employer was at a marked disadvantage after
the organization of his employees. The result has been the rapid
spread of employers' organizations, so that in industries where
laborers are highly organized, two-sided collective bargaining has
become more and more usual.

A large part of the effort of trade unions is directed toward ensuring
the use of collective bargaining. This is the purpose of many of
their demands, even of some that hardly appear to have any such
consideration. Collective bargaining practically necessitates the use
of "the standard rate," since only with reference to some standard
rate, a market price for labor, is it possible for a wage contract to
be made by labor officials for a group of men. The standard rate may
be a piece price or a time price, and in many cases the unions strive
to secure the latter as more convenient for their purposes. The
standard time rate usually is but a minimum and many of the more
skilful workers receive wages above the minimum. But the standard
minimum tends to become also the maximum in many cases, the more so
when the union has succeeded in enforcing a pretty high standard rate.

§ 7. #Limitation of competition among workers#. In order that
the representatives of organized laborers may act effectively in
collective bargaining the first condition necessary is that a
large proportion, if not all, of the workers of the trade in the
establishments concerned shall be organized. A common sense of wrong
is one of the strongest motives to bring workers together, and
has prompted the origin of many a local chapter. Then constant and
strenuous efforts are made to bring workers into the organized ranks.
Experienced organizers knowing all the arts of persuasion devote their
whole time to this task, being paid regular salaries. When friendly
argument fails, threats may be used and sometimes personal violence.
The public opinion and class feeling fostered among members of an
organization in times of difficulties are analogous to the sense of
patriotism in the nation at large and at times may displace it in the
hearts of organized laborers as is seen in opposition to the militia
and to the maintenance of order in times of strikes. The most
effective of all peaceful methods if petty persecution rising at times
to social ostracism. The individual who declines to enter the union is
denounced as a traitor to his fellow workers and is made to feel their
scorn. The use of the union card to be carried by every member to show
whether he is in good standing is an effective way of enforcing these
measures. Finally, where all these measures fail, pressure may be
brought upon the employer to get him to force unwilling workers into
the union.[4]

Further to give control over those working in a trade and to
reduce competition among workers, unions often limit the number of
apprentices and determine who shall have the privilege of learning the
trade. By a variety of regulations they limit the output and in many
cases (tho less frequently now) have opposed the use of labor-saving
machinery. Further to enforce these policies they seek to have each
special kind of work controlled by a special union. This gives rise
to disputes between rival unions and causes annoyance and loss to the
workers themselves, to the employers, and to the general public.

§ 8. #Strikes in labor disputes.# A strike is a concerted stopping of
work by a group of employees to enforce a demand upon the employer. A
lockout is an employer's closing of his shop because of a disagreement
with his employees. The strike is, in its direct and indirect,
immediate and ultimate, effects the most important weapon of the
organized wage-earners in their relations with their employers. To
newly organized laborers the union appeals mainly as an instrument for
striking, for threatening the employer, or for making him suffer to
compel him to accede to their demands. The effectiveness of a
strike lies in the loss it threatens or occasions in the stopping of
machinery, the ruin of materials, the loss of custom, and the failure
to complete contracts that have been undertaken.

The employers will often, to break a strike, pay to others for a time
more than the current rate of wages. The success of the strikers being
dependent on their ability to keep the employer from filling their
places, their energies are bent upon that end. The losses that strikes
cause to workers in stoppage of wages, to employers and investors in
destruction of plant and in suspension of profits, and to the public
in the interruption of business, aggregate an enormous sum. The direct
losses to employers and strikers in the 20 years between 1881 and 1900
have been estimated to have been nearly $500,000,000, a large sum, but
amounting to less than 1 per cent of the wage-earners' incomes. It
is, however, impossible to estimate at all exactly losses that in many
cases are indirect and intangible. The strikers are concerned in each
case not with the balance of total losses and total gains to society
as a whole, but with the net gain that they expect to accrue in the
long run to themselves. Viewed in this way it is true that there are
various indirect benefits in strikes that are not easily calculable,
particularly the advances of wages made by employers to avoid strikes
which they know will otherwise occur. In regard to the wisdom of any
contemplated strike, opinion is always somewhat divided, as it is in
regard to the value of strikes in general.

§ 9. #Frequency and causes of strikes#. Strikes were relatively
decreasing in number from 1880 to 1900, but from 1901 to 1905 the
annual average was more than twice as large as in the preceding
decade. On the whole, strikes have been more numerous in periods of
business prosperity when there was a better chance to get concessions
from the employers. But they occur also in the periods following
crises, when the workers seek to minimize cuts in wages and to prevent
the depression of working conditions. More broadly viewed, strikes
appear to accompany readjustments to dynamic conditions. As wages as
a rule rise more slowly than general prices,[5] it was to be expected
that the period since 1900, in which the general price level was
rising at the rate of about 3 per cent a year, should have been marked
by increasing resort to strikes.

The immediate causes of strikes have been changing in relative
importance. In 1881, at the time of the very rapid organization of
unions, over 71 per cent of all strikes were directly connected
with wage demands (61 per cent for increase and 10 per cent against
reduction). But in 1905 the total for these causes was only 37 per
cent, whereas the proportion of strikes for reduction of hours nearly
doubled (from 3 to 5 per cent) and the proportion of those concerning
recognition of unions and union rules increased fivefold (from 6 to 31
per cent). Ultimately nearly every demand of the laborers is
related to the question of wages; but these figures show that when
organization is new this relationship is more immediate, whereas
later more effort is directed toward securing the stronger strategic
position that comes with recognition of the union.

§ 10. #Picketing and the boycott#. Picketing by strikers or their
friends is intercepting and accosting all persons approaching or
leaving the place of work, to inform them of conditions and to
dissuade them from working there. When peaceable means fail, often
there is recourse to violence both against the employer and his
property and against nonstriking workers. Indeed, many persons declare
that peaceable picketing is impossible, and it surely is difficult
to attain in view of the temptations of human nature under the
circumstances.

Almost always connected with a strike is the practice of the boycott,
which is a combination of wage-earners to cut off an employer (or
group of employers) from business dealings. The boycott is found
in varying forms and degrees, broadly distinguished as simple and
compound-boycott. In simple boycott only persons directly interested
in the trade dispute refuse to deal with the boycotted person. The
question arises as to who are to be deemed directly interested,
whether it includes only the actual strikers in a particular
establishment, or whether it includes organized workers in sympathy
with them. The latter case is presented when an "unfair" list is
published in labor journals. It seems that only the former case is a
really simple boycott. The use of the simple boycott, the refusal of
a person, or even of a conspiring group of persons, to deal with a
person with whom they have an industrial dispute, appears to be a part
of the elementary rights of personal liberty. Beyond that point the
boycott is compound in varying degrees.[6] It is the compound form
which is usually referred to in discussion and in court decisions on
the subject. It is the compound boycott that has been described as "a
combination to harm one person by coercing others to harm him." The
compound boycott, as experience shows, has moral limits as well as
legal limits. It is doubtful whether the boycott can be extended at
all beyond the first degree of personal relations without becoming
antisocial, whether it is the weapon of organized workers or
of organized wealth. The endless-chain boycott, a measure of
excommunication without limit, pronounced against an offending
employer, non-union workers, and every one in any way befriending
them, is an effort to drag every one else into a dispute that is
primarily a private matter.

§ 11. #Effects of organization upon general wages.# The crucial
economic problem in connection with trade unions is not as to their
methods (that being rather a political problem) but as to their effect
upon wages. There must be distinguished two questions: first, as to
their effect upon the general level of wages; and next, as to their
effect in raising the wages of the organized laborers alone. As to the
first, the thought has sometimes been expressed by sympathetic social
students outside of trade-union circles that but for the organization
of labor wages in America would be no higher than they were in 1850.
This seems to be assumed in much of the argument of labor leaders,
for they speak as if all wages, but for trade unions, would be at the
starvation level; and they credit everything above that level to the
work of the union.[7] This claim is peculiarly effective in America,
where wages are and always have been relatively high. But proof of the
claim is lacking. As we have seen, even now fewer than 1 in 16 of
all gainfully employed, and fewer than 1 in 12 of those working for
contractual wages are organized. On no principle of value could
the mere organization of one-twelfth of the wage-earners, without
permanently withdrawing them from the labor market, explain the
relatively high wages of the other eleven-twelfths. In many lines
where labor is not organized, as in teaching, clerical, professional,
domestic, and agricultural services, wages have risen as much or even
more than in most of the organized trades. The underlying economic
forces determining the general level of labor-incomes in a country
are much more fundamental in nature than labor unions or protective
tariffs.[8] The trade-union authority already cited seems in another
passage to admit a view not essentially unlike that just expressed
when he says: "Capital is increasing faster than population.... It
seems therefore merely in obedience to natural laws that wages should
rise."

The only reasons ever suggested for thinking that the organization of
one-twelfth (or any larger proportion of the wage-earners) could in
any general way raise the labor-incomes of those remaining unorganized
are: first, that organized labor sometimes leads the way in securing
favorable legislation; and, secondly, that if organized workers
get higher wages this sets a standard which it is easier for the
unorganized then to attain. Both of these suggestions may have
some little validity in special cases, affecting slightly a small
proportion of the unorganized workers, but neither touches fundamental
causes of general high wages. Whereas, it is clear that when the
unorganized laborers constitute the main body of consumers for the
products of organized labor (and this unquestionably is in large
measure the case) any increase in wages that can be secured through
organization by a portion of the workers must, in part, be subtracted
from the "real" incomes of the unorganized workers. The employer is
middleman, not to a great degree the ultimate consumer of labor.[9]
Some part, it is true, of the higher wage might be taken from profits
or from wealth-incomes, but this would still leave the unorganized
workers the losers.

§ 12. #Competitive aspect of organization and particular wages.#
A different question is presented as regards the influence of
organization upon particular wages, and primarily upon the wages of
organized labor. The trade-union authority before cited says, "Where
there are no unions wages should be lower. This is exactly the case."
And he quotes: "Wherever we find union principles ignored, a low rate
of wages prevails and the reverse where organization is perfect." But
he later explains in part this difference: "The union men are the best
workmen and often employers pay a man more than union wages. This is
not surprising as no man can be a union carpenter unless he be in good
health, have worked a certain number of years at his trade, be a good
workman, of steady habits and good moral character." If this be true,
as doubtless it is to some degree in many trades and places, it is
in accordance with competitive principles that, as the elite of the
trade, the organized laborers should get higher wages than those
outside the unions. Moreover, the unions exist mainly in the more
populous places where costs of living as well as wages range higher
than in the small towns and in the rural districts. A comparison
merely of wages in money in such cases is misleading as to the
conditions of real income. Further, a higher standard of output
prevails in the cities where organization is greatest, and older men
and the less efficient that are unable to "keep up the pace" drift
away into unorganized shops or to villages where no standard union
rate is in force. So far as unions help to develop the intelligence
and promote the sobriety and efficiency of their members, they are
a positive economic force making for higher wages. The book before
quoted expresses, somewhat vaguely, an opinion in accord with these
facts when it says: "It is an error to think that the trade union
seeks to determine the rate of wages. It cannot do that. It can do no
more than affect them." And so, with organization as well as without,
the wages of individuals and of classes of laborers are determined by
the general principles of price as applied to their services. Where
neither the employer has a monopoly in his business nor the organized
laborers have a monopoly of the labor supply, there is two-sided
competition in the labor bargain, and organization may help to raise
particular wages inasmuch as it acts in the competitive ways above
mentioned and as it helps to restore to the laborers a truer equality
of competition.

§ 13. #Monopolistic aspect of organization and particular wages.# The
action of organized labor is not, however, limited to the competitive
field, above discussed. Wages in particular industries may, by
the action of trade unions be raised and maintained above a true
competitive rate. This of course can be done only in accordance
with the principles of the service-value to the consumer and of
service-price in the employment-market. The supply of labor is in a
variety of ways artificially limited by the efforts of the unions. It
may be done temporarily by striking when a failure to fill orders will
cause the employer exceptional loss. Violence in strikes and boycotts
is often the desperate attempt to create and assert a measure of
monopoly power where of itself it does not exist, i.e., where other
workers stand ready to take the jobs at the prevailing rates of wages.
Monopoly is created if apprentices are limited to fewer than in the
long run would be attracted into the trade by the prevailing wages.
It is created if the unions artificially limit output to less than
is consistent with the health of the worker. Monopoly is created if
unions strong enough to keep "scabs" from getting work, fix their dues
high or put other obstacles in the way of increasing the membership.
Probably the most striking cases of high wages for organized labor are
of this kind. The element of labor-monopoly evidently is mingled in
all degrees from the slightest to a very great amount, in particular
economic situations.

§ 14. #Open vs. closed shop.# The question of labor monopoly is
involved in the very crucial question of the closed vs. the open shop.
A closed shop (or union shop) is a shop in which no non-union men may
be employed, even at union wages. Its existence is evidence that the
union is strong enough to compel the employer to act on this principle
and thus virtually to force all his employees into the union. The
refusal of a demand for the closed shop is often the ground for a
strike. Where this is so unions usually assert that the closed shop
is essential to the existence of the union. If union and non-union men
work side by side there are many ways in which the employer is able
to discriminate so as gradually to break down the union. If business
slackens, the union man may be the first to be discharged; if any
preference is given it is to the non-union man. While this may be
true, it would seem, on the other hand, that an unmodified closed
shop, with the conditions of membership in the control of the union,
creates a distinct monopoly of labor leaving the employer helpless in
any wage dispute and enabling the union to enforce its every demand
regardless of the competitive conditions of the labor-market for that
class of services.

§ 15. #Political and economic considerations.# The question here takes
on a broad aspect, Is the closed shop, and are the other policies of
trade unions, morally right; and ought they to be legally sanctioned?
The answer to such questions is not for the economist alone to give.
The questions involve other than economic considerations. They involve
moral and political considerations--not merely existing formal law,
but the fundamental issue of personal liberty and of interference with
the liberty of some citizens by another group acting without political
authority. For example, if a workman is unable to earn the standard
rate[10] and is not permitted to take less, he is forced to move to a
place where there is no union, or is forced out of the trade entirely.
In the latter case he probably is compelled to take a lower wage
than he could get in his regular occupation. Likewise, this change
artificially increases the pressure of competition and reduces the
wages of others in the occupation to which he turns. So in the case of
persons prevented from becoming apprentices in a trade, or kept from
taking work by threats, or by the dread of boycott, or by the fear of
violence, in any degree however slight, there is present an element of
personal coercion by the organized laborers. This is the price others
are made to pay for a favorable effect on the wages of the organized
laborers. Now the strictly economic question concerns merely the part
as to the effects upon wages, and the economist (as such) is going
outside of his special field when he pronounces on the moral rectitude
(and the desirability in law) of such acts and policies. One who fully
shares the feelings of the organized workers will believe that the
winning of a strike or the general improvement of the strikers'
condition is so important that it outweighs the evils to other
individuals and to society as a whole. Indeed, to one in that state
of mind the evils appear very small or nonexistent. The economist can
only issue the warning that the commonest illusion he encounters
is the belief of each class--commercial, banking, manufacturing,
wage-earning--that what is for its particular interest is, in a
peculiar manner, for the general interest, so much as to justify
favoring legislation or special exemption from the general law, or
even sheer lawlessness.

§ 16. #The public's view of unions.# We may, however, observe the view
of the onlooker striving to be impartial. The attitude of the public
in labor disputes, and particularly in regard to the closed shop, is a
vacillating one. The general public sympathizes in large measure with
the unions in their efforts up to a more or less uncertain point;
but the public does not like to see organized labor with the power to
dictate terms absolutely to the employers any more than it likes to
see employers crush the union. The unions are effective in varying
degrees in strengthening the bargaining power of the workers, and
accordingly the results vary not merely in degree but in kind. The
public wishes to see "fair play," and up to a certain point the
union is a device to get fair play. In truth, what is in the public's
thought, somewhat vaguely, is approval of unions so far as they go
to establish a real equality in competitive bargaining with the
employers, but disapproval where the power of the union gets greater
and becomes monopolistic. It is at this point that organized labor
loses the sympathy of most of "the general public" outside of unions.
When the union tries to force a higher wage than the market will
warrant, when it strives not to establish but to defeat competition,
the public condemns. It sees, tho not quite clearly, that such action
makes an unstable equilibrium of wages which tempts to constant
friction and discord with employers and with unorganized laborers. It
sees also that if the unions force a wage higher than a fair and open
market affords, this is rarely done at the expense of the employer;
that in the long run it is at the expense of the purchasing public
itself, including the unprivileged workmen.[11]

In accordance with these facts and opinions there has developed, at
least in one respect, a pretty definite conviction on the part of the
public regarding the closed shop, namely: the closed shop should go
only with the open union. A union under the closed shop policy is
exercising a quasi-public function, that of controlling the industrial
action of private citizens against their will. The union therefore, in
this view, must cease to be a purely private, voluntary organization,
and become in some respects subject to public regulations as to
its internal rules and administration. This view, however, is very
unacceptable to the leaders of organized labor in America, and there
the question now stands.

§ 17. #Future role of organization#. In the light of the principles of
wages it appears that organization most easily gains results, and
the most stable results, when wages are below or near the competitive
rate. An earnest effort on the part of the workers is necessary for
them to get the share that true competition would accord them, but
the attempt to force wages beyond that point must be the occasion
of increasing friction. With so modest an ideal however, as the true
competitive wage, organized laborers and their leaders cannot be
expected always to be content.

Aside from its effects upon the wage-bargain, unionism finds
its greatest justification is in its unspectacular fraternal,
mutual-benefit, and educational functions. The chief forces favorable
in the long run to wages that can be affected by organization are
domestic peace, order, and security to wealth; honesty and good faith
between man and master, in law-maker and in judge; efficiency and
intelligence of the workers; and far-sighted social legislation. Some
of these contribute to greater productiveness, others to a fairer
distribution. In all these ways organized laborers have made valuable
contributions, unfortunately neutralized in many cases by a narrow
class outlook. Organized labor is here to stay for a long time to
come, and as the elite of the wage-earning class it should, and
probably will, be an increasing force for political betterment and for
social welfare in the republic.


[Footnote 1: See ch. 19, secs. 1-3.]

[Footnote 2: See Vol. I, p. 459.]

[Footnote 3: See _Quarterly Journal of Economics_, May, 1916, article
by L. Wolman.]

[Footnote 4: See below, sec. 14, on the closed shop.]

[Footnote 5: See Vol I, pp. 223-224, and above, ch. 6, sec. 12 and ch.
10, sec. 7.]

[Footnote 6: The "unfair list" is usually given as a form distinct
from either the simple or compound forms. The "fair list" published
either by labor journals or by a consumer's league is not declared to
be a boycott.]

[Footnote 7: In a book by an English trade-unionist, Trant, reprinted
and circulated by the American Federation of Labor as representing its
theory and claims, all the advances that have been made in wages are
said to be due to the trade-unions.]

[Footnote 8: See Vol. I, pp. 227, 439, 466, 467, 504-507; and above,
ch. 14, sec. 8.]

[Footnote 9: See Vol. I, pp. 217, 222-223, 352, 356.]

[Footnote 10: See above, sec 12.]

[Footnote 11: We are expressing here the general opinion, not
pronouncing a final justification of competition as a rule of conduct.
On this something will be said later, in ch. 31.]




CHAPTER 21

PUBLIC REGULATION OF HOURS AND WAGES

  § 1. Spread of the shorter working day. § 2. The shorter day and
  the lump of labor notion. § 3. Fewer hours and greater efficiency. § 4.
  Child-labor. § 5. Child-labor legislation. § 6. Limitation of the working
  day for women. § 7. Limitation of the working day for men. § 8.
  Broader aspects of tins legislation. § 9. Plan of the minimum wage.
  § 10. Some problems of the minimum wage. § 11. Mediation and voluntary
  arbitration. § 12. Compulsory arbitration. § 13. Organized labor's
  attitude, toward labor legislation. § 14. Organized labor's opposition to
  compulsory arbitration. § 15. The public and labor legislation. §16.
  The public and compulsory arbitration.


§ 1. #Spread of the shorter working day.# Since about 1880 a shorter
working day has been one of the prime objects of organized labor in
America. Notable progress was early made in some trades, reducing
hours from 11 to 10, or from 10 to 9, and in a few cases from 9 to 8.
In the building trades in the cities, especially, the eight-hour day
has come to be well nigh the rule. In 1912 it was estimated[1] that
1,847,000 wage earners were working in the United States on the
eight-hour basis; of these 475,000 were public employees. A large
proportion of the remainder were women and children whose hours were
limited by law, or were men working in the same establishments with
them. Since that date the eight-hour day has been more widely adopted
both through private action in many establishments and by legislation.
The year 1915 witnessed an especially rapid spread of the eight-hour
day.

§ 2. #The shorter day and the lump of labor notion.# The shorter
working day is advocated by most workers in the belief that it will
result not in less pay per day, but in even greater pay than the
longer day, even if the output should be decreased. This view is
connected with the lump of labor notion.[2] It assumes that men will
work no faster in a shorter day, and that there is so much work to be
done regardless of the rate of wages; and concludes that the shorter
day will reduce the amount of labor for sale and cause wages to rise.
To the extent, however, that laborers, as consumers, mutually buy each
other's labor, evidently this loss due to curtailing production must
fall upon the laborers as a class. The workers nearly always call for
the same daily pay for a shorter day, which means a higher wage per
hour. If wages per hour increase less than enough to make up for the
fewer hours,[3] the purchasing power of the workers must be reduced.
If the output per hour is increased proportionally to the pay per
hour, the existing wages equilibrium would not be disturbed. But if
the output increases not at all or in less than the proportion of
the increase in pay, there is an inevitable disturbance of the wage
equilibrium. In a competitive industry this would compel a speedy
readjustment of wages downward. If a certain group, or large number,
of workers were to begin turning out only 80 per cent as large a
product as they did before while getting the same money wage, the
costs per unit would be thereby increased. Prices must rise or many of
the establishments must close, and then prices would rise as a result.
This must throw some of the workmen out of employment and create a
new bargaining situation for wages. If the general eight-hour day were
applied to every industry and to all wage workers at once, then
all workers and all employers in the industry would be in a like
situation. But at once there must occur changes of consumers'
choices in a great number of ways. If there are one fifth fewer goods
evidently at least one fifth of the consumers must go without. This
would largely be the wage workers. The things of which wage labor
makes up a large part of the costs will rise in price relative to
the things of which self-employed labor and of which materials
and machinery make up a relatively larger part. This must compel a
reduction of the demand for the products of wage labor relative
to other things, and be reflected to labor in a lower wage. This
reduction would not necessarily be just in proportion to the reduced
output (that is, say, 20 per cent if from 10 to 8 hours, or 11 per
cent, if from 9 to 8 hours). It might even be more, but probably would
be somewhat less. In any case, both the money wages and the real wages
of laborers, either in the particular trade or generally, must be
reduced by a general reduction of hours that results in a decreased
output. In such cases, even when the workmen by a strike or general
movement secured the same wage scale for a day of fewer hours (a
higher wage per hour), they would be unable to hold it excepting where
they had monopolistic control of the trade.

In a period of rising prices due to an increasing supply of gold, the
readjustment of wages (per hour) away from an artificially high level
down to a competitive rate goes steadily on. Even when money wages
remain the same their purchasing power declines at such times, and
this serves soon to bring the high money wages into accord with the
lower value of the services.[4]

§ 3. #Fewer hours and greater efficiency.# Quite contrary to the
foregoing view is the claim that in the shorter day the rate of work
is so increased that the output is at least as large as in the longer
day, or even larger. A faster working pace is possible with a shorter
day, particularly in those operations calling for physical or mental
dexterity. This view is less attractive to the workers than the
preceding one, but is more acceptable to the employers and to the
public. The change undoubtedly has resulted in many cases in the
manner indicated, and could be made to result so in many other cases
by applying the methods of scientific management. But it is a change
which cannot be repeated indefinitely and under all conditions with
like favorable results. Whether in any particular case it can be,
depends in part on the length of the working day at the start. Such an
increase in output might occur in a change from exhausting hours, as
from 12 to 10, and again from 10 to 9, and yet not be possible in a
change from 9 to 8. Moreover, the speeding up of the workers beyond
a certain point may have had physiological effects outweighing the
benefit from shorter hours. It is now said that with the increase of
automatic machinery there are more and more workmen who much of the
time have merely to watch the machine-tool run, and occasionally
adjust the material. There has, however, been collected a notable
body of evidence to show that, in many industries and in different
establishments using much machinery, a reduction of hours to a number
as few as eight has been followed by the increase of the output per
worker, or by improvement in the quality of work, or by improvement
in the management, resulting in a reduction of the cost of production.
This is often sufficient, or more than sufficient, to compensate for
the shorter time. Wages have remained as high as, or higher than,
before, and employment has been more regular. So far as this result
is due to the individual worker, it is explained by the same evidence
referred to below[5] as bearing upon the health of the worker.
This evidence tends to prove that with longer periods of rest and
recreation the worker lives in a physical and mental condition fitting
him far better for his work, and for continuing his working life.

§ 5. #Child-labor.# All the foregoing arguments are weighed in terms
of private incomes and of the value of the products, whereas the main
considerations that have of late been influencing legislation and
judicial decision in favor of shorter hours have been those of public
welfare. The legal limitation of working hours is being treated
primarily as a health measure, into the judgment of which is more and
more entering a broader conception of the happiness, morality, and
opportunities for good citizenship for the worker and his family.

In agricultural conditions, such as have prevailed generally in
America, there is little need of limiting the hours of work and the
age at which children may begin to work. The barefoot boy trudging
over clover fields to carry water to the harvesters may be the
happier, healthier, and better for his work. Child-labor in
agriculture has never become a social "problem" so long as the
children work with their own parents at their own homes; but the labor
of children for wages, especially in gangs on large farms (as in
beet cultivation and cranberry picking) or in canning factories,
has exhibited evils as pronounced as any in urban manufacturing
conditions.

The evil of forcing children into factories was early recognized.
The most obvious evils of child-labor are neglect of the child's
schooling; destruction of home life; overwork, overstrain, and loss of
sleep, with resulting injury to health; unusual danger of industrial
accidents; and exposure to demoralizing conditions. The usual
assumption that the worker is able to contract regarding the
conditions of labor on terms of equality with the employer is most
palpably false in the case of children. The child, subject to the
commands of his parents and guardians, is not a free agent. Lazy
fathers are tempted to support themselves in idleness on the wages
of their young children. Often poverty leads the parents to rob their
children of health, of schooling, and of the joys of childhood. The
competition of child-labor also depresses the wages of adults, and
thus the evil grows.


§ 5. #Child-labor legislation.# The limitation of hours was first
applied to children working in English factories early in the
nineteenth century and thence has extended throughout the world,
tardily following the spread of the factory system. The first American
law of the kind was in Massachusetts, in 1842, limiting to 10 hours
the labor of children under twelve years of age in manufacturing
establishments. All the earlier state laws established low minimums of
age and high maximums of hours, and were poorly enforced for lack of
adequate administrative machinery, this in turn being the result of
lack of active public interest. In all these respects many states
gradually improved their child-labor laws in the latter part of
the last century, and much more rapidly since 1903. Now the maximum
working day for children in about one half of the states is 8 hours,
in one quarter is 9 hours, and in one quarter is 10 hours (and in
a few southern states, 11 hours). Night work by children is very
generally forbidden (in about forty states). During the same time the
minimum age has been pretty generally raised to fourteen years for
factory work, with higher ages (sixteen, eighteen, or even twenty-one)
in some states for certain occupations dangerous to health or morals.
In addition to these general limitations, special provision is made
for individual examinations to determine whether the child is mentally
and physically fit to work and has met the requirements of the
compulsory education laws of the state.

The most important child-labor legislation in recent years was the
enactment of the long debated national child-labor law (passed
in August, 1916). This prohibits the interstate shipment of goods
produced in factories wherein any child has, within thirty days, been
employed under unfavorable conditions as to hours and time of work as
specified in the act. The passage of this act was the culmination of
years of efforts in and out of Congress.

Child-labor legislation viewed as a merely negative policy is not of
great moment. Its real significance is to be judged only in connection
with the broader social policy of protecting and developing all of
the children of the nation to be healthy, intelligent, moral, and
efficient citizens. Children growing into blighted and ignorant
manhood and womanhood are threats to society.

§ 6. #Limitations of the working day for women#. But little later than
the limitation of child-labor usually comes some legislation to limit
the hours and conditions of employment of women. The grounds of this
policy are that women likewise are less able than men to protect
themselves in the labor contract, that they are physically weak and
are peculiarly exposed to certain dangers to health, that as future
mothers they need protection for their own and the public welfare, and
that in the period of maternity the dangers are especially great. The
work of women in factories operates in some ways to depress the wages
of men, and it is harmful in its effects upon the home and family
life. At present five states limit the hours of women to 8 a day,
twelve to 9 a day, fifteen to 19 a day, four to 11 or less a day. A
number of states forbid the work of women in designated places of work
such as saloons, mines, or where constant standing is required. Only
as late as 1911, in America, has legislation, now in four states,
given maternity protection, as is now more fully provided in European
countries in connection with systems of health insurance.

In all of the great industrial countries of Europe night work by
women is restricted (prohibited between 10 P.M. and 5 A.M. or yet more
narrowly limited); but legislation along this line is found in only
eight American states.

§ 7. #Limitations of the working day for men#. The general assumption
made in law has been that the adult male worker is competent to judge
of the working conditions, hours of labor, and wages, and is capable
of protecting his own interests sufficiently by his power of refusal
to accept employment. The legislatures have, much more tardily than in
their legislation for children and for women, acted contrary to this
assumption, but, when this has been done, the courts in America
have vigorously asserted the general doctrine and denied the
constitutionality of the laws. However, some exceptions were made in
legislation, and, after much apparent hesitation and vacillation, were
allowed by, the courts to stand, and these have now grown in number
until they form an impressive total.

These exceptions have come in various ways. There is first, the
eight-hour limitation in public employment, required in federal
employment in 1868, really effective since 1892, and now in force
likewise in about two thirds of the states. In almost the same
jurisdictions--national, state and municipal--eight hours is the legal
day on work done in private business for the governments. Work on
railroads and street railways, particularly in the direct operation of
trains, such as the work of dispatchers, signal men, and trainmen,
is subjected to a large variety of regulative measures, hours being
limited in some cases to 8, in others to 9, 10, 12, or 16, and in
a number of cases a specified minimum number of hours of rest is
required after the maximum hours of labor. These laws are primarily
for the protection of the public, but they afford a protection to the
employee much needed, as many well-authenticated cases of excessive
and exhausting hours demonstrate.

The limitation of hours has very recently been extended to many
private businesses in which exceptional conditions exist affecting the
health of the workers or the safety of the public. This development
has occurred almost entirely since the United States Supreme Court in
1898 (Holden vs. Hardy) sustained a Utah statute limiting to eight
the hours of labor in underground mines. Now 8 hour laws in certain
specified cases are found applying to mines, smelters, tunnels, and a
variety of other kinds of work, and in a few cases the limit is 9, 10,
or 11 hours.

§ 8. #Broader aspects of this legislation#. The subject took on a new
aspect when the legislature of Oregon, in 1913, declared broadly that
"no person shall be hired, nor permitted to work for wages, under
any conditions or terms, for longer hours or days of service than
is consistent with his health and physical well-being and ability to
promote the general welfare by his increasing usefulness as a healthy
and intelligent citizen," and fixed ten hours as the limit of work
consistent with such a measure of health and welfare, in work in any
mill, factory, or manufacturing establishment. This law was sustained
by the Supreme Court of that state and was carried on appeal to
the United States Supreme Court.[6] In support of the law there was
presented a voluminous brief giving a most impressive body of evidence
from scientific and from practical business sources, to show the many
evils, popularly unsuspected or underestimated, that result from long
hours even in industries of no exceptional hazards.[7] Physiological
and psychological tests demonstrate that the fatigue following more
than a moderate working period not only reduces immediate efficiency,
but so poisons the system that greater liability to accident, disease,
intemperance, immorality, and premature decay, results.

Two main purposes appear somewhat intermingled in this legislation
in limitation of hours. The first purpose is to protect the public
directly where the safety of others is dependent on the health and
efficiency of the worker. The second purpose is to protect directly
the worker's health and welfare, that policy being recognized to be
in the long run the best likewise for the public welfare. In legal
reasoning it is being recognized that the individual wage-worker, even
the adult male, is not in a position to judge the number of hours he
ought, for his own good, to work, and is unable to fix the length of
his own working day. As a matter of economic theory, the usance of a
child, a woman, or a man, is merely that kind and amount of
service that can be given out by each without repressing the normal
possibilities of growth, reducing the normal health and vigor, or
shortening the normal period of healthy productive human existence.[8]
It is becoming a general social policy to prevent the abnormal strains
of industry that cause the unnatural deterioration of the human factor
in industry. A wage-worker may be permitted to sell his daily _net_
fund of working power--his usance--but not his life.

§ 9. #Plan of the minimum wage.# Even more recent than the legislative
regulation of hours downward is the attempt to regulate wages upward
in the case of certain low-paid wage-workers. The modern[9] movement
for the minimum wage began in Victoria in 1896, and it soon extended
to nearly all the other Australasian states. Great Britain applied the
plan in 1910 to industries in which wages were exceptionally low. The
plan was first adopted in the United States by Massachusetts in the
year 1912, tho in an emasculated form, and spread so rapidly that at
the end of 1915 it was found in at least 11 states. Minimum wage
laws usually lay down "a living wage" as the standard to be used,
and either prescribe a flat rate of wages, or, more often, leave the
decision in each case to the wage commission established to administer
the law.

Generous sympathies have guided this movement of which much has
been hoped and which, on the other hand, has always had its adverse
critics. The most that can be claimed for it by its friends after more
than twenty years of experience, is that the "dire predictions" have
not been verified. In truth it would seem that the plan as yet has not
been tried on a scale that could yield very large fruits either
for good or for evil. The persons whom it is sought to aid are only
selected groups of the lowest paid workers, generally limited to
minors and young women, who in many cases are those of immigrant
families in urban districts. A large volume of discussion on this
subject has developed, mostly of an _a priori_ nature, of which we may
here touch only a few of the salient points.

At first glance the principles involved in the legislation limiting
hours and those in minimum wage legislation may seem to be the same.
But an important difference soon appears. In the former case the evil
is that of a too long working period, injurious to health, and this
can be reached directly and stopped by an efficiently administered
law. But in the latter case the real evil is industrial weakness and
incapacity such that the workers are unable to command "a living wage"
in a competitive market. A minimum wage law, by itself, neither cures
the industrial incapacity nor ensures employment to the industrially
weak at any wage. The law does not attempt to compel employers to
employ at the legal minimum wage every one who wishes to work; it
merely declares that the employer shall _not_ employ any one whom, in
his employ, he finds to be not worth that high a wage.

§ 10. #Some problems of the minimum wage#. Unless the demand for a
particular kind of service is absolutely inelastic (a rare if not
impossible situation in a large market), there must be fewer jobs
for the less capable workers at high than at low wages, other prices
remaining the same. Further, some of the less capable workers must be
crowded out of such jobs as remain; for an artificially higher wage
attracts into an occupation some from other occupations before paid
more highly. It seems to be admitted by the friends of minimum wage
legislation that this result is logically to be expected and that to
some degree it appears. Of course it is never possible to tell to just
what extent workers have been and are being excluded in this way from
any particular establishment or occupation. Forbidden to earn what
they can, the poorer workers must become dependent on charity. It
may be said, and perhaps truly: better this than underpaid labor
destructive to the health of the workers and evil in its competitive
effects upon other wage workers.

In most discussions of the wages of women there is a ready confusion
of sympathetic ideals of what one would like to see with the cold
facts as they are. Women's services (especially those of young women)
have increasingly of late been coming upon the labor market in such
a way as to cause abnormal congestion in a few occupations. Employers
have not caused low wages in these cases. Partly these occupations
are the clean, light, and agreeable ones, partly they have a relative
social glamour, largely they can be followed for a few years near the
home of the worker, nearly always they may be undertaken with brief
training and little skill. Investigation has shown that at least
eighty per cent of this group of girl workers live at home. A wage
that is amply a "living wage" when used as a pro-rata contribution
to an American family income is frequently insufficient for the girl
living "independently." Such a girl is, under the conditions, unable
to earn a living in her chosen occupation, and it may be better to
recognize that fact and to deal with such individual cases as appear
among the one fifth of all girls employed.

The one unquestioned service of the minimum wage law is that of
diagnosing the evil of low wages rather than in remedying it.
The minimum wage law brings to light the industrial incapacity of
particular individuals to earn a living wage. The direct remedy is to
abolish the incapable workers or their incapacity by such methods
as regulating foreign or cityward immigration, custodial care of the
physically, mentally, and morally weak, vocational guidance, and
more effective measures of industrial education. Alongside of the
abnormally low paid occupations or elsewhere in the industrial
organization are other occupations in which with, or often
even without, special training, the sweated workers could get,
competitively, more than the minimum wage, if they could, or would,
qualify for the work.

§ 11. #Mediation and voluntary arbitration#. The labor controversies
in which the public has the largest interest as a third party[10]
are those which result or may result in strikes. The public interest
becomes acute when a strike results in interference with the
individual freedom of other workers and of nonparticipants, when it
causes a blocking of the highways and disturbance of the peace, and
when it prevents the regular production and transportation of the
commodities which the public consumes. The public, therefore, has
steadily become more interested in all methods and agencies designed
to conserve better relations between employers and wageworkers, and to
diminish or, if possible, to do away with strikes when individual and
collective bargaining between the two parties fail.

_Mediation_, or conciliation, is the effort of a third party to get
the two parties to a trade dispute to come together to agree peaceably
upon a settlement. Mediation may be voluntarily undertaken in a
particular case by any citizen or by a public official, usually the
executive (mayor, governor, or President); or it may be by a regular
public state or national commission charged with this duty (as in some
17 states).

_Arbitration_ is the decision, by a disinterested person (or
commission) to whom it is submitted, of the exact terms, after a
provisional settlement of a dispute. It is voluntary when the parties
agree in advance to accept the verdict, and compulsory when they are
compelled by law to submit to arbitration and abide by the verdict.

Some provision either of voluntary private or of public agencies
to mediate between the parties in labor disputes and to facilitate
voluntary arbitration has been made of late in most communities of the
civilized world, including 32 of our states, and the nation as a
whole particularly in respect to disputes between railroads and train
operatives engaged in interstate commerce.[11] No one objects to
them, and they accomplish much good, but fail oftenest in the greater
emergencies because of the unwillingness of one or the other party
to submit the case, or because of lack of any power to enforce the
decisions.

§ 12. #Compulsory arbitration#. The serious question in the subject of
arbitration concerns the introduction of the principle of coercion by
government, in compulsory arbitration. This, in principle, is pretty
radically different from voluntary arbitration, for as it denies to
the parties the right to settle their dispute by private agreement,
it becomes in effect the legal regulation of rates of wages and
conditions of work. In principle this was involved in the legal
regulation of wages in England from the fourteenth to the nineteenth
centuries. The plan is closely approached in the industrial courts
that are now provided in a number of European countries for a cheap
and expeditious settlement of small disputes regarding trade matters,
arising in the relations between employer and employees. The new
modern development began when New Zealand passed a compulsory
arbitration act in 1894, followed to some extent since by all the
other Australian states, largely through the action of the Labor
party. Through the operation of its act New Zealand came to be called
the "land without strikes," tho the description was inaccurate,
especially after 1907. The Canadian Industrial Disputes Act of 1907 is
an example that has had influence upon public opinion everywhere, and
has been followed to some extent in recent legislation in New Zealand,
America, and elsewhere. It involves the compulsory principle in a
limited degree, making it unlawful in public utilities and mines to
change the terms of employment without thirty days' notice, or to
strike or lock-out until after investigation and hearing before a
board to be nominated for the purpose. The Colorado Act of 1915 goes
even beyond the Canadian act in its scope. The plan seems destined to
have wider applications and a larger development in the not distant
future. Let us note the general attitude of the various interests
concerned.

§ 13. #Organized labor's attitude toward labor legislation#. Labor
organizations hitherto have been in their legal nature almost entirely
private and voluntary. They are seldom incorporated and are rarely
even recognized in any way by legislatures and by courts, which deal
merely with the members as individuals.[12] Their private character,
combined with their limited membership as compared with the total
population, leaves them without the power to accomplish legally by
themselves the results which they desire in their own interest. Hence
they are tempted at times to usurp public authority over the field of
private rights in industry.[13] In other cases, when they have come
to the end of their unaided powers, they invoke the aid of the law to
accomplish their objects. But the appeal of organized labor to the law
is special and qualified, being confined to cases where the actions
of others are controlled to the advantage of the union, such as
regulating the work of women and children, controlling the acts of
employers in respect to construction of factories, and limiting the
length of trains. This does not imply a peculiarly selfish attitude
on the part of organized labor. Action together in any social group
always develops in men their loyalty and spirit of coöperation without
always making them more considerate to those outside of their group.
Indeed, often men acting through their chosen officials, private or
public, are more selfish collectively than they are individually.
The leaders of any group of men, whether of wage workers, merchants,
manufacturers, or political constituents, find it necessary to
show that the interest of their supporters rather than a broader
"sentimentality" is uppermost in their thought. And further, the
jealousy of any limitation of their power is as powerful a motive in
one group of men as in another. All are made of the same human clay.
But the stronger and more successful a labor organization is, the
more vigorously do its leaders resist any legislation that limits the
functions and field of action of the labor leaders, or that settles
labor troubles in a way that makes the voluntary labor organization
less necessary to the individual worker. Of course self-help, as a
spirit and as a policy, is a virtue, if it does not sacrifice the
rights of others. But if the facts above suggested are borne in mind
they will help to explain the otherwise often puzzling attitudes of
organized labor toward different measures of social legislation.

§ 14. #Organized labor's opposition to compulsory arbitration.#
Organized labor in America has attained to a highly influential
position. On the whole it constitutes an "aristocracy of labor,"
consisting largely of skilled workers that obtain a wage exceeding
that of unskilled workers to a degree not seen anywhere else in the
world. In this they have been favored by a combination of conditions
which it is not possible to describe briefly; suffice it here to say
that organization is itself not the whole explanation, but only
a small part of it. That organized labor, officially, is strongly
opposed to compulsory arbitration in America, is thus perhaps
sufficiently to be understood on the principle of "Let well enough
alone." When in August, 1916, a strike on the entire railroad system
was threatened by the four railroad brotherhoods, and some action was
proposed in the form of the Canadian act, the trade-union officials
issued a statement containing these words: "Since the abolition of
slavery no more effectual means has been devised for insuring the
bondage of the workingman than the passage of compulsory investigation
acts of the character of the Canadian Industrial Disputes Act." Within
less than a week the brotherhoods called off the strike after Congress
had passed an act giving the men immediately the eight-hour
day--a substantial part of what they had asked--and providing for
investigation, by a commission, of the effects of the rule. This is
compulsory upon the railroads but it is not compulsory upon the men to
accept these terms.

§ 15. #The public and labor legislation.# It has come to be recognized
that in every serious labor dispute, especially in such as develop
into strikes, those concerned are not merely the two parties,
employers and employees, but a third party, the public, consisting of
every one else whose interests are not directly or indirectly bound up
with one of the other two parties. The line of demarcation is not easy
to draw exactly. An individual may be divided in sympathy, inclining
to the one party perhaps because of some personal friendships or class
loyalty or to the other party because of material investments, while
in the main having interests distinct from either. But wherever
the public is drawn in as a party, it includes far more persons
and embraces far larger interests than does either of the other two
parties or than do both of them together. The public becomes a party
primarily because it consists of the purchasers and consumers of the
products, who are deprived of the usual supply of goods, more or
less essential to their welfare or even to their existence. With the
increasing division of labor and complexity of industrial organization
more and more kinds of business have, in a greater and greater degree,
become "affected with a public interest." The public becomes an
unwilling party, therefore, in every serious labor controversy.

In order that any kind of labor legislation shall be enacted, it is
necessary (so far as we have a government by public opinion) for a
majority of the public to be convinced that the conditions are such
as call for governmental interference. It becomes so convinced in
two broadly distinguishable classes of cases: one, when the masses of
unorganized workers are too weak to secure for themselves conditions
of work and wages consistent with health and morality; and the other,
when strong bodies of organized workers, in their attempts to win
their ends in an industrial dispute, exceed their private rights and
invade the public welfare.

§ 16. #The public and compulsory arbitration#. Where the railways are
owned and operated by the state (as is now the case pretty generally
except in America and Great Britain) the question of the "right to
strike" arises from time to time, in critical forms. The logic of the
situation compels even those officials that are of the labor party or
are most favorable to labor, to maintain an uninterrupted service on
the public railways. The experiences of that nature in France and in
Australasia have been notable. Nowhere in the United States has the
principle of compulsory arbitration been adopted, but at the time of
the great anthracite strike, in 1902, public sentiment grew strong in
favor of it. As a result of the intolerable conditions in the mines of
Colorado was passed the compulsory investigation act of 1915 in that
state. In 1916 the threat of a general railroad strike brought from
many quarters strong expressions of condemnation in principle, of the
strike as a method of settlement of wage disputes on the railroads.
And in the end the organized laborers themselves accepted, apparently
with much satisfaction, a law involving the legal fixation of wages
and the principle of compulsion as applied to the employers.


[Footnote 1: By the Secretary of the American Federation of Labor.]

[Footnote 2: See Vol. I, pp. 458-467.]

[Footnote 3: For example, increase less than 25 per cent per hour in
changing from a 10 hour to an 8 hour day.]

[Footnote 4: See above, ch. 6, sec. 12.]

[Footnote 5: See especially, sec. 8.]

[Footnote 6: At this writing the case, Bunting vs. the State of
Oregon, is still undecided.]

[Footnote 7: Published as "The case for the shorter working day," by
the National Consumers' League, see especially pp. 621-892.]

[Footnote 8: See Vol. I, pp. 135 and 197.]

[Footnote 9: Much public regulation of wages occurred in Europe until
near the end of the eighteenth century. In England this was done
mainly by the justices of the peace and, in the main was directed
toward limiting the demands of the wage-workers.]

[Footnote 10: See below, sec. 15.]

[Footnote 11: By the act of 1888, the Erdman act of 1898, superseded
by the Newlands act of 1913, and supplemented by measures for
mediation by the Department of Labor.]

[Footnote 12: The few exceptions to this statement are mostly recent;
such as the recognition of the unions in New Zealand in 1894 as
parties in the plan of compulsory arbitration, and in Great Britain
in 1909 as agencies through which unemployment insurance may be
administered.]

[Footnote 13: As appeared in ch. 20.]




CHAPTER 22

OTHER PROTECTIVE LABOR AND SOCIAL LEGISLATION

  § 1. Evils of early factory conditions. § 2. Improvement of factory
  conditions. § 3. Limitation of the wage contract. § 4. Usury laws. § 5.
  Public inspection of standards and of foods. § 6. Charity, and control of
  vice. § 7. City growth and the housing problem. § 8. Good housing
  legislation. § 9. General grounds of this social legislation.  § 10.
  Training in the trades. § 11. Prevalence of unemployment. § 12. Evils of
  unemployment. § 13. Definition of unemployment. § 14. Individual
  maladjustments causing unemployment. § 15. Maladjustment of wages
  causing unemployment. § 16. Individual maladjustment in finding jobs,
  § 17. Public employment offices. § 18. Fluctuations of industry causing
  unemployment. § 19. Remedies for seasonal fluctuations. § 20. Reducing
  cyclical unemployment and its effects.


§ 1. #Evils of early factory conditions#. The time is but brief in
the life of nations since the main manufacturing processes, now mostly
conducted in great factories, were carried on in or near the homes
of the workers. This change has been reflected in the meaning of
"manufactures," which first meant literally goods made by hand but now
conveys the thought of goods made by machinery. The craftsmen worked
alone in their own homes or with the help of their wives and children.
If the master craftsmen had other helpers these were usually lodged
and fed in the homes, and were taught by the side of the masters' own
families. The old English law of master and servant was the labor law
of that time as, to some extent, it still is to-day in Great Britain
and America. The living and working conditions of the wage-workers
were in general the same as those of the master himself and of his own
family; and this was the best possible guarantee that the conditions
would be kept up to the best standards of that time. The same change
in industrial relations that led to the rise of the organized labor
movement[1] revealed new and often horrible neglect and evil in
and about the factories. They had been erected with no thought of
sanitation, safety, and decency for the workers.

§ 2. #Improvement of factory conditions#. Legislation to remedy these
evils began in England a century ago, and the English code of factory
laws, regulating the construction and operation of factories and
providing for their inspection, has become voluminous. It has been
copied, and in some respects improved, by all of the great industrial
nations. This is true in America of the manufacturing states, tho the
agricultural states have still very few such regulations. As a result
of these measures, accompanying and stimulating an enlightenment
of the employers' self-interest, there has been a very remarkable
improvement in such matters in recent years. In many American
factories erected in the last quarter-century the conditions as to
lighting, heating, ventilation, stairways, fire-escapes, protection of
the workers against accidents, and lavatory and sanitary arrangements,
are better than the best conditions ever existing in domestic
manufactures. A somewhat corresponding improvement has taken place on
railroads, in mercantile establishments and, perhaps less, in mining.

Factory legislation often has been opposed by employers because of the
expense it causes; but if the regulations apply to all factories, the
expense becomes a part of the cost of production and is shifted, like
the other expenses of production, to the general body of consumers,
of which the employers form only a small part. Much of the recent
progress in some establishments has, however, gone much beyond the
requirements of any existing laws. Many employers recognize that it is
costly and unprofitable to themselves to allow their workmen to be in
surroundings that reduce their vitality and efficiency, such as do the
conditions mentioned at the close of the preceding section.

§ 3. #Limitation of the wage contract#. In general the law does
not attempt to interfere with the making, by individuals, of such
contracts as they choose to make. Its main function is to interpret
and enforce the contracts that are made. But there has been an
increasing group of exceptions to this general statement. It was
forbidden even by the English common law for wage-workers under
some conditions to sign away their right to claim damages in case
of accident, and many recent statutes have added more specific
limitations in this respect.[2] Legislatures and courts have been
particularly watchful of the interests of children, who are usually
deemed incapable of entering into contracts binding them to their
injury. Sailors, likewise, have been somewhat exceptionally treated,
because, journeying far from home, they are under the often despotic
control of their employers. The English courts may even change the
contract if the sailors have been coerced by their masters.

Laws regulate the form, time, and methods of payment in manufactures
and mining. Companies sometimes keep stores and pay the workers in
mines and factories in goods instead of money. Such a store in the
hands of a philanthropic employer might easily be made, without
expense to himself, a great boon to his workmen, giving them the
benefits of consumers' coöperation. But the usual result is told
by the fact that such stores are often known as "truck stores" and
"pluck-me stores," and heartily disliked by the wage-workers. They
are most often found where some one large corporation dominates in
the community, as in a mining district, and the workers are in a very
dependent condition. If the higher prices demanded practically lower
real wages, it would seem that the worker had an immediate remedy in
his power to demand higher money-wages. Recognizing that this is for
the most part an illusion--for it is just in such places that the
conditions for free competition are least present--the law in many
states prohibits these stores. It regulates also the measuring of
work, fixing the size of screens and of cars used in coal-mining.
The law is especially favorable to the hand-laborer in regard to the
collection of his wages, requiring monthly or fortnightly or sometimes
weekly payments. Mechanics' liens give to workmen in the building
trades the first claim upon the products of their labor.

§ 4. #Usury laws#. The limitation by law of the rate of interest that
may be charged affects many persons outside the ranks of wage-workers.
Usury laws are found almost universally in civilized lands. By usury
was formerly meant any payment for the loan of goods or money; now it
means only excessive payments. In former times moralists and lawmakers
were opposed to all usury or interest. The reason for this attitude
is not hard to find.[3] Most loans were made in times of distress. The
sources of loanable capital and the chances of profitable investment
were few. But for the last four centuries there has been on the
question of usury a gradual change of opinion, beginning in the
commercial centers and progressing most rapidly in the countries
with the most developed industry. A moderate rate of interest is now
everywhere permitted; but in all but a few communities the rate that
can be collected is limited by law, and penalties more or less severe
are imposed upon the usurious lender.

Usury laws are practically evaded in a number of ways within the
letter of the law.[4] Many persons maintain that they do more harm
than good even to the borrower, whom they are designed to protect. In
a developed credit economy, where a regular money-market exists, they
are superfluous, to say the least, as most loans are made below the
legal rate. Such laws, however, have a partial justification. In a
small loan market they to some extent protect the weak borrower at the
moment of distress from the rapacity of the would-be usurer. There
has been great need to check the rapacity of the "loan-shark" in the
cities. Usury laws are fruits of the social conscience, a recognition
of the duty to protect the weaker citizen in the period of his
direst need. Their utility is diminishing; and at best they are only
negative in their action, preventing the needy borrower from borrowing
when his need is acute. In many European countries a more positive
remedy has been found in the provision of public pawn-shops. In
America a very little has yet been done in this way, and that mostly
by private philanthropy.[5]

§ 5. #Public inspection of standards and of foods#. The determination
and testing of standards of weights and measures has long been a
function of government. English laws of the Middle Ages forbade
false measures and the sale of defective goods, and provided for the
inspection of markets in the cities. Usually, the self-interest of
the purchaser is the best means of ensuring the quality of goods;
but personal inspection by each buyer frequently is difficult and
time-consuming, requiring special and unusual knowledge of the
products and special costly testing apparatus. The states and the
nation undertake, in some cases, therefore, to set minimum standards
of quality, and to enforce them by governmental inspection. Government
coinage had its origin in this need.

This policy is applied, however, mainly to commodities affecting
health; its application to art products, except to protect the
morality of the community, would be difficult or unwise. Recent
legislation in many lands and in all of the American states has
developed greatly the policy of insuring the purity or the safety of
many articles consumed in the home; notable is the Federal Pure Food
and Drug Act of 1906. The federal law levying a tax on oleomargarine,
however, was designed as protective legislation in the interest of the
farmer. Public regulation and inspection sometimes raises the price,
but the cost is small compared with the convenience and the benefits
resulting to the citizen.

§ 6. #Charity, and control of vice#. The public relief of the
defective classes, insane, feeble-minded, and paupers, is a part
of the social protective policy. The public interest undoubtedly is
served by having these suffering classes systematically relieved, but
the extent and nature of the provision are questions ever in debate.
Still more debated is temperance legislation, both as to licensing and
as to prohibiting the liquor traffic. Nowhere is the manufacture and
sale of intoxicating liquor treated quite like the traffic in most
other goods, because it is recognized that the public interest is
affected in a different way. While it is beyond question that society
should protect itself and its innocent members against the drunkard,
it is more doubtful whether it owes to the man, for his sake,
protection against his own blunders. Not even the gods can save the
stupid. Temperance legislation is strongest in its social aspect. The
opponent of it usually champions the individualist view; its partizans
uphold, in varying degrees, the social view.

Similar questions arise regarding lotteries, gambling, betting, and
horse-racing. When a man backs a worthless horse against the field,
money probably is transferred from the stupider to the shrewder party.
The philosopher may say that the sooner a prodigal and his money
are parted the better; but the broken gambler remains a burden and a
threat to honest society. Gambling, lotteries, and speculation cause
embezzlement, crime, unhappy homes, and wrecked lives.[6] Here are
to be found with difficulty the true boundaries between ethics and
expediency. A busybody despotism may protect the fool, but it thereby
helps to perpetuate and multiply his folly; yet if the fool is left
alone, he too often is a plague to the wise and the virtuous.

§ 7. #City growth and the housing problem#. In 1790, of our population
only 3 per cent lived in cities of over eight thousand inhabitants;
in 1900 the percentage was 33. Then the largest city (Philadelphia)
numbered 50,000; in 1910 the largest city (New York) numbered
5,500,000; that is, 110 times as large 120 years later. The total
number of persons living in cities of 8000 had increased in more than
double that ratio. The rapid growth of cities brought with it many
evils. Considered in their more material aspects, nearly all of these
are summed up in the expression "the housing problem."

As population grows denser in cities, land rises in value, yards and
gardens narrow and then disappear, light, sun, and air are shut out,
and cleanliness, decency, and home life become more difficult and,
for many, impossible. The residents gradually group themselves in
districts corresponding to their economic incomes, and the poorer
parts of the population become tenement dwellers in the neighborhood
of factories or become segregated in "slum" districts of unsanitary
and dilapidated houses.

§ 8. #Good housing legislation.# Two policies are open under
these conditions. The one, always followed for a time, is to leave
individual self-interest unguided to solve the problem. If the tenant
agrees to rent a disease-breeding house, he is the first to suffer.
The interests of investors, it is said, will supply as good a house
as each tenant can pay for. The other policy now adopted is to set
a minimum standard of sanitation and comfort, in respect to plans,
lighting, materials, and proportion of lots to be covered, to which
standard all builders and owners must attain. Complying with the legal
requirements, they are left free to collect whatever rent they can
get. As one bad building may bring down the rent of all on the street,
such legislation may sometimes be in the interest of the body of
landowners as against the selfish desires of some individuals. Mainly,
however, the regulation is in the interest of the tenants and of
society as a whole, and against that of the landlords. The rents
from slum property are threatened, hence the strong opposition always
manifested against tenement-house legislation by some landlords,
architects, and contractors, who fight it as an interference with
their interests and as a confiscation of their property. It is not
unlikely that this policy has the effect of making rents too high for
some poorer tenants and driving them into the country. But this result
is not so undesirable. Moreover, the control and inspection of housing
conditions has in a few states been made statewide to reach even "the
country slums" which lately have been recognized to exist. Enlightened
sentiment to-day favors efforts to destroy the breeding-places of
disease, misery, and crime, no matter where they may be.

Property owners are in many communities no longer left free to
determine height of buildings, appearance, or even the uses for which
houses may be erected in any district. American cities have still much
to learn in this regard from the example of many European cities which
have developed the art of city planning with wonderful results in
beauty of landscape and of architecture, in practical economy for
business, and in the health and welfare of the mass of the people.

§ 9. #General grounds of this social legislation#. Why are not such
matters as we have been discussing safely left to individuals? It is
for the interest of every one that his back yard should not be a
place of noisome smells and disagreeable sights. But men are at times
strangely obstinate, selfish, and neglectful, and through one man's
fault a whole community may suffer. The refusal of one man to put
a sewer in front of his house may block the improvement of a whole
street. The heedlessness of one family may bring an epidemic upon an
entire city. There must be a plan, and by law the will of the majority
must be imposed upon the unsocial few. Where voluntary coöperation
fails, compulsory coöperation often is necessary. Thus health laws,
tax laws, and improvement laws regulate many of the acts of citizens,
limit the use of property, and compel men to better social courses
against their own wishes and judgments.

All such laws as these are protective legislation, in that they depart
from the rule of free trade taken in its broadest sense. It does
not follow, however, that all these laws stand or fall together. The
justification of such measures is limited and relative, and therefore
of varying strength. All protective measures are alike in that
the free choice of one citizen is forbidden by law in the supposed
interest of some other citizen who is to be "protected." While the
purpose of the tariff is economic and political, in a large majority
of social laws the moral purpose is fundamental. It is the demand of
humanity that competition be placed upon a higher plane. Most social
legislation is to protect the weak from being forced into contracts,
or from living in conditions injurious to their welfare and happiness.
The justification for these limitations upon the right of private
property, upon the free choice of the individual, upon "free
competition," must be found in the social result secured. The best
test of social protective laws is their contribution to a higher
independence and to a freer competition on a higher, more worthy, and
more humane plane.

§ 10. #Training in the trades#. Free elementary and secondary
education has become the all but unquestioned public policy in the
American commonwealths. The main motive for it has been the belief
that education in books is a necessity for good citizenship in a
republic. At the same time it has been thought that the training of
the school would help the child to earn a living. This appears to have
been true so long and so far as it was combined with, or supplemented
by, industrial training on the farm, in the home, and through
apprenticeship in the manual trades, as once was so prevalent. But
industrial conditions have changed. Most of the old-time education
of the schools has now little relation to the industrial life of the
great majority of the children, for few enter clerical or professional
callings. Germany was the first nation to recognize the new
educational need (in fact, never as urgent there as here) and to
provide for systematic and efficient training in all the industrial
arts. Since the beginning of the century the American public has been
awaking to the needs of the situation. We appear to be on the eve of
a great development in industrial training that will equip youth for
more efficient life in business and in the home, either in rural or in
urban conditions.

§ 11. #Prevalence of unemployment.# Many other forms of social
legislation on behalf of the common man might well deserve, did
time and space permit, a larger measure of the economic student's
attention. However, excepting the subjects treated in the next two
chapters, the one remaining that is most important at this time is the
problem of unemployment.

In every country and at all times where the wage system prevails, some
wage-workers, now more and now less, are "out of work" and unable to
get it. The proportion that they constitute of all workers cannot,
with the aid of any existing statistics, be exactly told, nor
can exact comparisons be made between different countries. Of
the magnitude, importance, and difficulty of this "problem of the
unemployed" there is, however, no question. It is greatest, speaking
generally, in manufacturing industries, tho, among the various kinds,
great differences in this respect appear. In 1900 the United States
census reported that of all persons in gainful occupations 2.5 per
cent had been unemployed more than half the year, 8.8 per cent from
three to six months, and 11 per cent one to three months, a total of
22.3 per cent more than one month.[7] In 1911 in a large group
(nearly all) of the manufacturing industries, the minimum number of
wage-earners employed (in January) was 13 per cent below the maximum
(in November). In some the difference was much greater (e.g., 24
per cent in the iron industry, 63 per cent in the brick and tile
industry). Statistics of unemployment among trade-unions in New York
and Massachusetts indicate that the annual average of unemployment is
between 12 and 15 per cent. In some years upwards of 10 per cent
of all the working time of the wage-earning population is lost by
unemployment.

§ 12. #Evils of unemployment.# A considerable part of the total in
an ordinary year may be set aside as "normal" in the sense that it is
allowed for in the wage-workers' plans;[8] and a part of it may even
be desirable. Yet there remains an inconceivable sum of suffering in
the lives of the workers, and an enormous economic waste of
productive energy not only for them but for the whole community.
The irregularity, and occasionally the excessive duration, of these
periods of unemployment too often makes unemployment not a beneficent
vacation (comparable to shorter hours), but a period of tragic
anxiety, demoralizing and unfitting for return to work. Irregular work
is generally recognized to be a greater cause of poverty and of actual
pauperism than is a low wage regularly received.

§ 13. #Definition of unemployment.# Unemployment is the state of a
wage-worker for the time out of a job. But this definition needs to be
further explained and limited if it is to be useful in the discussion
of unemployment as an evil calling for social remedy. There must be
set aside the cases where the lack of a job is due to one rest day
in seven and to legal holidays, a total of nearly 65 days in most
American states; to the worker's being on strike; to temporary
sickness; finally, and more difficult to distinguish, that due to
continued disability, physical, mental, or moral, to do the work up to
an acceptable standard and to retain a job in the occupation chosen
by the applicant. The first cannot be called a problem, and the others
constitute the problems of strikes, of industrial sickness, and of the
unemployables, respectively.

There still remain some unanswered questions such, for example, as:
whether in seasonal trades (e.g., teaching, or the building trades)
allowance should be made for normal vacations and for slack times,
not to be counted as unemployment; and whether lack of work at one's
principal occupation is ever or always unemployment when the person is
actually employed or can get work at some lower paid employment. The
more frequent answer to these questions is in the negative but this
in some cases is almost palpably absurd. Further study is necessary to
work out a generally acceptable concept of unemployment.

§ 14. #Individual maladjustments causing unemployment.# The cause
or causes of the evil must be ascertained before a remedy can be
intelligently applied. It is pretty generally agreed that unemployment
is essentially a problem of maladjustment of the labor supply, and not
that of an absolutely and permanently redundant supply. That is, there
is, under static conditions, work for all to do at various rates of
wages that would bring about a value equilibrium of services.[9] The
maladjustments are either of an individual or of a general character.
Individual maladjustment may be due to a mistake in choosing an
occupation (e.g., through the vain ambition of one unfitted to be
an artist, actor, lawyer, or teacher); or to failure to acquire by
adequate training the necessary skill; or to loss of capacity by
accident, old age, or failure of mental or moral powers; in all
of which cases the problem verges upon or becomes that of the
unemployable. The "can't-works" and the "won't-works" must be divided
from the "want-works." If there is any remedy in such cases it must be
through re-education, personal reform, or change of occupation.

Many persons look upon this type of cases as almost wholly accounting
for the problem of the unemployed. They are confirmed in this opinion
by the fact that the out-of-work group in any trade at any time is, on
the average, the least efficient group of workers in the trade. This
results from selection by the employers. This selection is due to
the _relative_ not to the _absolute_ efficiency or inefficiency of
workers, and must result whenever there are any discoverable economic
differences in the workers (all things considered) that are employed
at the same wage. This would continue even tho the poorest workers
were to raise their efficiency above that of the best men now
retained. "Personal inefficiency" may explain a chronic low wage or
absolute unemployability in a particular case, but it does not
explain intermittent lack of work for those willing and able to work.
Unemployment is a social problem and not merely an individual problem.

§ 15. #Maladjustment of wages causing unemployment.# It seems
highly probable that the artificial maintenance of a wage above the
competitive, or value-equilibrium, rate of the individual, whether
this be done by sympathy, by custom, or by the action of trade unions,
must cause some maladjustment of workers in relation to available jobs
and thus increase unemployment. To doubt this is again to maintain
the absolute inelasticity of the demand for labor with changes in its
price.[10] If the true equilibrium wage in a certain industry were
$3.00 a day, then a wage of $4.00 a day would attract to the trade
more than enough workers to meet the demand for labor in normal
periods (unless entry to the trade is controlled by monopoly power),
and at length the losses from unemployment would balance the day-wages
received in excess of the rate obtaining elsewhere for that quality
of labor. Any artificial obstacles to change of occupation or to
concessions in the kind of work done and in the rate of wages must
operate to increase the maladjustment. So far as this maladjustment
occurs, it may cause unemployment neutralizing the apparent gain
of higher day-wages obtained by monopoly power. The very inertia of
wages, however, in new price situations[11] makes the wage-workers
resist more vigorously such a policy of wage concessions. Moreover,
the difficulty here indicated is more particularly one occurring
in static conditions and is to be distinguished from the dynamic
maladjustments next to be considered.

§ 16. #Individual maladjustment in finding jobs.# Another kind of
individual maladjustment is the failure of the jobless man to connect
with the manless job. A certain amount of this maladjustment must
exist in the most stable industries and in the most settled industrial
conditions. Fluctuations occur in the market demand for the products
of various establishments, requiring the taking on or laying off of
some men. Fluctuations occur in the plans both of employers and of
wage-workers as a result of age, of removal, for reasons more or
less non-economic, of desire to change occupations, of variations in
health, and of countless other causes. The needs of the employer for
a worker, and of the worker for a job, are mutual. To a large degree
these various fluctuations are mutually compensatory, workers going
and coming, orders increasing here and decreasing there. Total jobs
and total workers capable of filling the jobs, are at any moment in
normal times equal quantities, if they can be brought together. But
almost everywhere is lacking a real labor-market. The substitutes
for it are largely ineffective: trade-union action, employers'
associations, "want ads," cards in shop windows, weary walks from door
to door, lines of waiting men outside of factories, private employment
agencies. At their best the private employment agencies perform
valuable services within limited fields, but they are uncoordinated,
and utterly inadequate to meet the chief need, and at their worst they
are the instruments of great abuses against the unemployed.

§ 17. #Public employment offices.# Vigorous efforts to create local
"free employment offices," or "labor exchanges," began in a number
of countries about 1895. The movement gained headway in the next ten
years and has since steadily grown. In Germany the chief exchanges
have been founded and conducted by the municipalities (while others
are controlled by the unions and by groups of employers) and have
remained largely decentralized, tho coöperating to some extent through
voluntary state conferences of officials of the exchanges, and since
1915 required to report to the imperial statistical office. The total
number of exchanges in Germany (in 1915) was nearly 3000. The general
results have been remarkably good, altho not completely satisfactory.

Every industrial country of Europe has done something of this kind.
Great Britain, however, after some experiments with a similar
local system, established in 1909 the first national system of
"labor-exchanges." In America the movement is developing in three
directions, through municipal, state, and federal offices. These are
united (since 1913) in an "American Association of Public Employment
Offices." In 1915 there were known to be 99 state and city employment
offices distributed through 30 states, besides federal offices
operated in 18 cities in connection with the Bureau of Immigration.
The clearly recognized task is now to coördinate these various
agencies into an efficient national system, eliminating partizan
politics and elevating the management of all branches to the plane
of professional service. Through these agencies can be operated an
industrial service, analogous in function to the weather bureau, and
reporting from day to day the pressure of demand and the prospects for
labor in the various parts of the country. The economic results of
a complete, exclusive, and efficient service of this kind would far
exceed its legitimate cost to the community.

§ 18. #Fluctuations of industry causing unemployment.# Any one of the
maladjustments in employment thus far considered may occur at a
given moment, in static conditions of industry. But there are
also maladjustments resulting from more general industrial changes
throughout a period of time. The two main types of these are seasonal
and cyclical changes, the one occurring within a year, and the other
occurring within the longer period of the business cycle. At the
downward swing of these seasonal and cyclical changes the number of
would-be workers exceeds the number of jobs [12] and the resulting
unemployment is greatest when the minor and the major swings are both
downward, about midwinter in a period of industrial depression. Thus
in 1893-94, and to a lessening degree in 1894-95, 1895-96; in 1907-08,
and 1914-15. Of course employment offices alone are no remedy for the
exceptional difficulties of such times, and the individual, whether he
be an unfortunate "out-of-work" or a more fortunate well-wisher, feels
helpless in the face of the overwhelming burden of distress. Such
a situation is declared by the radical communists to spell the
bankruptcy of the wage-system; while the most conservative students
of the subject confess that this periodic chaos in the labor market is
the strongest indictment of, and involves the gravest dangers to, the
existing economic and social order.

§ 19. #Remedies for seasonal fluctuations.# But of late there has been
a growing hope that an answer may be found to this economic riddle of
the Sphinx. A number of different measures are being experimentally
tested and applied. Many years of effort will be required for the
perfecting of these plans separately and collectively. Some of these
plans may be here indicated, however briefly. To remedy seasonal
fluctuations within the establishments output may be regularized by
taking orders in advance; by producing various products successively
in the same factory; by overcoming weather conditions as has been done
successfully in brick and tile making, ditch digging, and building
operations; by transferring workers from one department of an
establishment to another; by improving the employment departments so
as to build up a more stable force, thus reducing the great expense
of "hiring and firing" and the loss through training "green hands"; by
varying the length of the working day while keeping the same working
force throughout the year; by coöperating with other industries
to build up a regular working force and transferring it from one
establishment to another with seasonal changes.

Of great aid in a number of these measures is a broader industrial
training for the workers, making them more able to change from one
occupation to another. For this purpose every period of unemployment
and of temporary shortening of the working day ought to be used as
a time for trade education, by the recently devised and successfully
applied "short-unit courses for wage-earners."[13]

§ 20. #Reducing cyclical unemployment and its effects.# The
maladjustments due to the movement of the business cycle are even more
difficult to remedy completely, but are diminished by every measure
that helps to reduce the great financial fluctuations.[14] Further,
many communities have already begun to plan large public works more
systematically so that they may be carried on mainly when private
business is more slack. A comparatively small amount of such work
would serve as a gyroscope to preserve the balance of employment for
a large part of the less skilled workers. It has been estimated by
Bowley, an English statistician, that in the United Kingdom, it would
be necessary to set aside only 3 per cent of the annual expenditure
for public works to be used additionally in years of industrial
depression, in order to balance the wage loss at such times. This is a
well-nigh incredibly small proportion, hardly as great as that of the
weight of the gyroscope compared with the car or ship to which it is
applied. It is hardly to be doubted that hitherto, in America, public
undertakings have been executed much more largely in periods of
business prosperity, and have been diminished during "hard times,"
thus greatly accentuating the harmful swing of the labor-demand.
Finally, unemployment insurance, which has already been applied
by parliamentary legislation in Great Britain to a group of nearly
3,000,000 wage-workers, is an indispensable and highly hopeful
measure of relief. The place of this in a general system of industrial
insurance will be indicated in the next chapter.


[Footnote 1: See above, ch. 20, sec. 1.]

[Footnote 2: See ch. 23, secs. 5-7, on the old law of employer's
liability.]

[Footnote 3: See Vol. I, pp. 292-293.]

[Footnote 4: See Vol. I, p. 304.]

[Footnote 5: See Vol. I, pp. 293 and 303.]

[Footnote 6: See above, ch. 12, sec. 2.]

[Footnote 7: Great importance should not be attached to these
figures for they contain errors resulting from the inexact notions
of inexperienced enumerators as to what constitutes unemployment,
and from the inclusion of all persons gainfully employed, whether
self-employed or in professional, salaried, or wage-earning
positions.]

[Footnote 8: See Vol. I, p. 207, on irregularity of employment as
influencing wages, psychic income, and choice of employment.]

[Footnote 9: On static, see Vol. I, ch. 32; on the scarcity of labor,
see Vol. I, ch. 18, sec. 2 and references there; on value of
services and wages see Vol. I, ch. 18, especially sec. 3, and ch. 19,
especially sec. 7.]

[Footnote 10: See above, ch. 21, sec. 9 on the minimum wage.]

[Footnote 11: See Vol. I, p. 223, on friction in the adjustment of
wages.]

[Footnote 12: See above, ch. 10, secs. 6 and 7, on the industrial
crisis.]

[Footnote 13: See Bulletin of the United States Bureau of Labor
Statistics, No. 159 (April, 1915). ]

[Footnote 14: See above, ch. 8, secs. 6, 7; ch. 9, secs. 6, 8; ch. 10,
secs. 14, 16; ch. 14, sec. 12. ]




CHAPTER 23

SOCIAL INSURANCE

  § 1. Purpose and meaning of social insurance. § 2. Increasing need
  of social insurance. § 3. The new era of social insurance. § 4. Features
  of social insurance. § 5. Historical roots of accident insurance. § 6.
  Development of compensation for accidents. § 7. The compensation plan
  in America. § 8. Standards for a compensation law. § 9. Historical
  roots of sick-insurance. § 10. Need of sick-insurance in America.
  § 11. Old-age and invalidity pensions. § 12. Unemployment insurance.
  § 13. Need of ideals in social insurance. § 14. Insurance rather than
  penalty. § 15. The compulsory principle. § 16. State insurance and
  a unified system. § 17. The contributory principle.


§ 1. #Purpose and meaning of social insurance.# In importance
surpassing at present any one of the various measures on behalf of
the wage-earning class that have thus far been considered is the
remarkable development now under way of plans and agencies to provide
insurance for "the common man." Insurance means making some kind
of provision out of present means, so as to reduce the injury and
suffering that would result from a future mishap. Usually, likewise,
it implies uniting with others to distribute the expense fairly over
all in the group. Social insurance is the term most frequently applied
to the various institutions and plans provided, more or less under
the regulation of law, for the protection of the lower-paid workers in
most modern countries. The terms industrial insurance and workingmen's
insurance are likewise used. The principal types of events for which
social insurance in its various branches provides, are (1) accident,
(2) sickness, (3) incapacitation (either by old age or by invalidity,
that is, permanent failure of health within the normal working years),
(4) death (generally called "life" or "survivor" insurance), and (5)
unemployment.

The direct aim of social insurance is not to prevent these mishaps
(tho that may be an indirect result), but it is to provide some
financial indemnity for the economic loss and expense involved in the
mishap. The principal kinds of losses are two. First, that occasioned
directly in caring for the sick or injured person, the expense of
medical attention, nursing, hospital care, drugs and special apparatus
such as crutches and glasses, and burial expenses. The second is the
loss of income because of inability to work as a result of injury,
of illness, or of permanent disability, or (in the case of life
insurance) of the death of the bread-winner, or of want of employment.

§ 2. #Increasing need of social insurance.# In various connections we
have observed how the changes that have been occurring in modern times
have increased the uncertainties of the industrial life and of the
earning power of the mass of the workers.[1] It should be further
observed that in city conditions, a working family does not have, as
in agricultural conditions, the supplementary sources of income from
garden, field, forest, and stream, and it is not so possible to use
the earning power of children, of old people, and of the partially
disabled. The faster working pace of factories, the rapid fluctuations
of employment with changing fashions, inventions, shifts of
population, and waves of industrial prosperity and depression, all
have introduced new risks and problems into the worker's life. The
increasing payment of wages in money, and the more temporary nature
of employment of men in many kinds of factory work, have added to
the problem. With these changes have come a growing interest in
the welfare of the mass of the workers and a growing sense of
responsibility on the part of the public.

There is an appalling mass of misfortune in the United States
requiring social insurance for its relief, altho satisfactory
statistics of the various types of misfortune are still lacking. On
the basis of the experience of private industrial insurance companies
it appears that there are not less than 25.000 fatal industrial
accidents yearly, and 700,000 injuries causing disability for more
than four weeks, to say nothing of the enormous number of slight
injuries--if injuries, many of them very painful, disabling for a
period from one day to four weeks, should be called slight. As to loss
of time due to illness, the experience of Germany shows an average of
eight or nine days a year per worker, which figure, applied to those
gainfully employed in America, would mean nearly 300,000,000 days of
illness, or 1,000,000 one-man working years, causing a loss estimated
to be $750,000,000 annually.

It is estimated that one on eighteen of American wage-workers attains
the age of sixty-five with no financial provision for old age, and
that about 1,250,000 persons above the age of sixty-five are dependent
on their families or on charity, public or private, receiving
$250,000,000 yearly.

The losses and suffering to dependents due to the death of the
bread-winner are very partially accounted for by accidents, but no
estimate of much value can now be made of the other cases. Some notion
of the losses from unemployment has been given in discussing that
subject in the preceding chapter.

§ 3. #The new era of social insurance.# Some not insignificant
attempts to deal with these problems were made throughout the
nineteenth century, but the new era of social insurance may be said to
date from the message of the Emperor William to the German Reichstag
in 1881, in which he said:

  We consider it our imperial duty to impress upon the Reichstag the
  necessity of furthering the welfare of the working people.... In order
  to realize these views, a bill for the insurance of workmen against
  industrial accidents will first of all be laid before you; after which a
  supplementary measure will be submitted, providing for a general
  organization of industrial sick-relief insurance. Likewise, those who are
  disabled in consequence _of_ old age, or invalidity, possess a
  well-founded claim to more relief on the part of the state than they have
  hitherto enjoyed.

The program here outlined was carried out by the enactment between
1883 and 1889 of a series of laws, which taken together constituted
a pretty effective system of social insurance for the mass of
wage-workers in the German Empire. Later amendments have extended
and improved the various features of the plan, which has served as a
stimulative example to other countries. America has been the tardiest
among all the industrial nations to undertake this kind of social
reform.

§ 4. #Features of social insurance.# The plans of social insurance,
in force in various countries, present a great variety of features
combined in many ways. The main characteristics in which they may
differ relate to (1) the element of compulsion, (2) contributions by
the insured, (3) the nature of the insurance organization.

Insurance may be _voluntary_ or _compulsory_. It is voluntary when
the state simply encourages the formation of insurance agencies, and
perhaps contributes something to them, leaving it to the individuals
to insure themselves as they choose, in mutual societies, or in
privately managed companies. In the case of accident insurance,
however, there is often a semi-compulsion by which the employer is
requires to pay indemnity to his workers, according to fixed scales of
compensation, but is left free to insure himself against this risk
or not as he pleases, in which case it is still called voluntary
insurance. Compulsory insurance is that which the state requires to
be provided be means of some mutual organization of the insured, or of
the employers, or by the state.

Insurance may be _contributory_ or _noncontributory_. It is on the
contributory plan when the insured workers contribute something
toward the premiums that provide the funds for eventual payment. It is
noncontributory when the funds are provided either by the employers or
by the state without any payments from the insured.

Insurance may be (a) in _private_ companies, carrying on the business
for profit; or (b) in _mutual_ companies of workingmen, or of
employers insuring themselves against the cost of compensation in case
of accident to their employees; or (c) in a _state_ bureau, or fund,
organized and conducted by government.

§ 5. #Historical roots of accident insurance#. The different kinds
of social insurance had different origins, some knowledge of which is
necessary to an understanding of the present situation. These origins
still affect the nature of social insurance to-day, and have prevented
the development of a truly unified and logical system in accord with
present conceptions of needs and of justice.

Accident insurance had its beginnings in the liability of employers
for accidents that happened as a result of the employer's negligence,
a principle found to some degree in all countries. Thus the earlier
payments to workers in cases of accidents were not insurance indemnity
but merely damages collected in court for the fault of the employer.
In Great Britain and the United States, indeed, by judicial
interpretation the law grew more strict as against the claims of the
workers, until about 1880 in Great Britain and 1910 in the United
States. To collect damages it was not enough for the workman to prove
the employer's negligence, for collection was made more difficult by
(1) the doctrine of contributory negligence, (2) the doctrine of the
assumption of risk, and (3) the fellow-servant doctrine.

By the doctrine of contributory negligence, the workman's claim could
be defeated by showing that he had by his carelessness contributed
to the accident even when the employer had been negligent. By the
doctrine of assumption of risk the workman was presumed, in entering
upon employment, to have taken upon himself the risks usually incident
to the employment, including the chance of imperfections in the
machinery, of which he might by some care have known. By the
fellow-servant doctrine the employer was freed from responsibility for
accidents due to the negligence of other employees, "fellow servants,"
even when it was impossible for him to know their character and
reputation as in the case of a large factory or of a great railroad.

§ 6. #Development of compensation for accidents#. In some countries of
continental Europe, notably Germany and France, the law of employers'
liability was altered in favor of the worker early in the nineteenth
century, so as to make compensation more usual and adequate. Since
1885, especially, this liability has been much further extended in
many countries and in various directions, and yet the laws of accident
compensation still retain many features of the old liability laws and
remain in their legal character somewhat apart from the other branches
of social insurance. Even in the newer type of "compensation" laws the
indemnity paid by employers on account of accident is looked upon as
commuted damages, but the old employers' defenses, just named, are
abolished or made more difficult to plead. The new plan has the
advantages of granting compensation by a schedule fixed in the law,
insuring greater certainty, more adequate payments, greater ease of
securing redress, and abolishing the cost of law suits. Still, in most
countries and in most states in America, the worker has the option
of suing under the old law. In some forty countries the principle of
compensation by a prearranged schedule of rates has to some degree
replaced that of litigation, and determination by a jury of the
damages, in each separate case. The insurance spoken of in relation to
accidents is technically that which the employers may or must take to
protect themselves against loss, not that which the workman has.

The situation as to compensation in a few leading countries is as
  follows, the dates given being those of important legislation.

  ACCIDENT INSURANCE

  _Voluntary_ (as to employers insuring, but compulsory compensation).

  Great Britain, 1897, 1906, 1907.

  France, 1898, 1907, (compulsory for seamen, 1898, 1905).

  Denmark, 1898, 1908.

  Belgium, 1903, (voluntary except for miners).


  _Compulsory insurance of their risks, by employers_.

  Belgium, for miners, 1868.

  Germany, 1884, (in employers' associations), 1887, 1900,
  1911 (voluntary for some classes).

  Austria, 1887 (as in Germany), 1894 (voluntary for some
  classes).

  Norway, 1894 (in a state central insurance office), 1896.

  Italy, 1898, 1904.

  Holland, 1901 (in the Royal Bank or in private companies).

  Sweden, 1901 (as in Norway).

§ 7. #The compensation plan in America#. Under the practical operation
of the law of employers' liability in force in any American state
until 1911, a very small proportion of the workers injured while
at work were legally entitled to any indemnity, and a still smaller
proportion could succeed in recovering any substantial amount.
Employers, and the accident companies with which employers insured,
either compromised the claims for small amounts or fought bitterly
in the courts the claims of those who refused to compromise. When the
courts awarded damages, large or small, a large part of the proceeds
went for legal expenses. But a small proportion of the total costs to
employers came as benefits to the victims of accidents. It appeared
in an extensive investigation of the business of the large industrial
insurance companies that but 28 per cent of the premiums paid by
employers were paid to workmen as indemnity.

Between 1911 and 1916 the laws have been changed to some extent in
their application to selected occupations in at least 34 states and
territories of the United States, and covering nearly all but some of
the distinctly agricultural states. This remarkable development has
been largely actuated and guided by a comparatively small group
of socially minded nonworking class citizens rather than by either
employees or organized workers. It is an encouraging example of
what can be done by skilful methods, when conditions are ripe, in
furthering righteous social legislation without the use of money or of
corrupting influences.

§ 8. #Standards for a compensation law#. The standards which, in
detail, in one jurisdiction or another, have already been attained,
and which are the provisional ideals now sought by reformers, may
be briefly stated as follows.[2] All employments should be included,
altho, as yet, there are various exceptions, such as farm labor
and domestic service, employers with but few employees (the
number excepted being one to five), and nonhazardous employments.
Compensation should be granted for all injuries, suffered in the
course of employment, that cause disability beyond a definite waiting
period of three to seven days. Compensation should include medical
attendance for a limited period, and two-thirds of the estimated
loss of wages for disability, either total or partial, during its
continuance; and, in case of death, funeral expenses, and from one to
two-thirds of the estimated wages, to the widow (or dependent widower)
and children, or to other dependent relatives. To secure the full
benefit of the plan it must be made the exclusive remedy, replacing
entirely the old remedy of suits for negligence. The employer should
be required to insure his risk, and general sentiment is moving
rapidly toward the plan of a state insurance bureau as the exclusive
agency.[3] For the administration of the system an accident and
insurance board should be created in each jurisdiction. Experience
shows the importance of careful attention to numerous other details,
and many amendments will be made as the needs become manifest in
practice.

§ 9. #Historical roots of sick-insurance.# Sick-insurance had its
origin partly in trade unions and in fraternal societies voluntarily
organized by workers, and partly in the system of public poor
relief. The voluntary societies were first recognized, regulated, and
encouraged by law (in some cases being given state subsidies), and
later, in some cases, being made compulsory for some classes of
members (i.e., such as miners and seamen). On these institutions have
been built the later state systems of social sick-insurance. This
movement had made large headway by the end of the third quarter of the
nineteenth century in various European countries. The two systems that
are the most typical and influential examples are those of the German
Empire and of Great Britain, the former local and the latter national
in organization. The British plan of national health insurance
promises to be on the whole of the greatest influence upon American
opinion and policy. However, the best informed American students
favor in some features the more decentralized German rather than the
centralized British system. While it is impossible to describe the
various systems in detail, the situation in the leading industrial
countries of Europe may be indicated as follows.

  SICK-INSURANCE

  _Voluntary_.

  France, 1850, 1898 (voluntary except for miners).
  Belgium, 1851, 1894.
  Italy, 1886.
  Sweden, 1891.
  Denmark, 1892.
  Holland (authorized private societies and poor relief).


  _Compulsory_.

  Germany, 1883, 1911 (voluntary for others with earnings
  of $500).

  Austria, 1888 (voluntary for some classes).

  France, for miners, 1894.

  Norway, 1909.

  Great Britain, national system 1911 (was voluntary 1875-1911).

§ 10. #Need of sick-insurance in America#. Contrary to the usual
opinion in America, the sick-insurance in Germany is, both in amount
of contributions collected and in importance to the welfare of the
workers and their families, of more importance than is either accident
compensation or the system of invalidity pensions. Yet, thus far, our
interest and efforts in America have been directed almost entirely
toward the reform of accident compensation and almost everything
remains to be done in the matter of social insurance against sickness.
It is true that in recent years there has been a rapid development,
in some of the larger cities, of medical insurance clubs conducted by
private companies, with dues of ten cents weekly. They give medical
care in ordinary cases, but require extra payments for surgical
treatment and for medical supplies. They as yet touch only the
outer fringe of the problem, but they testify to the need and to the
increasing desire of the wage-workers for insurance of this kind. It
is believed that at least 4 per cent of the income of wage-workers
now is expended for the care of sickness and for burial insurance. The
losses of wages meantime remain unequalized by insurance indemnities.
A large proportion of the cases of temporary destitution in ordinarily
self-supporting families is due to sickness. The German experience
shows that 4 per cent of wages, collected in part from employers and
in part from wage-workers, is sufficient to give a far better medical
service than can be had through private effort, to give some indemnity
for loss of wages, and to carry on a very useful hygienic work for the
families and for the public health.

§ 11. #Old-age and invalidity pensions#. Insurance to provide pensions
for old-age and permanent (partial or total) disability is in nature
but an extension of the insurance against accident and sickness. In
a relatively small number of cases accidents result in permanent
disability and it is both illogical and inhumane to limit,
arbitrarily, the compensation in such cases to a certain period,
as two or three years, as is done in many compensation laws. The
disability due to advancing years is in nature a chronic illness,
inevitable, sooner or later, to all who survive. The movement to
provide some indemnity in such cases has been rapid in European
countries, doubtless because the problem was a very pressing one where
the average earnings are low. In Germany and Austria this development
has been more in connection with other forms of insurance; in Denmark,
Great Britain, and France it has had more the aspect of an extension
of poor relief. In the United States little has been done to provide
for these great needs. Massachusetts in 1907 authorized savings
banks to sell insurance and old-age pensions to those who applied. An
increasing number of corporations, especially railroads, are adopting
a pension system for men growing old in their service, but nothing has
been done of a general public nature toward compulsory and universal
protection against these misfortunes.

The following table shows the situation in some of the leading
countries:

  OLD AGE AND INVALIDITY PENSIONS

  _Voluntary_.

  Belgium, 1850, 1903 (voluntary except for miners).

  Italy, 1898, 1907 (all wage earners).


  _Compulsory_.

  Belgium, for miners, 1868.

  Germany, 1889, 1899, 1911.

  Austria, 1889 (miners only); 1906 (office employees).

  Denmark, 1891, 1908 (noncontributory).

  France, for seamen 1850, 1881; for miners, 1894, 1905,
  1907 (noncontributory, all indigent citizens); 1910 (contributory,
  all workmen and employees; was voluntary
  by laws 1850, 1886).

  Great Britain, 1908 (noncontributory, old age pensions,
  granted by the government).

  Sweden, 1913  (universal, contributory).

§ 12. #Unemployment insurance#. The most difficult of all the problems
of insurance is that of unemployment. There the amount of the risk
in any case is so largely dependent on the personal qualities of the
worker. There are obvious objections to making the competent, steady,
sober members of any trade bear the burden of the infirmities of their
fellows. But, on the other hand, as we have seen,[4] a large part of
the problem of unemployment is chargeable to social maladjustments
rather than to individual faults.

At present development in this field is along two lines, that
of subsidized trade-union relief (the Ghent system), and that of
compulsory state insurance in certain industries. The former has been
adopted by many cities and by some countries in western Europe, the
public paying a certain proportion (from one sixth to one third) of
the amounts of the benefits paid by the unions. Great Britain is
the only country as yet to adopt a compulsory state system. It began
operation in 1912, and applied to 2,500,000 persons, or one sixth of
all the wage-earners. The contributions are made 3/8 by employers, 3/8
by wage-earners, and 2/8 by the state. There are several original and
interesting features of the act, such as rewarding, by the refunding
of dues, those employers that provide regular employment and older
workmen that have received benefits amounting to less than their
contributions. Its administration in close connection with the labor
exchanges will give valuable experience in this field. The working
out of the many minor problems of classification, assessment, and
administration, of unemployment insurance, will require many more
years of experimentation.

§ 13. #Need of ideals in social insurance#. The world has had nearly
forty years of experimentation of a remarkably varied kind, in the
field of social insurance, since the German system was inaugurated in
the eighties of the nineteenth century. America stands almost at the
beginning of a development along those lines that is certain to be of
enormous extent and importance. It would be folly for us to repeat
the costly errors of other countries by failing to recognize certain
principles which have been clearly established by experience. If these
could be grasped and firmly kept in mind our progress in this field
in America would be faster, more certain, less costly, and farther
reaching than it promises otherwise to be. We can here attempt no more
than merely to outline these principles that must be embodied in an
ideal system of social insurance in America.

§ 14. #Insurance rather than penalty#. The principle of social
insurance rather than that of legal penalty should be universally
recognized. At present, in all countries where the several kinds of
insurance are found side by side, accidents are indemnified on plans
that are still rooted in the notion of employers' liability for
negligence; whereas, necessarily, the indemnity in case of sickness
and of old age has no such explanation. The unfortunate result of
this difference of view is that whereas all cases of sickness and
invalidity entitle to benefits, only those accidents suffered "in
the course of employment" are indemnified, and the worker is left
unprotected in a large share of the accidents to which he is liable.
The worker's need and the social need are thus not adequately met. We
have started along the same line of development in America, and it
is to be feared that only through a long series of legal fictions and
contradictory judicial decisions shall we be able to work out toward
consistency in this matter. Another unfortunate result of this
difference is that accident compensation, being made peculiarly the
task of the employers, does not develop the spirit of responsibility
on the part of the workers and of coöperation between them
and employers that other forms of insurance call forth, where
representatives of both parties sit together in the administration of
the system.

§ 15. #The compulsory principle#. Insurance must be general in its
application to all the persons within broad wage-earning classes,
and in order to be general it must necessarily be compulsory,
not voluntary, in its application. To leave any form of insurance
optional, or elective, with either employers or wage-workers, is to
fail of the main purpose in a large proportion of the individual cases
where it is most needed, and to increase the expense to those that are
included. Within a compulsory system, however, there should be given
wide opportunity for the voluntary principle by admitting to the
system others that are not compelled to insure, and to enable any
insured person to increase his paid-up, nonforfeitable insurance at
any time by extra payments made at times of unusually high wages, from
legacies, or from any other exceptional income.

§ 16. #State insurance and a unified system#. The state, through
the public insurance office, must ultimately be the sole agency for
insurance. Only in this way can the maximum of simplicity and economy
be attained. Of course, this calls for a better appreciation of expert
training, and a broader sentiment in favor of the merit system in the
public service than we yet have in America.

There should be a unification of various kinds of insurance in one
general plan and under one general administration for the whole state.
This should be done with full regard to the actuarial differences in
costs as among various kinds of insurance, various trades, various
establishments, and, to some extent, even the various individuals, so
as to ascertain the costs and to distribute them equitably.

Only in this way can provision be made for entire mobility of labor,
so that men may not be bound, as a condition for obtaining benefits,
to continue in the service of any one employer. To this end there
should be interstate comity and coöperation, so that the insured could
at any time transfer his actuarial equity from one state to another.

§ 17. #The contributory principle#. The contributory principle should
be adopted, and both employers and wage-earners contribute to the cost
in equal amounts. But further, the general public interests may
be recognized through the payments in aid of the funds (subsidies,
subventions). Both employers and employees usually seek to escape
the burden, by getting the state to bear the whole expense[5] or by
getting the other party to pay all or the larger part. But it is much
to be desired that in large part the finances of a system of social
insurance should be disassociated from the ordinary budgetary system
of taxation and public expenditures. The fundamental reason why the
premiums should be divided between employers and employees is that
this is most favorable to the equal participation and coöperative
efforts toward reducing the risk, and developing right industrial
and political relations. Everywhere it is the practice to provide for
representation nearly in proportion to contributions.

It is usually assumed by employers, by wage-workers, and by others in
the discussion of the subject, that the burden remains and is borne by
those who directly pay the premiums, and just in proportion to their
payments. This is an almost utterly mistaken view. There is, on the
contrary, every reason to believe that the general principles of
shifting and incidence of taxation apply fully here.[6] It cannot be
doubted that, if wages are not arbitrarily fixed, if they result, as
we must believe, from an adjustment and equilibrium of the various
classes of labor in a general economic situation, then after a
time the premiums become a part of that general situation. Payments
compulsorily made by employers (by all, without exception) will
ultimately be offset by a lower wage, and if transferred to the
workmen will ultimately be offset by a higher wage. Of course, there
is some delay and friction in making the adjustment, but, under any
settled policy, the adjustment once made will be maintained. The
benefit of social insurance to the workingmen is not mainly that their
wages are increased by the direct contributions of employers to the
premiums, tho there are doubtless some cases of "parasitic" industries
and parasitic employers that escape their due share of payments for
risk, now that there is no insurance system. The great benefits are
that total wages and losses are apportioned economically to the points
of maximum utility; that accumulation of capital by and for the wage
workers is made regular, automatic, safe, and in great amounts; and
that financial aid, physical care, and mental relief from, some of the
most tragic anxieties of life, are given effectively and economically
to the masses of the people.

But, as has been indicated in another connection above, it is far
from being a matter of indifference, psychologically, where the first,
immediate burden of premium payment falls. The persons paying the
premiums, in whole or in part, are far more keenly aware of the cost,
and alive to reducing and removing the evil conditions. Moreover,
their interest is stimulated by the fact that they are the first
to gain by any temporary economies, and the more so because of the
illusory belief sure to persist, that they are the ultimate as well as
the immediate bearers of the costs.

The development of a complete system of social insurance along these
lines promises to do more than any other single measure of practical
social reform now under consideration to change the conditions and the
outlook of the wage-earning class.


[Footnote 1: See above ch. 2, sec. 14; ch. 10, sec. 7; ch. 20, sec. 1;
ch. 22, secs. 11-18.]

[Footnote 2: The American Association for Labor Legislation has issued
a pamphlet describing these features more in detail.]

[Footnote 3: Thirteen states had, in 1916, state insurance funds,
and, in five states (Oregon, Nevada, Washington, West Virginia, and
Wyoming), they are the only insurance agencies allowed.]

[Footnote 4: Ch. 22, secs. 14-18.]

[Footnote 5: See examples in the lists of laws above cited, sec. 11.]

[Footnote 6: See above, ch. 16, sec. 14.]




CHAPTER 24

POPULATION AND IMMIGRATION

  § 1. Nature of the population problem. § 2. Complexity of race problems.
  § 3. Economic aspects of the negro problem. § 4. Favorable economic
  aspects of early immigration. § 5. Employers' gains from immigration.
  § 6. Pressure of immigration upon native wage-workers. § 7.
  Abnormal labor conditions resulting from immigration. § 8. Popular
  theory of immigrant competition. § 9. Divergent views of effects on
  population. § 10. The displacement theory; its fundamental assumption.
  § 11. Magnitude of the inflow of immigrants. § 12. Earlier and recent
  effects of immigration upon wages. § 13. _Laissez-faire_ policy of
  immigration. § 14. Social-protective policy of immigration. § 15.
  Population and militarism. § 16. Problem of maximum military power.


§ 1. #Nature of the population problem.# No one of the problems of
labor thus far discussed is of so great importance in relation to
popular welfare as is "the problem of population." By this is meant
the problem of determining and maintaining the best relation between
the population and the area and resources of the land. What is to be
deemed "best" in this case depends, of course, on the various human
sympathies and points of view of those pronouncing judgment. Very
generally, until the nineteenth century, the only view that found
expression was that of a small ruling class which favored all increase
in population as magnifying the political power of the rulers and as
increasing the wealth of the landed aristocracy. This view still is
unconsciously taken by the members of a small but influential class,
and is echoed without independent thought by many other persons.
But more and more, in this and other labor problems, another more
democratic standard of judgment has come to be taken, that of the
abiding welfare of the masses of the people. This is the point of view
that must be taken by the political economist in a free republic.

The problem of population presents two main aspects: one as to
composition, and the other as to numbers of the people. Changes in
either of these respects concern the welfare of the masses. Changes in
the kinds of people, or in their relative numbers, may greatly affect
the welfare of the people, in some cases touching special large
classes, and in others affecting the whole mass of the people.

§ 2. #Complexity of race problems.# The questions of race composition
that we shall here consider are those of the negro and of the
immigrant.[1] Both of these questions are complex and go beyond
the limits of mere economic considerations, touching the most vital
political and social interests of the nation. Indeed they involve the
very soul and existence of peoples, for who can doubt that ultimately
racial survival and success are mainly to be determined by physical
and spiritual capacity?

The negro in America is the gravest of our population problems. In
large portions of our land it overshadows every other public question.
Yet the negro is here because men of the seventeenth century ignored
the complexity of the labor problem and thought only of its economic
aspect. The landowners wished cheaper labor and, reckless of other
consequences, they imported slaves from Africa to get it. They gained
for themselves and a few generations of their descendants a measure
of comparative ease, but at a frightful cost to our national life--a
cost of which the Civil War now seems to have been merely a first
installment on account rather than a final payment.

§ 3. #Economic aspects of the negro problem.# The negro as a wage
earner is found very little outside of the least skilled branches of
a limited range of occupations. Of these the principal ones, as is a
matter of common knowledge, are farm work, domestic service (including
janitor service in stores and factories and work in hotels), and crude
manual outdoor labor. Repeated attempts to operate factories with
a labor force of negroes have proved unsuccessful. In some of the
better-paying occupations in which large numbers of negroes were found
in the North soon after the Civil War, such as barbering, waiting
on table in the best hotels, and skilled manual work, they have been
largely displaced by European immigrants. Negroes are a disturbing and
unwelcome influence in labor organizations, and even when nominally
eligible to membership are in fact rarely accepted. They very
frequently are employed as strike-breakers and this fosters race
antagonism both immediately and permanently.

The negro problem is, from our present outlook, insoluble. The most
laudable of present efforts, that for industrial training, represented
by Hampton and Tuskegee Institutes, and the work of Booker T.
Washington, leaves the dire fact of two races side by side and
yet unassimilated socially, politically, and, in large measure,
economically. Two other possibilities, race admixture and caste,
are both so repellent to white American thought, that they cannot be
looked upon as solutions. Segregation in a separate state, or separate
states, is a thorogoing proposal, but is practically impossible.
Finally there is the conceivable, but improbable, event of the
decrease and extinction of the negroes in America, Their relative
number has declined since 1800,[2] but their absolute number still
continues to increase. It seems probable that if European immigration
were to be stopped that a very large migration of negroes from the
South to the North and the West would occur to take places hitherto
filled by unskilled immigrant workers. In the year 1915, following the
check to immigration as a result of the European war, a very marked
movement of this kind set in. If this occurred on a much larger scale
it might result in greatly reducing the negro population in some
portions of the South, and as the "natural rate of increase" of the
negroes in the North is a negative quantity, it might cause the total
negro population of the country to begin absolutely decreasing.

§ 4. #Favorable economic aspects of earlier immigration.# Regarding
the immigration problem we are not confined to futile expressions of
regret as in the last case. For by the "immigration problem" is
meant primarily and mainly the coming of immigrants, and we can by
legislation limit or stop their coming, if we will. The question at
issue is whether their coming really is an evil or, on the whole, a
blessing to the country.

The historic American attitude toward immigration has been highly
favorable to it. The early settlers on these coasts were led by
various motives, some political, some religious, but far the largest
part economic, the motive of bettering their worldly condition.
Land was plentiful and all men of any capacity could easily become
landowners. An inflow of laborers was favorable to the interests
of all the influential elements of the population, especially to
landowners and active business men. Increase of numbers, favoring
division of labor and the economies of production in manufacturing,
and reducing the dangers from Indians and from foreign enemies, seemed
an unmixed blessing. Many of the newcomers soon became landowners and
employers, and in turn favored a continuance of the movement. Thus was
hastened the peopling of the wilderness. The interest of these classes
harmonized to a certain point with the public interest; but likewise
it was in some respects in conflict with the abiding welfare of the
whole nation. It led to the fateful introduction of slavery from
Africa, and it encouraged much defective immigration from Europe, the
heritage of which survives in many defective and vicious strains of
humanity, some of them notorious, such as the Jukes, the Kallikak
family, and the Tribe of Ishmael.

§ 5. #Employers' gains from immigration.#. The immigration from Europe
has furnished an ever-changing group of workers, moderating the
rate of wages which employers otherwise would have had to pay. The
continual influx of cheap labor aided in imparting values to all
industrial opportunities. A large part of these gains have been in
trade, in manufacturers, and in real estate as the cities have taken
and retained an ever-growing share of the immigrants. Successive waves
of immigration, composed of different races, have ever been ready to
fill the ranks of the unskilled workers at wages somewhat lower than
the current American rate.

The lower enterprisers' costs that resulted from immigration surely
did not accrue to the advantage of the employers alone. Bearing in
mind the fact that the employing-enterpriser is a middleman,[3] we
may see that the lower costs must, in most cases, be passed on to
the consumers in the form of lower prices of products. And often the
consumer, as the employer of domestic service at lower rates than
otherwise would be possible, gets this advantage directly. This
increases the number of those whose self-interest, at least when
narrowly judged, leads them to favor the policy of unrestricted
immigration, Tho perhaps less general than it once was, this sentiment
in favor of immigration is still potent. The continuous inflow
of immigrants has in many industries come to be looked upon as an
indispensable part of the labor supply. Conditions of trade, methods
of manufacturing, prices, profits, and the capital value of the
enterprises have become adjusted to the fact. Hence results one of
those illusions cherished by men whenever they identify their own
profits with the public welfare. Without immigration, it is said, "the
supply of labor would not be equal to the demand." It would not at the
wages prevailing. But supply and demand have reference to a certain
price. At a higher wage the amount of labor offered and the amount
demanded would come to an equality. This would temporarily curtail
profits, and other prices would, after readjustment, be in a different
ratio to wages.

§ 6. #Pressure of immigration upon native wage-workers.# There
must always have been cases where the labor incomes of workers were
somewhat depressed by the incoming of immigrants. Indeed, that must to
some extent always be so when the natives continue to work alongside
of the immigrant at just the same job. But before the Civil War living
conditions were simple, wages comparatively high and (more important)
pretty steadily rising, and the wage-earning class not yet a large
share of the population. Moreover, this conflict of interest was
minimized and often quite avoided by the native changing to another
occupation. In the old days there was always the outlet of free
land on the frontier, now closed. Always there has been a better
opportunity for natives to move into higher positions of foremanship
or as employers of immigrant labor.

As the wage-earners have become relatively more numerous, many of
them have felt more keenly the pressure of competition from immigrant
labor. Moreover, the immigration since 1890 has been increasingly
from southern and southeastern Europe, from countries with much lower
standards of living, and has been of enormous proportions. Here are
some significant figures as to immigration since 1820.

  --------------------------------------------------------------
                   |               |             | Immigration,
                   | Immigration   | Increase of | per cent of
     Decade        | in the period | population  | population-
                   |               |             | increase
  -----------------|---------------|-------------|--------------
    1820-30        |    124,000    |  3,300,000  |  3.8
    1830-40        |    528,000    |  4,200,000  | 12.3
    1840-50        |  1,604,000    |  6,100,000  | 26.3
    1850-60        |  2,648,000    |  8,200,000  | 32.3
    1860-70        |  2,369,000    |  8,400,000  | 28.2
    1870-80        |  2,812,000    | 10,400,000  | 27.0
    1880-90        |  5,246,000    | 12,700,000  | 41.3
    1890-1900      |  3,687,000    | 13,100,000  | 28.1
    1900-1910      |  8,795,000    | 16,000,000  | 55.0
    Total, 90 yrs. | 27,800,000    | 82,400,000  | 33.7

§ 7. #Abnormal labor conditions resulting from immigration.# The
labor supply coming from countries of denser population and with low
standards of living creates, in some occupations, an abnormally low
level of wages and prices. Children cannot be born in American homes
and raised on the American standard of living cheaply enough to
maintain at such low wages a continuous supply of laborers. Many
industries and branches of industry in America are thus parasitical
A condition essentially pathological has come to be looked upon as
normal. The commercial ideal imposes itself upon the minds of men in
other circles.

Statistics show that the prevailing wages for unskilled manual workers
in America have risen much less since the Civil War than have other
wages.[4] Wages in the great lower stratum of the unskilled and
slightly skilled workers are much lower in America relative to those
of more skilled and professional workers than they are in Europe. It
can hardly be doubted that the most important, tho not the sole, cause
of this situation has been the unceasing inflow of immigrants going
into these low-paid occupations. The "general economic situation" in
America, but for immigration, would compel higher wages to be paid to
the masses of the workers. If immigration were suddenly stopped in a
period of normal or of increasing business, wages in these occupations
would at once rise, and that, without the aid of organization, of
strikes, or of arbitration. This would affect most those occupations
which now present the most serious social problems, in mines,
factories, and city sweatshops. In some small measure the war in the
Balkan States, by recalling many men for service, had this influence
in 1912; and the great war beginning in 1914, by stopping a large
part of the usual immigration, gave a striking demonstration of
this principle. In employing circles the rise of wages was sometimes
referred to with an air of grievance as due to the "monopoly of
labor," as if the economic situation here, enabling the wage-earners
(millions of them immigrants), to get a higher competitive wage when
immigration temporarily was diminished, constituted a monopoly.

§ 8. #Popular theory of immigrant competition.# The depressing effect
of the ever-present and ever-renewing supply of immigrant labor upon
wages appears most clearly at the time of wage contests, and often
seems to be the most important aspect of the question. Laws against
contract labor, passed to prevent this particular evil, have put
no check to the great stream of those guided by friends to a "job."
Organized labor thinks most of these immediate effects. Commonly
labor's protest is expressed in terms of the untenable "lump of labor"
theory of wages. "Every foreign workman who comes to America" is
believed to take "the place of some American workman." The error in
this too rigid conception of the influence exerted upon wages by new
supplies of labor is evident in the light of the principles of wages.
Yet it may be true that, both immediately and ultimately, the foreign
workman depresses the incomes of those already here with whom he
directly competes. On the other hand, those in occupations into
which few immigrants enter may, as consumers of cheaper products,
be immediately the gainers in real wages, by the very change
that depresses the wages in the lower strata.[5] The
manufacturing-employers advocate "protection" which enhances the price
of their products, while usually favoring "free trade" in immigration
to cheapen their costs. What more natural than that laborers should
favor a policy of protection to labor, to keep foreigners from coming
here to be their competitors.

§ 9. #Divergent views of effects on population.# The foregoing views
of the effects of immigration upon wages, both of those favoring and
those opposing it, are short-time views, relating to immediate rather
than ultimate effects. If the immediate causes are continuously
repeated throughout the lives of successive generations the results
are for those mortal men as ultimate as anything that concerns them.
In this case it would make no difference to the millions of workers,
whose wages are depressed, if it could be shown that wages fifty or
a hundred years from now would be no lower as a result of continued
immigration than they otherwise would be; or to the employer that
wages would then be no higher. But to the social philosopher and to
the statesman, interested in the abiding general welfare, the ultimate
economic effects are of the greatest importance.

The question is: What will be the far-reaching, long-time effects of
immigration upon the general economic situation, as that determines
the welfare of the mass of the people? We confine ourselves here to
the economic effects, leaving aside as far as possible the racial,
moral, religious, political, and general social aspects of the
subject.

We are met at the outset by two divergent opinions as to the permanent
results of immigration upon the growth of population. The one is that
all immigrants coming to our shores are net additions, hastening by
so much the growth in density of population; the other opinion, the
displacement theory, is that immigration has the effect of checking
the natural increase of the native stock so much that it does not
materially change the total population, or actually causes it to be
less than it would have been had no immigration occurred.

§ 10. #The displacement theory; its fundamental assumption.# The
latter opinion which still has many upholders[6] was first advanced by
a distinguished economist, Francis A. Walker, but his first statement
of it referred only to the period between 1830 and 1860. The main
argument in support of this opinion was that in the three decades from
1830 to 1860 during which a large immigration occurred, the decennial
rates of increase of the population were almost the same as in the
three decades from 1800 to 1830.[7] The conclusion drawn from these
figures is that the immigrants were the cause of the decline of the
average birthrate that occurred in the families of native stock. The
validity of this conclusion is absolutely dependent on the assumption
that no other forces were at work to produce this result. Must we
believe that, but for immigration, the native birthrate would not have
declined at all? This is incredible. The birthrate of the native stock
had already begun to decline before 1820 as is shown by many family
records, and by the fall of the decennial rate of increase from 35 and
36 in the decades ending 1800 and 1810, to 33.1 and 33.5 in the next
two decades. This occurred despite the enormous western settlement
then under way on the Louisiana Purchase. The decline of the birthrate
began at that time to appear as a world-wide phenomenon, accompanying
improved transportation (roads, steamboats, steam railways), the rapid
growth of cities, and the general industrial revolution. The general
birthrate has declined of recent years in Australia and New Zealand,
where there has been little immigration, more rapidly than it has in
the United States.[8]

§ 11. #Magnitude of the inflow of immigrants.#In view of these facts
it seems necessary to modify the displacement theory greatly. To the
extent that the coming of immigrants caused a net addition to the
population, it doubtless hastened the growth of cities and the
development of industrialism, and thus helped to reduce the birthrate
in some classes. But this view admits the effect upon population which
the displacement theory denies. Probably, in a good many cases the
more rapid business advancement of the natives, because of the
coming of the immigrants, led to the decline of birthrate that is a
consequence of economic success.[9] But a large part of this change
would have inevitably occurred even if there had been no immigration
after 1820. Between 1820 and 1910 the population increased 82,400,000,
and the total number of immigrants was 27,800,000, or 33.7 per cent
of the total increase. In an urban environment the birthrate among
immigrants always has been very much higher than that of native
Americans. This fact alone might well be taken as sufficient to offset
whatever depressing effects the coming of the immigrants may have
had upon the native birthrate, leaving the immigration nearly a net
addition to population. It does not seem possible to believe that
if there had been no immigration, our native population, rapidly
advancing in average wealth, wages, and general education, would have
continued with an unchecked birthrate, and would have filled all the
places taken by immigrants. And no believer in the displacement
theory has ever ventured to claim, as the argument requires, that if
immigration were now stopped, the birthrate would again return to the
old standard of 1820, or would cease to decrease somewhat. Especially
of late, since the rate of increase of the native population has
become much less, is the effect of continuing immigration apparent.
In the decade of 1900-1910 the total population increased 16,000,000,
while nearly 9,000,000 immigrants arrived. Of the remaining increase,
3,000,000 consisted of children born of foreign parents. That leaves
three or at the most four million (4,000,000) increase attributable to
the native stock, white and negro combined.

§ 12. #Earlier and recent effects of immigration upon wages.# Let us
now correlate the principle of decreasing returns and the facts as to
the exploitation of our natural resources[10] with the growth of
our population, on the assumption that immigration has been a net
contribution to our numbers. While the vast frontier was open to
settlement, the growth of population could not fail to be looked
upon as a blessing, even tho somewhat mixed with political evils,
immorality, and pauperism. Beginning in colonial times, the policy of
"the open door" to immigrants came thus to be deemed the traditional,
patriotic American policy. Yet there is grave reason to believe that
the rate of growth in the nineteenth century was wastefully rapid and
that a slower and sounder growth might have been better.[11] However,
this rapid growth was largely extensive, spreading over wider areas,
and was consistent with a pretty steady rise of real wages in America
until about 1895,[12] the level continuing higher than that of Europe
despite the contemporaneous rise of wages there. Much of this general
rise is undoubtedly attributable to the adoption of better tools,
machinery, and industrial processes, the more so as inventions and
new methods have rapidly become free goods.[13] The beneficial
improvements long cooperated with the rapid exploitation of rich
resources to raise real wages, and then undoubtedly continued to
offset for a time the unfavorable effects as the richer resources
began to show signs of exhaustion. Since the end of the last century,
however, the net trend upward seems to be checked, and "the rising
cost of living" (real cost) has come to be a serious actuality for
larger sections of the population.[14]

Yet so long as wages are enough higher in America to pay the passage
of the low-paid workers of the industrially backward nations, they
will continue to come. The ease and cheapness of migration in these
days of steamships, the encouragement of immigration by the agencies
and advertisements of the steamship lines, and the increasing
readiness of the peasantry to migrate, have become well known through
recent discussions. Unless immigration is limited, it must continue to
depress the wages of American workingmen, through both its immediate
and its ultimate effects.

§ 13. #Laissez-faire policy of immigration.# There are those who take
a fatalistic, or a _laissez-faire_, view of the subject, and declare
that the problem will solve itself as the level of American wages
comes to be nearly the same as that of the countries of Europe from
which our immigration is coming. True enough, if this can be called a
"solution." There are many who cherish the commercial ideal according
to which cheap labor is absolutely desirable and needful to produce
cheaper products. This ideal has spread to wider circles. Here, for
example, are the words of a man who combines wide knowledge of the
facts of immigration with keen sympathy for the working classes:[15]
"The past industrial development of America points unerringly to
Europe as the source whence our unskilled labor supply is to be drawn
. . . America is in the race for the markets of the world; its call
for workers will not cease." Yet a little further on he must say: "All
wage-earners in America agree that it is not as easy to make a living
to-day as it was twenty years ago, and the dollar does not go so far
now as it did then. The conflict for subsistence on the part of
the wage-earner is growing more stern as we increase in numbers and
industrial life becomes more complicated, and the fact must be faced
that the vast army of workers must live more economically if peace and
well-being are to prevail."

§ 14. #Social-protective policy of immigration.# A different kind of
solution is offered by those who favor the strict limitation, if not
the complete prohibition, of immigration.

The foregoing study indicates that the time has come, if it is not far
past, when the traditional policy of fostering immigration is opposed
to the welfare of the masses of the people. This belief can be based
solely on grounds of numbers, the relation of population to resources,
quite apart from a preference for particular races or the familiar
arguments regarding social and political evils and lack of
assimilation, however valid they may be. The limitation of immigration
would immediately improve working-class conditions where they are
worst in America,[16] and would check and probably reverse the
tendency to diminishing returns already manifest in many directions.
This opinion does not necessitate an absolute prohibition of
immigration; it is consistent with the continuance of immigration of a
strictly selected character, and in numbers so small that all European
immigrants now here could be rapidly and completely assimilated,
economically and racially. With a slow national increase of population
and with the continued progress of science and the arts, it should be
possible for real wages to continue indefinitely rising in America.
The selection of immigrants to be admitted should be a part of a
national policy of eugenics,[17] which aims to improve the racial
quality of the nation by checking the multiplication of the strains
defective in respect to mentality, nervous organization, and physical
health, and by encouraging the more capable elements of the population
to contribute in due proportion to the maintenance of a healthy,
moral, and efficient population. In such a view, a eugenic opportunity
is presented in the selection and admission of immigrants that are
distinctly above (not merely equal to) the average of our general
population.

§ 15. #Population and militarism#. In view of the recrudescence of the
spirit of armed national aggression evident of late, and especially
in the outbreak of the Great War in 1914, the military aspect of the
population question deserves serious consideration. The growth of
savage and barbarian tribes in numbers, so that their customary
standards of living were threatened, frequently has led to the
invasion and conquest of their richer neighbors.[18] To-day nations
on a higher plane of living are probably repeating history. The nation
with an expanding population is tempted to seek an outlet for its
numbers and for its products by entering upon a policy of commercial
expansion, which in turn has to be supported by stronger military and
naval establishments. It is led by primitive impulses that to it
carry their own moral justification, to possess the territory of its
neighbors. The immediate occasion is probably some matter of internal
politics, such as growing discontent and democratic sentiment among
the people. Nations with slowly growing populations, and still
possessed of ample territories to maintain their accustomed standards
of life, naturally favor the _status quo_, and are pacifist or
nonmilitarist. If they arm it is for their own safety. In this view,
militarism is seen to consist not in having drilled soldiers and
stores of munitions, but in the national state of mind that would
use these for aggression, not merely for defense. When, therefore,
a powerful nation has reached a certain stage in the relation of its
population to resources, limitation of population not limitation
of armaments is the real pacifism; and increase of population, not
increased military training or a larger navy, is the real militarism.

§ 16. #Problem of maximum military power.# It is a grave question,
however, whether a nation with a comparatively sparse population,
high wages, and great wealth can safely limit that population in the
presence of a capable, ambitious, and efficient rival that covets such
opportunities. On the one hand, a population may be so sparse that
it has not soldiers enough to defend its territory against a numerous
enemy; on the other hand, it may be so dense, and consequently average
incomes be so low, that it cannot properly train, arm, and support
its population of military age. The recent developments in the art
of warfare call for great use of the mechanical industries, for
great power to endure taxation, and for great financial resources,
conditions found only where the average of national income is high.
The point of maximum military power must be far short of the maximum
possible population. It would seem that a nation of 100,000,000
inhabitants favorably situated to resist aggression, well supplied
with the natural materials for munitions, and well equipped to produce
them, might safely limit its numbers so as to ensure a high level of
popular income. This safety would be greatly increased by permanent
alliance with other peoples likewise limiting their numbers and,
therefore, interested in maintaining the peace of the world. In
this way it would be possible for them all to maintain a standard
of popular well-being even higher than is fully consistent with
the maximum military power, even in the presence of prolific and
aggressive rival nations.


[Footnote 1: Even more important than these is the relative decrease
of the successful strains of the population, briefly treated in Vol.
I, ch. 33. This is the problem of eugenics, the choice and biologic
breeding of capable men to be the citizens of the nation, and broadly
understood, it includes both the negro and the immigrant problems.]

[Footnote 2: See Vol. I, p. 430, figure 58, showing the fall in the
decennial rate of increase of negroes compared with whites; and see
comment in accompanying note.]

[Footnote 3: See above, ch. 20, sec. 11, and references in note.]

[Footnote 4: See below, sec. 12.]

[Footnote 5: See Vol. I, p. 221, on non-competing classes.]

[Footnote 6: The latest and best statement is that of H.P. Fairchild,
"Immigration," pp. 215-225, citing various opinions, and accepting the
view of Walker. But he says (p. 216): "It must be admitted that
this is not a proposition which can be demonstrated in an absolutely
mathematical way, which will leave no further ground for argument."]

[Footnote 7: See Vol. I, p. 429, for figures of population and of
decennial rates of increase.]

[Footnote 8: The effect of the growth of cities is discussed in the
"American Journal of Sociology," Vol. 18, p. 342, in an article on
"Walker's Theory of Immigration," by E.A. Goldenweiser.]

[Footnote 9: See Vol. I, p. 420.]

[Footnote 10: See Vol. I, chs. 34 and 35.]

[Footnote 11: E.g., see above ch. 14, sec. 11 on the prodigal land
policy.]

[Footnote 12: See Vol. I, p. 436 ff.]

[Footnote 13: See Vol. I, ch. 36, on machinery and wages.]

[Footnote 14: For analysis of the available statistics bearing on the
subject, with conclusions that real wages are no longer rising, see
H.P. Fairchild, in "American Economic Review" (March, 1916), "The
standard of living-up or down?"]

[Footnote 15: Peter Roberts, in "The New Immigration," 1912, preface,
p. viii, and p. 47.]

[Footnote 16: See above, sec. 7; also ch. 21, sec. 9.]

[Footnote 17: See above, sec. 2, note; also Vol. I, p. 422.]

[Footnote 18: See Vol. I, p, 412, on war and the pressure of
population.]




PART VI


PROBLEMS OF INDUSTRIAL ORGANIZATION




CHAPTER 25

AGRICULTURAL AND RURAL POPULATION

  § 1. Agriculture and farms in the United States. § 2. Rural and
  agricultural. § 3. Lack of a social agricultural policy in America. § 4.
  Period of decaying agricultural prosperity. § 5. Sociological effects of
  agricultural decay. § 6. Fewer, relatively, occupied in agriculture; use
  of machinery. § 7. Transfer of work from farm to factory. § 8. The
  rural exodus. § 9. The farmer's income in monetary terms. § 10.
  Compensations of the farmer's life. § 11. Ownership and tenancy.


§ 1. #Agriculture and farms in the United States#. There were
nearly 12,400,000 persons in the United States gainfully occupied in
agriculture in 1910, this being 32.5 per cent of all in occupations.
These, together with other family members not reported as engaged
in gainful occupations, constitute the agricultural population, and
comprize more than one third of the total population of the country.
"Agriculture" is here used in a broad sense, including floriculture,
animal husbandry (poultry, bee culture, stock raising), regular
fishing and oystering, forestry and lumbering. Agriculture thus
produces not only the food but (excepting minerals, including coal,
stone, natural gas, and oil) the raw or partly finished materials for
all the manufacturing and mechanical industries.

With the exception of areas devoted to forestry on a large scale and
to fishing, the industry of agriculture is pursued on the 6,400,000
farms, covering 46 per cent of the total land area of the country. Of
the land in farms, a little over half is classified as improved. The
estimated value of farm property, including buildings, implements,
machinery, and live stock, was, in 1910, about $41,000,000,000,
somewhere near one fourth of the estimated wealth of the country at
that date.[1]

§ 2. #Rural and agricultural.# The adjectives rural and agricultural
are often used loosely as synonyms. Agricultural refers primarily to
the occupation of cultivating the soil, and is properly contrasted
with other occupations, as mechanical and professional; whereas rural
refers to place of residence outside of incorporated places of
a specified minimum population (of late, 2500), and is properly
contrasted with urban, applied to those living in larger population
groupings. In 1910 the rural population comprised 53.7 per cent of the
total population. It is true that the two groups of the agricultural
and the rural populations are largely composed of the same persons,
but to a considerable extent they are not. Many farm houses, together
with part or all of the farm lands, lie inside urban boundaries, and,
besides, some persons engaged in agriculture reside in urban places.
On the other hand, any one acquainted in the least with a rural
district (in the statistical sense) can at once think of many
persons living there that are not engaged in agriculture; they may
be merchants, warehousemen, railway employees, physicians,
handicraftsmen, teachers, artists, retired business men, and others.
The percentages given in this and in the preceding section indicate
that about two fifths of the rural families are not engaged in
agriculture.

It is often important to make this distinction, tho it is difficult
to do; for some of the much-discussed rural questions are of a
broad social nature, are matters of rural sociology, relating pretty
generally to the rural population; while other questions of "rural
economics" are more strictly matters of agricultural economics and
relate to the farm as a unit of industry, or to agriculture as an
occupation.

§ 3. #Lack of a social agricultural policy in America.# It is a common
remark that the farmer lives an independent life. This develops in him
a self-reliant spirit. He readily gives and takes simple neighborly
help in informal ways, but he does not readily turn to government
for aid. While every influential urban group, organized or
unorganized--manufacturers, merchants, wage-earners--has sought and
obtained special protective social legislation, the farmer has, from
choice or necessity, usually had to work out his economic problems
unaided. The exceptions are few and of small importance. For example,
the prodigal land-policy of the state and national governments
encouraging the settlement of the frontiers was not a farmers'
policy. It was originally inspired by the larger political purpose
of extending the bounds of the nation; later it was advocated and
fostered by a land-speculating element, linked with bad politics, in
the frontier states, and not by farmers as such. It in time greatly
injured the farmers of the eastern states. The "Granger legislation,"
to regulate railroad rates, was so called by the East in a spirit of
derision because it began in the distinctively agricultural states
of the Northwest; but it had neither the aim, nor the result, of
obtaining especially for farmers any rates that were not open to
every one on the same terms. The tariff rates on American agricultural
products, placed in the acts as a matter of form, have, with minute
exceptions, been ineffective to favor farmers, as the shipments were
all outward and none inward, while heavy and effective rates were
placed on most things that the farmers had to buy.[2]

In part the explanation of the lack of legislation favoring farmers
is to be found in their small part and influence, as a class, in
political affairs, outside of minor executive offices in township and
county governments. In the state legislatures farmers are few relative
to their numbers in the community, and still fewer in either House in
Washington. Among the real exceptions to the otherwise fair record of
the farming class in this respect is the tax on oleomargarine and the
special favor accorded to farmers' associations in the Clayton Act. It
might be cynically said that the farmer has not been "sharp" enough
to get his share of the "good" things" that the business classes were
passing around in protective legislation. But farmers have, as has
every economic group, interests which may legitimately be the subject
of social legislation; whereas they have limited their attention to
their private affairs at home and have been prone to vote patiently
and proudly the "straight ticket" to elect business men and lawyers to
office.

§ 4. #Period of decaying agricultural prosperity#. Despite the facts
just stated, every campaign orator admits that there is no other
occupational class of the nation of greater importance to the nation
than the farmers, or more deserving of prosperity. Every other part
of the industrial organization of a nation is interrelated with
its agriculture. Great changes, in respect to growth of population,
immigration, exhaustion of natural resources, mechanical inventions,
scientific discovery, and many things more, have been occurring,
which have altered and, in some communities, have destroyed the very
foundations of agricultural enterprise in America since the close
of the Civil War in 1865. But the farmers have been left to struggle
individually with their individual difficulties, tho the outcome was
of the gravest portent to the whole social economy. Such was the case
in the period of agricultural depression from 1873 to about 1896.[3]
Multitudes of ancestral homesteads were then left behind by the last
farmer-descendant of the old line. No longer able to make a living on
the soil, he took up an urban occupation.

§ 5. #Sociological effects of agricultural decay#. Such changes caused
a relative decline in the birthrate of the old American stock. The places
of many of these long-settled families remained unfilled as thousands of
abandoned farm houses testified. The places of others were taken by a
tenantry, white or black, lacking the thrift of ownership; the lands of
others passed to new owners of alien races. The populations of many rural
neighborhoods thus became heterogeneous, with results calamitous to the
social life. Once prosperous schools declined, once thronging country
churches were deserted, and much of the old neighborhood democracy
disappeared. When, about the year 1900, prosperity began slowly to return
to the American countrysides in the form of rising prices of farm produce,
it was in large part too late to remedy the evil, except as it may be
done by generations of effort under more favoring conditions. There
are merely suggested here some of the complex sociological effects of
past economic changes in American agriculture. It is certain that in
the future also the economic changes in this field will be related
closely to social and political changes of a fundamental character.

§ 6. #Fewer, relatively, occupied in agriculture; use of machinery.#
Probably ever since the first census in 1790, the relative number of
agriculturists in this country has been decreasing. Beginning in
1880, the numbers of those occupied in agriculture for gain have
been reported at the census dates in a form that makes them fairly
comparable.[4]

The explanation of this decrease in the proportion of the population
that is engaged in agriculture is twofold; the first is the real
increase in the productive output per person in agricultural industry.
In larger part this is due to the increasing use of machinery in place
of simple hand tools, and the substitution of horse-, hydraulic-,
windmill-, steam-, and gasoline-power for human labor. This change has
been made readily in the regions of level fields, but of late has been
made possible to a greater extent in hilly country, by rearranging
and combining the old irregular fields into regular fairly level
rectangular fields easily tillable, while turning the rougher lands
and hillsides into wood lots and pastures.[5] One man, thus, driving
three or four or more horses, can do the work formerly done by two
or more men and do it just as well. The farmers' incomes in different
parts of the country vary pretty nearly with the amount of horse-power
used per man. Economies equally great are made in the work done in the
barnyards and barns. In most parts of the country only a beginning
has been made in these ways, and in future the census will continue to
reflect the progress in these directions.

§ 7. #Transfer of work from farm to factory#. The other part of the
explanation of the decrease in the proportion of the population that
is engaged in agriculture is that many operations are, step by step,
being transferred from the farm to the factory. "Agriculture," we have
observed, is a great complex of industries, in which many different
products are taken from the first simplest extractive stage, and then
put through successive processes to make them more nearly fitted for
their final uses. Not so long ago grain cut in the field was threshed,
winnowed, shelled, made into flour, and baked on the farm, as it still
is in many places. Logs were cut into boards, planed, and made into
houses or furniture by the farmer. The old-time farmer made by hand a
large number of his farm implements--rakes, ax handles, pumps, carts,
and even wagons. Until a generation ago all butter, cheese, and other
dairy products were made on the farm. Now these things are being done
in steadily increasing proportion by workers classified as in the
manufacturing industries, and agriculture contains fewer separate
industries and processes. Of course there is economy of labor in
nearly all of these changes, but the number occupied in agriculture is
greatly reduced. Many farmers and more farmers' sons are moving from
agriculture into occupations of manufacturing, trade, transportation,
and the professions, and are becoming more narrow specialists.

§ 8. #The rural exodus#. The percentage of persons in the rural
population changes at about the same rate as does that of the persons
occupied in agriculture. In 1890 it was 64, in 1900 it was 60, and in
1910 it was 54 per cent. The percentage of the population in cities of
8000 or more has steadily increased. This phenomenon has been marked
in all of the countries that have been developing along industrial
lines. It has been variously described as "the rural exodus," "the
abandonment-of-the-farm-movement," and "the city-ward drift."[6] It
is only in part explained by the change from agriculture to other
occupations; perhaps even in greater part it is due to the decline
and disappearance in many rural places of small manufacturing and
mercantile businesses before the competition of large business in the
cities. In much of the long-settled area of the country every hillside
stream once turned a little mill to saw timber, grind corn, forge
iron, or weave cloth. Most of these mills are now deserted. In
countless villages the old blacksmith shop, once a center of business,
is abandoned. Here and there a patriarchal smith still serves a
dwindling group of customers and speaks with mingled pride and pathos
of his sons, now in the automobile business in the city.

The movement away from the countryside has been but little
counteracted as yet, but may be more in future, by the growing
enjoyment of rural life, by the back-to-the-land movement, by
interurban railways, by improved roads, and by automobiles.

§ 9. #The farmer's income in monetary terms#. Census figures and some
additional investigations have led to the estimate of the average
real income of the farmers of the United States in 1909, expressed in
monetary terms, as $724. The estimated value of all products, whether
sold or used by the farmer, plus the value of his house rent and fuel
consumed by family, was $1236, from which expenditures of $512 are
deducted for outside labor, and for materials used for operating and
maintaining the farm. Of the $724 the sum of $402 is estimated to
be the labor-income of the family and $322 is estimated to be the
wealth-income (at 5 per cent of the capitalization of the farm). This
was in a period of rising values in farm lands, averaging about $323
per farm annually, and this to most farmers was equivalent to so much
monetary savings. The main items of net income, therefore, are as
follows:

  Rent                                            $125
  Food from the farm                               261
  Fuel                                              35
  Cash                                             303

  Total                                           $724
  Increase in value of farm                        323

  Total estimated monetary income                $1047

Of the total, $422 is a labor-income, and $645 is a wealth income.[7]

It would be difficult, even if the available statistics were much more
exact than they are, to compare exactly the farmer's income with those
of urban classes. Averages of such large numbers and over such a wide
area have a limited significance in the specific case; and living
conditions and the purchasing power of money are so different in
country and city and in different parts of the country.[8]

§ 10. #Compensations of the farmer's life#. In bare monetary terms
the average farmer's family gets a labor-income less than that of the
ordinary wage-earner in a factory, and it is only by the aid of the
wealth-income that it appears to fare as well or better. Even the few
largest incomes made in farming are small in comparison with many of
those made in commerce, transportation, and manufacturing. The great
mass of farmers of the nation are hard-laboring men, poor in the eyes
of the city dwellers.[9]

But this much is certain: the farmer's income in monetary terms has
on the average much larger power to purchase the main goods of life
(material and psychic goods) than it would have in town. Equally good
house usance would cost more in nearly all towns, and much more in
larger cities. Retail prices of the same food and fuel even in small
towns would be much greater. The necessary outlay for clothes to
maintain the class standard is much less for farmers than for city
dwellers. Moreover, in the use of horses and carriages, and now of
automobiles, and in the free control of his own time--in many elements
of psychic income--the farmer is on a parity with men in other
occupations of double or quadruple his income expressed in monetary
terms.

Tho the farmer's working day in the busiest season of summer is very
long compared with that of factory or office workers, his working
day at other seasons is usually much shorter than the average urban
worker's day. The farmer's life is nearly always free from the
excessive pressure, haste, and competition of city life, and the
value, to many a man, of the more natural and wholesome conditions of
outdoor life and outdoor work are hardly to be measured in terms of
even the most untainted dollars.

§ 11. #Ownership and tenancy.# Since 1880, when the first figures
on farm tenures were collected, the proportion of farms operated by
owners has steadily decreased.

                          Percentage of farms operated by
                     Owners       Cash tenants   Share tenants

  1880 ............   74.5             8.0            17.5
  1890 ............   71.6            10.0            18.4
  1900 ............   64.7            13.1            22.2
  1910 ............   63.0            13.0            24.0

These statistics arouse fears that the class of independent farmers
operating their own farms is gradually giving way to a tenantry
in America. But in some respects the figures are misleading unless
carefully interpreted. The increasing proportion of tenants is due not
so much to owners falling into the class of tenants as to the
hired laborers rising into the class of tenants. The number of male
operating owners compared with all male workers (not merely with all
farms) has remained almost constant at about 42 per cent; while the
per cent of hired workers has decreased from 43.3 (in 1880) to 41.4
(in 1890) and to 34.6 (in 1900). Most hired men on farms are farmers'
sons; the city boy does not adapt himself readily to farm work. Most
hired men of native stock become tenants, and finally owners. Only 11
per cent of the hired workers in agriculture (in 1900) were over 35
years of age.

The landlord of a farm let to a tenant, especially to a share tenant,
is still to a large extent the general manager, controlling in a
large measure through the renting contract and by his oversight, the
operations of the farm. Older men find that letting the farm to
a share tenant is easier for them and gives better results than
continuing to operate the farm with hired labor. And it evidently
gives a man a somewhat higher status to become a tenant than to
continue to be a hired laborer. In the South this movement has taken
on large proportions in the breaking up of large plantations once
operated by the owner with hired labor, and now let in smaller lots
to operating tenants. Yet such a change appears, statistically, as a
decrease in the proportion of farms operated by owners. Despite these
somewhat reassuring facts, the problem of maintaining and increasing
operating ownership of farms in America is one deserving of the most
earnest thought and efforts. The best form of farm tenure is
not necessarily that giving the best immediate economic results.
Politically in a democratic nation, and sociologically in its effects
upon the size of families and the raising of healthy children, the
preservation of an independent American yeomanry is of fundamental
importance to the nation.

The problem is as difficult as it is important, and becomes more
difficult with the rise in the acreage value of lands and with the
economical size of farms, both calling for a larger investment to
become an owner. Changes in the system of taxation should be made with
reference to this object; the system of agricultural credit should be
developed and administered to assist; special efforts in agricultural
education should be made and active administrative efforts should be
directed, toward this important end.


[Footnote 1: See above, ch. 1, secs. 7 and 8.]

[Footnote 2: See ch. 14, sec. 5.]

[Footnote 3: See Vol. I, p. 437.]

[Footnote 4: It must be observed in studying these figures, that
farmers' wives and children, working at home, are not reported as
gainfully occupied. But a widow or a spinster owner, if herself acting
as the enterpriser, is reported as "occupied" in agriculture. The
increasing number of such cases in the past generation in part
explains the growing number and percentage of females in agriculture.

          Number occupied in agriculture   Per cent of all persons occupied
            Males      Females  Both sexes      Males Females Both sexes

  1880... 7,068,658    594,385   7,663,043      47.9   22.5      44.1
  1890... 7,787,539    678,824   8,466,363      41.4   17.3      37.2
  1900... 9,272,315    977,336  10,249,651      39.0   18.4      35.3
  1910...10,582,039  1,806,584  12,388,623      35.2   22.4      32.5
]

[Footnote 5: See further, ch. 26, secs. 1 and 2 on the size of farms
as an economic factor.]

[Footnote 6: See above, sec. 2, on the distinction between rural and
agricultural. In part the change here noted results from increases in
the population of towns and incorporated places from a little below
2500 to something about 2500. For example, if there were 2499 persons
in a town in 1900 they would all be classified as rural; if in 1910
there were 2500 or more they would all be classified as urban.]

[Footnote 7: Sec Vol. I, p. 225, and note 11.]

[Footnote 8: See Vol. I, p. 206.]

[Footnote 9: See Vol. I, p. 227, note, for figures on owners and farm
laborers.]




CHAPTER 26

PROBLEMS OF AGRICULTURAL ECONOMICS

  § 1. Size of farms, and total farming area. § 2. Influences acting
  upon the size of farms. § 3. Self-sufficing versus commercial farming.
  § 4. Farming viewed as a capitalistic enterprise. § 5. Diversified versus
  specialized farming. § 6. Conditions favoring diversified farming. § 7.
  Intensive farming in Europe and America. § 8. Prospect of more intensive
  cultivation of land in America. § 9. The new agriculture. § 10.
  Difficulty of coöperation among farmers. § 11. Rapid growth of farmers'
  selling coöperation. § 12. Some economic features of farmers' selling
  coöperation. § 13. Coöperation in buying. § 14. Need of agricultural
  credit. § 15. Recent provisions for farm loans.


§ 1. #Size of farms, and total farming area#. The average area of
farms has varied from a maximum of 203 acres, in 1850 (the first
figures), to a minimum of 134 acres in 1880, being 138 acres in 1910.
A better index, perhaps, is the average improved area per farm, which
has been more nearly stationary, varying from a maximum of 80 acres
in 1860 to a minimum of 71 acres in 1870 and 1880, being 75 acres in
1910. Here again the statistics require interpretation, for in the
spread of the frontier the addition of large farms in the arid and
semi-arid regions may raise the average, or the breaking up of large
plantations in the South may decrease the average, without this
indicating any essential change in the technical conditions of farming
in the country generally. Since about 1900 the total area in farms has
increased very slowly. Between 1900 and 1910 the increase was only 4.8
per cent; whereas a larger increase occurred in the area of improved
land, 15.4 per cent, and the unimproved area in farms decreased
5.6. Future changes of farm areas may be expected to be of this same
nature, mainly in the improvement of rough pastures, swamps, partly
cleared woodlands, and desert lands awaiting irrigation. An increasing
population will have to be provided with food and other products of
agriculture on a farming area that henceforth will be increasing less
rapidly than it has in the past and than the population increases.

§ 2. #Influences acting upon the size of farms#. In these averages
for the whole country many conflicting influences unite and neutralize
each other. Making for smaller farms is the breaking up of large
grazing areas in the West into smaller general purpose farms or
irrigated fruit districts, and of larger general farms in the North
and East into small poultry, flower, and fruit farms. Opposed to this
is a movement toward the merging of farms of 50 to 100 acres into
larger farms of 300 acres, more or less. The economic cause of this
movement is interesting and important. The typical and economic size
of farms when the Atlantic states were settled, was determined by the
use of hand tools, which permitted a man and his family to operate a
farm of about 75 acres of which about half was tilled and the rest was
in permanent pasture and woodland. The fields were small and were laid
out irregularly, which was no disadvantage for hand cultivation. But
for the most economic use of land in field crops and under more modern
conditions it is necessary to have pretty level fields, of regular
rectangular shape. The farm unit should be of such extent as to permit
of the proper use of the soil by rotation of crops, and to employ
fully the best modern labor-saving machinery for each purpose.
Numerous recent agricultural surveys point to the conclusion that for
general farming this unit is a comparatively large area of about 300
acres.

These conditions offer a reward to those agricultural enterprisers
who can purchase lands at a price based upon the high costs and lower
yields of the older methods and cultivate them at the lower costs and
with the larger yields of the newer methods. This movement, therefore,
toward the consolidation of smaller into larger farms is likely to
continue in many communities for several decades. This is likewise
an advantage to the community in increasing the production with less
labor. But the net effect upon the social life of the countryside is
more doubtful, and calls for careful consideration.

§ 3. #Self-sufficing versus commercial farming. The typical American
farming family once produced nearly everything it used, and used
nearly everything it produced. It was very nearly a self-sufficing
economic unit, "a closed economy," as it sometimes called. Food,
clothing, fuel, lumber, houses, furniture, tools, were on the farm
carried through the various processes from the first gathering of the
raw materials to the finished product. They were then consumed by the
farm household. It is true that even in the first settlements there
were some craftsmen, cobblers, millers, weavers, blacksmiths--whose
services and wares were got by trading some of the surplus products
from the farms--butter, cheese, eggs, wool, hides, furs, live stock,
grain lumber. A few rare commodities of foreign make found their way
to the farm through peddlers and merchants; but altogether the goods
produced outside the farm were a small fraction of the family's
consumption, and were exchanged for but little of the farm's
production. Most farmers tried to produce for themselves, as far as
possible, everything their families needed, when the soil and
situation were poorly suited to the purposes. True, there were early
some exceptions to the general rule, where only one kind of crop was
taken from the land. Such was the forest product of masts, shingles,
lumber, and turpentine, and the great southern staple, tobacco, and
later, cotton. The exceptions have been tending to become the rule
in more and more communities. Farmers have been specializing more
and more in the kinds of products to which their farms are adapted in
respect to soil, relation to market, and otherwise. These products are
taken to market and sold for money with which are bought the things
needed for use on the farm.

§ 4. #Farming viewed as a capitalistic enterprise#. Thus the farm
comes to be looked upon more and more, not just as a home, but much as
if it were a commercial enterprise or a factory, by which products are
made for sale. This change, to be sure, is far from complete, as the
figures for the average farmer's income show that a large share of the
family living still comes from the farm. It has gone on much further
in some districts than in others, as is indicated in the types of
farming discussed below. But just to the extent that the farmer grows
crops to sell, his outlook on his work undergoes a change. He is
less exclusively a farmer, concerned with the technical processes of
farming; he must be more largely a business man. Like a manufacturing
enterpriser, he buys the factors of production, combines them into
new products, and sells them again. He becomes interested in market
conditions and prices. He grows more commercially-minded. He views
the farm no longer as a fixed area, but one that may be enlarged by
purchase or by rental, and that may be reduced by selling or letting
the less needed parts. One-fifth of farm owners now rent additional
land. In commercial farming the land is not contrasted with capital as
something apart, consisting of the value of the equipment and stock;
but the whole complex of land and other goods is thought of as a
capital-investment. The greater ease of transferring landed-property
in America and the greater mobility of our population have always made
it more natural here than in Europe to look upon land as a capital
investment. This view is now becoming more general as a result of the
commercializing of farming enterprise.

This change has been favored by other influences. Particularly has
the use of machinery and of other equipment, calling for a larger
investment per man and per acre, been making agriculture, in its
form of enterprise, more and more like manufacturing and commercial
undertakings.

§ 5. #Diversified versus specialized farming#. To be self-sufficing a
farming family must carry on general farming, that is, must produce
a diversity of products. As farming becomes more commercialized it
necessarily becomes somewhat more specialized, and produces a smaller
variety of products. In some parts of the country and on particular
farms this specialization is extreme: in California, citrus fruits, or
prunes, or beans, may be the only crop raised; wheat in Kansas and
the Dakotas, and dairy products in thousands of farms surrounding
the great cities, are the main, tho not the exclusive products. Many
farmers in these districts have no gardens or orchards, keep no cow,
and buy much or all of the grain for their horses, as well as milk,
butter, vegetables and fruits for their own use. Poultry and eggs
are shipped in trainloads two thousand miles from the Middle West to
California to be consumed by orange growers. Many farmers in the East
no longer keep sheep, pigs, or beef cattle, and they buy out of the
butcher's wagon all the meat except fowls used by their families. This
partly explains the decrease of live stock in the whole country in
recent years and the increase in the price of meat.

§ 6. #Conditions favoring diversified farming#. There are, however,
limits to the net advantage of specialization in crops, and competent
authorities on agriculture question whether in many cases that limit
has not been readied and passed. Most farms have a variety of soils
and of conditions--hilltops, slopes, bottom lands--which are suitable
for different purposes. A rotation of crops is necessary to get good
yields. Live stock must be kept to maintain the fertility of the land,
which deteriorates fast if hay and grain are continually sold. Some
live stock can be kept on every farm very cheaply with the food that
would go to waste otherwise. The specialization in stock raising in
the prairie states ceased to be profitable when lands became more
valuable. Specialization in wheat production in the states just west
of the Mississippi is possible only so long as wheat will grow on
the virgin soil without costly fertilizers. The cotton farmers of
the South, especially the negro farmers, have been forced by debt and
thriftlessness into a one-crop policy that is now seen to be wasteful
in the long run. A variety of production is necessary to employ labor
somewhat regularly on a farm throughout the year. These and other
conditions will make most farming always an industry of comparatively
diversified products. Only 1 per cent of the farms get as much as 40
per cent of their receipts from fruit; 2 per cent get that much from
tobacco; 3 per cent from vegetables; 6 per cent from dairy products;
and 19 per cent from cotton. The remaining 60 per cent of receipts
were in most cases from various sources, and these figures did not
include the value of produce consumed by the farmer's family.

§ 7. #Intensive farming in Europe and America#. No other farm problem
interests the city man so much as that of increasing the production
of the land. To most city men farming hardly seems to be an occupation
giving livelihood and life to the farmer; it seems rather to exist
for the sole purpose of feeding men living in cities. The city man,
therefore, measures the success of farming not by the farmer's income,
by the level of countryside prosperity, but by the number of bushels
per acre raised to ship to town. Every city newspaper and magazine
contains articles pointing to the fact that larger crops per acre
are raised in Europe than in America, and broadly suggesting that the
American farmer could do as well, if only he would. Foreign travelers
comment in like vein on the wasteful use of land in America as
compared with farming methods in Europe.

Land is used most extensively, with respect to labor, when it is in
forests; somewhat less so when in pasture as care must be given to the
live stock; and still less when used for hay, grain, and other crops.
But the use of machinery in large fields is far more extensive than
the patient work of peasants with their hand tools. The more labor or
the more equipment (or both together) that is put upon an acre, the
larger the product, but the larger the cost per unit. It is a familiar
economic principle.[1] It would bankrupt any farmer, excepting the
millionaire amateur, to farm in America by European methods. American
farmers, at least many of them, could raise as many bushels per
acre and keep their farms as thoroly cultivated as do the European
peasants, if wages were as low here as are the peasants' incomes.

§ 8. #Prospect of more intensive cultivation of land in America#. As
the aggregate need for food increases in America there must come a
steady pressure upon our stock of land uses, resulting in decreasing
returns to labor in agriculture, unless this movement can be
counteracted by the spread of better methods in agriculture--not
European peasant methods, but new American methods consistent with
high labor-incomes. A good deal of our farm land is undoubtedly too
intensively used now in view of present and prospective commodity
prices and wages. Maladjustment of land uses has resulted
from mistaken judgment, from changing conditions as to prices,
transportation, and markets, and from loss of soil fertility. There
are thus, on nearly every old farm, some fields that would better be
in pasture and much hillside pasture that would better be woodland. It
is often declared extravagantly that our country could support easily
the total population of China, or as great a population per square
mile as that of Italy. If it did so it would be only on the penalty
of lowering wages toward, if not quite to, the level of the Chinese
coolie or of the Italian peasant. Great metropolitan dailies gravely
present as an argument in favor of unrestricted immigration, the
proposition that "if" the cheaper immigrants would but go upon our
"waste" land (which they refuse to do), and raise food by European
methods the problem of the rising cost of food in the cities would be
solved. This urban ideal of a frugal, low-paid agricultural peasantry
can hardly be adopted in America as the national ideal. Rather,
it would seem, any movement toward more intensive agriculture that
necessitates a lowering of the standard of living of the masses of the
American people will, when it is recognized, be condemned and opposed.

§ 9. #The new agriculture#. Agricultural method, the technic of
farming, has been constantly progressing for two hundred years in
Europe and in America, Were it not for this, the great growth of
population on this combined area would have been quite impossible.
But the betterments since about 1890 in America have been especially
great. They are mostly the first large fruits of the scientific study
made possible by the land-grant colleges and agricultural experiment
stations fostered by state and national, legislation. These many
diverse improvements are grouped under the general title of "the
new agriculture." Its chief features are: new machinery and other
labor-saving methods; better methods of cultivation of the soil;
better selection of seed; introduction of new plants and trees from
abroad to utilize low-grade lands; plant-breeding to develop new
varieties of better quality, heavier bearing, or immune to disease;
more efficient and economical ways of maintaining soil fertility;
better methods of marketing; and better technical education of the
individual farmer. Each of these topics, and a number of other minor
ones, would require a chapter in a complete treatise on agricultural
economics. Here this mere enumeration must be allowed to convey its
own suggestion of far-reaching results for the whole political economy
of the nation and of the world.

Indeed, so much has been written in a Barnumesque way of the
wonders of the new agriculture, that its actual results and further
possibilities are in many minds absurdly exaggerated. It has not as
yet been potent enough to prevent diminishing returns in respect to
the great staple foods and raw materials obtained by agriculture.
It apparently has barely kept pace with the needs of the growing
population of Christendom. It has enabled a larger population to exist
in about the same, if not in a worse condition, on the same area,
while progress in cheapness of goods has come almost entirely from the
side of the chemical and the mechanical industries. It does not
give the promise of an indefinite amelioration of the lot of an
indefinitely multiplying population. But to a population slowly
increasing, a new and ever newer agriculture, utilizing constantly the
achievements of the natural sciences and the mechanic arts, ensures
the possibility of a steady betterment of the popular welfare in city
and in open country alike.

§ 10. #Difficulty of coöperation among farmers#. Rural communities
are proverbially conservative; the American farmer is proverbially
an individualist. No wonder, then, that the new ideas and plans of
coöperation in business matters have made headway in agriculture
slowly and with difficulty. The need of mutual aid among American
farmers is especially great, for, as has often been, said, isolation
is the problem of the farm as congestion is that of the city. On the
frontier a coöperative spirit manifested itself frequently in mutual
helpfulness, in house raising bees, husking bees, threshing bees, and
other similar gatherings.

But this spirit seems to have almost disappeared in the older
communities, the more rapidly doubtless in the period of decaying
agricultural prosperity.[2] To-day, for example, it is impossible on
a certain Pennsylvania road for one more progressive farmer to get
his neighbors to coöperate in so simple a matter as hauling their
milk cans to the creamery, and so every day in the year ten horses are
hitched to ten delivery wagons carrying two or three milk cans apiece,
and driven by ten drivers along the same road to and from the railroad
station. One driver and two horses could easily carry as much or
more, as is done now in many other dairy districts. Even of successful
coöperation among farmers sympathetic critics are forced to say: "Many
students of rural economics assert that coöperation as applied to the
distribution and marketing of farm products is not very successful
unless it is founded upon dire necessity. When the records of the
organizations of the country are analyzed it becomes almost necessary
to accept that statement. So long as farmers do fairly well in their
own way they are not inclined to coöperate."

§ 11. #Rapid growth of farmers' selling coöperation#. Despite what has
just been said, coöperation among farmers now is more developed and is
growing faster than all other kinds of coöperation in America. This
is most marked in farming communities in the West, especially in
California and in the Middle Western or Northwestern states (e.g.,
Minnesota and Wisconsin). There the farmers are younger, and many have
been educated in the state agricultural colleges. They all produce
nearly the same kinds of crops of staple produce which must be shipped
to distant markets. The need of uniting to get what they thought
would be fair treatment from the railroads, and to protect themselves
against the abuses of the competitive commission salesagents, seems to
have given the first impetus to farmers' coöperation.

The most notable developments were those of the California Fruit
Exchange and of coöperative societies of the Northwest for marketing
grain. The membership of the former is made up entirely of the
local citrus growers' associations in California. It has a complete
organization of selling agents in the Eastern cities and a remarkably
efficient, tho simple, system of equalizing and expediting shipments.
Now the agricultural coöperative associations of various kinds are
multiplying all over the country, for shipping live stock, fruits,
butter, cheese, and other farm products. Coöperation for these
purposes called forth new activities; packing houses were built, and
grain elevators and creameries and dairies, and now a goodly number of
the simple manufacturing processes are undertaken by these societies,
now numbering thousands.

§ 12. #Some economic features of farmers' selling coöperation#. This
type of producers' selling coöperation is proving in America to be far
more successful than producers' coöperation among workingmen;[3] and
certain important economic features in it should be noted. The local
producers' selling coöperative society is composed of farmers who as
enterprisers own and carry on their own separate businesses; they
are not, as in the other case, wage workers. Any productive processes
undertaken by this kind of society are subordinate to the main
business, being such as picking, packing, drying, preserving, and
making boxes for packing. This form of coöperation with the related
form of consumers' coöperation that is fostered by it, promises to
have a wide extension.

Some of these societies, as those dealing in citrus fruits, regulate
with some success the picking and the marketing so as to distribute
them more evenly throughout the year. They watch the markets and
direct their agents by telegraph to divert cars _en route_ away from
markets that are glutted with products and into markets where prices
are higher. They take some of the products, as eggs in the spring at
the period of low prices, and pack or refrigerate them, to be sold
when prices are higher. For thus withholding the supply they are said
by some to exercise a monopolistic power. But this is a more than
doubtful view. So long as only the seasonal variations are equalized
and the total supply of the year is not reduced it is, on the marginal
principle, an economic service to the consumers, comparable to
insurance in its utility. Any reduction of the area planted or of the
entrance of others into the industry would be a monopolistic act but
this as yet has not occurred.

§ 13. #Coöperation in buying.# Coöperative buying (called also
consumers' coöperation or distributive coöperation) has had a large
growth in the British Isles, since 1844, when the society called the
Rochdale Pioneers was founded by a group of factory workingmen. The
coöperative stores, both in Great Britain and on the Continent, have
continued to develop mainly among the industrial classes in urban
centers. However, this has not been exclusively the case, and
particularly in Denmark and Ireland coöperative buying has increased
in agriculture in connection with selling associations. Since 1890
the growth of consumers' coöperation among European industrial
wage-earners has been phenomenal, especially in Belgium, Germany, and
Switzerland. American wage-workers, however, have made few and feeble
efforts in this direction.

In the period beginning 1867 many coöperative stores were founded in
America by farmers in the Grange movement, who operated also grain
elevators, warehouses, and steamboat lines. But the movement failed
about 1877. This result is easily explained by lack of commercial
knowledge and lack of harmony among the members, selling on credit,
and inefficient management. A new era in consumers' coöperation for
farmers began about 1900 and now in several widely separated parts
of the country--Minnesota, Kansas, California, Washington, and
elsewhere--the movement is spreading rapidly, supported in large part
by the same persons who are members of the selling associations.

§ 14. #Need of agricultural credit.# Banking originated in cities and
for the use of the merchant-class. It still retains pretty faithfully
its commercial character. The change of farming toward a more
commercial form[4] has been little aided by banking credit. National
banks and many others were forbidden in their charters to lend on the
security of real-estate, the farmer's one business asset.[5] A great
number of farms are always in course of being purchased, the balance
of purchase money being borrowed by the purchaser. A group of private
agencies such as life insurance and mortgage loan companies and local
money lenders has supplied in somewhat costly ways the need of farm
credits. Tho rates of interest have become more equalized throughout
the whole country, they still range between 7 and 10 per cent in the
Southern and Western states, averaging 7 per cent in the whole country
for interest and commission. The need of better opportunities for
credit in the agricultural districts has long been recognized. The
high rate of interest for borrowed money necessarily placed a limit on
improvements in equipment and methods of farming.[6]

§ 15. #Recent provisions for farm loans#. The Federal Reserve Act
made two important changes to improve agricultural credit.[7] Soon
afterward some of the states took more vigorous action to provide
a special system of agricultural credit, especially New York and
Missouri. In the latter state, on the initiative of a public-spirited
citizen of St. Louis, was passed in 1915 a notable act of legislation
known as the Gardner State Land Bank Act (effective December 1, 1916,
provided a constitutional amendment is adopted in November, 1916).
This authorizes the establishment of a land bank, with power to lend
on the security of farming lands, for buying farms and for productive
improvements, and to issue bonds to be sold to investors.

Following this general plan the Federal Farm Loan Act became law
July 17, 1916. It authorized the establishment of twelve Federal Land
Banks, each with a capital of not less than $750,000 to make loans
through national farm loan associations organized somewhat after the
model of the building and loan associations. The bonds issued by these
banks are to bear not to exceed 5 per cent interest. It is hoped that
they will have the high credit of municipal bonds so that they may
be sold at parity, bearing interest at 4 or 4.5 per cent. The loan
is repaid by the farmers under a regular plan of amortization. The
practical results of these measures are yet to appear. They are
expected to give to loans that are made on the security of farms as
wide a market and as high credit as state and municipal bonds now
have. They bid fair to bring the rate of interest on long-time loans
to farmers down to 5 per cent or less in the remotest parts of the
land. This will stimulate agricultural improvement, and facilitate
the purchase of land by tenants. Where the interest rate has been
the highest it should raise the value of farm lands as it brings them
within the circle of a lower-interest-rate economy. This may hasten
the transfer of the lands from less provident to more provident
owners, who are willing to take the land at a higher capitalization.
But the system of loans will probably help to develop greater thrift
in the younger farming population.


[Footnote 1: See Vol. I, chs. 12 and 13 on proportionality and
usance.]

[Footnote 2: See ch. 25, secs. 4 and 5.]

[Footnote 3: See above, ch. 19, secs. 13, 14, 15.]

[Footnote 4: See above, sec. 3.]

[Footnote 5: See ch. 8, sec. 8.]

[Footnote 6: See Vol. I, pp. 495-497, on the relation between lower
interest rates and productive processes.]

[Footnote 7: See ch. 9, sec. 7 on time deposits, and sec. 9 on farm
loans.]




CHAPTER 27

THE RAILROAD PROBLEM

  § 1. Rise of the corporation concept. § 2. The modern era of
  corporations. § 3. Beginning of corporation problems. § 4. The era of
  canals. § 5. Rapid building of American railroads. § 6. Reasons for
  governmental aid. § 7. Kinds of governmental aid. § 8. Emergence of
  the railroad problem. § 9. Discrimination as to goods. § 10. Local
  discrimination. § 11. Personal discrimination. § 12. Economic power
  of railroad managers. § 13. Political power of railroad managers,
  § 14. Consolidation of railroads. § 15. State railroad commissions. § 16.
  Passage of the Interstate Commerce Act. § 17. Working of the Act.
  § 18. Public nature of the railroad franchise. § 19. Other peculiar
  privileges of railroads. § 20. Private and public interests to be
  harmonized.


§ 1. #Rise of the corporation concept#. In the legal systems of
primitive people and long afterward, only natural persons had legal
rights, could make contracts, have property, and carry on a business.
But in a number of cases, very early, groups of men came to have
certain interests in common and certain possessions. Gradually some
such groups gained more or less of legal recognition, with certain
political and economic rights as a body and not as individuals.
Thus evolved the conception of a "corporation" (body) having men as
"members," an artificial person, yet not the same as any one or as all
the individuals together, and legally distinct from the individuals.
A group of burghers obtaining a charter from the lord of the realm
became a municipal corporation; a group of teachers, a _collegium_,
became the corporation of the college or a university (a number of
persons united into one association); a group of craftsman became a
gild-corporation. Each corporation had certain rights, privileges, and
immunities, and used a corporate seal as a signature. All of the early
corporations had some economic features that were incidental to the
main purposes, which were political, ecclesiastical, educational,
and fraternal. Toward the end of the Middle Ages groups of traders
obtained charters to act as corporations permanently for business
purposes, such as foreign trade, colonization, and banking. These
increased in the sixteenth and seventeenth centuries, and in the
eighteenth century this form of organization was adopted also and
parliamentary charters obtained, by groups of men for building
turnpikes and canals and for carrying on other kinds of business.

§ 2. #The modern era of corporations#. The great era of the
corporations did not begin, however, until well on in the second
quarter of the nineteenth century. Then, both in Europe and in
America, the corporate form of organization was extended to a greater
number, and to other kinds, of enterprises. It proved itself to be
well adapted to enterprises for the construction and operation of
canals and railroads, requiring a larger amount of capital than
usually could or would be risked by one person. The investor in a
corporation bought shares, and his liability for debts and losses
was limited by charter to his share capital. It is an advantage that
permanent enterprises of that kind are owned by corporations
with charters perpetual or for long periods. It is possible for
corporations to make investments running for longer periods than would
be safe for individuals. The corporation with an unlimited charter
has legally an immortal life. Sale and change of management are not
necessary on the death or failure in health of any one owner. As the
factory system and large production developed, the corporate form of
organization was found to have these same advantages in manufacturing.
It appeared in textile, iron, mercantile, and other industries. After
1865 the corporate form of organization increased at a cumulative
rate, until now it is applied to many enterprises of small extent and
local in operation. There are 300,000 corporations making returns
to the United States Commissioner of Internal Revenue.[1] There were
70,000 manufacturing corporations, which were 26 per cent of the whole
number of manufacturing establishments, but which employed 76 per cent
of all wage earners and turned out 79 per cent of the whole product.

§ 3. #Beginning of corporation problems.# With the corporations
came "the corporation problem," a single name for a complex of
problems--legal, political, moral, and economic--which arise out of
the relations of corporations to their individual stockholders, to
their employees, to the state, to the general public, and to their
competitors in business. The problems differ also in corporations of
different sizes and in different businesses. We shall discuss in
this and succeeding chapters but a few of the larger aspects of the
corporation problem, the railroad, the industrial trust, and certain
other kinds of monopolistic industry.

Of the various forms of corporations, banks first presented problems
calling for economic legislation and regulation. This is explained by
the fact that it was the first kind of business corporation to become
important, and further by the fact that its work was in various ways
closely connected with the coinage and regulation of money, which had
already become a governmental function. The railroad was the form
of corporation next in point of time to become a great problem; this
because of the peculiarly vital and far-reaching effects that such
railroad transportation has upon all other kinds of business in the
community, as appears in what follows.

§ 4. #The era of canals.# Canals were used in the ancient empires
for irrigating, for the supplying of cities with water, and for
navigation. In the late eighteenth and the early nineteenth centuries
they were rapidly built in England and America. Six canals had been
built in the United States before 1807, but the "canal-era" in America
dated from the beginning of work on the Erie canal in 1817, and
continued until about 1840, when nearly all new work ceased; over 4000
miles of canals had been built at a cost of $200,000,000.

The great advantage of canals is cheapness of operation due to the
simplicity of the machinery needed and to the great loads that can be
moved with small power. A cent a ton-mile proved to be a paying rate
on a small canal. For heavy, slow-moving freight, a railroad can even
now barely rival a parallel canal at its best. As canals, however, can
be built only along pretty level routes and where the water supply is
at high level, their construction is limited to a small portion of the
country. The principle of diminishing returns applies strongly to
the construction of canals; the first canals in favored locations
are easily constructed and economically operated, but it is only
with greater cost and difficulty that the system can be successively
extended. In temperate climates the use of canals is limited by ice
to a part of the year, and by the summer's drought sometimes still
further. At its best, therefore, the small land-locked canal is fitted
only to be a supplementary agent in the system of transportation
wherever another transportation agency of higher speed and greater
regularity is possible. Far different is the case of the oceanic canal
in a tropical climate.

Canals do not appear to have developed any serious problems calling
for public regulation of rates. A first simple legislative act fixing
the rate of tolls for boats was sufficient. Charges were made by
distance as on a toll road and the boats were owned by different
private shippers or by common carriers among whom competition
prevailed.

§ 5. #Rapid building of American railroads#. The canal was just
reaching the peak of popular favor when the railroad in 1830, after a
half-century of slowly accumulating technical improvements, burst into
view as a demonstrated success as a means of transportation.[2] The
railroad excels in adaptability any other agent of transportation; it
can go over mountains or tunnel through them. It is markedly superior
in certainty; it may be blocked for a day or two by floods and snows,
but it suffers no seasonal stoppage of traffic. In speed, even the
early railroad so far excelled that the canal could survive only by
dividing the traffic, taking the lower grades of freight, and leaving
to the railroad the passenger traffic and fast freight. Even in
respect to cheapness, the unique virtue of waterways in favored
localities, the railroad made rapid gains. Improvements in roadbed,
rails, cars, engines, and other equipment soon reduced greatly the
cost of conducting traffic on the main lines of roads. Because of
these qualities railroads soon surpassed in importance every other
agency of internal transportation. The miles constructed and miles in
operation in the United States, by decades since 1830 were as follows
(route mileage, not counting double tracks and sidings):

                            Miles constructed     Total route miles
                                in decade.          in operation.

  1830 ........................       23                     23
  1840 ........................    2,795                  2,818
  1850 ........................    6,203                  9,021
  1800 ........................   21,605                 30,626
  1870 ........................   22,296                 52,922
  1880 ........................   40,345                 93,267
  1890 ........................   73,924                167,191
  1900 ........................   31,773                198,964
  1910 ........................   51,028                249,992
  1915 (5 yrs.) ...............   13,555                263,547

The extension of railroads was so rapid that there was not time for
a gradual adjustment of industrial conditions. In many places the
resulting changes were revolutionary. The building of railroads in
the Mississippi valley in the seventies lowered the value of eastern
farms, ruined many English farmers, and depressed the condition of
the peasantry in all western Europe.[3] With the lower prices that
resulted when the fertile lands of the western prairies were opened
to the world's markets, the less fertile lands of the older districts
could not compete. Many other changes, of no less moment in
limited districts, resulted from the building of railroads. Local
trading-centers decreased in importance. Villages and towns, hoping
to be enriched by the railroads, saw their trade going to the cities.
Commerce became centralized. Enormous increases of value at a few
points were offset by losses in other localities.

§ 6. #Reasons for governmental aid#. The growth of railroads in
America was more rapid than in any other part of the world, but it
did not occur without much help to private capital from governmental
agencies. The railroad enterprise was uncertain, the possibilities of
its growth could not be foreseen, and private capital would not invest
without great inducements. In European countries the railways were
built through comparatively densely populated districts to connect
cities already of large size. Yet railroad extension was very slow
there, even tho the states in many ways aided the enterprises. America
was comparatively sparsely populated, and most of the railroads were
built in advance of and to attract population, business, and traffic.
In many cases railroad building in America was part of a gigantic
real-estate speculation undertaken collectively by the taxpayers of
the communities.

§ 7. #Kinds of governmental aid#. American states recklessly abandoned
the policy of non-interference, and vied with each other in giving
railroad enterprises lands, money, and privileges, in loaning bonds,
in subscribing for stock, and in releasing from taxation. These
fostering measures were expected to increase wealth and to diffuse a
greater welfare through the community. Many states were forced to
the point of bankruptcy by their reckless generosity, and some states
repudiated the debts thus incurred.

The national government then took up the same policy and granted lands
to the states to be used for this purpose. The first case of this kind
was the grant to the Illinois Central road, in 1850, of a great strip
of land through the state from north to south. Grants were made in
fourteen states, covering tens of millions of acres of land. Then the
national government, between 1863 and 1869, aided the building of the
Pacific railroads by granting outright twenty square miles of land for
every mile of track and by loaning the credit of the government to
the extent of fifty million dollars,--a debt which was settled by
compromise only after thirty years.

Counties, townships, cities, and villages then entered into keen
competition to secure the building of railroads, projected by
private enterprise. Bonds, bonuses, tax-exemptions, and many special
privileges were granted. To obtain this new Aladdin's lamp, this great
wealth-bringer, localities mortgaged their prosperity for years to
come. The promoters bargained skilfully for these grants, playing off
town against town, cultivating the speculative spirit, punishing the
obdurate. Not the civil engineer, but the railroad promoter determined
the devious lines of many a railroad on the level prairies of America.
The effects of these grants were in many cases disastrous, and after
1870 they were forbidden in a number of states by legislation and by
constitutional amendments. But before this era of generosity ended,
probably the railroads in America had received more public aid than
has ever been given to any other form of industry in private hands.

§ 8. #Emergence of the railroad problem#. In most charters and laws
authorizing the building of railroads, either nothing was specified
regarding rates, or maximum rates were fixed which proved to be so
high that they were of little, if any, practical effect. But very soon
began to appear some serious evils in the policy of railroads toward
the shipping and traveling public in matters of rates and of service.

As the ownership of the wagons, ships, and canal-boats of a country
is usually divided, ocean ports and points along the lines of
turnpikes and canals enjoy competition between carriers. In the early
days of the railroads it was believed that a company or the government
would own the rails and charge toll to the different carriers, who
would own cars and conduct the traffic as was done on the canals.
Experience soon showed the impracticability of this scheme and the
need of unified management. An operating railroad company, therefore,
has a monopoly at all points on its line not touched by other
carriers. This, like any other monopoly, is limited, for the railroad,
to secure traffic, is led to meet competition of whatever kind--that
of wagons, canals, rivers, or of other railroads--wherever it occurs.
The railroads in private hands early began to "charge what the traffic
would bear," high where they could, and low where they must, to get
the business. Thus developed the various forms of discrimination which
are now to be described.

§ 9. #Discrimination as to goods#. Discrimination as to goods is
charging more for transporting one kind of goods than for another
without a corresponding difference in the cost. When reasonably
understood, this proposition does not apply to a higher charge for
goods of greater bulk, as more per pound for feathers than for iron,
the "dead weight" of car being much greater in one case than in the
other. It does not apply where there is a difference in risk, as
between bricks and powder, or coal and crockery; nor where there is a
difference in trouble, as between live stock and wheat. Any difference
that can reasonably be explained as due to a difference in cost is
not discrimination; on the other hand a difference in cost without a
difference in rate is discrimination. Discrimination as to goods may
be by value, as low rates for heavy, cheap goods, and high rates for
lighter, valuable ones. Coal always goes at a low rate as compared
with dry goods, and sometimes more is charged for coal to be used for
gas than for coal to be used for heating purposes.

Railroad discrimination so frequently has resulted in injustice to the
shipping public that the term has taken on an evil significance. But
it is well to observe that the word discrimination is not derived from
_crimen_ (crime), but from _discernere_ (to discern). There are
both reasonable and unreasonable forms of discrimination. In
general discrimination as to goods more often appears, under certain
conditions and made with due regard to the public interest, to
be reasonable; less often to be justified is the form of local
discrimination, next to be described; and least often of all to be
justified is the last named form of personal discrimination.

§ 10. #Local discrimination#. Discrimination between places (called
also local discrimination) is charging different rates to two
localities for substantially the same service. This occurs when local
rates are high and through rates are low; when rates at local points
are high and at competing points are low; when less is charged for
shipments consigned to foreign ports than for domestic shipments;
when, more is charged for goods going east than for goods going west.
The causes of local discrimination are: first, water-competition,
found at great trade centers such as New York and San Francisco;
second, differences in terminal facilities, making some places better
shipping-points than others; third, competition by other railroads,
which is concentrated at certain points, only one tenth of the
stations of the United States being junctions; fourth, the influence
of powerful individuals or large corporations and the personal
favoritism shown by railroad officials.

The effects of local discrimination are to develop some districts and
depress others; to stimulate cities and blight villages; to destroy
established industries; to foster monopolies at favored points; and to
sacrifice the future revenues of the road by forcing industry to move
in the competing points to get the low rates. The power of railroad
officials arbitrarily to cause rates to rise or fall is happily
limited in practice by the need of earning as large and as regular
an income as possible, but even as exercised it has been at times as
great as that possessed by many political rulers.

§ 11. #Personal discrimination#. Discrimination between shippers
(personal discrimination) is charging one person more than another for
substantially the same service. This most odious of railroad vices,
rarely practised openly, is done by false billing of weight, by
wrong descriptions or false classification to reduce the charge below
published rate-sheets, by carrying some goods free, by issuing passes
to some and not to all patrons under the same conditions, or by
donations or rebates after the regular rate has been paid. In some
cases a subordinate agent shares his commission with the shipper, and
the transaction does not appear on the books of the company. In other
cases favored shippers are given secret information that the rate is
to be changed, so that they are enabled to regulate their shipments to
secure the lower rate.

One group of reasons for personal discrimination is connected with the
interests of the road. It is to build up new business; it is to
make competition with rival roads more effective by favoring certain
agents, as was very commonly done in the Western grain business; it
is to exclude competition, as by refusing to make a rate from a
connecting line or to receive materials for a new railroad which is
to be a competitor; and it is to satisfy large shippers whose power,
skill, and persistence make the concession necessary. Another group of
reasons has to do with the interests of the corporate officials. It is
to enable them to grant special favors to friends; or it is to build
up a business in which they are interested; or it is to earn a bribe
that has been given them.

The evils of personal discrimination are great. It introduces
uncertainty, fear, and danger into all business; it causes business
men to waste, socially viewed, an enormous fund of energy to get good
rates and to guard against surprises; it grants unearned fortunes and
destroys those honestly made; it gives enormous power and presents
strong temptations to railroad officials to injure the interests of
the stockholders on the one hand and of the public on the other.

§ 12. #Economic power of railroad managers.# Other evils of
unregulated private management of railroads appeared. When the
railroad was a young industry, it was thought to be simply an
iron-track turnpike to which the old English law of common carriers
would apply. This and similar notions soon, however, proved illusory.
It was seen that the higher railroad officials had, in the granting
of transportation service and the fixing of rates, a great economic
power. They had complex and sometimes conflicting duties to
the stockholders and to the shipping public. They wore their
conscience-burdens lightly, before the days of effective regulation,
and frequently made little attempt to meet the one and no attempt
whatever to meet the other obligation. The opportunities for private
speculation brought to many railroad managers great private fortunes.
There were no precedents, no ripened public opinion, no established
code of ethics, to govern. It was a betrayal of the interests of
the stockholders when directors formed "construction companies" and
granted contracts to themselves at outrageously high prices. It was
an injury not only to shippers, but also to the stockholders, when
special rates were granted to friends and to industries in which the
directors were interested. In general, however, the interests and
rights of the stockholders were more readily recognized than
were those of the public. A railroad manager is engaged by the
stockholders, is responsible to them, and looks to them for his
promotion. Hence their interests are uppermost whenever the welfare
of the public is not in harmony with the earning of liberal dividends.
The managers long felt bound to defend the principle of "charging what
the traffic will bear" in the case of each individual, locality, and
kind of goods, even if this ruined some men and enriched others, and
if it destroyed the prosperity of cities to increase the earnings of
the road.

§ 13. #Political power of railroad managers.# Likewise in various ways
railroad managers may exercise great political influence and power.
Some writers maintain that the power to make rates on railroads is
a power of taxation. They point out that if rates are not subject to
fixed rules imposed by the state, the private managers of railroads
wield the power of the lawmaker. By changing the rates on foreign
exports or imports, the railroads frequently have made or nullified
tariff rates and have defeated the intention of the legislature.
High rates on state-owned roads in Europe have been used in lieu of
protective duties. These facts go to show that a change of railroad
rates between two places within the country is similar in effect to
the imposing or repeal of tariff duties between them.

The wealth and industrial importance of the railroads soon began to
give them widespread political power in other ways. It was commonly
charged in some states that the legislature and the courts were
"owned" by the railroads. The railroads, in part because they were
the victims at times of attempts at blackmail by dishonest public
officials, declared that they were compelled, in self-defense to
maintain a lobby. The railroad lobby, defensive and offensive, was, in
many states, the all-powerful "third house." Railroads even had their
agents in the primaries, entered political conventions, dictated
nominations from the lowest office up to that of governor, and elected
judges and legislators. The extent to which this was done differed
according as the railroads had large or small interests within the
state. These statements can with approximate truth now be made in
the past tense, as was not possible a few years ago. A better code
of business morality has developed, and the railroad management's
relationship of private trusteeship toward the shareholders and of
public trusteeship toward the patrons of the road is now much more
fully recognized. The change was not brought about without long and
strenuous agitation and effort, educational and legislative, as is in
part described below.

§ 14. #Consolidation of railroads#. Gradually the consolidation of the
railroad mileage into larger units put into fewer hands greater and
greater economic power. The early railroads, many of which were built
in sections of a few miles in length, have been slowly welded into
continuous trunk lines with many branches. The New York Central
between Albany and Buffalo was a consolidation, by Commodore
Vanderbilt, of sixteen short lines. The Pennsylvania system was formed
link by link from scores of small roads. In the decade of the nineties
the growth of consolidation went on more rapidly than ever before. In
1903 it could be said that 60 per cent of the mileage of the United
States was under the control of five interests; 75 per cent was
controlled by a group of men who could sit about one table. The
country was being divided territorially into great railroad domains,
within each of which one financial interest was dominant. Since that
time the policy of the leading roads has been still further unified
by great financial alliances and by the method known as "community of
interests."

Toward this result strong economic forces have been working.
Consolidation has many technical advantages: it saves time, reduces
the unit cost of administration and of handling goods, gives better
use of the rolling stock and of the terminal facilities of the
railroads, and insures continuous train service. It has the advantage
of other large production and the possible economies of the trusts.
Most important, however, from the point of view of the railroads, is
the prevention of competition and the making possible of higher
rates and larger dividends. The statement that competition is not an
effective regulator of railroads often is misunderstood to mean that
it in no way acts on rates. It is true that competition between roads
does not prevent discrimination and excessive charges between stations
on one line only; but competition usually has acted powerfully at
well-recognized "competing points." The larger the area controlled
by one management, the fewer are the competing points; the larger,
therefore, is the power over the rate and the more completely
the monopoly principle applies. It is a grim jest to say that
consolidation does not change the railroad situation as regards the
question of rates.

§ 15. #State railroad commissions.# When it became evident that public
and private interests in the railroads were so divergent, it still was
not easy to determine how the public was to be safeguarded. At first,
some general conditions such as maximum rates were inserted in the
laws and charters; but these were not adaptable to changing conditions
and, for lack of administrative agents, could not be enforced. Some
early efforts at state ownership were disastrous. The old law of
common carriers gave to individual shippers an uncertain redress in
the courts for unreasonable rates; but the remedy was costly because
the aggrieved shipper had to employ counsel, to gather evidence, and
to risk the penalty of failure; it was slow, for, while delay was
death to the shipper's business, cases hung for months or years in
the courts; it was ineffectual, for, even when the case was won, the
shipper was not repaid for all his losses, and the same discrimination
could be immediately repeated against him and other shippers.

In the older Eastern states, attempts to remedy these and other evils
by creating some kind of a state railroad commission date back to the
fifties of the last century. Massachusetts developed in the seventies
a commission of "the advisory type" which investigated and made public
the conditions, leaving to public opinion the correction of the evils.
A number of the Western states, notably Illinois and Iowa, developed
in the seventies commissions of "the strong type," with power to fix
rates and to enforce their rulings. The commission principle, strongly
opposed at first by the railroads, was upheld by the courts and became
established public policy. By 1915 every state and the District of
Columbia had a state commission. In Wisconsin and in New York, in
1907, in New Jersey, in 1911, and in many other states since, the
"railroad" commissions were replaced by "public utilities" or "public
service" commissions, having control not only over the railroads but
over street railway, gas, electric light, telephone, and some other
corporations. The state commissions have found their chief field
in the regulation of local utilities, and they fall far short of a
solution of the railroad problem. Altho they from the first did much
to make the accounts of the railroads intelligible, something to make
the local rates reasonable and subject to rule, and much to educate
public sentiment, on the whole their results have been disappointing.
It was difficult to get commissioners at once strong, able, and
honest; the public did not know its own mind well enough to
support the commissions properly; and the courts decided that state
commissions could regulate only the traffic originating and ending
within the state.

§ 16. #Passage of the Interstate Commerce Act.# Public hostility to
private railroad management was greatest in the regions where the
most rapid building of roads occurred from 1866 to 1873. One center of
grievances was in "the granger states' of Illinois, Wisconsin, Kansas,
Nebraska, Iowa, and Minnesota; another center was in the oil regions
of Ohio and Pennsylvania. The Eastern states were not without their
troubles, for the report of the Hepburn Committee of the New York
legislature in 1879 showed that discrimination between shippers
prevailed to an almost incredible degree in every portion of New York
state. When the courts, in 1886, decided that the greater portion of
the railroad rates could not be treated by state commissions, national
control was loudly demanded. Scores of bills were presented to
Congress between 1870 and 1886, and, despite much opposition, the
Interstate Commerce Act was passed in 1887.

The act laid down some general rules: that rates should be just and
reasonable; that railroads should not pool, or agree to divide,
their earnings to avoid competition; that they should, under similar
conditions, and, unless expressly excused, fix rates in accordance
with the long- and short-haul principle (to charge no more for a
shorter distance than for a longer one on the same line and in the
same direction, the shorter being included within the longer). The
act provided for a commission of five men, to be appointed by the
President, which might require uniform accounts from the railroads,
and which should enforce the provisions of the act.

§ 17. #Working of the Act.# The commission in its earlier years
gave promise of effectiveness, but its powers, as interpreted by the
courts, proved inadequate to its assigned task. The railroads in many
cases refused to obey its orders, and court decisions paralyzed its
activity. Competent authorities declared in 1901, after fourteen years
of the commission's operation, that discrimination never had been
worse, and a series of exposures of abuses strengthened the popular
demand for stricter legislation. The result was first the Elkins' Act
of 1903, aimed at discrimination and rebates, and then the Hepburn
Act Of 1906, which marked a new era in railroad regulation in this
country. The commission was increased to seven members, its authority
was extended to include express, sleeping car, and other agencies of
transportation, and it was given the power to fix maximum rates,
not to be suspended by the courts without a hearing. It became thus
unquestionably a commission of "the strong type." It began to exercise
its new powers with vigor, and the carriers reluctantly accepted its
authority. Responsive to a calmer but insistent popular demand
further amendments were made by the Mann-Elkins Act of 1910,
which strengthened the long-and-short-haul clause, and gave to the
commission, among other new powers, that of suspending new rates
proposed by carriers. A special Commerce Court of five judges was
created with exclusive jurisdiction in certain classes of railroad
cases, but this was abolished after a short trial.

It cannot be said that a final satisfactory solution of the railroad
problem has been attained; indeed, in most human affairs such a thing
is unattainable. But it can be said that there is no considerable
sentiment anywhere in favor of reversing the railroad policy that has
been developed, as here briefly outlined. Certainly the public has no
such sentiment, and the railroads, which for many years opposed the
progress of strong federal control, are now foremost in advocacy of
a policy of exclusive national regulation, to remedy the evil of
"forty-nine masters."

§ 18. #Public nature of the railroad franchise.# A pretty definite
public opinion regarding the nature of the problem has emerged from
the nearly half-century of experience and discussion, since the
first vigorous agitation of the subject in the seventies of the last
century. Railroads in our country are owned by private corporations
and are managed by private citizens, not, as in some countries, by
public officials. They have been built by private enterprise, in
the interest of the investors, not as a charity or as a public
benefaction. Railroad-building appears thus at first glance to be
a case of free competition where public interests are served in the
following of private interests. But, looked at more closely, it may
be seen to be in many ways different from the ordinary competitive
business. Competition would make the building of railroads a matter of
bargain with proprietors along the line, and an obdurate farmer could
compel a long detour or could block the whole undertaking. But the
public says: a public enterprise is of more importance than the
interests of a single farmer. By charter or by franchise the railroad
is granted the power of eminent domain, whereby the property of
private citizens may be taken from them at an appraised valuation.
The manufacturer, enjoying no such privilege, can only by ordinary
purchase obtain a site urgently needed for his business. Why may the
railway exercise the sovereign power of government as against the
private property rights of others? Because the railway is peculiarly
"affected with a public interest." The primary object is not to
favor the railroads, but to benefit the community. These charters and
franchises are granted sparingly in most European countries. In this
country they have been granted recklessly, often in general laws, by
states keen in their rivalry for railroad extension. When thus
great public privileges had been granted without reserve to private
corporations, it was realized, too late in many cases, that a mistake
had been made and that an impossible situation had been created.

§ 19. #Other peculiar privileges of railroads.# Further, do the
various grants of lands and money to the railroads make them other
than mere private enterprises? One answer, that of those financially
interested in the railroads, was No. They said that the bargain was
a fair one, and was then closed. The public gave because it expected
benefit; the corporation fulfilled its agreement by building the road.
The terms of the charter, as granted, determined the rights of the
public; but no new terms could later be read into it, even tho the
public came to see the question in a new light. Similar grants, tho
not so large, have been made to other industries. Sugar-factories were
given bounties; iron-forges and woolen-mills were favored by tariffs;
factories have been given, by competing cities, land and exemption
from taxation; yet these enterprises have not on that account, been
treated, thereafter, in any exceptional way. So, it was said, the
railroad was still merely a private business.

But the social answer is stronger than this. The privileges of
railroads are greater in amount and more important in character than
those granted to any ordinary private enterprise. The legislatures
recognize constantly the peculiar public functions of the railroads.
In other private enterprises, investors take all the risk;
legislatures and courts recognize the duty of guarding, where
possible, the investment of capital in railroads. Laws have
been passed in several states to protect the railroads against
ticket-scalping. Whenever the question comes before them, the courts
maintain the right of the railroads to earn a fair dividend. Private
enterprise has been invited to undertake a public work, yet public
interests are paramount.

§ 20. #Private and public interests to be harmonized.# If an extremely
abstract view is taken there is danger of losing sight of the real
problem, which is that of harmonizing these two interests in thought
and in public policy. Yet the extreme advocates of the private
control of railroads for a long time resented indignantly any public
interference with railroad rates and with railroad management as
an infringement of individual liberty. Before the passage of the
Interstate Commerce Act, in 1887, this position was inconsistently
taken by those in whose interests free competition had been violently
set aside at the very outset of railroad construction, and for whom
governmental interference had made possible great fortunes. It has
become generally recognized that the railroads ought not to be allowed
to change from a public to a private character just as it suits
their convenience. True, they are private enterprises as regards the
character of the investment, but they are public enterprises as to
their privileges, functions, and obligations.

Finally, it might be said that if there were none of these special
reasons for the public control of railways, there is an all-sufficient
general reason in the fact that a railroad is always, in some respects
and to some degree, a monopoly. Therefore, the railroad problem may be
viewed as but one aspect of the general problem of monopoly. To other
aspects of this problem we are now to turn our attention.


[Footnote 1: Returns for 1915. The following figures are from the
census taken in 1909.]

[Footnote 2: See A.T. Hadley, "Railroad Transportation," pp. 10, 32.]

[Footnote 3: See Vol. I, pp. 437, 438, 443.]




CHAPTER 28

THE PROBLEM OF INDUSTRIAL MONOPOLY

  § 1. Kinds of monopoly. § 2. Political sources of monopoly. § 3.
  Natural agents as sources of monopoly. § 4. Capitalistic monopoly;
  aspects of the problem. § 5. Industrial monopoly and fostering
  conditions. § 6. Growth of large industry in the nineteenth century. § 7.
  Methods of forming combinations. § 8. Growth of combinations after
  1880. § 9. The great period of trust formation. § 10. Height of the
  movement toward combinations. § 11. Motive to avoid competition.
  § 12. Motive to effect economies. § 13. Profits from monopoly and
  gains of promoters. § 14. Monopoly's power to raise prices.


§ 1. #Kinds of monopoly.# Monopolies may, for special purposes, be
classified as selling or buying, producing or trading, lasting or
temporary, general or local, monopolies. The terms selling or buying
monopoly explain themselves, tho the latter conflicts with the
etymology.[1] Under conditions of barter the selling and the buying
monopoly would be the same thing in two aspects. A selling monopoly
is by far the more common, but a buying monopoly may be connected with
it. A large oil-refining corporation that sells most of the product
may by various methods succeed in driving out the competitors who
would buy the crude oil. It thus becomes practically the only outlet
for the oil product, and the owners of the land thus must share
their ownership with the buying monopoly by accepting, within certain
limits, the price it fixes. The Hudson Bay Company, dealing in furs,
had practically this sort of power in North America. Many instances
can be found, yet, relatively to the selling monopolies, those of the
buying kind are rare.

A producing monopoly is one controlling the manufacture or the source
of supply of an article; a trading monopoly is one controlling the
avenues of commerce between the source and the consumers.

Monopolies are lasting or temporary, according to the duration of
control. By far the larger number are of the temporary sort, because
high prices strongly stimulate efforts to develop other sources of
supply. Yet the average profits of a monopoly may be large throughout
a succession of periods of high and low prices.

Monopolies are general or local, according to the extent of territory
where their power is felt. At its maximum where transportation and
other costs most effectually shut out competition, monopoly power
shades off to zero on the border-line of competitive territory. The
frequent use of the adjectives partial, limited, and virtual are
implied but usually superfluous recognitions of the relative character
of monopoly.

§ 2. #Political sources of monopoly.# Monopoly gets its power from
various sources. A political monopoly derives its power of control
from a special grant from the government, forbidding others to engage
in that business. The typical political monopoly is that conferred
by a crown patent bestowing the exclusive right to carry on a certain
business. A second kind is that conferred by a patent for invention,
or the copyright on books, the object of which is to stimulate
invention, research, and writing by giving the full control and
protection of the government to the inventor and the writer or their
assignees. In this case the privilege is socially earned by the
monopolist; it is not gotten for nothing. Moreover, the patent, being
limited in time, expires and becomes a social possession. A third
kind is a governmental monopoly for purposes of revenue. In France and
Japan the governments control the tobacco trade, and the high price
charged for tobacco makes this monopoly yield large revenues. A fourth
kind is that derived from franchises for public service corporations,
such as those supplying electricity, gas and water. These franchises
are granted to private capitalists to induce them to invest capital in
enterprises that are helpful to the community.

§ 3. #Natural agents as sources of monopoly.# "Economic" monopoly,
so-called, arises when the ownership of scarce natural agents, as
mines, land, water-power, comes under the control of one man or one
group of men who agree on a price. Economic monopoly is a result of
private property that is undesigned by the government or by society.
It is exceptional, considering the whole range of private property,
but it is important. The oil-wells embracing the main sources of the
world's supply have largely come under one control. One corporation
may control so many of the richest iron mines of the country as to
be able to fix a price different from that which would result under
competition. Coal mines, especially those of some peculiar and
limited kind, such as anthracite, appear to become easily an object
of monopolization. Economic monopoly merges into political monopolies,
such as patents and franchises. Private property is a political
institution designed to further social welfare, and only rarely is
property in any particular business a monopoly. Private control of
great natural resources might have been prevented in many cases had it
been foreseen.

§ 4. #Capitalistic monopoly; aspects of the problem.# Capitalistic
monopoly, variously called contractual, organized, commercial or
industrial monopoly, arises when men unite their wealth to control
a market, to overpower or intimidate opposition, and to keep out or
limit competition by the mere magnitude of their wealth. These
various kinds so merge into each other that they cannot always be
distinguished in practice. A patent may help a capitalistic monopoly
in getting control of a market; great wealth may enable a company to
get control of rare natural resources.

In the discussion of industrial monopoly, the problem now before us,
there is a good deal of vagueness and misunderstanding because of
lack of definiteness in the use of words which have rapidly shifted in
meaning. The word "trust" originally applied, and still in legal usage
applies, to a particular form of organization, that of a board of
trustees holding the stock, and thus unifying the control, of two or
more formerly separate enterprises. The Standard Oil Company at one
time had this form of organization, which was declared by the courts
to be illegal _(ultra vires)_ for corporations. Now "trust" often
is used in the sense of a corporation having monopoly power in some
degree; either broadly, of any monopolistic corporation (including
railways and local public utilities), or, oftener, limited to
manufacturing and commercial monopolies, otherwise called "industrial
trusts" in contrast with franchise trusts and railroads.[2] The word
"combination" referred originally to a more or less thoro "merger,"
with a view to attaining monopolistic power, of a number of formerly
separate organizations, as in the case of the United States Steel
Corporation. But the word is often used as if it were a synonym for
trust (in a narrower or wider sense) even as applied to a single
enterprise that has grown to be monopolistic. A "trust" in the legal
sense of a form of organization, and "combinations" as above defined,
might have no monopoly power whatever; whereas a monopoly may be
possessed by an individual owner (e.g., of a patent right, railroad,
waterworks plant), or by a single corporation that has simply grown
monopolistic without the trust form of organization or without
combination.

Now it is evident that the real problem is that of monopoly, however
attained. Monopoly may be defined as such a degree of control over
the supply of goods in a given market that a net gain will result if a
portion is withheld.[3] In accord with growing and now dominant
usage it is well to observe the following meanings in our discussion.
"_Combination"_ is a term referring particularly to one method by
which monopolies are formed. "_Trust,"_ in the now popular sense, is
best limited to an industrial, primarily manufacturing, enterprise or
group of enterprises, with some degree of monopoly power due not to
a "special franchise" giving the use of streets and highways and the
right of eminent domain, nor to a single patent, but to a group of
favoring technical, financial, and economic conditions. The trust may
consist of a single establishment; or of a group of establishments
separately operated but united in a "pool" to divide output,
territory, or earnings; or of such a group held together by a holding
company, or combined into one corporation. Public utility is the
name of special franchise enterprises of the kind just mentioned,
including, in the broad sense, railroads and local utilities such as
street railways, gas, water, and electric light-plants.

§ 5. #Industrial monopoly and fostering conditions.# The problem of
monopoly is probably as old as markets. From the first coming together
of groups of men to trade there were doubtless efforts made by some
individuals and groups of traders to manipulate conditions so as to
get higher prices than they could get in a free and open market.[4]
There are traces of these practices in ancient times, and the history
of the Middle Ages is full of evidences both of monopolistic practices
and of the efforts to prevent or control them.

If this fact is borne in mind it may help us to distinguish in thought
four features of enterprise that are readily and constantly
confused, viz: large individual capital, large production, corporate
organization, and monopoly.[5] Evidently any one of these features may
appear without the other; e.g., a person of large aggregate capital
may have his investments distributed among a large number of small
enterprises, such as farms, without a trace of corporate organization
or monopoly, and numerous examples could be given of large production,
or of corporate organization, or of monopoly without one or more of
the other features.

But the presence of any one of these features is a favoring condition
for the development of the others. Hence they are frequently found
together, and of late this occurs increasingly. It is difficult to say
in every, indeed in any, case which feature has been cause and which
effect in this development, but, on the whole, large production seems
to have been primary. Itself made possible by inventions, by better
transportation, and by the widening of markets, it in turn helped to
build up large individual fortunes, and then to create a need for the
corporate form of organization. And monopoly power no doubt is more
easily gained by large aggregations of capital in a corporation having
the advantages of large production.

§ 6. #Growth of large industry in the nineteenth century.# The great
recent growth of the monopoly problem is in part to be explained as
the result of the growth of large industry, not as the sole cause,
but as a favoring condition. Before the middle of the last century a
tool-using household industry, on farms and in homes where the greater
part of the things used were produced in the family, was still the
typical organization in the United States.[6] A family produced
somewhat more than it needed of food and cloth and exchanged with its
neighbors; so with shoes, candles, soap, and cured meats. The early
factories growing out of the household industry were small. Since
that time two counter forces have been at work to affect the ratio
of manufacturing establishments to population. The number of small
establishments has been increased by the many industries producing the
things once made on farms, and by increasing demands for comforts and
luxuries. Many establishments producing the staple products that can
be transported have been consolidated or have been enlarged, so
that the unit of production now averages much larger. The number of
cotton-weaving factories was about the same in 1900 as it had been
seventy years earlier, while population has grown six fold. Iron-
and steel-mills were fewer in 1900 than in 1880. In industries having
local markets or local sources of materials, such as grist mills
and saw mills, the change in numbers was less, for many small
establishments were started in outlying districts at the same time
that the mills became larger in the great population centers. But the
average number of employees and the average capital per establishment
increased in every period between census enumerations.

§ 7. #Methods of forming combinations.# Combinations of previously
independent enterprises may be more or less complete and are made by
different methods. Four major methods are:

(1) The pool, by which the enterprises continue to be separately
operated, but divide the traffic (or output), or the earnings, or the
territory, in prearranged proportions.

(2) The trust, in a legal sense (as defined above in section 5).

(3) The holding company, a corporation with the sole purpose of
holding the shares of stock, or a controlling number of them, in
various corporations otherwise nominally independent.

(4) Consolidation into one company.

At least five minor methods may be distinguished; these are here
numbered continuously with the preceding four.

(5) Lease by one company of the plants of one or more other companies.

(6) Ownership of stock by one corporation in another corporation,
sufficient to give substantial influence over its policy, if not
absolute control.

(7) Ownership of stock in two or more competing companies, by the same
individual or group of individuals, to such an extent as appreciably
to unify the policies of the competing companies.

(8) Interlocking directorates, that is, boards of competing companies
containing one or more of the same persons as directors.

(9) Gentlemen's agreements, mere friendly informal conferences and
understandings as to common policies.

§ 8. #Growth of combinations after 1880.# Undoubtedly industry before
1860 had some elements of monopoly. Monopoly constituted part of the
banking problem; it began to be evident in the railroads almost at
once, and it rapidly increased as street railways and other public
utilities were constructed. But after 1880 occurred the formation in
larger numbers of industrial enterprises which appeared to exercise
some monopoly power. In the years between 1890 and 1900 this movement
was still more rapid. Consolidation took place on a great scale in
railroads and in manufactures. Much of this has been of such a kind
that it does not appear at all in the figures showing the number of
establishments and of employees. In the data regarding this movement
given by different authorities, many discrepancies appear, as there is
no generally accepted rule by which to determine the selection of the
companies to be included in the lists. One financial authority
gave the following figures[7] regarding the industrial companies
reorganized into larger units in the United States between 1860
and 1899, not including combinations in such businesses as banking,
shipping, and railroad transportation. Some of the enterprises here
included have much and others probably have little or no monopolistic
power.

  _Decade             Number Organized     Total Nominal Capital_

  1860-60   ...............    2                    $    13,000,000
  1870-79   ...............    4                        135,000,000
  1880-89   ...............   18                        288,000,000
  1890-99   ...............  157                      3,150,000,000
  ---------------           ------                   ---------------
  Total, 40 years ........   181                     $3,586,000,000

§ 9. #The great period of trust formation.# The number of trusts
organized and the capital represented by this movement in the last
of these decades were seven times as great as in the thirty years
preceding. The figures by years for the decade 1890-1899 are as
follows:

     Decade             Number Organized     Total Nominal Capital

  1890  ...................     6                       $82,000,000
  1891  ...................    13                       168,000,000
  1892  ...................    13                       140,000,000
  1893  ...................     5                       226,000,000
  1894  ...................     2                        35,000,000
  1895  ...................     7                       104,000,000
  1896  ...................     3                        40,000,000
  1897  ...................     6                        93,000,000
  1898  ...................    22                       574,000,000
  1899  ...................    80                     1,688,000,000
  ----------------            ----                   --------------
  Total, 10 years .........   157                    $3,150,000,000

The influence of great prosperity shows in the large number of
combinations; but in 1893, the number was less, altho the total
nominal capital (stocks and bonds) was still the greatest it had ever
been in any year. Then came the period of depression, 1894-97, when
both the numbers and the capital were comparatively small. Then from
1898 to 1901 followed the period of the greatest formation of trusts
the world has ever seen.

The list of these four years contains the names of the most widely
known American combinations, a few of which are here given with the
years of their formation: 1898, American Thread, National Biscuit;
1899, Amalgamated Copper, American Woolen, Royal Baking Powder,
Standard Oil of N.J., American Hide and Leather, United Shoe
Machinery, American Window Glass; 1900, Crucible Steel, American
Bridge; 1901, United States Steel Corporation, Consolidated Tobacco,
Eastman Kodak, American Locomotive.

§ 10. #Height of the movement toward combinations.# In a list by
another authority[8] it appears that the data for all industrial
trusts are in round numbers as follows:

                               Number of
                            Plants Acquired              Total
  Date          Number       or Controlled           Nominal Capital

  Jan. 1, 1904   318             5288                    $7,246,000,000

These figures compared with those given above would indicate that the
industrial trusts had about doubled in the years 1900-1903 inclusive.
Probably most of this growth was in the years 1900 and 1901; then the
movement became very slow, because, as is generally believed, of
the aroused public opinion, of more vigorous prosecution by the
government, and of additional legislation against trusts. The
authority last cited gives in a more comprehensive list, in six
groups, all the monopolistic combinations in the United States, at
the date of January 1, 1904, as follows (the figures just given above
being the totals of the first three groups):

                                    No. of Plants          Total Nominal
      Groups             Number   Acquired or Controlled       Capital

  1. Greater industrial
       trusts              7          1528               $2,260,000,000
  2. Lesser  industrial
       trusts            298          3426                4,055,000,000
  3. Other industrial
       trusts in process
       of reorganization
       or readjustment    13           334                  528,000,000
  4. Franchise trusts    111          1336                3,735,000,000
  5. Great steam
       railroad groups     6           790                9,017,000,000
  6. Allied independent   10           250                  380,000,000
                         ---         -----               --------------
          Total,         445          8664              $20,000,000,000

§ 11. #Motive to avoid competition.# This remarkable movement toward
the formation of united corporations from formerly independent
enterprises called forth a variety of explanations. The organizers of
trusts gave as the first explanation of their action that it was the
necessary result of excessive competition. It is not to be denied
that a hard fight and lower prices often preceded the formation of
the trusts. But as this excessive competition usually is begun for the
very purpose of forcing others into a combination, this explanation
is a begging of the question. It is fallacious also in that it ignores
the marginal principle in the problem of profits. Profits are never
the same in all factories, and to those manufacturers that are on the
margin competition may appear excessive. It generally has been the
largest and strongest factories, in the more favored situations,
that, in order to get rid of troublesome competitors, have forced the
smaller, weaker, industries to come into the trust. In other cases the
smaller enterprises have been eager to be taken in at a good price,
altho they might have continued to operate independently with moderate
profits. When, therefore, it is said that competition is destructive,
it may be a partial truth, but more likely it is a pleasantry
reflecting the happy humor of the prosperous promoters of the
combination.

§ 12. #Motive to effect economies.# Another advantage of the
combination of competing plants that was strongly emphasized was the
economy of large production.[9] The economies that are possible within
a single factory may be still greater in a number of combined or
federated industries. The cost of management, amount of stock carried,
advertising, cost of selling the product, may all be smaller per unit
of product. Each independent factory must send its drummers into every
part of the country to seek business. In combination they can divide
the territory, visit every merchant and get larger orders at smaller
cost. A large aggregation can control credit better and escape
losses from bad debts. By regulating and equalizing the output in
the different localities, it can run more nearly full time. Being
acquainted with the entire situation, it can reduce the friction. A
combination has advantages in shipment. It can have a clearing-house
for orders and ship from the nearest source of supply. The least
efficient factories can be first closed when demand falls off.
Factories can be specialized to produce that for which each is best
fitted. The magnitude of the industry and its presence in different
localities often, in the period of trust formation, served to
strengthen its influence with the railroads, and to increase its
political as well as its economic power.

Another phase of corporate growth is the "integration of industry,"
that is, the grouping under one control of a whole series of
industries. One company may carry the iron ore through all the
processes from the mine to the finished product. A railroad line
across the continent owns its own steamers for shipping goods to Asia
or Europe. Large wholesale houses own or control the output of entire
factories.

§ 13. #Profits from monopoly and gains of promoters.# There are,
however, well-recognized limitations to the economy of large
production in the single establishment,[10] and of late there has been
ever-increasing skepticism as to the net economy actually attributable
to combinations. Undoubtedly the merging of a number of old plants has
sometimes effected an immediate improvement in the weaker ones. A new
broom sweeps clean. This movement chanced to be contemporaneous with
the development of "efficiency engineering," and of "scientific
cost-accounting," and these better methods, already developed and
applied in comparatively small plants, could be more quickly extended
to the other plants brought into the combination. Moreover, the
personal organizations in the separate enterprises had been brought to
a high state of efficiency by the stimulus of competition, and there
is reason to fear that, after some years of centralized bureaucratic
organization, much of this efficiency may be lost.

There seems no doubt that the strong motive for forming combinations
is the profit to the organizers.[11] Whatever was the more generous
motive or more fundamental economic reason assigned by the promoters,
the investing public confidently expected that higher prices would be
the chief result. There are indirect as well as direct gains to the
promoters of a combination. There is the gain from the production and
sale of goods to consumers, and there is the gain from the financial
management, from the rise and fall in the value of stock. The
promoters of a combination often expect to make from sales to the
investing public far more than from sales to the consumer of the
product. A season of prosperity and confidence, when trusts and their
enormous profits are constantly discussed, has an effect on the
public mind like that of the gold discoveries in California and in the
Klondike. Then is the time for the promoter to offer shares without
limit to investors.

§ 14. #Monopoly's power to raise prices#. There is no doubt that the
formation of a combination from competing plants can and does give a
control over prices, a monopoly power, not possessed by the separate
competing establishments. The same kind of power might be attained by
the growth of one establishment outstripping all its competitors,
or by a new enterprise coming into the field backed by powerful
capitalists. But this would work slower and less extensive results
than does the formation of a combination.

Of course, the fundamental principles of price cannot be changed by a
trust; a selling monopoly can affect price only as it affects supply
or demand.[12] The strongest trust yet seen has not been omnipotent.
Many careless expressions on the subject are heard even from
ordinarily careful writers and speakers: "The trust can fix its own
prices," "has unlimited control," "can determine what it will pay
and for what it will sell." This implies that trusts are benevolent,
seeing that the prices they charge are usually not far in excess of
competitive prices in the past. Such a view overlooks the forces that
limit the price a monopoly can charge. If the supply remains the same,
no trust can make the price go higher. The monopoly usually directs
its efforts to affecting the supply, leaving the price to adjust
itself. It can affect the supply either by lessening its own output or
by intimidating and forcing out its competitors. It is true that this
logical order is not always the order of events. The trust may not
first limit the supply, and then wait for prices to adjust themselves;
it may first raise its prices, but unless it is prepared to limit the
supply in accordance with the new resulting conditions of demand,
such action would be vain. The control of the sources of supply is the
logical explanation of the higher price, even tho the limitation
of supply is effected later by successive acts found necessary to
maintain the higher price.

The report of the Federal Industrial Commission, which, from 1898
to 1901, investigated the trusts, showed that immediately upon their
formation, the industrial combinations had raised their prices.[13]
Prices might be lowered again but only when and where competition
became troublesome, thus causing either "price-wars" or
discrimination.


[Footnote 1: See Vol. I, p. 76.]

[Footnote 2: As in the list in sec. 8, below.]

[Footnote 3: See Vol. I, chs. 8 and 31.]

[Footnote 4: See Vol. I, ch. 8, on competition and monopoly, and ch.
31, on monopoly prices and large production. An understanding of the
definitions and of the general principles distinguishing competition
and monopoly is a necessary prerequisite to a profitable discussion of
the practical problem of monopoly.]

[Footnote 5: See Vol. I, p. 267, on capital; pp. 388-393, on large
production. See also references in preceding note on monopoly; and ch.
27, secs. 1 and 2, on corporate organization.]

[Footnote 6: See above, ch. 26, sec. 3; and ch. 25, secs. 6 and 7.]

[Footnote 7: Compiled from data given by "The Journal of Commerce and
Commercial Bulletin," reprinted in "The Commercial Year Book," Vol. V,
1900, pp. 564-569.]

[Footnote 8: John Moody, "The Truth About the Trusts," 1904]

[Footnote 9: See Vol. I, pp. 388-393.]

[Footnote 10: See Vol. I, pp. 391-392.]

[Footnote 11: See Vol. I, p. 334, on the function of the promoter.]

[Footnote 12: See Vol. I, pp. 80-85, 382-387, 394-396.]

[Footnote 13: A summary of this evidence is given in the author's
"Principles of Economics" (1904), pp. 327-330. A fuller outline of
the results of the Commission's conclusions may be found in "The Trust
Problem," by J.W. Jenks, who acted as expert in the investigation.]




CHAPTER 29

PUBLIC POLICY IN RESPECT TO MONOPOLY

  § 1. Moral judgments of competition and monopoly. § 2. Public character
  of private trade. § 3. Evil economic effects of monopolistic price.
  § 4. Common law on restraint of trade. § 5. Growing disapproval of
  combination. § 6. Competition sometimes favored regardless of results.
  § 7. Increasing regard for results of competition. § 8. Common law remedy
  for monopoly ineffective. § 9. First federal legislation against
  monopoly. § 10. Policy of the Sherman anti-trust law. § 11. Policy of
  monopoly-accepted-and-regulated. § 12. Field of its application. § 13.
  Industrial trusts,--a natural evolution? § 14. Artificial versus natural
  growth. § 15. Kinds of unfair practices. § 16. Growing conception of
  fair competition. § 17. The trust issues in 1912. § 18. Anti-trust
  legislation in 1914.


§ 1. #Moral judgments of competition and monopoly.# What should be the
attitude of society toward monopoly? Is it good or bad as compared
with competition? Some very strong ethical judgments bearing on
practical problems are found in the popular mind connected with the
ideas of competition and monopoly. Competition usually is pronounced
bad when viewed from the standpoint of the competitors who are losing
by it, and as good when viewed from the standpoint of the traders on
the other side of the market who gain by that competition. Competition
among buyers thus appears to sellers to be a good thing; that among
sellers appears to themselves to be a bad thing (and _vice versa_).
Many persons are moved by sympathy to pronounce competition among
low-paid and underfed workers to be bad, and each worker is convinced
that it is so in his own trade. Yet nearly all men are of one mind
that competition is a good thing in most industries, those that are
thought of as supplying "the general public." Monopoly is believed by
the public to be wrong in such cases, and competition to be the normal
and right condition of trade. Yet there are some men interested in
"large business" who look upon competition as bad, and upon monopoly
as having essentially the nature of friendly coöperation. The roots
of these opinions, or prejudices, are easily discoverable in the
theoretical study of the nature of monopoly.[1] Yet often different
men or groups of men feel so strongly on this matter, viewing it from
their own standpoints, that they are quite unable to understand
how any one else can feel otherwise. There is thus a great deal of
controversy to no purpose.

§ 2. #Public character of private trade.# Any such general judgment as
that of the public, tho it may be mistaken in some details, is likely
to be a resultant of broad experience. There is in competitive trade a
public, a social character, which monopoly destroys. Even in a simple
auction, when the bidding is really competitive, price depends far
less on shrewd bargaining, on bluff, or on stubbornness, than is the
case in isolated trade. Each bidder is compelled by self-interest to
outbid his less eager competitors, and thus the limits within which
the price must fall are narrowly fixed. The auction-sale is less a
purely personal matter, takes on a more public aspect, has a more
socialized character than isolated trade, depends more on forces
outside the control of any one man, and results in a price fixed with
greater definiteness. The price in a more developed market results
from the play of impersonal forces, or at least from the play of
personal forces which have come under the rules of the market.[2] This
price men are ready to accept as fair. It has a democratic character,
whereas the gains of monopoly price arouse resentment as being the
work of personal, and felt to be despotic, power. Monopoly price is a
bad price to the one who pays it, not only because it is a high price
but because it bears the character of personal extortion.

The medieval notion of _justum pretium_, the just price, may have
been often misapplied, and it was often criticized and ridiculed by
economists in the period of idealized competition (from Adam Smith
to John Stuart Mill). But at the heart of the notion was the judgment
that general uniform prices fixed in the open market are the proper
norms for prices when one of the traders is caught at an exceptional
disadvantage. The modern world has been compelled to reëxamine the
conception of the just price.

§ 3. #Evil economic effects of monopolistic price.# Theoretical
analysis confirms this view. Any exercise of monopolistic power over
price keeps some, the weaker bidders, from getting any of the desired
goods, or limits them to their most urgently desired units. What
may be called "the theoretically correct price"[3] with two-sided
competition is the one that permits the maximum number of trades
with a margin of gain to each trader. In narrowing the possibility of
substitution of goods by trade, the sum of values of goods for most
men is diminished. All citizens thus that are the victims of an
artificially created scarcity look upon monopoly as "bad," just
as they do upon the evils of nature--drought, locusts, fires, and
pestilence. A monopoly has an indirect and more distant effect upon
the spirit of all those trading with it. If they are producers selling
at prices depressed by monopoly, their money incomes are reduced; if
they are consumers buying at monopoly prices, their real-incomes are
reduced; in either case their psychic incomes, the motives of all
industry, are diminished, and their industrial energies are relaxed.

§ 4. #Common law on restraint of trade.# The first recorded case in
English law, wherein the courts sought to prevent the limiting of
competition by agreement, runs back to the year 1415, in the reign
of Henry V. This was a very simple case of a contract in restraint of
trade, whereby a dyer agreed not to practise his craft within the town
for half a year. The court declared the contract illegal (and hence
unenforceable in a court) and administered a severe reproof to the
craftsman who made it. Thus was set forth the doctrine of the moral
and legal obligation of each economic agent to compete fully, freely,
and without restraint upon his action, even restraint imposed upon
himself by a contract voluntarily entered into for his own advantage.

Not until the eighteenth century was this rigid doctrine somewhat
relaxed so as to permit the sale of the "good will" of a business
under limited conditions, and some "reasonable" contracts in restraint
of trade. Later the emphasis was somewhat further shifted, by judicial
interpretations, from the notion of free competition to that of "fair"
competition, so as to permit contracts involving moderate restraint of
trade, if the essential element of competition was retained. Thus
it was said that a piano manufacturer might by contract grant an
exclusive agency to a dealer in a certain territory, there being many
other competing makes of pianos, and such a contract "does not operate
to suppress competition nor to regulate the production or sale of any
commodity."[4] But with such moderate limitations the courts in cases
under the common law have steadily disapproved contracts in restraint
of trade that would appear to be to the disadvantage of third parties,
whether producers or consumers.

§ 5. #Growing disapproval of combination.# The attitude of the courts
became in one respect stricter. Some earlier cases involved the
doctrine that what is lawful for an individual to do alone is lawful
if done in combination with others. Indeed, a comparatively recent
case[5] declared regarding a group of dealers, agreeing not to deal
with another, that "desire to free themselves from competition was a
sufficient excuse" for such action. But the general trend has been
to the doctrine that a combination of men "has hurtful powers
and influences not possessed by the individual." Hence threats of
associations of traders (retailers or wholesalers) not to deal with
another if he continued to deal with some third party have been
declared acts in restraint of trade.[6] Yet in the case cited the
court seemed to have been more concerned with protecting "the
individual against encroachment upon his rights by a greater power,"
"one of the most sacred duties of the courts," than with rights and
interests of the general public, endangered by such restraint of
trade.

§ 6. #Competition sometimes favored regardless of results.# In another
respect the courts have wavered in their attitude toward competition,
the general doctrine being that competition, particularly the cutting
of prices, is absolutely justifiable, regardless of circumstances. In
the leading English case[7] the facts were that the larger steamship
companies sent to Hankow additional ships, now called, figuratively,
"fighting ships," to "smash" freights in order to ruin tramp steamship
owners and drive them out of the field. The court held that this
constituted no legal wrong to the tramp steamship owners, and scouted
the idea of the court's looking at the motives in price cutting,
or taking into consideration in any way what the court called "some
imaginary normal standard of freights and prices." And of this case
the lawyer is forced to say: "Undoubtedly the excellent opinion just
quoted represents the law everywhere," even tho there are other cases
difficult to harmonize with it.[8]

To the economist, not bound in like manner by legal precedent, such
a verdict was from the first impossible. The court appears to have
considered that only the rights of the private litigants, the tramp
steamship owners, were involved, not the rights and interests of the
shipping public; it considered the immediate and not the ultimate
effects of the "smashing" of rates; it allowed itself to be deceived
by the appearance of acts that in outer form were competition,
but that had as their purpose the strengthening and maintenance of
monopoly. These acts are forms of the "unfair" practices that will be
mentioned later.[9]


§ 7. #Increasing regard for results of competition.# Despite the
binding precedents, the courts in some later decisions have refused
to look upon competition as good regardless of its motives and of its
consequences. In a federal case[10] the judge, in a brief and acute
dictum, recognized the evil of a rate war that would result from
threats of definite cuts. They impair "the usefulness of the railroads
themselves, and cause great public and private loss." The court's
opinion was no doubt largely influenced by the fact that railroad
rates were already subject to regulation: "Every precaution has been
taken by state legislatures and by the congress to keep them just and
reasonable,--just and reasonable for the public and for the carriers."

In a state case[11] the facts were that a man of wealth started a
barber shop and employed a barber to injure the plaintiff and drive
him out of business. The court recognized that while, as a general
proposition, "competition in trade and business is desirable," it
may in certain cases result in "grievous and manifold wrongs to
individuals"; and in this case the "malevolent" man of wealth was
declared to be "guilty of a wanton wrong and an actionable tort."
The economists can but pronounce this judgment admirable so far as it
goes, but it is remarkably confined to a consideration of the private
legal rights of the injured competitor, and gives hardly a hint of
a higher criterion for judging competitive acts, that of the general
welfare.

§ 8. #Common law remedy for monopoly ineffective.# The common law
contained prohibitions enough, both broad and specific, against
contracts and acts in restraint of trade. The common law contained
likewise a closely related body of doctrine by which the railroads,
as common carriers, ought to have given equitable and undiscriminating
rates to all shippers. There was a strong body of influential opinion
that long maintained that the case was sufficiently covered, that the
only thing needed was to enforce the common law. Even now, after all
that has elapsed, there are some in railroad and business circles
who still appear to hold that opinion. But the evils of railroad
discrimination and of other monopolistic practices continued, and for
some cause the common law was not enforced, excepting occasionally,
disconnectedly, and without important results.

Why? The answer may be ventured that in the common law the whole
question of restraint of trade was treated primarily as one of private
rights and only incidentally as one involving general public policy.
Cases came before the courts only on complaint of some individual
that felt injured. Now the injury of higher prices due to contracts in
restraint of trade is usually diffused among many customers, and
the loss of any one is less than the expense of bringing suit.
Consequently, it rarely happened that cases were brought before the
courts except by one of the two equally guilty parties to a contract
in restraint of trade, when the other party had failed in some way to
do his part. When such an illegal contract in restraint of trade was
proved before a court by a defendant in a civil suit the contract was
declared unenforceable, and the only penalty in practice was that the
plaintiff could not collect his debt or secure performance from the
defendant.[12] A very similar situation existed in the case of the
individual's grievances against railroad charges and services.

§ 9. #Federal legislation against monopoly.# The passage of the
Interstate Commerce Act in 1887[13] prohibiting discrimination and
railway pooling, and that of the Act of 1890 "to protect trade and
commerce against unlawful restraints and monopolies," popularly known
as the "Sherman Anti-trust Law," were part of one public movement to
remedy monopoly. From one point of view it seems true, as has often
been said, that in essence these statutes were simply enactments
of long established principles of the common law. Section 1 of the
Sherman law declared illegal "every contract, combination in the
form of trust or otherwise, or conspiracy, in restraint of trade or
commerce among the several states, or with foreign nations." Section 2
made it a misdemeanor "to monopolize, or attempt to monopolize."

But from another point of view, these new laws showed a marked change
both in the conception of the interests involved and in the means of
preventing the evils. The evil was at last conceived of as a general
public evil; the laws are not merely to protect individuals,[14]
but "to regulate commerce," "to protect trade and commerce."
More important still, it was made the duty of public officers
(district-attorneys of the United States) to institute proceedings in
equity "to prevent and restrain" violation of the Sherman Act, and a
special Commission was instituted to deal with railroad cases. It was
this undertaking of the initiative by the government, the treatment of
the problem as one of the general welfare, that marked a new epoch
in this field. The methods and agencies provided might be at first
inadequate and ineffective, but time and experience could remedy those
defects.

§ 10. #Policy of the Sherman anti-trust law.# But in important
respects opinion and policies were not yet clear and consistent. They
wavered from one to another conception of the method for dealing with
the problem. It was clear only that _laissez-faire_ had been laid
aside. There are three other possible policies reflecting as
many different conceptions of the problem of monopoly: (1)
monopoly-prosecuted, (2) monopoly-accepted-and-regulated,
(3) competition-maintained-and-regulated. The policy of
monopoly-prosecuted