Growth of Industry after the Civil War

1
Growth of Industry after the Civil War
2
Changing Industry Structure
Capital/labor ratio
1840 1.0
1850 1.24
1860 1.82
1870 2.25
1880 2.51
1890 3.78
1900 4.56
Increased importance of capital in manufacturing,
leads to bigger firms
3

• Technological Change
• of steam engines doubled from 1860 to 1880 and
  then doubled again from 1880-1900
• Electric power began to replace steam power in
  late 1880
• By 1890 could power machines with electric motors

4
Changing Industry Structure
4 Largest Industries in Value Added (1914 )
1860 1920
Cotton Goods 58.8 Machinery 575.6
Lumber 54 Iron and Steel 492.8
Boots Shoes 52.9 Lumber 393.4
Flour and Meal 43.1 Cotton Goods 363.7
Increase in importance of industries outside
agriculture and increase in size.
5
Changing Industry structure

• Some of this change is predictable
• Income elasticity of food is low
• Income elasticity of manufactured goods is higher

6
Changes in Firm Structure

• Increase in Plant size
• Increase in K/L ratio
• Increase in Firm size
• Multi-plant firms
• Vertical integration
• Merger Movement starts in late 1890s-1904
• New forms of Ownership
• Modern corporation
• All of these trends are related

7
Increase in firm size

• Due to technological change
• Two examples, Steel and Oil

8
Steel Industry

• Innovations
• Bessemer Process and open hearth process kept
  iron in liquid form though out process of making
  steel
• Result was increase in size of Blast Furnaces and
  increase in steel production
• 1860 Blast furnaces produced 6-10 tons of pig
  iron per day. By 1910 average production was 500
  tons per day

9
Steel Industry

• Large increase in steel production and big
  decrease in price of steel rails
• Decrease in price of machinery made of steel
• Price of farm machinery falls over 50 from 1870
  to 1910

1873 120/ton
1898 17/ton
1902 28/ton
10
Two types of Vertical Integration

• Blast furnaces and steel plants integrate
• Producers of pig iron integrate forward into
  steel production
• Allowed pig iron to be transferred to steel plant
  in molten form
• Big Firms
• Even as early as 1870 only 10 firms producing
  steel in US
• In 1901 US Steel has 65 of market

11

• Backward integration into iron mining and
  processing

12
Oil Industry

• Before Civil War, most oil is used for lighting
• 20 from coal
• 80 whale oil
• Civil War disrupts whaling, increase in oil
  prices (First US energy crisis)
• Increases incentives to drill for oil
• Oil is discovered in PA, big decrease in price
• 1880, 66 of families use oil for heating

13
Oil Industry

• Crude oil is refined into kerosene
• 1860 1 million barrels, cost 12-16/barrel
• 1900 63 million barrels , cost lt 1/ barrel

14
Vertical Integration

• Refiners first use railroads to distribute oil
• By 1880 refiners integrate forward into pipelines
  and backwards into oil production
• By 1890, fully integrated

15
Other industries

• Tobacco industry
• Bonsack cigarette machines 60,000 a day, much
  more than could have been rolled by hand.
• Grain processing machines lead to modern cereal
  industry
• Leads to new functional areas in the firms,
  especially in marketing and distribution
  networks
• Chandler

16
Firm Growth

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

17
Average costs
Technological change causes average cost curve to
shift from 1 to 2. Firm size should shift from q1
to q2. We would expect a decrease in price of
product.

Av Cost 1
Av Cost 2
Q
q1
q2
18
Firm growth

• Firms could also grow large to increase monopoly
  power. (Ability to set price above marginal cost)
• Firms could also achieve power to set price above
  marginal cost through price fixing agreements.
• If there are no economies of scale this would be
  cheaper than increasing firm size either through
  growth or merger.
• Such agreements were not initially illegal.
  (Trusts become common)

19
Vertical Integration

• Why determines the functions included in a firm?
• What is the nature of the firm?
• Coase says the firm is a non-market organization
  where decisions are made by management
• What determines which functions will be done
  inside the firm and which will be contracted out?
• Assumption is firm will choose the least cost way

20

• Technological change alters the costs
• Steel plant
• See increases in vertical integration during this
  period
• Will this increase market power?
• Firm is larger, but market share will not
  increase, unless vertically integrated firm is
  more efficient

21
Legal Changes-Rise of the corportation

• Prior to 1880, most firms in the US were owner
  managed firms which were not incorporated.
• Increase in the number of incorporated firms
  begins after the Civil War
• Change in the types of firms that are
  incorporated, large industrial firm
• First jt. stock companies are trading companies
  or banks or railroads

22
What does it mean to be incorporated?

• Corporation
• Ownership in the firm can be sold to many
  investors
• Firm is a legal person.
• Limited Liability, Firms liability is not the
  owners liability
• Early Jt stock companies do not have limited
  liability

23
Benefits of incorporation

• Spread risk over many owners
• Diversification
• Shares can be traded
• Incorporation and stock market growth go together
• Before 1890, there were few industrial stocks
  traded on New York exchange
• By 1914, rare to find a large industrial firm
  which was not publically held

24
Costs of incorporation

• Separation of Ownership and Control
• What keeps managers acting in the shareholders
  best interest?

25
How does incorporation take place?

• In England, an act of parliament
• In US choice between incorporation by legislative
  charter or general incorporation laws
• Early general incorporation were restricted to
  certain business types or states
• Incorporation laws liberalized in first in New
  Jersey in 1889

26
Changes in Industry Structure

• Increase in size of firms, both vertically and
  horizontally and change in structure of firms
  cause concern about monopoly power
• Trusts (Organizations of firms to control price
  and output) and mergers also caused concern

27

• Sherman Antitrust passed in 1890
• Outlawed every contract, combination in the form
  of a trust or otherwise or conspiracy in
  restraint of trade illegal.
• Also made it illegal to monopolize or attempt to
  monopolize an industry
• Not clear what this meant. Determined by the
  courts

28
Important Cases

• 1899 Addyston Pipe and Steel Company v. United
  States ruled cast iron pipe pool illegal
• Price fixing is illegal per se
• only defense is we did not do it
• Economist agree that cartels create nothing but
  dead weight loss

29

• What about mergers or large firms?
• 1904 Northern Securities ruled mergers for
  monopoly power were illegal
• Court ruled against Standard Oil in 1909
• Court ruled in favor of US Steel in 1920
• Size alone is no offense
• Mergers or large firms are not per se illegal

30
When should mergers be illegal?

• Economists answer is it depends
• If merger creates monopoly power and no
  efficiency or cost savings it should be illegal
• If merger creates no monopoly power it should not
  be illegal
• Vertical mergers generally do not create monopoly
  power
• If merger does both, then court should decide
  which is larger

31
Two Questions

• What about mergers during this period were the
  for monopoly power or cost savings?
• How were Antitrust laws enforced? What were the
  effect on efficiency?

32
Cause of mergers?

• If mergers increase monopoly power, prices should
  increase
• If there are no barriers to entry high prices
  should attract entry and firms would loose
  monopoly power and prices would go down
  eventually
• If mergers were to lower costs and take advantage
  of economies of scale prices should decrease

33
Market Share

• 4 firm concentration ratio
• Share of industry output produced by 4 largest
  firms
• Can be misleading
• No clear link between structure and performance
• Concentration does not increase by that much
• Chandler finds evidence that mergers for market
  power loose market share over time

34
Industrial Concentration
NE 1860 MW 1860 S 1860 1901 1963
Machinery 30 15 25 41 93
Iron Bars 29 100 37 46 50
Lumber 10 6 9 .5 11
Cotton Goods 14 99 30 20 30
35
Prices

• Wholesale price index declines during this period
• Price of steel rails falls from 120/ton in 1873
  to 17/ton in 1898 and then is stable at 28/ton
  from 1902-1919
• Price of farm machinery falls 55 from 1870 to
  1910
• Price of oil falls from 24.67 in 1865 to 3.36
  in1884

36

• Evidence does not suggest monopoly power in spite
  of mergers, trust and other price fixing
  agreements
• Consistent with what economic theory would
  predict
• Chandlers work is consistent with this

37
Antitrust

• Economic theory suggests practices which do not
  increase monopoly power should not be prohibited
• Assumes consumer welfare is goal
• Law may have other goals
• Protect competitors
• How were cases decided? What was effect on
  efficiency?

38
Standard Oil

• Formed in 1872 by JD Rockefeller
• Refining
• Cleveland, favorable for Rail transport
• 10 of refining market
• Market competitive
• Attempt to form cartel in 1870s failed
• Increases size of Standard oil through merger to
  get rebate from RR
• Integrates forwards into pipelines in 1880
• Reduced number of firms

39

• Integrates backwards into oil drilling in late
  1880s
• Fully integrated by 1890s
• Market share in 1880 was 95

40

• Justice dept brought suit in 1911
• Predatory behavior in acquiring rivals, reducing
  price to reduce value of assets
• Not clear this would pay, must be able to
  increase price latter on and keep entry out
• Not clear whether they did this
• Court ruled against Standard Oil
• Broken up into 33 companies

41
What was effect of decision on efficiency?

• Price had fallen from 24.67 in 1873 to 3.36 in
  1884
• Market share was falling as well
• Not clear there was any effect

1880 95
1899 62
1906 70
1911 64
42
US Steel

• Andrew Carnegie pioneered new techniques in steel
  production
• Carnegie Steel had 15-20 of market in 1898
• JP Morgan created Federal Steel by merging
  several companies in 1898. About same size as
  Carnegie Steel
• US Steel result of merger of these two companies
  in 1901. Had about 65 of market.

43

• Justice dept brought suit in 1911, not decided
  until 1920
• Court ruled in favor of US Steel in 1920
• Size alone is no offense
• Market share was 40 in 1929
• Prices

1873 120/ton
1898 17
1902-1919 28
44

• US Steel was not dissolved because it did not
  lower prices competitively
• Good for competitors, not for consumers

45

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