Monday, October 19, 2009

The robber barons slashed prices, boosted output, and saw eroding profit margins

One of the lessons we take away from our high school and college history classes is that during the latter half of the 19th C. America was ruled by robber barons -- powerful businessmen who wielded nearly monopolistic power over the hapless little guy, riding roughshod over the entire society for want of regulatory restraints. That all changed when populist and progressive politicians and muckraking journalists exposed the abuses of Gilded Age and turn-of-the-century industrialists.

Like most folktales, though, it bears little resemblance to the truth. Its function is instead to provide a creation mythology for contemporary regulators to justify present-day attacks on so-called robber barons. I've gone through data on railroads from a turn-of-the-century edition of the Statistical Abstract of the United States, and right in the middle of all of that populist and progressive agitation, it was totally clear that they were pushing an image of the world that was completely backwards. If powerful monopolists are harming consumers, we should see output shrinking and prices soaring. If they were gouging consumers, they should have seen ever greater profits over time -- again, until they were restrained by the government. This approach also allows us to test whether the antitrust legislation had any beneficial effect -- we can just look at what was going on before and after it was passed.

I've chosen railroads because the Wikipedia article on robber barons shows that most of the outrage was directed at railroad magnates -- they are more represented in lists than are captains of other industries. Let's first take a look at output. Imagine De Beers, which used to control almost all of the world's diamond supply, responding to lower revenues -- they'd simply choke off the flow of diamonds into the market, so that diamond buyers would compete more intensely over an artificial shortage of diamonds. Here are graphs showing the total number of miles of railroad in operation, the number of miles added each year, the number of passengers carried, and the amount of freight carried:

The antitrust era began more or less in 1890 with the Sherman Act. Before this time, output did not contract. There is stagnant output from about 1830 to 1850 while the industry is in its infancy. After 1850, though, there may be cycles up and down, but the clear trend is toward steadily greater output over time. If anything, the decade after the Sherman Act was passed saw shrinking or stagnant output. The number of passengers served and the weight of freight carried also rose steadily at least from the early 1880s for the next decade (earlier data are not available). The picture after 1890 isn't clear, but we can rule out a beneficial effect of the Sherman Act, which would have sent the numbers steadily upward and at a faster rate than before. Remember, the trend was already increasing before 1890.

This behavior is the opposite of a monopolist who would want to only serve fewer and fewer people. Imagine if the Super Bowl organizers sold 1000 fewer tickets year after year -- prices would skyrocket. So, these three separate measures of output show that railroad owners behaved in the opposite way of monopolists -- they kept giving consumers more of what they wanted.

We might predict from this that prices that consumers paid would have fallen as a result of expanding output -- when there's a glut of stuff, people prefer to pay less for it. The evil robber baron picture predicts that prices should have shot up. Let's see who is right by looking at freight rates on wheat per bushel (in dollars), while comparing rates across three types of transportation:

Water-only transport became nominally more expensive from the early 1850s through the late 1860s, although this is not adjusted for inflation. The key is that it began falling sharply from the late 1860s through the late 1870s, fell a bit more shallowly for another decade, and declined very modestly after 1890. Here is a completely different method of transportation -- by water rather than over land -- and we see falling prices. So at least owners of water transport were not monopolists. Was the story any different for the rates that railroad owners charged? Not at all: we see the same pattern of rapid decline from the late 1860s through the late 1870s, modest decline for another decade, and very slow decline after 1890. Again, we see no effect of the Sherman Act -- if anything, the antitrust era saw slower price decreases.

So, railroad magnates were the opposite of monopolists, boosting output and charging lower prices over time. Still, we might salvage the picture of bloated industrialists by looking at their profits -- you could charge lower prices and make up for it on volume. Alas, when we look at how much money they brought in for carrying either passengers or freight for a mile (in cents), we see that railroad owners pocketed less and less dough:

Whether it was from freight or passengers, railroads received less and less money from at least the early 1880s onward, again with no sign of the Sherman Act in the data. The leading railroads have data going back farther, and they show falling revenues going back at least to the 1870s. Here too we see that the antitrust era that began in the 1890s was associated with a slower rate of declining revenues. In fact, the robber barons took their biggest clobbering of the Gilded Age during the 1870s, decades before there was any substantial elite outcry to rein them in.

That is exactly what we expect from a new and highly profitable industry -- once businessmen hear about how profitable it is, more and more will enter it, and the resulting bitter competition will drive down profits until the industry is no more profitable than a typical industry. If you were one of the lucky initial railroad owners back in the 1830s, you may have made a pretty penny for the moment when you had little or no competition. But at least by 1870 -- and probably somewhat earlier -- that brief period of uncolonized paradise was long gone. The magnates saw leaner and leaner profit margins, while consumers saw more and more miles of railroads that could carry them and their stuff for lower and lower prices.

Not to put too fine a point on it, but a lot of what we learned in school about businessmen was utter nonsense. If we taught facts, we would teach kids that the robber barons kept giving their consumers more of what they wanted and at lower prices -- and these data don't even factor in the consumer benefits of enjoying improvements in quality that railroads implemented as they grew from newcomer to mature industries. A railroad trip in 1885 was more pleasant than a railroad trip in 1845. And all the while, they made less and less money on these ventures, rather than fatten themselves up by abusing their power, which they clearly had very little of.

The facts are not hard to understand, so that's not the reason that they aren't taught. Indeed, the teachers themselves don't know these facts because they're not taught in intro college history classes either. The idea that captains of industry were ruining the lives of ordinary people can be very easily tested with data available to anyone with an internet connection, and the results show that our received picture of the world is not just a little bit off but completely wrong. As I said earlier, this mythology about the dark demons known as robber barons and the angelic saviors called populists and progressives is really just another creation myth. Like other such myths, it merely rationalizes the will of the group that is currently in power -- namely, the government and particularly the regulators.

"Why do those people have jobs, teacher?"

"Well, you see Jayden, if we didn't have them, darkness would descend over the land. Let me tell you the story of how the world used to be before the antitrust regulators arrived to deliver us from the wickedness of the robber barons..."

This fake picture we have extends to other industries as well -- I got the idea for this post by learning about the history of Standard Oil, which also was responsible for higher output, lower prices and profits, and saw its market share erode over time. In the popular-audience stuff, I haven't seen much discussion of railroads, although there may be academic articles on the topic. The most important thing here is the graphs, which you rarely see even in journal articles. You're lucky to see full tables. Here, the pattern jumps out at you, showing just how ridiculous the stories we've been told are.

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