H^tt CfoUcgc of AgcicuUttte Kt (S^otmll UntaerBttH HB i715^f'42"'""'™''""-"'"''' Modern economic problems. 3 1924 013 992 296 Cornell University Library The original of tiiis book is in tine Cornell University Library. There are no known copyright restrictions in the United States on the use of the text. http://www.archive.org/details/cu31924013992296 ECONOMICS IN TWO VOLUMES Volume II MODERN ECONOMIC PROBLEMS Economics— IDolume 11 MODERN ECONOMIC PROBLEMS SECOND EDITION, REVISED BY FRANK A. FETTER, PH.D., LL.D. PROFESSOR OP POUTICAIi ECONOMY, PRINCETON UNIVERSITI NEW YORK THE CENTURY CO. 1922 Copyright, 1916, 1922, by The Centuet Co. First Edition, 1916 Reprinted January, 1917 December, 1918 September, 1919 February, 1920 March, 1920 February, 1921 Revised Edition, 1922 !'Z_ 7^^ PRINTED IN U. S. A. TO THE MOTHER WITH A YOUTHFUL HEART AND SYMPATHETIC INTEREST IN ALL THINGS HUMAN TABLE OF CONTENTS PAQB Part I. Money and Prices 1. Nature of economics problems . . .3 2. Origin and nature of money ... . ... 11 3. Commodity money and the quantity theory ... .25 4. Fiduciary money, metal and paper . . .36 5. Price levels and the gold standard . . 54 6. Rising prices and the standard . . . . 70 Part II. Banking and Insurance 7. The functions of banks . . .91 8. Banldng in the United States before 1914 . 107 9. Th(^ Federal Reserve Act 117 10. Crises and industrial depressions 138 11. Institutions for saving and investment 158 12. Principles ,of insurance ... . 176 13. Scientific life insurance ... 191 Part III. Tariff and Taxation 14. American tariff history ... . 207 15. International trade . . 230 16. The policy of a protective tariff . 246 17. Objects and principles of taxation . 270 18. Property and corporation taxes .... . . 288 19. Personal taxes . 304 Part IV. Wages and Labor 20. Methods of industrial remuneration . . 321 21. Organized labor . . 337 22. Public regulation of hours and wages . . . 358 23. Other protective labor and social legislation . . . 379 24. Social insurance . . . . 398 25. Population and immigration ... . 417 Part V. Public Policy Toward Private Industry 26. Agricultural and rural population . .... 441 27. Problems of agricultural economics . .... 457 TABLE OF CONTENTS PAOB 28. The transportation problem ... 477 29. Railroad regulation 490 30. The problem of industrial monoply 505 31. Public policy in respect to monopoly 522 Paet VI. Private Property versus Socialism 32. Thei present economic system 543 33. Public ownership .... 558 34. Methods of distribution 574 35. Socialism, present and future 588 Index 605 FOREWORD TO THE REVISED EDITION. In this revised edition every chapter has been rewritten with reference to the momentous events that have filled the years since 1916, when the first edition of this work appeared. The statements of facts and figures have so far as possible been brought down to date. The materials formerly con- stituting the first two chapters have been distributed under other headings. New sections appear in every chapter, and new chapters have been added in the treatment of money, insurance, transportation, and socialism. Numerous charts have been added which, it is hoped, will be helpful to the reader. 'Most of these have been reproduced from charts prepared for the use of the author's classes, and others have been taken from various sources. A brief list of references has been appended to each chapter. The year 1921, in the depths of an industrial depression, does not mark the end of an era of normal economic changes in anything like the sense that did the year 1916. Rather it might be said that it is the half-way stage in another decade. After five years more the broader economic effects of the world war can be much better appraised. It is the author's hope, however, that in its present form this volume will aid, in some measure, the earnest and open-minded reader to in- terpret the important changes now in progress. The author makes renewed acknowledgment to those col- leagues and other friends who assisted him in various ways in the preparation of the first edition. Thanks are due to the statistical officers of the Federal Reserve Bank of the Second District for permission to reprint diagrams that have appeared in the Monthly Review, and to others named specifi- cally in notes to the charts and maps. Princeton, N. J., Jan. 2, 1922. MODERN ECONOMIC PROBLEMS PART I MONEY AND PRICES MODERN ECONOMIC PROBLEMS CHAPTER 1 NATURE OF ECONOMIC PROBLEMS § 1. Increase of economic problems. § 2. Opinions and feelings in economic discussion. § 3. False contrast of theory and practice. § 4. Superficial thinking and popular error. § 5. American economic problems in the past. § 6. Main factors in economic problems. § 7. Range of economic problems treated. § 1. Increase of economic problems. The present volume deals with various specific problems in economics, as an earlier volume deals with the general economic principles of value and distribution. The word "problem" is often on our tongues. Life itseK 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 the present 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 institu- 3 4 MONEY AND PRICES [Pt- I tions ; 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, 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. § 2. Opinions and feelings in economic discussion. The student beginning economies, or the general reader, is likely to think that the study of principles is more difficult than is that of concrete questions. In fact, the difficulty of the latter, though less obvious, is equally great. The study of princi- ples makes demands upon thought that are open and unmis- takable ; its conclusions, drawn in the cold light of reason, are uncolored by feeling, and are acceptable of all men as long as the precise appliaation that may justly be made of them is not foreseen. But conclusions regarding practical questions of public policy, though they may appear to be simple, usually are biased and complicated by assumptions, prejudices, selfish interests, and feelings, deep-rooted and often unsuspected. "When the casual reader declares that he finds the study of practical questions in economics much easier than that of theory, he really means that the one seems to require little or no thought, while the other requires much. In many questions feeling is nine tenths of reason, and one's Ch. 1] NATURE OF ECONOMIC PROBLEMS 5 sympathies often dictate one's conclusions. In the following pages the reader is repeatedly warned when the discussion reaches such a danger point. When, however, in this work, outlooks and sympathies are expressed or tacitly assumed, they 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 different as to the ends to be attained, a different public policy must be formulated, though the logical analysis of the problems may not need to be greatly changed. § 3. False contrast of theory and practice. Still another word of caution should be given to those who find theoretical economic questions hard but who imagine that the under- standing of "practical" economic questions is comparatively easy. The very contrasting of theoretical and practical study in this way is erroneous and misleading. The true under- standing of every so-called "practical" question requires the understanding of theory, both the general theory (treated in Volume I) that underlies all economic activity, and the special theories that are related to the particular problems (treated in this volume). Indeed, theory as it is here used, and as it ought to be used, is hardly more than a synonym for "understanding"; it is logical analysis, insight, orderly ar- rangement, in our thought, of the forces, motives, and mate- rial conditions that help to bring about certain results. The more clearly the student has thought through the general theories of value, price, time-preference, wages, etc., the better prepared he is to take up the study of such practical problems as money, banking, tariff, labor and capital, etc., every one of which involves more special theories of price levels, fiat money, international trade, the open shop, and minimum wage, re- spectively. § 4. Superficial thinking and popular error. A practical economic problem is always presented as a question: What is the right thing to do or the best course to pursue with re- spect to some matter that is tied up with many other matters ; 6 MONEY AND PRICES [Pt. I SO that the whole situation is usually very complex. The first answer of the untrained mind is almost certain to be a wrong one — just as to the natural man the earth seems flat, though it is round, the sun seems to circle around us, whereas we revolve om the earth's axis daily, and at the same time slowly circle around the sun ; the echo seems to be a mocking spirit answering us, whereas it is our own voice reflected back. Thousands of erroneous ideas were held by primitive man, and still are held by the savage, the child, and the untrained adult mind, regarding the simplest affairs of every-day life. In a like manner, the first answers to economic problems are usually superficial. Since almost every economic matter affects various interests, there is the additional difficulty that some groups of persons, often influential and powerful, have something to gain by continuing to think superficially and by getting those who would benefit by the truth to keep on thinking superficially. Indeed, to think clearly, even if one suspects that it would be to his advantage to do so, is even for the ablest minds a dif- ficult task, and for the mass of men, under the conditions, is often impossible. It should not surprise us, therefore, to find that nearly all economic improvements have been opposed not only by the few who would lose but by the many who would gain by the change ; and to find, likewise, that the projects of reform that most quickly win the belief and support of the mass of men seeking relief from hard conditions have usually been as superficial and false in their theory as the errors they were meant to displace. Truth, when at last found, is simpler than error, but often it is to be attained only by the hard road of analytic and abstract thought that foUows through to the end the workings of each separate force and factor. § 5. American economic problems in the past. What, then, are the 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 Ch. 1] NATURE OF ECONOMIC PROBLEMS 7 can be solved only collectively by political action. With the first settlements of colonists on this continent politico-eco- nomic problems appeared. Take, for example, the land policy. Bach group of colonists and each proprietary land- holder 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 an- swered; 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 coloniza- tion of Texas territory by American settlers and the desire of powerful interests to extend the area of land open to slavery. The CivU 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 eco- nomic 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. § 6. Main factors in economic problems. 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 people composing the nation. The one is what we have, the other is 8 MONEY AND PRICES [Pt. f what we are. 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. I. The objective factor presents two phases : (a) The basic material resources, consisting of the mate- rials of the earth's surface and the natural climatic condi- tions which together provide the physical conditions neces- sary for human existence, and which furnish the stufE out of which men can create new forms of wealth. (b) The industrial equipment, consisting of all those arti- ficial 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. II. The subjective factor presents two phases: (a) The people, considered with reference to their num- ber, race, intelligence, education, and moral, political, and economic capacity. (b) The social system under which men live together, make use of wealth and of their own services, and exchange economic goods. The particular economic problems that are presented to each generation of 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, (I a) with the discovery or the exhaustion (or the increase or decrease) of any kind of basic material resources; (lb) with the multiplication or the improvement of tools and machinery or the invention of better industrial equipment; (II a) with the increase or decrease of the total number of people, and the consequent shift in the relation of popula- tion to resources; (II b) with changes in the ideals, educa- tion, and capacities of any portion of the people whether or not due to changes in the race composition of the population. Cii. 1] NATURE OF ECONOMIC PROBLEMS Many examples of these various 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. § 7. Range of economic problems treated. Of number- less economic problems that are calling for solution in a modern nation like the United States of America, only the more important in relation to present needs can be discussed in their main aspects within the limits of a single volume. The ones here chosen, as may be seen by referring to the table of contents, include a wide range, from the more impersonal financial questions connected with money and the medium of exchange, to the most burning issues of class interests and conflicts; and from those that seem to do merely with the individual (as incomes or wages or taxes) to the most funda- mental questions of the form of economic organization and the displacement of private property by communism. In truth, these contrasts are often misleading; for the welfare of individuals is affected in many ways, often remote and unsuspected, on the one hand by impersonal factors such as the production of gold or the invention of machinery, and on the other hand by the form and function of the social organi- zation of which each of xis is a part. Some conceive of the economist's task narrowly as being merely the study of market prices ; others broaden the field to include the study of individual valuations and gratifications ; and stiU others make it include the solution of all problems of economic legislation affecting the general welfare of society. No practical problem in the field of economics can be rightly solved as if it were an economic problem in any narrow sense untouched by political, moral, and social considerations. In this volume the broadest of these conceptions is taken, prices and values being studied because of their bearing upon social welfare. "Welfare economics rather than price economics is our ideal. 10 MONEY AND PRICES [Pt. I Refeeenoes : The titles of the chief encyclopedias of economics and of several good collections of general readings are given in the Manual of references and exercises in economics, for use with the author's Economic Principles, published by the Century Co., New York. (Ref- erences to the author's Source Book in Economics [1912] have been dropped in this edition, as that work is now out of print.) Several American general texts on political economy treat more or less fully the questions taken up in the present volume. Some of the texts are listed here, and are not referred to specifically in connection with the various chapters following. Carver, T. N., Principles of political economy, 1919. 8ame, Principles of national economy. Boston. Ginn & Co. 1921. Fisher, Irving, Elementary principles of economics. New York. Macmillan. 1912. Ely, R. T., Outlines of economics. Rev. Ed. New York. Macmillan. 1908. Clay, H. Economics. (American Revision.) New York. Macmillan. 1918. Seager, B. R., Principles of economics. New York. Holt. 1913. Seligman, E. R. A., Principles of economics. 3d ed. Taussig, F. W., Principles of economics. 2 vols. New York. Mac- millan. 1911. Turner, J. R., Introduction to economics. New York. Scribners. 1919. CHAPTER 2 ORIGIN AND NATURE OP MONEY § 1. Origin of money. § 2. Money as a tool. § 3. Money defined. § 4. Qualities of the original money-good. § 5. Industrial changes and forms of money. § 6. The precious metals as money. § 7. Varying extent of the use of money. § 8. Eelative importance of money. § 9. Standard-commodity money. § 10. Commodity money without coinage. § 11. The money -material in its commodity uses. § 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.^ 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, ta,ken for the purpose of using it as a price-good to get something else which they de- sire, that a thing has the character of money. The thing caUed 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 in exchange for something else. 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 1 See Vol. 1, pp. 15-16, 50-53, and 26|2-264,for an introductory state- ment of the origin and functions of money. 11 12 MONEY AND PRICES [Pt. I 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. Money as a 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 : it moves things into one's control. A man takes it, not to get enjoy- ment out of it directly, but to apply force, to move something, and that which he moves is the thing he buys. 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 appor- tion 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 can take place. Like any tool or agent, money is valued for what it does or helps to do. It en- hances the value of the goods that it buys and sells by divid- ing them into quantities convenient for use and by making them available at the right times. It has been said that the service performed by money is to overcome the difficulty in barter of the double coincidence of wants and possessions. For example, a man may possess a horse that he is willing to sell, and he wants in place of it not just one thing, but a group of things, say a cow, a bag of flour, a pair of shoes, and several other small commodities, perhaps preferring not to have them all at once, but distributed over a period of some days or some weeks. Now, it is not likely that these things would exchange at such ratios in the market that the horse would just be of equal value to the group of other goods. Little less than a miracle would be needed to find a man desiring a horse, and who at the same time pos- sessed just that group of goods to exchange for it. So, either no trade at all could take place, or there must be a series of trades Oh. 2] OEIGIN AND NATURE OF MONEY 13 in which the man tak;es some of the things he wants (say a cow) and other things "to boot," in the hope that later these may be traded for the right things. Evidently, when the "possession" is one large thing and the "wants" are many (or vice versa), the coincidence required is much more than double. In the light of the principles of diminishing gratifi- cation 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 suc- cessful device ever discoveried 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.^ § 3. Money defined. Money may be defined as a material means of payment and medium of trade, passing from hand to hand and generally accepted as the most usual price-good. The definition contains several ideas. Trade means the taking and giving of things of value. Money passes from hand to hand, is a thing that can be handled and is, or can be, bodily transported. 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. 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. Money is not merely an order for goods, as a card or paper requesting payment; it is itself a thing of value (though this value may be due partly or solely to its possessing the money function) . Such things as a tele- gram when transferring an order for the payment of money, 2 The olfl-fashioned miaer, 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. 14 ' MONEY AND PRICES [Pt- I as the spoken word, and as a mere promise to pay, are not money. Even checks and drafts are merely written evidences of credit, and are used as substitutes for money. In many problems money appears to be at the same time like and unlike other things of value, and just wherein lies the difference it is often 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. §4. Qualities of the original money-good. The selection of any money-commodity has not been made by chance, but has been the' result of that object being better fitted than others to serve as a medium of exchange. The main quali- ties that affected the selection of primitive forms of money were as follows : 1. Marketability (or salability) ; that is, it must be easy to sell. The first forms of money had to be things that 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 when he did not wish its direct use 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 condi- tions. 3. Cognizability; that is, the money-good must be easy to know, and to judge as to quality. If expert knowledge or Ch. 2] ORIGIN AND NATURE OF MONEY 15 special apparatus is needed to test it in order to avoid counter- feits, 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, basing 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 ma- terial that permits it to be divided easi|ly i'nto) 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 homogeneous throughout the whole mass, a condition fulfilled more com- pletely 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 transac- tions 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. § 5. Industrial changes and the forms of money. The money use, as has just been shown, is a rpsultant of a number of different motives in men. The changing material and in- dustrial 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 developmenc have a low claim at another. The final choice of the money-good de- pends on the resultant of all the advantages. Shells are 16 MONEY AND PRICES [Pt. I used for ornament in poor communities, but cease to be so used in a higher state of advancement, and thus their salability 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 pas- toral communities where every one had a share in the pas- ture, cattle were a fairly convenient form of money; but in the city trads 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 con- ditions. If a new and more convenient material is found or th|S 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 prjecious 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 affectsd by and in turn affects all others. § 6. The precious metals as money. Certain of the met- als 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. Th^3se 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 orna- ments and for use as tools and weapons. But as the great Cii. 2] ORIGIN AND NATURE OF MONEY 17 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 reg- ular 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 growmg monetary need, especially in the larger transac- tions. Silver and gold, step by step, oftjsn making little progress in a century, became the staple and dominant forms of money in the world, while copper and nickel still con- tinued to be used for the smaller mon>3tary pieces. Every community has witnessed some stages of this evolution. In this contest silver had, up to the end of the Middle Ages, proved itself to be, on the whole, the fittest medium of ex- change for most purposes, though gold was at the same time in use in larger transactions and in international trade among the leading commercial countries. Gold discoveries in California in 1848, and in Australia, two years later, caused the production of gold to increase enormously,^ and gold became a relatively larger part of the monetary stocks of western European and North American countries. In a higher degree than any other one material, gold has the qualities of the main monetary material for rich and in- dustrially developed communities. England was first to give to gold the chief place in its monetary system; the United States did so in 1834, and has continued to keep gold in that place (except for the period of paper money from 1862 to 1879) ; Prance did so about 1879, having shifted gradually from silver, after 1855, under the working of the bimetallic law ; Germany in 1873 ; and Japan since the later nineties. Other countries have been moving in the same direction. 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-ex- 8 See chart of gold production, ch 5, Fig. 2. 18 MONEY AND PRICES [Pt. I change 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. The most important of the countries in which silver is still the chief form of money is China. There are, however, nu- merous countries, notably in South America and Central America, in which paper notes have long been almost the only form of money ; and in the period of the Great War every one of the belligerent countries excepting the United States approached or reached that condition where neither gold nor silver was actually in circulation. § 7. 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.* 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 Eu- ropean 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 back- ward 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 cir- 4 See Vol, I, p. 43, on the decline of barter. Ch. 2] ORIGIN AND NATURE OF MONEY 19 culation in a country may indicate backwardness in the de- velopment of banks and other credit agencies rather than greater amount of wealth or of business. Notice, for ex- ample, 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 Cieculation of Monet in Leading Countries decbmbeb 31, 1912.5 Krance $48.91 Norway 12.50 Australia 38.45 Sweden 11.59 Canada 33.57 Greece 11.02 America (U.S.) 32.98 Mexico 9.17 Portugal 29 .46 Finland 8 . 38 Netherlands 26.86 Chile 8.24 Switzerland 24.32 Turkey 7.09 Germany 21.36 Russia 6.45 United Kingdom 21.21 Japan 5 . 68 Spain 19.96 Bulgaria 5 . 57 Brazil 18.79 Serbia 5.49 Denmark 17 . 73 Venezuela 5.51 Belgium 15.83 India (British) 5.19 Austria-Hungary 14 . 68 Ecuador 4. 62 Rumania 13.24 Peru 3.17 Italy 13.09 Colombia 2.32 South Africa 12.93 Paraguay 57 § 8. Relative importance of money. Because money is the general expression of purchasing power, and comes to symbolize all other wjealth, it often assumes undue and ex- aggerated 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 5 These figures for a year just before the outbreak of the World War are in terms of the American gold standard dollar, and are retained here as indicating much better than later statistics what may be deemed the "normal" situation, in those countries that had the gold or silver standards at that time. The immense issues of paper money in many of these countries since 1914, as well as the changed value of gold, has quite altered the present status of the monetary stocks. 20 MONEY AND PRICES [Pt. I is enormous. In a society without money industrial processes would be very different, and trade would be hampered in manifold ways. If a poor community lias relatively little money it is 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 than 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 communi- ties imagine that their poverty is due to the small amount of money in circulation. Many of the most common errors in economies are the result of confusion as to the real nature and place of money. The word "money" is so often used, in a figurative sense, for any or all of the goods for which it may be exchanged, that men forget that it is often a mere symbol of wealth and not the wealth itself. To give only two illustrations out of many that could be given : In relation to foreign trade, men continually speak of bringing money into the country, or of sending our money abroad, when in neither case, probably, has any money moved in the direction indicated. Again, in reference to the interest rate or to the cau.ses of business crises, men speak of money being more plentiful or less plentiful, when the amount of money has either not changed or has changed in the con- trary direction, and what is really meant is that some change has occurred in credit conditions. So persistent is this idea that there is hardly an economic problem in which this charac- teristic monetary illusion does not serve to mislead popular opinion. The safest course for the student is to assume al- ways that any explanation of processes of production or of trade in terms of money is superficial, and that the real forces Ch. 2] ORIGIN AND NATURE OF MONEY 21 and reasons are to be found only by penetrating more deeply into the situation. § 9. 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, papfer 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 preeminent and in a peculiar position as the standard money to which the value of all the othjer kinds of money is in some manner adjusted. Usually this standard money is composed of a ma- terial (gold or silver) that is a commodity; but there are many examples of paper money being for the time the stand- ard. "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 who deny the title of money to everything else. Some- times the standard may legally be a double one, as in bimetal- lism, both gold and silver; but in such cases it actually is either gold or silver most of the time. The difficulties of the money problem must be attacked at the point of standard-commodity mon|ey, where it is nearest to ordinary value problems and is less complicated than when the various other kinds of money and the various money sub- stitutes are included. § 10. Commodity money without coinage. Let us con- sider the problem of money and its 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 hav,e seen, be traced back to a point where they were not money, but commodities with only a 22 MONEY AND PRICES [Pi- I 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 that is the reflection of its power to appeal to choice. Now, if to the commodity-use is added the monetary 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 per- Mn being determined by the consideration of all the uses united into one scale of varying gratification. 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." In countries industri- ally backward, payments are still made in this manner. For some time after the discovery of gold in Calfornia, 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 gov- 6 "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 in recent years from twenty to sixty cents in gold. At that time, however, the purchasing power of silver was many times greater than it now is. Ch. 2] OK.IGIN AND NATURE OF MONEY 23 ernment. 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. § 11. The money-material in its commodity uses. In the ease of a commodity-money, such as gold, 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. 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 com- peting for it : its uses for rings, pens, ornaments, champion- ship 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 corre- spondingly diminished in other uses.'' 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 pro- duction, 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.* 7 See § 1 and § 2 of this chapter; also Vol. I, especially pp. 31-38 and 353-355. 8 See Vol. I, pp. 138 ff. and 361 ff. 24 MONEY AND PRICES [Pt. I Eefeebnces. Jevons, W. S., Money and the mechanism of exchange. N. Y. Ap- pleton. 1875. Chs. III-VII, XIII. Johnson, J. F., Money and currency. N. Y. Ginn & Oo. 1905. Chs. I, II, IX. Phillips, C. A. {Ed.), Readings in money and banking. N. Y. Mac- millan. 1916. Chs. I-III, XIV. Walker, P. A., Money in its relations to trade and industry. 1st ed. N. Y. Holt. 1879. Chs. I, II. White, Horace, Money and banking illustrated by American history. Ed. Bost. Ginn & Co. 1914. Bk. I. CHAPTER 3 COMMODITY MONEY AND THE QUANTITY THEORY § 1. Coinage and seigniorage. § 2. Technical features of coinage. § 3. Coined commodity money. § 4. Concept of the individual mone- tary demand. § 5. Factors influencing individual monetary demand. § 6. Concept of the community's monetary demand. § 7. Quantity of money and prices. § 8. The quantity theory of money. § 9. Inter- pretation of the quantity theory. § 10. Practical application of the quantity theory. § 1. Coinage and seigniorage. 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?- The coinage by government had notable ad- vantages in giving to the monetary units uniformity of size, fineness, and value, with the stamp that was readily recog- nized. 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 weill, if only it had carried with it equal assurance of the quality and weight of the metal. Coinage, as practised by early governments and rulers, came to be a function of great importance politically as well as eco- nomically. 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 ; 1 From the French ooin, 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 Uunze is from the Latin moneta (as is the English mint, the place where coins are made), which meant money, that name heing taken from the temple Juno, called Moneta, where coins are made. 25 26 MONEY AND PRICES [Pt. I 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 stiU broader sense, the profit made by the government in issuing any kind of money with a value higher than that of the ma- terials (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 advan- tage 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 gov- ernment 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 coin- age 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. § 2. 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 Ch. 3] COMMODITY MONEY AND THE QUANTITY THEORY 27 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 to make the coins easily recognizable and difficult to counterfeit ; and milled or lettered edges are to prevent clip- ping and otherwise abstracting metal from coins. § 3. Coined commodity money. "Wben coinage is free and gratuitous the standard money is a commodity. Such coin- age is essentially but the stamp and certificate that the coin contains a certain weight and fineness of metal. Where coin- age is free and gratuitous '^ each coin will be worth the same as the bullion that is in it, as far as the citizens exercise their choice. They will not long keep uncoined metal in their pos- session 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. 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 and in methods of trade. 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 com- pared with other forms of wealth evidently would be increased. If all the increased amount went into the industrial arts, the value of gold in its industrial uses would fall below its value in monetary uses. Then a part of the increased amount 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 2 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 vwe versa; e. g., the gold may be in Australia and the mint in London. 28 MONEY AND PRICES [Ft- 1 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 ex- cess of money to others. This bids up the price 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. § 4. 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 re- quired by an individual to make his purchases in expending his income. Every man may be thought of as having an aver- age monetary demand, or his average individual cash re- serve, 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 per- haps $10. Many a workman purchases on credit, running ac- counts 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 equail to one day's wages. Evidently any person's cash re- serve 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. Every moment beyond the average time that any one keeps money increases his monetary demand. If he delays a day, a week, or a month in spending the money, waiting until he can buy in some other market or until a better time to buy, he thus increases insomuch the amount of money needed to make tlio trade (on that scale of prices). It requires more slow Ch. 3] COMMODITY MONEY AND THE QUANTITY THEORY 29 dollars than swift dollars to make a given volume of pur- chases. § 5. Factors influencing individual monetary demand. In this conception of the individual monetary demand must, however, be included not merely the demands of retail pur- chasers, 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 ; ' 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 the individual 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 direcHy 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 en- 3 See on kinds of income, Vol. I, p. 26 ff. 30 MONEY AND PRICES [Pt. I terprises. It is that stock of money which is necessarily- present to effect the exchanges of the community in the pre- vailing manner at any given level of prices. 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 circu- lation. Let us suppose that every piece of money passed from one person to another once each day. Then a doUar 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 $3.33i^. The times of maximum monetary demand of the different individuals do not coincide; often 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 com- munity depends on several factors, the chief among them be- ing the amount of goods to exchange, the methods of exchange, and the value of the commodity material in other uses. The amount of goods to be exchanged may change even when the amount produced is unaltered (e. g., a change from agrieul- turail to industrial conditions). The methods of exchange may alter so as to require either more money (e. g., cash in- stead 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 commodity money production are altered. § 7. Quantity of money and prices. Consider the effect of a large and rapid increase in the production of gold in a community where the gold dollar is the standard commodity money. At first some few men, the miners, may have far more dollars than before, while most men have nearly the same number as before. But those nearest the miners and selling to them will get more dollars, which they will pass Ch. 3] COMMODITY MONEY AND THE QUANTITY THEORY 31 on to others, and thus, in ever-widening circles, the in- creased supply of gold win spread until a new equilibrium of the monetary value is attained, when every one wiU have got his due proportion of the new supplies. If the number of dollars has been doubled, every one will, in the long run, and "other things being equal," have twice as many dol- lars as before. Now, prices of goods cannot remain the same as before; for if they did 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 and of services. At what point will this movement stop 1 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 that each individual is purchasing becomes the same as before. The money in a community being doubled, prices must be doubled, and proportionally for any other change in the quantity. § 8. 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 faU 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," be- tokens the statement of a tendency where there are several 32 MONEY AND PRICES [Ft. I 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 avail- able. According to the quantity theory, we must expect that, when conditions (1) and (2) remain fixed, prices (the gen- eral price level) will vary directly, and the value of money will vary inversely as the quantity of money. This quan- tity theory may be expressed in the formula P ^ -— 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 E, or inversely with N.* § 9. Interpretation of the quantity theory. The quan- tity 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 cer- tain moment to different countries. For example, Mexico may have $9 per capita and the United States $35, while av- erage 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.^ (3) It cannot be applied as a per capita rule to the same country through a series of years, without taking account of 4 This formula is presented by E. W. Kemmerer in "Money and Prices" (2d ed., 1909), p. 15 flf. See table in cb. 2, § 7. Ch. 3] COMMODITY MONEY AND THE QUANTITY THEORY 33 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 ° but average prices have not neces- sarily 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 is equivalent to increasing N in the formula; whereas an increased use of banks and check- ing accounts, by economizing the use of money, enables a smaller amount of money to maintain the same level, and may be considered as increasing R in the formula.' (4) Tho applied originally to standard money, the quan- tity theory applies to all other kinds of money circulating side by side and at a parity of value, as far as these fulfil the definition of money and are not merely supplementary aids to money. These supplementary forms of money en- able each standard dollar to do more work, to circulate more rapidly. If the standard money alone were doubled in quan- tity, while the various forms of fiduciary money (smaller coins, banknotes, government notes) remained unchanged, the quantity of money as a whole would not be doubled. In- deed, in such a case the method of exchange would be greatly altered. According tq_ the quantity theory, therefore, prices would not be expected to double. § 10. Practical application of the quantity theory. De- e Pee Capita Circulation of Monet (Estimated) in the United States in Various Years. 1850 $12.02 1900 $26.93 I860 13.85 1910 34.33 1870 17.51 1915 35.44 1880 19.41 1920 57.18 1800 . . . $4.99 1810 . . . 7.«0 1820 . . . 6.96 1830 . . . 6.78 1840 . . . 10.91 1890 22.82 7 On the function of deposits see ch. 7, § 11. 34 MONEY AND PRICES [Pr. I spite the number of changing factors affecting the methods of exchange and the amount of business, the quantity theory is a rule usable 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 in- crease 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 ex- emplify 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, es- pecially in the sixteenth century, quantities of silver flowed into Europe. The great rise of prices that occurred was ex- plained by the keenest thinkers of that day along the essen- tial 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 banknotes) and prices rose above those of the Continent, led to the modern formulation of the theory of Rieardo 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. The wave- like movements of prices since 1897 are explicable as the Ch. 3] COMMODITY MONEY AND THE QUANTITY THEORY 35 periodic up and down swings of confidence and credit, but in the main the general trend upward has been due to the stimuilus of increasing gold supplies.* 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. 8 Consult Figures 1 and 2 in chapter 5 for the graphic presentation of these and related facts. References. Fisher, Irving, The purchasing power of money. N. Y. Macmillan. 1913. Johnson, J. F., Money and currency. N. Y. Ginn. 1905. Chs. III- VIII, X. Eemmerer, E. W., Money and credit instruments in their relation to general prices. 2d ed. N. Y. Holt. 1909. Phillips, O. A., Readings in money and banking. N. Y. Macmillan. 1916. Walker, F. A., Money. N. Y. Holt. Chs. IV, V. CHAPTER 4 FIDUCIARY MONEY, METAL AND PAPER I 1. Character of fiduciary money. § 2. Present monetary system of the United States. § 3. Saturation point of fractional money. § 4. Light-weight fractional coins. § 5. Gresham's law. § 6. Seign- iorage on standard money. § 7. Fiduciary coinage on governmental account. § 8. Two stages of coinage debasement. § 9. The gold-ex- change standard. § 10. Nature of governmental paper money. § 11. Irredeemable paper money in America. § 12. Irredeemable paper money in Europe. § 13. Theories of political money. § 14. Political money; theory and practice. § 1. Character of fiduciary money. 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 usually the standard money and usually is a commodity. The ex- ceptions indicated by the word "usually" are (a) that un- der the plan of bimetallism, two metals may be legally des- ignated as the standard, making in fact an alternative standard, called, however, a double standard; and (b) that an irredeemable paper money may be, for the time, the stand- ard money. The coinage of standard money often is free and gratuitous (or nearly so), 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 ap- preciable difference between the value in the two uses. This adjustment is brought about by the free action of the people. The government, having declared w^hat is the standard money unit, and having provided a mint to make coins, leaves it to citizens, acting on the ordinary business motives, to decide 36 Ch. 4] FIDUCIARY MONEY, METAL AND PAPER 37 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 may 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, as long as any of it is in circulation. In contrast with commodity money, these other kinds may be called fiduciary money. By fiducim-y money we mean money that has not a commodity value equal to its money value, but which is generally ac- cepted because each receiver has faith that others in turn will take it in the same way. 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 irre- deemable, that is, either carrying no promise of redemption in the standard money or in fact not being redeemed. Yet often 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. § 2. Present monetary system of the United States. In the following table is given a summary of the main features marking the monetary system of the United States in 1920. Not all this variety is essential to an efficient monetary system, and several of the kinds survive as the result of his- torical accidents (political a,nd 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 doH'ars are no longer coined, subsidi:ary silver and minor coins are issued only in exchange for other money, as are gold and silver certificates in ex- change for gold or for silver, which they merely represent while in circulation. 38 MONEY AND PRICES [Pt. I MONETARY SYSTEM OF THE UNITED STATES, 1920 Metalt Weight, grains Fineneo Ratio to gold 25.8 412.5 885.8 1 77.0 1 48.0 1 .90 .90 .90 .25 .95 100 2. Silver dollar 3. Silver, subsidiary . . 4. Nickel (5 cents) .. 5. Copper (1 cent) . . . 15.988 to 1 14.953 to 1 Metal LimU of iatue Legal tender for private debte Receivable for public dues 1, Gold coins 2. Silver dollar 5. Silver, subsidiary... 4. Nickel (5 cents) . . . 6. Copper (1 cent) . . . Paper 6. Gold certiflcateB 7. Silver certificates . . . 8. U. S. notes 9. Treasury notes of 1890 Unlimited. Ceased in 1906 In exchange for other forms Do. Do. Unlimited in ex- change for gold coin. In exchange for silver dollar No new issues. No new issues. Capital of banks To replace Nat. bank-notes Per cent, of gold reserves. Unlimited. Unlimited. $10 25 cents 35 cents Yes (since 1919) No Yes Fes No Same as Nat. bank-notes At banks of re- serve system For aU For all $10 25 cents 25 cents For all For aU Except customs For all 10. National bank-notes. 11. Federal Reserve notes 12. Federal Reserve notes Except customs Same as Nat. bank-notes For aU Metal Exchangeable at Treasury for Redeemable at Treasury in In circulation June 30, 1920 1. 2. S. 4 Gold coins Silver dollar Silver, subsidiary . . Nickel Gold certificates, U. S., Treas., or Fed. Res. notes. Silver certificates Minor coins Subsidiary and minor coins Silver and minor coins Subsidiary and minor coins Silver and minor coins Subsidiary silver and minor coins Same Gold' Lawful money," in sums or mul- tiples of $2( 1 Do. 1 Do. J Gold coin Silver dollars Gold Gold Lawfiil money " Same Gnld" 839,000,000 134,000,000 252,000,000 5 96,000.000 " 6. 7. 8. 9. Paper Gold certificates .... Silver certificates .... U. S. notes Treasury notes of 1890 391,000,000 • 118,000,000 ' 337,000,000 1,656,000 10. 11. 12. National bank notes. Fed. Res. bank-notes. Federal reserve notes 696,000.000 199,000,000 3.120.000.000 Total ' 6,183,656,000 " "Lawful money" includes gold coin, gold certificates, silver dollars, U. S. notes, and Treasury notes. * Redeemable also in lawful money at bank of issue. " Redeemable also at Federal Reserve banks in gold. * Not usually included in the estimates of total money in circulation. * Represented dollar for dollar by gold kept in the U. S. Treasury. ' Represented dollar for dollar by silver kept in the U. S. Treasury. " Besides, there were about $464,000,000 in gold and $22,000,000 in silver, in the U. S. Treasury, mints, and Federal Reserve banks, not offset by gold and silver certificates, respectively. Ch. 4] FIDUCIARY MONEY, METAL AND PAPER 39 § 3. Saturation point of fractional money. Fiduciary money is that on -which regularly the issuer makes a seign- iorage charge.^ Let us consider now the effect of seigniorage on the value of money. Fractional coins, called also subsidiary 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 denomina- tions, and "small change" is necessary to make small pur- chases 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 frac- tional 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 con- venience quarters may be used for halves, and dimes for niekles (and vice versa) ; but each person has a point of pref- erence. 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. § 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 use for small transactions. But if coins of these metals are issued at weights corresponding with their bullion value, difficulties often arise. Not only are they too heavy for convenience, but with every slight rise in 1 In the broad sense as before defined, ch. 3, § 1. 40 MONEY AND PRICES [Pt. I 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 frequently made to coin gold and silver at a ratio of weight corresponding exactly to their market values at the time and, every time the market conditions varied, the best full-weight coins of one of the two metals were taken out of circulation; whereas the worn coins might remain in cir- culation.^ Business thus often suffered for lack of the proper proportion of the various denominations of 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, as compared with the standard commodity money. 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 dollar of 23.22 grains, and was freely coined. The fractional coins were made a little more than six 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. Later silver bullion became worth much less in terms of gold, and for years the bullion value of the silver in a dollar of silver small change was between forty and sixty cents. Yet the fact that fractional coinage continued to circulate and exchange freely at parity with standard money showed that it had a monetary value equal to the standard money, dollar for dollar. Why was this? The answer is, because it is artificially limited in quan- tity, 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 2 See next section on worn coins in connection with Gresham's law. Ch. 4] FIDUCIARY MONEY, METAL AND PAPER 41 of the larger denominations, and by redeeming it in other money on demand. Mostly, fractional coins are issued by the mints on the request of banks. One needing "change" gets it at the bank; when the bank finds its supply falling short it gets more in exchange for other forms of money, as shown in the table of the monetary system. As business increases in a period of prosperity, the demand for nickels, dimes, and quarters rises, and the mints work night and day to supply the need. 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 be- come 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 Treas- •ury (and practically at every bank and post-office) in other money, any slight tendency to depreciation in any locality, is at once corrected. 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. The government makes a seigniorage profit on the fiduciary coinage, as shown in the appended table.^ OPERATIONS OF THE U. S. MINT SERVICE, 1920 Receipts : Charges for refining, assaying, manufacture for other countries, etc $668,000 Profits on seigniorage, subsidiary and minor coinage .... 12,333,000 Total receipts 12,901,000 Expenditures : All kinds 2,377,000 Net revenues from mint service 10,524,000 § 5. 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, and ordinarily without any depreciation. It makes no differ- 3 Receipts and Expenditures of Mint Service in 1920. 42 MONEY AND PRICES [Pt. I ence 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. They have a value as money greater than the value of the bullion that is in them. Yet 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 worn coins remain in circula- tion — a fact that iu medieval times was found both mystify- ing and annoying. In explanation of this phenomenon was formulated Gres- ham's law of the circulation side by side of coins of differ- ent 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 Eliza- beth when counseling her regarding the recoinage of the de- based 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 fuU-weight coins, the old lighter ones re- mained as money, while the new ones, being heavier, were picked out by jewelers and others needing to send money abroad. Gresham 's law has a paradoxical wording and is frequently misunderstood. "Bad money," as he used the term, meant, not counterfeit money, but merely worn coins that have a bullion value less than that of some other money then in circulation. But such "bad money" will not always drive out "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 circula- tion 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 money altogether, the bad money is just as gcod as the good money. But, even if good money is driven out, it may mot leave the Country. It may bei Ch. 4] FIDUCIARY MONEY, METAL AND PAPER 43 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 ap- plied to the plan of recoinage it is: Withdraw worn coins as rapidly (in equal numbers) as you put new coins into circulation. The continued circulation of "bad" money alongside of "good" money (light-weight alongside of full -weight coins), as long as the total number of coins is not in excess of the money demand for full-weight coins, is explained thus on exactly the same principle as is the circulation at parity of a light-weight fractional coinage, in the preceding section. § 6. Seigniorage on standard money. The fiduciary coinage problem presents itself under a somewhat 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 might be free but not gratuitous. Then no bullion would be brougit to the mint unless the coined pieces the owners received had a value equal to the bullion value plus the seigniorage charge. The power to impose a seigniorage charge is a monopoly power, a power of artificial limitation. 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. With this number of pieces, the money demand of the country is at the saturation point for full-weight metal coins. If more coins could in any way be put into circulation they would be worth less as money than as bullion, and would be melted or exported. Assume that this full supply of gold money at the satura- tion point is 100,000 pieces or dollars; then consider the effect of imposing a seigniorage charge of 10 per cent on further coinage. If business or population did not increase, and until through loss, by fire and in other ways, and through use for industrial purposes, the quantity of money had been reduced below this point, the seigniorage charge 44 MONEY AND PRICES [Pt- I would have no effect, and there would be no desire to change gold from bullion form into coin. But when any or all of these suggested changes take place, the value of the mone- tary unit relative to the bullion value will begin to rise. It will take on a monopoly value due to the limitation of coin- age. When it has risen until the coin will buy any more than one ninth more bullion than was in it, the citizens will begin to take metal to the mint. After the 10 per cent charge is taken out they will receive a coin which, though containing one tenth less bullion, will be worth very nearly the same as the metal taken to the mint. No 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 seign- iorage, 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 con- tained. We thus have arrived at the general principle of seignior- age: when coins are not issued beyond the saturation point, a seigniorage charge raises the monetary value of the money- material above its bullion, that is, its commodity, value. 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. Fiduciary coinage on governmental account. The fiduciary coinage problem may be presented also when coin- age 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 Ch. 4] FIDUCIARY MONEY, METAL AND PAPER 45 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 one tenth 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 profit would be one-tenth of 90,000, or 9,000 units. No depreciation has taken place,* 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 bul- lion value one tenth below their money value. As this proc- ess is repeated the number of coins 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 ten to nine. At this point the 111,111 pieces would contain just the same amount i 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 bpl'"'gs in a more complete theoretical treatment of the subject. 46 MONEY AND PRICES [Pt. I 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. § 8. Two stages of coinage debasement. It will be seen that, taking the number of full-weight coins at the saturation point as parity (when price is 100), then (a) price rises directly as the number of units of money; (b) the value of the monetary unit is the reciprocal of price (changes in- versely with the number of units of money). When a new seigniorage charge is imposed, the change in the physical content of the coin is called debasement. Two stages of this change may be distinguished (as is shown in the preceding description). The first stage is debasement without depreciation of the monetary unit; the second stage is debasement with depreciation. In the first stage the mone- tary unit, as a result of limitation, has an artificial value in excess of its bullion value; in the second stage its monetary value falls toward its bullion value, but may (depending on limitation) rest anywhere between the former full- weight bullion value and the new bullion-content value. The process illustrated above was often repeated in the Middle Ages. A ruler, either by making a higher seignior- age 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, circu- lated 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 be- gan 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 Ch. 4] FIDUCIARY MONEY, METAL AND PAPER 47 successive steps the coinage came to consist almost entirely of cheaper alloy. § 9. 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 pay- ment 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 prevent the adop- tion of gold and the disuse of silver as the actual money in circulation. The method adopted, that of the gold-exchange standard, in operation in India since 1893, in the Philippines since 1903, and in Mexico since 1904, involves these features : (1) Closing the mints of the country to the free coinage of silver. (2) Adoption of a fixed ratio of exchange between the silver coins in circulation and a 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) Eegulation and limitation of the amount of silver money in circulation, so that a fixed parity between it and gold may be maintained, (a) by issuing coins in limited num- ber and 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 in a special reserve, thus reducing the total volume of money in circulation ; (c) by the purchase of foreign bills of ex- change at a fixed rate, thus paying out and putting again into circulation some of the fiduciary money in the special re- serve. These monetary changes furnish numerous illustrations and demonstrations of the quantity theory of money as applied to the entire circulating medium of the country.' The silver 5 See "Modern Currency Reforms" (1916) , by E. W. Kemmerer, pro- fessor of Economics and Finance in Princeton University, for a detailed 48 MONEY AND PRICES [Pt. I coins which alone are in actual circulation become fiduciary by reason of the artificial limitation of their number, and their monetary value is made to conform to the vailue of gold° as used in international trade. § 10. Nature of governmental paper money. The prob- lem 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 govern- mental notes here, reserving until later 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 100 per cent is charged. The gain of seigniorage from paper monej^ is greater and is just as easily secured as that from coinage of metals. Governmental paper money is called "political money," in contrast to commodity money. However, all coins that contain an element of seign- iorage, 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 u^sed 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 pur- pose 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 bank- treatment of this remarkable series of monetary changes, probably un- equaled in instructiveness to the student of monetary tlieory. « That is, it is made to conform as closely as do the values of gold in two different countries, fluctuating within the upper and lower limits of the gold-shipping points, as explained more fully under inter- national trade in ch. 15- § 10. Ch. 4] FIDUCIARY MONEY, METAL AND PAPER 49 rupt 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 prom- issory notes and bonds in thiat its value is not based on the in- terest it yields, but mainly on its monetary uses. The issue of paper money may save the government the payment of in- terest on an equal amount of bonds. The promise to receive paper in payment for taxes or for public ilands may help to maintain its value by reducing its quantity, but nothing short of its prompt redemption in standard coins makes it truly re- deemable. § 11. Irredeemable paper money in America. 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 be- fore 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 j-ear 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, more than $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. 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 re- verse 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 50 MONEY AND PRICES [Pt. I 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." Ever since that time the United States has maintained the gold standard. § 12. Irredeemable paper money in Europe. The leaders of the French Revolution, failing to learn the lesson of the American revolutionary 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 by the Bank of England under the restriction act of 1797-1820 is especially notable because it gave rise to the controversy which did much to develop the modem theory of the subject. Parliament for- bade 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 de- preciated and drove gold out of circulation, and it was not until 1821 that specie payments were definitely resumed. Essentially the method of the restriction act was applied by each of the belligerent nations to its state bank in the period of the World War. 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 gov- ernments of the warring nations began to exercise a strict Ch. 4] FIDUCIARY MONEY, METAL AND PAPER 51 control over the issue of paper money, sought in every way possible to gather into the public treasury all the precious metals in the form of coins or ornaments, and to give paper (either governmental notes or bank-notes) a forced circula- tion, making it the sole circulating medium. In such cases the money partakes somewhat of the characters both of bank- notes and of political money. Even in Great Britain the paper money (mostly notes of the Bank of England) depre- ciated 20 per cent or more, compared with gold; in France and in Belgium, at the worst, nearly 60 per cent; whereas in many of the other continental countries (notably Germany and Austria) it fell nearly 99 per cent. In Eussia the paper seems to have become quite worthless. The return to the gold standard is one of the most difficult tasks these countries have to perform. § 13. 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 govern- ment 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 re- demption, just as is any private note. Depreciation, accord- ing 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 as- sert 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, 62 MONE'^ AND PRICES [Pt. I "Let it 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 dream. The depreciation that has taken place in nearly every ease 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 cir- culate 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. The almost universally accepted opinion among economists rejects both of these views, while recognizing in each a cer- tain limited aspect of the truth. The cost-of -production view overlooks the features in which paper money differs from or- dinary credit paper. The value of a man's promises to pay depends on his reputation and his resources ; the resources con- stitute 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. § 14. Political money; theory and practice. The theory of paper money here outlined explains the value of paper money as a special ease of political monopoly. 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 that gives the economic condition for value in paper money and strictly limits the power of the govern- ment — a fact overlooked by the fiat theorists. Business con- ditions remaining unchanged, the limit of possible issue with- Ch. 4] FIDUCIARY MONEY, METAL AND PAPER 53 out depreciation is the number of units in circulation before the paper money was issued, the saturation point of full- weight and full-value coins. Under wise and honest con- trol and regulation, political paper money might serve the monetary function very effectively. Since the end of the World War, from various quarters has been advanced the plan of an international paper money, to be issued by some organization like a world federal reserve bank. The amount and value of the notes would be regulated in conformity with the gold standard. To monetary students this plan is not new and is theoretically sound except for the political difficul- ties likely to arise. Resorted to in desperate extremities, political money has usually proved to be a costly experiment. Once the issue of political money begins to be excessive, its further limitation proves to be most difficult. A result usually unintended is the derangement of business and of the existing distribution of incomes. The rapid and unpredictable changes in prices give 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, that makes political money in general a poor kind of money. Refebences. Jevons, W. 8., Money and the mechanism of exchange. N. Y. Ap- pleton. 1875. Chs. VIII, XVII, XVIII. Johnson, J. F., Money and currency. Bost. Ginn. 1905. Chs. XIII-XVI. Kemmerer, E. W., Modern currency reforms. N. Y. Macmillan. 1916. P. 541. Phillips, G. A. N. Y. Macmillan. 1916. Chs. IV, V, XII. United States Director of the Mvnt, Annual reports. Walker, F. A., Money. N. Y. Holt. Chs. VIII-XII. White, Horace, Money and banking illustrated by American History. Bost. Ginn & Co. 1914. Bk. II, chs. III-VI. CHAPTER 5 PRICE LEVELS AND THE GOLD STANDARD § 1. Concept of the general price level. § 2. Index numbers. § 3. Definition of the standard of deferred payments. § 4. Increasing im- portance of the standard. § 5. Defectiveness of the gold standard. § 6. Relative values of gold and silver. § 7. Gold production, 1800-1850. § 8. Gold production and price changes, 1850-1873. § 9. The great fall of prices, 1873-1896. § 10. Nature and object of bimetal- ism. § 11. The free-silver movement. § 1. Concept of the general price level. The price of any good is some other good or group of goods given for it in trade.^ 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 any 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 com- modity 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 gen- 1 See Vol. I, p. 45 B. 64 Ch. 5] PRICE LEVELS AND THE GOLD STANDARD 55 eral 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 conven- ience 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 gen- eral 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 pur- chasing power), and vice versa. § 2. 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. No list of articles that can be selected is of equal 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 that in some measure affect the interests of every member of the community. General prices are conveniently compared frbm one time to another through the use of index numbers. An index number of any article is the per cent that 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 68 MONEY AND PRICES [Pt. I Fig. 1. Index Nujibees of Prices. The four series of prices here shown begin at different periods: the American in 1840 (Aldrich re- port 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 dia- gram'. It does not represent the heights of any particular prices of the different countries compared with eacli other either at any one date or for the entire period. The average prices of selected groups of com- modities are compared every year with the average of the prices for 1890-1899 in each country, respectively. The important facts to observe are the fluctuations, both their times and their directions, both the larger tidal movements and the lesser wave-like movements within the business cycles. The figure indicates that both American and German average 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 that on gold pro- duction. 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 actu- ally continued to fall after gold production had begun to climb. Like- wise the growing monetary use of gold accentuated strongly the effects between 1873 and 1883 of a comparatively small decrease in gold pro- duction. Ch. 5] PRICE LEVELS AND THE GOLD STANDARD 57 be 120. A tabular index number is the per cent that 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 that has been taken as the base. Numerous tabular index numbers have been worked out for different countries and periods. A chart of the principal index numbers of the leading coun- tries is shown in Figure 1. 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. § 3. Definition of the standard of deferred payments. 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.^ This makes it also the most convenient unit in which to express the amount of credit transactions and of existing debts.^ A credit transaction is a trade lengthened in time; one party fulfils his part of the contract by delivering the goods or money, 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 prom- ise 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 2 See Vol. I, p. 262. 3 See Vol. I, p. 263, on credit transactions, and p. 302, on interest contract. 58 MONEY AND PRICES [Pt. I 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 the law or by contract, the amount of a debt is expressed and payable. § 4. 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 ex- pressed in terms of a common circulating medium. It there- fore 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 effect 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.* 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 i See Vol. I, p. 304. Ch. 5] PRICE LEVELS AND THE GOLD STANDARD 59 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^ 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. § 5. 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 speak- ing 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. Although the value of gold is stable a.s compared with most things, it rests on the estimates made by men and is constantly changing with con- ditions. 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 make 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 produc- tion ; the existing stock is twenty or thirty times the annual output. 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 out- put in any year or short period. It changes in volume as does B See Vol. I, p. 319. 60 MONEY AND PRICES [Pt. I a glacier fed by the snows of many years, not as does a river, filled by a single rainfall. Yet the value of gold expressed in other things is never quite stable, and sometimes several influences combine to affect it greatly. At various times the discovery of gold deposits, and recently the invention of chemical and mechani- cal processes, have suddenly altered the conditions of gold production, causing revolutionary results in the field of prices and deferred payments. A brief survey of these changes will be helpful to an understanding of the problem in- volved. § 6. Relative values of gold and silver. Both gold and silver were used as moneys in Greece and Rome, and con- tinued to be used in Europe in the Middle Ages, though silver was much the more common. The two metals continued in the seventeenth and eighteenth centuries 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 legal forms of money 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 which at the moment was the cheaper at the legal ratio. Fluctuations in the prices of gold Fig. 2. 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 mod- ern economic problem. Compare in the present connection this figure ■with Figure 1 in this Chapter showing changes in index numbers of prices. GOLD PRODUCTION OP THE WORLD. 1493-1710 I . AVEBAQES FOB FEBIODs'bEFOEE 1870 I | 1500 ; I T T [ T I ; : 1600 ; : : : I : : : ; 1700 i Ch. 5] PRICE LEVELS AND THE GOLD STANDARD 61 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. Table — Gold production of the World. By decades and years, in $1,000,000 coinage value 1890 1900 1910 1911 1912 1913 1914 1915 1916 1917 1918 1919 1920 119 255 455 462 466 46B 456 469 454 424 381 364 337 1710-1918 . . QvJ^ l--: --:--;--ri8oo 62 MONEY AND PRICES [Pt. I It is a remarkable fact that from the time of Xenophon until the discovery of America (a period of nearly two thou- sand years) the market ratio of silver to gold bullion in Europe had remained pretty close to ten to one, being only temporarily altered by sudden and unusual occurrences. From 1492 to 1660 the ratio changed to fifteen to one, 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 fifteen to one as the natural order, deter- mined (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 eiJect 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 hemi- sphere was the main source of the precious metals, the allu- vial deposits were widely scattered, were gradually discovered, were usually found in small quantities, and were extracted in primitive ways. For a short time after the discovery of America (from 1493 to about 1544) the average coining value ^ of the world's production of gold, nearly all found in America, was about one and one-half times as great as that of silver; but thereafter for three centuries from about 1545, the annual value of silver produced was between one and one-half to four 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. § 7. Gold production, 1800-1850. The legal ratio of 15 to 1 in the United States, at which by the law of 6 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 al- ways in ratio of 16 to 1. Ch. 5] PRICE LEVELS AND THE GOLD STANDARD 03 1792 both metals were to be freely coined at the mint, proved to be an undervaluation of gold. The market ratio of the two metals had been gradually changing before 1792, and continued to change, gold becoming more valuable in terms of silver. Gold largely left circulation, and by 1818 silver and bank-notes formed nearly the whole of the circulating medium. Then the production of gold began to increase ab- solutely and relatively somewhat more than that of silver, and when the market ratio had become about 15i/^ to 1 in 1834, the legal ratio of the United States was changed to 16 to 1. This overvalued gold and brought a good deal of it back into circulation, gradually driving out most of the silver (the heavier coins disappearing first). In the decade 1841-50 the average annual value of the gold production, 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. The value of gold produced in the world in 1851 was one and one half times that of silver, in 1852 three times, and in 1853 four times as great; and then slowly declined, but continued every year as late as 1870 to more than twice as great. Let us observe the effect on prices that was brought about by the discoveries of 1848-49. § 8. Gold production and price changes, 1850-1873. The unprecedented increase in gold production between 1849 and 1853, and the continuance of production in volume about fourfold as great as that of the decade 1840-49, caused the displacement of silver by gold in the United States and drove out a large proportion of the silver coins of smaller denominations. To make possible their retention the law of 1853 was passed, authorizing subsidiary coinage (on gov- ernment account only) of lighter weight.'' Gold became then the one standard money actually in circulation in the United States, and the increased gold production was reflected at once in a rise of prices. This was the most revolutionary 7 See ch. 4, § 4. 64 MONEY AND PRICES [Pt. I price change that had occurred since the sixteenth century. A period of prosperity in business culminated 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. Then the substitution of gold for silver in monetary uses made an additional market for gold, and at the same time the rapid growth of population, commerce, and industry in Europe and America began to take up ("absorb") the new supplies of gold. The price movements in the United States between 1860 and 1879 are passed over 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). In the European countries prices in terms of gold, though fluctuating some- what, 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. § 9. The great fall of prices, 1873-1896. In the year, 1873, notable in monetary history, just as the gold production for the first time since 1851 had fallen below $100,000,000, several notable changes in monetary legislation were effected which made gold more important in the circulation of a number of countries. In 1873 Germany made gold the standard through- out 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 that resulted in demonctiz- Cn. 5] PRICE LEVELS AND THE GOLD STANDARD 65 ing silver, that is, in limiting its coinage to governmental ac- count, and in making gold their one standard money. In the United States at that time, and until 1879, green- backs were standard money, and neither gold nor silver was regularly in circulation (except in California). There was a long-continued discussion of a " return to specie payments, ' ' which meant the return to a metallic standard, and the re- demption 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.^ From 1873 until 1879 prices (in greenbacks) were falling in this country very rap- idly 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 coun- try 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.^ Between 1864 and 1876 our own gold product had been nearly all exported; but, beginning in 1878 and continuing till 1888, the demand of our Treasury and banks for gold caused the retention of our own gold product in this country (nearly $400,000,000 worth, coining value, in the period of eleven years), and required an enor- mous net importation, amounting (in the same period) to $225,000,000 worth of gold. The combined effect of these causes is seen in the great fall of prices in all gold-standard countries in the period of 1873-1896. The general price level fluctuated but on the whole tended downward between 1884 and 1893 (the year of panic), and 8 This change wag 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. 7See ch. 4, § 4. 66 MONEY AND PKICES [Pt. 1 reached a mininmln in the year 1895 in Germany, 1896 in England, and 1897 in America. The resulting increase ia 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 aggra- vated 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.^" 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 politicail 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.^^ This then gave way to an agitation for bimetallism. Bimetallism is the plan of using two metals as standard moneys. Bimet- allism 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 work- ing; for if the market value long continues to vary appre- ciably from the legal ratio, only one of the metals may in fact be left in circulation. This situation is called limping bimet- allism (or halting double standard), though this is a contra- diction of terms. National bimetallism is confined to a single country, as was the case in the United States before the Civil "War, and 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 substi- tution. The metal tending to become dearer will not be 10 See Vol. I, on agricultural leases, p. 159, wheat prices, p. 436, and changes in the land supply, p. 442. 11 See ch. 4, § 13. Ch. 5] PRICE LEVELS AND THE GOLD STANDARD 67 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 remain- ing 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 bimetallism was to put an end to the great fluctuations in the rates of exchange of money between the silver-uising and gold-using countries, fluctuations that occa- sioned 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 aJso an in- crease 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 move- ment 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 ; 68 MONEY AND PKICES [Pt. I though England was in the main opposed. The movement came to nothing. § 11. The free-silver movement. When all hope of inter- national bimetallism failed, the efforts of many of its advo- cates were turned to the plan of legalizing national bimet- allism in the United States at a ratio of 16 to 1. This was very different from the market ratio. Gold had become be- fore 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 nf 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. However, the "free- silver movement" to open the mints to the free coinage of silver at the ratio of 16 to 1, supported by one of the leading political parties in the year 1896, threatened a sudden and marked cheapening of money. Probably gold would have been entirely driven out as money for the time and silver would have taken its place as the standard. It is not im- possible, however, that the substitution of silver for gold in the United States would have brought the two metals to parity at a level of prices much less than 100 per cent higher than the existing one, possibly not more than 20 or 30 per cent higher. 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 Ch. 5] PRICE LEVELS AND THE GOLD STANDARD 69 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 cam- paign 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. References. Anderson, B. M. Jr., Efifectg of the war on money, credit and banking in France and the U. S. Carnegie Endowment for International Peace. P. 227. New York. Oxford University Press. 1919. Mitchell, W. C, History of prices during the war. P. 95. Wash- ington War Industries Board. 1919. CHAPTER 6 RISING PRICES AND THE STANDARD § 1. Rising prices, 1896-1913. § 2. Rising prices in Europe, 1914- 1920. § 3. Causes of European inflation. § 4. Gold stocks of belliger- ents. § 5. Redistribution of European gold stocks. § 6. The flood of gold to America, 1915-1917. § 7. The gold embargo in tbe United States. § 8. Gold depreciation and gold production. § 9. The high cost of living, 1919-1920. § 10. Various ideal standards suggested. § 11. The tabular or multiple standard. § 12. Fluctuating standard and the interest rate. § 1. Rising prices, 1896-1913. 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 justly claim the credit. In 1883 the gold production of the world was less than $100,000,000. From that date, with the opening of new gold-yielding territory in South Africa and in the Klondike, the annual output of gold had Deen 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 intro- duced (notably the cyanide process), and the principal pro- duct began to come from the regular and certain working of deep mines rather than from chance surface discoveries. In many parts of the world there were enormous deposits of low-grade ores, before useless, that could be worked eco- nomically by the new methods. 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 $200,000,000 mark. The gold output had not only caught 70 Ch. 6] RISING PRICES AND THE STANDARD 71 18 YEARS, 1901 -1916 7300 MILLION DOLLARS 25 YEABS. 1676-1900 up with, but had begun to surpass, the normal monetary de- mands of the world, meaning by that phrase the amount of gold needed to maintain a stationary level of prices. A study of Figure 1, chapter 6, will help to an apprecia- tion of the enormous increase in the world's production of gold after 1850. The production of gold from the discovery of America to 1850 doubtless was much greater than it had ever been in any equal period. But this amount was dupli- cated in the next quarter of a century, again duplicated in the next twenty-five years, and more than doubled in the fol- lowing eighteen years. The annual average output in the 357 years ending 1850 was $8,700,000, in the quarter century fol- lowing 1850 was $124,000,000, from 1876 to 1900 was $140,000,- 000, and from 1901-1918 was $405,000,000. The whole character of the monetary problem was changed. A period of rising prices set in, as is shown graphically in Figure 2, chapter 6. By 1913 prices had risen just about 50 per cent above the low level of 1896. The rise was 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 burden of the average debt began relatively to decrease. A wide field for enterprisers' profits was opened up by the rapid displacement of prevailing prices in all quarters of the industrial world. The price of manufacturers' 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 357 YEARS, 1493-1850 = 25 " 1851 1875 3100 MIWOH DOLLARS Fis. 1. Gold Production BY Periods f2. MONEY AND PRICES [Pt. I of most of the commodities that are bought with wages, thus causing great hardship to large classes living on com- paratively slowly moving incomes/ Extremes meet, and these classes include both those living on passive investments and those dependent on their daily labor for a livelihood. § 2. Rising prices in Europe, 1914-1920. The year 1913, the last before the outbreak of the World "War, marks a new 140 130. 110- Wholesale Prices laso-isw 1914-100 1 — I — I — I — I — I — I — I — 1 — I — I — I — I — I — I — I — I — I — I — 1 — 1 — I — I — I — 1B90 I89Z 1894 1896 1898 1900 1902 1904 1906 1908 1910 1912 1914 Fig. 2. \YiioLESALE Prices in the U. S., 1890-1914. era in price history, and is now usually taken as the base from which are measured in the various coujntries the remark- able series of price changes that followed. The year 1914 was one in which the political outlook was disquieting, and the European state banks and treasuries were quietly build- ing up their gold reserves to meet possible emergencies, thus 1 This happened to coincide with a relative increase of the prices 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 livin" must be carefully distinguished from that of the change of the general price level, and also from that of the relatively slower change of wa^es. See Vol. I, pp. 437, 445-446 on population and food supply. Ch. 6] RISING PRICES AND THE STANDARD 73 contracting the circulation. The annual average index num- bers in all the leading countries were nearly the same in 1914 as in 1913. In the warring countries, however, wholesale prices began at once in August to rise rapidly, attaining in the last quarter of 1914 the figure of 107 in France and 108 in Great Britain. Retail price changes in every country lagged behind the whole- sale, not infrequently being retarded a year or more. This 260 260 2-40 iZO 200 ISO 160 - 140- IZO 100 ao 60 Wholesale Prices isis-iszi 1914 =100 191S- Fig. 3. Wholesale Prices in the U. S., 1913-1921. rise of prices continued, with hardly an Interruption, in all countries, reaching the maximum about the middle of 1920. In the United States prices fell quickly to 98 in the last quarter of 1914, as gold was clamorously (and foolishly) de- manded by European bankers, and a brief financial panic occurred. But the average of prices continued in th'f United States almost stationary until the last quarter of ' 5 (that 74 MONEY AND PRICES [Pt. I is, about one year after the war began in Europe), when they began to rise sharply, for reasons that will be indicated in the next section. The changes are shown graphically in Figures 3 and 4, Chapter 6. § 3. Causes of European inflation. Changes in index numbers reflect changes in the relation of the quantity of goods to be exchanged, expressed in their prices, and the quantity of money used in exchanging them. Therefore the explanation of any particular rise in the price level may be 19IS 19JG J9I7 I9IS 1919 ISaO 1921 Fig. 4. Prices in the U. S., 1915-1921. found in the factor of goods, (a) in a reduction of their amount or (b) a lessened need to exchange them by means of money; or may be found in the factor of money, (x) in an increase in the amount of money or (y) in an increased use of substitutes for money, such as banking credit. At the outbreak of the war the popular explanation of rising prices is the lack of goods- yhat is, (a). Attention is drawn dramatically to the numb ; , men taken out of industry to go into war service, Ch. 6] RISING PRICES AND THE STANDARD 75 at the front or behind the lines. But these comprise only a small percentage of the total population; their places are in large part taken by women and by older men, inspired by patriotic motives, and the exercise of war-time economies largely reduces the demand for many kinds of goods. Factor (b) doubtless has some validity: withdrawing men from ordinary industry, where they receive wages in money and spend it in retail purchases, and putting them into the army, where their food, clothing, and other wants, are sup- plied by the government, reduces the monetary demand of the community. At the same time, the use by the govern- ment, factor (y), of the facilities of the banks in its war purchases reduces the field within which money is required in war-time as compared with ordinary peace-time business. Much the larger part of the explanation sought is to be found in (x). Immediately on the outbreak of war all the warring countries began to issue paper money, usually through the agency of their central state banks. They con- tinued to issue it in larger and larger amounts not only until the armistice in November, 1918, but, under the pressure of financial need, after the armistice. Even England and France, whose prices were already up to 235 and 330, respec- tively, at the armistice (on the basis of 1913 prices), each increased their note issues about 130 per cent, between the armistice and the middle of 1920. The effect is seen in the mounting price, curves. Though it is impossible to estimate exactly the amount of paper money issued, because of differ- ent agencies, governmental and banking, through which it was done, the rise in prices probably fell short of the paper money inflation; but it must be considered that this was in part offset by the complete withdrawal of gold and silver from circulation. § 4. Gold stocks of belligerents. The depreciation of the paper currency was not due to the absence of gold in these countries. They all alike made strenuous efforts to impound in their central treasuries all the gold that was in the 76 MONEY AND PRICES [Pt. I countries. A strong patriotic appeal was made to all citizens. Some gold that had been in circulation was exchanged for paper issued by the banks ; in many cases old coins that had been hoarded for generations (as is not uncommon in Europe), and therefore having no more effect on prices than so much gold in the earth, were brought out of hiding and into the banks. Family plate, ornaments, and jewelry were brought to the mints, were melted and assayed, the owners not only being paid in bank-notes, but receiving certificates of patriotic service, and often, besides, some valued privilege, such as that of driving a nail into the Hindenburg wooden statue in Berlin. This process of getting gold has been called "min- ing it out of the pockets of the people." The total gold held by all European banks and state treas- uries between 1914 and 1919 increased every year (excepting in 1916). Most of this increase took place in the neutral countries, notably Spain, Holland, and the Scandinavian countries, to which it was shipped to pay for war supplies. But France and Italy nearly held their own, and England and Germany each largely increased their gold stocks. Russia and Austria, however, lost a large part of their gold stocks, Russia by export to buy goods under the Bolshevik regime, and Austria by forced deposit with Germany as a con- dition of financial assistance. § 5. Redistribution of European gold stocks. The net gain of gold, expressed in terms of American dollars, in lead- ing European banks and central treasuries was approximately as follows (not including Russia, the data for which are un- certain) : Year Amount in $1,000,000 1914 329 gain 1915 690 gain 1916 190 loss 1917 89 gain 1918 214 gain Total (5 years) 1132 net gain ch. g] rising prices and the standard 77 Olassified by groups of countries,^ it appears that in the war period the Central Empires gained net about 6 per cent (Austria losing nearly all and Germany more than doubling its stock), the Allies (England, France, and Italy) gained net 28 per cent (Prance and Italy, which had large stock at the beginning, losing little, and England, which had a small stock, more than trebling), and European neutrals gained net 66 per cent, of which Spain got $338,000,000, Holland $216,000,000, the Scandinavian countries $102,000,000, and Switzerland $47,000,000 value. It is apparent that the gold that was collected by the belligerents did not, as it is often assumed, serve "to support" the value of the paper money which had been issued in ex- cess. Indeed, it may be said that it did not in the least so serve. What it did do was to give to these countries a valuable exportable commodity to exchange with neutrals for much-needed supplies of goods, and to afford the readiest of assets for post-war financing. Error will be avoided by clearly recognizing that these European- stocks of gold had ceased to be money for domestic purposes, and that their essential use was to be found only in international trade as long as specie payments were suspended. § 6. The flood of gold to America 1915-1917. The United States lost some gold to Eu[rope in the first months of the war ; but thereafter, while it remained neutral, it received large quantities of gold from Europe. In the first month of the war, August, 1914, and increasingly in the following months, contracts for food and supplie? of all kinds were placed in America by European countri ;s, and soon a large and steadily swelling stream of exports was moving toward Europe. The Central Empires were prevented by the Allied blockade from getting many of these goods directly, 2 These figures are- from a different source ; the relatively small dis- crepancy in the total does not necessarily indicate an error, but a slight difference in the data, or the inclusion of some minor countries in the figures. 78 MONEY AND PRICES [Pt. I Imports of Gold to U.S. Exports ofGoub from U.S.I 1915 1916 1917 1918 1919 Movement of Gold by Years but large amounts got into Germany and Austria through .bor- dering neutral countries, which profited greatly by this trade. As England and France accumulated rapidly large debits in America, they not only floated loans of various kinds to satisfy these for the time, but also shipped here gold in un- precedented amounts. For two years our gold stock had been almost unchanging; but between July 1, 1915, and the end of June, 1917, the net increase of gold stocks in the United States was about one and a quarter billion dollars — a veritable "flood of gold" borne upon which prices rapidly rose. This inflow contnued until after our entry into the war (in April, 1917), w'len our large loans to the Allies reduced their need of sending us gold, and at the same time our increasing purchases from Spain, South America, and Asiatic countries made some net exports of gold necessary, first in May, and then after June in increasing amount. The movement of gold by years is shown graphically in Figure 5, chapter 6. § 7. The gold embargo in the United States. Moved by mistaken fear, the Federal Reserve Board imposed an embargo Ch. 6] RISING PRICES AND THE STANDARD 79 on the export of gold (made its export illegal). This pol- icy of gold-fetichism, which remained in force from Septem- ber, 1917, to June, 1919, involved a deplorable lapse from sound monetary principles. The gold embargo had the evil effect of introducing into conditions ailready bad, a new and artificial element of inflation. However, trade conditions were such that the general world balance of gold payments would, on the whole, have been little away from America, otherwise the embargo would have been still more difficult to enforce. As far as it was enforceable (which it was probably, for the time, in large part), the embargo could have only the evil efi'eets of disrupting the exchange rates (as it did) with countries to which we had international balances, notably Argentine, Spain, and Japan. Indeed, in principle, it is suspension of specie payments in international trade, and this is an abandonment of the international gold standard. Our exchanges with a few foreign countries that were selling us largely were thrown into disorder. In the twenty-month period of the embargo, our net loss of gold was only $5,000,000. Just as the embargo was removed these conditions were already changing. In the next ten months (June 1, 1919, to April 1, 1920) our net exports of gold were more than $400,000,000, which served to restore the value of the dollar in those countries where it had depreciated. Then, again, after a few. months of fluctuating balances, began, in September, 1920, a new flood of gold to the United States, which by the end of May, 1921, amounted to more than $480,000,000. The exports of gold from the United States between November, 1918, and August, 1920, have gone largely to Japan, China, British India, Hongkong, Spain, Argentine, and Mexico. Imports since September, 1920, however, have been largely sent by England, France, Sweden, and Canada, not merely to pay their trade balances, but because the United States has become the most important free gold market in the world, and "dollar exchange," the best international currency, is eagerly desired by producers and owners of gold every- where. 80 MONEY AND PRICES [Pt. I § 8. Gold depreciation and gold production. In explana- tion of the changes in price levels in the various countries, a distinction should he made between gold depreciation and paper depreciation — or, otherwise expressed, between gold inflation and paper-money inflation. The one expression re- fers to the value of gold in terms of goods, the other to paper prices expressed in gold. In the United States (except dur- ing the embargo, to a slight degree) and several other coun- tries gold has continued to be the standard- money in in- ternational trade, and the rising index number has reflected a real fall in the purchasing power of gold. The main reasons for this are: (1) the transfer of large amounts of gold from the countries where for the time being it has been in fact demonetized, to the coun- tries still maintaining the gold standard; our own gold stock in two years increased by the amount of the world 's total production for three years; (2) the increased use of banking credit under the Federal Reserve system has en- abled an equal amount of gold to perform more monetary services ; and (3) the world's production of gold, which reached its highest peali in 1915, continued, relative to the narrowed field of its monetary uses, to be larger until 1920 than it had ever before been in history. This is shown in Figure 6, chapter 6. Higher prices in terms of gold mean higher wages, higher costs for machinery and supplies, in short, higher costs of every kind in gold-mining. Many mines formerly profitable must be abandoned, one after the other, until the costs of mining on the marginal mines are brought into accord with the value of the gold produced. The folly, at such a time, of proposals for governmental subsidies and bonuses to gold- DETAIL- 1908 ON, HIGH TIDE 08 09 to II 12 IS 14 IS 16 17 IB 19 20 Fig. 6. Gold Pbodvction AT TiiK Peak Ch. 0] RISING PRICES AND THE STANDARD 81 mining to keep up the quantity of gold ought to be apparent to any one with the most elemetary understanding of mone- tary principles. Yet such a proposal was presented in a bill in Congress, and strongly supported, as it was said, "to aid us to maintain the gold standard." The increase of index numbers in countries with paper currencies is in every case greater than that in gold-stan- dard countries. The difference measures, pretty exactly, reciprocally the depreciation of the paper in terms of gold, and the abnormal rise of foreign exchange rates. § 9. The high cost of living, 1919-1920. The curve of general wholesale prices that began to rise in the United States about July, 1915, reached its peak in May, 1920, at a point 172 per cent above the level maintained from 1913 to June, 1915. Retail prices (estimated as "cost of living" on a standard family budget) followed on the up-swing, but, as usual, lagged behind, reaching a maximuan in the middle of 1920, a little more than 100 per cent above the 1913-15 level. A very large part of this increase both of wholesale and of retail prices occurred in the post-war period of great specu- lation between March, 1919, and May, 1920. This movement was world-wide, as the result partly of great increases of paper money and bank credits, in the European countries, necessary because of the desperate state of their finances, and needlessly assisted in America by those having ultimate authority in the Federal Reserve system. Prices ran the usual course as a financial crisis approached, goods being bought and contracts made with borrowed funds in the hope of a further rise of prices. It was for many a veritable financial joy-ride. Such a rapid rise affected different classes of persons in business and different classes of goods very unequally. Cases of extravagant expenditures (relative to former standards) were conspicuous in working class circles, where wages rose faster than the cost of living, and among the newly-rich employers who had ' ' profiteered ' ' in the war and the post-war 82 MONEY AND PEICES [Pt. 1 period of speculation. Less conspicuously, great numbers of wage-earners and salaried and professional workers felt keenly and suffered greatly from the higher cost of living (popularly denominated the H. C. L.). The different ele- ments in the cost of living moved at various rates, as is shown in Figure 8, chapter 6. Among the industries that profiteered most for the time were those engaged in producing clothing, furniture, and food, including nearly all agricultural products. Among those that were losers in the purchasing power of their incomes were 1916 1917 1918 1919 1920 1921 Fig. 7. Average WiEekly Earnings AND Cost op Living op Factory Employees in New York State. many active enterprisers whose products rose in price more slowly than the average (or than their wage bills and other costs) and all public utilities fixed by charter or controlled by price-fixing commissions. Many railroads, trolley lines, gas and electric companies were brought to the verge of bankruptcy or beyond. § 10. Various ideal standards suggested. Price history since 1873, however varied, teaches one lesson clearly: that our "standard" unit of price has in fact been subject to great fluctuations in its value. "We escape the evils of a Ch. 6] RISING PRICES AND THE STANDARD 83 280 t8l4 1915 I9IB 1817 1918 1918 I9e0 1921 Fig. 8. Cost of Living in the U. S. (By permission of the Na- tional Industrial Conference Board.) rising standard of deferred payments (falling prices) only to meet those of a falling standard (rising prices) . And as long 84 MONEY AND PRICES [Pt. I as we have so fluctuating a standard these difficulties must arise again and again, continually repeated, causing unmerited gains and undeserved losses to individuals. But what stand- ard would be better than that of gold? 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 attrac- tive 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 ch£inging. 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 sug- gestion is that the goods returned should represent the same sacrifice as those lent. 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.^ It must be recognized that any possible concrete standard of deferred payments will sometimes work hardship in in- dividual 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. § 11. The tabular or multiple standard. Gold is the best 3 See on the labor theory of value, Vol. I, pp. 210, 228-229, 502. Ch. 6] RISING PRICES AND THE STANDARD 85 standard yet devised and put into actual practice, but it is very imperfect. A standard better than a single metal, more stable than a single commodity, is desirable if it can be found. Apart from the difficulties of its practical operation, such a standard 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. This 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, though not in individual cases). While some natural mate- rials 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 diffi- culties, ways may yet be found for putting it into practice. After choosing the components of tlie multiple 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 re- quiring a greater or less number of dollars to be given in fulfillment of all outstanding contracts. For example, if prices by the multiple 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. Another plan is that of a "compensated gold dollar." By this plan the legal weight of gold coins would be increased or decreased from time to time to conform with the changing index numbers. 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 with- drawal from depository banks, at regular intervals to bring prices into conformity with the tabular standard. These are 86 MONEY AND PRICES [Pt. I 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. § 12. 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.* As the general price level falls or rises, the monetary standard conversely appreciates or depreciates.^ 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 from 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 invest- ment period $1000 principal, each dollar of which will pur- chase the same composite quantum of goods that a dollar would have purchased at the time the loan was made. Like- wise, 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 lent, 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 4 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 re- quires adjustment to apply to a condition of a changing price level. 5 See ch. 5, § 1. Ch. 6] RISING PRICES AND THE STANDARD 87 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 re- pay 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 bor- rowers and lenders are able to talie it into account, and, as experience shows, do take it into account." When prices fall men become more eager to sell wealth, to lend the pro- ceeds, 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 ris- ing 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 in- terest 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 fall- ing 1 per cent each year, the adjusted rate of interest would be 4 per cent; and when prices were rising 1 per cent each 6 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. 88 MONEY AND PRICES [Pt. I 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 as 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. The principal and interest com- bined have no greater purchasing power at the end of the period than the principal alone had at the beginning of it. It is the same as if the dollars had been buried during a period of stationary prices.'' 7 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 ap- preciating dollar to a falling rate of interest). More generally the theory is that of the relation of a changing standard of deferred pay- ments and the rate of interest. Eefeeences. Bureau of Applied Economics, Changes in the cost of living 1914- 1919. P. 55. Washington. 1919. Fisher, Irving, Appreciation and interest. A. E. Assn., Pubs. 11: 331-442. 1896. Same, Stabilizing the dollar. P. 205. New York. Macmillan. 1920. Jevons, W. S., Money and the mechanism of exchange. N. Y. Ap- pleton, 1875. Ch. XXV. Johnson, J. F., Money and currency. Bost. Girm. 1905. Chs XI, XII, XVTI. Marshall, L. P. and others. Materials for the study of elementary economics, Chicago University Press, 1913, 787, 788 {extract from Brown, H. G.,) , 788, 789 (extract from Clark, W. E., in "How to invest when prices are rising." 1912). Noyes, A. D., Forty years of American finance. N. Y. Putnam. 1909. Chs. I-III. Phillips, C. A., Ed., Headings in Money and banking. N. Y. Mac- millan. 1879. Chs. VI, VII, XIII. Walker, F. A., Money. N. Y. Holt. Chs. Ill, VI, VII. PART II BANKING AiSTD INSURANCE THE FUNCTIONS OF BANKS CHAPTER 7 § 1. Nature and classes of banks. § 2. Functions of banks. § 3. The essential banking function. § 4. Demand deposits. § 5. Discount and deposit. § 6. Nature of banking reserves. § 7. Time deposits. § 8. Bills of exchange, domestic. § 9. Issue of notes. § 10. Diver- gent views of typical bank-notes. § 11. Banking credit as a medium of trade. § 12. Productive services of banks. § 13. Earnings of banks. § 1. Nature and classes of banks. A bank, as one first comes to know it, is a building (or a room in some building) in whicb there is a fire- and burglar-proof safe. In this room are men receiving and paying out money and acting as bookkeepers. Usu[ally, however, the word bank means, not the building, but the business organization or the enter- prise as a whole. Banks perform a variety of useful func- tions 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 nature and work of banks in relation to the general business activity of the community. In the United States there were on June 30, 1920, more than 30,000 banks reported. 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.^ Banks may be classified also, according to the two main types of business they perform, as banks for 1 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. 91 92 BANKING AND INSURANCE [Pi. II savings and commercial banks. Most banks do mainly a gen- eral commercial business; some are distinctly banks for sav- ings ; but in truth this dividing line can be less and less sharply drawn between banks as units; 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 statistical data collected in the United States distinguish only imperfectly between these two. The trust company usually unites these two functions in large degree. This matter will be better understood in connection with the analysis of the functions that banks per- form, now to be given.^ § 2. Functions of banks, incidental. 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 pos- session of the valuables, but himself retains the key to the 2 Banks in the United States, 1920. Sesources $1,000,000 COMMERCIAL BANKS 'Numher 'National charter: National banks 8,030 22,197 State charter : State banks 18,195 14,010 Loan and trust companies 1,408 8,320 Private : b Private banks 799 213 SAVINGS BANKS (all state) Mutual 620 5,619 Stock 1,087 1,506 Total 30,139 51,865 National 8.030 22,197 Total state 22,109 29,668 Ch. 7] THE FUNCTIONS OF BANKS 93 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. More- over, 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 was taken up rapidly after about 1890 by trust companies ' or- ganized under state laws, and after 1918 (as a result of an act of Congress) by many national banks. (e) Receiving time deposits at a low' rate of interest to lend or invest in securities at a higher rate of interest. Such time deposits are not subject to withdrawal by customer's check, excepting after notice to the bank (if required) . Re- ceiving time deposits is the essential function of savings banks (as distinct from commercial banks) and will be more fully discussed in a later chapter. (f) Selling its credit, that is, giving its promise to pay at some other place, or at some other time, in return for a payment that yields a profit. § 3. The essential banking function. The one essential 3 Not to be confused with a trust in the sense of a monopolistic enter- prise, with which it has no connection except by mere verbal accident, through the word trust. 94 BANKING AND INSUKANCE [Pt. II function of a bank is selling (lending) its credit to its cus- tomers in some form that will conveniently serve the same function as money. A bank of this kind is sometimes de- scribed 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 abilty to fulfil its promise to pay whenever it is due. This confidence is built upon the bank's paid-up capital; its surplus and un- divided 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 finan- cial 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 char- acter of its loans and of the securities which it owns; and, finally, the reliance placed upon the control and inspection by official examiners. The bank then may (in addition to receiving time deposits) sell its credit in any one or in all of the following foujr ways: (1) by receiving demand deposits; (2) by the method of discount and deposit; (3) by selling exchange of funds to distant points; (4) by issuing bank- notes. § 4. Demand deposits. Demand deposits are those pay- able 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 custom- er's bank account consisting of demand deposits is called a checking account. Since the turn of the century it has be- come 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 Ch. 7] THE FUNCTIONS OF BANKS 95 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 corpora- tions. Large amounts of deposits (though only a small pro- portion of the total) are brought to the banks in the form of bags and rolls of money, or as funds consisting of credit papers, such as checks and drafts, calling for the payment of money. But most deposits are created in another manner now to be described. § 5. Discount and deposit. The process of discount and deposit is the purchase of the promissory note of a customer,* the price being a credit in the form of a demand deposit on the books of the bank. This — the central and most char- acteristic banking operation — ^has something of mystery in it at first view. In simple deposit, described in the last section, the bank becomes the debtor and the depositor be- comes 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 $1000 note for three months and credits its customer with the pro- ceeds, 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 pay- able on demand. As an offsetting asset it holds the note of its customer receivable at some future time. Most of the loans and discounts of commercial banks serve thus to create deposits, and the two items (loans and deposits) rise and fall in about the same ratio. In 1920 in all reporting banks (exclusive of the twelve Federal Reserve banks) individual deposits were $38,000,000,000 and loans were $31,000,000,000. 4 Usually with deduction of interest in advance; a process called discount. See Vol. I, pp. 275, 302. 96 BANKING AND INSURANCE [Pt. II § 6. Nature of banking reserves. Banks would have noth- ing 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). It was found necessary in practice for banks 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 de- mands under ordinary business conditions. 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, or of both together. Frequently, as in the United States, a mini- mum percentage of reserves is fixed by law.' A bank's reserves consist, first, of the lawful money that it actually holds in its vaults at any moment, and, secondly, of certain other credit items in other banks or with the govern- ment, of such a nature that a bank is permitted to count them as though immediately available. The explanation of the adequacy of a mere fractional re- if he would avoid overdrawing his account, must at most mand " and in the effective way in which a checking account serve is found in the nature of the individual monetary de- serves as a substitute for actual money.'' Every customer, 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 5 The legal requirements as to minimum reserves vary greatly from no specific per cent to 40 or more in diflferent 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. 6 See ch. 4, § 5. 7 See below, § 11. Ch. 7] THE FUNCTIONS OF BANKS 97 fractional reserve is therefore ordinarily fully adequate, although with any less than 100 per cent reserve any bank would be insolvent if all of its demand obligations were pre- sented at the same instant. Such an extreme condition is made impossible by business custom and public opinion, es- pecially among the larger customers of banks ; but the panic of small depositors and the urgent need of larger ones often bring about a dangerous situation, in which banks with abundant assets find their reserves nearly or quite exhausted. To prevent the breakdown of the separate banks and of the whole banking system at such times, by providing ways of replenishing the reserves, is a large part of the "banking problem. ' ' § 7. 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 from thirty to ninety days; but only in times of general financial crises or of runs on particular banks is this require- ment 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 de- posits. 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 98 BANKING AND INSURANCE [Pt. II a mueli 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.' In Some cases time deposits are cared for by a separate department and kept separate from the general busi- ness of a commercial bank. § 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 send- ing the money in some way. It must often occur, for ex- ample, 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 waste- ful 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 funds in correspondent banks in one or more of the larger cities on which it draws bills of exchange for its cus- tomers and to which in turn it remits for collection drafts and checks which it has received. Before 1914 such deposits might, up to a certain percentage, be coutnted as part of the depositing bank's legal reserves. 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 mutually cancelled. Similarly, the settlement of ac- counts between any two localities can be made by the ship- ment of comparatively small sums of money. Under the Federal Reserve Act the reserve banks have in various ways 8 The Federal Reserve Act of 1913 has given encouragement to this practice by reducing to 3 per cent the reserve required to be kept against time deposits. See ch. 9, § 7. Ch. 7] THE FUNCTIONS OF BANKS 99 assumed the functions of the correspondent banks, aiming to bring about parity of checks issued in any part of the country. The wider use and acceptance of individual checks at long distances from the banks upon which they are drawn limit by so mx^ch 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. Issues 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. The function of bank-note issue has come to be looked upon 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 an organ of the govern- ment. To such banks the right of note issue is granted as a monopoly in return for specified payments aad services. In normal times the issues of bank-n-gtesi are regulated by the banks themselves ; but in times such as those fallowing the outbreak of the World "War the bank-note issues become es- sentially political money (irredeemable) issued by command, and to meet the urgent financial needs, of the sovereign state. No two countries have quite the same kind and system of bank-notes. Typical bank money ( ol" "credit currency") consists of notes issu,ed by banks on the credit of their gen- eral assets, without special regulation by law. Many of the bank-notes issued by the banks chartered by either the federal or the state governments before the Civil War were of this 100 BANKING AND INSUEANCE [Pt. II kind; but after 1837 the notes of the Second Bank of the United States, which had been prudently controlled, were. retired. The experience with many (not all) of the state bank-notes issues thereafter, until the Civil War, was less fortunate. As it was to the interest of the banks to keep in circulation as many notes as possible, many banks yielded to the temptation to abuse the power of note issue. The period is known as that of "wild-cat" banking. In 1866 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 bank-notes, the old bond-secured notes, in use since 1863 (very different from the typical form),'* 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 eastomer, 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 regula- tions) has the ganie claim on the bank that a depositor has. § 10. Divergent views of typical bank-notes. Some per- sons, seeing in bank-notes but a form of ordinary commercial credit (like the promissory note or an individual's check), have contended that their issue should be entirely unlimited » Including, now, two varieties: the "national bank-notes,'' issued, as before, through local banks, and some ''Federal Reserve bank-notes," which are national bank-notes that have been taken over by the Federal Reserve banks. Ch. 7] THE FUNCTIONS OF BANKS 101 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 tliem 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. 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. Be- tween 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 charactei- 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 inconvertable paper money, depend for their value on the credit of the bank, not on their legal-tender quality and on political power.^" They must 10 In some cases, as during the bank restriction in England, 1797- 102 BANKING AND INSURANCE [Pt. II be redeemed on penalty of insolvency ; government notes need not be, and yet will circulate at par if properly limited. Ade- quate provisions for the prompt return and redemption of bank-notes makes tbem "elastic" in their adaption to mone- tary needs, which fluctuate with changes in commerce and industry from season to season and even from day to day. The predominent 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. In ordinary times they stand midway between the two, though in war financing they may virtually become merely fiat notes. Everjrwhere 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 coTne 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 of payments to the government. § 11. Banking credit as a medium of trade. The credit which, in various ways, banks sell ^^ serves, in most eases, the purposes of money to their customers. On the contrary, this is not usually 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. How- ever, 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 tempo- rary savings, which otherwise would be hoarded in the form of money and thus withdrawn from circulation. In such cases the time deposit may serve both as an investment and as a monetary fund for future use. This is a great economy 1821, and after 1914 in all the European countries, bank-notes become inconvertable — practically political money. 11 See above, § 3. Ch. 7] THE FUNCTIONS OF BANKS 103 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 11/2 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 $6,500,000,000 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. Payment of in- terest on credit balances reduces the motive to withdraw for investment elsewhere any such excess, and mingles in the depositor's thought moneta:ry and investment motives. De- mand deposits are often spoken of (somewhat inaccurately) as "deposit currency," being funds at the command of de- positors which are as disposable and as active and current for the monetary function as so much actidjal money would be. It is estimated that the rate of turnover of deposits in the United States is about fifty 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 re- serves is multiplied manyfold.^^ 12 In the United States in 1920 individual deposits in banks could be classified as follows: PayaWe on demand $17,500,000,000 Time deposits (or not classified) 20,200,000,000 Total 37,700,000,000 Of the total $14,000,000,000 were in national and $23,700,000,000 were 104 BANKING AND INSURANCE [Pt. II The metliod of payment by bank drafts in domestic ex- change 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 cancella- tion of drafts, bills of exchange, and checks. The use of bank-notes reduces the amou^nt needed of other kinds of money more directly, though not more effectively, than do deposit accounts. Bank-notes are money, and as long as their amount is limited by prompt redemption they circulate mstead of so much of other kinds of money. Re- demption 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 mystery about banking credit than about the nature of money, itself. Banks are the labor-saving machin- ery of finance. They gather loanable funds, reduce hoard- ing, make money move more rapidly, and create a central in other banks. All the demand deposits were subject to check, ex- cepting $1,300,000,000 of demand certificates. Of the time deposits $7,500,000,000 were in savings accounts, $2,000,000,000 in time certi- ficates, and $10,100,000,000 not classified, of which a large part was "time deposits on open account," for the withdrawal of which ordi- narily no notice is required. It appears, therefore, that at least $25,000,000,000 of deposits are almost as good as cash in hand for the depositors' current needs. This was more than four times the $6,000,000,000 of cash in circulation and in banks at the same time, and was twenty-five times the $1,000,000,000 cash in these same banks (the Federal Reserve banks not included) at that time. These figures indicate the great influence that banking has in increasing the average efficiency of the circulating medium of the country. (Figures from Annual Report of the Secretary of the Treasury, 1920, pp. 1188, 1430, 1431). Ch. 7] THE FUNCTIONS OF BANKS 105 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 per- form incidentally a further service in developing better busi- ness 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 men comes to exercise a practical monopoly of business credit in any community, and uses this power for its own greedy and selfish ends. § 13. Earnings of banks. The earnings of banks are 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 have been increasing in number. The earnings of banks are 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 " could be lent with less trouble and more cheaply without starting a bank, but used as a banking capital it can be lent in part while still serving to attract deposits, which are the main source of the income of banks to-day. In the past it has been customary for many banks, especially "coun- try banks," to charge for remittances and for the collection of checks from other banks; but under the Federal Reserve system great progress has been made toward parity of ex- change, or parity of checks, everywhere in the United States. 13 See above, § 3. 106 BANKING AND INSURANCE [Pt. II While many small banks have strenuously opposed this be- cause it cuts off a considerable source of revenute, they gain in other ways by performing this service freely for their cus- tomers. 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. Refebei^ces. Agger, E. E., Organized banking. P. 385. New York. Holt. 1918. Cleveland, F. A., Funds and their uses. N. Y. Appleton. 1902. Conant, G. A., History of modern banks of issue. 5th ed. N. Y. Putnam. 1915. Dunbar, C. F., Theory and history of banking. New ed. N. Y. Putnam. 1917. Fiske, A. K., The modern bank. N. Y. Appleton. 1903. Holdsworth, J. T., Money and banking. N. Y. Appleton. 1914. Phillips, G. A., ed., Readings in money and banking. N. Y. Mac- millan, 1916. Chs. IX, X. Same, A study of the principles and factors underlying advances made by banks to borrowers. P. 374. New York. Macmillan. 1920. Pratt, 8. 8., The work of Wall Street. P. 447. An account of the functions, methods, and history of the New York money and stock markets. New York. Appleton. 1921. Scott, W. A., Money and banking. N. Y. Holt. 1916. White, Horace, Money a,nd hanking illustrated by American History Bost. Ginn. 1914. Bk. III. Chs. I-III. CHAPTER 8 BANKING IN THE UNITED STATES BEFORE 1914 § 1. The First and Second Banks of the United States. § 2. Bank- ing from 183C to 1863. § 3. National Banking Associations, 1863- 1913. § 4. Defects of our hanking organization before 1913. § 5. Lack of system. § 6. Inelasticity of credit. § 7. Periodical local con- gestion 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. The form of our present banking system has been affected by various economic and political events, a knowledge of which is helpful f an understanding of the present banking system in our country. Alexander Hamilton, the great first Secretary of the Treas- ury in Washington's cabinet, advocated the charter of a cen- tral national bank as one portion of his larger plan of na- tional financiering. His purpose was realized in the charter- ing, in 1791, of the First Bank of the United States for a period of twenty years. The capital for this institultion 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 estab- lished 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 con- troversies over state rights and was from the first opposed by 107 108 BANKING AND INSURANCE [Ft. II 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 banl? became, even in a greater de- gree than did the First Bank, the creature of political rival- ries. 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. Jackson's suspicions and hostility to a central bank were magnified by the untactful conduct of the head of the bank, and Congress permitted its charter to expire by limitation in 1836, near the close of Jackson's administra- tion. In the light of history the change of policy must be pronounced unfortunate, the more so because it committed the then leading political party to opposition against a bet- ter organization of banking on a national scale. The action was directly that of Jackson, but the fixing of the blame is not an entirely simple thing. § 2. Banking from 1836 to 1863. The federal govern- ment, which up to that time had deposited its funds in the central bank and its branches, and in local state banks, es- tablished the "independent treasury" in 1840. This was abolished in 1841, but reestablished in 1846, and continuously maintained until January, 1921, when the Federal Reserve Board took over all nine of the offices and sub-treasury branches. 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 con- tinuously a central banking system was in operation, other banks, organized under state charters, were steadily increas- Ch. 8] BANKING IN THE UNITED STATES BEFORE 1914 109 ing 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-chartered banks for twenty-seven years all the banking functions of the country. A few of the states be- came stockholders in central state banks, or even undertook to conduct a banking business, with unsatisfactory results. The banks of some states (notably those of New England and New York), conducted as private enterprises iinder care- ful regulation and held to strict standards by public senti- ment, 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 apparent in connection with exces- sive issues of bank-notes. § 3. National Banking Associations, 1863-1913. No further step was taken in federal legislation until 1863, when, in the midst of the Civil War, local ' ' national banking asso- ciations" were chartered. The purpose was in part to pro- vide 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 govern- ment credit was at low ebb. The plan adopted followed the experience of New York state (from 1829 on) with a system of bond-secured banknotes. 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 valU(e of the bonds, 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.) Notes of failed banks or of banks that go out of business are re- deemed from the guaranty fund held at Washington and from the proceeds of the sale of the bonds. Bank-notes issued on this plan, being secured by the bonds and a redemption 110 BANKING AND INSURANCE [Pt. II fund, rest ultimately on tlie 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 perfectly safe for the holder, but are not an "elastic cur- rency," 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 there- after 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.^ 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 thou- sand, 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 forty-seven other cities as reserve cities, in which the reserves of banks have always been re- quired to bear a considerably larger proportion to their de- posits than in other cities.^ Other banks might, until 1914, count as part of their legal reserves their deposits in reserve 1 In recent years that 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. 2 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, § 7) were all altered by the legislation of 1913, effective late in 1914. Oh. 8] BANKING IN THE UNITED STATES BEFORE 1914 111 city banks, up to a certain proportion. The national banks in tbe 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 that has strengthened public confidence in their stability. Except in this and the other respects above mentioned, a national char- ter 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 national banks in the United 'States between 1863 and 1913 represented great banking power and very efScient service for the community in times of normal business, as with few exceptions ' did also the state banks. But in several respects it long ago became apparent 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 diffi- culty of its task. Especially at the recurring periods of financial stress, such as those of 1878, 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 this fact clearly was trace- able in large part to defects in the banking situation. In academic teaching and in public conferences of bankers, busi- ness 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 bank- ing and currency. After the most extended inquiry and dis- cussion that the subject had ever received, the commission submitted its report in January, 1912. The defects to be 112 BANKING AND INSURANCE [Pt. II remedied, as enumerated in the report^ may be reduced to the following five headings: (a) Lack of system, (b) In- elasticity of credit, (e) 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 couild the banks of the United States be said (before 1914) to constitute a system at all. Both national and state laws dealt with indi- vidual 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 cooperation 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 caU for any sums it had deposited with other banks,* 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 de- veloped 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 with- drawal of money from circulation and thus depleting bank 3 The expressions within quotation marks in the following sections are taken from this report. 4 See further on this in § 7 on periodical congestion of funds. Ch. 8] BANKING IN THE UNITED STATES BEFOEE 1914 113 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 lend- ing 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. Eeserves 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 prudent 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 lending power of the indi- vidual banks to be increased at such times, so that no customer with good commercial paper need fear to be refused a loan even though 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 quaility of elasticity needed to meet these changing business needs.' Their value being dependent primarily upon the 5 See above, § 3. 114 BANKING AND INSURANCE [Pt. II 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 that were required in the so-called "country" 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^ per cent might be kept in central reserve cities. There it counted as part of the depositing banks' legal reserves, was a fund upon which domestic exchanges could be drawn, and earned a small rate of interest (usually 2 per cent) paid by banks in reserve and central reserve cities to their "country" correspondents. By this process of pyramiding, reserves in very large part came to be kept in New York city, where they could be lent "on call," and the largest use for call loans was in stock-exchange specula- tion. Thus every period of prosperity encouraged an un- healthy distribution of reserves, gave an unhealthy stim- ulus to rising prices, and "promoted dangerous specula- tion." § 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 manufacturng sections, and imperfect provision in the agri- cultural districts. The whole financial system seemed de- signed to induce the poorer country districts to lend tempo- rarily available 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 enter- prise. 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 Ch. 8] BANKING IN THE UNITED STATES BEFORE I9l4 115 Canada, with a different system of banking, the rates have long been much more approximately uniform in urban and agricultural districts. Indeed, our national banking development has been pre- dominately urban and commercial to the neglect of rural and agricultural interests. National banks were (until 1913) for- bidden to make loans on real estate, and this greatly "re- stricted their power to serve farmers and other borrowers in rural communities." There was in the more agricultural regions, "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 stand- ards 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 considera- tion that we had "no American banking institutions in for- eign countries. ' ' Many bankers and business men felt, as did the Commission, that the time had come when the organiza- tion 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 mer- chants. 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 im- IIG BANKING AND INSURANCE [Px. II portant to us from a national than from an international standpoint. ' ' §10. The "Aldrich plan." The report of the National Monetary Commission represented most careful study of the whole subject, and embodied the efforts and aid of many of the best financial experts of this and other lands. The Com- mission in its work gave an admirable example of the right way to prepare for and undertake important economic legis- lation. Though it discovered nothing essential that was not known to the small group of expert economic students, it put all material into systematic and convincing form and served during several years to educate public opinion as to the needs and proper means of sound banking policy. The analy- sis of difficulties as outlined above has not merely a tempo- rary but a lasting interest to the student of financial history, for it implies an ideal for the banking system of the nation. The Commission submitted with its report a constructive 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, wliich bore some likeness to the great central banks of Europe. In the many details of the plan an effort was made to remedy every one of the difficulties above described and to supply all the needs indicated. The plan was favored pretty gen- erally 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, biit particular proposals were not discussed in the campaign. References. National Monetary Commission, Report. 1912. In Sen. Doc. 243, 62d Cong., 2d Cess. Phillips, 0. A., ed., Readings in money and banking. N. Y. Mac- millan. 1916. Ch. XXX. United States Comptroller of the Currency, Annual reports. White, Horace, Money and banking illustrated by American History. Bost. Ginn. 1914. Bk. Ill, chs. IV, XV, XVII, XX, XXI, and appendices A and B. CHAPTER 9 THE FEDERAL RESERVE ACT § 1. General banking organization. § 2. The Federal Reserve Board. § 3. Federal Reserve banlis. § 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. Opera- tion in the pre-war period. § 11. Operation in the war period. § 12. Gold hoards and artificial interest rates. § 13. The post-war period. § 14. Future of the Federal Reserve system. § 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 amend- ments in details, and, though 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 were the friends of the Aldrieh plan, and the Federal Reserve Act embodies, in a greater degree than its authors were ready to admit, the main features of the Aldrieh plan. In one important respect, however, it is different : it provides for more decentralization of control and of reserves than did the Aldrieh plan. It created, not one central banking reserve, but, in the end, twelve regional, or 117 118 BANKING AM) INSURANCE [Pt. II bo Ch. 9] THE FEDERAL RESERVE ACT 119 district, banks, each to keep the reserves of its district. The Jacksonian tradition of opposition to a central bank ^ in part helps to explain this ; in part the contemporary congres- sional 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 (Fig. 1) are given the outlines of the districts as constituted and altered down to 1921.^ § 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 chair- man. The term of the appointive members was fixed at ten years and the salary at $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 resen'es 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 cen- tral bank under the Board's control, although centralization was in outward form avoided by the bill. Alongside of the Reserve Board is placed a Federal Advisory Council, eon- 1 See ch. 8, § 1. 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 designed. Whenever, 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 now say twelve. Bee map, Figure 1, ch. 9. 120 BANKING AND INSURANCE [Pt. II sisting 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 institutions of a type new in our financial history. They are "banks for banks," that is, for the "member banks" in their respective districts. Every national bank must, and any state bank or trust company may (on agreeing to comply with reserve and capital requirements for national banks and to submit to federal examination), subscribe for stock to the amount of 6 per cent of its capital and surplus, and thus be- come a "member bank." The capital of each Federal Re- serve bank was to be at least $4,000,000; in fact, only two of those organized (Atlanta and Minneapolis) had at their open- ing less than $5,000,000 capital; the largest (New York) had $21,000,000; and the average was $9,000,000. The member banks receive dividends of 6 per cent, cumulative, on their paid-in shares of capital, and (beginning 1921, by amend- ment) all remaining net earnings are added to surplus until it amounts to 100 per cent of the subscribed capital; after that 10 p€r cent shall be added to surplus and the rest goes to the government as a franchise tax. By the end of 1920 the total surplus of the system exceeded the subscribed cap- ital, and only two of the banks (Cleveland and Dallas) had less than 100 per cent surplus. 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 smajUer ones. Directors of class A are chosen by the banks to repre- sent them, and are expected to be bankers; those of class B, though chosen by the banks and though they may be stock- holders, shall not be officers of any bank, and shall at the Ch. 9] THE FEDERAL EESERVE ACT 121 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 Keserve Board, one of them being designated as chairman of the board of directors and as Federal Reserve agent. They rep- resent the public particularly, and may not be stockholders of any bank. Any Federal Eeserve bank may : a. Receive deposits from member banks and from the United States. b. Discount upon the endorsement 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 outstand- ing about $750,000,000 of what we may now call the old-style bank-notes (bond-secured). These were not retired by the new act; but the law was shaped with the purpose of retir- ing them at the rate of about $25,000,000 a year, so that they would all disappear from circulation in thirty years.^ 3 These notes were all secured by the deposit of bonds of the United States, a large share of them bearing interest at the artificially low rate of 2 per cent. Two per cent, was less than the market rate for 122 BANKING AND INSURANCE [Pt. II "Whenever the banks having old-style bank-notes outstanding desire to retire any of their circulating notes, the Federal Reserve banks may be required by the Federal Reserve Board 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 Fed- eral 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 redeemable by the latter in gold or in lawful money (which includes, greenbacks. Treasury notes, gold certificates, and silver dollars). Thirdly, their credit and prompt re- demption is insured by certain elastic rules as to re- serves in gold which must be kept for the redemp- tion of outstanding notes. Fourthly, they are secured by collateral, consisting of notes and bills accepted for re- discount 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 apparent that the notes unite in a manner without example the characteristics of asset bank- notes with those of political paper money.* government loans, for 3 per cent bonds without this privilege sold above par. Therefore these 2 per cent bonds were held almost exclu- sively by banks, and would have lost a good share of their value had the note-deposit privilege been withdrawn. * 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 Re- serve Board"; that "the said notes shall be obligations of the United States." Further on the notes are spoken of as "issued to" a Federal Ch. 9] THE FEDERAL RESERVE ACT 123 Notes, it will be observed, are issued only on request of a Federal Reserve bank, and not by or on request of the mem- ber banks. After the notes have been issued, the bank may re- «"•* Federal Reserve Note Circulation ""'* 3500 3500- 3000- 2500 2000- 15 00- 1000- 500 - .12X2.. .--••' '-^.:..... e < £ § Sk ^3 >^ u e O Z -3000 -2500 -2000 -1500 -1000 - 500 Fig. 2, Chapter 9, shows the steady rise of Federal Reserve note circulation by months until the latter part of 1920, a level for several months as credits began to be curtailed, and a fall beginning the first of 1921. duce 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 Reserve bank, and again as "issued through" a Federal Reserve bank, but not hy 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 pay- ing 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. 124 BANKING AND INSURANCE [Pt. II must promptly return to the banks through which they were issued all notes as fast as they are received, and "no Federal Keserve bank shall pay out notes issued through another on penalty of a tax of ten per centum." This regulation does not apply to the member banks, but its 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 de- posit in the Treasury of the United States. The proportion of reserves to the liability for note issues by any bank, how- ever, 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 321/2 per cent and thereafter a graduated tax of not less than 1% per cent on each additional 2i/2 per cent, deficiency or fraction thereof." This tax must be paid ],y the R'^'serve bank, but it must add an amount equal to the tax to the rates of interest and dis- 5 This may be shown in the following table: When reserves against notes the tax rate upon the total are — deficiency shall be — Below 40.0 to 32.5 per cent 1.0 per cent 32.5 to 30.0 " " 2.5 " 4.0 5.5 7.0 8.5 10.0 11.5 13.0 14.5 16.0 17.5 19.0 20.5 30.0 to 27.5 27.5 to 25.0 25.0 to 22.5 22.5 to 20.0 20.0 to 17.5 17.5 to 15.0 15.0 to 12.5 12.5 to 10.0 10.0 to 7.5 7.5 to 5.0 5.0 to 2.5 2.5 to 0.0 Ch. 9] THE FEDERAL RESERVE ACT 125 count 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 not less than 20 per cent of outstanding notes, and the rate of discout to cus- tomers 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 still be doubled, becoming $2,000,000,000, the proportion of reserves falling to 2.5 per cent, the rate of discount rising to 24 (5 plus 19). loo- ps- 90- 8 5 8 0- 7 5- 7 6 5- 60- ss- so- 4 5- 4 0- JS- 19141 Federal Reserve Banks 'Y'* *V-^ Reserve Pecentaqe \ A V....,' '. t I ■ •■•• ... War I Period | 1915 1916 1917 1918 1919 I 19.20 11921 100 •95 ■90 ■85 80 -75 70 65 60 55 50 45 40 35 Fig. 3 shows the changes in the reserve percentages of the the twelve Federal Reserve banks, combined, in the first seven years. It was above 80 until 1917, and about 90 in April just as we entered the war. It fell to about 55 in the war period, where it remained until the latter part of 1919, and fell to 40 the first half of 1920, the period of greatest speculation and highest prices. The reserve of some of the banks fell several points below 40. (The average reserve re- quirement against notes and deposits together was about 38. ) Recall this chart when considering §§ 11-13 below. 126 BANKING AND INSURANCE [Pt. II § 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 thirty days and from time to time renew the sus- pension for periods not exceeding fifteen days; but in that case it must establish a graduated tax upon the amounts by which the reserve requirements may be permitted to fall be- low the levels specified as to note issues. Although the amount of the tax on the deficiency of reserves against de- posits is not indicated in the act, it is plainly the thought that the Board will follow somewhat the same rule as in re- spect to excess note issues. 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. Important changes were made in the rules as to the reserves against deposits that had been in force under the old national banking system. A new distinction was made between time and demand de- posits. Time deposits are defined as those payable after thirty days or subject to not less than thirty days' notice; and demand deposits as those paj^able within thirty days. In every case the reserve requirement against time deposits is now only 3 per cent (first 5 per cent, but later amended). This gives encouragement to banks to rnaintain savings de- partments and to make agricultural loans. The Federal Re- serve banks take the place of the banks in reserve and cen- tral reserve cities as the depositories of funds that were^ The complete application of the new rule was deferred for a period of three years from the passage of the act. Ch. 9] THE FEDERAL RESERVE ACT 127 counted as a part of the reserves of member banks. The legal minimum reserves for country banks (as fixed by amend- ment June, 1917) is 7 per cent; for banks in reserve cities 10 per cent; for banks in the three central reserve cities 13 per cent, all of which must be kept in the Federal Reserve bank, till-money not being counted as part of the reserve/ These legal requirements as to proportion of reserves, as compared with those of national banks under the old law, are smaller by 53 per cent, 60 per cent, and 48 per cent, re- spectively (though practically less reduced because till-money is no longer counted). The large increase in lending power thus given to the member banks explains in part the I'arge expansion of banking credit between 1915 and 1920, the en- couragement of speculation in 1918-1920, and the large earn- ings of most member banks.* § 8. Rediscounts by Federal Reserve banks. More im- portant than any other single feature of the act is that by which each Federal Reserve bank is to rediscount notes, drafts, and bills of exchange arising out of actual com- mercial transactions, when endorsed 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 in- definitely at any time for real business purposes. This en- ables any business man who can offer commercial paper of sound quality to borrow on it at some rate of discount, even in the most stringent times. And, in turn, every member bank should be able at such times to rediscount such paper T By amendment, September, 1918, banks in outlying districts of central reserve cities, or of reserve cities, may, by affirmative vote of five members of the Federal Reserve Board, be permitted to hold reserves less than the usual 13 and 10 per cent, respectively. 8 The original act reduced the legal minimum of reserves required of each of the three classes of banks to 12, 15, and 18 respectively, and laid down an over-ingenious rule for the proportion that must be left in the member bank's own vaults and in the Federal Reserve Bank, respectively, or that might be in either place. 128 BANKING AND INSURANCE [Pt. II and thus secure credit toward its reserve requirement on the books of its Federal Eeserve bank. Suppose, for example, that a member bank (in a central reserve city) saw its re- serve in the Federal bank fall below 13 per cent of its de- mand deposits. It could by rediscounting $13,000 worth of notes increase by $100,000 the amount to which it might legally extend credit to its customers. The deposits of the Federal Reserve bank would then be increased $13,000, against which it must have a reserve of 35 per cent or I9M 1915 a 1916 1917 1918 1919 1920 Fig. 4, Chapter 9, shows the growth of the deposits and note cir- culation of the Federal Reserve banks during the war period, and their continued expansion after the end of the war. This caused the "free gold" (the margin of gold above the legal minimum requirements) to decrease until the middle of 1920. This was getting nearer and nearer to the point where discount rates must legally be raised (in some dis- tricts the point was passed), and finally compelled a contraction of credit, which then came quickly and violently. $4550. If the reserves of any Federal Eeserve bank fall too low, it can in turn rediscount its paper with the other Federal Reserve banks." If the time comes when no one of the twelve banks can longer maintain a 35 per cent reserve 8 See on "piping" provision, § 2, above. Oh. 9] THE FEDERAL RESERVE ACT 129 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 solid- arity of all the central banking reserves of the country to meet unusual demands in emergencies, exceeds any needs that can be expected to arise. § 9. Changes in national banks. There was thus created a national system of reserves, but it will be observed that membership in the new system of the Federal Reserve banks was not limited to national banks, but was opened on equal terms to banks organized under state laws. While in most respects the general banking law remained as it was, cer- tain changes of importance were made. The percentage of reserves required of all member banks (as above indicated) is a substantial reduction of the former requirement for na- tional banks. In some other respects the powers of national banks were 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 lend 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 in the pre-war period. Nearly a year was spent preparing for the opening of the Federal Reserve banks. The organization committee, after holding meetings in many cities, divided the country into twelve districts. Officers and a staff of employees had to be selected for each of the twelve banks, part of the capital had to be paid in, bank buildings and equipment had to be secured, and many details arranged. It was fortunate that the district banks were nearly ready to begin operations when, August 1, 1914, the great European 130 BANKING AND INSURANCE [Ft. XI 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 system would early begin to function was reassuring in the grave financial stress of the next three months, and the opening of the district banks November 16, 1914, at once made possible the release for commercial uses of cash reserves and credits to meet the needs of reviving business.^" The history of the Federal Reserve system for the first seven years of its operation may be divided into four periods : (1) the pre-war period, from the opening of the banks till our entrance into the war on April 6, 1917; (2) The war- time period, till the armistice, November 11, 1918; (3) the post-war period of expansion to May 1920; the period of falling prices and contraction thereafter (not yet ended at this writing). Two years and nearly five months elapsed from the open- ing of the banks until the United States entered the war. This period was filled with work of organization, redistricting, preparation of rules and regulations, development of plans for the clearing of checks between Federal Reserve banks and between member banks, and the admission of state banks (a few of which entered the system) . Growth was steady but slow up to April, 1917. A general idea of the development of the system can be gained from a study of the charts show- ing some of the more important statistical data. Federal Reserve notes were issued to the amount of $36,000,000 and net deposits were $707,000,000, making $113,000,000 total liabilities against which reserves must be held; whereas the reserves held equaled 89 per cent of liabilities. For several months before our entrance into the war the sj^stem increased the reserve percentages, absorbing some of the gold that was flowing into the country and, consequently, reducing some- what its "earning assets," which fell to $168,000,000. Little use had as yet been made by member banks of the re- 10 See § 7 above. Ch. 9] THE FEDERAL RESERVE ACT 131 discount privilege, because, as the new legislation had re- duced their own reserve requirements, they had "plenty of slack" lending power, which only gradually had begun to be taken up. Nevertheless, all of the Federal Reserve banks, before the end of 1916, had earnings in excess of expenses, and one after the other began to declare dividends and to increase their surpluses, to the surprise of many who had pre- dicted that this would not be possible. § 11. Operation in the war period. With our entrance into the war the Federal Reserve system, and our banking institutions altogether, entered upon a growth that has been characterized by the Federal Reserve Board as "in many ways the most remarkable in the financial history of the world. ' ' At the beginning of the period the volume of busi- ness at the Federal Reserve banks was too limited, while the available resources of member banks were too large to enable the Federal Reserve institutions to exert more than an in- cidental influence upon credit uses. The period of belliger- ency changed these conditions, and at its close the Federal Reserve banks stood as the holders of nearly the entire re- serves of the country, the directors of the one unexhausted reservoir of banking credit in the world.^^ The Federal Reserve system began at once to act as the fiscal agency of the government, and continued throughout the war period and the post-war period, including the fifth (or Victory) loan, to fill the central role in fiscal operations. During this period the net deposits of the system increased 2i/2-fold, the notes in circulation increased 7-fold, and earning assets in- creased 14-fold. Paper admissable under the rules for re- discount, especially that based on governmental securities, which were given preferential treatment and rates, increased greatly in amount. Member banks made use extensively of 11 Paraphrased from editorial statement in the "Federal Reserve Bul- letin," Dec. 1, 1918, p. 1164. 132 BANKING AND INSURANCE [Pt. II 3.3- EARNING Assets op ki 3.0- FederalBeserve Banks 2.7- I9I4-I920 2.4- War Period 2.1- 1.8- 1.5- ■ 1.2- .9- U.S. Securities nuaicipal Warrs z'.-m War Paper .6- .3- .0 ^ lA O O O* & ob ob ± t ± ^ i 3.3 -3.Q. ■2.7 -2.4 2.1 1.8 1.5 1.2 - .9 - .6 - .3 n 1914 1 19!$ I 1916 I 19I7 I 1978 ^ a ^ a 1 i919 I 1920 Fig. 5, Chapter 9, shows the rapid growth of earning assets of the Federal Reserve banic during the war period, from barely more than a tenth of a billion dollars to over two billions at the date of the armi- stice. Observe that after the war, as the member banks availed them- selves freely of the rediscount privilege, the total rediscounts rose ra- pidly by more than another billion, despite the decrease of war paper. The "other discounts," which meant commercial loans, must be looked upon as in large part the cause of the commercial speculation, "profit- eering,'' and inflated prices, which marked the period from the middle of 1919 to the middle of 1920. the rediscount privilege, and took the proceeds, either in notes or in credit, to their reserves, this being a source of large earnings for the Federal Reserve banks. The accompanying table shows the net earnings by years: Net Eabnings of Federal Reserve System Net earnings of capital Per cent Nov., 1914, to end of 1915 $516,116 Calendar year 1916 2.750,999 5.0 1917 11,202.992 18.9 1918 55,446,979 72.6 1919 82,038,785 98.2 1920 151,408,031 160.7 Ch. 9] THE FEDERAL RESERVE ACT 133 § 12. Gold hoards and artificial interest rates. The war- time influence and activities of the Federal Reserve Board, and of those controlling the various district banks in general, merit high praise. They steadily urged the sound economic policy of industry, thrift, and self-denial on the part of the people. They fostered no illusions that the magic of bank- ing credit or of paper money could take the place of real production of the goods needed, and of real abstaining from the goods not needed, for the prosecution of the war. Al- though the banks (district and member) found it necessary to take and hold for a time an increasing proportion of the successive loans ("war paper"), and the local banks to lend heavily at low rates of interest to customers on the security of war paper, great efforts were made to get the public to pay in full and to relieve the banks of this burden. In two particulars the policy of the Board is more open to question. The Board showed a mercantilist bias in favor of an artificial heaping up of gold in this country, as shown in its fathering and defense of the gold embargo. It de- fended this on the ground, first, that it was desirable to con- serve the available gold supply on the assumption that this would make the country stronger economically. But this could but have the effect, in the end, of artificially inflating our prices at home, of increasing the amount of Liberty bonds to be issued, and of causing the value of the American dol- lar to depreciate in the countries from which at the time we were buying in excess of our sales. The Board thus con- tradicted its own sounder doctrine that goods, not artificial inflation of credit and prices, was what was needed to win the war. The Board further attached undue importance to maintaining low interest rates artificially at a time when the natural trend of rates was upward. This could but en- courage the increased use of credit by the public, and thus neutralized the Board's ovm sound policy of keeping down the use of credit for purposes less urgent or of a speculative nature. Throughout the war period (and for a full year 134 BANKING AND INSURANCE [Pt. II thereafter) our banking practice was in violation of the basic principle of central rediscount, "well established in the tradition of Europe, that the ofBcial rate of rediscount should be above the market rate." 200 ISO 100 50 e ^A 200 150 100 SO f =?s= =^=- -. — • _^. y u .'<" r INDEX NUMBERS OF MONETARY CIRCULATION, BANK DEPOSITS AND WHOLESALE PRICES FIVE YEAR AVERAGE.±91Q-I9l4= IQO Fig. 6. Chapter 9. The increasing wholesale prices appear to be even more nearly parallel with the rapidly expending bank deposits than with the monetary circulation. § 13. The post-war period. At the sudden termination of military operations, the Federal Reserve Board at once gave expression to wise warnings against the inflation and specula- tion that usually have occurred at such a time. It declared the immediate problem to be that of "preventing credit from expanding too far, and so far as practicable of reducing any excess that already exists." It again counseled thrift and the acceptance of falling prices by the people, and limitation of credits by the banks. If this policy could have been made effective, the price index of armistice month (which was 206) might have been the peak, and prices might have moved Ch. 9] THE FEDERAL RESERVE ACT 135 slowly downward to lower levels. As it was, prices wavered, fell as low as 197 in February, 1919, rose again, then with a bound went up in July, 1919, to 219, and still upward to the peak of 272 in May, 1920, then to plunge steeply down- ward to 151 in May, 1921. Enormous evils of speculation and undeserved profits to some, unjust burdens of rising prices to many others, great waste of productive effort, and finally much unemployment and suffering in the period of crisis, would have been avoided if the price readjustment downward had progressed evenly from the date of the armis- tice. To fix the blame precisely is not easy, or indeed possible ; but a large part of it must be traced back to the policy of the United States Treasury in fixing the rate of interest on all its issues of loans artificially below the market rate. As a result the bonds had to be marketed more by appeals to patriotic motives, enforced by many measures of popular coercion to induce and compel the public to subscribe to the loans, and still further supported by preferentially low in- terest rates by member banks to enable customers to carry bonds on bank loans, and preferentially low rediscount rates on such paper presented for rediscount at the Federal Re- serve banks. At one time the total of war paper held by all banks (including the Federal Reserve), exceeded $6,000,- 000,000, and the very preference given to it for rediscount was a premium to active business not to pay off the loans but rather to use funds for other purposes in a period of rapidly rising prices. The Treasury and the Federal Re- serve banks, in this policy of artificially low interest rates, had "caught a Tartar," and did not know how to let go without causing a slump in the price of Liberty bonds, which nevertheless was sure to occur. The 414 per cents (which composed the larger part of those outstanding) fell some- what below par early in 1919, fell to 92 in December, 1919, as discount rates and rediscount rates were raised, and as low as 82 in May, 1920. Large quantities of the bonds appear 136 BANKING AND INSURANCE [Pt. II to have been thrown upon the market by holders who had been carrying them on credit. The whole policy above dis- cussed must be looked upon as a case of price-fixing by which the rate of interest on government loans was kept artificially lower through an unsound use of government con- trol over banking policy. The results were speculation, infla- tion of prices, and eventual disillusionment and loss to in- vestors and to large numbers of other citizens. § 14. Future of the Federal Reserve system. The Fed- eral Reserve system rendered valuable service during the war, and was a stabilizing influence in the period of industrial de- pression that began midway in 1920. While there has been enormous shrinkage in prices, in valuations of goods in stock, in securities, and in "paper profits," and inevitable loss to manjr investors and business men, the ' ' retreat ' ' has been more orderly than in previous financial crises, and at no time has the banking system as a whole been anywhere near danger of collapse, as in former crises. The Federal Reserve banks have become an indispensable part of our banking system. Probably valuable lessons have been learned from the war- time experience. It is probable that the use of the rediscount privilege will, in normal times, not be extended to the limit, as in 1919 and 1920, but will be kept in large part in reserve for emergencies. This would result in smaller earning assets and earnings for the Federal Reserve banks, and would make the recent figures in these respects appear abnormal, and not to be expected regularly. Altogether, as a piece of financial machinery, the Federal Reserve system has been a demonstrated success, and doubtless is capable of beneficial development. However, the possibility of political inter- ference with banking policy is apparent, and might become a grave danger to the whole financial situation. Eei'erences. Federal Reserve Board, The Federal Reserve Bulletin. Monthly. Kemmerer, E. W., The A B C of the federal reserve system. Prince- ton. Pp. 192. Princeton University Press. 3d ed. 1919. Cii. 9] THE FEDERAL RESERVE ACT 137 Phillips, 0. A., Readings in money and banking. Ch. XXXI. N. Y. Macmillan. 1916. White, Horace, Money and banking illustrated by American History. Boat. Ginn. 1914. Bk. III. Ch. XXII and appendices D and E. Willis, B. P., The Federal Reserve Act. A. E. Rev., 4: 1-24. 1914. 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. The use of credit. § 9. Interest rates in a crisis. § 10. dynamic conditions and price readjustments. § 11. Tariff changes and business uncertainty. § 12. Rhythmic changes in weather and in crops. § 13. "Glut" theories of crises. § 14. Monetary theories of crises. § 15. Capitalization theory of crises. § 16. Remedies for crises. § 1. Mischance, special and general, in business. Every separate business enterprise is subject to chances that sud- denly 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.^ 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 mer- chants 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 mod- ern community, as a whole, "general business," moves along 1 On the way these affect private profits see Vol. I, pp. 340, 341 (and references there given in note), 348 fif. and 361 ff. There are thus good reasons for discussing crises in connection with profits, as well as with money and banking. 138 Ch. 10] CRISES AND INDUSTRIAL DEPRESSIONS 139 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 mo- ment 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 eco- nomics, the term, however, implies a sudden change of busi- ness conditions for the worse, a collapse of prosperity. What proceeds has not the appearance of disease, but rather that of exuberant health. Crises in economics may be distin- guished 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 that brief period in which the gen- eral rise of prices culminates and a general fall begins which shatters the credit of some banks, brokers, merchants, and manufacturers. Every crisis is marked by much con- fusion and loss and by hasty efforts of individuals and in- stitutions to meet their pressing obligations. Sometimes this process of liquidation goes on quietly; when it becomes a wild scramble, each one trying to save himself, it is called a financial panic. An industrial depression is the period of hard times that usually follows a financial crisis. A business cycle is the period from one crisis to another within which occurs the complete series of price and business changes above and below the average. § 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, pesti- lence, and scourges of nature. Throughout the lands money 140 BANKING AND INSURANCE [Pt. II 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 ap- pear in city trading circles, on a small scale, the phenomena of the modern crisis.^ § 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 his- tory. 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, thereafter, the crises were of unequal force in various European countries, usually be- ing more severe in England, where they occurred in 1803, 1825, 1838, 1847, 1857, 1864-66, 1875, 1890, 1900, 1907, and 1914. These have been attributed to various causes: that of 1825 to over-trading abroad ; that of 1847 to railroad-build- ing; while that of 1864-66 was attributed to the severe disturbance of the cotton trade and of 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 Prance, although prostrated by the war of 1870-71, losing a large amount of wealth and paying a thou- sand millions of dollars to Germany as a war indemnity, es- caped a commercial crisis almost entirely at that time. § 5. American crises. Since the beginning of the nine- teenth century the financial connections of the United States 2 See Vol. I, pp. 51, 154, 300-302. Ch. 10] CRISES AND INDUSTRIAL DEPRESSIONS 141 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 disturb- ances are so modified by the particular conditions (of crops, politics, and speculation) that the phenomena never corres- spond exactly in time of occurrence, in duration, or in in- tensity. The first notable crisis in America occurred about 1817 in the very violent readjustment of trade after the re- sumption of commerce with Europe in 1816.' 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.* 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 his- tory, 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 con- traction of currency then in progress, leading to the return to a specie basis and lower prices.^ The crisis of 1884, a com- paratively 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 in America was checked but little in 1900, when a crisis was occurring in Europe, especially severe in 8 See ch. 14, § 6, on the tariff legislation at this time. 4 See ch. 8, § 1. 5 See ch. 5, § 8. i42 BANKING AND INSURANCE [Ft. II Germany. In November, 1902, beffan in America what has been called the "rich man's panic" of 1903, in which for a year many securities were sold by holders probably because European creditors were recalling their loans. Although building operations were somewhat checked, American busi- ness slackened but little. General prices, which had been moving upward since 1897, remained almost unchanged in 1903 and 1904, and then continued upward until 1907. In the period from September to November of that year occurred a severe crisis both in Europe and in America. The indus- trial 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. The rise in war prices, slightly checked at the beginning oF 1919. reached its peak in America, as we have seen," in May, 1920, and within about a month of the same time in most of the leading countries. The average fall of whole- sale prices in the next year (from 272 to 151) was the most rapid that has ever been experienced in America. § 6. A business cycle. Let us now sketch in broad out- line 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 econ- omy and great caution prevail; few enterprises are under- n See ch. 6, § 9 ; oil. 9, § 13. Ch. 10] CRISES AND INDUSTRIAL DEPRESSIONS 143 taken. 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 under- taken. 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 employ- ment, 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 pui'chasing power of their incomes correspondingly falls. At length prices begin to go up less rapidly, and the ques- tion arises in many minds whether the movement can con- tinue, 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, com- pels 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 144 BANKING AND INSURANCE [Pt. II are many failures.' The falling prices, the shattered credit, and the financial losses force many factories to close, and many workmen are thrown out of employment. This period of beginning collapse 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 com- pleted another cycle. 17W KK lew 1U0 1S30 iMo leso vu> ie70 imo wn mo 1910 nia Fig. 1, Chapter 10 shows the great similarity in the changes of gen- eral prices in England and in the United States from 1790-1920, both in respect to the larger movements and levels, and to the minor fluctua- tions. It shows also that this relationship has become much closer since 1870. See also Figure 1, Chapter 5. § 7. General features of a crisis. Although 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 un- usual prosperity. This succession of events occurs pretty T See diagram of business failures, 1860-1914, in Vol. I, p. 364. Ch. 10] CRISES AND INDUSTRIAL DEPRESSIONS 145 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 efSeiently co- BUSINESS CrcLES Ba/tft Reservei Ba/fA Loans (inf/atfOfi) Failures (Bank Beserifet) Fig. 2, Chapter 10, on Business Cycles, shows the rhythmic movement that occurs in various business and financial conditions. Taliing the curve of commodity prices as the central fact, it is seen that its peak has been preceded in time successively by peaks of bank reserves, loans, and clearings, and by stock prices (which always speculatively anticipate higher dividends) and is soon followed by declining divi- dends, by the peak of discount rates, and by failures; then bank re- serves gradually being built up, the cycle is repeated. This diagram, hitherto unpublished, was prepared by Professor G. R. Davies, Univer- sity of North Dakota, to whose courtesy we are indebted for permis- sion to use it here. The data are plotted so as to show the variations above and below the averages, eliminating the absolute growth due to increasing population, business, etc. 146 BANKING AND INSURANCE [Pt. II ordinated. As a rule they have been 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 finan- cial speculation. Their effects are least felt in the staple in- dustries, 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 is the flour- mill. In a crisis wages and salaries are less quickly aifected than are profits, but wageworkers suffer in the loss of employ- ment. 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 staple kind often lose much. § 8. The use of credit. The general use of credit is, as we have observed, an essential condition to the occurrence of a financial crisis, so that, indeed, a crisis might be called a disease of the credit system. The use of credit greatly en- hances 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 trans- actions. 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, ordi- narily the pillars of financial strength, become at such a time the points of greatest weakness in the financial structure. If many of the customers were not restrained by their sense of personal obligation to the banks, by the strong pressure that 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 Cii. 10] CRISES AND INDUSTRIAL DEPRESSIONS 147 nature of their business; for all their ordinary deposits are nominally payable on demand. § 9. Interest rates in a crisis. In normal times there is always outstanding a great mass of short-time commercial loans.* 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 with- out 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 borrowers with maturing obligations would face bank- ruptcy if they could not renew their ioans. 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 may prevail in these loan markets for a few days or a few weeks, rates that 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 at just such times that both the equipment he has bought and the products he has made become temporarily almost unsalable 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 unfavor- able 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 sacri- fice sale thus reveals the merchant's high estimate of present goods in the form of money. The purchaser of some kinds of 8 See Vol. I, p. 304. 148 BANKING AND INSURANCE [Pt. II 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 ob- taining. 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 long-term loans as fall due can generally be renewed at rates little higher than usual, the market for long-time and short-time loans be- ing 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 lend 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 eiJect of this is to raise somewhat the interest rate on long-time paper to accord with the new conditions. § 10. Dynamic conditions and price readjustments. A condition favorable to large and rapid shifts in prices and credits is a djoiamie 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 undreamed 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 Ch. 10] CRISES AND INDUSTRIAL DEPRESSIONh 149 toward higher values in the older lands, and stimulate the hopes of all investors. "When the balance between the prices and profits in various industries and between the incomes of the various periods proves to be false, the inevitable read- justment causes suffering and loss to many, but particularly in the inflated industries. But, because of the mutual re- lations 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 produc- tion of the standard money commodity (relative to popula- tion) 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. 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 adjust- ments proceed uncertainly and unevenly in different indus- tries, with much speculation in shifting from one type of business to another, and with mucn accompanying miscalcula- tion. § 11. Tariff changes and business uncertainty. Another variable influence in American business has been the tariff. Every tariff revision, whether the rates go upward or down- ward, shifts somewhat the relative opportunities and profit- ableness 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 has been contended that a reduction of tariff rates has a more disturbing effect upon business than does an increase. If this is true it may be because the industries injured by a lowering of tariffs in America are those most fully within the circle of the credit system; whereas most of the consumers adversely affected by a rise of tariff rates are 150 BANKING AND INSURANCE [Pt. II outside the commercial circles where short-time credit is com- mon 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.' § 12. Rhythmic changes in weather and in crops. The periodic though not quite regular recurrence of crises has suggested the thought that they may be causally related with some one dominating force such as is found in the conditions of nature. The English economist Jevons attempted toward the end of the nineteenth century to show statistically a re- lationship between financial crises and the variation in sun- spots. This idea has usually been treated as whimsical, but the continued efforts of physicists to discover a causal relation between sun-spots and the weather suggests that a real causal relation between the physical and the economic phenomena may yet be found. The alteration of seasons of poor with seasons of good harvests, "lean years with fat years," follows a line strikingly suggestive of the curve of the business cycle. Some reasons for this relationship are apparent. For example, 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 stimu- late 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 shown 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, and that the cycle of yield per acre of the nine principal crops corresponds closely with the cycle of pig-iron production " See on tariff legislation and business crises, ch. 16, § 13. Ch. 10] CRISES AND INDUSTRIAL DEPRESSIONS 151 (one of the best single indices of growing business and of an upswing in the business cycle) dated from one to two years later. There is found what is called in statistics a high degree of correlation (.719 in the former and .800 in the latter case), indicating that there is that percentage of proba- bility that there is some causal relation between the two sets of figures. 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 bet- ter understanding of objective conditions of this kind will give fuller meaning to the interpretation of the financial and the psychological features of crises. § 13. " Glut" theories of crises. Many explanations of the causes of financial crises have been offered.^" Nearly all of these belong to the general group of "glut" theories, of which genus there are two species, under-consumption and over-pro- duction theories. These are, in truth, but two aspects of the same idea.^^ 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 10 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. 11 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." 152 BANKING AND INSURANCE [Pt. II grows faster than wages, wages being fixed, as he believes, by the minimum of subsistence — a theory akin to the iron law of wages. The Marxian socialist's theory of crises is a more complex variety of this type, being connected with the "theory of surplus value, ' ' in which the capitalist class is conceived of as gradually appropriating the surplus value produced by the workers until there is no longer enough purchasing power left in the workers' hands to purchase the products of the capitalists' factories. These views have wide vogue, but they have the same taint of illogicalness as the "fallacy of waste" and the "fallacy of luxury. ' ' ^^ Both in over-production and in under-con- sumption 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. Such theories 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 direct consumption or for further indirect use in durable form. Through miscal- culation there may be, at a given moment, too many con- sumption goods of a particular kind, but the durable applica- tions could find no limit until the material world became incapable of improvement; but that day is inconceivable. At the time of a crisis, there is unquestionably a bad appor- tionment 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. § 14. Monetary theories of crises. Another group of theories of crises connects them with the supply of money, either too great or too small. The unregulated issue of bank- notes has been assigned as the cause of crises, especially such as those of 1837 and 1857 in America, when bank-note issues 12 See Vol. I, ch. 37, § 6 and § 9. Ch. 10] CRISES AND INDUSTRIAL DEPRESSIONS 153 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 con- traction 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. If it may be said to be "lack of money" at the moment of a crisis that is the immediate cause of particular failures and losses, it is "money" only in the figurative sense of credit and immediately available purchasing power. The question is, whether in any reasonable sense it can be said that it Was lack of a circulating medium before th^ 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 explana- tion. The monetary theories of crises are a bit nearer to the truth than are those of the over-production type, for a 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 in- flation. 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. § 15. Capitalization theory of crises. Here, as repeat- edly above, we verge upon a diiferent type of explanation of the 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 154 BANKING AND INSURANCE [Pt. II confidence has a larger power of sustaining prices than money without, or with less, confidence. And throughout the busi- ness 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-con- fidence at one time is suddenly followed by widespread lack of confidence. This has led some to say that lack of con- fidence is the cause of crises. This is true, but does not ex- plain 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 capitaliza- tion of productive agents. Capitalization runs through all industry. The value of everything that iasts for more than a moment is built in part upon incomes that are not actual, but expectative, whose amount, therefore, is a matter of guess- work, or "speculation." ^' Many unknown factors enter into the estimate of future incomes. The universal tendencj' 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 until 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 6t 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 particu- 13 See, e.g., Vol. I, pp. 271, 335, 365-367. Ch. 10] CRISES AND INDUSTRIAL DEPRESSIONS 155 larly in certain lines. This subjective cause in men is given an opportunity for action only when certain favoring objective conditions are present. This rhythmic movement as it appears in the capitalization of enterprises is favored and magnified by the wide use of credit and by the constantly changing tech- nical and physical conditions of industry. These call for constant revaluations of the sources of incomes, thus destroy- ing customary and habitual valuations. 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. But, the lack of coincidence in the im- pact of various influences which occur accidently, such as political changes, wars, and the rapid opening of new routes of transportation, serve to hasten or to retard, perhaps for a time quite to alter, what would otherwise be the rhythm of the cycle. § 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 recent past the crisis has been more severe in America than in Europe because of certain well-recognized defects which now have been ilargely remedied in the Federal Reserve Act.^* The provision whereby any one may get credit on good commercial assets should make it difficult if not impossible for a crisis to degenerate into a panic. It provides springs to reduce the jolt of the change from a higher to a lower level of prices. " See above, ch. 0, §§ 5, 6, 8. 150 BANKING AND INSURANCE [Pt. II 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 de- posits constitute the greatest danger at critical times. In principle this objection is sound, though 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 disap- proval of stock-market speculation on margins may some day be able to express itself effectively in ways that will not in- jure 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 un- employment, 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 sta- tistics 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 re- evaluation 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 mag- nitude 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 disEister in business that efforts should be directed. Ch. 10] CRISES AND INDUSTRIAL DEPRESSIONS 157 Refeeences. Dewey, D. R., Financial history of the United States, 4th ed. N. Y. Longmans. 1912. Hamilton, W. B., Readings in current economic problems. Univ. of Chic. Press. 1914. 91-93, 93-95, 95-98. Hoison, J. A., Evolution of modern capitalism. Ch. 7. Lond. Walter Scott Pub. Co. 1912. Jones, E. D., Economic crises. N. Y. Macmillan. 1900. Juglar, C, and Thorn, O. W., A brief history of panics and their periodical recurrence in the United States. N. Y. Putnam. 1918. Marshall, L. P. and others, Materials, for the study of elementary economics, Pp. 391-396. Chicago Univ. Press. 1913. Mitchell, W. C, Business cycles. Berkeley. Univ. of Cal. Pre^s. 1913. Moore, H. L., Economic cycles: their law and cause. N. Y. Mac- millan. 1914. Nelson, S. A., The A B C of Wall Street. N. Y. S. A. Nelson. 1900. Phillips, C. A. (Ed.) Readings in money and banking. N. Y. Mac- millan. 1916. Chs. XXVIII, XXIX. Sprague, 0. M. W., The crisis of 1914 in the United States. A. Ej Rev., 5: 499-533. 1915. United States Bureau of Labor, Annual report for 1886. CHAPTER 11 INSTITUTIONS FOR SAVING AND INVESTJIENT § 1. The nature of saving. § 2. Economic limit of saving. § 3. Commercial bank deposits of an investment nature. § 4. Investment banliing and bond houses. § 5. Savings banks in the United States. § 6. Security for thrift. § 7. Postal savings plan. § 8. Advantages and limitations of postal savings. § 9. Collection of savings and educa- tion in thrift. § 10. Building and loan associations. § 11. The main features. § 12. The continuous plan. § 13. The distribution of profits. § 14. Possible developments of savings institutions. § 1. The nature of saving. The motives actuating differ- ent classes of lenders may, for our present purpose, be re- duced to two : to postpone the expenditure 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 fam- ily'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 who 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 an- other purpose; spending less than some one else for a par- ticular purpose, such as food, but offsetting this by larger outlay for another purpose, such as clothing; spending all 158 Ch. 11] INSTITUTIONS FOR SAVING AND INVESTMENT 159 one's own income, but less than some one else with a larger income. We may define saving as the conversion, into expen- diture for enjoyable 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.^ It goes on to-day by the replacement of perish- able by durative agents, as in replacing a wooden bridge 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 indi- vidual.^ The ultimate purpose of every act of saving is the provision of futtire 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 depend- ent upon the person's present needs in relation to present in- come 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 oc- casion 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 them- selves, the apportionment of their incomes in time is fre- 1 See Vol. I, chs. 9 and 10. 2 See Vol. I, pp. 285-290, for the analysis of saving from the indi- vidual standpoint; and pp. 482-499 for its relation to general economic conditions. 160 BANKING ANT) INSURANCE [Pt. II quently woful. It is uneeouomic for families of small income to save through buying less food than is needed to keep them in health ; but it is ilikewise 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 pro- vision for any of the mischances of life — business reverses, loss of employment, accidents, temporary sickness, perma- nent invalidity, or unprovided old age. Despite the develop- ment of late of new agencies and opportunities for saving, there is need of doing more toward popular education in thrift.^ It has been estimated that the net annual investment fund of the United States is on the average about fifteen per cent of net incomes. The annual savings in the years just pre- ceding 1914 were probably three billion dollars, and in 1919, an especially prosperous year, about ten billion dollars. Of course, as the amounts are expressed in terms of dollars, changes in the totals must be interpreted in connection with the changing price levels. § 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 in- come. 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 or 3 per cent is 3 See Vol. I, p. 484. Ch. 11] INSTITUTIONS FOR SAVING AND INVESTMENT 161 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 (demanf^^ deposits). If the 3 per cent, rule * as to reserves against time deposits). If the 3 per cent rule * as to reserves against time a rate ranging from 2^^ to 3% per cent on time deposits, their amount will greatly increase. But still, in the future as in the past, those depositors having funds that can be in- vested for considerable periods will seek a higher rate of in- terest than can be obtained from commercial banks. In their lending function the "commercial" banks (as the adjective indicates) serve mainly the special needs of the commercial elements of the community — business men bor- rowing 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 lent 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 import- ance 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. In 1920 the national banks alone had more than 9,000,000 deposit accounts (nearly one half of all their accounts) on which interest was allowed. Like information is not avail- able regarding state banks (and trust companies) doing a com- mercial business, but probably the number is as great, if not greater. If so, there is one interest-bearing banking ac- count, outside of regular savings banks, on the average, for i See ch. 9, § 7. 162 BANKING AND INSURANCE [Pt. II every family in the United States. Evidently, in many families there are two or more such accounts. § 4. Investment banking and bond houses. Enormous amounts of securities issued by governments or by corpora- tions (railroad or industrial) are now on the market and to be bought conveniently by private investors. Some bonds are to be had in denominations as small as $I00 and $500. The regular brokers on the stock exchanges buy and sell, for a small commission, the regular bonds and investment stocks. For many investors the personal examination and selection of sound securities is too difiScult a task. Several large statis- tical and financial agencies,^ in return for an annual sub- scription, offer advice to investors regarding general market conditions and special securities. Many banks 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 hia task special training and a high sense of his professionnl obligations, and is employing the services of statisticians, financial experts, and of practical engineers to determine isxactly the funda- mental conditions of each investment. Investment banking promises to increase steadily in amount and importance. § 5. Savings banks in the United States,, For the in- creasing number of wage-earners, salaried employees, and per- sons following professions, investment as active capitalists has bc'sn steadily growing more difficult." Their savings must tisually take the form of passive investments. The op- portunities for lending money in small amounts without great risk are few, and the requirement of skill, time, and labor to 5 E. g., Babson Statistical Organization, Brookmire Economic Service, Harvard University, Committee on Economic Research, Moody Manual Co., Moody Corporation Service. 6 See Vol. I, p. 318. Ch. 11] INSTITUTIONS FOR SAVING AND INVESTMENT 163 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 directors are self-perpetuating and the members receive only fees for attending meetings. In their legal aspects 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 1920 was 620, all but 24 of which are located in the North- eastern and Eastern states. (The 24 are all in the four states of Ohio, Indiana, Wisconsin, and Minnesota). These banks are not increasing in number, though their depositors and resources are. They have nearly 10,000,000 depositors, deposits to the amount of more than $5,000,000,000, an aver- age of $550 per depositor, or of nearly $200 per capita of the population of the geographical divisions in which they are located. Though but one third of all institutions with the name of "savings banks" are on the mutual plan, these are the most important, the typical "savings banks" in the United States, and hold about four fifths of all the deposits in "savings banks" (as distinct from the savings depart- ments of commercial banks). Savings banks seek to keep invested as large a part as pos- sible of their assets, keeping in ready cash only enough to meet a possible temporary excess of withdrawals over de- posits. The mutual savings banks average about $.006 of actual cash (and "checks and cash items") in their tills for every dollar^ of deposits, but in addition they have for 164 BANKING AND INSURANCE [Pt. II every dollar of deposits $.04 due on demand from state and national (commercial) banks (in the aggregate a large sum, much of which bears a low rate of interest). About one half of their resources are invested in long-time loans, mostly to small borrowers and on the security of real estate, and most of the remainder is in bonds and other securities of the safer kinds. The average rate of interest they have paid to depositors since 1914 has been nearly 4 per cent ; the rate is not fixed in advance by contract, but is declared at regular periods (usually three months), as in the case of a dividend of a corporation. The name "savings bank" is applied also to institutions known as "stock savings banks," organized for profit like other banks.'' These are not in most cases sharply marked off from commercial banks with savings departments. The number reported in 1920 was 1087, their deposits being more than $1,300,000,000; almost one third are in Iowa, and al- most two thirds in California, the remainder (only 3 per cent) being in nine other states. The capital stock of these banks is about 9 per cent of their deposits. Since the change in reserve requirement for time deposits under the Federal Reserve Act, the contrast between savings banks and com- mercial banks has become less significant and that between time and demand deposits (and banking departments) more significant. § 6. Security for thrift. It is essential to sound policy that savings banks have the right to require depositors to give notice of intention to withdraw deposits. The period of such notice varies from a minimum of ten days (almost invariably now the minimum is thirty days) to a maximum of about sixty days. In ordinary circumstances it is not needful or usual for a bajak to exercise this right, but it 'Stock and mutual savings banks are both found in only two states. New Jersey has 26 mutual and one stock, New Hampshire 45 mutual and 11 stock savings banks. The other stock savings banks are in the District of Columbia, one southern and seven western states. Ch. 11] INSTITUTIONS FOR SAVING AND INVESTMENT 165 is a needfuil safeguard in times of commercial crises. This requirement of notice is greatly to the advantage of de- positors 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 that is impossible for aU, and thus to endanger the interests of all. The Federal Reserve Act, by making it possible for loans to be had at any time (through member banks) on good security, reduced the danger of runs on savings banks. 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 mistaken judgment or dishonesl^r on the part of the bank officials. The average losses to deposits in savings banks have been about one-fifth of 1 per cent of total deposits. It is highly desirable that a plan of insurance of deposits should be worked out which would make savings deposits absolutely safe. This measure is even more important than that repeatedly proposed by the Comptroller of the Cur- rency to insure or guarantee aU deposits of $5000 or less in national banks, the effect of which would be to bring from hiding-places many millions of dollars of hoarded money, largely prevent in the future runs on banks, and, more than anything else that could be done, unify and solidify the entire banking system. It would doubtless also greatiy stimulate the saving habit among the people and increase the use made of the savings banks. 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 build- ing and equipping of these actual forms of wealth, and have an equitable claim upon the usance of them, which claim 166 BANKING AND INSURANCE [Pt. II is met by the payment of interest and dividends by the sav- ings banks. Viewed in this way, the great social importance of the savings function appears, and the importance of de- veloping 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-oiBces. Postal savings banks, or postal savings systems as divisions of the postal service, are now found in all the larger eoimfrries 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 author- ized 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 deposits began to flow in at the average rate of more than a million dollars a month, and then more rapidly until the war period. The maximum balance to the credit of de- positors was attained in March, 1919, when it was $177,000, 000, from which point the withdrawals have pretty reg- ularly exceeded the new deposits each month. This may be explained by the rise of the general interest rate, the opportunities for good investments of small sums in Liberty Bonds, and heavy withdrawals by immigrants for remittance to Europe. The funds of the postal savings system 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 21^ per cent on the amount of the deposits. The % per cent difference between this Cir. 11] INSTITUTIONS FOR SAVING AND INVESTMENT 167 rate and that paid to individuals goes far toward paying the expense of operating the system. Provision is made for the issue, in exchange for certificates of postal savings, of bonds bearing interest at the rate of 21/2 per cent. Postal savings bonds are exempt from all kinds of taxes, federal and local. § 8. Advantages and limitations of postal savings. As compared with ordinary 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 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 hearing 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 offers less favorable conditions than do ordinary banks, and its usefulness was deliberately restricted by provisions in the law, as has been clearly pointed out and deplored by com- petent critics. The post-office will not receive deposits of less than one dollar, whereas regular savings banks usually accept for deposit as small an amount as ten cents. It pays 168 BANKING AND INSURANCE [Pt. II only 2 per cent interest (only half as much as the regular savings banks now pay) and only for a full year instead of quarterly. Only simple interest is paid, not interest com- pounded automatically, as in the case of banks. These and other features of the law so greatly restrict the usefulness and appeal of the system that its failure to grow is not surprising. With wise and proper changes it should be pos- sible to refund a large part of the national debt in securities issued in small denominations through the postal savings system. § 9. Collection of savings and education in thrift. Small savings have been encouraged in many places by penny provi- dent funds, dime savings banks, and school savings funds, which have been conducted at public schools, sociail settle- ments, 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 pro- vided 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 meas- ured merely by the magnitude of the sums collected. They are not rivals of the ordinary savings banks, but ratlie' auxiliary methods of encouraging their use. The funds col- lected by these agencies are usually deposited in local savings I 'nks. find depositors aic encouraged to open individual ac- counts there, whenever they have considerable sums saved. Before the Great War began, public schools in Germany were equipped with automatic machines vending savings stamps in as small denominations as ten pfennigs (2% cents) when a coin was dropped into a slot. This method could be used effectively in connection either with the postal sav- ings system or with a local savings bank. It ought to be made easy to deposit funds at every schoolhouse, 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 nickel or the Ch. 11] INSTITUTIONS FOE SAVING AND INVESTMENT 169 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 jthe person of small means. § 10. Building and loan associations. Building and loan association is the name applied to a cooperative organization having as its purpose the collecting regularly from mem- bers of small sums which are loaned to some members for the purpose of building or paying for homes.^ The first associa- tion of this type was organized in Prankford, 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 (though 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 (in 1920) was 4,300,000, which is about one third of that of savings banks depositors, and the amount of their assets ($2,100,000,000) is nearly one third that of the reported savings banks. But they are growing more rapidly, and their relative influence in educating and en- couraging to thrift is doubtless much greater than these figures indicate. There are nearly eight thousand of them, more than three times as many as savings banks; their manage- ment 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 houses that are fully paid for, and that continue to yield their usances and rents 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 more than half a billion dollars, which is twice as 8 See rol. I, pp. 290, 297-298, 484, and 486. 170 BANKING AND INSURANCE [Pt. II much as the annual increase in the deposits of the reported savings banks. 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 associa- tions from all state and municipal taxation. As the houses built or paid for are taxed, this is of course just, but it is an exception to the rule of the illogical general property tax.' 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 associa- tions which took the name "National" building and loan as- sociations, to carry on a business in a larger field. The num- ber of these has always besn comparatively small, and their operation is less simple, democratic, and economical than the local associations. They have had more of the nature of or- dinary profit-making enterprises. They should not be eon- fused with the local associations. § 11. The main features. A building and loan association is organized by a group of persons in a neighborhood, unit- ing to form a corporation under the laws of the state, everj' member to subscribe for one or more shares. The officers elected all serve without pay, excepting the secretary-treas- urer, who receives a small fee for his services. All official meetings are open to all members. The shares vary in de- nomination from $25 to $200 ; the larger figure being common under the serial plan and $100 being usual under the con- tinuous (or permanent) plan, described below. "Whenever there is a sufficient sum it is lent to one of the members for the purpose of building a house. The borrower must sub- scribe for shares to the par value of his loan. 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 encumbrance, and its value » See ch. 18, § 4. Ch. 11] INSTITUTIONS FOR SAVING AND INVESTMENT 171 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. The receipts of the association are of several kinds. (a) Interest is received from borrowing 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. (b) Premiums may be charged, either in the form of a higher rate of interest bid by the applicant for a loan, or in the form of additional weekly dues. Dozens of premium plans are in effect or have been tried, but the practice of charging premiums has decreased so that the total premiums now constitute 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 these 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 associa- tion dissolves or starts anew. The chief difficulty in this plan is that the association has too few funds to lend at the begin- ning of its career, and a surplus of unlendable 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 de- vised, by which new series of stock are issued at intervals — yearly, half-yearly, quarterly, and even oftener. 172 BANKING AND INSURANCE [Pt. II § 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 contuiuous stream of new members (or new subscriptions) flowing into the association, and a con- tinuous 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 as- sociation 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 build- ing 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 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. These safeguards make impossible anything like a "run" on a bank or a forced liquidation of the association. The most intelligent and prudent workers were formerly deterred from subscribing by the fear that sickness, unemploy- ment, or other mishap might make it impossible to keep up Ch. 11] INSTITUTIONS FOR SAVING AND INVESTMENT 173 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 borrow- ing members, to hasten the date when their shares mature and their debt will be discharged. These privileges are pos- sible because of the method of distributing profits, which will now be described. § 13. The distribution of profits. At least twenty-five plans, with hundreds of variations in details, have been in operation for the distribution of profits. The essential fea- tures are, however, these. Periodically, usually 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, in- creasing its "book value," and paid in cash to holders of paid-up stock. The dues frequently are 25 cents a week per share, in other cases $1 per month. Take, for example, the latter case, when the maturing value of a share is $200. If all of the capital paid in is lent out continuously at 6 per cent, the profits will be equal to about 6 per cent com- pound interest, and the shares will mature in about IIV2 years (the average experience has been 138 months) . A non- borrower will then be paid $200, of which $138 has been paid as dues over the period and $62 is the accumulated profit of each share. A borrower of $3000 (on this plan) must take at least fifteen shares, and would pay $30 each month, $15 as dues and $15 as interest. If he keeps up his regular payments, he will at the maturity of his shares have a capital just sufBcient to pay off the whole debt. In most cases a pmdent tenant can become the owner of a house while paying no more than the rent would be. As the active investor he becomes his own rent-collector, and uses 174 BANKING AND INSURANCE [Pt- II the house with less need of repairs, thus dispensing with services and costs that are included in contractual rents/" § ,14. Possible developments of savings institutions. The social importance of increasing and improving the agencies of savings for the masses is being more fully recog- nized, 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 depart.ments 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 sav- ings 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 oper- ated in connection with a general bank. It is much to be de- sired, however, that a larger measure of popular cooperation might be made possible to the depositors, both for its educa- tional 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 easilj' to convert their savings-bank deposits over cer- tain amounts into good bonds, bearing a higher rate of in- terest (after the method of the issue of postal savings bonds). There is need of a central market in each community where bonds can be bought and sold at any time ; and banks ought, as they increasingly do, 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 that issue bonds for such purposes as schools, roads, and public utilities, by creating a more open and regular market to small in- vestors than now is provided for such securities. This might somewhat reduce the rate of interest, and there would be 10 On these economies, see Vol. I, p. 298. Ch. 11] INSTITUTIONS FOR SAVING AND INVESTMENT 175 a gain divided between taxpayers and lenders. The large amounts of Liberty bonds now are especially suitable for the small investor. The general plan and principles of local building and loan associations was extended in 1916 to groups of rural co- operators in the joint-stock land banks, enabling them to make loans to their members^^ ; and it might well be extended 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. 'Savings institutions are necessarily also lending institu- tions. 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 coordinate 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. 11 See ch. 27, below. References. Chamberlain, Laurence, Principles of bond investment. 4th ed., N. Y. Holt. 1911. The work of the bond house. 1913. Devine. H. C, Peoples cooperative bank for workers in towns, and small holders, allotment cultivators, and others in country dis- tricts. N. Y. Cassell. 1908. Dexter, Seymour, A treatise on cooperative savings and loan associa- tions. N. Y. Appleton. 1804. HamAlton, J. JJ., Savings and savings institutions. N. Y. Mac- millan. 1902. Kemmerer, E. W., Postal savings. P. 176. Princeton. Princeton University Press. 1917. (A historical and critical study of the postal savings system of the U. S. ) Kniifin, W. U., The savings bank and its practical work. N. Y. Bankers Pub. 1912. Phillips, C. A.. Readings in money and banking. N. Y. Macmillan. 1916. Ch. XVI. Wolf, n. W., A cooperative bank handbook. Lond. King. 1909. Cooperative banking. Lond. King. 1907. People's banks. 3d ed. N. Y. Longmans. 1910. CHAPTER 12 PRINCIPLES OF INSURANCE § 1. Chance, unavoidable and average. § 2. Uneconomic cliaracter, of ganibl,ing. § 3. Borderland of gambling. § 4. Insurance: deiinition and kinds. § 5. Insurance viewed as a wager. § 6. Insurance as mutual protection. § 7. Conditions of sound insurance. § 8. Farmers' mutual insurance. § 9. Joint-stock insurance of property. § 10. Purpose of life insurance. § 11. Assessment life insurance. § 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 in- dustry, and it still remains and must always remain impor- tant. 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 careless- ness 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 ths 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 direc- tion or for those materials. Some of these chances are more connected with money- 176 Ch. 12] PRINCIPLES OF INSURANCE 177 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 indi- vidual 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 may be favorable as well as unfavorable. Extra-hazardous enter- prises must in general afford a higher average of profit in order to induce men to engage in them. It is folly to take a risk without ascertaining its degree as far as general ex- perience enables one to choose. But inasmuch and in so far as the gains and losses fall unequally upon different indi- viduals, 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 be- tween gambling and legitimate risk-taking. The chances enumerated above are not sought, but avoided as far as pos- sible ; yet they must be borne by some one if productive enter- prise is to continue, and the burden must somehow be dis- tributed throughout the community. Gambling is, however, a kind of risk-taking that 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 neces- sary part of productive enterprise. Typical gambling is the transfer of wealth on the outcome of events absolutely un- predictable, as far as the two gamblers are concerned. Ex- amples are the shaking of unloaded dice or the honest deal- ing 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 noth- ing as a result of mere chance. 178 SAKK;ING and insurance [Pt. II Cheating is not a necessary mark of gambling, although 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 use- ful purpose or result outside itself. Betting and gambling do not produce wealth, but merely shift the ownership of ex- isting wealth. The gamblers constitute themselves a little fic- titious 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.^ 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 decreas- ing gratification) less in amount than the desires that the loser must forgo. As a result the loser is often seriously in- jured by the loss of his income, and driven to despair, while the winner makes reckless and extravagant use of his win- nings. Easy come, easy go, is the rule of gamblers. More- over, gambling reduces the amount of wealth by relaxing the motives of economic activity, diverting energy from pro- ductive enterprise, tempting men into dishonesty to offset their losses, and leading them into speculation and embezzle- ment. § 3. Borderland of gambling. Ranging between the ex- tremes of unavoidable risk-taking and of gambling are a num- ber of cases of a mixed nature. In nearly all wagers, judg- t See Vol. I, ch. 5, § 7. Ch. 12] PRINCIPLES OF INSURANCE 179 ment in some degree influences the choice of sides. One man bets on a horse whose pedigree and performances he knows thoroughly; 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 run- ning, 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 econ- omic 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 profit- ing 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 there- fore be a benefit to the community, if this element of unavoid- able chance cannot be reduced as a whole, at least to regu- larize it and make it exactly calculable for any individual. In this way each may be encouraged by the more certain pros- pect of receiving a reward proportionate to his efforts and 180 BANKING AND INSURANCE [Pt. II abilities. This desirable condition has in many respects been accomplished by means of insurance. Insurance is a guaranty of partial or complete indemnity against a financial loss that will result if an event of a speci- fied kind occurs. The person seeking some surety against the possible loss is the insured; the person contracting to in- demnify against the loss is the insurer; the written contract of insurance is the policy; the price paid by the insured in fulfilment of his part of the contract is the premium; the amount paid when a loss has been incurred is the in- demnity; 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 break- age (as 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, acci- dent, sickness, invalidity, old age, and unemployment. The principle of insurance is being constantly extended to new subjects. The Jeffries-Johnson and the Dempsey-Carpentier prize-fights were insured against rain. 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. Insurance 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 ves- Ch. 12] PRINCIPLES OF INSURANCE 181 sels 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 malies 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 ex- perience 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 ves- ssl 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 the character- istics that 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 the insured runs, but to neutralize or offset an already existing chance. The insurance bet is what is called a "hedge." § 6. Insurance as mutual protection. The difference be- tween gambling and insurance lies further in the collective method of insurance, which combines the chances scattered among a number of persons. Insurance does not increase the 182 BANKING AND INSURANCE [Pt. II 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 to all members of the group. 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 mates 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 that, as a whole, are ap- proximately ascertainable in advance — however irregularly they may fall upon individuals. The insured must be numer- ous enough, and the objects insured so distributed in space and in time, that the "law of large numbers," or of statis- tical averages, applies. This means that in any one year the cost will not vary greatly from the average ; otherwise the security is weakened. The beneficiary must have an insurable interest in the property or person insured, that is, the beneficiary must actually suffer a loss by the occurrence insured against, and 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 Ch. 12] PRINCIPLES OF INSURANCE 183 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 in- creases the loss against which insurance was taken. When the insured sets fire to his own buildings, or drives his auto- mobile more carelessly than he otherwise would, 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 insur- ance is regarded as coming under the ordinary rules of chance. Yet it is to be feared that this liberal policy ser\es as a temptation at times to crime and to self-destruction. §8. Farmers' mutual insurance. Property insurance may be viewed as an aspect of enterpriser's cost,^ but may also, as may any insurance, be considered a form of saving. The premium paid each year may be looked upon as a sum prudently saved and laid aside to repair or rebuild the house when later it burns. Let us suppose that the chance of any one house being destroyed by fire in any one year is 1 in 500; then, on the average, the owner of each house would in 499 of the years have no loss from fire and the other year would lose the whole house. If the loss could be mathematically distributed over 500 houses, each house would burn down 1/500 each year, never more nor less, and fire loss would be a regular cost of repair. If no provision is made for this, the actual income of each owner in his lucky years would be .2 per cent greater (estimated on the cap- italization) than, on the average, is the net income of the whole group of owners. A prudent owner of one house, 2 See Vol. I, pp. 365 and 374. 184 BANKING AND INSURANCE [Pt. II understanding this, could only in small measure protect him- self against this loss by setting aside each year $2 for each $1000 of valuation, for any year his whole house might burn down, long before he had laid aside its valuation. If, how- ever, one man owned 500 houses of equal value, so situated that no two of them could ever catch fire from the same cause, and if in fact fate so distributed the fires that just one house burned down each year, his loss would be actually distributed in time according to the mathematical proba- bility. If 500 different owners of houses, alike but each located- apart from all the others, band together, they be- come collectively like one owner of 500 houses as regards the chance of loss in any one year. Still better, if 10,000 owners unite, the distribution of losses will approach much mors closely to the mathematical probability. In fact, a very simple application of this idea has been made in the insurance of farm property. It was a not un- common custom in agricultural communities in America for the neighbors to band together to help rebuild a house that had been destroyed by fire, or to take up a collection for the family that was in distress. Insurance affords a more regular, equitable, and effective way of accomplishing the same pur- pose, and likewise is a cooperative enterprise of neighbor- hood good-wiU. There are now about two thousand farmers' mutual fire insurance companies in the United States,^ with $6,000,000,000 of insurance in force, insuring the property usually up to a maximum of two thirds of the estimated true value. Usually the organization of these companies is simple, their officers unpaid, the overhead expenses very small, and the operations of each company limited to a small area, a township or at most a county. Premiums are usually not collected, or even determined, 3 These figures were collected by V. N. Valgren, investigator in agricultural insurance for the United States Department of Agriculture. They do not include a large number of similar companies that carry risks other than farm property to an extent greater than 35 per cent. Ch. 12] PRINCIPLES OF INSURANCE 185 in advance; but, the losses having been determined at the end of the year, the amount is collected pro rata in propor- tion to the face of the policies in force. More often of late, to add to safety and to equalize variations in losses from year to year, a small reserve is laid aside, $3 per thousand dollars of insurance in force being deemed ample for this purpose. Otherwise this is pure assessment fire insurance, and is not only very inexpensive, but very generally safe and convenient. This cooperative plan is, however, less suit- able in an urban neighborhood, because of the concentration of risks. Mutual hail insurance companies provide on a similar plan indemnity for the destruction of growing crops. Forty-one such mutual companies were in existence in 1919, and in recent years have collected premiums ranging from $3,000,000 to more than $6,000,000 a year. The smaller measure of success of these, as compared with the mutual fire insurance companies, is largely due to the irregularity of the losses from year to year and their wide extent when they do occur. The risks are not distributed in a manner suitable for neigh- borhood insurance, and mutual companies that are not or- ganized and managed in a neighborhood are less honestly and efficiently run. In the attempt to improve conditions, four states (the two Dakotas, Nebraska, and Montana) had hail insurance departments and collected premiums (in the year 1919) of more than $6,000,000, paying losses of three fourths of that amount, and setting aside a surplus. Mutual and state haU insurance premiums are virtually collected on the assessment plan, but it has been found best to collect a definite amount in advance, and, in case of unusual losses, to pro-rate among the losses the premiums collected. The plan of mutual property insurance is likewise being applied to live stock and other farm property. § 9. Joint-stock insurance of property. Much the largest part of insurance against fire and other causes of property losses is carried by joint-stock companies, or by so-called 186 BANKING AND INSURANCE [Pt. II mutual companies. Though these companies have, like banks, more of a public character than have most businesses, and are subject to special legislation and supervision by state officials, they were organized and are conducted pri- marily for the profit of the owners. Even in many rural districts, especially where conditions are unfavorable to mutual companies, the joint-stock companies have large amounts of insurance in force, and in urban communities they all but completely obtain the business. The joint-stock fire insurance companies* collect each year in the United States $700,000,000 in premiums on risks to the value of more than $72,000,000,000. The premium rate thus averages about 1 per cent. In 1917, a fairly representative j'ear, substan- tially this group of companies returned to the insured, in pay- ment of losses, only 48 per cent of the premiums received, used 34 per cent for expenses, and applied the remaining 18 per cent either to dividends or to surplus. The dividends were nearly 15 per cent of the capital stock (a considerable portion of which represented stock dividends in previous years) and the increase in assets 84 per cent of the capital of the preceding year. When it is considered that 20 per cent of all premiums received are paid in commissions, and that in the case of the higher officials the salaries and commissions run to very large amounts, it appears that the insurance business is exceedingly profitable to the fortunate few in control of these organizations. The starting of new com- panies is now attended with increasing risk and cost, so that the existing companies occupy, in some respects, a monopo- listic position. Another large group of stock companies (about 200) engaged in casualty, surety, and miscellaneous insurance, very rapidly growing in magnitude and impor- tance, now collecting more than one third of a billion dollars a year in premiums, returned (in 1919) to the policy-holders * National Board tables for 1917, published in the "Insurance Year Rook,'' 1918, p. 448. The Spectator Company. Mostly fire insurance but including marine, automobile, and other business, see also p. 540. Ch. 12] PRINCIPLES OF INSURANCE 187 41 per cent ("including all expenses in connection with pay- ment of claims") and expended 40 per cent on actual ex- penses of management. § 10. Purpose of life insurance. Of all forms of insur- ance at present, the most important in the extent of its finan- cial operation and as an agency of thrift is life insurance. The total receipts (about $1,800,000,000 in 1919) of life in- surance organizations (fraternal, ordinary, and industrial) are almost twice those of all other forms of insurance, and the total assets more than twice as great ($6,800,000,000 in a total of $9,100,000,000 in 1919). Life insurance is to provide partial indemnity for sur- vivors against the financial loss incurred by th° death of the insured. Usually the insured is the bread-winner of the family and the beneficiary is a member of his family; but the number and variety of other cases in which life insur- ance is provided is now large. In an increasing number of cases the beneficiary is the surviving business partner, a creditor, or a business corporation with an insurable in- terest in the life of one of its officers or employees. "Babe" Ruth is said to be insured for $200,000 in favor of the owners of the ball club for which he wields his mighty bat; Mary Pickford, Charlie Chaplin, and Douglas Fairbanks are each insured for $1,000,000 in favor of the moving picture company, their "producer"; and one of the large motion- picture corporations insured the life of its managing head in 1921 for $5,000,000. This is said to be the largest life insurance policy ever written, and it was divided among six or more insurance companies. Life insurance has been much used by persons mainly dependent on labor incomes,^ salaries, professional fees, and active business profits, rather than from funded incomes. In essence and largely in origin it is a cooperative method of providing for survivors, by all in a group contributing a sum to be given to the families of those dying. Naturally, 5 See Vol. I, labor incomes, in Index. 188 BANKING AND INSURANCE [Pt. II the need is most urgent in families not having accumulated wealth. It has of late been extended rapidly, as "indus- trial insurance" to wage-earners, in policies never exceeding $1000, but averaging very much less, 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, there- fore, necessarily high in proportion to the amount of insur- ance. § 11. Assessment life insurance. Life insurance plans may be distinguished, with reference to the time and method of collecting the premiums, as assessment and reserve insur- ance. In the simplest form of assessment insurance the losses are paid by contributions taken after the losses occurred, each member paying an equal share without regard to age. In a slightly modified plan the assessments are made at the beginning of the year, based upon the expected mortality for the year. Life insurance of this plan is essentially like the mutual fire insurance already described, the percentage of risk for each policy, whether on persons or houses, being assumed to be equal to that of every other policy. The great variation in the chance of loss in the case of various forms of urban property makes simple mutual assessment fire insurance unsuitable in such cases, and even in the case of farm buildings it has been increasingly seen that differ- ences in location, grouping, structural materials, nature of uses, condition of water supply, and other means for fight- ing fire, cause differences in risk whi(3h properly should be recognized. This can be done by classifying risks and in- suring on a scale at lower or higher assessment rates. If some concession is not made to the better risks, some enter- prising commercial companies will see a profit in giving them a lower rate. Mutual companies which ignore these differ- ences feel the effects of "adverse selection" in that they are left with only the more hazardous property. Ch. 12] PRINCIPLES OF INSURANCE 189 Now, in the case of life insurance the risk varies with great uniformity (considering the average mortality of large groups of men) according to the one factor of age. The cos\ of assessment life insurance, therefore, is closely related to the average age of the members composing the group of in- sured. 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 the constant addition 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. But other young men are averse to entering the organiza- tion under these conditions; and the result is that the rate of assessment must be steadily increased. Finally failure results, or some form of "reorganization" that drives out the older members. The simple 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 classi- fication by age, 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 the annual cost to the insured rises so rapidly that many surviving members are forced to drop the insurance in later years. Assessment insurance is sold by stock companies organ- ized for profit, by fraternal orders, and by various types of mutual organizations. Many of the stock companies have had a dismal history of hardship to surviving members and of eventual failure. They are reforming or disappearing under the influence of hostile legislation resulting from a better popular knowledge of insurance principles. The fraternal 190 BANKING AND INSURANCE [Pt. II orders have more than ten million policies in force and in- comes totaling more than $180,000,000. They combine insur- ance 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. Many in the past have failed, with disappointment and disaster to the older members. Still others are struggling with difficulties that presage dis- solution. Most of them now have some, though inadequate, reserve accumulations, and some have so improved their methods that they begin to resemble reserve companies. The assessment companies average $1.37 reserves per $100 of insurance in force, and get 10 per cent of their total in- comes from their funded investments. Even with the favor- able conditions under which fraternal orders conduct their insurance business, they eventually must fail unless they adopt rates and policies based upon adequate reserves. Many thousands of present members are paying for insurance at rates that 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. References. Gephart, W. F., Principles of insurance, vol. 2, Fire. N. Y. Mac- • millan. 1917. Same, Insurance and the state. N. Y. Macmillan. 1913. Huebner, S. 8., Property insurance. N. Y. Appleton. 1913. Willet, A. H., Economic theory of risk and insurance. N. Y. Long- mans. 1901. Winter. W. D., Marine insurance. Pp. 450. New York. McGraw- Hill. 1919. Zartman, L. W. (Ed.) Fire insurance. Yale Univ. Press. 1915. CHAPTER 13 SCIENTIFIC LIFE INSUKANCB § 1. Reserve life insurance. § 2. The mortality table. § 3. The single premium for any term. § 4. Level annual term premiums and reserves. § 5. Term policies and straight life. § 6. Limited premium paj-ments. § 7. The endowment feature. § 8. The choice of a policy. § 9. Insurance assets and investments as savings. § 10. Future of insurance. § 1. Reserve life insurance. The plan of reserve insur- ance provides a remedy for 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 sufBcient to offset the increase in losses as years ad- vance. In reserve insurance, therefore, the premium never increases from year to year, although it may be so arranged as to diminish or to cease entirely some time within the term for which the insurance continues. The premium must always be fixed in advance. The cal- culations for determining the premiums on different kinds of insurance policies are many and complex, but all con- form 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 on outstanding insurance. Insurance on the re- serve 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 re- 191 192 BANKING AND INSURANCE Pt. II spect to age of insured, number of payments, method of pay- ing the beneficiary, and any other conditions. The premium thus fixed is, however, only a maximum, and usually is re- duced as the result of conditions more favorable than those assumed. § 2. 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 tables generally used in the United States are the "Actuaries" which assumes the limit of life to be 100 years, and the American Experi- ence Table of Mortality, constructed by Sheppard Homans in 1868, which assumes the limit of life to be 96. Some figures from the latter table, at specified years, are given below : Ige Xumier Living Deaths loithin u, Death rate year perl,OUO 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 7C5 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 deaths in any group of insured are not exactly the number in the mortality tables. But this is not an es- sentia] difficulty as long as the deaths are fewer than the figures of the tables, at least in the earlier years of the policy. Any excess Of premiums thus collected but increases the safety of the insurance or reduces the need of later pay- ments. In fact, the mortality in all well conducted companies in the United States is below the figures of these tables, partly because the tables were conservatively calculated, partly because of the favorable influence of medical selec- Ch. 13] SCIENTIFIC LIFE INSURANCE 193 tion, especially among the recently insured, and partly be- cause of the improvement in longevitj' since the tables were constructed. The premiums given as illustrations in the following dis- cussions are "net premiums," or natural premiums, esti- mated as just sufficient to meet the actual payments required by the contracts in the policies. To provide for the ex- penses of management, an addition is made to the net premium, called the "loading." The entire premium is 40- 35- o 30 o u =■ 20- = 15 H 10 5- Mortality Bate American Experience Ages 35-65 IT 40 Ts ^To 5% SS Age at beginnins of year Fig. 1, Chapter 13, shows the rise of mortality rates between the ages 35 and 65, which calls for more and more rapidly increasing pay- ments under the simple assessment plan. called the "gross premium." The loading, a large part of which goes for agents' commissions and the costs of manage- ment, is a very considerable addition to the net premiums, adding in the case of the standard companies nearly 25 per cent to the premiums for an endowment policy, nearly 30 per cent on a limited payment, and more than 40 per cent on a straight life. A part of this, however, may be re- funded to the insured in the form of "dividends." § 3. The single premium for any term. It is apparent that the natural assessment premium (ignoring the factor of interest) for $1000 of insurance is expressed by the death 194 BANKING AND INSURANCE [Pt. II rate for that year, e. g., at age 20 the payment of $749 by each of the 100,000 living at the beginning of the year will provide the $749,000 needed to pay the losses. 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% per cent, the premium in advance for a one-year term policy is the natural premium dis- counted, e. g., $8.64 is the present worth of $8.95, which is the natural premium at age 35 due a year later, interest being 3i/^ per cent. In these calculations there is no allow- ance for expenses, the necessary "loading." In the same manner may be determined the natural assess- ment premium for each year of insurance. 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 neces- sary only to apply the formula of present worth and that of compound interest on investments.^ Thus the losses of any future year, according to the table of mortality, discounted by the rate of yield on investments, are the present worth of insuring the entire group for that year. The single premium for each of the insured for any term of years is the sum of the present worth of insurance for all the years of the term, divided by the number living at the beginning of the period.^ The payment in advance of the single premium for any 1 See Vol. I, p. 279. 2 Let P be the cresent wortli of all the policies for a. group of the same age, p the present worth of one policy, X the total insured at the beeinning of the period, f the natural assessment premium this year, or the natural premium reauired for any year. Then P- 4- + — : + . ^_ (1-1-r) (l-l-r)2 (l-|-r)3 (l-fr)n P= X Ch. 13] SCIENTIFIC LIFE INSURANCE 195 definite term provides a reserve fund sufficient, on the as- sumptions 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 yield- ing income, thus providing a larger sum than is needed to pay all the policies at maturity. This surplus might be dis- tributed 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. § 4. Level annual term 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 qther forms of premium payment. The processes are but variations of present worth and compound interest calcula- tions. Such calculations, however, lead into many complexi- ties 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 insLTrance 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 a. Rate of normal AdditionaZ tax normal 1 2 2 6" 4 26 4 61 41 Surtax begins $20,000 20,000 5,000 6,000 Surtax attains maximum $500,000 Surtax rates 1-6 Number of returns 357,598 357,515 336,652 437,036 3,472,890 4,425,114 Amount collected $28,300,000 41,000,000 67,900,000 173,400,000 675,200.000 1,127,700,000 1913 1914 1915 1916 $2,000,000 1-13 1917 2,000,000 1-63 1918 1,000,000 1-65 1919 1920 » And $1000 more for married person. .... b There was here introduced, under the name of ' additional normal rate, a new surtax rate, applicable to all incomes of more than $3000 for single Tjersons and $4000 for married persons. , » v u i, ' This act provided that the normal rate and additional normal rate should be 6 per cent in the calendar year 1918 and 4 per cent thereafter. "The additional normal rate began at $3000, whereas the normal rate began at $1000 (for a married person the exemption was $1000 more). Ch. 19] PERSONAL TAXES 311 income of husband and wife living together (this distincton, it will be observed, offers a reward of $20 per annum to make marriage a failure). Among allowable deductions 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 that 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," by which corporations and other businesses were required to deduct taxes before paying dividends, salaries, etc., to taxable persons. 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, gave an ingenious way in our law of checking up the returns of individuals in respect to a class of investments that is steadily increasing in importance. By amendment, stoppage-at-source was in many cases changed to the requirement of reporting-at-source, as less troublesome and equally efficient. The most disputed feature of the income tax probably was the principle of graduation, called also progression. It is up- held 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 in- vestments. 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 wide- spread approval of the progressive rate just because it in so far acts as a leveling influence upon fortunes. The "addi- 312 TARIFF AND TAXATION [Pt. Ill tional" tax is already important fiscally, yielding more than one half of the total paid by individuals and one fourth of the total from corporations and individuals. § 8. Development and yield. The income tax was made retroactive to include incomes accruing from March 1, 1913, to the end of the year, and continued to apply to December 31, 1915, and the personal income tax yielded approximately $28,000,000 in the ten months of 1913, $41,000,000 in 1914, and $68,000,000 in 1915. In September, 1916, the law was changed by doubling the normal rate and increasing the sur- tax rates to a maximum of 13 per cent. This law also was applied retroactively to incomes accruing from January 1, 1916, and continued in force during the calendar year 1916, yielding more than $173,000,000. After our entry into the war was passed the act of October 3, 1917, called the War Revenue Act, reducing the normal ex- emption from $3000 to $1000 ($4000 to $2000 in case of mar- ried persons living together), imposing under the name of an ' ' additional normal tax ' ' a new surtax of 2 per cent on all in- comes of more than $3000 for single persons and $4000 for married persons, increeising the surtax maximum rate to 63 per cent and reducing to $5000 (taxable income) the point at which it began. The number of returns (that is, taxable per- sons) was thereby increased to nearly three and one half millions, and the yield of the calendar year 1917 was more than $675,000,000. The war tax legislation of February 24, 1919, attempted to meet the financial needs of the government when they were at the maximum. The principal changes in the individual income-tax law were in the normal and the additional normal rates, both being trebled to apply retroactively to incomes in the calendar year 1918, and the increase of the surtax by rearranging the classes and applying the maximum rate of 65 per cent to all incomes of more than $1,000,000 (half the amount previously paying the maximum). Under this act there were nearly four and one half million tax- Ch. 19] PERSONAL TAXES 313 able persons, and the yield for the calendar year 1918 was $1,128,000,000. The act provided for the reduction of the normal rates (regular and "additional") each from 6 to 4 per cent for the calendar years 1919 and 1920. § 9. Corporate income and excess profits. Along with the federal taxation of individuals under the income tax has since 1913 been closely linked a new and special form of taxation of corporations. Important legislative changes in the one have been nearly always accompanied by equally important changes in the other. Before the adoption of the sixteenth amendment, the need for new revenue in the Taft adminstration led to the en- actment, August 5, 1909, of an "excise tax" on corporations, measured by net profits within the taxing period. This yielded in the four years that it was in force an average of about $32,000,000 annually. This excise-tax feature was abandoned in 1913, or it may be better to say that it was incorporated into the income-tax law of that year, by which net corporate profits ("incomes") were made subject to a normal rate of 1 per cent, as were those of individuals. This yielded between 1914 and 1916, between $30,000,000 and $60,000,000 a year. In 1916 this normal rate was increased to 2 per cent, at which the yield in- creased to $180,000,000 in the fiscal year 1917. At the same time a tax of 121/0 per cent was laid upon net incomes de- rived from the manufacture of munitions (a business then most prosperous through enormous sales to the Allies) ; and the capital stock of certain large classes of corporations was subjected to a tax of 50 cents (soon doubled) on each $1000 par value in excess of $99,000. These various taxes on cor- porations in the aggregate were capable of yielding nearly a quarter billion dollars. But this was only the beginning of corporation taxation. "While continuing the normal income rates on corporations, the law of March 3, 1917, laid the first excess profits tax (8 per cent on corporate profits exceeding 8 per cent of actual capital invested) ; but this law 314 TARIFF AND TAXATION [Pt. Ill was superseded by the "War Eevenue Act of October 3, 1917, which levied war excess profits taxes upon incomes alike of individuals, partnerships, and corpora- tions. The details are too complicated for discussion here, but a few features may be noted. A distinction was drawn between incomes derived chiefly from personal or pro- fessional service (taxed at a flat rate of 8 p-er cent, after the exemptions) and incomes derived primarily from invested cap- ital (taxed at progressive rates in accordance with the per- centage that profits bore to "invested capital" value). In the case of the latter the lowest rate, 20 per cent of profits, was applied on "net income" not in excess of 15 per cent of the invested capital; and the highest rate, 60 per cent on "net income" in excess of 33 per cent of invested capital. The amount of income exempted was $3000 for corporations and $6000 for partnerships and individuals, and also, in all cases, an amount of new income equal to a specified percentage of the invested capital during the "pre-war period," defined as the years 1911, 1912, and 1913. The yield from this tax was enormous, the total from corporate incomes and excess profits (mostly the latter) in the calendar year 1917 being nearly $3,000,000,000 and in 1918 more than $4,000,000,000. § 10. Defective theory of corporate income taxation. There is apparent in all this legislation the attempt to treat corporations and individuals on the same principles, especi- ally in applying to both of them alike exemptions and pro- gressive rates. There is much confusion of thought here, for (1) "income taxes on individuals" and (2) "income and ex- cess profits taxes on corporations" are very diflierent in their nature and their sources. The term "net income" as applied to individuals is charged with psychological meaning. The whole modern theory and justification of progressive rates as applied to income taxation assumes that the income on which the rates are imposed is a total of the various income items (real and monetary) of an individual. His net income within the year is available for spending and enjoyment, or Ch. 19] PERSONAL TAXES 315 to add to his capital as a net addition. If this net income total is small, it should not be taxed at all, for that would take away part of what is conceded to be necessary for the minimum of comfort. Hence, exemptions are granted not only to the poorer citizen, but to all citizens, for even the richer taxpayer should not be taxed on that portion of his income necessary to existence or minimum comfort. Hence, also, progressive rates on larger incom>es, since the sacrifice, the psychic cost, of giving up the marginal portion of in- comes is assumed to become progressively less to the indi- vidual as his income increases. The second reason for pro- gressive taxes, namely, the social benefit of leveling somewhat the larger fortunes, is likewise applicable only to individuals, or at most to large corporations owned by one or by few. men. In truth, the concept of income is not applicable at all to corporations without confusion of thought. Only indi- viduals have net incomes, enjoyable or available for rein- vestment. Corporations have receipts and expenditures, have net profits (or losses), at the end of the year, the equitable title to which belongs to various individuals, as evidenced by the securities they hold. But a moderately small cor- poration may have virtually but one owner, and he very rich, whereas an extremely large corporation may have many par- tial owners, most of them with very modest incomes. Ex- emptions and progressive rates, varying in accordance with the total of the profits ("income") of corporations, have therefore no relationship in principle to those in the case of individuals. Nor can taxation of corporate profits at progressive rates in accordance with the ratio of profits to invested capital be justified on the same grounds as progressive income taxa- tion. "Invested capital" is a term that in practical busi- ness has a wide range of meanings, and the excess profits tax, when first imposed, caught the corporations with the most varied book values of capitalization. In general, the more 316 TARIFF AND TAXATION [Pr. Ill recklessly they have been financed and the Jarger the amount of watered stock they had issued, the smaller the rate of profits on which they were taxable, and vice versa. The im- perative necessities of war finance may relatively justify any measure of taxation that produces the results immediately desired; but the fundamental defects soon produce grave abuses and widespread protests, and will compel revision of our federal corporate taxation. The income tax is here as a permanent feature of our tax system. Eventually it should be reconstructed on the sound principle that only individuals have incomes. In various ways increments in capital value and tindistributed profits of partnerships and corporations might be periodically assessed as income to the individual owners, thus verging into one simple whole the many diverse elements in our present complex of income and excess-profits taxation. § 11. 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, how- ever, have consistent principles by which its steps may be guided. In the foregoing kinds of taxation are the various elements that 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 owner- ship or of the residence of the owner. The present misnamed "general property tax" already presents the main outlines of Ch. 19] PERSONAL TAXES 317 this form of taxation, and the general changes necessary in law and method of assessment have been indicated above." Cor- poration taxation may be adjusted to this either by separate treatment and assignment to state purposes only, or more sim- ply for most states, by assimilating it with the general taxa- tion of wealth and allotting due shares of the proceeds to the various taxing divisions.^" The national government can, be- cause 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 combina- tion of tariff and internal duties levied upon business acts. These mostly become merged into business costs, and are diffused over the whole population through general prices.^^ This system of impersonal wealth taxation may then be supplemented by personal taxation, applied through inherit- ance and income taxes. These forms of taxation extend over and reach many of the same persons and incomes as do ulti- mately the impersonal taxes. But the summation of personal incomes gives the necessary condition for applying the prin- ciple of progression as far as this is, by public opinion, deemed desirable either for fiscal or for social reasons. 9 See above, ch. 18, § 5. 10 See ch. 18, § 15, and § 16. 11 See ch. 16, § 12 and § 14, first paragraph. Refebences. Bullock, C. J., Selected readings in public finance. Bost. Ginn. 1920. Chs. XII, XVI. Daniels, W. M., The elements of public finance. N. Y. Holt. 1904. Pt. II, ch. VIII. Bill, J. A., The income tax of 1913. Q. J. E., 28: 46-68. 1913- 1914. Seligman, E. R. A., The income tax. N. Y. Macmillan. 1914. West, Max, The inheritance tax. 2d ed., N. Y. Longmans. 1908. PART IV WAGES AND LABOR CHAPTER 20 METHODS OF INDUSTRIAL REMUNERATION § 1. Workers subordinate in early societies. § 2. Workers in the Mid- dle Ages. § 3. Growth of the wage system. § 4. Pros and cons 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 the- ory of profit-sharing. § 13. Purpose of producers' cooperation. § 14. Limited success of producers, coBperation. § 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. Civili- zation 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 indus- trial organization in early tropical civilization, seems to have been one of the necessary steps to progress from rude condi- tions; students to-day incline to view it as an essential stage in the history of the race. But, as conditions changed with in- dustrial development, chattel slavery became an inefficient form of industrial organization and a hindrance to progress. Slavery in the southern states of the American union was long a modern exception. The combination of racial differ- ence between subject and master people, of warm climate, of special agricultural crops and of conditions in which slave labor could be employed with least disadvantage, combined to 321 322 WAGES AND LABOR [Pt. IV delay the disappearance of slavery from a community in which the life of the master people was in many respects on the highest plane of civilization. § 2. Workers in the Middle Ages. Serfdom for rural labor and many limitations of workman's freedom in the towns were the prevailing conditions in medieval Europe. Serfdom was both a political and an economic relation. The serf was bound to the soil ; the lord could command and con- trol him; but the serf's obligations were pretty well defined. He had to give services, but in return for them he got some- thing 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 ease 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 forbid- ding the free choice of a trade or a residence; laws against migration into the town; settlement laws making it impos- sible for poor men to remove from one place to another; ar- bitrary regulation of wages, either by the gilds in the towns or by national councils and parliaments, forbidding the work- men 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, in England, by the sixteenth centurj^ commuted for cash payments, and Ch. 20] METHODS OF INDUSTRIAL RENUMERATION 323 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 increas- ing investments. This required in the towns an increasing proportion of hired laborers having little or no capital in- vested 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.^ § 4. Pros and cons of the wage system. The wage system has certain practical merits of workableness which account for its progress and dominance. It keeps alive competitive motives among the wage workers to improve and advance by skill and industry; it brings the planning and management of business into the hands, in the main, of the provident and capable.^ Under the wage contract, the employer, as the one best prepared to do it, takes the risk as to the future sell- ing price of the produce ; the worker receives in a definite sum at once the market value of his services. This is of growing importance, for the larger the market and the longer the wait- ing period in industry, the greater the element of uncer- tainty and financial risk. 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 his labor, embodied in a product for future sale, discounted at the prevailing rate. iSee Vol. I, pp. 227, 318, 322. 2 See Vol. I, p. 329, on selection of managed and managers. 324 WIAGES AND LABOR [Pt. IV But the wage system has brought with it grave problems of inequality of incomes and of opportunity that at times threaten the very existence of democratic society. It means for the mass of men continuance throughout life in the posi- tion of hired workers, with no possibility of becoming self- directing enterprisers. In connection with increasing division of labor, it means for great numbers unvarying application to one narrow task, with little understanding of its relation to the whole and with less joy in workmanship than the old independent handicraftsmen had. Yet is it correct to say that the wage system causes these inequalities in ability and in variety and agreeableness of tasks? Is it not rather itself the result of the differences of ability, a way found through society's long experience by which individuals may choose their occupations within the range of their abilities to gratify the desires of consumers, a way of attaining a high degree of efficiency in production 1 ^ The problem for a wise political economy to solve is, and will be, to retain the best in the wage system, while remedying its evils or reducing them to a minimum. § 5. Time work. 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 remunera- tion." 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. 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, oversee- 3 See Vol. I, chs. 16-19. Ch. 20] METHODS OF INDUSTRIAL REMUNERATION 325 ing him, teaching him, and stimulating him by his own pres- ence 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 gen- eral 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 per- formance. However, in every industry there is a recognized, f£iirly 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, reli- ability, and good temper, the better workman is likely to obtain a better position, higher pay, more regular employ- ment, 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. In 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 dis- advantages in time work, and their relative importance varies in different industries and industrial conditions. Especially is the difficulty of supervising workers and of insuring the performance of a certain standard, or minimum, amount and 326 WAGES AND LABOR [Pt. IV quality of work great in larger enterprises. Various methods of measuring the performance of the worker directly by some other than the time standard have been developed. All of these, in some measure, involve the piece-work principle. Task work, also called "doing a stint," 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 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 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 con- venient 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 fac- tories in textile and mechanical industries. Selling on com- mission is a form of piece work. In piece work the motive to activity is ever present to the worker, and generally 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 dex- terity 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 Ch. 20] METHODS OF INDUSTRIAL REMUNERATION 327 because of the undue strain upon the worker that often occurs, piece work is in many trades not favored by the workers.* § 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. The~se plans are called "premium plans," "pro- gressive 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 Jess than the standard time he receives a fixed premium per hour equal to one third of the wage for the time saved. For example, if the standard time is 10 hours for a $3 job the premium for speed is ten cents per hour, and 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 evi- dently would be 40 cents in the first case and $1 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. 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 is larger for the earlier reduc- tions in time and becomes less for the later reductions than in either of the other plans. i See ch. 21, § 6. 328 WAGES AND LABOR [Pt. IV Examples Wheke Standard Time is 10 Houbs, at $3, Standard Pay Pek Hour 30 Cents Premiwm for the job by Time to Number Halsey Weir plan, Rowan plan, complete of hours plan, fixed saving div- hourly premium job saved per hour, ided equal- equals percentage 10 cts. ly of reduction 10 D 9 1 .10 .15 .27 8 2 .20 .30 .48 7 3 .30 .45 .63 6 4 .40 .60 .72 5 5 .50 .75 .75 4 6 .60 .90 .72 3 7 .70 1.05 .63 Z 8 .80 1.20 .48 1 9 .90 1.35 .27 By Halsey 's plan the employer gets two thirds of the total saving in time, by Weir's plan one half, and by Rowan's a percentage varying directly in the ratio of the time saved. A number of other variations have been worked out by the promoters of recent scientific management, notable ones be- ing 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 consider- able improvement with unusual efEort, 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 re- duce 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 fire- man for using less coal), or for various other results. Every business has its peculiar conditions that make certain results especially desirable and certain methods of reward prac- Ch. 20] METHODS OF, INDUSTRIAL REMUNERATION 329 ticable. 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 in- dustry 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 that are expected to result from their efforts. There is, in every fac- tory, 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 in- terest, 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 the worker's interest. Either responsibility for the fault can- not be fixed, or the defect is one not measurable by any easily applied standard. Strikes may be averted, good feeling pro- moted, 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 eco- nomic result of the plan, if it can be made to work, should be to reduce the costs of these establishments below what they 330 WAGES AND LABOR [Pt- IV are. The crucial question is whether profit-sharing alone in any particular ease 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. I'or 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 remark- able fact that the plan has been continued successfully by the same firm to the present time. It has been tried in many hun- dreds, possibly thousands, of cases, and is operating in some form or other, in more than a hundred firms in Europe and America. The most notable examples of profit-sharing in the United States are the Pillsbury ilills in Minnneapolis, Procter and Gamble's soap-factories in Ivorydale, Ohio, the Nelson Manufacturing Company in Leclaire, 111., and the Ford Auto- mobile "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 work- ing 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 impor- tant fact is that true profit-sharing has spread little since 1890, though 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 cor- poration, so that, as stockholders, they may have a motive to work for the success of the company (e. g., the United States Ch. 20] METHODS OF INDUSTRIAL REMUNERATION 331 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. Many have found it hard to credit the evidence of this comparative failure of a plan that looks so attractive in spirit and for which so much was hoped. Yet objections come from the side both of the workman and of the employer. The workman lacks the knowledge of the business and is suspicious of the book- keeping. If at the end of the year the books show no profits, the worlanan loses confidence, considers tbe plan to be mere deception, and rejects it. The working of the plan remains in the employer's hands, and the work- man 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 ttie 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 332 WAGES AND LABOR [Pt. IV 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 im- mediately 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, though all the manual workers may be exerting themselves to the utmost. The wage bill is but one of the group of costs. Profits are the net result of many influences, and chief among these is the skill in planning and conducting the business. This function of management is either performed by the same person who 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 enterprises for which they work. But ordinary profit-sharing is not in accord with the general trend toward' the centraliza- tion of responsibility in the hands of competent managers, in- suring 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. Ch. 20] METHODS OE INDUSTRIAL REMUNEEATION 333 Likewise the pretty general participation in ownership of stock by the employees of a corporation may exert an in- fluence distinctly steadying upon labor conditions in the in- dustry, and may increase the personal interest of the workers in the efficiency of the factory operations. It may, in the plan of partial payments, help to develop a spirit of thrift in the employees, a result beneficial alike to them, to the corporation, and to the civic community in which they live. But this is not truly profit-sharing; and wage-earners gener- ally should be encouraged to invest in government and cor- poration bonds of a conservative sort rather than in the common stock of a manufacturing corporation. § 13. Purpose of producers ' cooperation. 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' cooperation among workingmen. Producers' cooperation 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 represen- tatives, they must undertake to furnish capital and manage- ment 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 in- vestors. 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 producers' cooperation. Practi- cally, the plan has been made to work in a comparatively 334 WAGES AND LABOR IPl. IV few simple industries. A much cited example of successful cooperation in America is that in the cooper-shops in Minne- apolis. 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. At its largest development the enterprise was small compared with the typical manufacturing enterprises in America. After more than thirty years the main shop, when visited by the writer, was still in operation, but with a membership of the older men and with no growth. A number of the less skilled workers received ordinarj' wages, and there had recently been labor troubles of quite an ordinary kind. In America a few of the productive cooperative 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 cooperative enterprises. This result has dis- appointed the hopes, and prophecies of many well-wishers of the working-classes. § 15. Its main difficulty. The main difficulty in producers' cooperation 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 cooperative shops by jealousies and rivalries and by politics among the workmen. A man selected by his fellows finds it difficult to enforce discipline. In cooperation there is occasionally developed good business ability that micht Cii., 20] METHODS OH INDUSTRIAL REMUNERATION 335 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 demon- strated their ability, the leaders go to competing establish- ments where their function is not in such poor 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. Cooperative 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, cooperation would be possible in many indus- tries where now it is not. Producers' cooperative 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 cooperative principle has been embodied much more successfully and on a larger scale in America in the form of producers' selling organizations or of consumers' cooperative stores. As, however, both of these forms of organization have been developed in America more largely by farmers than by wage-workers, the discussion of them may better be undertaken in connection with problems of rural organization rather than with those of labor. 336 WAGES AND LABOR [Pt. IV Refeeences. Adams, T. S., and Sumner, H. L., Labor problems. 8th ed., N. Y. Macmillan. 1914. Chs. IV, IX, X. Burritt, A. W. and associates, Profit sharing. Its principles and practice. Pp. 328. New York. Harpers. 1918. Commons, J. R., (Ed.), Trade umionism and labor problems. 1905. Second series. Boston. Ginn. 1921. (Selected readings.) Commons, J. R., and Andrews, J. B., Principles of labor legislation. Rev. ed. Harper, 1920. Ch. II, sees. 1-3. Fay, G. R., Cooperation at home and abroad. N. Y. Macmillan. 1898. Gilman, N. P., Profit-sharing between employer and employee. Bost. Houghton. 1889. National Civic Federation. Profit Sharing by American Employers. New ed. 1921. (Analysis of 200 plans.) Schloss, D. F., Methods of industrial remuneration. 3d ed. N. Y. Putnam. 1898. CHAPTER 21 ORGANIZED LABOR i 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. Fre- quency and causes of strikes. § 10. Picketing and the boycott. § 11. Competitive aspect of organization and particular wages. § 12. Mo- nopolistic aspect of organization and particular wages. § 13. Open vs. closed shop. § 14. Political and economic considerations. § 15. The public's view of unions. § 16. Effects of organization upon general wages. § 17. Future rOle of organization. § 1. Changing relations between employers and wage workers. The "organization of labor," or the "labor move- ment," so striking a feature of the world to-day, is of com- paratively recent origin. It did not begin and advance pari passu with the beginning and early growth of the wage sys- tem as above briefly described.^ In anything like its modem 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 be- fore the industrial revolution,^ and has extended as fast and 1 See ch. 20, § 1-3. 2 See Vol. I, p. 459. 337 338 WAGES AND LABOR [Pt. IV 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 con- centrated 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 ap prentice 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-con- scious" 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 stockhold- ers, 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 own- ers to drive hard bargains with their employees. Many exam- ples 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-con- scious" feeling, which tempered the spirit of their mutual Cm 21], ORGANIZED LABOR 839 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. Espe- cially in times of industrial depression is a change of employ- ment 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 notori- ously 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 em- ployers 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 opin- ion, 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. As long as a eommimity is small and men know each other personally, popular govern- ment may exist without complex machinery, but when num- bers become larger, public opinion can be concentrated and made effective only by delegating the functions to elected representatives. 340 WAGES AKD LABOR [Pt. IV § 3. Functions of labor organizations. Out of these con- ditions have grown the various kinds of labor organizations. (1) their first object is to maintain and increase wages. (2) Closely connected with this is the remedying of various abuses in respect to methods of payment, measurement of the output, and conditions of work. (3) Almost co- ordinate 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. (4) Better conditions of safety and sanitation in their work were not the first thought of laborers when they organ- ized. 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 en- lightened labor movement has better ideals and policies in re- spect to the safety, sanitation, and decency of working- places. Labor organizations have also secondary objects of very great importance. (5) They are nearly always in some meas- ure mutual-benefit associations, and provide in varying degrees insurance against accident, sickness, death, or lack of employ- ment. (6) All unions in a measure serve their members as employment bureaus, and some make this an important fea- ture. Through trade papers, correspondence, traveling mem- bers, and in meetings, information is exchanged regarding conditions of employment in various parts of the country. (7) Labor organizations, by means of their discussions and through their special periodicals, are a strong educational force in matters political and economic. (8) The local labor organizations often come to be the center of the social activi- ties and interests of many of their members, and even of all the members of their families. The organizations thus serve Ch. 21] ORGANlZEt) LABOR 341 the functions of social clubs, of literary societies, and of civic centers for their members. § 4. Types of labor organizations. Among the many or- ganizations of wage-earners three main types may be distin- guished : the labor-union, the trade-union, and the industrial union, though often they are all spoken of as trade-unions or as labor-unions without distinction. In the more special sense, however, a labor-union is one that admits several classes of wage-earners, sometimes 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 mem- bership in which every one was elegible 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, although 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 others such as musicians and retail clerks. The local chapters in many cases have been long united in national unions (often international, embracing 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 Work- ers, and the Industrial Workers of the World. In 1881 a number of national trade-unions united, for cer- tain 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 in- 342 WAGES AND LABOR [Pt. IV dustrial 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 organizations. The ratio of or- ganized workers to the population is estimated * to be highest in the United Kingdom, being 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 impor- tance of agricultvire in the United States. The total membership of trade-unions in the United States and Canada was estimated (in 1910) to have been 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 em- ployed, 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 occu- pying nearly one half of all workers, including agriculture, the hand trades, oil and natural gas, salt, and rubber facto- ries. 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, sta- tionary engineers, in public, professional, and domestic serv- ice, 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, pub- licly employed, commercial, and domestic workers, about 16 3 In the Federation in 1921 were 111 national and international unions, representing 34,000 local unions, 46 state branches, 801 city centrals, and 823 local trade and federated labor-unions. 4 These and the following fig^ires were compiled before the World War; no revised estimates are as yet available. Ch. 21] ORGANIZED LABOR 343 per cent of the remaining 13,760,000 persons were 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 were 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 in- dustry; of stereotypes 90 per cent were 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) .^ § 6. Collective bargaining. The fundamental policy of trade-unions is the substitution, for the individual wage bar- gain, of collective bargaining between the delegated repre- sentatives of the workingmen and the employer, or group of employers, or their representatives. The wage-earners bar- gaining 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 one another before labor- ers were organized. But in many cases the individual em- ployer was at a marked disadvantage after the organization of his employees. The result has been the rapid spread of em- ployers' organizations, so that, in industries where laborers are highly organized, two-sided collective bargaining has be- come more and more usual. A large parf of the effort of trade-unions is directed toward insuring the use of collective bargaining. This is the pur- pose of many of their demands, even of some that hardly ap- oSee Quarterly Journal of Economics, May, 1916, article by L. Wol- maji. 344 WAGES AND LABOR [Pt. IV pear to have any such consideration. Collective bargaining virtually 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 pur- poses. The standard time rate usually is but a minimum, and many of the more skillful 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 ef- fectively 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 com- mon 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 or- ganizers 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 difficulty are analogous to the sense of patriotism in the nation at large, and at times may displace it in the hearts of organized labor- ers, as is seen in opposition to the militia and to the main- tenance of order in times of strikes. The most effective of all peaceful methods is 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 stand- ing is an effective way of enforcing these measures. Finally, Ch. 21] ORGANIZED LABOR 345 ■when all these measures fail, pressure may be brought upon the employer to get him to force unwilling workers into the union.® 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 (though less fre- quently 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 de- mand 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 ulti- mate, 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 in- strument 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 suc- cess 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 8 See below, § 13, on the closed shop. 346 WAGES AND LABOR [Pt. IV interruption of business, aggregate an enormous sum. The direct losses to employers and strikers in the twenty years between 1881 and 1900 were 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 indi- rect 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 rela- tively 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 condi- tions. Since wages, as a rule, rise more slowly than general prices, '' 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 rela- tive importance. In 1881, at the time of the very rapid or- ganization of unions, more than 71 per cent of all strikes were directly connected with wage demands (61 per cent for in- 7 See Vol. I, pp. 223-224, and above, ch. 6, § 10. Ch. 21] ORGANIZED LABOR 347 crease and 10 per cent against reduction). But in 1905 the total for these causes was only 37 per cent, whereas the pro- portion of strikes for reduction of hours nearly doubled (from 3 to 3 per cent) and the proportion of these concerning recog- nition 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 secur- ing 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 ap- proaching 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 non-strik- ing 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 circum- stances. 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 only the actual strikers in a particular establishment are included, or whether organized workers in sympathy with them are in- cluded. The latter case is presented when an "unfair" list is published in labor journals. It seems that only the former ease is a really simple boycott. The use of the simple boy- cott, the refusal of a person, or even of a conspiring group of persons, to deal with a person with whom they have an 348 WAGES AND LABOR [Pi. IV industrial dispute, appears to be a part of the elementary- rights of personal liberty. Beyond that point the boycott is compound in varying degrees. It is the compound form that is usually referred to in discussion and in court deci- sions 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 experi- ence 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 anti- social, 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 of- fending 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. The "unfair list" is usually given as a form distinct from either the simple or compound forms of boycott. The "fair list," published either by labor journals or by a consumer's league is not declared to be a boycott. § 11. Competitive aspect of organization and particular 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 the influence of organization upon particular wages, and primarily upon the wages of organized labor; and, next, as to their influence upon the general level of wages. As to the first, it may be seen that the wages of workers who are organized are generally (though not always) higher than those of unorganized workers in the same trades and neighborhoods. An English trade-unionist, Trant, 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 Ch. 21] ORGANIZED LABOR 349 the reverse where organization is perfect." (1) 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. (2) 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 con- ditions of real income. (3) Further, a higher standard of output prevails in the cities where organization is greatest, and older men and the less efficient, who are unable to "keep up the pace, ' ' drift away into unorganized shops or to villages where no standard union rate is in force. (4) As 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. (5) Organization may help to raise particular wages, inasmuch £is it helps to restore to the laborers a truer equality in the making of the wage contract, by creating two-sided competi- tion. The book before quoted expresses, somewhat vaguely, an opinion in accord with these facts and principles 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." "With organization as well as without it, the wages of individuals and of classes of laborers are determined by the general principles of competitive price as applied to their services, where neither the employer has a monopoly of employment nor the organized laborers have a monopoly of the labor supply. 350 WAGES AND LABOR [Pt. IV § 12. Monopolistic aspect of organization and particular wages. Tlie action of organized labor is not, however, lim- ited to the competitive field. 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 lim- ited by the efforts of the unions. (1) It may be done tem- porariljr by striking when a failure to fill orders will cause the employer exceptional loss. (2) 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. (3) It is created if appren- tices are Hmited to fewer than in the long run would be attracted into the trade by the prevailing wages. (4) It is created if the unions artificially limit outpu.t to less than is consistent with the health of the worker. (5) It is created if unions strong enough to keep "scabs" from getting work, fix their dues high or put other obstacles in the way of in- creasing the membership. Probably the most striking cases of high wages for organized labor are of this kind. The ele- ment of labor monopoly evidently is mingled in all degrees, from the slightest to a very great amount, in particular eco- nomic situations. § 13. 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-unioin men may be employed, even at union wages. Unions usually assert that the closed shop is essential to the existence of the union, although some strong unions, notably the Railroad Brotherhoods, have not urged this point. The existence of a closed shop 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. Ch. 21] ORGANIZED LABOR 351 The refusal of a demand for the closed shop is often the ground for a strike. If union and non-union men work side by side there are so 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 dis- charged; if any preference is given it is to the non-union man. Therefore, most spokesmen of organized labor believe and declare that efforts of employers to secure or to maintain the open shop are disguisied attacks upon the very principle of organized labor. Labor leaders ridicule as hypocritical the employers that say they are trying, in keeping their shops open, to protect the workmen's liberty to join or not to join a union, which in the eyes of the law is a voluntary organiza- tion. While these accusations may too often be trae, 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 en- force its every demand, regardless of the competitive condi- tions of the labor market for that class of services. The employers, in their more moderate claims, profess to aim at an open shop only in the sense of the principle laid down by the governmental Anthracite Coal Commission of 1902, as one where no person is "refused employment, or in any way discriminated against, on account of membership in any labor organization"; and where there is "no discrimination against or interference with any employee who is not a mem- ber of any labor organization, by members of such organiza- tion." Such an open shop, with its conception of two-sided duty, fairness, and toleration, nearly commands public ap- proval, acquiescence, and acceptance by both sides. But un- fortunately, in practice, whichever side chances to get the upper hand in the situation is too often tempted greedily and ruthlessly to push its advantage far beyond the ideal point of toleration. 352 WAGES AND LABOR [Pt. IV In the war and after-war boom period from 1917 to 1920 the greater bargaining power of organized labor enabled it to push not only for higher wages and shorter hours, but for the closed shop, which made great headway. The rail- roads, under federal control by the Railway Administration, were almost completely unionized, and great numbers of manufacturers conceded the closed shop to the imions. In 1920, with the onset of unemployment, began a most active propaganda in favor of the open shop. This produced, prob- ably, an exaggerated effect upon the public mind, seeking a scapegoat for the high cost of living, and finding easy ex- planations in "profiteers" on the one hand, and on the other in the unreasonable demands of labor, excessive wages, and re- duced output. The effect was to neutralize in large part within the year the gains made by the closed shop, and to produce alarm in circles of organized labor. § 14. Political and economic considerations. The ques- tion of the closed or open shop has some very broad aspects. Is the closed shop, and are the other policies of trade-unions, morally right ; and ought they to be legally sanctioned ? Such questions are not for the economist alone to answer. They in- volve moral and political considerations — not merely exist- ing 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 ° 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 viol- 8 See §11. Ch. 21] ORGANIZED LABOR 353 ence, in any degree however slight, there is present an ele- ment 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 more strictly economic question concerns the part as to the effects upon wages, and hardly extends to a judgment on the moral recti- tude (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 im- provement 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 non-existent. The economist can only issue the warning that the commonest illusion he encounters is the belief of each class — commercial, banking, manufactur- ing, wage-earning — that what is for its particular interest is, in a peculiar manner, for the general interest, so much so as to justify favoring legislation or special exemption from the general law, or even sheer lawlessness. § 15. The public'* 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 gen- eral public sympathizes in large measure with the unions in their efforts up to a more or less certain 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 ef- fective 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, some- what vaguely, is approval of unions as far as they go to es- tablish a real equality in competitive bargaining with the employers, but disapproval where the power of the union gets 354 WAGES AND LABOR [Pt. IV 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, though not quite clearly, that such action makes an un- stable 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 aifords, 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 work- men. In accordance with these facts and opinions there has devel- oped, 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 func- tion, that of controlling the industrial action of private citi- zens against their will. The union, therefore, in this view, must, with anything like the closed shop, cease to be a purely private, voluntary organization, and become in some respects subject to public regulations as to its internal rules and ad- ministration. This view, however, is very unacceptable to the leaders of organized labor in America, and there the question now stands. § 16. Effects of organization upon general wages. A question different from that discussed above is as to the effect that the organization of labor has upon the general level of wages, including those of unorganized workers. The thought has sometimes been expressed by sympathetic social students outside of trade-union circles that, but for the organization of labor, wages in general 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 Ch. 21] ORGANIZED LABOR 355 they credit everything above that level to the work of the unions. In Trant's book already referred to, which was re- printed and circulated by the American Federation of Labor as representing its theory and claims, all the advances that have been made in wages are attributed to the trade-unions. 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, fewer than one in sixteen of all gainfully employed and fewer than one in twelve of those working for contractual wages have been organized. On no principle of value could the mere organization of one twelfth of the wage-earners, without permanently withdraw- 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 un- derlying economic forces determining the general level of labor incomes in a country are much more fundamental in nature than labor-unions or protective tariffs." 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 or- ganization of one twelfth (or any larger proportion of the wage-earners) could in any general way raise the labor in- comes of those remaining unorganized are: first, that organ- ized 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 unorgan- ized then to attain. Both of these suggestions may have some little validity in special cases, effecting slightly a small pro- portion of the unorganized workers, but neither touches 9 See Vol. I, pp. 227, 439, 466, 504-507; and above, ch. 16, § 8. 356 WAGES AND LABOR [Pt. IV 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 por- tion 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.^** 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. § 17. Future role of organization. In the light of the principles of wages and of experience, it appears that organ- ization most easily gains results when wages are below the competitive rate; and it gets the most stable results when wages are kept at or little above the competitive rate. Only exceptionally is the control of a labor organization in a trade so strong that it is able to maintain monopoly wages for long periods. 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 com- petitive 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 worker and employer, in law-maker and in judge; efficiency and intelligence of the workers ; and far-sighted social legislation. Some of these con- tribute to greater productiveness, others to a fairer distribu- tion. In all these ways organized laborers have made valu- 10 See Vol. I, pp. 217, 222-223, 352, 356. Ch. 21] ORGANIZED LABOR 357 able 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. Refebences. Adams, T. S. and Sumner, H. L., Labor problems, chs. VI, VII. N. Y. Macmillan. 1914. Carlton, F. T., The history and problems of organized labor. Revised. N. Y. Heath. 192(K ComMions, J. R., and associates, History of labor in the United States. 2 vols. N. Y. Macmillan. 1918. Commons and Andrews, Ch. Ill, see. 1. Principles of labor legisla- tion. Rev. ed. N. Y. Harpers. Gompers, S., Labor and the common welfare. Pp. 306. New York. Button. 1919. (Extracts from Mr. Gompers' articles and ad- dresses made during the past thirty-five years.) Croat, O. 0., An introduction to the study of organized labor in America. N. Y. Macmillan. 1916. Hoxie, R. F., Scientific management and labor. N. Y. Appleton. 1915. Hoxie, R. F., The truth about the I. W. W. J. P. E., 21: 785- 797. 1913. Hoxie, R. F., Trade unionism in the United States. Pp. 426. N. Y. Appleton. 1917. (General character and types; the interpretation of union types.) McCabe, D. A., The standard rate in American trade unions. Bait. Johns Hopkins. 1912. Mitchell, John, Organized labor. 1902. Well). Sidney and Beatrice, Industrial democracy. Pp. 899. N. Y. Longmans. 1920. Sam,e, History of trade unionism. Pp. 784. Revised edition. N. Y. Longmans. 1920. Wolman, L., The boycott in American trade unions. Johns Hop- kins. 1916. CHAPTER 22 PUBLIC REGULATION OP HOUES 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 work- ing-day for women. § 7. Limitation of the working-day for men. § 8. Broader aspects of this legislation. § 9. Plan of the minimum wage. § 10. Wage theory in the minimum wage. § IL Limitations of the minimum wage, § 12. Mediation and voluntary arbitration. § 13. Compulsory arbitration. § 14. Organized labor's attitude toward labor legislation. § 15. Organized labor's opposition to compulsory arbitra- tion. § 16. The public and labor legislation. § 17. 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 iu America. Notable progress was early- made in some trades, reducing hours from eleven to ten, or from ten to nine, and in a few cases from nine to eight. 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 ' 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 Jaw, 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. Beginning in 1915, occurred an especi- ally rapid spread of the eight-hour day, continuing through- out the period of rising prices until 1920. 1 By the Secretary of the American Federation of Labor. 358 Ch. 22]: PUBLIC REGULATION OP HOURS AND WAGES 359 § 2. The shorter day and the lump-of-labor notion. The shorter working-day is advocated by most workers in the be- lief 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.^ 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 work- ers naturally desire and strenuously demand 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, the purchasing power of the workers must be re- duced. If the output per hour is increased proportionately 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 in- evitable disturbance of the wage equilibrium. In a competi- tive 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 bargain- ing situation for wages. But, it is said, let the general eight-hour day be 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. At once, however, there must occur changes of consumers' choices in a great number of ways. If there are 2 See Vol. I, pp. 458-467. 300 WAGES AND LABOR [Pt- IV one fifth fewer goods, evidently at least one fifth of the con- sumers must go without. These 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 ma- chinery make up a relatively larger part. This must com- pel 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 ten to eight hours, or 11 per cent if from nine to eight hours). It might even be more, but probably would be some- what 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 monopo- listic control of the trade. The conclusion to which the foregoing reasoning has led is, then, that, excepting in certain situations of labor monop- oly which are comparatively rare, the shorter day will not raise total wages when it cuts down production, certainly not for the reason that it cuts down production. When the working-day is already not so long that it exhausts the physical and nervous powers of the workers, a general re- duction of hours without increased production per hour will reduce the real incomes of the workers, as well as those of the whole community. However, a reduction of hours is eco- nomically justified, even if material production is reduced, if the working-day is so long that it is injurious to health, to morals, and to family life. In that case the disutility of the later hours doubtless exceeded to the workers and to society the utility of the additional material product. § 3. Fewer hours and greater efficiency. A very diflfer- Ch. 22] PUBLIC REGULATION OF HOURS AND WAGES 301 ent argument for the shorter day is that the rate of work may be so increased that the output remains at least as large as in the longer day, or even larger. A faster work- ing pace is possible in many eases with the 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 to fewer hours undoubtedly has resulted in many cases in larger production, and could be made to result so in many other eases by applying the methods of scientific management. But it is a change that 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 twelve to ten, and again from ten to nine, and yet not be possible in a change from nine to eight. Moreover, the speeding up of the work- ers 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 occasionallj^ adjust the ma- terial. 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 in- crease of the output per worker, or by improvement in the quality of work, or by improvement in the management, re- sulting 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. As far as this result is due to the individual worker, it is explained by the same evidence referred to below ^ as bearing upon the 3 See especially, § 8. 362 WAGES AND LABOR [Pt. IV 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. All of 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 opportuni- ties for good citizenship for the worker and his family. 4. Child-labor. In agricultural conditions, such as have prevailed generally in America, there is little need of limiting the hours of work for children and the age at which they 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 agricul- ture 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 recog- nized. 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 de- moralizing 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. Often poverty leads parents to rob their children of health, of schooling. Ch. 22] PUBLIC REGULATION OF HOURS AND WAGES 363 and of the joys of childhood. Lazy fathers are tempted to support themselves in idleness on the wages of their young children. In some immigrant groups, particularly, conditions of child-serfdom have developed in America. The competi- tion 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 sys- tem. The first American law of the kind was in Massachu- setts, in 1842, limiting to ten hours the labor of children under twelve years of age in manufacturing establishments. Fol- lowing this, all the earlier state laws fixed the minimum age low and the maximum of hours high, and the laws were poorly enforced for lack of adequate administrative machinery and of 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 eight hours, in one quarter is nine hours, and in one quarter is ten hours (and in a few southern states eleven hours). Night work by children is very generally for- bidden (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 examina- tions, to determine whether the child is mentally and physi- cally fit to work and has met the requirements of the com- pulsory education laws of the state. The ciilmination of years of efEort in and out of Congress was the enactment, September 1, 1916, of a child-labor law that prohibited the interstate shipment of goods produced in factories wherein any child had, within thirty days, been 3G4 WAGES AND LABOR [Ft. IV employed under unfavorable conditions as to hours of work as specified in the act. This act was soon, however, declared unconstitutional. Another way of attacking the problem through the use of the federal taxing power was then found. In the so-called "Revenue Act of 1918" (enacted February 24, 1919) a child-labor employment tax was imposed on the entire net profits of persons or of corporations employing children at specified times and under specified ages (sixteen in mines, fourteen in mills, canneries, workshops, or factories). The constitutionality of this act has been questioned in a district court, but, up to this writing, not in any higher federal juris- diction. , In the labor section of the treaty of Versailles of 1919, among the nine points, or general principles, held to be of special and urgent importance, the sixth reads : ' ' The aboli- tion of child-labor and the imposition of such limitations on the labor of young persons as shall permit the continuation of their education and assure their proper development." 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 protect- ing 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 Avomanhood are threats to society. § 6. Limitation of the working-day for women. Legisla- tion to limit the hours and conditions of employment of women usually comes later than the limitation of child-labor. The grounds of special laws to protect workingwomen are that women are less able than men to protect themselves in the labor contract, that they are physically weak and are pe- culiarly 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 oper- ates in some ways to depress the wages of men, and it is harm- Ch. 22] PUBLIC REGULATION OF HOURS AND WAGES 305 ful in its effects upon the home and family life. At present five states limit the hours of women to eight a day, twelve to nine a day, fifteen to ten a day, four to eleven 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 coun- tries in connection with systems of health insurance. In all of the great industrial countries of Europe night work by women is restricted (prohibited betAveen 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. Limitation of the working-day for men. The gen- eral 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 in- terests sufSciently by his power of refusal to accept employ- ment. 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 ex- ceptions 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 munici- pal—eight hours is the legal day for work done by private con- tradtors for the government. Work on railroads and street railways, particularly in the direct operation of trains, such as the work of dispatchers, signalmen, and trainmen, is sub- 366 WAGES AND I.ABOR [Pt. IV jected to a large variety of regulative measures, hours being limited in some cases to eight, in others to nine, ten, twelve, or sixteen, and in a number of cases a specified minimum num- ber 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 ex- hausting 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 pub- lie. 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 eight-hour laws in certain speci- fied cases are found applying to mines, smelters, tunnels, and a variety of other kinds of work, and in a few cases the limit is nine, ten, or eleven hours. § 8. Broader aspects of this legislation. The subject took on a new aspect when the legislature of Oregon, in 1913, de- clared 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 citi- zen, ' ' 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 sus- tained by the Supreme Court of that state, and on appeal the decision was affirmed by the United States Supreme court.* 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, popu- larly unsuspected or underestimated, that result from long 4 Bunting vs. State of Oregon, 243 U. S. 426 (Oct., 1916). Ch. 22] PUBLIC EEGULATION OF HOURS AND WAGES 367 hours even in industries of no exceptional hazards.^ Psysio- logical and psychological tests demonstrate that the fatigue following more than a moderate working period not only re- duces immediate efficiency, but so poisons the system that greater liability to accident, disease, intemperance, immo- rality, and premature decay results. Two main purposes appear somewhat intermingled in this legislation in limitation of hours. The first purpose is to pro- tect the public directly where the safety of others is dependent on the health and efficiency of the worker. The second pur- pose is to protect directly the worker's health and welfare, that policy being recognized to be in the long run the best like- wise for the public welfare. In legal reasoning it is being rec- ognized 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 nor- mal health and vigor, or shortening the normal period of healthy productive human existence." It is becoming a gen- eral 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. Among the principles in the labor section of the Versailles treaty are the following : "the adoption of an eight hours' day or a forty-eight hours' week as the standard to be aimed at where it has not already been attained," and "the adoption of a weekly rest of at least twenty-four hours, which should include Sunday whenever practicable." 5 Published as "The Case for the Shorter Working Day," by the National Consumers' League; see especially pp. 621-892. p See Vol. I, pp. 135 and 197. 368 WAGES AND LABOR [Pt- IV § 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 ease of certain low-paid wage workers. It is true that much public regulation of wages occurred in Europe before the end of the eighteenth century ; but in the main this was directed toward limiting the de- mands of the wageworkers, and in England its administration was in the hands of justices of the peace who were of the em- ploying class. The modern 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, though in an emasculated form, and spread so rapidly that at the end of 1919 it was found in fourteen states and in the District of Columbia. Minimum-wage laws usually lay down a ''living wage" as the standard to be used, and they are known as "flat-rate" or "wage-board" laws, according as they prescribe a fiat rate of wages or, as is more frequent, leave the decision in each case to a wage commission established to administer the law. At first glance the principles involved in the legislation limiting hours and those in minimum-wage legislation may seem to be the same. But there is an important difference. In the former case the evil is that of a too long work- ing period, injurious to health, and this can be reached di- rectly and stopped by an efficiently administered law. But in the latter case the real evil is industrial weakness and in- capacity such that the workers are unable to command a "living wage" in a competitive market. A minimum- M'age law, by itself, neither cures the industrial incapacity nor in- sures 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 Ch. 22] PUBLIC REGULATION OF HOURS AND WAGES 369 declares that the employer shall not employ any one whom, in his employ, he finds to be not worth so high a wage. § 10. Wage theory in the minimum wage. 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 (espe- cially 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 occupa- tions 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 80 per cent of this group of girl workers live at home. A wage that is 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 con- ditions, unable to earn a living in her chosen occupation, and the minimum-wage law takes her need as the standard up to which must be raised the wages of the other four fifths. It may be better to deal with such individual cases as ap- pear among the one fifth of all girls employed than to apply governmental wage-fixing to the whole group. Unless the demand for a particular kind of service is absolutely in- elastic (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. Fur- ther, some of the less capable workers must be crowded out of such jobs as remain; for an artificially higher wage at- tracts into an occupation some from other occupations in which the pay before was higher. It seems to be admitted by the friends of minimum-wage legislation that this result is logi- cally to be expected, and that to some degree it appears. Of 370 WAGES AND LABOE [Pt. IV course, it is never possible to tell to just what extent workers have been and are being excluded in this way from any par- ticular 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. § 11. Limitations of the minimuin wage. Generous sympathies have guided this movement, of which much has been hoped, and which, on the other hand, has always had its adverse critics. Its friends, after more than twenty years of experience, hardly claim more for it than 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 fam- ilies 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. The one unquestioned service of the minimum-wage law is that of dia^iosing the evil of low wages rather than in rem- edying it. The minimum-wage law brings to light the in- dustrial incapacity of particular individuals to earn a living wage. Alongside of the abnormally low paid occupations or elsewhere in the industrial organization are other occupa- tions 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. More direct remedies would be to transfer workers to jobs in which they can get a living wage, to abolish the incapable workers or their incapacity by such methods as regulating foreign or cityward immigration, custodial care of the physi- cally, mentally, and morally weak, vocational guidance, and more effective measures of industrial education. Ch. 22] PUBLIC REGULATION OP HOURS Al^D WAGES 871 § 12. Mediation and voluntary arbitration. The labor controversies in which the public has the largest interest as a third party ^ are those that 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 non-participants, when it causes a blocking of the highways and disturbance of the peace, and when it prevents the regu- lar production and transportation of the commodities that the public consumes. The public, therefore, has steadily be- come more interested in all methods and agencies designed to conserve better relations between employers and wage workers, 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 volun- tarily 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 seventeen 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 com- pulsory when they are compelled by law to submit to arbitra- tion and abide by the verdict. Some provision either of voluntary priA'ate 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 thirty- two of our states. No one objects to them, and they ac- complish much good; but they fail oftenest in the greater emergencies because of the unwillingness of one or the other 7 See § 16. 372 WATJES AND LABOR [Pt. IV party to submit the ease, or because of lack of any power to enforce the decisions. During tbe World War many plans of arbitration were devised in various countries. The most notable of these in America was the Federal War Labor Board to arbitrate in disputes between railroads and train operatives engaged in interstate commerce. Steps had earlier been taken in this direction, first by the act of 1888, then by the Erdman Act of 1898, superseded by the Newlands Act of 1913, and sup- plemented by measures for mediation by the Department of Labor. Under the Federal Control Act creating the Fed- eral Railway Administration for war purposes, a labor board exercised virtually absolute power. But, in the transporta- tion act (Esch-Cummins Act) of February 28, 1920, re- storing the railroads to private control, the voluntary prin- ciple was maintained. Provision was made for "Railroad Boards of Labor Adjustment" to be established by agreement between any carrier or group of carriers and employees; and for a supreme Railroad Labor Board of nine, three for each of the groups of management, labor, and public, with a central office at Chicago. If the decision of any of these boards is violated, apparently the utmost remedy of the Labor Board is to "make public its decision in such manner as it may determine." Great Britain, by the Industrial Courts Act of 1919, has provided for a central court to be appointed by the Minister of Labor, and for such other courts of in- quiry as may be needed to take up particular labor disputes as they arise, on the principle of voluntary arbitration. § 13. Compulsory arbitration. The serious question in the subject of arbitration concerns the introduction of the principle of coercion by government, in compulsory arbitra- tion. 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 Ch. 22] PUBLIC REGULATION OF HOURS AND WAGES 373 of work. In principle this was involved in the regulation of wages in England from the fourteenth to the early part of the nineteenth centuries. The plan is approached in the indus- trial courts that are now provided in a number of European countries for a cheap and expeditious settlement of small dis- putes regarding trade matters, arising in the relation.'s 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 Australasian 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," though the description was in- accurate, especially after 1907. The Canadian Industrial Dis- putes 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 iu 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 lockout until after investigation and hearing before a board to be nominated for the purpose. The Colo- rado Act of 1915 went even beyond the Canadian act in its scope. A notable experiment was undertaken when the Kansas legislature in January, 1920, established a Court of Indus- trial Relations. This court, in addition to the powers pre- viously held by the state Public Utilities Commission, -was given other regulative powers in respect to wages, hours, and conditions of work in a number of industries affected with a public interest, including coal-mining and all public utili- ties. The individual worker is guaranteed freedom of action in making or terminating contracts, bvit the right to strike is denied in forbidding conspiracy to quit employment. The operation of this act, strongly denounced by organized labor, 374 WAGES AND LABOR [Pi- IV is watched with, great interest by the general public. The plan seems destined to have wider application and a larger development in the not distant future. § 14. Organized labor's attitude towardlabor legislation. Labor organizations hitherto have been in their legal nature almost entirely private and voluntary. They are seldom incor- porated and are rarely even recognized in any way by legisla- tures and by courts, which deal merely with the members as individuals.^ Their private character, combined with their limited membership as compared with the total population, leaves them witliout the power to accomplish legally by them- selves the results that they desire in their own interest. Hence they are tempted at times to usurp public authority over the field of private rights in industry.^ 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 quali- fied, 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 em- ployers in respect to construction of factories, and limiting the length of trains. This does not imply a peculiarly selfish at- titude on the part of organized labor. Action together in any social group always develops in men their loyalty and spirit of cooperation 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. s The few exceptions to this statement are mostly recisnt ; such as the recognition of tlie 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. 9 As appeared in ch. 21. Ch. 22] PUBLIC REGULATION OF HOURS AND WAGES 375 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 meas- ures of social legislation. § 15. Organized labor's opposition to compulsory arbi- tration. Organized labor in America has attained to a highly influential position. On the whole, it constitutes an "aris- tocracy of labor," consisting largely of skilled workers who 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 pos- sible 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 char- acter of the Canadian Industrial Disputes Act. ' ' Within less than a week the brotherhoods called off the strike after Con- gress had passed the much discussed Adamson Act giving the men the eight-hour day — a substantial part of what they 376 WAGES AND LABOR [Pt. IV had asked — and providing for investigation, by a commission, of the effects of the rule. The decision was compulsory upon the railroads, but not upon the men to accept the terms. § 16. The public and labor legfislation. 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 inter- ests 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 dis- tinct 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 supplj^ of goods more or less essential to their welfare or even to their ex- istence. 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 (as 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 interfer- ence. It becomes so convinced in two broadly distinguish- able 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 at- Ch. 22] PUBLIC REGULATION OF HOURS AND WAGES 377 tempts to win their ends in an industrial dispute, exceed their private rights and invade the public welfare. § 17. 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 senti- ment 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 the public press almost unanimous condemnation of the strike as a method of settlement of wage disputes on the railroads. In the end, organized labor accepted, apparently with much satisfaction, a law involving the legal fixation of wages and the principle of compulsion as applied to the employers. President Roose- velt, at the time of labor trouble in the government printing office, maintained that employees of the government could not have the right to strike. Governor Coolidge (later Vice- President) upheld the same principle in the case of the po- licemen's strike in Boston in 1919. The trend of public opinion seems to be strongly to the same general conclusion. References. Abbott, Edith, Women in industry. N. Y. Appleton. 1915. Adams, T. 8. and Sumner, 3. L., Labor problems. Chs. II, VIII, XII, sees. 1-4, 9, XIII, sec. 2. N. Y. Macmillan. 1914. Bamett, 0. E., and McCabe, D. A., Mediation, investigation and ar- bitration of industrial disputes. N. Y. Appleton. 1916. Ola/rk, V. 8., The labor movement in Australasia. N. Y. Holt. 1906. Commons, J. R., and associates, History of labor in the United States. 2 vols. N. Y. Macmillan. 1918. 378 WAGES AND LABOR [Pt. IV Gommons and Andrews, Principles of labor legislation. Chs. Ill, sees. 2, 3, IV, V. Rev. Ed. N. Y. Harper. 1920. Compton, W. M., Wage theories in industrial arbitration. A. E. Rev., 6: 324-342. 1916. Mote, G. E., Industrial arbitration. 1916. Suffem, A. E., Conciliation and arbitration in the coal industry of America. Bost. Houghton. 1915. Vtvited States Bureau of Lahor Statistics, Bulletins on many subjects. WeJib, Sidney, The economic theory of a legal minimum wage. J. P. E., 20: 973-998. 1912. CHAPTER 23 OTHER PROTECTIVE LABOR AND SOCIAL LEGISLATION § 1. Evils of early factory conditions. § 2. Improvement of factory conditions. § 3. Limitations 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. Definition of unemployment. § 12. Extent and evils of unemployment. § 13. Individual malad- justment of wages causing unemployment. § 15. Individual maladjust- ment in finding jobs. § 16. Public employment ofiices. § 17. Fluctua- tions of industry causing unemployment. § 18. Remedies for seasonal fluctuations. § 19. 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 car- ried 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 help- ers, 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 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 him- self and of his own family; and this was the best possible guaranty that the conditions would be kept up to the best 379 380 WAGES AND LABOR [Pt. IV standards of that time. The same change in industrial rela- tions that led to the rise of the organized labor movement ^ revealed new and often horrible neglect and evil in and about the factories. They had been erected with no thought of sani- tation, 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 American states in which manufacturing is largely de- veloped, though the states in which agriculture is the domi- nant industry still have very few such regulations. As a re- sult of these measures, accompanying and stimulating an en- lightenment 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 some- what 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 produc- tion, 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 far beyond the require- ments of any existing laws. Many employers recognize that it is costly and unprofitable to themselves to allow their work- men to be in surroundings that reduce their vitality and efficiency. 1 See ch. 21, § 1. Ch. 23] PROTECTIVE LABOR AND SOCIAL LEGISLATION 381 § 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 gen- eral statement. It was forbidden even by the English com- mon 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 re- spect.^ Legislatures and courts have been particularly watch- ful of the interests of children, who are usuallj' deemed in- capable of entering into contracts binding them to their in- jury. 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 em- ployer might easily be made, without expense to himself, a great boon to his workmen, giving them the benefits of con- sumers' cooperation. 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 de- mand higher money wages. Recognizing that this is for the most part an illusion — for it is in just such places that the conditions for free competition are least present — ^the law in many states prohibits these stores. It regulates also the meas- zSee ch. 24, §§ 5-7, on the old law of employer's liability. 382 ' WAGES AND LABOR [Pt. IV Tiring 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. Me- chanics' 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 univer- sally 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 lawmak- ers were opposed to all usury or interest. The reason for this attitude is not hard to find.' Most loans were made in times of distress. The sources of lendable capital and the chances of profitable investment were few. But for the last four cen- turies 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 de- veloped industry. A moderate rate of interest is now every- where 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.* 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 cities. Usury laws are fruits of the 8 See Vol. I, pp. 292-293. 4 See Vol. I, p. 304. Ch. 23] PROTECTIVE LABOR AND SOCIAL LEGISLATION 383 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 posi- tive 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. Public inspection of standards and of foods. The determination and testing of standards of weights and meas- ures 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 insuring the quality of goods ; but personal inspection by each buyer frequently is difficult and time-con- suming, requiring special and unusual knowledge of the prod- ucts 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 af- fecting health; its application to art products, except to pro- tect the morality of the community, would be difficult or un- wise. Eecent 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 Pood and Drug Act of 1906. The federal law levying a tax on oleomargarine, how- ever, 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 con- venience 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 5 See Vol. I, pp. 293 and 303. 384 WAGES AND LABOR [Pt. IV a part of the social protective policy. The public interest undoubtedly is served by having these suffering classes sys- tematically relieved, but the extent and nature of the pro- vision are questions ever in debate. Still more debated is temperance legislation, both as to licensing and as to pro- hibiting the liquor trafSc. 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 in- terest is affected in a different way. While it is beyond ques- tion that society should protect itself and its innocent mem- bers 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 legis- lation 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, bet- ting, 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 bet- ter ; but the broken gambler remains a burden and a threat to honest society. Gambling, lotteries, and speculation cause em- bezzlement, crime, unhappy homes, and wrecked lives." 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 more than 8000 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, one hundred and ten times as large as the largest one hundred 6 See eh. 12, § 2. Ch. 23] PEOTECTIVE LABOR AND SOCIAL LEGISLATION 385 and twenty years before. The total number of persons liv- ing in cities of 8000 had. increased in more than double that ratio. In 1920, for the first time, the population classed as urban (in places with 2500 population or more) exceeded that classed as rural, being 51.4 per cent of the total. The rapid growth of urban communities brought many evils. Considered in their more material aspects, nearly all of these are summed up in the term, "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 resi- dents gradually group themselves in districts corresponding to their economic incomes, and the poorer parts of the popu- lation become tenement dwellers in the neighborhood of fac- tories or become segregated in "slum" districts of unsani- tary and dilapidated houses. § 8. Good housing legislation. Two policies are open un- der these conditions. The one, always followed for a time, is to leave individual self-interest unguided to solve the prob- lem. 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 the immediate interests of the landlords. The rents from slum property are threatened; hence the strong opposition always manifested against tenement-house legislation by some 386 WAGES AND LABOR [Pt. IV landlords, architects, and contractors, wlio fight it as an inter- ference with their interests and as a confiscation of their prop- erty. It is not unlikely that good housing legislation 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 state-wide to reach even the "country slums," which lately have been recognized to exist. Enlightened sentiment to-day favors efforts to de- stroy the breeding-places of disease, misery, and crime, no matter where they may be. Property-owners are in many communities limited as to height of buildings, appearance, and, by the zoning sj^stem, 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 busi- ness, 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 cooperation fails, compulsory cooperation often is necessary. Thus health laws, tax laws, and improve- ment 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 Ch. 23] PROTECTIVE LABOR AND SOCIAL LEGISLATION 387 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 for- bidden 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 con- tracts 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 sec- ondary education has become the all but unquestioned public policy in 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 as long and as far as it was combined with, or supplemented by, indus- trial training on the farm, in the home, and through appren- ticeship 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 train- ing in all the industrial arts. Since the beginning of the cen- 388 WAGES AND LABOR [Pt. IV tury the American public has been awaking to the needs of the situation. "We appear to be on the eve of a great develop- ment 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. 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 sixty-five days in most American states ; to the worker 's being on strike ; to temporary sickness ; finally, and more difficult to distinguish, that due to con- tinued disability, physical, mental, or moral, to do the work up to an acceptable standard and to retain a job in the occu- pation 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 unemployable respectively. There still remain some unanswered questions, such, for ex- ample, as: whether in seasonal trades (e.g., teaching or the building trades) allowance should be made for normal vaca- tions 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 em- ployed 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. § 12. Extent and evils of unemployment. In every coun- try 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 Ch. 23] PROTECTIVE LABOR AND SOCIAL LEGISLATION 389 different countries. Of the magnitude, importance, and difficulty of this "problem of the unemployed" there is, how- ever, no question. It is greatest, speaking generally, in manu- facturing industries, though, 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 from one to three months, a total of 22.3 per cent more than one month.' In 1911 in a large group (nearly all) of the manu- facturing industries, the minimum number of wage-earners employed (in January) was 13 per cent below the maxi- mum (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 upward of 10 per cent of all the working time of the wage earning population is lost by unemployment. A considerable part of the total in an or- dinary year may be set aside as "normal" in the sense that it is allowed for in the wage- workers' plans.^ 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 r Great importance should not be attached to these figures for they con- tain errors resulting from the inexact notions of inexperienced enumer- ators as to what constitutes unemployment, and from the inclusion of all persons gainfully employed, whei;her self-employed or in professional, salaried, or wage-earning positions. 8 See Vol. I, p. 207, on irregularity of employment as influencing wages, psychic income, and choice of employment. 390 WAGES AND LABOR [Pt. IV anxiety, demoralizing and unfitting for return to work. Ir- regular work is generally recognized to be a greater cause of poverty and of actual pauperism than is a low wage regularly received. It is impossible for the industrially more fortunate per- sons and classes of the nation (excepting the few who have learned by personal adventures or by sympathetic study of the problem) to comprehend how inevitably unemployment and the fear of it shape the social theories as well as the industrial character of the propertyless workers. The edu- cated and the prosperous denounce with contempt mingled with inquietude the vagaries of the Industrial Workers of the World and the destructive doctrines of Utopian com- munists. Such ideas are attributed to ignorance, to natural perversity, or, still more often, to the influence of ignorant and dangerous leaders. But, as an employer who lived for months as a manual laborer, has said: "To the worker the job is the axle of his entire world." It is "impossible to overstate the way in which the having of the job affects the whole circle of a man's life; all his thinkings, all his feelings, all his believings, all his attitudes and concepts and beliefs." "When we see men thinking 'queerly' or feeling 'queerly' and embracing strange philosophies, ... we ought to put our first question mark against the circumstances of their job."" § 13. Individual maladjustments causing unemployment. The cause or causes of the evil must be ascertained before a remedy can be intelligently applied. At the outset the problem of unemployment must be clearly distinguished from that of over-population and low wages. It is essentially a problem of maladjustment of the labor supply. That is, there is, under static conditions, work for all to do at various rates of wages that would bring about a value equilib- Mr. Whiting Williams, formerly vice-president of the Hydraulic Pressed Steel Company, in an address, "The Job and Utopia." Bul- letin of the American Association for Labor Legislation, March, 1921. Ch. 23] PROTECTIVE LABOR AND SOCIAL LEGISLATION 391 rium of services.^" The maladjustments are either of an individual or of a general character affecting numerous in- dividuals. 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 be- comes that of the unemployable. The "can't-works" and the "wont- works" must be divided from the "want- works." If there is any remedy in such cases, it must be through reedu- cation, 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 rela- tive, 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 though the poorest workers were to raise their efficiency above that of the best men now retained. "Personal inefficiency" may ex- plain a chronic low wage or absolute unemployability in a par- ticular 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. § 14. 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 10 On static, see Vol. I, ch. 32 ; on the scarcity of labor, see Vol. I, ch. 18, § 2 and references there; on value of services and wages see Vol. I, ch. 18, especially § 2, and ch. 19, especially § 7. See also, be- low, ch. 25, on pressure of population with immigration. 392 WAGES AND LABOR [Pt. IV 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 abso- lute inelasticity of the demand for labor with changes in its price.^i If the true equilibrium wage in a certain industry were $3.00 a day, then a wage of $4.00 a day would at- tract 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 re- ceived 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. This may, and doubtless often does, occur, and cause unemploy- ment which neutralizes, in greater or less degree, the appar- ent gain of h)igher day-wages obtained by monopoly power. The very inertia of wages, however, in new price situations'^ makes the wage workers resist vigorously wage reductions at times of unemployment. They know that if the wage rate is cut, it will not easily be raised again as times get better. 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. § 15. 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 estab- lishments, 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 11 See ch. 21, § 9, on the minimum wage. 12 See Vol. I, p. 223, on friction in the adjustment of wages. Cii. 23] PROTECTIVE LABOR AND SOCIAL LEGISLATION 393 or less non-economie, of desire to change occupations, of vari- ations 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 arid coming, orders in- creasing here and decreasing there. Total jobs and total work- ers capable of filling the jobs are at any moment in normal times equal quantities, if they can be brought together, the wage being adjusted, like any market price, so as to equilibrate demand for and supply of labor.^^ But al- most everywhere is lacking a real labor market. The substi- tutes for it are largely ineffective: trade-union action, em- ployers' 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 iitterly inade- quate to meet the chief need, and at their worst they are the instruments of great abuses against the unemployed. § 16. Public employment offices. Vigorous efforts to create local "free employment offices" or "labor exchanges" began in a num^ier 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 have been controlled by the unions and by groups of employers) and have remained largely decentralized, though cooperating to some extent through voluntary state conferences of officials of the exchanges, and after 1915 required to report to the imperial statistical office. The general results were remark- ably good, although not completely satisfactory. In the revolution that marked the military collapse of Germany in November, 1918, the trade-unions got from the employers recognition of the principle of "parity" in the management of the offices of employment, along with recognition of the 13 See Vol. I, especially chs. 7, 19, and 28. 394 WAGES AND LABOR [Pt. IV unions, tlie eight-hour day, and various other claims that they long had urged. Every industrial country of Europe has done something to provide free labor markets. Great Britain, after some ex- experiment with a local system, established in 1909 the first national system of ' ' labor exchanges. ' ' In America the move- ment is developing in three directions — through municipal, state, and federal offices. These united, in 1913, in an "American Association of Public Employment Offices." In 1915 there were known to be ninety-nine state and city em- ployment offices distributed through thirty states, besides federal offices operated in eighteen cities in connection with the Bureau of Immigration. The federal service in the De- partment of Labor, the management of which had been much criticized, was brought to an end, just when most needed, in the midst of demobilization in 1919, by the failure of Con- gress to appropriate the necessary funds. The clearly recog- nized task is now to cooordinate these various agencies into an efficient national system, eliminating partizan polities and elevating the management of all branches to the plane of professional service. Through these agencies should be op- erated 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 various parts of the country. The economic results of a complete, exclusive, and efficient service of this kind would far exceed its cost to the community. § 17. Fluctuations of industry causing unemployment. Any one of the maladjustments in employment thus far con- sidered 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 Ch. 23] PROTECTIVE LABOR AND SOCIAL LEGISLATION 395 would-be workers exceeds the number of jobs," and the re- sulting 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. The unemployment beginning with the onset of the crisis in the summer of 1920 grew almost steadily worse, even after the return of spring in 1921, as prices tobogganed swiftly to lower and lower levels, and business of nearly all kinds was reduced in volume. The railroads alone, in des- perate financial straits, discharged about 500,000 workers, and the total number of industrial unemployed in the nation was estimated to be from three to six millions. 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 fortu- nate 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. § 18. 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, (1) output may be regularized by taking orders in advance; (2) by producing various products successively in the same factory; (3) by overcoming weather conditions, as has been done successfully in brick- and tile- making, ditch-digging, and building operations; (4) by trans- it See ch. 10, § 6 and § 7, on the industrial crisis. 396 WAGES AND LABOR [Pt. IV ferring workers from one department of an establishment to another; (5) 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"; (6) by varying the length of the working- day while keeping the same working force throughout the year; (7) by cooperating with other industries to build up a regular working force and transferring it from one estab- lishment to another with seasonal changes. Of great aid in a number of these measures is a broader in- dustrial 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 educa- tion, by the recently devised and successfully applied "short- unit courses for wage-earners. ' ' ^^ § 19. Reducing cyclical unemployment and its effects. The maladjustments due to the movement of the business cycle are even more difficult to remedy completely, but will be diminished by every measure that helps to reduce the great financial fluctuations.^" Further, many communities have al- ready 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 emer- gency work would maintain 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 King- dom 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 well-nigh in- crediblj' small proportion may be compared to that between 15 See Bulletin of the United States Bureau of Labor Statistics, No. 159 (April, 1915). 16 See eh. 8, § 6, § 7; ch. 9, § 6, § 8; cli. 10, § 14, § 16; ch. 14, § 12. Ch. 23] PROTECTIVE LABOR AND SOCIAL LEGISLATION 397 the weight of the gyroscope and the ear 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 dur- ing "hard times," thus greatly accentuating the harmful swing of the labor demand. Finally, unemployment insur- ance, which has already been applied by parliamentary legis- lation in Great Britain to a group of nearly three million wage- workers, is an indispensable and highly hopeful measure of relief. The place of this in a general system of industrial in- surance will be indicated in the next chapter. References. Commons, J. R. and associates, History of labor in the United States. 2 vols. N. Y. Macmillan. 1918. Commons and Andrews, Principles of labor legislation in the U. S. Chs. VI, VII, IX. N. Y. Harper. 1920. Pigou, A. C, Unemployment. N. Y. Holt. 1914. Sumner, H. L., and Merritt, E. A., Child labor legislation in the United States. U. S. Children's Bureau. Supt. of Docs. 1915. United States Bureau of Labor Statistics, Bui. 159. 1915. CHAPTER 24 SOCIAL INSURANCE § 1. Purpose and meaning of social insurance. § 2. Increasing need of social insurance. § 3. The new era of social insurance. § 4. Fea- tures of social insurance. § 5. Historical roots of accident insurance. § 6 Development of compensation for accidents. § 7. The compen- sation plan in America. § 8. Standards for a compensation law. § 9, Old-age and invalidity pensions. § 10. Life insurance for wage-earners. § 11. Historical roots of health insurance. § 12. Need of health in- surance in America. § 13. Unemployment insurance. § 14. Need of ideals in social insurance. § 15. Insurance rather than penalty. § 16. The compulsory principle. § 17. State insurance and a unified system. § 18. The contributory principle. § 1. Purpose and meaning of social insurance. In im- portance surpassing at present any one of the various meas- ures 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 "com- mon 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 in- dustrial 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) in- capacitation (either by old age or by permanent failure of health within the normal worlring years); (3) death; (4) 398 Ch. 24] SOCIAL INSURANCE 399 sickness; and (5) unemployment. The five types of insurance to provide indemnity in these cases are usually known as (1) accident insurance, (2) old-age and invalidity pensions, (3) life insurance, (4) health insurance, and (5) unemploy- ment insurance or out-of-vi^ork benefits. The direct aim of social insurance is not to prevent these mishaps (though that may be an indirect result), but it is to provide some financial indemnity for the economic loss and ex- pense involved in the mishap. The principal kinds of losses are two : first, medical expense, occasioned directly in caring for the sick or injured person, the' expense of medical atten- tion, nursing, hospital care, drugs, and special apparatus such as crutches and glasses, and burial expenses; second, wages, 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 con- nections we have observed how the changes that have been oc- curring in modern times have increased the uncertainties of the industrial life and of the earning power of the mass of the workers.^ It should be further observed that in city condi- tions a working family does not have, as in agricultural con- ditions, 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 increase of power-driven machinery, the rap-id fluctuations of employment with changing fashions, inventions, shifts of population, and waves of industrial , prosperity' and depression, all have introduced new risks ami 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 addied t6 the problem. With these changes have come belatedly a growing interest in iSee ch. 10, § 7; ch. 21, § 1; ch. 23, §§ 10-19; and ch. 33, § U. 400 WAGES AND LABOR [Pt. IV 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, although satis- factory 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, besides an enor- mous number of slighter injuries, many of them very pain- ful, disabling for a period from one day to four weeks. This means that the loss in life and bodily injuries in industry in the United States while the cou.ntry was at war in 1917 and 1918 was about equal to the like losses of our soldiers on the battle-field. As to loss of time due to illness, the experience of Ger- many shows an average of eight or nine days a year per worker, and investigations in America point to a very simi- lar figure. This, 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 at $750,000,000 annually (but at present wage rates fully $1,000,000,000). It is estimated that one in eighteen of American wage work- ers 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-win- ner are partiallv 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 insignifi- cant attempts to deal with these problems were made in the nineteenth century, but the new era of social insurance may Ch. 24] SOCIAL INSURANCE 401 be said to date from the message of the Emperor William to the German Eeichstag in 1881, in which he said : We consider it our imperial duty to impress upon tlie 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 or- ganization 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 Tras carried out by the enact- ment between 1883 and 1889 of a series of laws which, taken together, constituted a pretty effective system of social insur- ance for the mass of wage workers in the German Empire. Later amendments extended and improved the various features of the plan, which served as an 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 in- surance, 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 com- pulsion, (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 required to pay indem- nity 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 402 WAGES AND LABOR [Pt. IV provided by means of some mutual organization of the insured, or of the employers, or by the state. Insurance may be contributory or non-contributory . It is on the contributory plan when the insured workers contribute something toward the premiums that provide the funds for eventual payment. It is non-contributory 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 work- ing men, 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 gov- ernment. The state insurance is said to be competitive when private companies are permitted to sell insurance to em- ployers, and exclusive when all the policies are issued by the state bureau. § 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 situa- tion. 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 em- ployer's negligence, a principle found to some degree in the law of all countries. Thus the earlier payments to work- ers in eases of accidents were not insurance indemnity, but merely damages collected in court for the fault of the em- ployer. 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 negli- gence, for collection was made more difficult by (1) the doc- Ch. 24] SOCIAL INSURANCE 403 trine of contributory negligence, (2) the doctrine of the as- sumption 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 care- lessness 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 ma- chinery, of which he might by some care have known. By the fellow-servant doctrine the employer was freed from re- sponsibility for accidents due to the negligence of other em- ployees, "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, espe- cially, this liability has been much further extended in many countries and in various directions, and yet the laws of acci- dent compensation still retain many features of the old lia- ' bility 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 pay- ments, 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 re- 404 WAGES AND LABOR [Ft. IV placed that of litigation and determination by the 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 legisla- tion. Accident Insurance Voluntary (as to employers insuring, but compulsory compensation). Great Britain, 1S97, 1906, 1907. France, 1898, 1907, (compulsory for seamen, 1898, 1905). Denmark, 1898, 1908. Belgium, 1903 (voluntary except for miners). Compulsory insurance of their risJcs, hy 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). Svjreden, 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 com- promised the claims for small amounts or fought in the courts the claims of those who refused to compromise. If the court awarded damages, large or small, a large part of the proceeds went for legal expenses. Only a small pro- portion of the total costs to employers went as benefits to the victims of accidents. It appeared, in an extensive investi- Ch. 24] SOCIAL INSURANCE 405 gation of the business of the large industrial insurance com- ponies, that but 28 per cent of the premiums paid by em- ployers were paid to workmen as indemnity. Between 1911 and 1921 the laws have been changed to some ' extent in their application to selected occupations in at least forty-three states and territories of continental United States, (covering all but five of the southeastern states, which are distinctly agricultural) . Seventeen states had, in 1921, state WORKMEN'S COMPENSATION I.AWS-1921 (Revised to May 1st) LEGEND i^H No Compen;aMon Lawj L — J CompensitionLi. \ < 3Si \ \LZL ITALY Itl \'e?i *t SCANDINAVIA ■srM —~'Z1^ ma GERMANY UNITED KINCDOn m--\ m A /.t910-V r 1 921 -i Fig. 5, Chapter 25. Immigration restriction law of 1921; restric- tive effects upon various nationalities, shown graphically. of commercial expansion, which in turn has to be supported by stronger military and naval establishments. It is led by primitive impulses that to itself seem to be a moral justifica- tion, to possess the territory of its neighbors. Such a nation points to its increasing population and declares that it must have its "place in the sun"; it must find lands and food for its swarming numbers. Other nations with lower birth-rates and higher standards of living, which they seek to preserve 18 See Vol. I, p. 412, on war and the pressure of population. 436 WAGES AND LABOR [Pt. IV by various measures excluding immigration, appear to he greedy, malevolent, and insulting. These are not the con- ditions for rational thinking. The immediate occasion of war may be some matter of internal politics, such as growing discontent and democratic sentiment among the people, while the deeper cause is the pressure of population in a limited territory. Nations with slowly growing populations, and still possessed of ample territories to maintain their ac- customed standards of life, naturally favor the status quo, and are pacifist or non-militarist. If they arm, it is for their own safety. In this view, militarism is seen to consist, not in hav- ing drilled soldiers and stores of munitions, but in the na- tional 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 more truly than limitation of armaments is the real pacifism ; and increase of population, not increased military training or a larger navy, is the real militarism. § 17. Problem of maximum military power. It is a grave question, however, how far a nation with a relatively sparse population, high wages, and great wealth can safely limit population in the presence of a capable, ambitiou.s, and efficient rival that covets such opportunities. On the one hand, a population may be so sparse that it has not sol- diers enough to defend its territory against a numerous enemy; on the other hand, it may be so dense, and conse- quently 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 taxa- tion, 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 Ch. 25] POPULATION AND IMMIGRATION 437 supplied with the natural materials for munitions, and well equipped to produce them, might safely limit its numbers so as to insure a high level of popular income. This safety would be greatly increased by permanent alliance with other peoples likewise limiting their numbers and, therefore, in- terested 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 pro- lific and aggressive rival nations. Refebences. Adams and Sumner, ch. III. Cx)m.m,ons and Andrews, ch. II, sec. 4. Commons, J. R., Paces and immigrants in America. Revised. 1920. Davis, P., Immigration and Americanization. Selected Readings. Bost. Ginn. 1920. Fairchild, H. P., Immigration. 1913. The standard of living — up or down? A. E. Rev., 6: 9-25. 191^. Fetter, F. A., Population or prosperity. A. E. Rev., 3 (no. 1, supp.) : 5-19. 1913. (Presidential address before the American Economic Association, 1912; partly incorporated vcith chap. 25 in the text.) Foerster, R. F.. The Italian emigration of our times. Pp. 558. Cambridge. Harvard University Press. 1919. Goldemceiser, E. A., Walker's theory of immigration. Am. J. Soc, 18: 342-351. 1912-1913. Grant, M., The passing of the great race. Pp. 245. New York. Scrib- ners. 1916. Hamilton, W. 3., Readings in current economic history. P. 384- 386, 392-395. Univ. of Chic. Press. 1914. ■Jenks, J. W.. and Lauok, W. J., The immigration problem. Pp. 605. 4th ed. N. Y. Funk. 1917. Materials for the study of elementary economics. 146-156. Chic. Univ. Press. 1913. Millis, H. A., Some economic aspects of Japanese immigration. A. E. Rev., 5: 787-804. 1915. Roberts, Peter, The new immigration. N. Y. Macmillan. 1912. Ross, E. A., The old world in the new. N. Y. Century. 1914. Warne, F. J., The tide of immigration. N. Y. Appleton. 1916. PART V PUBLIC POLICY TOWARD PRIVATE INDUSTRY CHAPTER 26 AGRICULTURAL AND RURAL POPULATION § 1. Sources of food and organic materials. § 2. Agriculture and farms in the United States. § 3. Rural and agricultural. § 4. Lack of a social agricultural policy in America. § 5. Period of decaying agricultural prosperity. § 6. Sociological effects of agricultural de- cay. § 7. Fewer, relatively, occupied in agriculture; use of machin- ery. § 8. Transfer of work from farm to factory. § 9. The rural ex- odus. § 10. The farmer's income in monetary terms. § 11. Com- pensations of the farmer's life. § 12. Ownership and tenancy. § 1. Sources of food and organic materials. The land area of the United States is about 1,900,000,000 acres, of which 879,000,000 acres were in farms in 1910, this being 46 per cent of tl^e total area. A very small part of the vet- mainder is used for residential and commercial pur- poses, 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 pro- duced not merely food but many kinds of materials, such as cotton, wool, hides, and lumber, while much of the unim- proved 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 441 442 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 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 apparent that a very large number of economic problems must arise in connection vpith the land supply for food: such as problems of land-owner- ship, taxation, irrigation, drainage, forestry, and encour- agement or limitation of population. We are just beginning to awake to the needs in this direction. The farm-lands supply, besides food, a large part of the raw materials FOREST REGIONS OF THE UNITED STATES Fig 1, Chapter 26. Natural Forests of the U. S. for many other goods, all such organic materials as cotton, flax, wool, hides, feathers, lumber, and firewood. The farm wood-lots 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 most important we have to solve. The rivers, lakes, and ocean waters near our coasts are Ch. 26] AGRICULTURAL AND RURAL POPULATION 443 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 ' ' capi- tals, ' ' yet they are more important to the nation than a large part of the land area. They are only beginning to be de- veloped artificially by the propagation of oysters, clams, and fish. The development of a proper fishery policy is an eco- nomic problem closely connected with that of agriculture. § 2. Agriculture and farms in the United States. There were nearly 12,400,000 persons in the United States gain- fully 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 comprise more than one third of the total population of the country. ' ' Agri- culture" is here used in a broad sense, including floriculture, animal husbandry (poultry, bee culture, stock-raising), forestry and* lumbering, and is even extended to include regular fishing and oystering. "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 more than 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. § 3. Rural and agricultural. The adjectives rural and agricultural are often used loosely as synonyms. But agricul- tural 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 mini- mum population (of late, 2500), and is properly contrasted with urban, applied to those living in larger population 444 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V groupings. In 1910 the rural population comprised 53.7 per cent of the total population, but had fallen to 48.1 per cent in 1920. It is true that the two groups of the agri- cultural and the rural populations are largely composed of the same persons, but partly they are not. Many farm- houses, together with part or all of the farm-lands, lie in- side 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 three fifths of the rural families are engaged in agriculture and two fifths are not. It is often important to make this distinction, though it is difficult to do ; for some of the much-discussed rliral 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. § 4. 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 ob- tained special protective social legislation, the farmer, from choice or necessity, has usually had to work out his economic problems unaided. The exceptions are few and of small im- portance. 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 in- Cir. 26] AGRICULTURAL AND RURAL POPULATION 445 spired 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 in- jured the farmers of the eastern states. The "Granger leg- islation" to regulate railroad rates was so called by the Bast 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 nearly all outward and few inward, while heavy and effective rates were placed on most things that the farmers had to buy.^ 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 legisla- tures farmers are few relative to their numbers in the com- munity, and still fewer in either House or Senate in "Wash- ington. Moreover, the farmers have rarely asked or re- ceived, as a class, any favoring legislation. 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 pro- tective legislation. But farmers have, as has every economic group, interests that 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. There are evidences, with increas- 1 See ch. 16, § 5. 446 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V ing organization among farmers, of an intention to seek political power and favors, which promises to present a new problem of monopoly and bodes ill for the other elements of the community. The road of true progress is not toward more monopoly for farmers, but toward less monopoly for large business and favored commercial interests. § 5. Period of decaying agricultural prosperity. Despite the fact that frequently in economic legislation the farmer has been the victim, every compaign orator admits that there is no other occupational class that is of greater impor- tance to the nation than are 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 discov- ery, and many things more, have been occurring, which have altered, and in some communities 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, though the outcome was of the gravest portent to the whole so- cial economy. Such was the case in the period of agricul- tural depression from 1873 to about 1896.^ 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. § 6. Sociological effects of agricultural decay. Such changes hastened, no doubt, the decline in the birth-rate 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 ten- antry, 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 hetero- 2 See Vol. I, p. 347. Ch. 26] AGRICULTURAL AND RURAL POPULATION 447 geneous, with results calamitous to the social life. Once pros- perous schools declined, once thronging country churches were deserted, and much of the old neighborhood democracy dis- appeared. 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 fundamen- tal character. § 7. 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 occu- pied in agriculture for gain have been reported at the census in a form that makes them fairly comparable.^ 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 in- creasing 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 3 It must be observed, in studying these figures, that farmers' wives and children, vrorking 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 e.xplains 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 32.5 448 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V readily in the regions of level fields, but of late has been made possible to a greater extent in hilly country by rearrang- ing 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.* One man, thus, driving three or four horses or a tractor, can do the work formerly done by two or more men and do it just as Fig. 2, Chapter 26. — All farm crops. Note: This does not include value of live-stock products, the total of which ia fully half as great. well. The farmers' incomes in different parts of the coun- try 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 coun- try only a beginning has been made in these ways, and in fu- ture the census will continue to reflect the progress in these directions. § 8. Transfer of work from farm to factory. The other * See further, ch. 27, § 1 and § 2, on the size of farms as an eco- nomic factor. Ch. 26] AGRICULTURAL AND RURAL POPULATION 449 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 Fig. 3, Chapter 26. — Manufactures. Note: The scale of valuation is not the same as in Fig. 2. Observe how in the northeast manufactures and farming are combined. 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 pro- portion by workers classified as in the manufacturing indus- 450 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V tries, 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. § 9. The rural exodus. The percentage of persons in the rural population changes at about the same rate as does Fig. 4, Chapter 26. — Products of mines. Compare with distribution of farm crops and manufactures. that of persons occupied in agriculture. In 1890 it was 64, in 1900 it was 60, in 1910 it was 54, and in 1920 it was 48 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 ' ' cityward drift. " It is only in part explained by the change from agriculture to other occupations; perhaps even Cii. 26] AGRICULTURAL AND RURAL POPULATION 451 as much 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 cit- ies. In much of the long-settled area of the country every hillside stream once turned a little mill to saw timber, grind com, 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 patri- archal 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 coimtryside 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 rail- ways, by improved roads, by telephones, and by automobiles. The great growth of education (in the sense of school- ing) and rise of educational standards has put the country child at a disadvantage as compared with the child in the city. For this reason, great numbers of farmers' families move to villages and cities, to enable the children to attend high school, even when the move involves a sacrifice. Better roads and the consolidated country school, with free trans- portation for the pupils, replacing the one-room, one-teacher schooUiouse, have done much to meet this need. Still, as com- petent observers have pointed out, the normal farming life of the country is an education in the manual arts and in other ways, so that even with briefer school terms the coun- try child may be better educated for life than is the city child. The pubUc was startled to learn that the army tests showed that country youth, on the average, were not as healthy as city youth. Here, again, the progress of the cities in sani- tation, medical inspection in schools, care of teeth and of the eyes of school children, gymnasia, organized and directed physical recreation, etc., has left the country homes and the country children at a relative disadvantage. The natural 452 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V advantages of country life (sunshine, healthy exercise in the open, freedom from noise and strain) cannot always com- pensate for the poorer water supply, defective sanitation, and lack of medical and surgical care for the growing child. Here is a field for future reform. § 10. The farmer's income in monetary terms. Census figures and some additional investigations led to the estimate of the average real income of the farmers of the United States in 1909, expressed in monetary terms, as $724. This was after some twelve years of slowly rising agricultural prices and improving conditions. The estimated value of all products, whether sold or used by the farmer, plus the value of his house rent and fuel consumed by famity, was $1236, from which expenditures of $512 are deducted for outside labor and for materials used for operating and main- taining 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. Main items of net income, Rent $125 Food from the farm 261 Fuel 35 Cash 303 Total $724 Increase in value of farm 323 Total estimated monetary income $1047 Labor income .$402 Wealth income 322 Capital income 323 $1047 Of the total $402 is a labor income, and 645 is a funded in- come.^ 6 See Vol. I, p. 225, and note 11. Ch. 26] AGRICULTURAL AND RURAL POPULATION 453 It would be difficult, even if the available statistics were much more exact than they are, to compare exactly the farm- er's income with those of urban classes. Averages of such large numbers and over such a wide area have a limited sig- nificance in the specific case;, and living conditions and the purchasing power of money are very different in country and city and in different parts of the country.® § 11. Compensations of the farmer's life. In bare mone- tary 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 when the value of the wealth income is added that it is as great. 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.^ 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. Ketail prices of the same food and fuel even in small towns would be much greater. The necessary outlay for clothes to main- tain tlie 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. Though the farmer's working-day in the busiest season of 6 See Vol. I, p. 206. 7 See Vol. I, p. 227, note, for figures on owners and farm laborers. 454 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 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. The joy and pride of possession that goes with even a little plot of ground and a house that is one's own, the satisfaction of "being one's own boss," the very real and deep sense of workmanship and of independ- ence that comes from planning and carrying through even simple tasks, rather than in acting under the orders of others — these are motives, not easily measurable in money, which keep many men on farms despite the temptations of higher financial rewards in cities. Many mistaken ideas are current among city folk in re- spect to country life, and much mistaken sympathy is wasted. The city man, living on external excitements, speaks with dread of the solitude of the country life, with no "movies" just around the corner and no Coney Island near. But he forgets that the people living in the country as real farmers were, with few exceptions, born and reared in the country. Families in the country average larger than in the cities, and the country has a rate of natural increase greater than the city. Persons raised in the country prefer to stay there, if they can make a living, a preference that tends to depress labor incomes in the country. The interests that fill the lives of country people are not the same as those of city people, but they are often far more real. I know a farmer- boy who when ten years old refused a ticket to the circus because he preferred to help on threshing day; and he and his brother probably have had more pleasure breaking and driving a yoke of calves to a homemade cart than any family of city boys ever got riding the elephant at the zoo. The non-pecuniary compensations in farm life help to outweigh Ch. 26] AGRICULTURAL AND RURAL POPULATION 455 larger pecuniary rewards in manufacturing, transportation, mining, and trade, and prevents the rural exodus from being as great as it would otherwise be. In consequence the price of food is kept at relatively low levels, giving to the farmer and his family lower average monetary labor incomes than those earned in city occupations (organized or unorganized). § 12. Ownership and tenancy. Since 1880, when the first figures on farm tenures were collected, the propor- tion 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 18'JO 71.6 10.0 ],s.4 moo 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 proportion of male operating own- ers to all male workers on farms has remained almost constant at about 42 per cent ; while hired workers have 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 thirty-five 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, con- trolling 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 456 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 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 pro- portions 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 main- taining and increasing operating ownership of farms in Amer- ica is one deserving of the most earnest thought and effort. 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 fam- ilies and the raising of healthy children, the preservation of an independent American yeomanry is of fundamental im- portance 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 admin- istered to assist; special efforts in agricultural education should be made and active administrative efforts should be directed toward this important end. Refebenoes. Benton, A. H., Farm tenancy and leases. Agricultural Experiment Station Bulletin, No. 178. 1919. Carver, T. N., Selected readings in rural economics. Bost. Ginn 1916. Mead, E., Helping men own farms. N. Y. Macmillan. 1920. Nourse, E. (?., Agricultural economics. Chicago University Press. 1916. (A large volume of readings, well selected and edited.) Phclan, J., Readings in rural sociology. New York. Macmillan 1920. Taylor, II. C, Agricultural economics. Pp. 439. N. Y. Macmillan 1919. Vogt, P. L.. Introduction to rural sociology. Pp. 443. N. Y. Ap- pleton. 1917. CHAPTER 27 PROBLEMS OF AGRICULTURAL ECONOMICS § 1. Size of farms, and total farming area. § 2. Influences acting upon tie 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 farm- ing. § 7. Intensive farming in Europe and America. § 8. Prospect of more intensive cultivation of land in America. § 9. The new agricul- ture. § 10. Difficulty of cooperation among farmers. § 11. Rapid growth of farmers' selling cooperation. § 12. Some economic features of farmers' selling cooperation. § 13. Cooperation in buying. § 14. Need of agricultural credit. § 15. Provisions for farm loans. § 16. Need of an agricultural policy. § 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 break- ing 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. 1 A farm is defined for census purposes as "all the land which is di- rectly farmed by one person, either by his own labor alone or with the assistance of members of his household, or hired employees. When a landowner has one or more tenants, renters, croppers, or managers, the land operated by each is considered a farm." 457 458 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 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 im- proved land, 15.4 per cent, and the improved 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 Fig. I, Chapter 27. Acreage of Corn. Note: Now king of all crops, in value equal to that of cotton and wheat combined. Generally cultivated in eastern half of country. 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 one another. 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 Cii. 27] PROBLEMS OF AGRICULTURAL ECONOMICS 450 of larger general farms in the North and Bast into small poul- try, 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 eco- nomic 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 "# ^-. -f^ ^^v^^S^^S^^^g5^^f*^" 1 ^:i m P-^-^ ®^^^^ ^^^^^^m -Mm^^w '3=1^^^ -^^^^^« ^^F'""""" f sSEsS" i ~ ■ _L .j". L. f- '^^^^5^?^^?^^^tfl^^-^^^fS^ '^°"^*°^ '™* idj- ^^«!?K r\l)^'^^^Vvi £iikl)a-^''^ny?Syd~f^J^fc\ EACH DOT REPRESENTS S?M-VV-W -MSScS-T^^ ^y=^fCWA 6,000 ACRES ~'\- ^^S^5d2=i^^«.'' TSTV\ \ \% sssjsr^ ■s_ii...; '?""""""'■- ■■■•■ ■- ^^- Fig. 2, Chapter 27. — ^Acreage of cotton. Note: Second in value among farm crops, but limited to a region less than a fourth of the whole country. Some production in the three states west of Texas is not shown on this map. and woodland. The fields were small and were laid out irreg- ularly, 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 agri- cultural surveys point to the conclusion that for general farm- 460 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V ing this unit is a comparatively large area of about 300 acres. These conditions offer a reward to those agricultural enter- prisers who can purchase lands at a price based upon the high costs and lower j'ields 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 consolida- tion of smaller into larger farms is likely to continue in many communities for several decades. This is likewise an ad- vantage 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 consider- ation. § 3. Self-suiRcing versus commercial farming. The typi- cal American farming family once produced nearly every- thing it used, and used nearlj^ everything it produced. It was very nearly a self-sufficing economic unit, a "closed econom}', " as it is sometimes called. Food, clothing, fuel, lumber, houses, furniture, tools, were on the farm carried tlirough the various processes from the first gathering of the raw materials to the finished product. They were then con- sumed 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 them- selves, as far as possible, everything their families needed, even when the soil and situation were poorly suited to the purposes. True, there were early some exceptional cases in which only one kind of product was taken from the land. Such were the forest products of masts, shingles, lum- ber, and turpentine, and the great southern staple, tobacco, Ch. 27] PROBLEMS OF AGRICULTURAL ECONOMICS 461 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 prod- ucts to which their farms are adapted in respect to soil, rela- tion to market, and otherwise. These products are taken to market and sold for monoy with which are bought the things needed for use on the farm. § 4. Farming viewed as a capitalistic enterprise. Thus Ul TED STATES J, y WHEAT PRODUCTION Fig. 3, Chapter 27. — ^Production of wheat. Note: La/gely produced in a comparatively restricted wheat belt bordering the semi-arid region; elsewhere mainly a rotation crop. the farm comes to be looked upon more and more, not merely 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 462 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 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 con- ditions 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, consist- ing 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 tranferring 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 becom- ing more general as a result of the commercializing of farming enterprise. This change has been favored by other influences. Partic- ularly 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 like manu- facturing and commercial undertakings. § 5. Diversified versus specialized fanning. To be largely self-sufScing a farming family must carry on general farming, that is, must produce a diversity of products. As farming becomes more commercialized it usually becomes more specialized, and a certain district produces a smaller variety of products. In some part of the country and on particular farms this specialization is extreme : In various parts of Cali- fornia, citrus fruits or prunes or beans may be the only crop raised ; wheat in central Kansas and the Dakotas ; fresh milk and vegetables on thousands of farms surrounding the great cities ; cotton in many parts of the South. Many farmers in these districts have no gardens or orchards, keep no cow, and Ch. 27] PROBXEMS OF AGRICULTURAL ECONOMICS 463 buy much or all of the grain for their horses, as well as milk, butter, vegetables, and fruit 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 Bast 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 relative increase in the price of meat. Fig. 4, Chapter 27. Dairy products. Observe the close relation with manufactures in Fig. 3, ch. 26. §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 reached and passed. Most farms have a variety of soils and 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 de- teriorates fast if bay and grain are continually sold. Some 464 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 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 as 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 64 per cent of receipts are in most eases from various sources, and these figures do 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, there- fore, measures the success of farming, not by the farmer's income or by the level of the 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 com- ment 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 Ch. 27] PROBLEMS OF AGRICULTURAL ECONOMICS 465 it is in forests ; somewliat 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 cultivation with machinery' in large fields is a far more extensive method of agriculture than that carried on by 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.^ 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 thor- oughly 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 ag- riculture, unless this movement can be counteracted by the spread of better methods in agriculture — not European peas- ant methods, but new American methods consistent with high labor incomes. A good deal of our farm land is un- doubtedly too intensively used now in view of present and prospective commodity prices and wages. Malad.justment of land uses has resulted from mistaken judgment, from chang- ing 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 hiUside 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 2 See Vol. I, cha. 12 and 13, on proportionality and usance. 466 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 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 to- ward 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 pos- sible 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, wou,M require a chapter in a complete treatise on agri- cultural 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 Ch. 27] PROBLEMS OP AGRICULTURAL ECONOMICS 467 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 chemica,' 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, insures the possibility of a steady betterment of the popular welfare in city and in open country alike. § 10. Difficulty of cooperation among farmers. Rural communities are proverbially conservative ; the American farmer is proverbially an individualist. No wonder, then, that the new ideas and plans of cooperation in business mat- ters have made headwaj^ in agriculture slowly and with dif- ficulty. 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 cooperative 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 agricul- tural prosperity.^ To-day, for example, it is impossible on a certain Pennsylvania road for one more progressive farmer to get his neighbors to cooperate 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 3 See ch. 26, § 5 and § 6. 468 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 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 cooperation among farmers sympathetic critics are forced to say : ' ' Many students of rural economies assert that cooperation 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. As long as farmers do fairly well in their own way; they are not inclined to cooperate." § 11. Rapid growth of fanners' selling cooperation. Despite what has just been said, cooperation among farmers now is more developed and is growing faster than all other kinds of cooperation in America. In 1920 there were at least 14,000 farmers' buying and selling associations, distributed throughout every state in the union. Their growth has been 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 average younger, and many have been educated in the state agricul- tural 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 sales-agents, seems to have given the first impetus to farmers' cooperation. The most notable developments were those of the California Fruit Exchange and of cooperative societies of the North- west 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, though simple, system of equalizing and expediting shipments. Agri- cultural cooperative associations of various kinds are mul- Ch. 27] PROBLEMS OF AGRICULTURAL ECONOMICS 469 tiplying all over the country, for shipping live stock, fruits, butter, cheese, and other farm products. Cooperation 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 proc- esses are undertaken by these societies. § 12. Some economic features of farmers' selling coop- eration. This type of producers' selling cooperation is prov- ing in America to be far more successful than producers' co- operation among workingmen;* and certain important eco- nomic features in it should be noted. The local producers' selling cooperative 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 pro- ductive processes undertaken by this kind of society are sub- ordinate to the main business, being such as picking, packing, drying, preserving, and making boxes for packing. This form of cooperation, with the related form of consumers' co- operation that is fostered by it, promises to have a wide ex- tension. 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 di- vert ears 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. As 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 con- sumers, comparable to insurance in its utility. Reducing the *See ch. 20, §§ 13, 14, 15. 470 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V area planted or preventing the entrance of others into the in- dustry would be monopolistic acts, but these as yet Have not occurred. § 13. Cooperation in buying. Cooperative buying (called also consumers' cooperation or distributive cooperation) 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 cooperative stores, both in Great Britain and on the Continent, have flourished mainly among the industrial workers in urban centers. However, this has not been exclusively the case, and, particularly in Denmark and Ireland, cooperative buying has increased in agriculture in connection with selling associations. Between 1890 and 1914 the growth of consumers' cooperation among European industrial wage-earners was 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 cooperative stores were founded in America by farmers in the Grange movement, who operated also grain-elevators, warehouses, and steam- boat lines. But the movement failed, about 1877. This re- sult is easily explained by lack of commercial knowledge and lack of harmony among the members, selling on credit, and ineiBcient management. A new era in consumers' coopera- tion for fanners began about 1900, and in several widely sepa- rated parts of the country — ^Minnesota, Kansas, California, Washington and elsewhere — the movement has spread rap- idly, 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 re- tains pretty faithfully its commercial character. The change of farming toward a more commercial form = has been little 5 See above, § 3. Ch. 27] PKOBLEMS OF AGRICULTURAL ECONOMICS 471 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.^ A great num- ber of farms are always in course of being purchased, the bal- ance of purchase money being borrowed by the purchaser. A group of private agencies, such as life insurance and mort- gage loan companies and local money-lenders, has supplied Farm Prices Fig. 5, Chapter 27. — Farm prices, 190'9-1921. Note: The years 1917 to 1919 were years of exceptional prosperity for farmers, because the price of their products rose faster and highor than either farm wages or the prices of the things that farmers buy. The years 1920 and 1921 were disastrous. Farm products began to fall while nearly everything that the farmer had to buy kept on rising in 1920, and then fell in 1921, but less than did farm products. long-term farm credits at rates of interest considerably higher than were paid for loans on urban real estate. The total of agricultural loans was estimated in 1916 to be $3,500,000,000. Though rates of interest had become more equalized through- out the whole country, they still ranged 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 6 See ch. 8, § 8. 472 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 'of better opportunties for credit in the agricultural districts was long recognized. The high rate of interest for borrowed money necessarily placed a limit on improvements in equip- ment and methods of farming.' § 15. Provisions for farm loans. The Federal Reserve Act made two important changes to iiliprove agricultural credit.* Long and vigorous discussion of the subject led at length to the enactment of the Federal Farm Loan Act, 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 associations organized somewhat after the model of the building and loan associ- ations. The bonds issued by these banks may bear not to ex- ceed 5 per cent interest and are tax exempt. The loan is re- paid by the farmers under a regular plan of amortization. This plan went into effect opportunely, when the with- drawal of loans from America by European investors and the financing of the war was already causing rising interest rates. But for this act, the financial difficulties to agriculture would have been serious just as the patriotic slogan declared, "Food will win the war." As private investors were not ready to subscribe for stock in the banks, the Treasury of the United States did so. In the first year of its operation the Federal Farm Loan Banks issued nearly $100,000,000 of bonds ; and at the end of about three years (by October, 1920) more than $350,000,000; at which time farm loan associations to the number of four thousand were operating. Besides, there were operating under the act twenty-five Joint Stock Land Banks with mortgage loans of nearly $80,000,000 outstand- ing. All of the effects of this legislation are not yet fully appar- ent; but it is clear that it has brought down the rate of 7 See Vol. I, pp. 495-497, on the relation between lower interest rates and productive processes. 8 See ch. 9, § 7 on time deposits, and § 9 on farm loans. Ch. 27] PROBLEMS OF AGRICULTURAL ECONOMICS 473 interest on long-time loans of farmers to nearly 5 per cent in the remotest parts of the country. This must stimulate ag- ricultural improvement and make it possible for thrifty ten- ants to purchase land on long time. But, inasmuch as farm- lands are brought within the circle of lower interest rates, their capitalization will be higher, based on the net annual rental. But ultimately the law should, with wise administra- tion and careful changes made in the light of experience, broaden and strengthen the independent farm ownership of the nation, as well as increase agricultural production. § 16. Need of an agricultural policy. Men of the farthest vision in the field of agricultural and land eco- nomics — men such as Liberty Hyde Bailey, chairman of the Koosevelt Country Life Commission, Eugene Davenport, director of the Illinois College of Agriculture, Kenyon L. Butterfield, president of the Massachusetts College of Agri- culture, and Richard T. Ely, founder of the Institute for Re- search in Land Economies — have since the beginning of this century been striving to gain for this great problem some due share of the national thought and effort. The events of the Great "War gave force to their appeal for a national policy of agriculture. It is not too optimistic to believe that in some respects substantial progress toward this end has been made in the development of experiment stations and state colleges of agriculture, farmers' institutes, and "farmers* week" gatherings, that bring together the progressive farmers by thousands, not only to get some technical and practical hints on raising crops, but to gain a broader view of their economic task and of their civic responsibilities. These schools and meetings are helping, as are automobiles, good roads, tel- ephones, rural free delivery, better schools, and an active rural press, to destroy the isolation of country life and to make farmers as a class more broadly educated, more co- operative and more public-spirited than the average urbanite. More insistently the call is heard for a national policy in ag- 474 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pi. V riculture, with the belief that, more than any other occupation, agriculture is bound up with the very existence and survival of the nation. This belief rests not merely on the crude physi- cal fact that men must have food to live, but also, and even more, on the eugenic fact that whatever be the country pop- ulation will ultimately be the nation, and on the historical fact that democracy, stable government, and liberty must have their roots in the soil and in the ownership of homes. This and the foregoing chapter have but sketchily suggested some of the topics that make up the agricultural problems. It is even more important to appreciate that the agricultural prob- lem is connected with all the other industrial problems, and is but a part of the one greatest problem, transcending indi- vidual, class, and sectional interests, the problem of national welfare. Refekenoes. Adams, C. C, Commercial geography. N. Y. Appleton. 1906. Bruce, A. A., The Noii-Partisan League Citizens Library Series. New York. Macmillan. 1020. (By a former Supreme Court Jus- tice of N. D. Picture of the economic conditions leading to the formation of the League. ) Carver, T. N., Selected readings in rural economics. N. Y. Ginn. 1916. Cumberland, W. W., Cooperative marketing; the advantages as exemplified in the California Fruit Growers Exchange. Prince- ton. University Press. 1917. Kemmerer, E. W., Agricultural credit in the United States- A. E. Rev., 2: 852-872. Marsh, O. P., Man and nature: or physical geography as modified by human action. N. Y. Scribner. 1864. (Later editions un- der the title, "The earth as modified by human action.") Marshall, L. P. and others, Materials for the study of elementary economics, 58-61 (extract from Mason, 0. T., Technogeography, or the relation of the earth to the industries of mankind. Ameri- can Anthropologist, 7: 135-158. 1905); 61-66 (extract from Semple, E. C, Influence of geographic environment. 1911) Univ. of Chic. Press. 1913. Phillips, C. A., Readings in money and banking. Ch. XXVII. On agricultural credit. N. Y. Macmillan. 1916. Pope, J. E., The federal farm loan act. Washington. Bureau of applied economics: Department of banking and public finance Pp. 58. 1917. Teele, B. P., Irrigation in the United States. N. Y. Appleton 1915. Ch. 27] PROBLEMS OF AGRICULTURAL ECONOMICS 475 Warren, G. F., Farm management. N. Y. Macmillan. 1913. (Treats primarily the proljlem of the individual farm, but also many of the broader economic questions.) "Weld, L. D. E., The marketing of farm products. N. Y. Macmillan. 1916. CHAPTER 28 THE TRANSPORTATION PROBLEM § 1. Natural waterways. § 2. The era of canals. § 3. Temporary wreck of inland water transportation. § 4. Rapid building of American railroads. § 5. Eras in the railroad problem. § 6. Governmental aid to railroads. § 7. Emergence of the railroad problem. § 8. Discrim- ination as to goods. § 9. Local discrimination. § 10. Personal dis- crimination. § 11. Economic power of railroad managers. § 12. Polit- ical power of railroad managers. § 1. Natural waterways. In the simplest economic con- ditions the moving of men and their material goods from one place to another was a very important part of economic ac- tivity. Our elementary studies make clear that place change may be just as real and effective a way of increasing the value of goods as is form, stuff, or time change. Tens of thousands of years ago savage men began to supplement their comparatively weak powers as burden-carriers by using domestic animals, and to find other aids for carrying burdens in such instruments as yokes, litters, rafts, canoes, drags, and rude wheeled carts. Boats and ships on rivers, lakes, aad seas early proved to be the least costly means of transpor- tation for heavy weights and long distances ; as the old saying goes, the oceans unite rather than divide the lands. Other means of transportation were naturally the shortest and most easily traversed caravan routes to navigable water, or portages between two waterways. A good system of natural water- ways, while not reckoned among the private capital of a country, may be greater wealth to one nation than costly arti- ficial means of transportation are to another. In natural means of transportation, America was well en- 477 478 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V dowed. The straight ocean coast-line measures 5700 miles, and the line following indentations of the coast is about 64,000 miles. The Great Lakes, with a straight shore-line of 2760 miles, art; the most important inland waterways in the world. The 295 navigable rivers in the country have a length of 26,400 miles that might be navigable water. The natural conditions of transportation and primarily the location of the navigable waters of oceans and rivers, deter- mined entirely the location of industries and the spread of population in America until the eras of canals and railroads. The success of Fulton's steamboat in 1807, indeed, so in- creased the importance of our natural inland waterways that they were the dominating feature of transportation in many parts of the country until after the Civil War. The successive rise in importance, however, of two artificial kinds of trans- portation is indicated by the terms ' ' era of canals ' ' and ' ' era of railroads. ' ' § 2. 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 Brie Canal in 1817, and continued until about 1840 ; when nearly all new work ceased ; more than 4000 miles of canals had been built at a cost of $200,000,000. The New York State barge canal, costing more than $150,000,000, the most notable of our inland waterways, was opened for navigation May 10, 1918. It is the old Erie Canal, reconstructed to permit the passage of thousand- ton barges. 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 in the canal era. For heavy, slow-moving freight a railroad can even now barely rival a parallel canal at its Ch. 28] THE TRANSPORTATION PROBLEM 479 best. As canals, however, can be built only along fairly- level routes and where the water supply is at high level, their construction is limited to a small portion of the coun- try. The principle of diminishing returns applies strongly to the construction of canals : the first canals in favored loca- tions 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, there- fore, the small land-locked canal is fitted only to be a supple- mentary agent in the system of transportation wherever an- other transportation agency of higher speed and greater regu- larity is possible. Par different is the case of the oceanic canal in a tropical climate. Canals do not appear to have developed many serious prob- lems calling for public regulation. 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. § 3. Temporary wreck of inland water transportation. After the sudden check to canal-building about 1840, most of the existing canals continued to operate, with slowly de- clining prosperity, until after the Civil War, when many of them were abandoned. The reasons for their failure can be understood only in connection with the history of the railroads in that period. There was not enough traffic for both water and rail carriers to thrive, and, at every point where canals or rivers and railroads touched or were parallel, railroad rates were cut below average rates, or tem- porarily even far below the cost of carriage. The shipping on the Great Lakes was the one form of inland iwater trans- portation to survive and flourish. This wreck of the canal and the river carriers ruined the prosperity of great numbers of business enterprises and of 480 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V whole regions, while artificially favoring other enterprises and locations. In the long run (that is, forty or fifty years after it had been done), especially when traffic had so in- creased that the railroads were inadequate to care for it, this was seen to have been unfortunate for the country as a whole. Water transportation has its rightful place along with railroads in a general system of transportation, each agency to be used in the places and for the kind of traffic for which each is best fitted. The restoration and develop- ment of our inland waterways is one of the large transporta- tion problems 'awaiting solution in the second quarter of the twentieth century. § 4. Eapid building of American railroads. The canal was just reaching the peak of popular favor when the rail- road in 1830, after a half-century of slowly accumulating technical improvements, burst into view as a demonstrated success as a means of transportation.^ The railroad excels in adaptability any other agent of transportation; it can go over mountains or tunnel through them. It is markedly su- perior in certainty; it may be blocked for a day or two by floods and snows, but it suffers no seasonal stoppage of traf- fic. 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 pas- senger traffic and fast freight. Although in respect to cheap- ness, it could not equal the waterways in favored localities the railroad made rapid gains, and improvements in road-bed, rails, cars, engines, and other equipment soon reduced greatly the cost of conducting traffic on the main lines of roads. Be- cause of these qualities railroads soon surpassed in impor- tance 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) : 1 See A. T. Hadley, "Railroad Transportation," pp. 10, 32. Ch. 28] THE TRANSPORTATION PROBLEM 481 Miles constructed Total route miles in decade in operation 1830 23 23 1840 2,795 2,818 1850 6^203 9,021 I860 21,605 30,626 1870 22,296 52,922 1880 40,345 93,267 1890 73,924 167,191 19*^0 31,773 198,964 1910 51,028 249,992 1915 (5 yrs.) 13^555 263,547 1918 (3 yrs.) 2,798 264,233 2 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.^ 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. Enor- mous increases of value at a few points were offset by losses in other localities. § 5. Eras in the railroad problem. The history of rail- roads in the United States is closely interwoven with the general economic development, the political ideas, and the public opinion of the nation from 1830 to the present time. Despite the absence of clean-cut unified public convictions on the subject, the entire period divides into fairly well 2 In this period the mileage abandoned on small and non-paying roada partially offset the new mileage constructed. 8 See Vol. I, pp. 437, 438, 443. 482 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. \ marked eras, as new ideas and policies dominate, not entirely displacing the old, and already foreshadowing still others. These eras may be designated as follows : (1) Unregulated private enterprise, beginning 1830. (2) Ineffective state regulation, beginning about 1870. (3) Ineffective federal regulation, beginning 1888. (4) Strong federal regulation, beginning 1906. This latest era exhibits already two phases, the first being from 1906 to the war in 1917, and the second after that time. The history of these successive eras is instructive to the student of economic institutions in America, as showing how in a democratic society definite truths displace vague and mistaken opinions after long and bitter experiences. § 6. Governmental aid to railroads. The growth of rail- roads 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 enter- prise 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 exten- sion was very slow there, even though 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 tax- payers of the communities. American states recklessly abandoned the policy of non- interference, and vied with one another in giving railroad enterprises lands, money, and privileges, in lending bonds, in subscribing for stock, and in releasing from taxation. These fostering measures were expected to increase wealth and to diffuse a greater welfare throughout the community, ilany Ch. 28] THE TRANSPORTATION PROBLEM 483 states were forced to the point of bankruptcy by their reck- less 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 Illinois from north to south. Grants were made in fourteen states, cover- ing tens of millions of acres of land. Then the national gov- ernment, 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 lending the credit of the government to the extent of fifty million dollars — a debt that was settled by compromise only after thirty years. Counties, townships, cities, and villages then entered into keen competition to secure the building of railroads, pro- jected by private enterprise. Bonds, bonuses, tax-exemp- tions, 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 ob- durate. 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 amend- ments. But, before this era of generosity ended, the rail- roads in America had received probably more public aid than has ever been given to any other form of industry in private hands. § 7. Emergence of the railroad problem. In most char- ters 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 484 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V some serious evils in the policy of railroads toward the ship- ping 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 discrimina- tion. § 8. 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 dif- ference in cost is not discrimination; on the other hand, a difference in cost without a difference in rate is discrimina- tion. Discrimination as to goods may be by value, as low rates for heavy, cheap goods, and high rates for lighter, valu- able ones. Coal always goes at a low rate as compared with Cu. 28] THE TRANSPORTATION PROBLEM 485 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 in- justice to the shipping public that the term has taken on an evil significance. But it is well to observe that the word dis- crimination is not derived from crimen (crime), but from discernere (to discern). There are both reasonable and un- reasonable forms of discrimination. In general, discrimina- tion as to goods more often appears, under certain conditions and made with due regard to the public interest, to be rea- sonable; less often to be justified is the form of local dis- crimination next to be described; and least often of all to be justified is the last-named form of personal discrimination. § 9. 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, 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 corpora- tions and the personal, favoritism shown by railroad ofQcials. The effects of local discrimination are to develop some dis- tricts and depress others; to stimulate cities and blight vil- lages; to destroy established industries; to foster monopolies at favored points ; and to sacrifice the future revenues of the road by forcing industry to move to the competing points to get the low rates. The power of railroad officials arbi- trarily to cause rates to rise or fall is usually limited in prac- tice by the need of earning as large and as regular an in- 486 PUBLIC POLICY TOWAED PRIVATE INDUSTRY [Pt. V come as possible, but even as exercised it has been at times as great as that possessed by many political rulers. § 10. 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 dona- tions 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 reg-ulate their shipments to secure the lower rate. One group of reasons for personal discrimination is con- nected with the interests of the road. It is to build up new business; it is to make competition with rival roads more ef- fective by favoring certain agents, as was very commonly done in the western grain business; it is to exclude compe- tition, 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. An- other group of reasons has to do with the interests of the cor- porate 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 intro- duces 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 sur- prises; it grants unearned fortunes and destroys those hon- estly made; it gives enormous power and presents strong Ch. 28] THE TRANSPOETATION PROBLEM 487 temptations to railroad officials to injure the interests of the stockholders on the one hand and of the public on the other. § 11. Economic power of railroad managers. Other evils of unregulated private management of railroads ap- peared. "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 trans- portation 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 compa- nies" 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 re- sponsible 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 divi- dends. The managers long felt bound to defend the prin- ciple 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. § 12. Political power of railroad managers. Likewise in 488 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V various ways railroad managers, unlimited by rate regulations, 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 mana- gers of railroads wield the power of the lawmaker. By changing the rates on foreign exports or imports, the rail- roads frequently have made or nullified tariff rates and have defeated the intention of the legislature. On the other hand, 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 coun- try 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 rail- roads, in part because they were the victims at times of at- tempts 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 ofQce 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 busi- ness 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, however, without long and strenuous agitation and effort, educational and legislative. Ch. 28] THE TRANSPORTATION PROBLEM 489 Refeeences. Gephart, W. F., The place of the canal in a national system of trans- portation. A. E. Assn. Bui., 4th ser., 1 (no. 2) : 188-190. 1911. Round table discussion, 197-203. Hadley, A. T., Railroad transportation. N. Y. Putnam. 1884. Johnson, E. R., American railway transportation. 3d ed. N. Y. Appleton. 1908. Johnson, E. R., Inland waterway policy. A. E. Assn. Bui., 4th ser., 1: 166-174. 1911. Johnson, E. R., The Panama Canal and commerce. Pp. 29-5. New York. Appleton. 1916. Johnson, E. R., and Huebner, G. G., Principles of ocean transporta- tion. N. Y. Appleton. 1918. 5 ..,-•■"■ *-^ i-*,.„.W--^,.:^'^^/ a u u - u e u a ■V^ R » . - _ ,^ K ca o (D o Y, J^ « M OT * a -(J O.S n^ « o_s ■*J ca O t3 K O a ■O -n ■S'^l Ph V d 0-= t- 5 >>=s c o^,ja o Ph c -2 10 ja " c n.2-5 CS o ^ a 1 Oo (M ■:2 « ^^ OJ a-c 2 -4-1 "t/a 3 n^ Ph t3 .J5 ^ ;>>r'? f ) TS t?o c O -^ -*-» OJ 1— I ^ 01 -iJ o.W-5 S o a^ ^ ■•' '^. >.* Pnn mm Years -WO-IOO / f'1 PfiO I / '^ f '■ ^ ?eo ' !>nn ' ^ 1 an \ ' f. ^ ^ r fio ' 1 An A ^ r f ? 5^ T,1 ;;! J es to ') . \ 7Cl f- 1 an ^ ■a £ a -•• lUtt 11. a U c. «jj 11 4 r ' fin . . . _ _ Afl — ^ AIITMOBlTlE Ji WHOLESALE PB1CE3 - U.S. LABOR RtVlEW AMD BHADSTREETS RAILVrtV WAOC AND FHEIOHT RATES - I.C.C. STATISTICS — pft rt ' 1 1 M 1 1 1 M M 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 Fig. 2, Chapter 29. — Decline of railroad rates, relative to prices and railway wages, 1905-1920. Note: The main reason for the growing financial difficulties of the railroads, especially after 1915, is evident here. The increases in rates were tardy, and inadequate to keep pace with rising costs. The last large rate increase, effective in September 1920, occurred several months after wholesale prices had passed their peak and were rapidly falling, and traffic was declining. § 7. Fixed rates and declining net earnings. At this point a new feature appeared in the situation. The curve of general prices continued, with slight irregularities, to rise after 1897, and railroad wages had been about keeping pace, moving now a little behind and then ahead, as a result of concessions, of strikes, of threatened strikes, and of decisions Ch. 29] RAILROAD REGULATION 499 in arbitration. Thus almost everything that railroads had to buy — repairs, equipment, materials, labor of all kinds, had been increasing, while the average of freight rates was somewhat decreasing.^ The result was decreasing railway net earnings, falling railway credit, rapid slackening of rail- way-building, and inadequate maintenance of existing equip- ment. Railroad facilities and capacity, despite substantial technical progress in some respects (size of engines, train loads, etc.), was not keeping pace with the growth of the population and of the business of the nation. By 1914 the danger of this course began to be ap- parent to the public mind. The application of the roads for permission to raise va- rious rates (in what was called, somewhat inaccu- rately, the "5 per cent case") was still opposed by the irreconcilable opponents of the roads. Many state railroad commissions united to oppose the granting of the application, and Mr. Louis Note : The heavy line is a smoothed D. Brandeis, as special curve, shovifing the general trend counsel for the Commission, of net earnings of -.. representative ^^^^^ j^ ^ brilliant brief, group of railroads; a general down- ^^^ sophistical, half SOUnd, ward trend appears, only partiallj ^ ' offset by successive rate increases, that all 01 the additional revenues needed could and should be obtained by further economies in railroad manage- ment. In July, 1914, the Commission granted a part of the railroads' plea, the dissent of two members being on the ground that all was needed and should be granted. The Com- mission then by successive orders came over by the follow- 1 See Figure 2. Fig. 3, Chapter 29.— Decline of railroad net earnings, 1916-1921. 500 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V ing December to the view of the minority, and granted further increases. Even this relief proved to be quite inadequate, as prices rose in 1915, making railway rates, relative to the monetary values of the goods transported, less than ever be- fore. But in principle and as a precedent, this action of the Commission was important, for it reflected a change of public opinion. A good part of the public had begun to glimpse the truth that it is the duty of a public authority with absolute rate-fixing power to fix rates high enough as well as to keep them low enough; and they are not high enough if they do not give a return sufficient to maintain the existing plant and to attract new investments. § 8. Federal control of railroads. Railway net earnings moved up - and down in 1916, helped by the great growth of tonnage and hurt by further rise of prices and wages. Then came our entry into the war in April, 1917. At once the railroads united voluntarily in creating a Railroad War Board, seeking to put every facility of the railroads at the disposal of the government. The rolling stock and trackage, however, were quite inadeqviate to carry the war traffic, and, with a view to their more efficient use in the war, they were federalized by presidential proclamation in December, 1917 (under powers granted by an anticipatory law of August, 1916). The conditions and details were fixed by the Railroad Control Act of March, 1918. By this the roads were guaran- teed while under government control net revenues based on the earnings of the three-year test period ending the pre- ceding June. The roads were to be returned, not less than twenty-one months after the conclusion of peace, in as good condition as they were when taken. In every way possible, priority of shipment was given to materials for army and navy and to goods that had a more or less visible relation to the winning of the war. At the head of the federal "Railroad Administration" was the Secretary of the Treasury, who was clothed with well-nigh unlimited war-time powers, and 2 See Figure 3. Ch. 29] RAILROAD REGULATION 501 in fact became the president of the consolidated railroads of America. Whenever he and his advisors felt it to be to the public interest, the division lines of private ownership were obliterated in a manner that was revolutionary in rail- road practice. Palatial passenger terminals built by the enterprise of single companies were thrown open to the use of competing lines, equipment was interchanged, superfluous Bailroad Wages & Living Costs Compared with 1917 1918 1919 1920 / ■^■■■■■■■^■■H 41.3% Increase Year ly Wages Increase Cost ot Living f ^■■■■■^■^^■■1^47.7% Increase Yearly Wages 33Q.9% Increase Cost ol Living ■^^iHHii^^H>i^HH7<)i8 Increase Yearly Wages \ Increase Cost of Living ng NOTE: Cost ol Living highest in June 1920-52% above Dec.1917. Feb.1,1921 it was 11.4% lower than in June 1920, according to the U.S. R.R. Labor Board Kig. 4, Chapter 29. — Railroad wages compated with living costs, 1917 and succeeding years. Note: Wages are average for each year, cost of living is of date December of each year. After the slump in prices in 1920, railroad wages remained relatively much higher than railroad rates and net earnings. These figures were presented by the railroads in their plea to the public for a lowering of wages, to show that railroad labor had virtually "profiteered" in the war conditions. In some details the spokesmen of the railroads question these figures, although the gen- eral trend is unquestioned. competing trains between large cities were discontinued, to the astonishment of those who cherished the old competitive conception of railroad operation. Despite heroic efforts, rail- road operation at times nearly broke down, freight terminals were blocked for miles, and side-tracks were filled with loaded cars that could not be moved. In these conditions and with general prices and railroad wages rising, the net earnings 502 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V fell short of the guaranties. In May, 1918, rates both for passengers and for freight were sharply advanced, freights by a flat 25 per cent, besides many other advances and re- classifications. This gave immediate relief, -which helped to carry the railroads through to the end of federal control; but rising prices and wages again overtook the railroad receipts. § 9. Transportation Act of 1920. After the armistice, the return of the railroads io private control became the subject of much discussion in financial and in political circles. Though railroad finances fared better after the increase of rates in May, 1918, net earnings fell again in the tem- porary business recession early in 1919, to rise again ia the business boom of mid-1919 ; then, as a result of the continued rise of costs and wages, fell again nearly to zero by mid-1920. The Interstate Commerce Commission then granted a large increase of rates, both passenger and freight, effective in Sep- tember, 1920. Meantime in February the ' ' Transportation Act of 1920, ' ' otherwise known as the Esch-Cummins Act, became law, returning the railroads to their owners March 1, 1920. This law necessarily postponed the task of "unscrambling" the railroad omelet and settling the government's indebted- ness to the several roads. But, more important for the future, amendment of the Interstate Commerce Act increased its membership to eleven, and in various ways implied a new, or advanced, view of the railroad problem. The chief new features are : ' 1. Rates must be adequate to yield a fair return on the aggregate value of the property of the carriers, either in the entire country or in rate groups. This is assumed to be the first two years 51/2 per cent (but may be 1/2 per cent more to make provision for improvements) on the valuation to be fixed by the Commission. 2. Net earnings of any carrier are to be limited to 6 per 3 The labor adjustment features of the law have already been indi- cated in eh. 22. Ch. 29] RAILROAD REGULATION 503 cent and one half of the excess, the other half to be paid to the Commission for a contingent fund to be lent to weaker roads or used in other ways helpful to the railway conditions. 3. All the railroads are to be consolidated into a limited number of systems by a plan to be prepared by the Commis- sion, but this plan as yet is only to be recommended, not en- forced upon the carriers. "Within each system, consolidation, mergers, division of traffic, and pooling may be authorized by the Commission. 4. Joint use of terminals may be required by the Commis- sion. 5. Stricter control is to be exercised over railroad policies, including security issues, routing of -traffic, car service, dis- crimination, and other features. § 10. Significance of the Transportation Act. This act was almost unanimously conceded, by those of divergent views, to contain many commendable features, and is generally char- acterized as the last trial of private ownership as well by those who favor as by those who would deplore such an out- come. It brings to an end the regime of private railway ownership and management in the United States, in which private interests were uppermost for good and for evil. In that period constructive minds have built great railroad systems and have developed marvelously the technic of rail- road management; but great financial interests have made the railroads the pawns with which they played a game for private riches and personal power. The most important question to be answered is this : how is it going to be possible to preserve the vitalizing force of competition in railroad transportation when competition between carriers has been ended? The question is paradoxical, but it admits of a valid answer, if the American public has wisdom and political virtue enough to apply it. That answer is : keep politics out of railroad management; preserve and intensify the motives of personal ambition everywhere among the officers and em- 504 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V ployees of railroads; let merit, not favoritism, determine appointments; let railroad service in all its branches be a technical career in which one who succeeds in any position, on any road, in any part of the country, may hope for recog- nition and worthy reward anywhere else where there is a bigger job to fill. Railroads as such can no longer compete in rates; it is a question whether they may even continue to compete in service, for that too must tend to become stand- ardized, as well in quality as in price. But only in a figura- tive sense did railroads ever compete. Railroads are imper- sonal things; only men compete, only men can have motives that are an essential part of the idea of competition. Under a wise public policy, men ought to continue to compete in rail- road work and management; indeed, they might do it more effectively than under the regime of personal and corpora- tion favoritism and of frenzied finance that made such monu- mental failures of many of the railroads under unregulated private management in the past. Refebences. Adams, H. C, American railway accounting. A commentary. Pp. 465. New York State. 1918. By the director of the accounting and statistical work of the I. C. C. from 1887 to 1911. Brown, H. G., Transportation rates and their regulation. N. Y. Macmillan. 1916. Johnson, E. R., and Van Metre, T. W., Principles of railroad trans- portation. Pp. 619. N. Y. Appleton. 19161. McFall, R. J., Railway monopoly and rate regulation. N. Y. Long- mans. 1916. Materials for the study of elementary economics by L. P. Marshall and others. Pp. 627, 628. Univ. of Chic. Press. 1913. Ripley, W. Z., (Ed.), Railway problems. Bost. Ginn. 1907. Ripley, W. Z., Railroads: rates and regulations. N. Y. Longmans. 1912. CHAPTER 30 THE PROBLEM OF INDUSTRIAL MONOPOLY § 1. Kinds of monopoly. § 2. Political sources of monopoly. § 3. Natural and capitalistic monopolies. § 4. Monopoly and corporate organization. § 5. Rise of the corporation concept. § 6. Advantages of corporate organization. § 7. Growth of large industry in the nine- teenth century. § 8. Trusts and combinations. § 9. Methods of form- ing combinations. § 10. Growth of combinations after 1880'. § 11. The great period of trust formation. § 12. Height of the movement toward combinations. § 13. Motive to avoid competition. § 14. Mo- tive to effect economies. § 15. Profits from monopoly and gains of promoters. § 16. Monopoly's power to raise prices. § 1. Kinds of monopoly. 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 condi- tions so as to get higher prices than they could get in a free and open market.^ There are traces of the 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. 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. Monopolies may, for special purposes, be classified as selling or buying, producing or trading, lasting or temporary, 1 See Vol. I, ch. 8, on competition and monopoly, and ch. 31 on mo- nopoly prices and large production. An uuderstanding of the defini- tions and of the general principles distinguishing competition and mo- nopoly is necessary to a profitable discussion of the practical problem of monopoly. 505 506 PUBLIC POLICY TOWARD PRIVATE INI/oSTRY [Pt. V general or local, monopolies.^ The term monopoly applied by its etymology ^ only to selling, but by usage also to buying. Under conditions of barter the selling and the buying monop- olies would be the same things 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's Bay Com- pany, dealing in furs, had virtually 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 dura- tion of control. By far the larger number are of the tem- porarj' 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 peri- ods of high and low prices. Monopolies are general or local, according .j the extent of territory where their power is felt. At its maximum, where transportation and other costs most effectually shut out com- petition, monopoly power shades off to zero on the border- line of competitive territory. The frequent use of the ad- jectives partial, limited, and virtual are implied but usually superfluous recognitions of the relative character of monopoly. - For definitiong and discussions of monopoly as economic power and as an enterprise in which power is exercised, the reader should carefully consult the various references in the index of Vol. I. 3 See Vol. I, p. 76. Ch. 30] THE PROBLEM OF INDUSTRIAL MONOP^i^Y 507 § 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 govern- ment, forbidding others to engage in that business. The typ- ical 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 a copyright on books, the object of which is to stimulate 'in- vention, 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 obtained for nothing. Moreover, the patent, being limited in time, expires and be- comes 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 serv- ice 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 and capitalistic monopolies. Monopoly has been called economic or natural when it rests on the owner- ship of scarce natural agents, as mines, land, water-power, under the control of one man or one group of men who agree on a price. Economic monopoly is a result of private prop- erty that is undesigned by the government or by society. It is exceptional, considering the whole range of private prop- erty, 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 rich- est iron-mines of the country as to be able to fix a price dif- ferent 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 monop- 508 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Ft. V olization. Economic monopoly merges into political monopo- lies, such as patents and franchises. Private property is a political institution designed to increase social welfare, and only rarely is property in any particular business a monopoly. Private control of any great natural resources might have been prevented in many cases had it been foreseen. Monopoly is called capitalistic, or contractual, or organ- ized, or commercial, or industrial, when it arises from the power under one control to dominate the market, to intimi- date opposition, and to keep out or limit competition by the mere magnitude of iwealth. These various kinds so merge into one another that they cannot always be distinguished in practice. A patent may help a capitalistic monopoly in get- ting control of a market ; great wealth may enable a company to get control of rare natural resources. § 4. Monopoly and corporate organization. It is nec- essary to distinguish from monopoly three other features appearing in some enterprises, that are readily and constantly confused with monopoly, viz. : large individual capital, large production, and corporate organization.* Evidently any one of these four 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 monop- oly, and numerous examples could be given of large produc- tion, 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. It- * See Vol. I, p. 267, on capital; pp. 388-393, on large production. See also references in preceding not* 1 on monopoly. Ch. 30] THE PROBLEM OF INDUSTRIAL MONOPOLY 509 self 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 corpo- rate form of organization. And monopoly power no doubt is more easily gained by large aggregations of capital in a cor- poration having the advantages of large production. In the frequent concurrence of these four f eatvires in a mod- ern industry, probably the dominant role is taken by corpo- rate organization. It has been, often in a special sense, causal in that it has made possible and advantageous great aggrega- tions of capital and large units of production, and thus has bestowed monopolistic power. § 5. Rise of the corporation concept. In the legal sys- tems of primitive people and long afterwards, 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 a college or a university (a number of persons united into one association) ; a group of craftsmen became a gild corporation. Each corporation had certain rights, privileges, and immuni- ties, and used a corporate seal as a signature. All of the early corporations had some economic features that were inci- dental to the main purposes, which were political, ecclesias- tical, 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 for- eign trade, colonization, and banking. These increased in the 510 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pi. V 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. 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 corpo- rate form of organization was extended to a greater number and to other kinds of enterprises. § 6. Advantages of corporate organization. The cor- porate form 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 lim- ited by charter to his share capital. It is an advantage that permanent enterprises of that kind are owned by corpora- tions with charters perpetual or for long periods. It is pos- sible 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 organiza- tion increased at a cumulative rate, until now it is applied to many enterprises of small extent and local in operation. Of the 300,000 corporations making returns to the United States Commissioner of Internal Eevenue in 1915, 70,000 were 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. With the corporations came the "corporation problem," a ,Ch. 30] THE PROBLEM OF INDUSTRIAL MONOPOLY 511 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 busi- ness. The problems difEer also in corporations of different sizes and in different businesses. Of the various forms of cor- porations, banks iirst presented problems calling for eco- nomic legislation and regulation. This is explained by the fact that it was the first kind of business corporation to be- come important, and further by the fact that its work was in various ways closely connected with 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 pecul- iarly vital and far-reaching effects that such railroad ' trans- portation has upon all other kinds of business in the com- munity. Finally, industrial monopoly loomed before the American people threatening the very existence of our demo- cratic society. § 7. 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 as a favoring condition. Before the middle of the last cen- tury 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.^ 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 popu- lation. The number of small establishments has been in- creased by the many industries producing the things once made on farms, and by increasing demands for comforts 5 See ch. 27, § 3; and eh. 26, § 7 and § 8. 512 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 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 eotton-weaving factories was about the same in 1900 as it had been seventy years earlier, while population had grown sixfold. 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 dis- tricts at the same time that the mills became larger in the great population centers. But the average number of em- ployees and the average capital per establishment increased in every period between census enumerations. § 8. Trusts and combinations. In the discussion of monopoly, misunderstanding has resulted from lack of definite- ness in the use of words, which have rapidly shifted in mean- ing. The word tntst was 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 organiza- tion, 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 rail- roads.'' The word combination referred originally to a more or less thorough "merger," with a view to attaining monop- olistic 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 6 As in the list in § 10 and § 11, below. Ch. 30] THE PEOBLEil OF INDUSTRIAL MONOPOLY 513 a narrower or wider sense) even as applied to a single enter- prise 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, or water-works plant) or by a single corporation that has simply grown monopolistic (without the trust form of organization or without combina- tion. The chief problem is monopoly, however attained. In accord with growing and now dominant usage, it is well to observe the following meanings in our discussion. Comiina- tion is a term referring particularly to one method by which monopolies are formed. Trvst, in the now popular sense, is best limited to an industrial, primarily manufacturing, en- terprise or group of enterprises, with some degree of monop- oly power due 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 uUUty is the name of an enterprise having a "special franchise" giv- ing the use of streets and highways and the right of eminent domain, and includes, in the broad sense, railroads and local utiUties, such as street railways, gas, water, and electric- light plants. § 9. Methods of forming combinations. Combinations of previously independent enterprises may be more or less com- plete and are made by different methods. Four major meth- ods are: (1) The pool, by which the enterprises continue to be sepa- rately 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 in § 8). 514 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V (3) The holding company, a corporation with the sole pur- pose of holding the shares of stock, or a controlling number of them, in various corporations otherwise nominally inde- pendent. (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 cor- poration, sufBcient to give substantial influence over its pol- icy, if not absolute control. (7) Ownership of stock, by the same individual or group of individuals, in two or more competing companies, to such an extent as appreciably to unify the policies of the compet- ing 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 con- ferences and understandings as to common policies. § 10. Growth of combinations after 1880. Undoubtedly, industry before 1860 had some elements of monopoly. Mo- nopoly constituted part of the banking problem; it began to be evident in the railroads almost at once, and it rapidly in- creased as street railways and other public utilities were con- structed. 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 selec- Ch. 30] THE PROBLEM OF INDUSTRIAL MONOPOLY 515 tion of the companies to be included in the lists. One finan- cial authority gave the following figures^ regarding the in- dustrial companies reorganized into larger units in the United States between 1860 and 1899, not including combinations in such businesses as banking, shipping, and railroad transporta- tion. Some of the enterprises here included have much and others probably have little or no monopolistic power. Decade Number Organized Total Nominal Capital 1860-63 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 § 11. The great period of trust formation. The number of trusts organized and the capital represented by this move- ment 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 13 108,000,000 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, although the total nominal capital (stocks and bonds) was still the greatest it had ever been in any year. Then came the period of de- pression, 1894-97, when both the numbers and the capital were comparatively small. Then from 1898 to 1901 followed 7 Compiled from data given by the "Journal of Commerce and Com- mercial Bulletin," reprinted in the "Commercial Year Book," Vol. V, 1900, pp. 564-569. 516 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pi. V 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, Amer- ican Woolen, Royal Baking Powder, Standard Oil of New Jersey, 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. § 12. Height of the movement toward combinations. In a list by another authority ° it appears that the data for all industrial trusts are in round numbers as follows : Numher of Plants Ac- Date Number quired or Controlled Total Nominal Capital Jan. 1, 1904 318 5288 $7,246,000,000 These figures, compared with those given above, wou?d 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 move- ment 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 Ac- Total Groups Numher quired or Controlled Nominal Capital 1. Greater industrial trusts 7 1528 $2,260,000,000 2. Lesser industrial trusts 298 3426 4,055,000,000 sjolin Moody, "The Truth About the Trusts," 1904 Ch. 30] THE PROBLEM OE INDUSTRIAL MONOPOLY 517 No. of Plants Ao- Total Groups Numher quired or Controlled Nominal Capital 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 rail- road groups 6 790 9,017,000,000 6. Allied independent railroad groups 10 250 380,000,000 Total, 445 a 7664 a $20,000,000,000 ■ In round numbers. § 13. 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 ex- planation 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 a trust. In other cases the smaller enterprises have been eager to be taken in at a good price, although 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. § 14. Motive to effect economies. Another advantage of the combination of competing plants that was strongly em- 518 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V phasized was the economy of large production." The econo- mies 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 prod- uct. 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 con- trol credit better and escape losses from bad debts. By regu- lating 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 industrj- 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 prod- uct. A railroad line across the continent owns its own steam- ers for shipping goods to Asia or Europe. Large wholesale houses own or control the output of entire factories. § 15. Profits from monopoly and gains of promoters. There are, however, well-recognized limitations to the econ- omy of large production in the single establishment,^" and of late there has been ever-increasing skepticism as to the net economy actually attributable to combinations. Undoubtedly » See Vol. I, pp. 388-393. "See Vol. I, pp. 391-392. Ch. 30] THE PROBLEM OP INDUSTRIAL MONOPOLY 519 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 contemporane- ous with the developing of "efficiency engineering" and of "scientific cost-accounting," and these better methods, al- ready 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 rea- son 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.^^ Whatever was the more generous motive or more fundamental economic rea- son assigned by the promoters, the investing public confi- dently 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 con- stantly 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. § 16. 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 establish- ments. The same kind of power might be attained by the growth of one establishment outstripping all its competitors, 11 See Vol. I, p. 334, on the function of the promoter. 520 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V or by a new enterprise coming into the field backed by power- ful capitalists. But this would work slower and less exten- sive 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.^^ 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 un- limited 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 toward af- fecting the supply, leaving the price to adjust itself. It can affect the supply either by lessening its own output or by in- timidating 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 though the limitation of supply is effected later by successive acts found necessary to maintain the higher price. The report of the Federal Indiistrial Commission, which from 1898 to 1901 investigated the trusts, showed" that im- mediately upon their formation the industrial combinations 12 See Vol. I, pp. 80-8.5, 382-387, 394-396. 18 A summary of this evidence is given in the author's "Principles oi 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, vrho acted as expert in the investigation. CS. 30] THE PROBLEM OP INDUSTRIAL MONOPOLY 521 had raised their prices. Prices might be lowered again, but only when and where competition became troublesome, thus causing either "price-wars" or discrimination. Refeeences. Bolen, G. L., Plain facts ag to the trusts and the tariff. 1902. N. Y. Collier, W. M., The trusts. N. Y. Twentieth Century Press. 1900. Cotter, A., The authentic history of the United States Steel Cor- poration. N. Y. Moody magazine book Co. 1916. H.obson, J. A., The evolution of modern capitalism. N. Y. Scribner. 1912. Ch. V. Jones, Eliot, The anthracite coal combination in the United States. Harvard Univ. Press. 1914. King, W. I., The wealth and income of the people of the United States. N. Y. Macmillan. 1915. Meade, E. 8., Trust finance. N. Y. Appleton. 1903. Montague, O. H., Trusts of to-day. N. Y. Doubleday. 1904. ( Favorable. ) Ripley, W. Z., (Ed.), Trusts, pools and corporations. Ed., 1916. Stevens, W. S., (Ed.), Industrial combinations and trusts. N. Y. Macmillan. 1913. Stevens, W. S., Unfair competition. Univ. of Chicago Press. 1916. CHAPTER 31 PUBLIC POLICY IN RESPECT TO MONOPOLY § 1. Moral judgments of competition and monopoly. § 2. Public char- acter 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. Federal legislation against mo- nopoly. § 10. Policy of the Sherman Anti-Trust Law. § 11. Policy of monopoly accepted and regulated. § 12, Field of its applicatioa § 13. The industrial trust, — a natural evolution? § 14. Artiticial versus natural growth. § 15. Kinds of unfair practices. § 16. Growing conception of fair competition. § 17. The trust issues in 1912. § 18. Anti-trust legislation of 1914. § 19. Guiding principles of the new policy. § 20. Some early fruits. § 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 com- petition and monopoly. Competition usually is pronounced bad when viewed from the standpoint of the competitors who are losing by it, and .good when viewed from the stand- point of the traders on the other side of the market who gain by that competition. Competition among buyers thus ap- pears to sellers to be a good thing ; that among sellers appears to themselves to be a bad thing (and vice versa). Many per- sons 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 522 Ch. 31] PUBLIC POLICY IN RESPECT TO MONOPOLY 523 industries, those that are thought of as supplying the "gen- eral 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 co- operation. The roots of these opinions, or prejudices, are easily discoverable in the theoretical study of the nature of monopoly.^ Yet often different men or groups of men feel so strongly on this matter, viewing it from their own stand- points, that they are quite unable to understand how any one else can feel otherwise. There is thus a great deal of con- troversy to no purpose. § 2. Public character of private trade. Any such gen- eral judgment as that of the public, though 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. Bach bidder is compelled by self-in- terest 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.^ This price, men are ready to accept as fair. It has a democratic character, whereas the gains of monopoly price arouse resent- ment as being the work of personal power and felt to be des- potic. Monopoly price is a bad price to the one who pays 1 See Vol. I, especially pp. 74 and 75. 2 See Vol. I, pp. 59, 68, 70, 71. 524 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 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 disad- vantage. The modern world has been compelled to reexamine the conception of the just price. § 3. Evil economic effects of monopolistic price. The- oretical analysis confirms this view. Any exercise of monopo- listic power over price keeps some, the weaker bidders, from getting any of the desired goods, or limits them to their most urgently desired imits. What may be called the "theoret- ically correct price ' ' ^ 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 sub- stitution of goods by trade, the sum of values of goods for most men is diminished. Thus all citizens who are the vic- tims 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 bad effect upon the spirit of all those trading with it. If they are producers selling at prices depressed by mo- nopoly, their money incomes are reduced; if they are con- sumers buying at monopoly prices, their real incomes are re- duced; 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 re- corded case in English laiw wherein the courts sought to pre- vent the limiting of competition by agreement runs back to the year 1415, in the reign of Henry V. This was a very a See Vol. I, pp. 66, 67. Ch. 31] PUBLIC POLICY IN RESPECT TO MONOPOLY 525 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 doc- trine of the moral and legal obligation of each economic agent to compete fully, freely, and without restraint, even re- straint imposed 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 "reason- able" 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" com- petition, 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 con- tract grant an exclusive agency to a dealer in a certain ter- ritory, there being many other competing makes of pianos, and such a contract "does not operate to suppress competi- tion nor to regulate the production or sale of any commod- ity. ' ' * But with such moderate limitations the courts in cases under the common law have steadily disapproved eon- tracts in restraint of trade that would appear to be to the disadvantage of third parties, whether producers or con- sumers. § 5. Growing disapproval of combination. The attitude of the courts became in one respect stricter. Some earlier cases involved the doctVine that what is lawful for an indi- vidual to do alone is lawful if done in combination with oth- ers. Indeed, a comparatively recent case ^ declared, regard- ing a group of dealers agreeing not to deal with another, that * 77 Miss., 476. Cited by Bruce Wyman, "Control of the Market," p. 137. » 19 E. I., 255. 526 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pi. V "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. ° Yet in the case cited the court seemed to have been more con- cerned 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 re- sults. 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 Eng- lish case ^ 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 steam- ship 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 stand- ard 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 though there are other cases difficult to harmonize with it.* To the economist, not bound in like manner by legal prece- dent, such a verdict seems short-sighted and mistaken. The court appears to have considered only the rights of the private litigants, the tramp steamship owners, not the 6 115 Ga., 429. 7 Mogul Steamship Company v. McGregor (L. R. 23 Q. B. D. 598). 8 Bruce Wyman, "Control of the Market," p. 22. But see next §. Ch. 31] PUBLIC POLICY IN RESPECT TO MONOPOLY 527 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 monop- oly. These acts are forms of the "unfair" practices that will be mentioned later." § 7. Increasing regard for results of competition. De- spite the binding precedents, the courts in some later deci- sions have refused to look upon competition as good regard- less of its motives and of its consequences. In a federal case ^^ 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 them- selves, and cause great public and private loss." The court's opinion was no doubt largely influenced by the fact that rail- road rates were already subject to regulation: "Every pre- caution has been taken by state legislatures and by the Con- gress to keep them just and reasonable, — just and reasonable for the public and for the carriers." In a state case ^^ 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 economist can but pronounce this judgment admirable as 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. s See below, § 15. loAverrill v. Southern Railway (75 Fed. Rep. 736). 11 107 Minn. 145. 528 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V The further enlightenment of judicial opinion upon the subject of cutthroat competition used as a tool to create monopoly was shown in the granting of an injunction by a federal court, in 1914/^ restraining the use of "fighting- ships" by a combination, and by the indication in 1915 ^^ of the willingness to grant a similar injunction if necessary. Similarly "fighting brands" of goods have been recently pro- hibited. § 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 doc- trine by which the railroads, as common carriers, ought to have given equitable and undiscriminating rates to all ship- pers. There was a strong body of influential opinion that long maintained that the common law was sufficient to prevent monopoly, that the only thing needed was to enforce it. 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 colnmon 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 pri- marily 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 who felt injured. Now the injury of higher prices due to contracts in restraint of trade is usually difi'used 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 be- fore the courts except by one of the two equally guilty parties to a contract in restraint of trade, when the other party had 12 216 Fed. 971. 13 220 Fed. 235. Cn. 31] PUBLIC POLICY IX RESPECT TO MONOPOLY 529 failed in some way to do his part. When such an illegal con- tract in restraint of trade was proved before a court by a defendant in a civil suit, the contract was declared unenforce- able, and the only penalty in practice was that the plaintiff could not collect his debt or secure performance from the defendant/* A very similar situation existed in the case of the individual's grievances against railroad charges and serv- ices. § 9. Federal legislation against monopoly. The passage of the Interstate Commerce Act in 1887 ^^ prohibiting dis- crimination 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 con- tract, combination in the form of trust or otherwise, or con- spiracy, in restraint of trade or commerce among the several states, or vsdth foreign nations." Section 2 made it a mis- demeanor "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 in- volved 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,^" but ' ' to regulate com- merce, " "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 "Arnott V. Pittston and Elmira Coal Co., 08 N. Y. 558 (1877). i=See ch. 29. § 15. 16 At the same time the rights of injured individuals are better safe- guarded by section 7 of the Sherman law. permitting the recovery of three-fold damages and attorney's fees. 530 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V 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 ineffec- tive, but time and experience could remedy those defects. In important ways 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) mo- nopoly accepted and regulated, (3) competition maintained and regulated. § 10. Policy of the Sherman Anti-Trust Law. The policy of monopoly prosecuted embodied in the Sherman law is merely negative. It opposed no positive action to the mak- ing of monopolistic contracts and to the formation of com- binations, but declared them to be illegal and provided for their prosecution and punishment after the mischief had been done. The great epoch of the formation of combina- tions " followed the enactment of this law. True, lack of experience by the department of justice, and lack of vigor- ous effort to enforce the law, and the slow action of the courts were largely to blame for this result. The law has proved to be more effective to prevent new combinations, since it has been successfully enforced in a few notable cases. But once large combinations have been formed and complex individual financial interests have become involved, the courts have proved to be incapable of undoing the deeds. In practice the most sweeping remedy attempted under the law has been the dissolution of enormous combinations formed years after the law went into effect. This has been called the job of unscrambling the eggs. The most notable cases were those of the Standard Oil Company and of the 17 See ch. 30. § 8. Ch. 31] PUBLIC POLICY IN RESPECT TO MONOPOLY 531 Tobacco Company, decided in 1911, the results being absurdly futile. § 11. Policy of monopoly accepted and regulated. A sec- ond policy may be called that of monopoly accepted and regu- lated. This is represented by the Interstate Commerce Act (at first weakly, and more vigorously after its amendment), and by the great mass of state legislation putting the local and interurban public utilities under the control of regula- tive commissions. For some decades after these industries developed, the public faith was in competition as the effective regulator. If monopolistic prices were too high, another com- pany was chartered to build a parallel railroad or another horse-car line on the next street, or to lay down another set of gas-pipes in the same block. Almost from the first, some students of the subject saw the wastefulness and futility of this kind of competition, and nearly a half-eentuxy later the public reluctantly came to this view. Still, sad to relate, the same history had to be repeated in regard to the telegraph and telephone industry, and in some quarters the ultimate outcome is not yet recognized. The Interstate Commerce Act itself, with odd inconsistency, contains an anti-pooling provision (Section 5), the purpose of which seems to have been to compel competition as to rates, which is now practically im- possible under the other provisions of the law. The policy of "monopoly accepted" iwas seen to involve as a necessary feature public regulation of rates to the point, if necessary, of absolutely fixing them. The principle has come to be ac- cepted that wherever competition ends there public regula- tion of prices and service begins. Monopolistic enterprises are ipso facto quasi-public institutions. § 12. Field of its application. This policy, gradually ex- tending in practice, came to be applied to the class of indus- tries which, for lack of a better name, are called local utili- ties. The one characteristic that they all have in common is that the service, or product, which is sold requires for its delivery some special use of public highways and an expen- SS2 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V sive, permanent, physical plant, such as gas-pipes, water- pipes, poles and wires. The telegraph, the telephone, electric lighting, street railways, regular steam railroads, and some other minor industries all answer to this test.^* Beginning about the year 1900, one state after another enlarged the powers of its state railroad commission or cre- ated a new corporation commission to regulate these "local" or "public utilities." ^^ They have accomplished much, but the development of this kind of regulation has not proceeded in many eases beyond the adjustment of relative rates and the abolition of discrimination among the different individ- uals and classes of customers. Experience has shown the great difficulty of determining what is a fair absolute level of charges. A new science of accounting has been develop- ing to assist in the solution of a problem the compel exity of which transcends the agencies at hand to deal with it. With this policy applied to the local utility (and railroad) phase of monopoly, there remains still the problem of the industrial trusts in the manufacturing enterprises. § 13. The industrial trust — a natural evolution? The policy that one is inclined to favor regarding industrial trusts depends very much on one 's answer to the question : Are or are not industrial trusts natural growths ? In this bare form the question is somewhat vague, but the thought of those who answer it in the affirmative is positive if not always entirely clear. They (at least, the extreme representatives of this view) declare that trusts have been, are, and will continue to be the results of a "natural evolution" of business condi- tions, as inevitable as the great changes in the physical world. If this is so, man and society must recognize the facts, must waste no efforts vainly in fighting against fate, but must accept the trusts and realize their possibilities for good. And these are declared to be great, for it is assumed that without the trusts all of the economies of large production must be 18 See further, ch. 32, §§ 5-9. IS See cli. 29, § 3, on state conHmissions. Ch. 31] PUBLIC POLICY IN RESPECT TO MONOPOLY 533 sacrificed. Irresistible economic forces, it is said, are creating larger and larger units of business; friendly cooperation and unified action must take the place of competition in business. The outcome must be monopoly in every important line of manufacturing industry and perhaps of commerce. In view of public opinion toward monopoly, its acceptance necessi- tates its regulation. This argument is supported by appeal to the experience in the field of railroads and other local utili- ties, where public opinion has, after long hesitation, recog- nized competition to be impracticable and the acceptance of monopoly as inevitable. As extremes often meet, the view of the industrial trust as a natural evolution is most favored, on the one hand, by men of ' ' big business, ' ' already interested financially in trusts, and, on the other hand, by the most radi- cal communists (or socialists) whose ideal is the complete monopolization of industry under the government. § 14. Artificial versus natural grov?th. Opposed to this view is a deep and widespread popular opinion, or prejudice, against the trust and in favor of competition. General opin- ion in this case (as not always) finds much support in special economic studies of the methods by which the existing indus- trial trusts came into being. First the question properly is raised : Just what is meant by ' ' natural " ? In a sense, every- thing has been the natural outcome of evolution — the steam engine, the submarine, the boycott, militarism. In an equally good if not better sense, every mechanical invention and every method of industrial organization is artificial, has been the result of man's choice and effort. In any case, men may choose as good, or reject as unsuitable or bad, any particular mechanical device, and society may decide to adopt any par- ticular policy toward a certain form of business organization and certain business practices (unless, indeed, our philosophy be that of automatism, crude determination or fatalism, re- garding all human afEairs). Now, when one examines the methods that the notable trusts actually did employ, and apparently had to employ, 534 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V even when they were already powerful single enterprises, in order to destroy their competitors and to attain their monopo- listic power, the word "natural" seems hardly to describe the process. The evidence is not a matter of hearsay, but is embodied in a long line of judicial decisions, and in numerous special inquiries by governmental commissions and officials. § 15. Kinds of unfair practices. This evidence is a star- tling array of "unfair practices" and "unfair" forms of competition, which, however novel in appearance, are essen- tially of the kind that have been illegal under the common law for the past five hundred years. Many of these practices were baldly dishonest, many of them were contemptibly mean. The manifold varieties of unfair competition may be roughly grouped under three headings, according as they are connected with (1) illegal^ favors received from public or quasi-public officials; (2) discrimination against, or control of, custom- ers; (3) foul tactics against competitors. (1) Among the practices in the first group are discrimina- tory rates and rebates from railroads, favoritism in matters of taxation, undue influence in legislatures, special manipula- tion of tariff rates through powerful lobbies or paid agents, undue influence in the courts through the employment of law- yers of the highest talent, who often later became judges. (2) Among the unfair practices toward customers are dis- criminations among them by the various forms of price-cut- ting, grants of credit, and kinds of service. The liberty of retail dealers is limited in a variety of ways, such as flxing resale prices, requirement of exclusive dealing, and full-line forcing. (3) All the methods just mentioned as employed in deal- ings with customers are likewise unfair toward competitors. Many other methods are used to the same end, such as : entic- ing away their employees, or corrupting and bribing them to act as spies, paying secret commissions, false advertising, misrepresenting competitors, imitating their patterns in goods of defective workmanship, shutting off their credit or their Ch. 31] PUBLIC POLICY IN RESPECT TO MONOPOLY S35 supplies of materials, acquiring stock in competing compa- nies, malicious suits, infringement of patents, intimidation by threats of business injury or of scandalous exposures, opera- tion of bogus independent companies. § 16. Growing conception of fair competition. Any in- dustrial trust that was able to gain domination and monopoly power only by the use of such practices, or any part of them, can hardly be deemed the result of a "natural evolution." If "artificial" means the use of artifices, surely this develop- ment deserves the adjective. Yet, even if not natural, this development may be thought to be "inevitable," human na- ture being as it is. But the bald fact is that while the great trust movement was in progress no effort worthy of the name was being made to enforce even the then existing laws and to oppose this artificial development. The same allegation of inevitableness was once commonly made of discriminatory railroad rates and rebates, evils that have been in large part remedied only since the period 1903-1906, when at last in- telligent action was taken. To those who came to see the problem in this light, accept- ance of industrial monopoly, with its complex task of fixing by public commission the prices on innumerable kinds and qualities of goods, seemed at least premature. Eather, the first step toward a solution seemed to be the vigorous preven- tion of unfair practices, and the next step a positive regular- izing of "fair competition." The fundamental idea in this is the enforcement of a common market price (plus freights) at any one time to all the customers of an enterprise. By this plan, potential competition would become actual, and small enterprises that were efficient might compete success- fully within their own fields with large enterprises that main- tained prices above a true competitive level. Even general lowering of prices by a large enterprise with evident purpose of killing off smaller competitors is unfair competition under this conception. It was for years recognized that the realiza- tion of this policy required legislation regarding uniform 536 PUBLIC POLICY TOWARD PRIVATE INDUSTRY [Pt. V prices and the creation of a commission for the administra- tion of the law. § 17. The trust issues in 1912. The campaign of 1912 presented in an interesting manner the three policies above outlined. The Republican party, led by President Taft, stood for the policy of monopoly prosecuted; its program was the vigorous enforcement of the Sherman law. The Progressive party, led by Mr. Roosevelt, stood in the main for the policy of "monopoly accepted and regulated"; its program called for minimizing prosecution and for retaining trusts under a system of regulation. The Democratic party, led by Mr. "Wilson, stood for the policy of competition maintained and regelated, and the problem was to find means to strengthen and regularize the forces of competition. In practice these programs doubtless are less divergent than they appear. All alike proposed the retention of the Sherman law. The two proposals to go further were pre- sented as mutually exclusive alternatives, whereas they nec- essarily must supplement each other in some degree. The Progressives did not expect all industries to become monopo- lies, and the Democrats tacitly conceded to monopoly accepted the large field of transportation and local utilities it already had occupied. But there was a real difference in the angle of approach and a real difference in emphasis. The Demo- cratic program (though somewhat unclearly) showed greater distrust of monopoiV ^^^ greater faith in the possibilities of creating fair conditions of competition (which never had fully prevailed) in which efficiency would be able to prove its mer- its and monopoly would work its own undoing. It is more logical for the country to give this policy an adequate trial before adopting irrevocably the policy of general industrial monopoly. In either case, competition actual or potential is the fundamental principle by which prices have to be regu- lated. "Where competition is enforced it is by applying some general rules that create a general market price instead of discriminatory prices, but the fixing of the price is left to the Ch. 31] PUBLIC POLICY IN EESPECT TO MONOPOLY 537 competitors. Where monopoly is accepted prices must be fixed with reference to an estimated competitive standard, that which under hypothetically free conditions would just suffice to attract and retain private enterprise and capital. § 18. Anti-trust legislation of 1914. The anti-trust legis- lation of 1914, passed by the Democratic party to carry out its program, is embodied in two acts: the Clayton Act and the Federal Trade Commission Act. The Clayton Act for- bids discrimination where the effect may be to lessen com- petition or tend to create a monopoly, and lays down new rules f-or determining fair prices. It permits due allow- ance to be made for differences in the cost of selling or transportation, but a difference is not required in such cases. It forbids contracts to prevent dealers from handling other brands. It forbids corporate ownership of stock in a com- peting corporation, forbids interlocking directorates in large banks and in other competing corporations, with capital, sur- plus, and undivided profits aggregating more than $1,000,000. The Federal Trade Commission Act provided an agency with administrative and quasi-judicial functions to deal with unfair practices, displacing the Bureau of Corporations, established in 1903. In addition to its administrative provisions for investigation, reports, and readjustment of the business of companies upon request of the courts, the act declares that "unfair methods of competition in commerce" are unlaw- ful, and both empowers and directs the Commission to pre- vent their use (banks and common carriers subject to other acts being excepted). § 19. Guiding principles of the new policy. The Com- mission in March, 1915, began its work. Only two years later, and for the next three years, it was called upon to give a large part of its efforts to aiding other governmental agencies in their war-time and post-bellum work, especially in cost- fixing investigations, and could not adequately perform its original task. At the end of six years, many of the evils which the Commission was designed to correct still prevailed. 538 PUBLIC POLICY TOWAED PRIVATE INDUSTRY [Pt. V The price advances within that period had been so swift and bewildering that they obscured all distinctions of normal demand, normal supply, fair price, war- profiteering, and monopoly. For example, investigations in 1921 in New York and other cities revealed incredible monopolistic practices in the building industries, by labor and capital alike. But for all this it cannot be doubted that a new and potent agency for creating higher business standards has been brought into existence. The new legislation drew the atten- tion of the country to the development of a better commercial morality. Many business men wrote to the Commission com- mending the purposes of the law, and offering their coopera- tion to eradicate long standing practices which they deplored. The Commission admirably declared that it iwas seeking "to understand and make allowance for the difficulty of the prob- lem, to see both sides of every case, to protect men in the furtherance of legitimate self-interest by all reasonable and normal methods, and at the same time to keep the channels of competition free and open to all, so that a man with small capital may engage in competition with powerful rivals, as- sured that he may operate his business free from harassment and intimidation and be given a fair opportunity to work out his business problems with such industry, efficiency, and intelligence as he may possess." § 20. Some early fruits. Through the investigations of its economic division the Commission has collected a stupen- dous mass of detailed information on the conditions and the trade practices in many of the leading industries of the coun- try, throwing the light of publicity into many a dark corner of commercial abuses. The legal division of the Commission at the end of its first five years had received almost exactly two thousand ap- plications for complaints (for unfair practices and violation of the C'ayton Act), upon which it had made inquiries and dismissed about one half without publicity. The number of these had increased each year, more than one third having Ch. 31] PUBLIC POLICY IN RESPECT TO MONOPOLY 539 been in the last year. The Commission had in more than six hundred of these cases issued , formal complaints, of which more were in the last year than in the previous four years. In taking up these complaints the names of the complain- ing parties are not disclosed. The Commission's work is primarily to protect the public interest and not merely to intervene in "contests between individuals in relation to their private rights." On this theory, the Commission may and does institute proceedings "on its own motion without charges being made to it or iipon application of parties not directly affected by the practices complained of." This present policy in respect to monopoly stands out in striking contrast to the theory of the private litigant and the injured party as embodied in the preceding law and practice. It still remains to be seen whether, in the near future, it will be possible to scotch the snake of monopoly and give to the "common man" the chance to live and work according to fair rules of the game in business enterprise. REFEEEIirCES. Bolen., G. L., Plain facts as to the trusts and the tariff. 1902. N. Y. Brown, W. J., The prevention and control of monopolies. N. Y. Button. 1915. Clark, J. B., The problem of monopoly. N. Y. Lemcke. 1904. Clark, J. B., and J. M., The trust problem. Doubleday. 4th ed. 1917. Davies, J. E., Trust laws and unfair competition. U. S. Bur. of Corporations. 1916. Ely, R. T., Monopolies and trusts. N. Y. Macmillan. 1900. Grunshy, G. E., Public utility rate fixing. Journal of electricity technical book shop. 1918. Jenks, J. W., The trust problem. Kev. ed. N. Y. Doubleday. 1917. Kinley, David, The renewed extension of government control of economic life. A. E. Rev., 4 (no. 1, supp.) : 3-17. 1914. LeRossignol, J. E., Monopolies past and present. N. Y. Crowell. 1900. Orth, 8. P., (Ed.), Readings on the relation of government to prop- erty and industry. Bost. Ginn. 1915. t^j tj x Ripley, W. Z., (Ed.), Trusts, pools and corporations. Ed. Bost; Ginn. 1916. . . ., , ^ ^ * Turherville and Howe, Great Britain in the latest age— from Uissez faire to state control. New York. Dutton. 1921. United States Industrial Commission, Report. 1898-1901. 19 vols. Wyman, Bruce, Control of the market. N. Y. Moffat. 1911. PART VI PRIVATE PROPERTY VERSUS SOCIALISM CHAPTER 32 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 im- portance 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 in- stitutions 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 forebears. It is, indeed, a people 's whole state of civiliza- tion, with its political, economic, intellectual, scientific, re- ligious, 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 modem state make use of their own energies and of material wealth within the nation. We live in a regime of private prop- erty, and all our economic problems are affected by that fact. The determination of the exact boundaries of private property 543 644 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 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, defini- tion, or, more radically, abolition of present laws of property. Broadly understood, as above, therefore, determination of the nature of private property is the essential problem in eco- nomic legislation. § 2. Nature of property. Property means ownership, and ownership is the abstract noun expressing the qua,lity 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.^ Physical possession of an object is not necessarily ownership. The law makes between property rights and equitable rights some subtle distinctions, which have their reason in the his- tory, if not in the logic, of the law, but fwhieh 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. 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 1 See Vol. I, pp. 264-267. Ch. 32] THE PRESENT ECONOMIC SYSTEM 545 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 prop- erty and with many intermediate grades between private and common property. Though property meant originally and essentially the intan- gible 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 impos- sible 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 fail- ure 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.^ 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 in- 2 This confusion has had important practical consequences in the field of taxation. See Vol. 1, pp. 265-267, and above, ch. 18, §§ 3-5. 546 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI come of an individual constitutes 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 ex- istence 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 doe? :i 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 in- habitants, who in turn had taken them from other occupants many centuries before. The conquest theory applies, for ex- ample, to the invasion of the Roman provinces by barbarian tribes who divided the country and developed the feudal sys- tem 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 muscles have imparted value. It is apparent that this test leaves without explanation or justification a great num- ber 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 doc- trine, which makes no appeal to experience and results, is now quite discredited in political science. Ch. 32] THE PRESENT ECONOMIC SYSTEM 547 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. Although, 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 the five 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. They aU. find some place within a more comprehensive sixth theory, that of social expediency, which will be outlined be- low. First, however, let us briefly survey some of the histori- cal and legal qualifications of property as it has been and is. § 5. Origin vs. justification. The question of the origin is not the same as that of the present justification of the ex- isting system of private property. The institution of private property has evolved under diverse conditions. In early so- cieties 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 548 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI in land. A few years ago it was generally believed that the organization of the old German tribes was politically an al- most perfect democracy, and economically a communism in which all had equal claims upon the land. To-day this opin- ion is very seriously questioned. It seems probable that there was a goodly measure of communism in the control and use of lands (though not in other things), but this was largely eon- fined to an oligarchy of the favored ; whereas the masses lived in subjection, cut off from all but a meager share in the com- mon 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. Com- petition tended to bring the economic agents into more effi- cient 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 in- stitution 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 re- mote 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 in- stitutions by their present results. § 6. Limitations of private property. It is well, in dis- cussing private property, to rid the mind at once of the idea that it is an absolute and unchanging thing. Pew realize the manifold ways in which property rights are limited. Un- modified 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 Ch. 32] THE PRESENT ECONOMIC SYSTEM 549 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 may take the old homestead from the owner who would live and die there. Although pecuniary damages are paid to him, this is a limita- tion of his property rights. Bights of way on property exist either by contract or by prescription permitting its public use. Most important of all limitations is the right of tax- ation, 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 equity 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 con- trol 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.^ These claims mutually de- limit 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. § 7. Limitations of bequest and inheritance. The term lequest 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 3 See § 3. 550 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI treat it as necessary. 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 giv- ing outside the family are rare, and are almost always broken in the courts. John Stuart Mill contrasted this with the prac- tice in America, frequent even in his day and still more fre- quent now, of rich men giving for public purposes. In France the right of bequest outside the family is legally lim- ited; only the share of one child can be willed away by the father, and the rest must be equally divided among the chil- dren. "Settlements" and fidei commissa are limited in many countries because of the recognized soeia,! evils resulting from the tying up of estates for generations. Throughout the" his- tory of England, Parliament has given attention to the ques- tion 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 unlim- ited 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 history and of present political philosophy, the explanation and justification of private property must be on grounds of social expedienci/. 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 con- ditions. Even if private property works hardships to in- dividuals in many cases, it may be justified if, on the whole. Ch. 32] THE PRESENT ECONOMIC SYSTEM 551 it gives the best results that are practically possible. 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 advance the welfare of the nation better than would any alternative plan for the control of economic wealth ? The question is not whether it is fault- less, for no human institution is so. Nor must it be assumed that the rule of property ueeds 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 ex- pediency. In the last chapter have been seen many examples of the fact that 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 who meet the conditions. The very acceptance of the theory of social expediency im- plies the need of frequent readjustment of the institution of private property. The essential thought in the various at- tacks 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 relies 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 de- termined, not according to the logic of expediency, but by the social inertia that 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 one of 552 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI the greatest economico-politieal problems of our day, one that contains within it, indeed, the many minor problems that have appeared in the foregoing 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 con- nected in practice and in the thoughts of men, that every rad- ical proposal or attempt to abolish private property, includ- ing the recent marvelous performance of the Bolsheviki in Russia, 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 priA-ate 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, although it might still be used as a form of counter by the communistic state. We have already seen * how a monetary unit comes into use, and have treated of the nature of money. AYe note here 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 ^ in the biiying and sell- ing of wealth and of the usances and services of economic agents. By competition we mean here the condition of po- litical 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 to- * See Vol. I, p. 51, and above, ch. 2. 5 See Vol. I, p. 73. Ch. 32] THE PRESENT ECONOMIC SYSTEM 553 gether with him to withdraw or to alter his bid, in so far com- petition is limited. Private property and economic competi- tion do not merely happen to exist side by side, forming more or less favored conditions each for the other; they are essen- tially connected.* 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 a universal feature of our pres- ent system, but it is the most general and characteristic method of valuation, of price-fixing, and of trade. § 11. Limitation of competition by custom.' The rela- tively large influence of competition in present society ap- pears 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; though 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 limi- tation 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 6 This will appear in comparing the competitive methods of distribu- tion with other methods in eh. 34, §§ 7-11. 7 See Vol. I, p. 143, on medieval land tenures; p. 158, on customary rents; p. 190, on the effect of caste. 554 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI 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 serv- ices 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 modem 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 that 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 competi- tion. The inefficiency of customary services and the high prices charged by selfish privilege were constant invitations to men to become competitors. JMen strove to break over the barriers of custom and of prejudice. The effort to attain freedom to compete was the vital force of the time. The in- dustrial 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 in- dustrial events following the discovery of America strength- ens 1 the forces making for economic freedom. Discoveries in the western hemisphere opened up a wide field for the ad- ve.iture and enterprise of Europe. Commerce is the strong- est enemy of custom, and new opportunities gave a rude shock to the conservatism both of the manor and of the vil- lage. 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 Ch. 32] THE PEESENT ECONOMIC SYSTEM 655 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 con- sequences, were favorable to competition. Despite these facts, the restraints of the national governments on trade con- tinued great, in some respects increasing during the seven- teenth and eighteenth centuries in France, Holland, and Eng- land. The regulation before attempted by towns and vil- lages was employed on a larger scale by national governments in 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 Eng- lish policy of trade restriction. §13. Adam Smith's influence. "The Wealth of Na- tions," the first great work on political economy, was pub- lished in the year 1776. That was the "psychological mo- ment" 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, follow- ing 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. Although the movement for the repeal of medieval laws has continued in Europe from 1776 till the present time, yet eus- 556 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI torn still is stronger to-day in Europe than in America. Serf- dom 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 cultural forces fur- thered this movement, but the most powerful intellectual force in its favor was the work of Adam Smith. So strong an im- pression 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 prob- lem of the eighteenth century. Many men then thought that in "free and unlimited com- petition" 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 com- petition. This problem has appeared in various aspects throughout the foregoing pages. § 14. The wage system. Viewed in another aspect, the present economic and social order is called the wage system.* 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 many of the newly set- tled states may consist almost entirely of self-employed own- ers of land. Bulgaria, before the Balkan wars called the peasant state, presented this organization (though 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 e See Vol. I, p. 227, and above, eh. 20, §§ 1-4. Cn. 32] THE PRESENT ECONOMIC SYSTEM 557 is the manufacturing, transporting, and large 'commercial en- terprises in which the labor is done for wages. The accept- ance of the wage system thus far has been the inevitable price to be paid for manufacturing and industrial development. References. Brooks, J. G., Labor's challenge to the social order. Pp. 441. New York. Macmillan. 1920. An able description and analysis of the aims and accomplishments of the different labor groups. Cooley, G. H., Human nature and the social order. N. Y. Scrib- ner. 1902. Ely, R. T., Competition: its nature, its permanency, and its benefi- cence. A. E. Assn. Pubs., 3d ser., 2; 55-70. 1901. Ely, R. T., Property and contract in their relation to the distribu- tion of wealth. N. Y. Macmillan. 1914. (2 vols.) Gladden, Washington, Tools and the man. N. Y. Houghton. 1893. (One example of a large number of AmerUan bcoks appealing for the application of Christian ethics to social questions.) Gleason, A., What the workers want. A study of British labor. Pp. 518. New York. Harcourt, Brace and Howe. 1920. King, W. I., The wealth and income of the people of tue U. S. New York. Macmillan. 1915. National Bureau of Economic Research, The income of the U. S. New Y'ork. Harcourt, Brace & Co. 1921. Parker, C, The casual laborer and other essays. Pp. 109. New York. Harcourt, Brace & Howe. 1920. Study of the psychology of the laboring element that makes up the bulk of the I. W. W. Spahr, C. B., Present distribution of wealth in the United States. 1896. Watkins, G. P., Growth of large fortunes. N. Y. Macmillan. 1907. Williams, W., What's on the worker's mind? N. Y. Scribner. 1920. A first hand study of the problem of industrial unrest. CHAPTER 33 PUBLIC OWNERSHIP § 1. Waves of opinion as to public ownership. § 2. Primary functions of government favoring public ownership. § 3. Economic influences fav- oring public ownership. § 4. Forms of municipal ownership. § 5. Local- ized production favoring monopoly. § 6. Economies of large produc- tion favoring monopoly. § 7. Uniformity of products favoring monopoly. § 8. Franchises favoring monopoly. § 9. Various policies toward local public service industries. § 10. State ownership of various kinds. § 11. National ownership. § 12. Economic basis of public ownership. § 13. Sources of heat, light, and power. § 1. Waves of opinion as to public ownership. Opinion and practice in the matter of the public ownership of wealth and the direct management of enterprises has moved in waves. In feudal times, when government was virtually identical with the personal ruler, and the private "domains" of the lord or king were the sole source of his public reve- nues,^ holdings of this kind were very large. Their public nature came to be more fully recognized, but they did not yield large revenues, and gradually were in large part sold or given away to private owners. This was particularly true in England, and in a less degree on the continent of Europe. The conviction grew that the state, or government, was an in- efficient enterpriser, and that the sound public policy was to foster private industry and obtain public revenues by tax- ation. The ideal was embodied in the laissez-faire philosophy that government should confine itself exclusively to the most essential political functions, leaving the economic functions absolutely alone. It should keep the peace, prevent men from 1 See above, ch. 17, § 5. 558 Ch. 33] PUBLIC OWNERSHIP 559 beating and robbing each other, and preserve the personal liberty of the citizen.^ Thus, it was believed, all of the eco- nomic needs would be provided for by competition, in the best way humanly possible, in the quantities and at the rate needed. This policy attained its maximum influence in the first half of the nineteenth century in England, and in America prob- ably just before the Civil War, in the decade of the fifties. § 2. Primary functions of government favoring public ownership. Civilized government requires the use of numer- out material agents to make possible the exercise even of the primary political functions. The state may either own these agents or hire their use from private citizens who own them. It is now the general policy for government to own and control many of the more essential agencies, especially for the performance of the political functions; but a wide range of choice remains. Buildings for legislative and ex- ecutive oificers, customs-houses, post-offices, lighthouses, can be rented from private citizens, as post-offices usually are in small places; but it is obviously economical and convenient in large cities for the government to own the public buildings. A city may own the machines and wagons for cleaning the streets and for collecting garbage, and may hire day- labor directly, or it may have the work done by private con- tractors. The more simple political functions shade off into the economic. To coinage usually are added the issue of legal- tender notes and certain banking functions; the post carries packages, transmits money, and in most countries now performs the function of a savings bank for small amounts. The social and industrial functions undertaken by public agencies have steadily increased since the middle of the nine- teenth century, and the sphere of the state has been enlarg- ing.^ The question as to the proper limits to this develop- ment is ever open. § 3. Economic influences favoring public ownership. 2 See eh. 17, § 2, on the police function. 3 See ch. 17, § 3 and § 4. 560 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI In some cases private ownership is difSeult because of the excessive cost of collecting for the service. The cost of main- taining toll-houses on a turnpike sometimes exceeds the amount collected. Collection in other cases, as for the serv- ice of lighthouses to passing ships, is impossible. Public in- dustry may secure, through the economy of large production, a cheaper and more efficient service, the benefits and costs being diffused throughout the communitj'. A manufacturer able to keep his methods secret, or to retain his advantages for a time, can afford to undertake expensive experiments in his business, but the farmers seldom can. The benefits of the work of experiment stations for agriculture are felt im- mediately by the farmers, but are diffused to all citizens. The public ownership of parks for the use of all gives a maximum of economy in the production of the most essential goods, — fresh air, sunshine, natural beauty, and playgrounds in the midst of crowded populations. Municipal ownership of water- works is an extension of the same idea. Not only because large amounts of water are used by the public, but because cheap, pure, abundant water is an essential condition to good citi- zenship, it is felt that speculation should in every possible way be eliminated from this industry. The assumption is made in the laissez-faire doctrine that the interest of the public harmonizes with that of the individ- ual. But tliis proves often not to be the case. For example, the forest has an immediate value to its owners and to the consumers of lumber, and it has also a diffused utility in its influence on industry, on climate, on navigation, on water- power, and on floods. Yet, as the private owner, unless a great land monopolist, does not control enough of the forest appreciably to affect any of these things, and could rarely sell them even if he could affect them, he will cut down the tree whenever he can gain by doing so. In this situation either governmental control or governmental ownership of forests is essential. Each kind of political unit, or subdivision of government. Ch. 33] PUBLIC OWNERSHIP 561 develops characteristic kinds of public ownership and indus- try. Federal states consist of three main groups of political units ; national, provincial, and local. Provincial units are the largest subdivisions, as the American "states," or com- monvirealths, the German states, and the provinces in other countries. The term local political unit is more complex, and may mean county, township, village, city, or school or sani- tary district; but most of what is to be said of local owner- ship refers to cities or to incorporated villages. § 4. Forms of municipal ownership. Local political units acquire ownership only in local industries and in wealth used locally by the citizens. Nearly all parks and recreation- grounds are owned by cities. As population has become more dense, private yards of any extent have become impossible, in cities, for all but the wealthy. Public ownership of parks insures a " breatliing'-place " and recreation-grounds to the common man in the most economical way. Of late the move- ment for large and small piablic parks and playgrounds has gone on rapidly in American cities. Related to parks are public baths, public libraries, art collections, museums, zo- ological gardens, etc. Some have seen danger in this policy of "giving something for nothing," but the public sees no such danger as long as the things supplied gratify the higher tastes — as art, music, literature, and social recreation. These give no encouragement to the increase of improvident families and to the breaking down of independent character. Streets, roads, and bridges were once owned largely by pri- vate citizens. Here and there still are found toll roads and toll bridges built under charters granted a century ago, but tolls on public thoroughfares are for the most part abolished. Public markets, where the producer from the farm and the city consumer can meet, are old institutions. About two thirds of the cities of 30,000 population or more have public markets or scales, and fully one third have public markets of importance. New York city has six large retail and whole- sale markets for selling meat and farm produce, in which 562 PRIVATE PROPERTY VS. SOCIALISM [Px. VI rents or fees are charged, and several open markets. There has recently been a large movement in this direction. The providing of apparatus for extinguishing fires is al- ways a public duty; the conveyance of waste water is in- creasingly a public function. The supply of pure water for domestic and business uses, for fire protection, and for street cleaning, while often a private enterprise in villages and sometimes in large cities, is increasingly undertaken by pub- lic agencies. Most of the larger cities now own their own water-supply systems. Public ownership of gas and electric lighting is less common, as the utility supplied is not so essen- tial and the industry is somewhat less subject to monopoly; but the difference is one of degree only. Street railroads are often under public ownership in Europe ; but there have thus far been few cases of the kind in the United States and Can- ada.* § 5. Localized production favoring monopoly. A num- ber of these enterprises have characteristics in common which appear to make inevitable their drift into monopolistic con- trol. Waterworks, gas, electric lighting, street railways, tele- phone systems, are among these. However fierce may be the competition between separate private companies for a time, sooner or later either one company drives out the other or bu3's it up, or both come to an agreement by which the public is made to pay higher prices. A feature favoring the growth of monopoly when such in- dustries are left to private enterprise is the need to produce and supply the commodity or service at a given locality. WTiile two street railways can compete on neighboring streets, it is physically impossible for two or more to compete on the same street. Two systems of water-mains or gas-mains can be put dovm, as sometimes is done ; but this is not only a great economic waste, but the tearing up of the streets is an intol- erable public nuisance. This difficulty is less marked in the case of telephones and electric lighting, and some persons still cling to faith in competition to regulate the rates in those in- * See ch. 17. § 5, industrial revenues of governments. Ch. 33] PUBLIC OWI^EESHIP 563 dustries; but faith in competition between water companies and between gas companies has been given up by nearly all persons now, as it was long since by students of the sub- ject. § 6. Economies of large production favoring monopoly. A second feature favoring monopoly in such industries is the marked advantage of large production in them. These indus- tries are usually spoken of as "industries of increasing re- turns." This advantage is enjoyed in some degree by every enterprise, but it is gradually neutralized and limited. The need to extend an expensive physical plant to every point where customers are to be served, and the very much smaller cost per unit of delivering on the same street large rather than small amounts of water, gas, electricity, and transportation, offers a greater inducement for one competitor to crowd out or buy out the other at a more than liberal price. Even then, larger net dividends and correspondingly larger capitalization are secured than were before possible to both companies com- bined. § 7. Uniformity of products favoring monopoly. A third feature favoring monopoly is uniformity in the quality of the product furnished. It is a general truth that compe- tition is most persistent where there is the greatest range of choice open to the customer, and consequently the most indi- vidual treatment required of the enterpriser. An artist's product is very distinctive. Even a storekeeper attracts about him a body of patrons who like his product (for the merchant's manner and method of dealing are qualities of his goods) and who cannot be tempted away by slight differ- ences in price. Rival companies in the stage of competition are seen to claim superiority for their particular goods and to improve their service in every way possible. A new telephone company, entering where a monopoly has held the field, works at once a wonderful betterment in rates, courtesy, and service. But, as the product of all competitors attains the highest technical standard possible at the time, 564 PRIVATE PROPERTY VS. SOCIALISM [Ft. VI the rivalry is reduced to one of price, and it is usually a "fight to the finish." § 8. Franchises favoring monopoly. A fourth feature favoring monopoly in these enterprises is the necessity of making permanent and exceptional use of the public streets and alleys. If this right were granted by a general law to every citizen, this feature would be sufficiently implied in the foregoing discussion. As it would be intolerable to allow private interests to use public property in whatever way they wished, the legislative body makes special grants in such cases, in view of the circumstances. Not only is the legislature (or council, or county board of commissioners, etc.) led by the economic difficulties to withhold a charter from a second company, but it may be corruptly influenced by the company already established. The knowledge of the opposition to be encountered in getting a franchise must keep competitors out, even though monopoly prices are maintained. Because of these several features, which are so eloseV ^^- lated that they form a common character, more or less fully shared by various industries, and especially in view of the necessity for the formal granting to them of peculiar priv- ileges in the form of a public franchise, they are monopolies. The public, in order to protect itself, is forced to undertake an exceptional control of these industries. § 9. Various policies toward local public-service indus- tries. Several courses are open to the public, acting in its political capacity, to retain these monopolistic advantages for the general welfare, (a) It may do nothing, trusting vainly to competition to regulate the rate, or consciously leaving the result to be worked out by the monopoly principle; this is what in most cases has been done in the past in America, (b) It may leave the rate to be fixed by the monopoly prin- ciple, but charge for the franchise so much that the value of the monopoly is appropriated into the public treasury, virtually this is selling the franchise at auction, (c) It may attempt, in granting the franchise, to fix near cost the Ch. 33] PUBLIC OWNERSHIP 565 charge for the service or product, so that the franchise will be worth little as private property, (d) It may leave the price to be fixed at cost, not definitely by law, but by an administrative commission having the power to regulate rates, (e) ) It may have public officials carry on the busi- ness, either selling the product at cost or making monopoly profits that go into the public treasury. Various combina- tions of these plans are followed in practice. After plan (a), rates fixed in the franchise (c) had wide vogue. But fixed maximum rates, even under the most favorable conditions, are rarely equitable, for a uniform rate does not apply justly to all parts of a town and to all con- ditions of service. Fixed maximum rates become too high in periods of stationary prices, when technical improvements are rapidly introduced, and from a different cause, when gen- eral prices are falling, as between 1873 and 1897. They be- came too low (unless offset by extraordinary technical im- provements and economies of increasing output) in periods of rising prices. Since the nineties many public utilities have been brought to the verge, or quite into, bankruptcy, while many others have found their salvation in the admin- istrative commissions, which had the power to increase the rates as well as to reduce them. The plan of selling the franchise (b) is difficult to apply because of the limited number of bidders and because of the unpredictable character of the returns. There remain the policies of administrative rate-fixing (d) and of public owner- ship to secure the profits of monopoly to the public, either directly or in a diffused manner. In the recent period of rising prices the administrative state commissions have, like the Interstate Commerce Commission, performed very valu- able services. But, on the whole, the general trend of muni- cipal policy is everywhere toward public ownership of this type of local public-service industries. § 10. State ownership of various kinds. The movement toward public ownership by the American states has been 606 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI much less marked than that by the municipalities. Many of the states have retired from some fie^Ms where once they were engaged in industry. Students of American history know that between the years 1830 and 1840 some states en- gaged largely, even wildly, in canal-building, railroad con- struction, banking, and in other enterprises. The undertak- ing of these industries was determined often by political and by selfish local interests, and their operation often was waste- ful. A few enterprises succeeded for a time, the most notable of these being the Erie Canal in New York, though this too be- came almost worthless as a result of railroad competition. The unsuccessful ones remained in the hands of the state or were sold to private companies, as in the case of the Pennsylvania Railroad. These reckless state enterprises were bitter lessons in public ownership, and continued for three quarters of a cen- tury to have such an effect on public opinion that few pro- posals for public ownership could have a fair hearing in America. But railroads and canals are publicly owned, and more or less successfully operated, by many foreign states, as in Prussia and other German states, in Switzerland, and in the new states of Australia, and this policy is rapidly extend- ing to other countries and to varied industries. There has been recently a greatly increased interest in for- estry shown by the American states. This is especially likely to be a state enterprise wherever the forest tracts are entirely within the limits of the state, as in the ease in New York with 2,000,000 acres and Pennsylvania with 1,000,000 acres of state forests. At present at least thirty-three states have forestry departments. Most of the forests in Germany are either communal or state-owned. The schools, a great in- dustry for turning out a product of public utility, are largely conducted by the American state and by local units rather than by the nation or by private enterprise. The state en- courages researches in the arts and sciences, and gives tech- nical training. A variety of minor enterprises have been undertaken by states to supply salt, phosphate, banking f acili- Ch. 33] PUBLIC OWNERSHIP 567 ties, even some manufactures. One after another the states are adopting the "state use" system of labor in the prisons and public institutions, engaging in agriculture and manu- facturing on a large scale, and using the products, amount- ing to millions of dollars annually, almost entirely for public purposes. § 11. National ownership. The national governments ev- erywhere appear to be enlarging the field of their ownership. This policy has its roots far in the past. Some industries grow out of the political needs of government. Established as a means of communication with military outposts, the post be- came a convenient means of communication for merchants and other citizens and grew into a great economic institution. In most countries the telegraph is publicly owned and has been annexed to the post, to which it is very closely related in pur- pose. National ownership of railroads is the rule, and our policy of private ownership the great exception in the world to-day. jMany persons, some in railroad circles, have long believed that national ownership of railroads is sure to de- velop out of our present policy of regulation; and this opinion is gaining ground, since the passage of the Transpor- tation Act of 1920, even with many that deplore the prospect. The national improvements connected with rivers- and har- bors were first political — that is, they were for the use of the government's navy; they became, secondly, commercial^for the free use of all citizens engaged in trade ; and they con- tinue to unite these two characters. Forestry is most largely undertaken in this country by the national government, partly because some forest areas in the "West extend over state boundaries, and largely because large tracts of public forest- lands were still unsold at the time public attention was at- tracted to the subject. Since 1890 the policy of reserving great areas for forests, and picturesque districts for national parks, has developed greatly in the United States. The na- tional forest area contained in the various forests in twenty states (not including Alaska and Porto Rico) now covers 568 Ch. 33] PUBLIC OWNERSHIP 569 about 282,000, square miles, equal in area to six states of the size of Pennsylvania, with all of New Jersey, Delaware, and Rhode Island thrown in for good measure ; or to all New Eng- land and the middle Atlantic states, plus Ohio, Indiana, and "West Virginia. There are, besides, fourteen large national parks, ranging in size from a few hundred acres up to over 2,140,000 acres (the area of the Yellowstone National Park), and aggregating 4,600,000 acres, nearly the size of Massachusetts or of New Jersey, besides numerous other na- tional reservations for monuments and antiquities. In some countries mines are thought to be peculiarly fitted for national ownership and control. In Germany the several states own coal, salt, and other mines. Coinage and banking are everywhere looked upon as functions of sovereignty, and yet it is no more necessary for a nation to own its own mint in order to control the monetary system than for it to print the bank-notes in order to regulate their issue. The American government has its own printing-office. The fish commission, and the various branches of the depart- ment, cooperate with private industry in many ways. This brief survey suggests that the industries undertaken by gov- ernment are both varied in nature and large in extent, al- though small in proportion to the mass of private industry. § 12. Sources of heat, light, and power. Next to the question as to the public ownership of the railroads, that as to coal mines and hydraulic power sites is most likely to be- come insistent for answer in America in the not distant future. The law of the conservation of energy expresses the fundamental likeness of heat, light, and power. The prin- cipal sources from which man derives these agencies are coal and falling waters, though 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 five hundred miles of a mine. The enormous deposits, if used at the present amounts 570 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI per year, would last probably from two to four thousand years, but if used at the present increasing rate (doubling the prod- uct every ten years), they would, it has been estimated, last but one hundred and fifty years. What shall be the actual rate as between these extremes is a question the answer of which depends on our economic legislation as to ownership, exploi- tation, prices, use, and substitution. The experiences in the war, as well as the constantly recurring labor difficulties in f-VJ Fig. 2, Chapter 33.— Coal Fields of the U. S. coal-mining, verging upon civil war, have forced the public thought to recognize its dependence on the regular supply of coal, and the exceptional public nature of the coal industry. 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 waterfalls, whereas about 37,000,000 primary horse- power ^ was available ; but, by the storage of flood-waters so 5 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 Ch- 33] PUBLIC OWNERSHIP 571 as to equalize the flow, at least 100,000,000 horse-power, and possibly double that amount, could be developed. As it re- quires 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 from two to four times our annual use of coal (above 600,000,000 tons). 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 sub- stitution, is one of our great economic problems. The ques- tion is being daily decided, in numerous acts of legislation and administration, whether the water-power of the United States shall be more rapidly developed by becoming private prop- erty, or shall be developed more slowly as a part of the na- tional domain. § 13. Economic basis of public ownership. The question as to the proper limits of public ownership is one most ac- tively debated. The movement is progressing in accordance with the principle that. public ownership is economically jus- tified wherever it secures a product or service of widespread use that would otherwise be impossible, or insures the public a better quality or a lower price. The question of public ownership is not exclusively an economic question. There are incidental problems, such as its effects on enterprise and on political integrity, with which it is not possible here to deal. In the main, however, public ownership is simply a business policy which must be justified by its economic re- sults. In the case of a general social benefit not to be secured without public ownership (as popular education or the civ matic effect of forests), the only question to answer is whether the utility is worth the cost. In the case of industries already in private hands, as waterworks, gas and electric lighting, is the least," all the rest being allowed to escape unused. Van Hise, "Conservation of Natural Eesources," p. 119. 572 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI there is needed, to make a wise decision possible, a knowledge of the effect a change to public ownership will have upon cost and service. If public officials can furnish some goods more cheaply than they are furnished by private enterprise, it is be- cause of the wide margin of monopoly profit, not because there is any magic in public ownership. The same general items of cost must be met. The first cost of the plant and the annual interest payments are much the same. Experience shows that, because of political influence and of public opinion, wages are likely to be higher under public ownership, but salaries for management lower. Public collection of dues along with taxes is an advantage not enjoyed by private companies. Sev- eral public officials sometimes share the same office and thus reduce expenses. In small towns the public electric lighting and waterworks have been operated more economically under one roof. Some items of cost may be less under public man- agement, but, on the whole, public industry probably has no advantage in these respects. Public industry does not have to meet the costs of lobbying and blackmail which are often forced upon private companies. But the greatest source of saving in public ownership is the value of monopoly privi- leges that, under private management, go into private pockets. The temptation of political corruption may be more insist- ent when a large force of men is constantly employed, and when large supplies are constantly purchased, by public offi- cials, but the temptation is not so strong or so centralized as it is in the granting of franchises to wealthy corporations. Public industry is weakened by the absence of certain motives to excellence that are present in private business. The income of public officials not being dependent on the economy of management, the spur and motives of competitive industry are lacking. No social discovery has made individual hon- esty and civic virtue useless to good government. The decision in any specific case is one dependent on local conditions, and the exact limits of public ownership are not fixed. Industry is changing so rapidly that new adjustments Ch. 33] PUBLIC OWNEESHIP 573 are made every year. The main outlines of public ownership, however, are now in large part determined. Some industries do well, others ill, under public management, and between these lie many debatable cases. Waterworks and probably electric lighting, because of the comparative simplicity of their operation, are more suitable for public ownership than are gas-works. No absolute line divides the one group from the other. But, whatever the changes, the fact cannot be ignored that the increase of public ownership is altering in manifold ways the organization of industry, and is reacting upon the production of wealth and the distribution of in- comes. Refeeences. Bemis, E. W., (Ed.)_, Municipal monopolies. N. Y. Crowell. 1899. Brooks, R. C, Municipal Affairs, 5: 1-346. 1901. An exhaustive and well-arranged bibliography on all aspects of municipal prob- lems. ) Fairlie, J. A., Recent extensions of municipal functions in the United States. A. A. A., 25: 299-310. 1905. Giiyot, Yves, \^'here and why public ownership has failed. Trans- 19: 61-73. 1902. Lincoln, E. E., The results of municipal electric lighting in Massa- chusetts. Pp. 484. Boston. Houghton, Mifflin Co. 1918. Maltbie, M. R., Municipal utilities. Princeton. University Press. 1917. National Civic Federation, Report on municipal and private opera- tion of public utilities. 1907. 3 vols. (A monumental study by an American delegation, which visited many cities of Europe and America; favorable, in the main, to extension of municipal owner- ship. ) Stephens I. h., A bibliography of municipal utility regulation and municipal ownership. Pp. 410. Cambridge. Harvard Univ. Press. 1918. Todd, A. M., Municipal ovsTiership, with a special survey of municipal gas plants in America and Europe. Public Ownership League of America. Chic. 1918. Van Hise, C. R., Conservation of natural resources. N. Y. Mac- millan. 1910. CHAPTER 34 METHODS OF DISTRIBUTION § 1. The problem of distribution. § 2. Distribution by force and by status. S :l. Social ellects of the rif>ht to transmit property. § 4. Ef- fects of the riglit to inherit property. § 5. Broader social etFects of in- heritance. S G. Limitations upon intestate inlieritance. § 7. Some merits of competition. § S. Wide acceptance of competition. § 0. "Eco- nomic liarmonios" and discords. § 10. Competition modified by charita- ble distrilintion. §11. Competition modified by authoritative distribu- tion. § 12. Progressive versus reactionary. § 13. Progressive versus radical. § 1. The problem of distribution. The great economic progress of the past two centuries has been mainly in lines of technical production. The developing natural sciences and mechanic arts have given men a marvelously increased control over forces and materials. This has multiplied the quantities of goods of most kinds at the disposal of men, collectively con- sidered. All men, with rare exceptions, have been gainers; but the increased production has been very unequally dis- tributed among the members of the community. More and more insistently the plea and the demand have been made for better methods of distribution that will give to the masses of tlie people a larger share of the goods produced. Production is largely a problem of the technical arts; distribution is a problem of social economy. Distribution as a problem of in- comes is not to be confused with distribution of physical goods by transportation (as on the railroads) or by commercial cigencies transferring goods from producer to consumer (as ui cooperative stores and marketing). Two aspects of the distribution of incomes may be distin- 574 Ch. 34] METHODS OF DISTRIBUTION 575 guished. Functional distribution is the attribution of value (yields) to wealth and labor considered impersonally, as groups of productive agents. Functional distribution is the prime subject of the theory of value and price ^ (e. g., usance, value of labor, time preference, profits), a study of which is prerequisite to an intelligent study of the problems of per- sonal distribution. Personal distribution is the actual movement of incomes into the control of persons. Personal incomes, whether monetary, real, or psychic, are the sum of a number of elements. Some parts are due to services performed by the person himself. When one combs his own hair he is per- forming for himself a service that is a part of his income. Benjamin Franldin said it was better to teach a boy to shave himself than to give him a thousand dollars with which to pay barbers for a life-time. Other parts of income are the uses and fruits of legally controlled wealth; chance finds, as gifts of value or lost and abandoned goods f goods as- signed to one by authority; wealth inherited; illegal gains by robbery; goods secured on credit; gifts either of things or of services. The many methods by which incomes are distributed to the persons making up a society may be grouped in the fol- lowing five general classes: (1) force, (2) status, (3) charity, (4) competition, and (5) authority. These will be discussed in order. § 2. Distribution by force and by status. Distribution by force is the most primitive mode of distribution. The stronger takes from the weaker. Slavery is distribution by force, as is the levying of war indemnities from a conquered people. Forceful distribution still persists in the form of crime, and, if we include fraud within the term, it still affects an enormous amount of income. The lawless take whatever they can, and the supporters and officers of the law do what they can to check the acts. Distribution may be by status, or set rules and customs. In I Treated throughout Vol. I. 576 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI this case men receive incomes that are independent of their efforts and outside of their control. Distribution by status is guided neither by the personal merit of the recipients nor by the value of their direct services, but by the merits and acts of men not living. Feudal society was built on status. Men were born to certain privileges and positions; they inherited property which could neither be bought nor sold ; they fol- lowed trades which could rarely be entered by any outside of favored families. Caste in India and in other Oriental coun- tries regulates a large part of the life of the people. This method still prevails to a greater extent in our society .ban is usually recognized.^ By public opinion and by preju- dice, status is still maintained in respect to the choice of occu- pations even where the law has formally abolished it, as is seen in modern race problems. In western countries to-day in- heritance of property is the main legal form of status and it shades off into other forms of distribution. Private property must find its justification in social expediency.' There is no feature of it that is more questioned than is the right of in- heritance. § 3. Social effects of the right to transmit property. The right to transmit property by inheritance or by bequest may be judged with reference to its effects upon the giver, upon the receiver, and upon society at large. It is well to take these three points of view. The right to dispose of prop- erty either during life or at death has undoubtedly in many ways a good effect upon the character of men. It stimulates the husband and father to provide for his wife and children, and spurs others to continued economic activity. There is a joy in giving, a joy in the power to bestow one's wealth upon those one loves, or as one pleases. Much of the existing 2 See Vol. I, pp. 190, 223; and above, eh. 32, §§ 11-13. 3 See Vol. I, pp. 248-255, 297, 298, 406, 408, 415-418, 480, 481, 483, 484; also Vol. II, cha, 11, 20, and various passages in the chapters of *Viia Part. Ch. 34] METHODS OF DISTRIBUTION 577 wealth probably never would have been created if men had not had this right. But there is a limit to the working of this motive, and other motives often are more effective. Many a man after gaining a competence continues to work for love of wealth and power in his own lifetime, as the miser continues to toil for love of gold. When men without families die wealthy, when men not having the slightest interest in their nearest relatives labor till their dying days to amass wealth, it is apparent that the right to bequeath property has little to do with their efforts. Love of accumulation and love of power in these cases supply the motive. A more limited liberty to dispose of property at death might still suffice, therefore, to call out the greater part of the efforts now made to accumulate property. § 4. Effects of the right to inherit property. That the effects upon the receiver of the property are good is somewhat more doubtful. It is true that children reared in families of large incomes would be great sufferers if plunged into pov- erty at the death of their parents. There is much social justi- fication for permitting families to maintain an accustomed standard of comfort. Few would deny that provision by par- ents to provide education and opportunity for their children is commendable and desirable. But the evil effects of waiting for dead men's shoes are proverbial. Many a boy's greatest curse has been his father's fortune. Many a man of native ability waits idly for fortune to come and lets opportunities for self-help slip by unheeded. The world often exclaims over the failure of the sons of noted men to achieve great things, for, despite confusing evidence, men still have faith in biologic heredity. A too easy fortune saps ambition and re- laxes energy; and thus rich men's sons, if not most carefully and wisely trained, are often made paupers in spirit, while the self-made fathers think their boys have better opportuni- ties than they themselves enjoyed. The greater social loss is not the dissipated fortunes, but the ruined characters. An- 578 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI drew Carnegie said that it would be a good thing if every boy had to start in poverty and make his own way. Cecil Rhodes recorded in his will his contempt for the idle ex- pectant heir. § 5. Broader social effects of inheritance. Inheritance ■-^as good effects for the community in so far as it helps to secure efficient management of wealth. If the son or relative has been in business with the deceased, there is a reason why he should inherit the property, and his succession to it makes the least disturbance to existing business conditions. This con- sideration, however, has less weight as the corporate form of organization becomes well-nigh universal in "big business." Every profligate son, every incompetent heir, is an argument against the inheritance of property. It is to society's inter- est that no able-bodied member should stand idle. Every child should have presented to him the motive to use his powers in useful ways. Moreover, many feel that the great fortunes now accumulating through successive generations in the hands of a few families are a danger to our free society, even if these fortunes should continue to be well administered. There is a widespread feeling that the heredity of great wealth is, like the heredity of political power, out of harmony with the democratic spirit. Democracy wishes to see men and in- dividuals put to the test, not profiting forever by the deeds of their forebears. This feeling is shared by those who cannot be charged with radical prejudices. It was startling when a conservative body of lawyers, meeting in their state associa- tion in Illinois, passed a resolution favoring moderate limits to inherited fortunes. Almost every year sees bills of this pur- port introduced in the legislatures and in Congress. Prob- ably no one of many current radical proposals is more widely favored than this among men of otherwise conservative social views. The sum most often mentioned as the proper limit is $1,000,000, but usually it is a sum larger than the for- tune of the person speaking.* i See cli. 32, § 7, on limitations upon bequest and inheritance. Ch. 34] METHODS OP DISTRIBUTION 579 § 6. Limitations upon intestate inheritance. A proposal less crude, and with strong reasons of social expediency in its favor, is to limit the right of intestate inheritance to persons that have been in essential economic and social relations with the deceased. The foregoing considerations show that the case for the right of gift in the lifetime of the giver is strongest; that for the right of bequest comes next. The man who has acquired wealth may usually be trusted to decide who bear to him close social or personal relations, and to say whose lives have in a measure furnished the motives of his activity. But the right of intestate inheritance by distant relatives is one that stands on weak social foundations. It is a survival from more patriarchial conditions when, in the large family or elan, the bond of unity was very strong. A truer test to-day of the proper limits for intestate inheritance is whether the wish to provide for these heirs has furnished the motive for the pro- ducing and preserving of the wealth. The claims of those nearest in blood and closest in personal relations are strongest. Family afiEection and friendship form the strongest of social ties, and it is socially expedient to cultivate them. Motives for abstinence and industry must be strengthened. But the same test shows that the zealous regard of the American law for the rights of distant kinsmen in foreign lands or in dis- tant quarters of this country is irrational, and is unjust to the community where the fortune was made. Public opinion tends strongly toward this idea. Property rights as they exist are clearly seen not to be a product of pure reason. They are the result of social evolu- tion, of historical accidents, of class legislation, and in many cases of selfish interests. Changing social conditions and ideas are bringing many changes in law, and further changes must be expected to come that will reduce the influence of inheritance of property in fostering status in distribution. Especially important are the increasing application of the pro- gressive principle to incomes and inheritance," and the de- 5 See ch. 19. 580 PRIVATE PROPERTY VS. SOCIALISM [Pt. VT velopment of insurance to put family savings into the form of terminable annuities instead of capital sums.' § 7. Some merits of competition. The dominant method of distribution to-day is that of competition.' It is evident from the voices of praise and of blame that competition has its good and its bad aspects. Let us observe first the good ones. Competition acts to distribute the working force over the field of industry wherever it is most needed. The remarkable (though far from perfect) adjustment of industry to the needs of each neighborhood is brought about by individual motives, not by centralized authority. Wherever consumers settle, stores are started and factories are built. Wherever work is to be done, men come in about the right number to do it. It is not mere chance that produces this result. The available skill is adjusted to varying needs by the delicate measurement of the market rate of wages. Two-sided competition gives a definite rule of price — the only definite impersonal rule. The theoretical competitive price is the standard to which things tend constantly to adjust themselves in an open market.^ Competition is an essentially economic method as contrasted with the legal and personal methods above and later described, because it is impersonal and reducible to a rule of value. Dis- tribution under competition is made, not with reference to ab- stract ethical principles or to personal affection, but to the value of the product. Each worker strives to do what will bring him the largest return, and the price others pay ex- presses their estimates of the service in that market. Each seeking his own interest is led to make himself more valuable to others. In most cases and in large measure, competition stimulates men to sacrifice, to invention, to preparation ; thus is zeal animated and are efforts sustained. In the economic realm, as is now seen to be the case in the biologic realm, com 6 See ch. 13, § 9 and § 10. 7 See ch. 32, § 10. 8 See Vol. I, pp. 54 and 66 ; also pp. 504-507 on an organic theory of value. Ch. 34] METHODS OF DISTKIBUTION 581 petition af some effective kind is an indispensable condition not only of progress but of life without degeneration. Mo- nopoly, as we have noted, never has ceased to rest under the ban of Anglo-Saxon law, and therefore to exemplify compul- sory as opposed to competitive distribution. A striking fea- ture of the competitive method is its decentralization. Each helps to value the economic services of each. If one pays more for the services of the singer than for those of the cook, it is not because one would rather listen to the singing than to eat when starving, but because by apportioning one's income one can get the singing and the eating too. In the existing circumstances, the singer's services seem to the music lover to be « ortli paying for, and he backs his opinion with his money. So each is measuring the services of all others, and all are valuing the services of each. It is distribution by valuation, and it is valuation by democracy, with all of the defects of the frail and foolish human beings who are expressing their choices. § 8. Wide acceptance of competition. On purely abstract and a priori grounds competition cannot be accorded an un- qualified ethical sanction, as is sometimes assumed. It is not alwa3-s and necessarily "right" and "best" in an absolute sense. However, its dominant place is not a mere accident, but is a resultant of unending experimentation with different methods of distribution carried on since the beginning of human society. A method of distribution had to be found and retained that would work under the conditions of human nature at each stage of social progress; and competition has worked, Itowever imperfectly, because it has met in large measure the pragmatic test. The competitive rule of dis- tribution appeals to all men (even to those who denounce it) as having in many of its applications a moral character, as compared with the other possible methods of distribution. Indeed, the competitive rule is the only rule that does not involve either personal and arbitrary judgment (force, char- ity, and authority) or status. Even such a measure of justifi- 582 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI cation as is found in status is traceable, in the long run, to competition. The case for a limited application of status (as in property and inheritance laws) is based upon its results in stimulating motives of effort and accumulation." When the rule of authority is applied to-day in the large field of public regulation where actual competition has become impossible, almost the only guiding rule is hypothetical competition. The just rate is felt to be that which in the long run would be just sufficient to afford "normal" incomes to labor and to capital, to call forth the necessary effort, skill, judgment, fore- thought, abstinence, and investment, if competition were at work, as it is not.^° Only this rule of hypothetical compe- tition redeems these public rates from arbitrariness, favori- tism, and force. §9. "Economic harmonies" and discords. Every truth in political philosophy finds some exaggerated expression. Competition, as compared with status and custom, has some notable merits; and when the eighteenth century was throw- ing off some of the burdens inherited from the more static Middle Ages, competition appeared to be a panacea for all the ills of society." The belief in the benefits of competition and the virtues of economic freedom found its extremist expres- sion in the first half of the nineteenth century in the doctrine of the "economic harmonies." According to this, if men are left entirely free to do as their interests dictate, the highest efficiency and best results for all will follow; the economic interests of all men are in harmony. Corresponding with this doctrine is the economic policy of extreme laissez faire. But experience has shown that the economic intef ests of the individuals in a community are only partly, very rarely are they wholly, in harmony. There are three planes of compe- tition in every market : that between sellers, that between buy- ers, and that between sellers on the one hand and buyers on the 9 See above, § 2, note 3. 10 Compare, e.g., portions of chs. 9, 14, 21, 22, 28; and 31, § 16. 11 See ch. 32, §§ 11-13. Cil. 34] METHODS OF DISTRIBUTION 583 other. ^^ If at any point free competition is hindered, even the disciple of economic harmony must, from the very nature of his doctrine, expect a discordant result. In reality, competi- tion is rarely quite complete on both sides, and when it is not the weak usually suffer. Men do not start with fair oppor- tunities. All that they may be entitled to have under com- petition may be so little that social sympathy seeks to better the results; hence poor relief, public and private. Society as a whole has an interest in the outcome of the individual's eco- nomic struggle. It cannot see men starving or driven into crime. Moreover, when competition is the rule of valuation, it, like all valuations, partakes of the quality of those choosing — wise or foolish, good or evil.^? And though competition is the rule of democracy in economics, yet democracy cannot per- mit the economic vote of a vicious or of a foolish group to stand, where the goods, services, and prices resulting offend the prevailing public judgment and social conscience. § 10. Competition modified by charitable distribution. In practice the competitive method of distribution always has been modified or supplemented in varying degrees by the other methods. Important among these is charitable distribu- tion. Charitable is here used in its original sense, as synony- mous with benevolence and affection. First is parental love, the root and type of all the forms of charity. There is a complete lack of economic equivalence in the relation of par- ent and child in early years. The helpless infant does noth- ing for the parent, the parent gives all and does all for the child. Gradually, however, the balance is regained; as the years go on, not only do children repay in affection, but in many cases they repay in material ways. Especially in the factory districts and on the farm, the child sooner or later begins to reestablish the balance, becomes a worker, and con- tributes to the family income as much as the cost of his sup- port, and finally more. A student of modern English town 12 See \'ol. I, p. 75. 13 See, e.g.. Vol. 1, pp. 25, 71, 205, 470, 50!), 511, 513. 584 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI life has traced the curve of poverty traversed by the average poor family as the children are first an economic burden and later an aid to their parents. In the middle, or propertied, classes the children do not for many years cease to be a finan- cial burden to their parents, and in most cases the economic balance is never reestablished. It is not to the parents, but to the succeeding generation, that the debt is tardily paid. Friendship widens the range of generosity and multiplies the mass of gifts. Broad sentiments of humanity lead to gifts outside the range of personal affection and personal in- terest, to the beggar on the street, to institutions devoted to charity. In New York state alone a sum of more than $20,- 000,000 a year is expended by institutional charities. About $512,000,000 iu public benefactions were given in the United States by private donors in- the year 1915, and in this re- spect that year was not exceptional. An enormous and in- creasing body of property is thus being year by year socialized, largely through bequests from persons without direct heirs. Great public subscriptions to the sufferers from unusual dis- asters, such as the Irish and the Indian famines, the Chicago tire, the Galveston flood, the San Francisco earthquake, the great European war, bespeak a widening generosity. Re- ligion impels to the building of churches, to the support of priests, missions, and manifold religious undertakings. Charity in this connection is the expression of a sentiment that varies from the most intense personal affection to the broadest aud most general humanitarian sentiment. § 11. Competition modified by authoritative distribution. Autliority is essentially the assignment of a common, or social, income to individuals by some person or persons chosen, or accepted, by the society to perform this function. After force, it is the oldest and was the earliest widely operative method of distribution. It shades into force, status, and charity in manifold ways. But it may be distinguished from force, which takes for itself what belongs to another ; and from charity, which gives to another what belongs to one's self ; and Ch. 34] METHODS OF DISTRIBUTION 5Sa from status, which transmits claims to income from one gen- eration to another by a fixed impersonal rule, not by a per- sonal judgment in the particular case. Authoritative distribution is the dominant method in patri- archal tribes, in communal societies, and in monastic and other religious orders. Each person works at what he is com- manded to do, and some one in authority (patriarch, head of the community, father of the monastic order) portions out the tasks and the rewards. In the family this rule largely pre- vails, and even after the children have come to years of dis- cretion they not infrequently accept, from habit or affection, the will of the parents, and give up their entire wages to re- ceive back a portion. The method of charitable distribution while the child is young gradually changes to authoritative distribution after the child becomes a worker. The untrained and indocile youth, however, is made the subject of com- pulsory distribution. The collection and distribution of taxes is by public au- thority. No attempt is made to give back an exact equivalent to each taxpayer. The money is taken and spent by authority. The new forms, or at least the new extensions, of taxation, es- pecially of incomes and inheritances at progressive rates, are very important examples of authoritative distribution. The courts sometimes find themselves obliged to apply the method of authoritative distribution, although they do it unwillingly. They try to confine their efforts to interpreting the contracts men have voluntarily entered into, and they avoid, as far as possible, the making of contracts or the fixing of rates. Authoritative distribution is exemplified in the work of many commissions appointed by law to fix rates or settle disputes, such as boards of conciliation and arbitration and railway com- missions. § 12. Progressive versus reactionary. Distribution in the present economic system, in all its modifications in the various industrial states of the world, thus is revealed by our examination to be determined, not by a single principle, but 586 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI by an eclectic grouping of various principles and methods. It is further revealed not as final truth fixed in its details, not as an absolute expression of human wisdom, but as a constantly changing result of human experience. The vs^orld of free parliamentary governments is a vast laboratory of experi- mentation wherein the institutions of property and the process of distribution are being shaped by the forces of public opinion. Changes are constantly embodied in legis- lation, in judicial interpretation, and in the administration of the laws." The different individuals and groups in our society take various attitudes in respect to our present economic system and to the views just expressed. Indeed, opinions are in- numerable and grade off with manifold differences of degree and in detail from one extreme to the other. However, all opinions on this subject may be classified broadly in two groups — conservative and destructive (or disruptive) ; the one favoring the present economic system in its essentials, the other rejecting the essentials of the present system. Each of these broad groups may again be subdivided: the con- servatives having two wings, the stand-pat conservatives (the extreme being the reactionaries) and the other the progressive conservatives. (It need hardly be said that progressive is not used here with reference to any political party or group that has been designated by that name.) The reactionary conservatives are numerically a small group, but in wealth, social position, and political influence are very powerful. They favor the existing order, excepting in those features designed to limit wealth and the use of monopolistic power. The stand-pat conservatives are a much larger group of moderately well-to-do, including most of the residents on ' ' Main Street, ' ' who like things just as they are. § 13. Progressive versus radical. The conception of the present economic system outlined above may likewise be called 1* Almost every chapter of this volume gives examples of these state- ments; but recall especially chs. 17, 22, 23, 29, 31, 33. Ch. 34] METHODS OF DISTRIBUTION 587 conservative, but it must be modiliea by the adjective pro- gressive, or liberal, as contrasted with reactionary. In this view the central features of the present economic system must continue much as they are, and progress must be won by gradual correction of evils. These are recognized to be many, and to call constantly for remedial legislation and remedial effort in our rapidly shifting industrial conditions. The progressive-conservatives believe that the evils are not due solely or mainly to the "present economic system"; they believe that a workable economic system cannot be de- vised by doctrinaire philosophers as a thing apart from hu- man nature, a thing to be declared absolutely good or bad without reference to the kind of people who compose the com- munity. The present economic sj'stem can be made better only slowly and as the individuals who compose the com- munity keep pace with growth in virtue and wisdom. There- fore, the progressive-conservative sees that much of the task of social progress is individual and family education, moral- izing the oncoming generations with the old-fashioned virtues of thrift, honesty, loyalty, and duty. All such suggestions are impatiently and angrily rejected by the more radi- cal social reformers, who (again with varying emphasis and with many gradations of opinion) advocate abandoning the present economic system and substituting for competition with private property a universal principle of authoritJ^ Eefeeknces. Hinds, W. A., American communities, 2d ed. Chicago. Kerr. 1908. (Describes many e.'iperiments, all failures; by a sympathizer with socialism.) Lockwood, G. B., The New Harmony movement. 2d ed. N. Y. Ap- pleton. 1907. Nordhoff, C, Communistic societies of the U. S. N. Y. Harper. 1875. CHAPTER 35 SOCIALISM, PRESENT AND FUTURE § 1. Meanings of socialism. § 2. Philosophic socialism. § 3. So- cialism in action. § 4. Origin of the radical socialist party. § 5. The two pillars of "scientific" socialism. § 6. Aspects of the material- istic philosophy of history. § 7. Utopian nature of "scientific" so- cialism. § 8. Its unreal and negative character. § 9. Revisionism in the Marxian ranks. § 10. Socialism and anarchism. §11. Syndi- calism and I. W. W. § 12. Guild socialism. § 13. Opportunism in socialist party tactics. § 14. Alluring claims of party socialism. § 15. Changes in the socialist party vote. § 16. Economic legislation and the political parties. § 1. Meanings of socialism. Our reason for leaving to the last the discussion of authority as a method of distribu- tion is not that it appeared last in historical development, but that it now is the most strongly advocated as an alterna- tive of competition. In primitive, in ancient and in medie- val societies, authority as a method of distribution was used much more than it now is, and the history of Europe from about the eleventh century is filled with the record of the displacement of authority and status by competition. Bvit one of the most striking developments of opinion in the nine- teenth century was that favoring an increasing use of author- ity' in distribution. Authority has been advocated not merely to supplement and modify competition, but to displace it com- pletely or, in the more moderate program, in large part. This opinion, or plan, has appeared under a variety of names, the main ones being communism, collectivism, social- democracy, and socialism, of which the last name has just now the greatest vogue. Socialism is a word of manifold 588 Ch. 35] SOCIALISM PRESENT AND FUTURE 5S0 meanings no one of which is generally accepted. Discussion is therefore often a Babel of tongues. Much of the confusion may be cleared up by observing that the word "socialism" designates (1) a social ^ philosophy (2) a mode of social action, (3) a particular political party. There is thus philo- sophic, active, and partizan socialism. Bach of these may be taken either in an absolute or in a more or less relative sense. The first meaning is the most fundamental, the second less so, and the last the least fundamental, but just now the most frequently used. § 2. Philosophic socialism. As a philosophy socialism is related to social just as individualism is related to individual. Socialism is faith in the group motive and group action rather than in self-interest and competitive action. Instead of social philosophy we may say social faith, or social ideals. This faith may be absolute, or radical, to the rejection of all eco- nomic competition ; or it . may be moderate, and leave more or less place for self-interest and competition. Every man of conscience and of ideals has moods that are social- istic (in this sense) and dreams of a world without toil, com- petition, or poverty. This social philosophy has taken form as "Christian Social- ism" among men of strong religious natures, in various re- ligious denominations. Great secular dreamers — Plato in his "Kepublic," Sir Thomas Moore, in his "Utopia," Edward Bellamy, in "Looking Backward," William Morris, in "News from Nowhere," and others — have painted beautiful pictures of ideal economic states from which all of the great evils and problems of our society have been banished. § 3. Socialism in action. Active socialism is group action in economic affairs. This may be by private voluntary groups, as a club, church, or trade union, or by a public group, or political unit of government, which has therefore a com- pulsory character. The most radical kind of active socialism would be the ownership by government of all the means of 1 See Vol. I, p. 6, on "social" and the social sciences. 590 PRIVATE PROPERTY VS. SOCIALISM [Pt. Vl production and the conduct of all business, assigning men, by authority, to particular work and granting them ^ueh in- comes as the established authority thought they deserved. This kind exists nowhere, and never has existed, though it has been nearly approached in many parts of Russia under the Bolshevik regime. A moderate kind of active socialism is represented by each separate case of public ownership or industry. Even public regulation by authority, of the many kinds de- scribed in this volume, is touched with a quality of active socialism. In this sense there can be more or less of active socialism in a community; a state may be more or less social- ized in its economic aspects. An English Chancellor of the Exchequer declared in the last decade of the nineteenth cen- turj', "We are all socialists now." The ever-increasing sphere of the state ^ gives to that statement to-day a larger, fuller meaning than when it was uttered. Socialism in action is of course always the expression of a more or less socialistic philosophy held either by a democratic majority of the people or by a despotic minor- ity, as in Russia under the Czars and the Bolsheviki. IMost of the great recent movement of socialism in indus- try is the expression not of a radical but of a moderate social philosophy. It does not look to the abolition, but only to the modification and limitation in some directions, of pri- vate property and of competitive industry. The spirit of this movement is opportunist, or experimental. It is ready to try public action, but recognizes that it has difficulties and limita- tions. The ultra-radical and the ultra-conservative alike de- clare that these measures "logically" lead on to the com- plete destruction of private property. But men find that they can warm their hands without being "logically" compelled to thrust them into the fire, and that they can quench their thirst without a growing resolution to drink the well dry. When = See e.g., ch. 9, §§ 2, 10; ch. 11, §§ 7, 8; ch. 7, §§ 3, 4, 12; chs. 19, 22, 23, 24, 29, and 31. Ch. 35] SOCIALISM PRESENT AND FUTURE 591 this governmental activity has proceeded somewhat exten- sively and systematically in cities, as in Great Britain, it is called municipal socialism ; and in states, as in Germany be- fore the "World War, it is called state socialism. § 4. Origin of the radical socialist party. Socialism in the partizan sense is an actual political organization. Both in Europe and in America such organizations have been desig- nated as "social-democratic," "socialist labor," or "labor'" parties. Socialism in this sense of a party organization, or movement, is very different from a social philosophy. In its partizan phase socialism exhibits all of the baffling variability and elusiveness that it does in its other aspects. However, in its printed program, the socialist party sets forth both a social- ist philosophy and an ideal of active socialism in their most radical forms. Modern political socialism traces its origin directly to the most radical of German social philosophers, Marx, Bngels, and Lassalle. Karl Marx (1818-1883), preeminently the philo- sophic leader of the movement, collaborating with his friend Friedrich Engles (1820-1895), sought to give a solider founda- tion of reason to the somewhat romantic socialist philosophy current in his day. His own doctrine, first set forth con- nectedly ^ in the Communist Manifesto in 1847, and later developed in his chief book "Das Capital," he called Com- munism. He deemed this to be, as it has been called by his followers, "scientific socialism." "Scientific" was meant to emphasize the contrast with "Utopian" socialism, as Marx and Engels somewhat scornfully characterized alike the older communist philosophy, the romances of the ideal state, and the attempts to found and conduct small communistic societies. §5. The two pillars of "scientific" socialism. Scientific communism was to be based upon two immovable pillars, the one economic, the other historical (or historico-philosophical). The one was the labor theory of value, by which Marx sought 3 See Vol. I, p. 502, on communism and value theory. 592 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI to show that all profits and inconles from investment were due virtually to robbery of the wage-workers.* "Capital," that is, the ownership of the means of production, was declared to be the instrument of this "exploitation." The other pillar was "the materialistic philosophy of his- tory," that is, the explanation of all the intellectual, cultural, and political changes of mankind from the side of the material economic conditions as causes. As Bngels expressed it, "The pervading thought . . . that the economic production with the social organization of each historical epoch necessarily resulting therefrom forms the basis of the political and intel- lectual history of this epoch." This doctrine denies that, in an equally valid sense, biological changes in brain, and cultural changes in science, arts, and education, cause the mechanical inventions and improved processes and thus alter the form of economic production. § 6. Aspects of the materialistic philosophy of history. Marx's general philosophy of economic materialism had three minor propositions or doctrines, (a) The doctrine of increas- ing miser ;j ; capital in private hands results in the "exploita- tion" of the workers as explained by the economic theory of surplus value (labor theory of value) ; this causes and must cause the steadily increasing degradation of the masses, (b) The doctrine of the class conflict; all history is a record of the class struggle between those who have property, the ruling classes within the nations, and those who have not, the op- pressed working class, (a conception of history blind to most of the great international conflicts). The class conflict was declared to be growing more sharply marked and bitter than ever before ; "the entire human society more and more divides itself into two great hostile camps, into two great conflicting classes, bourgeoisie and proletariate." (e) The catastrophic theory; the final and inevitable result of this misery and class confiict must be a revolution, when the downtrodden workers * See Vol. I, pp. 210, 228, 502 on the labor -theory of value. Ch. 35] SOCIALISM PRESENT AND FUTURE 593 will throw off their chains and "expropriate the expropria- tors," and institute the communistic order in place of cap- italism. I '' j § 7. Utopian nature of "scientific" socialism. The term "scientific" set in contrast with " Utopian" was meant to im- ply that the doctrine of Marx was not " Utopian" (a word that had come to mean fanciful and impracticable). Marx had a contempt for the romances of the ideal state and for what he deemed to be the unfounded speculations of earlier prophets of communism. But Utopian (from utopia, Greek for no place) means nonexistent, and Marxian socialism surely was that. The words "experimental" or "actually at work" would have been a more logical contrast with "iitopian" than is the word "scientific." Marx and his followers likewise had a contempt for the communistic experiments, or settle- ments and colonies, which by the scores had been started and had failed, bringing discredit upon all communistic pro- posals. The beauty of "scientific" socialism for the purpose of discussion was that it never could be tried on a small scale, or tried at all until a whole nation adopted it; there- fore, its adherents believed that no facts of history or of human nature could be used to disprove its workableness. The old time "scientific" socialist had a lofty scorn for any less dogmatic philosophy than his own or for any less sweep- ing social change than that he expected. Moderate social re- form to him was but temporizing ; indeed, it was evil, inasmuch as it helped to postpone the inevitable, but in the end, benefi- cent catastrophe of the social revolution. A step-by-step movement toward socialism, state socialism,^ even of a pretty sweeping character, was, to the old-time Marxians, not really socialism at all. Some explanation of this attitude is found in the extremely limited manhood suffrage and in the aristocratic class government of most European countries, especially of Germany; so that, as the party socialists saw it, multiplying state enterprises but increased the power of the ruling, and See above, § 3. 594 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI eventually of the militarist, class. The social-democratic leaders felt that until they themselves were in power, the growth of "state socialism" would be a calamity for the na- tion. The events of 1914 may make our judgment tolerant toward their feeling. § 8. Its unreal and negative character. The so-called "scientific" socialism had, therefore, a peculiarly unscientific spirit ; for, in a modern sense, science implies a patient search for truth, not a sudden revelation ; a constant testing of opin- ions by observation and experiment, not a dogmatic conviction that refuses the test of reality. "Scientific" socialists talked much, and still talk much, of the "evolution" of social insti- tutions; but they refused to admit the essential condition for institutional evolution, the competitive trial on a small scale, of a new form of economic organization to prove its fitness to survive. Indeed, communism had been tried on a small scale many times in the communistic societies, and had always failed in a brief time. Lincoln said that a man's legs ought to be long enough to reach to the ground; but "scientific" socialism was not built on that plan. To be sure it contained many elements of truth, but these were so distorted that the result was a caricature of history, of philosophy, of economics, and of prophecy. The most important influence of radical socialism has been exerted through negative criticism. It has performed the function of a party in opposition, relentlessly hunting out and pointing out the defects of existing institutions, arousing the smugly con- tented, and, by its very recklessness and bitterness, inspiring at times a wholesome fear of more revolutionary evils. This has been a real service to the cause of moderate and con- structive reform in the more democratic countries of west- ern Europe and in America. § 9. Revisionism in the Marxian ranks. "Marxism" or Marxian "scientific" socialism, from the time of its promulga- tion was studied by a small but increasing group of disciples as a well-nigh inspired and perfect revelation of economic Ch. 35] SOCIALISM PRESENT AND FUTURE 595 truth. Das Kapital became known as the communist bible; zealous followers held it to be their duty to accept it, even where they could not understand it or reconcile it with the realities around them. The various doctrines composing the Marxian system were expressed in phrases ambiguous enough to permit much loose and shifting thought. But vigorous criticism forced upon the attention of the more frank and intellectual radicals, the need of more accurate and greatly modified conclusions. The labor theory of value which Marx had taken from English Ricardian economics was discredited by the critique of the psychological economists of Austria and America. The doctrine of increasing misery which first was taken to mean what is said, came to be explained not in an absolute sense, but in a relative sense (that the masses may be getting more wages, real as well as monetary, but they are not getting as much more as are the owners of cap- ital). The doctrine of class conflict, it was admitted, had to be softened greatly to fit the facts of modern society. Doubt as to the inevitableness of the great catastrophe grew stead- ily. It cannot be questioned that IMarx, when he first formulated his philosophy, believed that a revolution, most violent in nature, would occur within a few years. The revolutions of 1848 came, but with no such results as Marx predicted. Thereafter radical socialists played fast and loose with the word "revolution." They made it mean a violent and bloody civil war with victory for the warlike minority, whenever they wished to rouse a proletarian audience. But in addressing bourgeois hearers they made revolution mean a slow evolution ending in peaceful victory at the polls by a majority of the nation, after many years of educational propaganda and of further industrial changes. As socialist intellectual leaders began to be affected by the criticism originating outside of the ranks they lost some of their theoretical illusions, and began to temper their claims of Marx's infallibility. " Eevisionism, " the socialist higher criticism, beginning in 1899 with the work of Eduard Bern- 596 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI stein, a prominent German Social-democrat, gained influence in the party counsels in all countries in the years before 1914. This brought many of the Marxians much nearer to the more opportunist ideas and plans of the Fabian society, which had been founded in England in 1884, but which had been re- garded scornfully by the adherents of "scientific socialism." § 10. Socialism and anarchism. In these and other re- spects the socialist movement, while gaining in the total num- ber of its adherents, was breaking up into various schools of thought. Ceaseless and often bitter controversy over matters of doctrine and of policy have divided the leaders and split the parties. Almost the only general agreement among them is on a negative point, hostility to the existing system of private capital. In respect to the forms of politi- cal and of industrial organization that are to take the place of the present order, communist ideas and plans differ widely. In the last quarter of the nineteenth century Marxian social- ists were usually associated in popular thought with the bomb-throwing type of anarchists whose aim was to destroy all government and whose policy was that of terrorism and assassination of members of the ruling class. Usually the "scientific" socialists scornfully denounced this classifica- tion, declaring that socialism trusted to peaceful evolution, not to violence, that socialism put its hope in the triumph of democratic majorities, whereas anarchy hoped to win its ends through the violence of a minority. Socialism, they said, was primarily concerned with economic organization, and so far as it was concerned with government, looked toward a completer organization of the state for social purposes, whereas anarchy was essentially opposed to the state in any form. In truth, as we have observed above, some socialists conceived of class conflict as gradual evolution, while others conceived of it as bloody and not distant revolution. The rank and file of the socialists have been ready as a majority to "expropriate the expropriators" peacefully, if they could, and willing as a minority to do it violently if they must. Ch. 35] SOCIALISM PRESENT AND FUTURE 597 § 11. Syndicalism and I. W. W. Among the various ten- dencies, or schools, within socialistic circles, two especially, syndicalism and guild socialism, have shown the marks of anarchistic influence. These both share the anarchistic dis- like of strong central government, and cherish the ideal of self-governing independent communes. The model of the early anarchists was the simple Russian village community. Syndicalism in Prance originally meant trade unionism. The French syndicates (trade unions) which developed many years later than did the British unions, came under the in- fluence both of Marxian socialism and of anarchism in the '80 's and '90 's, and developed a hybrid form of theory and of program. Syndicalism is anti-parliamentary and opposed to political action within the present capitalist states. It opposes militarism, and repudiates patriotism for any coun- try. It favors the violent revolt of a minority whenever the workers are well organized enough to seize power. It favors the general strike as a means of wrecking society, not merely to win in immediate wage-controversies. Its most characteristic doctrine, detestable to all outside its ranks, is sabotage, which means any kind of vandalism, deceit and dishonesty which may inflict loss upon employers and capitalists and inspire their fears. Everything is permis- sible and laudable which would be done by a spy in modern war, for the syndicalist declares that a state of war exists. Yet he does not draw the corollary that every one with such a purpose and using such means should expect to be shot as an enemy spy. The syndicalist's economic ideal of the future state is somewhat vague, but it is one of commun- ism, in which the instruments of production in each trade would be controlled by the unionized workers. After a rev- olution attained by sabotage and bloodshed, men would dwell together peacefully without restraint of any government, ruled only by sweet reasonableness. Syndicalism has been most influential in Prance and Italy 598 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI among the less skilled workers, but in Europe appears to have lost of late somewhat both in its intellectual and in its popu- lar following. In America it appears as the I. W. W. (Inter- national Workers of the World) in some cities, but chiefly among the migratory workers in mines, lumber camps, and agriculture in the IMiddle and Far West. § 12. Guild Socialism. A school of writers, known as Guild Socialists, which has attracted wide attention since the war, had its origin in England about 1907, and in 1915 founded the National Guilds League. Guild socialism re- sembles syndicalism (and philosophic anarchy) in its plan of the future state. Producers are to be organized in shops, or in groups, which are to be further federated in a national guild, the supreme council of producers. This plan suggests more of a unified state than does syndicalism, a sort of ' ' dual sovereignty" of local producing guilds and central social organization. These ideas seem to be all in the realm of imagination (Utopian) but they were reflected som'ewhat in the widespread discussion after the war for "industrial democ- racy" as in the Plumb Plan for the ownership of railroads by the railroad workers. Unless and until groups of trade workers can demonstrate by experiment, at their own risk, that they can cooperatively carry on enterprises of some size with success, the rest of the nation, the great body of con- sumers, must look upon such proposals as unpractical. The Bolsheviki since the second revolution in Russia in 1917, have exemplified the syndicalist ideal of a ruling militant minority, and in the Soviets, or local governing bodies made up of organized workers, have shown some likeness to the guild ideal. § 13. "Opportunism" in socialist party tactics. While many winds of doctrine have been blowing over socialistic philosophy, the practical programs of the party have veered in various directions. Whenever the party gained any success at the polls, the socialists in public office and the party leaders found it necessary to "do something" imme- diately. The rank and file might be willing to talk of the mil- Ch. 35] SOCIALISM PRESENT AND FUTURE 599 lennium, but preferred to take it in instalments instead of waiting for it to come some centuries after they were dead. And so the socialist party, as fast as it gained any practical power, became "opportunist" and worked for moderate prac- tical reforms. The leaders did this with many misgivings lest the masses might become so reconciled to the present order that they would refuse to rise in revolt. In that case the revolution never could happen (although it was inevitable). As the party socialists did more to improve the present, they talked less of the distant future state. They ceased their criti- cisms of "mere temporijzing" "bourgeois" reforms, and be- gan to claim these as the achievements of the socialist party. They began to write of the remarkable growth of social legisla- tion in Europe and America in the past half century under such titles as "socialism in practice" and "socialists at work." This was despite the fact that these reforms were all brought about by governments in which the socialist party had no part whatever or was a well-nigh insignificant minority. This bald sophistry, or self-deception, was easily possible by confusing the word "socialist" as relating to the abstract principle of social action, with socialist as applied to their own party or- ganization. It is as if the Republican party in the United States were to claim as its own all the works of the republican spirit and principles of government in the world from the party's organization to the present time. The German democratic revolution of November 1918, which drove the Kaiser into exile, brought the social-demo- crats into power as the dominant party in Germany. The more moderate element is in the majority and, in alliance in parliament with various liberal parties, has thus far been administering the affairs of the state along economic lines little different from those of the old order. No serious modi- fication of private property has been made. The situation is far from clear as yet. We seem to see here again the sobering effect of responsibility, and the definite unwilling- ness of the German workingmen, with the example of Bol- 800 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI shevik ruin under their eyes at the Bast, to risk abolishing capitalism. § 14. Alluring claims of party socialism. In becoming opportunist, the radical socialist party in every country has been somewhat put to it to retain any clear distinction be- tween itself and other parties of social reform. It has done this however by continuing to proclaim the ultimate desir- ability of re-organizing all society without leaving any pro- ductive wealth in private hands; while in practice it has shown misgivings prompted by the experience of the world. Its case against the present order continues to be far the strongest in its negative aspect, the exposure of evils. To many natures the claims of the socialist party have all the allurements of patent medicine advertisements. These de- scribe the symptoms so exactly and promise so positively to cure the disease, that they are irresistible, especially when the regular physicians keep insisting that the only way to get well is to adopt such troublesome and disagreeable methods as taking baths and exercise, and stopping the use of whiskey and tobacco. Those attracted to the socialist party by its sweeping claims are of two main types. The one is the low-paid industrial wage-worker to whom competition awards so small a share of the national income; the other is the sympathetic person of education or of wealth (or of both), who has become sud- denly aroused to the misery in our industrial order. To both of these types, feeling intensely on the subject, the socialist party appeals as the only one with promises sweep- ing enough to be attractive. The one becomes the proletarian, workshop socialist, the other the intellectual, parlor socialist. Many of the latter type are persons overburdened either with unearned wealth or with an undigested education. Many of them, having enjoyed for a time the interesting experi- ence of radical thought and of bohemianism, come later to more moderate social opinions. § 15. Changes in the socialist party vote. The socialist Ch. 35] SOCIALISM PEESENT AND FUTURE 601 vote in Europe and in the United States had been steadily- growing in the forty years preceding the outbreak of the World War, and amounted in the aggregate at least to six and possibly to ten millions (as variously estimated, the name socialist being elastic). There were 3,000,000 social-demo- cratic voters in Germany at the outbreak of the war, and the socialist party in the United States polled 900,000 votes in the presidential election of 1912. The socialist parties were made up of men of many shades of opinion. They included not only the radicals, but large numbers of the discontented, unable to find an alternative economic philosophy and a plan that inspired their hopes. They included many others who held only the mildest sort of socialistic philosophy. In Amer- ica many men voted the socialist ticket as a protest against the inaction of the conservative parties, and barely one- tenth regularly enrolled as members of the party. Similarly, in Germany before the war many voters supported the social- democratic party merely as the most effective way to protest against Militarism, Kaiserism, and undemocratic class gov- ernment. The war affected profoundly the policies and fortunes of partizan socialism. In accord with the doctrine of the class conflict, Marx had exclaimed, in the Communist Manifesto, "Proletarians of all lands, unite." Marxian socialism con- demned national patriotism and fostered in its place a spirit of internationalism. For years prominent Marxians had boldly announced that any attempt to bring on a European war would be blocked by a general strike declared by the socialist workers. But when German militarism precipitated war in 1914, only a feeble fraction of the German radical socialists stood out against it, and nearly all socialists in every country lined up with their fellow nationals. The immediate result was loss of prestige and of following for the socialist parties in the allied countries. The American socialist party with an enrolled membership largely of immigrants, many of them still unnaturalized, was 602 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI more unpatriotic and pro-German than were tlie socialists in any of the other allied countries. A number of its American members and of those born in allied countries left the Amer- ican socialist party. The socialist vote for presidential electors fell to 590,000 in 1916, but rose again in 1920 to 900,000. In addition over a quarter of a million of votes were cast, mostly in the Northwest, for the Farmer-labor party, pre- senting a state-socialist program. § 16. Economic legislation and the political parties. These figures, while indicating no landslide to communism, do not forecast the disappearance of the radical socialist philosophy and of the socialist party. Both philosophy and party are based on the fact of great inequality in the distribu- tion of wealth, on the growth of cities and the spread of the wage system, on resentment at the abuse of power and at many cases of individual injustice suffered by the poor at the hands of employers, and on the conviction that conditions cannot be- come better under the present regime. The masses now, for the first time in history, have the ballot without hereditary, class, or property limitations. The world is for the first time trying the experiment of full political democracy side by side with great private fortunes and great economic in- equality. The democratic Samson may be blind, but he has the power to pull down the temple of capitalism in ruin upon our heads. The future of partizan socialism depends on the policy of the other political parties quite as much as it does on its own policy. The floating liberal vote with socialistic sympathies is now so large that it is eagerly sought by candidates of the other parties. These independent voters care little for the radical and distant tenets of the socialist party leaders, who, to attract wider support, are forced to place in- creasing stress upon immediate and moderate reforms. On the other hand, men of larger qualities of leadership in the older parties are constantly adopting and advancing pend- ing measures of social reform. Where this is not done the Ch. 35] SOCIALISM PRESENT AND FUTUKE 603 radical socialist party tends more quickly to develop into the one powerful party of protest and of popular aspiration, receiving support from many elements of the middle and small propertied classes and from non-radical wageworkers. This movement from both sides is leaving less noticeable the con- trast between the socialist party and other parties claiming to be "progressive" or "forward looking." The strongest allies of the more radical communistic faction of the socialist party are those members of the conservative parties who fail to rec- ognize the need of humane legislation, who irritate by their unsympathetic utterances, and who unduly postpone by their powerful opposition the gradual and healthful unfolding of the social spirit, energy, and capacity of the nation. The greatest problem of social and economic legislation for the next generation is to determine how far, and how, the prin- ciple of authority may wisely be substituted for the principle of competition in distribution. The many and varied forms of economic legislation de- scribed in the foregoing pages are so many experiments to find that better and that best adjustment of economic insti- tutions to the needs and actual capacities of the people. Some of these experiments turn out badly, others well, and accordingly some are extended, others after a time are aban- doned, perhaps to be tried again by a later hopeful genera- tion of men. It does not seem possible for human society to stand still or to remain unchanged in respect to the many features which go to make up the present order. In some ways things grow better, in other ways worse. Moreover, this process of change is no longer so unconscious, and human society is not now so passive in the hands of fate, as in the past. Democratic society has become self-conscious and aspires to shape its own destiny. Can it be wise enough to know and will it be virtuous enough to do, that which will lead to an ideal social state? In any case it is making the attempt which must spell the continued progress or the eventual downfall of human civilization. 604 PRIVATE PROPERTY VS. SOCIALISM [Pt. VI References. Brooks, J. O., The American syndicalism: the I. W. W. N. Y. Macmillan. 1913. Bussenden, P. F., The I. W. W. A study of American syndicalism. Pp. 432. New York. Longmans. 1919. (Historical study of the I. W. W.) Clark, J. B; Social justice without socialism. Bost. Houghton. 1914. Ensor, R. G. E., (Ed.), Modern socialism. 2d ed. N. Y. Scrib- ner. 1907. (Selections from socialistic sources.) Gompers, Samuel, Out of their own mouths; a revelation and an indictment of Sovietism. 12mo. New York. Button. 1921. Hillquit, M., History of socialism in the United States. N. Y. Funk. 1903. Hillquit, M., Socialism in theory and practice. N. Y. Macmillan. 1909. Laidler, H. W., Socialism in thought and action. New York. Mac- millan. 1919. Kirkup, T., Inquiry into socialism. 3d ed. N. Y. Longmans. 1907. (A sympathetic, but not a partizan statement.) Martin, John, An attempt to define socialism. A. E. Assn. Bui., 4th ser. 1 (no. 2) : 347-354. 1911. Round table discussion of above, 355-367. Uenger, A., The right to the whole produce of labor. Trans. 1890. (Masterly criticism.) Rae, John, Contemporary socialism. 3d ed. N. Y. Scribner. 1901. (Standard work by a non-socialist.) Sohaeffle, A., The quintessence of socialism. N. Y. Scribner. 1898. (Exposition by a non-socialist, so favorable that it is used by the socialists as a tract.) Spwrgo, JoMi, Socialism. 1906. N. Y. Macmillan. (Pro.) Walling, ^Y. W., and associates, The socialism of today. New York. Holt. 1916. (A source book of the present position and recent development of the Socialist and labor parties in all countries, consisting largely of original documents.) Wells. H. G., New worlds for old. N. Y. Macmillan. 1908. (An appeal for juster distribution; Fabian school.) INDEX I>JDBX Accident insurance, 402-406- Agricultural credit, 126, 470-473 Agricultural, decay, 446; eco- nomics, problems of, 457-475; prices, fall of, 261 Agricultural, and rural population, 441-456 Agriculture and crises, 150 Agriculture, exhaustion of the soil, 260; m^ieval, 322; number in, 443 ; the new, 466 Aldrich plan, 116 American I'ederation of Labor, 341 Appreciation and interest, 85 Arbitration, 371-377 Assessment of taxes, 283 Authoritative distribution, 583, 602 B Balance of merchandise, 238 Balance of trade argument, 255 Banii, deposits aa investments, 160; restriction act, 101 Banking, in the U. S., before 1914, 107-116 Banks, functions of, 91-106; in U. S., 91 ; taxes on, 299 Bills of exchange, 98, 241 Bimetallism, 66 Bolshevism, 590, 598 Bonds, as investments, 162; taxa- tion of, 292 Boycott, 347 Building and loan associations, 169-174 Business cycle, 142 C California Fruit Exchange, 468 Canadian Industrial Disputes Act, 373, 375 Canals, 478 Capitalistic monopoly, 507 Charitable distribution, 583 Capitalization theory of crises, 153 Charity, and control of vice, 383 Child-labor, 362-364 Christian socialism, 588 Clayton- Act, 537; and farmers, 445 Closed shop, see Open shop Coal, 569 Coinage on governmental account, 44 Collective bargaining, 343 Combinations, industrial, 513 Common law, on monopoly, 524 Comparative advantages, doctrine of, 233 Compensated gold dollar, 84 Compensation, for accidents, 403 Competition among employers, 339; among workers, 344; and monopoly, 522; as regulative principle, 535; merits of, 579; see also Monopoly Competitive system, 552 Compulsory insurance, 413; econ- omy of, 204 Consolidation, of railroads, 495 Consumers' League, 367 Contributory principle in insur- ance, 414 Cooperation, producers', 333-336; among farmers, 467-470 Corporation taxation, 298-303 Corporations, 509^511 Costs of production, and the tariff, 223; 262 Crises, and industrial depressions, 138-157; 266; and unemploy- ment, 394, 396 Custom, 553-555 607 608 INDEX D Debta, public, 275 Deferred payments, standard of, 54-69 Deposits, bank, 94-98 Dingley Act, 221 Discrimination, railroad, 484-487; see also Monopoly Displacement theory of immigra- tion, 428 Distribution of incomes, 574^587 Doctrine of comparative advan- tages, 233 Dollar, 38, 40 Dynamic conditions, 148 E Economic, harmonies, 592; prob- lems, 3-10; system, the present, 542-557 Employment offices, 393 Engels, Friedrich, 591, 592 Erdman act, 372 Eugenics, 419, 433 Factory conditions, 379-380 Farm, loans, 472 Farmers' income, 452; Mutual in- surance, 183 Farming, types of, 460-465 Farms, area, 457 Federal Farm Loan Act, 472 Federal Industrial Commission, 520 Federal legislation against mo- nopoly, 529 Federal Reserve Act, 98, 117-137, 155, 174 Federal taxation, 295 Federal Trade Commission Act, 537 Fiat money, 51 Finance, public, 270 Foreign, banking, 115, 121; trade, 230; exchange, 242 Forests, 442, 566-568 Fractional coins, 39 Franchises, railroad, 493; for pub- lic utilities, 564 Free trade, 208, 555; see also Pro- tective tariff G Gambling, uneconomic character of. 177 General property tax, see Property Glass-Owen bill, 117 Glut theories of crises, 151 Gold-exchange standard, 47 Gold, production, 60-64; 79, 80 Graduation principle, 303, 311 Greenbacks, 49, 52, 64 Gresham's law, 41 Guild socialism, 598 H Health insurance, 409-411 "High cost of living," 80 Home market argument, 253 Housing problem, 384-386 Hours and wages, public regula- tion of, 358-378 Immigrants, and organized labor, 339 Immigration, and low wages, 370; and population, 418-437; and farming, 465 Imports into the U. S. chart, 212, 213, 224 Income, taxation, by states, 307, federal, 308-316 Independent treasury, 108 Index numbers, chart, 56 Industrial revenues of government, 274; remuneration, methods of, 321; monopoly, problem of, 505; trust, 532; depressions, see Crises Infant industry argument, 251 INDEX 609 Inheritance, taxes, 304-306; limi- tations of, 549 Insurance, 176-204; companies, taxes on, 299; social, 398-416 Interest rate, and deferred pay- ments, 85; and prices, 244; in crises, 147 Internal revenue, 216, 295 International exchange, efjuation of, 236 International trade, 230-245 Interstate Commerce Act, 496; 529, 530, 531 Invalidity pensions, 406 Investment banking, 162 I. W. W., 597 Justice in deferred payments, 81 ; in taxation, 281 K Knights of Labor, 341 L Labor, and legislation, 340; and social legislation, 379-397; ejx- changes, see Employment offices Laissez-faire, 555, 558, 560 Land, taxation, 296-298; banks, 470 Large production, in public utili- ties, 563 Large industry, 511 Lassalle, Ferdinand, 591 Legal tender, 48 Loans, governmental, 275 Lump of labor notion, 359 M McKinlejy Act, 219 Market, public, 561 Materialistic philosophy, 592 Marx, Karl, 591-596 Mediation, 371 Mercantilism, 256 Merchandise, imports and exports, 238 Militarism, and population, 434 Mill, J. S., 524-550 Minimum wage, 368-370 Monetary economy, 552; system, 37 ; theory of crises, 152 Money, origin and nature, 11-24; value of, 41-54 ; quantity theory, 25-35; fiduciary, 36-53 Monopoly, and labor organization, 350; in railroads, 484-487; in protection, 260; industrial, 505- 521; public policy in respect to, 522-539; in public utilities, 562-564 Mortality table, 192 Mortgage taxation, 292 Municipal ownership, 561 National ownership, 567 National Monetary Commission, 111, 1161 Natural agents, and monopoly, 507 Negro problem, 419-421 Newlands act, 372 O Old-age pensions, 406 Open shop, 350 Organized labor, 337-357; and legislation, 374 Ownership of farms, 455 Panic, 139, 142 Paper money, 48-51 Par of exchange, 242 Payne-Aldrich tariff, 223 P(^rsonal taxes, 304-317 Picketing, 347 Piece work, 326 Police state, 271 Political, money, 48; aspects of labor, 352; aspect of railroads, 487 610 INDEX Population, agricultural and rural, 441-456; and immigration, 418- 437 Postal savings, 166-168 Premium plans, 327 Prices, general level, 54-57; market, 535; and international trade, 244; and monopoly, 519 Profit sharing, 329-333 Profits from monopoly, 518 Progressive taxes, see Graduation Property, private, 543-552; taxes on, 279, 289-298 Protection, "true principle" of, 223, 263 Protective, tariff, policy of, 246- 269; tariffs, prevalence of, 208; railroad rates, 488 Public, finance, 270; view of trade unions, 353; regulation, of hours, 358-378; of railroads, 492-504; ownership, 558-573 Public utility commissions, 494 Public utilities, monopolistic na- ture of, 562-564 Q Quantity theory of money, 30-35 R Race problems, 419 Railroad mileage, 480-481; prob- lem, 477-489; regulation, 490- 504 Reserve, cities, 110; plan of in- surance, 191-204 Reserves, bank, 96; against notes, 124; against deposits, 125 Restraint of trade, sep Monopoly Revenue tariff, 248 Revisionism, 594 Rural, definition, 443 ; exodus, 450 S Saturation point of money, 39 Saving, and investment, 158-175 Savings, banks: deposits? 102; in- surance assets as, 202 "Scientific" socialism, 591 Seigniorage, 39, 43 Sherman Anti-trust law, 448, 449, 529 Shifting and incidence^ 252; of in- aurance premiums, 363 Single tax. 296 Smith, Adam, 555 Social, legislation, 379; effects of inheritance, 472, 474 Social insurance, 398-416; by trade unions, 340 Social utility, 22 Social welfare, in taxation, 272; and shorter working day, 367 Socialism, 588-604 Standard money, 25, 57; see also Deferred paymepts State, sphere of, 270; insurance, 413; ownership, 565 Status, distribution by, 575 Strikes, 345, 373 Syndicalism, 597 Tabular standard, 83 Tariff, changes and crises, 149; and wages, 257; and unemploy- ment, 259; reductions, harm of, 266; history, American, 207- 229; rates, 209; for revenue, 248; "true principle" of, 223, 263 ; and business depressions, 264 Task work, 325 Taxation, objects and principles' of, 270-287; revenues from, 278; kinds of, 279; separation of, 295; system of, 316 Taxes, property and corporation, 288-303; personal, 304-317 Tenancy on farms, 458 Time work, 324 Trade ejducation, 387 INDEX 611 Trade unions, 337; see also Organ- ized labor Transportation, taxes on, 300; Act of 1920, 502. see also Rail- roads Trust company, 91, 93 Trust, definition, 512; see Monop- oly Two-profits argument, 254 U Underwood tariff, 225 Unemployment, 388-397; in crises, 142, 146; insurance; 411; and tariffs, 259 Unfair practices, 534 Usury laws, 382 W Wage contract, limitation of, 381 Wage-system, 321, 556 Wages, and tarifl', 257; and gen- eral prices, 81, 346, 359; and organization, 348, 354; and un- employment, 391; and immigra- tion, see Immigration; see also Hours and wages Walker tariff, 215, 265 Waterways, 477 "Wealtli of Nations," 555 Wilson tariff act, 220 Working day, 358-367