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OUTLINES OF ECONOMICS 
 
THE MACMILLAN COMPANY 
 
 NEW YORK • BOSTON • CHICAGO ■ DALLAS 
 ATLANTA • SAN FRANCISCO 
 
 MACMILLAN & CO., Limited 
 
 LONDON • BOMBAY • CALCUTTA 
 MELBOURNE 
 
 THE MACMILLAN CO. OF CANADA, Ltd. 
 
 TORONTO 
 
OUTLINES OF ECONOMICS 
 
 (THIRD REVISED EDITION) 
 
 BY 
 
 RICHARD T. ]^LY 
 
 PROFESSOR OF POLITICAL ECONOMY IN THE UNIVERSITY OF WISCONSIN 
 
 THOMAS S. ADAMS 
 
 PROFESSOR OF POLITICAL ECONOMY IN THE SHEFFIELD SCIENTIFIC 
 SCHOOL OF YALE UNIVERSITY 
 
 MAX O. LORENZ 
 
 ASSOCIATE STATISTICIAN, INTERSTATE COMMERCE COMMISSION 
 
 ALLYN A. YOUNG 
 
 PROFESSOR OF ECONOMICS AND FINANCE IN 
 CORNELL UNIVERSITY 
 
 THE MACMILLAN COMPANY 
 1918 
 
 All rights resetted 
 

 Copyright, 1893, 
 By hunt & EATON. 
 
 Copyright, 1908 and 1916, 
 By the MACMILLAN COMPANY. 
 
 First published elsewhere. Reprinted May, 1900; July, October, 
 1901; August, 1903; July, September, 1904; July, 1905; January, 
 August, 1906; July, 1907; April, igo8. 
 
 New edition, revised and enlarged, September, October, 1908; 
 January, August, 1909; December, 1910; August, 1911; June, 
 1912; May, 1913; January, July, 1914; January, September, 
 twice, 1915. 
 
 Third edition, revised and enlarged, September, 1916. Reprinted 
 November, igi6. 
 
 Reprinted with corrections, August, October, 1917. 
 
 
 NorbinolJ ?3rc88 
 
 J. S. Gushing Co. — Berwick & Smith Co„ 
 
 Norwood, Mass., U.S.A. 
 
// 
 
 PREFACE 
 
 The first edition of the Outlines of Economics, written by 
 Professor Ely, was published in 1893. Four persons codperated 
 in the preparation of a revised and enlarged edition, which 
 appeared in 1908. This was in many respects a new book, 
 although much matter from the earHer edition was incorpo- 
 rated in it, and although pains were taken to retain the general 
 organization and especially the general point of view of the 
 older volume. The present edition does not differ so much 
 from its predecessor as that differed from the first edition, but 
 it is, nevertheless, the result of a more thoroughgoing revision 
 than is usually given to books of this kind. 
 
 Some minor changes have been made in the order in which 
 the chapters appear; two chapters have been omitted; and 
 a chapter on labor legislation has been added. No chapter 
 in the book remains unaltered, and the larger part of Books II 
 and III has been virtually rewritten. While the number of 
 different subjects treated has been slightly reduced, the treat- 
 ment of the more fundamental subjects has been considerably 
 expanded. Each of us has undertaken the revision of a definite 
 portion of the book and, to secure unity, Professor Young has 
 had general editorial supervision of the revision as a whole. 
 
 Some of the changes are such as are necessary by reason of 
 eight years of progress in industrial life, in legislation, and in 
 economic thought. Other changes are the outgrowth of the 
 experience gained in eight years' use of the book in university 
 and college courses. Among the many persons to whom we 
 are indebted for helpful criticisms and suggestions are Dr. John 
 Cummings, Professor H. J. Davenport, Dr. C. S. Duncan, 
 Professor L. C. Gray, Professor J. E. Le Rossignol, Professor 
 
VI PREFACE 
 
 W. C. Mitchell, Professor T. W. Page, Professor F. M. Taylor, 
 Mr. Ray S. Trent, and Professor N. A. Weston. 
 
 The instructors in charge of the course in elementary eco- 
 nomics at the University of Wisconsin have generously cooperated 
 by submitting carefully prepared hsts of definite, well-con- 
 sidered, and pointed suggestions for the betterment of the 
 book. We make grateful acknowledgment to Professors T. K. 
 Urdahl, W. I. King, and H. D. Simpson, and to Messrs. Harry 
 Jerome, A. H. Hansen, J. G. McKay, and F. L. Vaughan. 
 
 THE AUTHORS. 
 September, 191 6. 
 
CONTENTS 
 BOOK I. — INTRODUCTION 
 
 PACK 
 
 Preface v 
 
 Chapter I. — The Nature and Scope of Economics 
 
 Diversity of economic study, 3 ; Definition of economics, 4 ; A 
 social science, 5 ; Studies man in process of development, 6 ; Eco- 
 nomic laws, 7 ; Relation of economics to other sciences, 1 1 ; Prin- 
 cipal divisions of economics, 15. 
 
 Chapter II. — The Characteristics of the Present Economic System 
 
 Human and physical conditions of economic activity, 17 ; Private 
 enterprise and state activity, 17; Division of labor and exchange, 
 19; Economic classes, 21 ; Private property, 21 ; Trade- marks, copy- 
 rights, and patents, 23 ; Inheritance, 24; Contract, 25; Vested in- 
 terests, 25 ; Freedom, 26 ; Competition and markets, 28 ; Fair 
 competition, 29; Cooperation, 30; Monopoly, 30; Custom, 31. 
 
 Chapter HI. — The Evolution of Economic Society 
 
 Basis of the economic stages, 33; Direct appropriation, 34; 
 Primitive man, 35; Pastoral stage, 36; Agricultural stage, 37; 
 Manorial economy in England, 37; Handicraft stage, 39; Gilds, 
 39; Domestic system, 40 ; Agricultural changes, 41 ; The mercan- 
 tile system, 42 ; Industrial stage, 44 ; Other classifications, 44. 
 
 Chapter IV. — The Evolution of Economic Society (Continued) 
 
 Industrial Revolution, 47 ; England in 1760, 47 ; Mechanical in- 
 ventions, 49 ; Agricultural changes, 50 ; Effects of industrial revolu- 
 tion, 51; The factory system, 51; Industrial specialization, 2; 
 Evils of the transition, 52 ; Competition and laissez-faire, 53 ; Re- 
 action against the passive policy, 54 ; Quality of goods, 55 ; Pro- 
 tection of labor, 55 ; Labor organizations, 57 ; Extension of govern- 
 ment enterprise, 58; Summary, 59. 
 
Vm CONTENTS 
 
 Chapter V. — The Economic Development of the United States 
 Economic stages in American industrial history, 6i ; Sectional- 
 ism, 62; Characteristics of the American people, 63; Growth of 
 popiilation, 64 ; Slavery and the negro problem, 66 ; Immigration, 
 68 ; Natural resources, 74 ; Public lands, 75. 
 
 Chapter VI. — The Economic Development of the United States 
 
 (Continued) 
 
 Mercantilism in America, 79; English colonial policy, 80; 
 American industries in 1776, 81 ; The Industrial Revolution in 
 America, 81 ; The development of agriculture, 84; Manufactures, 
 86 ; Transportation, 90 ; The labor movement, 93 ; State regula- 
 tion of industry, 96. 
 
 BOOK II. — PRINCIPLES AND PROBLEMS 
 PART I. — PRODUCTION AND CONSUMPTIONJ 
 
 Chapter VII. — Elementary Concepts 
 
 Motives in economic activity, 103 ; Utility, 105 ; Free and eco- 
 nomic goods, 105 ; Effort and waiting, 106 ; Risk, 106 ; Personal 
 quahties as goods, 107 ; Wealth and income, 108 ; Individual and 
 society, 109 ; Wealth and value, 109 ; Capital and other forms of 
 wealth, no; Capital goods and capital value, no; Social and in- 
 dividual capital, III ; National wealth and national dividend, in. 
 
 Chapter VIII. — Production 
 
 ProJ tion defined, 116; Production of values, 118; Factors of 
 producLi 1, 119; Saving and capital formation, 122; Production 
 and sacrifice, 124; Organization of productive factors, 123; The 
 entrepreneur, 1 23 ; Division of labor, 1 24 ; Advantages of division 
 of labor, 126 ; Effects upon the worker, 127 ; Territorial division of 
 labor, 128; Productive organization of the American people, 129. 
 
 Chapter IX. — Consumption 
 
 Consumption defined, 132; Productive and final consumption, 
 132 ; Human wants, 133 ; Law of diminishing utility, 133 ; Mar- 
 ginal utility, 135; Subjective value, 137; Economic order of con- 
 sumption, 139 ; Future wants, 140 ; Consumption and saving, 142 ; 
 Alleged present consumption of future products, 142 ; Luxury, 143 ; 
 Harmful consmnption, 144; Statistics of consumption, 144; Con- 
 sumption and sacrifice, 146 ; Cost of production, expense of produc- 
 tion, and opportunity cost, 148. 
 
CONTENTS IX 
 
 PART II. — VALUE AND EXCHANGE; 
 
 Chapter X. — Value and Price 
 
 Meaning and significance of value, 151 ; The market, 153 ; Ex- 
 change value and subjective value, 155 ; Supply and demand, 156 ; 
 Nature of demand, 156; Elasticity of demand, 159; Nature of 
 supply, 162 ; The determination of price, 164. 
 
 Chapter XI. — Value and Price {Continued) 
 
 Prices and the expenses of production, 167; Normal price, 169; 
 Different conditions of supply, 1 70 ; Fixed and variable expenses, 
 174; Jointexpensesof production, 179; Surplusof bargaining, 181 ; 
 Non-reproducible goods, 182 ; Retail prices, 182 ; Pubhc authority 
 and value, 183; Imputed value, 184; Valuation of production 
 goods, 185 ; Other theories of value, 186. 
 
 Chapter XII. — Monopoly 
 
 The idea of monopoly, 189; Classification and causes, 193; 
 Social and natural, 195 ; Monopoly price, 200 ; Effect of a tax, 202 ; 
 Relation of demand to monopoly price, 203 ; Class price, 204 ; 
 Monopoly price, high price, 205 ; Monopolies and distribution of 
 wealth, 207 ; Pubhc pohcy toward monopolies, 208. 
 
 Chapter XIII. — Business Organization 
 
 The meaning of "business," 212 ; The nature of business units, 
 212 ; The business unit in accounting, 213 ; The individual entre- 
 preneur, 214; Partnerships, 215; The business corporation, 216; 
 The corporation charter, 217; Lack of uniformity in state laws, 
 218; Corporation capital and capitalization, 219; Overcapitaliza- 
 tion, 221 ; Form of capitalization, 225 ; Corporation management, 
 226; Advantages of the corporation, 228; Social aspects of cor- 
 porations, 228; Trusts, 230; Causes of combination, 232; Anti- 
 trust laws, 235 ; Unfair competition, 239 ; Public policy towards 
 industrial combinations, 243 ; Federal control of Corporations, 
 24s ; Industrial combinations in other countries, 245. 
 
 Chapter XIV. — Money 
 
 Metallic money, 248 ; Coinage, 249; The meaning of "money," 
 250; The media of exchange, 252; The monetary standard, 255; 
 Seigniorage, 255; Limited coinage, 259; Bimetallism, 260; Bi- 
 metallism in the United States, 263 ; The gold-exchange standard, 
 269 ; Government paper money, 271 ; Colonial and Revolutionary 
 biUs of credit, 273; The greenbacks, 273; Fiat money, 278. 
 
CONTENTS 
 
 Chapter XV. — Credit and Banking 
 
 Credit transactions, 2S2; Personal credit, 2S5; Bank credit, 
 2S6 ; Bank notes, 290 ; State banks of issue, 290 ; National bank- 
 ing system, 291 ; The reserve system, 292 ; New York money- 
 market, 293; Speculation, 295; Independent treasury system, 
 297 ; The movement of money, 298 ; Inelastic currency, 300 ; In- 
 elastic reserves, 301 ; Absence of centralized control, 303 ; Steps 
 toward reform, 304 ; Federal reserve system, 307 ; State and private 
 banks, 313. 
 
 Chapter XVL — Other Problems in Money and Baneing 
 
 The \-alue of money, 317 ; Quantity of monej^ and the values of 
 money, 319; Equation of exchange, 321; Mechanism of general 
 changes in prices, 325; Industrial uses of gold, 327; Expenses of 
 gold production, 328; Increase in gold production, 329 ; Effects of 
 changes in prices, 331; Crises, S33'> Standard of deferred pay- 
 ments, 336; Index numbers, 337. 
 
 Ch.apter X\TI. — International Tr.ade 
 
 Foreign excJiange, 345; Regulation of the gold supplj^, 350; 
 Balance of trade, 354; Restriction of international trade, 35S; 
 Advantages of international trade, 361. 
 
 Chapter XV ill. — Protection and Free Tr.ade 
 
 The c-ase for protection, 36S; Arguments of free-traders, 374; 
 General considerations, 3S0; Conclusions, 3S1. 
 
 PART in. — DISTRIBUTION 
 Ch.apter XIX. — DiSTRXBtrrioN as an EcoNOinc Problem 
 
 The problem of distribution, 3S4; Distribution controlled by 
 existing institutions, 3S6 ; Money incomes, 3S7; Law of diminish- 
 ing producti\"ity, 3SS ; [Marginal product of labor, 390 ; jMarginal 
 products of land and capital, 392 ; ^Marginal productivity and the 
 prices of production goods, 30S ; The meaning of ''producti\"ity," 
 400 ; Social aspects of diminishing productivity, 404. 
 
 Ch.apter XX. — The Rent of L.and 
 
 Rent defined, 407 ; The sers-ices of land, 40S ; Rent imder uni- 
 form intensi\"ity of cultivation, 410 ; Rent under actual conditions, 
 413 ; The different uses of land, 416 ; The capitaMzation of rent, 
 41S; Rent and social progress, 419; The unearned increment, 
 422 ; Urban lands, 426. 
 
CONTENTS XI 
 
 Chapter XXI. — The Wages of Labor 
 
 Wages as the price of labor, 427; Demand for labor, 428; Labor- 
 saving machinery, 430; Supply of labor, 431 ; Growth of popula- 
 tion, 434; Subsistence theory of wages, 437 ; The standard of Ufe 
 and wages, 438 ; Supply of labor in different occupations, 439 ; The 
 wage contract, 442. 
 
 Chapter XXII. — Labor Problems 
 
 Types of labor organizations, 444; Economic justification of 
 labor organizations, 445 ; Labor organizations and monopoly, 446 ; 
 Methods and policies of labor organizations, 447 ; The closed shop, 
 448 ; Limitation of output, 449 ; Educational and fraternal activi- 
 ties, 45 1 ; The strike, 45 2 ; Employers' associations, 454 ; Trade 
 arbitration, 457 ; Voluntary arbitration, 458 ; Compulsory arbitra- 
 tion, 459 ; Profit sharing, 461 ; Industrial democracy, 463 ; Co- 
 operation, 465 ; The future of the union, 469. 
 
 Chapter XXIII. — Labor Legislation 
 
 Freedom of contract, conspiracy, and injunctions, 472; Child 
 labor laws, 476 ; The labor of women, 479 ; Minimum wage laws, 
 480 ; Factory acts, 484 ; Employers' liabiUty, 486 ; Philosophy of 
 labor legislation, 488. 
 
 Chapter XXIV. — Interest 
 
 Interest defined, 493 ; Inadequate explanations, 494 ; How in- 
 terest is possible, 495 ; Why interest is necessary, 496 ; Invest- 
 ment, 499 ; Replacement, 501 ; Shifting of investment, 502 ; 
 Expense and price of capital, 504; Free and speciaUzed capital, 
 506 ; Capital and land, 507 ; Capital and consumption goods, 512 ; 
 Capital and wages, 512; Competitive investment, 513; The 
 flow of money income, 515; The annual product and the social 
 dividend, 517 ; Sources of investment funds, 523 ; The interest rate, 
 521 ; Gross and net interest, 523 ; Usury laws, 524. 
 
 Chapter XXV. — Profits 
 
 Profits a surplus, 525; Entrepreneur's wage, 526; Pure profits 
 impossible under certain conditions, 527; Sources of pure profits, 
 528; Marginal productivity and profits, 532; Profits for the in- 
 dustry and profits for the establishment, 533 ; Good-wiU, 535 ; 
 The relation of risks to profits, 536 ; The entrepreneur, 537 ; Profits 
 and the defense of the competitive system, 538. 
 
XU CONTENTS 
 
 Chapter XXVI. — The Personal Distribution of Wealth 
 Wealth and income, 542 ; Absolute and relative well-being, 542 ; 
 Concentration of wealth and large-scale production, 542 ; Methods 
 of measuring concentration, 543 ; Statistics of distribution, 544 ; 
 Causes of poverty and riches, 549; Is greater diffusion possible? 
 551; Modifying the methods of wealth acquisition, 553. 
 
 PART IV. — SELECTED ECONOMIC PROBLEMS 
 
 Chapter XXVII. — Transportation Economics 
 
 Scope and significance, 557; Nature of the railway industry, 
 558; Railway competition, 560; Pooling and consolidation, 561; 
 The movement of rates, 563 ; The level of rates, 565 ; Relative 
 rates, 567; Distance, 570; Government ownership, 571; Regula- 
 tion, 573; The Interstate Commerce Commission, 574. 
 
 Chapter XXVIII. — Insurance 
 
 Nature of insurance, 577 ; Origin and development, 578 ; Forms 
 of insurance organization, 580; Life tables, 581; Reserve, 583; 
 Surplus, 583 ; Endowments, 584 ; Industrial insurance, 585 ; State 
 insurance, 585 ; State regulation, 586 ; Social insurance, 587 ; 
 Workmen's compensation, 588; Sickness insurance, 591; Old-age 
 insurance, 592 ; Unemployment insurance, 592 ; Objections to 
 social insurance, 593. 
 
 Chapter XXIX. — Agricultural Problems 
 
 Size of farms, 596 ; Ownership and tenancy, 603 ; Farm labor, 
 606 ; Farm indebtedness and agricultural credit, 609 ; Tenancy vs. 
 encumbered ownership, 615; Marketing of farm products, 618; 
 Speculation, 622. 
 
 Chapter XXX. — Socialism 
 
 Socialism defined, 627; Distributive justice, 627; Varieties of 
 sociahsm, 628; Communism, 631; SociaHsm an extension of 
 existing institutions, 632; The strength of socialism, 632; The 
 weakness of socialism, 634 ; The sociahst movement, 636 ; Anar- 
 chism, 638. 
 
 BOOK III. — PUBLIC FINANCE 
 Chapter XXXI. — Public Expenditures 
 Nature and significance of public finance, 643 ; Public and pri- 
 vate expenditures contrasted, 646 ; The proper proportion between 
 the total income of society and public expenditures, 648 ; Economy 
 
CONTENTS xiii 
 
 the total income of society and public expenditures, 648 ; Economy 
 vs. parsimony, 652; Historical development, 654; Development 
 of public expenditures with respect to regularity and irregularity, 
 659; Classification of public expenditures, 660. 
 
 Chapter XXXII. — Public Receipts from Loans and Government 
 
 Ownership 
 
 PubUc debts, 666; Public domains, 671; Land pohcy of the 
 United States, 673 ; Forest lands, 674; Mineral lands, 675 ; Success 
 of our land policy, 677 ; Land nationalization and mimicipalization, 
 679; Pubhc industries, 682. 
 
 Chapter XXXIII. — Public Receipts : Derivative Revenues, Fees, 
 Special Assessments, and Taxes 
 
 Definitions, 689 ; Fees, 690 ; Special assessments, 692 ; Taxes, 
 694; Justice in taxation, 696; Progressive taxation, 699; Direct 
 and indirect taxes, 702 ; The shifting of taxes, 703. 
 
 Chapter XXXIV. — Public Receipts : Federal, State, and Local 
 
 Taxes 
 
 Constitutional limitations, 710 ; Use of direct taxes by the federal 
 government, 712; Customs duties, 713; Internal revenue duties, 
 717; Taxes on transactions, 719; Income taxes, 720; Inheritance 
 taxes, 723; General property tax, 726; Corporation taxes, 731; 
 Business and Ucense taxes, 733; Poll taxes, 734; A balanced 
 revenue system, 735. 
 
 Appendix A : History of Economic Thought . . . . . 741 
 Appendix B : Suggestions for Students and Teachers . . . 754 
 Index ^ 761 
 
BOOK I 
 INTRODUCTION 
 
OUTLINES OF ECONOMICS 
 
 CHAPTER I 
 
 THE NATURE AND SCOPE OF ECONOMICS 
 
 The most striking characteristics of the great field of knowl- 
 edge the Outlines of which we attempt to sketch in the present 
 volume are its rich diversity and spacious amplitude. Start- 
 ing from psychology in its analysis of the human needs which 
 explain or condition wealth, it traverses the entire field of social 
 activities and institutions arising from man's efforts to supply 
 his material needs. It touches on one side the physical sciences, 
 from which it borrows some of its most fundamental prin- 
 ciples ; occupies joint territory at places with politics, ethics, 
 and law, although their respective jurisdictions are in the main 
 distinct ; and forms at once the most fertile and most thoroughly 
 developed province of the broad science of human society. 
 Within its borders, if we may continue to compare the scientific 
 possibilities of economics with the natural resources of an opu- 
 lent territory, opportunity is offered for the exercise of every 
 mental aptitude and every scientific method. The historian's 
 gift is needed to unravel the past and trace the development 
 of the industrial institutions whose present-day problems, in 
 turn, offer indefinite scope for the studies of the more practical 
 student with a taste for administration or business manage- 
 ment. For the legal mind there are the subtle problems of 
 property, inheritance, labor legislation, and corporation con- 
 trol ; for the mathematically inclined, insurance and modern 
 statistics ; for students with practical political interests, the 
 tarifi, currency reform, and a score of important problems in 
 which economics and politics are inextricably interwoven ; for 
 
 3 
 
4 OUTLINES OF ECONOMICS 
 
 the philanthropic, unemployment, accident insurance, and a 
 number of social problems growing out of the maladjustments of 
 modern industry. Animating the entire subject, blended with 
 the love of truth for truth's sake common to all sciences, is the 
 persistent hope that by systematic study we may eventually 
 abolish the material poverty which deadens and dwarfs the 
 lives of millions of our fellows. Economics is a science, but 
 something more than a science ; a science shot through with the 
 infinite variety of human life, calling not only for systematic, 
 ordered thinking, but for human sympathy, imagination, and 
 in an unusual degree for the saving grace of common sense. 
 
 To define such a subject adequately in a few sentences is 
 manifestly impossible. It is frequently said that economics 
 treats of man's efforts to earn a living, and this definition is 
 not inaccurate if by " man " we understand " mankind," and 
 if we fully appreciate that the individual's efforts to turn an 
 honest penny's profit receive but little attention in comparison 
 with the community's efforts to feed, clothe, and shelter itself. 
 Satisfaction of social need, and not individual profit, is the 
 objective point of the science. So, similarly, economics has 
 been characterized as the philosophy of human industry ; and 
 this description is illuminating provided we interpret " indus- 
 try " broadly enough. Even the old traditional definition, that 
 economics is the science of wealth, is true enough if we clearly 
 understand that there can be no wealth without man, and that 
 the science which deals with wealth, so far from being a " gospel 
 of mammon," necessarily begins and ends in the study of man. 
 As we prefer to define it, however, economics is the science which 
 treats of those social phenomena that are due to the wealth-getting 
 and wealth-using activities of man. 
 
 Economics treats of Man. — The supreme importance of 
 man in the study of wealth has not always been appreciated 
 by those who have expounded the science. Too often they 
 have considered man simply as a producer of wealth, the one 
 " by whom " the necessaries, conveniences, and luxuries of 
 life are created, whereas the infinitely greater truth is that man 
 is the one " for whom " they are all produced. Of course no 
 
THE NATURE AND SCOPE OF ECONOMICS 5 
 
 one denies this truth, but one might almost as well deny it as 
 to leave it out of account. The result of such neglect is that 
 men devise with great skill rules by which man may be made the 
 best possible manufacturing machine. It sometimes quite 
 escapes the notice of these persons that in making man the best 
 possible manufacturing machine they may make him a very 
 poor sort of a man ; that in teaching him to supply his wants 
 very bountifully they may prevent his developing and correct- 
 ing those same wants. They forget that there are two kinds 
 of poverty — one a lack of goods for the higher wants, the other 
 a lack of wants for the higher goods. To become rich in goods 
 while losing at the same time the power to profit by them is 
 unfortunately one of the commonest retrogressions in human 
 experience. We do not mean that the whole problem of human 
 development is the subject of economics, but simply that man- 
 hood, rounded human development, and the equitable organiza- 
 tion of human relationships are the objects of all social sciences, 
 and none must consider its subject so narrowly as to exclude 
 these objects. 
 
 Another common mistake has been to regard as of chief 
 importance the economic activities of one particular class, 
 especially the employer. Other men were treated simply as 
 *' a factor in production." An English writer speaks of dear 
 labor as one of the chief obstacles to England's economic pros- 
 perity. Could anything be more utterly an oversight of general 
 human well-being? Dear labor should be the very goal of 
 England's economic effort, for that means abundant supply 
 of the wants of the great mass of her people ; and the fact that 
 labor is dear, so far from being an obstacle to prosperity, is 
 the vSry proof and substance of that prosperity. A glance at 
 history indicates that men have made these mistakes not only 
 in theory but in practice. Industries have been developed to 
 majestic proportions while man was sinking into deeper deg- 
 radation; wealth has at times grown at the expense of that 
 human weal in whose service it won its name. 
 
 Economics treats of Man in Society. — This is one of those 
 truisms which only history can make real to us. As we pass 
 
6 OUTLINES OF ECONOMICS 
 
 from the savage and cannibal, up through all the stages of 
 development, we find an ever-increasing interdependence 
 among men. Man is least dependent when he wants least, 
 cares least, has least, knows least, and is least. With every 
 betterment of condition and character he is more dependent 
 than before, more dependent and yet more free. The beginnings 
 of barter are a confession of mutual need ; the coining of money 
 is a declaration of dependence to all men. We look with pride 
 upon a century of progress, but. that progress has consisted in 
 little else than a growth of dependence, an ever-increasing de- 
 parture from that rude kind of literal self-help in which each 
 one does everything for himself. Our fathers drev/ water, each 
 for himself, in " the moss-covered bucket," while our mothers 
 dipped candles for the evening's light. If one was negligent, 
 the rest did not suffer. Today a network of pipes radiates from 
 a common center to enter a thousand households. An engi- 
 neer makes a blunder at the station, and thousands are in dark- 
 ness or drought. Progress is a passage from independence to 
 dependence, from distrust to confidence, from hostility to amity, 
 from helplessness to helpfulness, while the great law of social 
 solidarity gains ever-increasing importance. Our science, then, 
 is interested primarily in man in his relations to others, and 
 not in man by himself. Moreover, as a science which studies 
 the present in order that it may predict and prepare for the 
 future, and discovering that interdependence is the law of 
 progress, it must not hesitate to shape its principles with refer- 
 ence to a solidarity which shall grow more rather than less, 
 stronger rather than weaker. 
 
 Economics treats of Man as in Process of Development. — 
 Few truths are more easily admitted or more persistently ig- 
 nored than that of change in human life and condition. His- 
 tory makes it real. Man now wanders about by force of 
 necessity and age-long habit, now starves rather than be moved 
 from his home. Land is now free to all, now parceled out with 
 well-nigh absolute right of individual possession. The seem- 
 ingly eternal features of the social structure are gone in a few 
 generations. Nothing so invalidates theories, laws, general 
 
THE NATURE AND SCOPE OF ECONOMICS 7 
 
 principles, institutions, and enterprises as this great law of 
 change of which we seldom take full account. Take, for in- 
 stance, bequests. Nothing is commoner than for a man to 
 leave a legacy under specified and detailed regulations, binding 
 for all time. One leaves money to endow a religious service 
 in a language which in a few generations no one understands; 
 another founds a college to teach certain doctrines which in a 
 century no one believes ; and so on indefinitely. These and a 
 thousand other laborious efforts of statesman, warrior, or 
 philosopher quite lose their worth for the future because their 
 authors assumed that the future would be like their present. 
 Even the wages system and the division between capital and 
 labor which seem rooted in the constitution of society are scarcely 
 two centuries old as a general system. One must never forget 
 in the study of economics that the phenomena with which it 
 deals are pervaded by the spirit of life, moving forward or back- 
 ward, progressing or decaying, under those influences which 
 control the rise and fall of social institutions. The science is 
 biological rather than mechanical. 
 
 The Laws with which Economics Deals. — The evolutionary 
 character and complexity of economic phenomena, which ac- 
 count for much of the charm of the subject, endow it also with 
 unusual difficulties. Conclusions true for one generation are 
 invalid in the next. Terms and definitions appropriate to one 
 stage of industry are misleading in a succeeding stage. Gen- 
 eralizations valid for one nation and government are inappli- 
 cable to another. Even those laws or uniformities which the 
 science prizes as the finest product of its research are but state- 
 ments of probabilities — declarations of what is most likely to 
 occur for the mass of men in the long run under certain specified 
 circumstances. 
 
 In no department of knowledge, consequently, is there greater need of 
 temperate statement and of that humihty of mind which is the surest safe- 
 guard against bigotry and dogmatism. No system of economics is appli- 
 cable unchanged to all times and all places : the premises of the arguments 
 change; the ingredients of nearly every problem present themselves in 
 different proportions ; and the conditions of almost every question vary from 
 
8 OUTLINES OF ECONOMICS 
 
 country to country and from generation to generation. The student must 
 not expect rules of thumb by which he can decide offhand the economic prob- 
 lems of the particular city or country district in which he is for the moment 
 interested. No general treatise on economics can authoritatively decide 
 the practical problems of particular times and places; although the econ- 
 omist, before all other students, is forced to deal with practical problems. 
 What such a treatise can do is to point out mistakes of logic common in the 
 current discussions of economic questions, call attention to obscure factors 
 — sometimes of great importance — which the practical man is likely to 
 overlook, give solutions of typical problems which are likely to arise, and 
 thus afford a training which will assist the student in solving practical 
 problems for himself. 
 
 The peculiar and distinctive ofi&ce of the economic scientist, however, is 
 to emphasize the less tangible truths, the remoter consequences, the deeper 
 and consequently less obvious forces of economic society. The impulses 
 of the moment, the immediate demands of the hour, the present "fact" that 
 stares us in the face (and sometimes blinds us) , are not likely to lack vigorous 
 champions ; and to preserve the balance there is need of a craft of thinkers 
 far enough removed from the battle to preserve the wider outlook, mindful 
 of the lessons of the past, jealous for the rights of the future, insistent upon 
 the less obvious truths. This is why economics so frequently appears to 
 the practical man strained and academic. This impression arises from a 
 difference of emphasis which in the main is as salutary as it is inevitable. 
 The academic quality of the economist's work arises sometimes from igno- 
 rance, sometimes from pedantry, but more frequently from his courageous 
 insistence upon the importance of the less tangible truths and the distant 
 consequences of present action. 
 
 Is not economics, then, a science based upon natural law? 
 The question is largely a verbal one. What do we mean by- 
 natural law? In the narrowest sense natural laws are the 
 habits of nature which are subject to absolutely no variation. 
 Such are gravitation and chemical affinity; and the sciences 
 based upon such laws — astronomy, physics, and chemistry — 
 were the first to develop, and have attained a maximum degree 
 of exactitude. The term " science " is sometimes used in a 
 way to imply only sciences of this character. These sciences 
 are more properly known as exact sciences, and they are char- 
 acterized by the fact that the relations with which they deal 
 can usually be expressed quantitatively. 
 
 When we come in contact with life, however, and especially 
 with its higher forms, the exactness with which an astronomer 
 
THE NATURE AND SCOPE OF ECONOMICS 9 
 
 predicts an eclipse or a chemist anticipates a reaction becomes 
 impossible. Not that life is without laws; very far from it. 
 There is, in the first place, the basis of physical nature, with its 
 perfect regularity, upon which all life rests and to which it 
 must conform. Then, too, there are laws governing fife 
 directly and pertaining to it. These form the subject of the 
 group of sciences known as biology. We must remember, 
 however, that all we can say of natural laws is that they are 
 habits, apparent regularities or uniformities in the succession of 
 events ; not, so far as we know, compulsory necessities of nature. 
 And the laws of fife seem to differ from those of inanimate nature 
 in that they are not quite invariable habits. Variability seems 
 to be inherent in hfe, increasing as hfe rises in the scale of 
 development. It is often assumed, to be sure, that these laws 
 are as invariable as any other, and that this seeming variability 
 is only a greater complexity which we do not yet understand. 
 However that may be, the result is the same for the present. 
 The sciences of life are not exact in the sense we have defined. 
 We must further note that in so far as a science deals with facts 
 which seem to be governed by no invariable law, or whose law 
 has not been discovered, it must content itself with a description 
 of this part of its subject. Thus we have the term " descriptive 
 science." We might better speak of the descriptive part of a 
 science, for all sciences are able in part to reduce their facts to 
 law. 
 
 What has been said of the sciences dealing with life applies 
 to an even greater extent to those sciences which deal with man. 
 It is true that within certain limits man is governed by ab- 
 solutely invariable laws. He is as much bound by gravitation 
 as anything else, and if he falls over a precipice, we can predict 
 the results as certainly as though a stone fell over. But, with- 
 out entering the bog of discussion as to the nature of human 
 freedom, we may safely assume, for practical purposes, that 
 man is also, within certain limits, a law unto himself. No- 
 where do we find an element of variability so great and so seem- 
 ingly ultimate as here. We must remember, therefore, that the 
 sciences which deal with man deal with a being who is modified 
 
lO OUTLINES OF ECONOMICS 
 
 by his environment, hut who has the power of modifying that 
 environment by his own conscious effort. 
 
 Let us consider very carefully what this means. It does not 
 mean simply that man modifies his environment because he 
 has been modified by it and so reacts upon it, just as things do 
 when they come in contact. If we accept this view, we shall 
 come to Herbert Spencer's theory of natural selection. The 
 forces at work accomplish their own results, according to this 
 theory, whether man will or will not, simply by natural action 
 and reaction. This implies that man is modified by his envi- 
 ronment, and that he in turn modifies that environment with- 
 out conscious effort. This theory is based on an assumption 
 that man has no power of initiating an influence, and consist- 
 ently concludes that social development, like geological develop- 
 ment, must be left to work itself out. Spencer, however, goes 
 farther, and stoutly maintains that man, by conscious effort, 
 especially by collective or state effort, not only does not help 
 this development, but actually hinders it. In this the whole 
 theory is abandoned, for it is plain that if man by conscious 
 effort can hinder a process, he can help that process in the same 
 way, if he only has enough wisdom and sense. These it is the 
 purpose of science to give him. 
 
 In opposition to the theory of natural selection, or unconscious 
 development, has been urged the theory of artificial selection, or 
 conscious development. Ages of natural selection made of 
 the potato a lean, watery, unpalatable tuber ; a relatively few 
 years of artificial selection made it a valuable food product and 
 a table delicacy. Compare the development of domestic ani- 
 mals in the last few years, under man's conscious guidance, with 
 their slow and meager development in a state of nature. Man 
 has precisely this power of consciously modifying the natural 
 and artificial elements of his environment, and this power 
 continually enlarges. 
 
 So, when we ask if economics deals with natural laws, we 
 really ask whether this being, whose activity in a certain line 
 we are studying, is governed by such laws. If we mean by 
 this to ask whether his action is characterized by absolutely 
 
THE NATURE AND SCOPE OF ECONOMICS II 
 
 invariable habits, like the forces of physics, we must plainly 
 answer, no. If man had no power of initiative, or, on the other 
 hand, were so perfectly rational as always to do the wisest thing, 
 there would be a regularity in his action which might perhaps 
 form the basis of a complicated, but exact, science. As it is, 
 all social sciences are approximate and partly descriptive. 
 There is much in man's action which is exceedingly (though not 
 perfectly) regular, and hence we have general, though appar- 
 ently not invariable, laws. There is a part of his action, how- 
 ever, that seems as yet to be capricious, and we can only make 
 note of it till we have more knowledge. 
 
 The laws of economics are not comparable to the laws of 
 inanimate nature in invariability, but they are of very general 
 applicability, and are wholly in line with the action and intent 
 of nature, and are, in this sense, " natural." But the laws of 
 economics are not natural laws in the sense in which the word 
 is often used ; namely, laws external to man and not at all the 
 product of man. The laws of economics have been designated 
 as social laws to distinguish them from those of physical science. 
 Social laws describe tendencies, or regularities, which appear 
 especially in the consideration of large masses of facts. Human 
 mortality serves as an illustration. When and how a certain 
 man, as A,, will die, is proverbially uncertain ; but when we 
 speak of hundreds of thousands of lives, we can predict with such 
 an approximation of accuracy that the vast business of life 
 insurance can be built upon the regularity of the action of death. 
 
 The foregoing discussion enables us to answer in a word the 
 much-mooted question, " Is economics a science? " It is not 
 an exact or mathematical science, though certain portions of 
 the subject may possibly become so. It is an approximate 
 and partially descriptive science, like all sciences dealing with 
 man, or even with life. The inexactness of the social sciences 
 is due to the very thing which gives them their supreme value, 
 the nature of man and the greatness of their subject. 
 
 The Relation of Economics to other Sciences. — We have 
 already referred briefly to the relations between economics 
 and some of the other sciences, but the topic is one which re- 
 
12 OUTLINES OF ECONOMICS 
 
 quires fuller treatment. In one sense, economics may be said 
 to be dependent upon practically every other science, since the 
 discoveries in every field of knowledge almost inevitably react 
 upon the economic life of man. Modern chemistry, to take a 
 single example, has revolutionized some industries, wholly 
 created others, and, through the agency of the pure-food laws, 
 may claim most of the credit for entirely suppressing others. 
 From psychology economics takes the axiomatic principles 
 upon which the laws of value rest; from physical science the 
 law of diminishing returns, which plays a very important 
 part in the theory of distribution ; and from mathematics the 
 methods by which to ascertain how insurance may be safely 
 supplied against accidents, death, and loss by fire. But it is to 
 the sister sciences dealing primarily with man that economics 
 is most vitally related. 
 
 Man has been busy from the first in several lines of effort. 
 He has talked, worshiped, fought, studied, and each of these 
 lines of effort has developed its own faculties and institutions. 
 For convenience we may arrange these in eight groups, as 
 follows: language, art, education, religion, family life, society 
 life, political life, economic life. Each of these is the subject 
 of a science more or less developed. The group of society life — 
 that is, the life of polite society, calls, parties, balls, and the 
 like — has been studied but little, and we know few of its 
 governing principles.^ Language, on the other hand, has a 
 science which has attained to very complete development. 
 The rest lie scattered between these extremes. 
 
 A peculiar feature of these activities is that they are all of 
 them collective activities, activities which one man cannot well 
 carry on alone. This is obviously true of family and political 
 life, language, and others ; and on careful examination it proves 
 to be true of the rest. It is now admitted, after many experi- 
 ments, that art and even religion do not thrive in solitude. It 
 
 1 An attempt to examine scientifically some, at least, of the phenomena of polite 
 society has been made by a learned jurist, the late Professor Rudolph von Ihering, 
 in his Zweck im Recht. Professor Thorstein Veblen in his Theory of the Leisure 
 Class gives a brilHant though half-satirical explanation of social conventions in 
 terms of origins and survivals. 
 
THE NATURE AND SCOPE OF ECONOMICS 1 3 
 
 would seem that if a man could do anything by himself, it would 
 be to get a living ; but the study of economic history impresses 
 us with the insignificance of all such effort and the inevitable 
 tendency of men to drift together in their economic activity. 
 If it were possible for men to live in isolation, every one of the 
 eight lines of effort we have mentioned woiild soon dwindle 
 into insignificance or altogether cease. So these sciences are 
 all of them social sciences; and as the sciences that deal with 
 life are now grouped together under the name biology (science 
 of life), so the social sciences may be grouped under the title 
 of sociology, or the science of society, although some sociologists 
 do not define the word " sociology " in this broad sense of an 
 all-embracing science of human association. 
 
 Economics, then, is a branch of sociology thus conceived. 
 We have already defined it as the science which treats of those 
 social phenomena that are due to the wealth-getting and wealth- 
 using activities of man. We may speak of the wealth-getting 
 and wealth-using activities in all their relations as economic 
 life or economy. Accordingly, economics is the science which 
 deajs with the economy of man. A useful distinction in lan- 
 guage is thus made between economy, the life itself, and eco- 
 nomics, the science dealing with that life. If this distinction 
 could always be observed, much confusion would be avoided. 
 
 We have economies of various sorts : the economy of an 
 individual, of a family, a tribe, a city, a state, or a nation, and 
 we have, correspondingly, many economic units. The domi- 
 nant unit in ancient Greece, for example, was the household, 
 which included the family and all the slaves and other depend- 
 ents. These lived together and formed a little group by them- 
 selves. The economic life of Greece meant, largely, a sum of 
 the economic activities of these households, each of which 
 strove to be sufficient unto itself. It is interesting to know that 
 many a well-managed Southern plantation before the Civil War 
 endeavored to produce nearly all the means of life on the planta- 
 tion, and in this respect, as in others, resembled a Greek house- 
 hold. But as time has progressed, these old groups have 
 been partially dissolved, and in many instances in modern 
 
14 OUTLINES OF ECONOMICS 
 
 times the individual, in his economic activity, constitutes a 
 unit, although the family is still the prevalent economic unit. 
 It is a natural outcome of economic progress, as already ex- 
 plained, that the relations between these units have multiplied 
 indefinitely in number and in importance. This is simply 
 another way of describing the growing interdependence of men. 
 Economics deals especially with the mutual relations of econo- 
 mies of all kinds, private and public. It is chiefly, if not 
 exclusively, a science of human relations, and without these 
 relations could not exist. 
 
 Because of the organic connection of these relations in their 
 common origin, man, and because economics deals with the 
 individual as he is, and not with an artificially simplified " eco- 
 nomic man," it is impossible wholly to dissociate the social 
 sciences, and particularly impossible to divorce economics 
 completely from ethics and politics. This does not mean that 
 these sciences are all one and cannot be profitably subdivided. 
 On the contrary, because of the limitations of the human mind, 
 they must be studied separately so far as is possible. Scientific 
 progress, like industrial progress, comes largely through spe- 
 cialization and the division of labor. Man cannot profitably 
 study things in general. What it does mean is that there is 
 some territory common to all these sciences, and that occa- 
 sionally the economist is forced to pass ethical judgments and 
 to decide political questions. In the consideration of railway 
 rates, for instance, the economist may be compelled to pass 
 judgment upon what is just and reasonable, and he discovers 
 upon investigation that by common consent what is fair or 
 reasonable must be decided largely upon economic grounds. 
 The same is true of the apportionment of taxes, in which subject 
 ethical, legal, and economic questions are inextricably inter- 
 woven. Commercial policies, restrictive regulations, and sump- 
 tuary laws have been the very stuff and subject-matter of the 
 science of economics from its first beginning. In analyzing 
 the progress of the past or the conditions of the present, we are 
 forced to pass judgment upon the success or failure of many 
 laws and policies which are still in force or under active dis- 
 
THE NATURE AND SCOPE OF ECONOMICS 1 5 
 
 cussion. Many of these must be indorsed or repudiated either 
 solely or largely upon economic grounds ; and because of these 
 facts, the economist cannot, even if he would, refrain from pass- 
 ing judgment upon laws and political policies. Nevertheless, 
 as was stated before, economics does not undertake the complete 
 and systematic study of law, ethics, and politics, and its conclu- 
 sions must almost always be supplemented by non-economic 
 considerations which the economist may not have taken into 
 account. 
 
 Principal Divisions of Economics. — This view of the in- 
 evitably practical character of economic science is carried out 
 in the treatment of the subject in the following pages. The 
 history of the evolution of economic society, sketched in Book I, 
 is followed, in Book II, by a discussion of the production, con- 
 sumption, exchange, and distribution of wealth. These sub- 
 jects are treated in close connection with those illustrative 
 economic problems of which the so-called " economic theory," 
 at its best, is but a more comprehensive and consequently more 
 abstract analysis. Book III has been reserved for the subject 
 of public finance, and in an appendix is given a brief sketch of 
 the history of economic thought. 
 
 QUESTIONS 
 
 1. What is the most essential characteristic of economics? Define eco- 
 nomics. 
 
 2. Is man or goods the more prominent thing in economic study ? Does 
 economics teach the student how to succeed in business ? 
 
 3. What determines ultimately whether a man is poor or not? What 
 kinds of poverty are there ? 
 
 4. What is meant by "dear labor"? Is it a good thing for society in 
 general ? for employers in general ? for an individual employer ? 
 
 5. What is the difference between natural and artificial selection ? Which 
 applies to human society? 
 
 6. Are practical ethical and political judgments the chief ends and prod- 
 ucts of economic science? 
 
 7. Is economics concerned with the negro question? bank notes? prohibi- 
 tion? anti-trust laws? race suicide? protection? 
 
 8. What is a scientific law ? Contrast with a statutory law ; with a moral 
 law ; with the laws of mathematics. 
 
1 6 OUTLINES OF ECONOMICS 
 
 REFERENCES 
 
 Caienes, J. E. The Character and Logical Method of Political Economy. 
 
 CossA, L. An Introduction to the Study of Political Economy. 
 
 Dunbar, C. F. "The Academic Study of Political Economy," in his 
 
 Economic Essays. 
 Ingram, J. K. A History of Political Economy. Chap. vii. 
 Keynes, J. N. The Scope and Method of Political Economy. 
 Marshall, Alfred. Principles of Economics, 6th ed., Appendixes C and D. 
 Mill, J. S. Essays on Some Unsettled Questions of Political Economy. 
 SiDGWicK, Henry. The Scope and Method of Economic Science. 
 Wagner, Adolph. "On the Present State of Political Economy," 
 
 Quarterly Journal of Economics, Vol. i. 
 
CHAPTER II 
 
 THE CHARACTERISTICS OF THE PRESENT 
 ECONOMIC SYSTEM 
 
 Our Environment. — Lying back of all of our economic ac- 
 tivity is the fact that we live in an environment in which the 
 things that we desire are not furnished spontaneously in un- 
 limited quantities. Whether it be looked upon as due to the 
 niggardliness of nature or to the insatiability of human wants, 
 the fact is that, for the most part, the material things that we 
 use must be economized. We must put forth effort and exer- 
 cise self-denial in order to enjoy the good things of life. Those 
 human arrangements which help to determine how much of ef- 
 fort, of self-denial, and of enjoyment is to fall to the lot of each 
 of us are the characteristics to which we now turn our attention. 
 There are, however, a number of social institutions which do 
 not fall wit.hin the scope of the present chapter. We deal here 
 only with the social conditions directly underlying our economic 
 activity, which is but one aspect of our social life. We must 
 leave to the sociologists and other students of society a discus- 
 sion of such topics as the family, religion, morality, ceremonial 
 institutions, and the nature of government, although, to be sure, 
 these also have their effect upon the economic sphere and are in 
 turn affected by it. 
 
 Private Enterprise and State Activity. — We live in an age 
 when private enterprise, for the most papt, is relied upon to 
 furnish us with the necessities and enjoyments of life. The 
 cultivation of the soil, the exploitation of the mines, transport, 
 the various stages of manufacture, and the distribution of the 
 finished product are all left mainly ^ to private initiative. The 
 
 ^This appHes especially to the United States and England so far as transport 
 is concerned ; it would not hold true of every country. 
 c 17 
 
1 8 OUTLINES OF ECONOMICS 
 
 discovery of new processes, invention, and experimentation are 
 carried on mostly by private individuals or corporations who 
 take upon their own shoulders the risk of failure. The State, 
 on the other hand, participates in this activity in a variety of 
 ways. It maintains order, promotes the public health and safety, 
 provides roads, and takes complete charge of some industries. 
 In its educational institutions the State, through its agents, un- 
 dertakes various experiments, and encourages the growth and 
 diffusion of knowledge, an indispensable condition of continuous 
 advancement in our economic life. The state university and the 
 experiment farms may be mentioned, and also the large and 
 extremely useful Department of Agriculture of the United States, 
 with its annual expenditure of about twenty million dollars. 
 Certainly in the vast majority of the enterprises with which we 
 are familiar, private and public activities are combined in vary- 
 ing proportions. 
 
 In speaking of "State" activity, the reference is to organized society 
 acting through any one of the various governmental agencies, such as the 
 township, city, or national governments, and not merely the political unit 
 which we know in this country as the state government. The term " govern- 
 mental activity" is sometimes employed but is less desirable. The word 
 "government" suggests to the ordinary mind a power apart from and 
 superior to the people — a restraining or punishing power — whereas the 
 modern concept of the State is that of a cooperative institution, main- 
 tained to safeguard and promote the general welfare. "Private" activity, 
 it should be noted, is a broader term than "individual" activity. It 
 includes all forms of joint or associated action except those which consti- 
 tute the activities of the State. 
 
 Let us take the case of an industry which is as nearly private, 
 perhaps, as any we can find — that of agriculture — and notice 
 the part which public activities play in securing the farmer's re- 
 sult. First, we may say that the farmer owns the farm that he 
 cultivates ; this is private property. But how comes it that the 
 farm is his? Why does not a stronger man drive him off and 
 take the farm himself? Plainly because the State protects him 
 in the possession of the farm. When he bought the farm, he took 
 his deed to a government official, who recorded it, and thus gave 
 him an additional guarantee of possession. A neighbor's dog 
 
THE PRESENT ECONOMIC SYSTEM 19 
 
 kills his sheep, and an appeal to the State compels the neighbor 
 to redress the grievance. Another, far below, dams a river and 
 backs the water up so that it overflows his land. Another appeal 
 to the State removes the dam or secures compensation. When 
 wheat is raised, the farmer hauls it to market by a road built, not 
 by private, but by public, activity. The railway lowers the price 
 of his wheat by a discriminating rate, and again government in- 
 terferes in his behalf. But manifold and important as are the 
 regulations of the government. State activity seems very much 
 restricted when we reflect that it might extend over the entire 
 industrial field. Today the distinctive characteristic of our eco- 
 nomic life is private, not public, enterprise. 
 
 Division of Labor and Exchange. — It is commonly taken for 
 granted that every man should prepare himself for some special 
 occupation, that one should plow while another builds or sings. 
 Hardly any civilization seems possible without some industrial 
 specialization, but our own age is peculiar on account of the ex- 
 tent to which this has been carried. The introduction of machin- 
 ery and the development of large-scale production have split up 
 the work of men so minutely that the products which they turn 
 out are not only of no immediate use to themselves in most cases, 
 but they are also useless to any one else until combined with the 
 results of other men's labor, often performed years before or 
 afterwards. It is a long and complicated process from the man 
 who mines the ore which is to reappear in a steel plow, to the 
 man who bakes the bread. This specialization of employment 
 has some far-reaching results : 
 
 I. It impHes the exchange of goods. If we produce things 
 we do not need, we must find some one else who does want them 
 and some one who has the things we desire. Money, banks, and 
 transportation agencies could largely be dispensed with if each 
 family produced for itself alone. There would be none of the 
 complex problems that center about the question of how much 
 each of us is to receive in exchange for his services. One of the 
 striking characteristics of this process of exchange is the great 
 extent to which it is automatic. There is no government ofiicial 
 whose business it is to discover how much of each commodity 
 
20 OUTLINES OF ECONOMICS 
 
 will be needed, and to direct that that amount shall be produced.^ 
 Men are legally allowed to engage in almost any undertaking 
 that attracts them, and yet we take it for granted that somehow 
 things will get produced in the proper proportions. A hundred 
 men are set to work in a factory making nothing but hats, many 
 more than they or their friends can use, but the manager has 
 faith that heads will be found to wear them all. Farmers con- 
 fidently proceed to raise wheat, never troubling themselves 
 about the grinding and baking. Neither workmen nor em- 
 ployers in general know why wages are as they are. Men lend 
 money or goods, now for one price, now for another, but few 
 know why they demand interest or why the rate changes. 
 These processes go on visibly before us, but the governing laws 
 are hidden except to the careful investigator. In this respect 
 they are Hke the laws of physiology. We eat and digest our 
 food, but how many people know how or why digestion takes 
 place? It is easy, however, to^ overemphasize this idea, for 
 a great deal of our economic activity is conscious and volitional. 
 When we decide to make a law or levy a tax, we do it consciously, 
 considering arguments, and finally will to do the thing in ques- 
 tion. And even in business undertakings there must be much 
 careful study of the probable demand for various kinds of goods 
 and of the most economical ways of producing them. 
 
 2. The specialization of work and exchange of goods just 
 referred to necessarily imply that mutual dependence briefly 
 considered in the preceding chapter. Instead of a number of 
 distinct, self-sufi&cient units, we have a coherent society where 
 one individual relies upon many others to complete his own one- 
 sided economic activity. A strike of street-car employees, or 
 of teamsters, or the destruction of an electric lighting plant, 
 would each send a shock of inconvenience through a community. 
 A prolonged railway strike would be felt as a national misfortune. 
 Indeed, this interdependence is international in its scope. Eng- 
 land relies on other nations to send her food in exchange for her 
 
 1 The government does help, however, by collecting and publishing information, 
 such as crop reports, statistics of the amount of cotton ginned, consular reports 
 as to opportunities m foreign markets, and in various other ways. 
 
THE PRESENT ECONOMIC SYSTEM 21 
 
 manufactured products, and many a German workman would 
 be in distress if our exports of cotton or copper should suddenly 
 cease, as is happening in the great European War, in progress 
 at the time that this is being penned. The United States is more 
 self-sufficient economically than many other nations, but we 
 are nevertheless dependent upon international trading for our 
 supplies of many things. 
 
 Economic Classes. — In part, also, the specialization of work 
 is responsible for the division of society into classes, but only in 
 part. The differences in the work of the carpenter, machinist, 
 and railway brakeman do not result in the formation of classes 
 of a higher and lower rank. On the other hand, the professional 
 brain worker enjoys some social esteem that does not fall to the 
 lot of the manual worker. But doubtless the most important 
 basis of social classification is the possession of wealth. The 
 power to spend freely, while not the only test, is today the most 
 widely recognized test of social status, regrettable as this may be. 
 
 Private Property. — We proceed now to examine the founda- 
 tion stones of this system of private enterprise. Private prop- 
 erty is the most important of these. For our present purpose 
 we may define private property as the exclusive control over valu- 
 able things by private persons. It is to be distinguished from mere 
 possession. The possessor has the use of the thing for the time 
 being, but unless he is at the same time the owner, he is depend- 
 ent upon the will of another for the use of it. Ownership implies 
 the right of excluding other persons from the employment of a 
 thing. The exclusive right must be recognized and guaranteed 
 effectively by third parties. If the exclusive right of control 
 over some valuable thing is asserted simply by the strength of 
 one's right arm, the right of private property is not thereby 
 established. The exclusive right of control must be recognized 
 by others and must be maintained by them. 
 
 Over against private property we have public property, and 
 there are some things, such as air, which fall in neither of these 
 categories. The sphere of private property at present includes, 
 not only food, clothes, and other things of personal use, but also 
 the instruments of production — land, buildings, and machinery. 
 
2 2 OUTLINES OF ECONOMICS 
 
 In the most important productive processes the tools are in gen- 
 eral not owned by the persons who use them. 
 
 It may be said that property is the chief seat of social authority. As 
 property carries with it the exclusive right to control things, others may have 
 access to these things only on conditions named by their owners. If we 
 look about us, we iind men organized and acting together under direction 
 for purposes of production. In a factory we find an organization of men 
 like that of an army. We discover men moving here and there and per- 
 forming arduous tasks in obedience to command. If we examine the nature 
 of the authority which some thus exercise over others, we shall find that it 
 resides in property. The law of the land to some extent establishes the 
 authority of man over man; but where one man obeys another because 
 the law in so many words tells him to do so, we find a hundred men obeying 
 others because these others have the authority which resides in exclusive 
 control over valuable things. Indirectly this latter sort of authority rests 
 back upon the laws in so far as these are responsible for the establishment of 
 property. But the chief seat of authority in society is based only indirectly 
 upon the government ; it rests immediately upon private property. 
 
 The right of private property is one so fundamental in our 
 modern life that we scarcely think of it as a creation of man, 
 maintained by constant vigilance on the part of the State, and 
 subject to human modification. It seems like bed rock, an ulti- 
 mate right, needing no other justification than its own obvious- 
 ness. When a custom has obtained very widely and is deeply 
 rooted in human life there is often a tendency to claim it as a 
 " natural right." But the right of private property as we know 
 it now did not always exist. It has not always been so extensive 
 or exclusive as at present. This is especially marked in the case 
 of individuals, whose claims as opposed to those of the tribe were 
 at first slight and vague; but these claims gradually grew, 
 especially in the case of the chieftain, until tribal or communal 
 rights broke down before them. The time was when a Scottish 
 clan had absolute right to the territory it occupied, and no chief- 
 tain, however powerful, could have abridged that right. Now 
 there are beautiful tracts of country in Scotland which are almost 
 denuded of their agricultural population because the owners, the 
 descendants of these same chieftains, preferred to raise game on 
 their estates. All are familiar with the liberty generally allowed 
 in this country of hunting and fishing on private estates. This 
 
THE PRESENT ECONOMIC SYSTEM 23 
 
 is unheard of in Europe. Slowly, however, we are extending 
 our property claims to game and fish, and the former leniency 
 of ownership is disappearing. 
 
 But the modern State is continually placing limitations and 
 restrictions on the right of private property. Our cities regulate 
 the height of buildings and prescribe the material from which 
 they must be made and the kind of plumbing which must be in- 
 stalled. Restrictions of the uses to which land may be put are 
 common, and no one can use his property in ways that constitute 
 a public " nuisance." The nature and extent of these changes 
 in private property must be controlled by the State in the public 
 interest. How far interference with the right is justified cannot 
 be discussed in general terms : such a discussion must deal with 
 the specific problems of municipal ownership, railway regula- 
 tion, and innumerable others. The point to be emphasized here 
 is that in solving such problems the mere fact that a proposed 
 solution restricts or enlarges the right of private property cannot 
 in itself be given much weight. 
 
 Trademarks, Copyrights, and Patents. — These are legal 
 arrangements whereby exclusive privileges are awarded in return 
 for certain services to society. These privileges become a special 
 form of private property. Their justification lies in the fact 
 that they are a means of promoting " the progress of science and 
 useful arts." It must be remembered, however, that all such 
 progress is a historical product. The telephone, for example, 
 was preceded by a century of scientific invention and discovery, 
 most of it poorly remunerated. The telegraph was, similarly, 
 the result of the careful plodding industry of scores of men. 
 Professor Henry, of Princeton College, whose services in connec- 
 tion with the completion of the telegraph were most distinguished, 
 conscientiously refused to take out any patent. It often happens 
 that several persons almost simultaneously and independently 
 make the same discoveries and inventions. Our patent laws 
 seem frequently to reward the man who makes the finishing 
 touches which lead to the utilization of a long line of work. But 
 it is the hope of being the one who may give the practical turn 
 to an idea that lures many a man on to undertake the laborious 
 
24 OUTLINES OF ECONOMICS 
 
 task of doing the extensive experimentation often necessary to 
 place an article on the market. 
 
 In order that patents and copyrights may not become the 
 bases of burdensome monopolies, they are of limited duration. 
 Patents in the United States run for seventeen years, and copy- 
 rights for a period of twenty-eight years. Copyrights may be 
 renewed for another term of the same length. These legal privi- 
 leges have resulted in an enormous amount of litigation and have 
 given rise to special problems. One of these is the question of the 
 extent to which the manufacturer of a patented article should 
 have the right to control the price after the article has left his 
 hands. It is frequently asserted that owners of patents should 
 be compelled to permit other persons to use them upon the pay- 
 ment of royalty, so as to promote competition in manufacture. 
 But there is some danger that such legislation would defeat the 
 primary object of the patent system. Even with the exclusive 
 right to manufacture an article it frequently requires a long 
 struggle to make an invention a commercial success. It has also 
 been suggested that the United States government should re- 
 serve the right to purchase a patent, but it is improbable that 
 this right, if reserved, would be often exercised. 
 
 Inheritance. — Inheritance is often regarded as a necessary 
 part of the right of private property, and it is true that the entire 
 abolition of the right of inheritance would result in a great en- 
 largement of public property at the expense of private property, 
 unless gifts were used to replace inheritance as a means of trans- 
 ferring property from one generation to the next. But, in 
 truth, property and inheritance are two distinct rights. Private 
 property is an exclusive right of control, whereas inheritance is 
 the transmission of this right from one generation to another. 
 
 As in the case of private property itself, the right of inheritance 
 is not recognized today as absolute. Detailed regulations exist 
 on our statute books regarding the making of wills and regulating 
 the descent of property where no will is made, and there is an 
 increasing tendency to limit the right of inheritance by taxation. 
 That which seems a mere natural right at one time seems a wrong 
 at another, as is illustrated in the changing ideas and practices 
 
THE PRESENT ECONOMIC SYSTEM 2$ 
 
 concerning the share of a father's estate to be inherited by the 
 oldest son. 
 
 Contract. — Hardly second in importance to the right of pri- 
 vate property is the right of contract, for the maintenance of 
 which we are equally dependent on the State. Some sort of 
 contract lies at the basis of all associated activity. To secure the 
 condition of such activity, it is necessary, first, that men should 
 be allowed to bind themselves ; and, second, that they should 
 be compelled to abide by the agreement thus entered into. The 
 entrance into a valid contract is ordinarily voluntary, but once 
 entered into with due formality, the State will use its superior 
 power to enforce it. To the anarchist this seems oppressive, and 
 it is true that a state of society is conceivable in which the ele- 
 ment of force might be removed from the idea of contract, but 
 something else would have to be substituted to make the keeping 
 of agreements the general rule. There are doubtless many 
 people living today with whom the feeling of honor or the fear 
 of social disapprobation would be sufficient for the enforcement 
 of contracts, just as these persons might not need the threat of 
 a jail sentence to keep them from stealing. 
 
 The economic ties which hold men together in industrial society are, on 
 their legal side, very generally contracts. The organization of an industrial 
 corporation implies many contracts. Our property is acquired very largely 
 through contract, and through contract we determine the conditions under 
 which we do our work, such as the length of the working day. The continu- 
 ity of our economic life rests upon contracts, which bind together past, 
 present, and future. Still, all that we have by no means comes to us through 
 contract. " Contract " does not exhaust the significance of parentage, home, 
 and education, and much wealth changes hands through gifts and inheritance. 
 
 Laws are frequently enacted regulating contract in the general 
 interest. This is especially marked in labor legislation, which 
 will be discussed in another chapter. Certain contracts cannot 
 be enforced by law, because they are held to be against public 
 policy, as, for example, gambling contracts and contracts in 
 restraint of trade. In some cases statutes make it illegal to 
 enter into such contracts. 
 
 Vested Interests. — A few words should be said about vested 
 
26 OUTLINES OF ECONOMICS 
 
 interests.^ Vested interests are legally recognized pecuniary 
 interests which cannot be impaired by public action without 
 indemnification. Vested interests generally arise through prop- 
 erty and contract. Outside of property and contract, however, 
 there may be vested interests. Leeds was compelled by a feudal 
 arrangement to grind its corn, grain, and meal at the lord's mill 
 till well on in the last century, and finally had to pay £ 13,000 to 
 terminate this obligation. When Prussia bought the railways, 
 the railway presidents were indemnified for the loss of their posi- 
 tions by large payments ; in other words, their ofiices were looked 
 upon as vested interests. England is the classic land of vested 
 interests. An ofiice in the army was until recently looked upon 
 as such, and so was an appointment in the established church. 
 It is generally held that keepers of public houses in England li- 
 censed to sell beer and spirits have a vested interest in their busi- 
 ness, so that they must be indemnified if their licenses are taken 
 from them. Workingmen have frequently claimed that they 
 have a vested interest in the advantages which their skill in their 
 trades gives them, and that if through industrial changes this 
 skill ceases to be of as great value as formerly, they ought to be 
 indemnified and in some way their former income continued. 
 This claim of the workingmen, however, unlike many other 
 claims put forward in the name of vested interests, has not re- 
 ceived recognition, either by Parliament or the courts. Vested 
 interests, apart from property and contract, are of less signifi- 
 cance in the United States than in most countries, but they 
 may become of more significance in the future. 
 
 Freedom. — The freedom to do certain things is legally 
 guaranteed at the present time, such as moving from one part of 
 the country to another, choosing one's own occupation, and 
 acquiring property. These, together with the absence of slavery 
 and of imprisonment for debt, are characteristic features of the 
 present economic order as distinguished from past conditions. 
 The right to manufacture and sell what and when one pleases is 
 also comparatively recent. It has often been greatly limited by 
 despotic governments, and has been made a matter of sale for 
 
 ^The term "vested rights" is also used. 
 
THE PRESENT ECONOMIC SYSTEM 27 
 
 the purpose of raising revenue. Such limitations gave rise to 
 many abuses, and our own time has seen the aboHtion of an im- 
 mense number of hampering and vexatious restrictions often 
 designed for extortion rather than for the promotion of private 
 enterprise. So far as the absence of legal restrictions on the 
 actions of individuals is concerned, the past century has been 
 distinctively an age of economic freedom. 
 
 Restrictive laws, however, are not the only limitations on eco- 
 nomic freedom. The system of private property itself means 
 that certain individuals in the community have power to com- 
 mand other people to work, and the lack of an income under our 
 present regime implies the lack of the real freedom to do things. 
 The cost of a railway ticket may be quite as effective as a legal 
 barrier would be in preventing movement from one state to an- 
 other. We say involuntary servitude, except as punishment for 
 crime, has been abolished, yet men are compelled to work by 
 the threat of economic distress, in most cases quite as effectively 
 as by means of the slave-driver's whip. Again, the choice of an 
 occupation is free according to the law, but we may find that a 
 long and expensive course of training is necessary, or trades- 
 unions effectively limit the number who can learn a given trade. 
 The right to establish enterprises is granted to all alike according 
 to the law, but today most persons would find it difficult and 
 hazardous to embark upon the refining of oil or the manufac- 
 ture of steel. For most men, the freedom to establish new en- 
 terprises has been growing less and less in this era of large-scale 
 production. 
 
 This leads us to a distinction between what have been called 
 negative freedom and positive freedom. Mere absence of re- 
 straint (negative freedom) is one thing, and the power to develop 
 our activities to the fullest extent (positive freedom) is a very 
 different thing. Legal restrictions may actually be the means 
 of increasing positive freedom. Thus, a library placed at the 
 disposal of the public without rule or regulation would result in 
 a smaller total utilization of the books than one in which the ob- 
 servance of certain rules is strictly enforced. All laws which 
 limit the power of the strong to oppress and which help to open 
 
28 OUTLINES OF ECONOMICS 
 
 the gates of opportunity to all must of necessity increase positive 
 freedom. The newer idea of freedom aims at the development 
 of such social arrangements that sane and complete lives will be 
 possible for the largest number of persons. 
 
 Competition and Markets. — As a result of the legal conditions 
 that have been mentioned, we find men engaged in many kinds 
 of rivalry. Our economic society is often called " competitive " 
 for this reason. But this term does not apply to all forms of 
 rivalry, for economic competition is based on private property and 
 free contract. There might still be conflicts between races and 
 nations if private property and free contract were abolished. 
 The men of any single nation might still vie with one another to 
 prove their superiority in the eyes of womankind or to gain posi- 
 tions of public honor and power. The kind of competition which 
 is distinctive of the present economic order is the all-pervading 
 endeavor to obtain the largest possible amount of wealth in ex- 
 change for commodities produced or services rendered. If we 
 except the idlers, the parasites, and the cheats, men are every- 
 where endeavoring to discover what other people urgently 
 want, and then to satisfy these wants in the most efficient manner 
 possible. Moreover, they attempt to give as little as possible 
 of their own products in exchange for the things they themselves 
 desire. Business competition thus has two sides: rivalry in 
 rendering a service, and alertness in exacting a return. Each 
 individual takes part in the competitive contest in two ways : 
 first, as a seller of goods or services, in which case he finds that 
 others are anxious to render the same service ; and second, as a 
 buyer of the things he wants, in which case he finds that these 
 same things are sought by other people. 
 
 The intensity of the competitive struggle is subject to a good 
 deal of variation. At times it may be characterized as cut- 
 throat, where the slashing of prices has for its object the elimina- 
 tion of one or more of the contestants. But in most lines of 
 endeavor many competitors may continue to exist side by side 
 indefinitely, each being confronted by the ever present threat 
 that, if his service becomes very poor, some other man will our- 
 strip him. Various as may be the character of competition, now 
 
THE PRESENT ECONOMIC SYSTEM 29 
 
 predatory, now a friendly rivalry, there is no resting place in the 
 contest unless one secures some special privilege as a shelter. 
 He who is energetic, and wins success in a certain line of business, 
 must continue to defend himself from a host of imitators who are 
 anxious to snatch his gains from him. Most of the competitors 
 are successful in getting something, some more than others, but 
 many fail altogether. These last, the inefficient, whether made 
 so by sickness, by inherited weakness, or by lack of proper train- 
 ing, fall by the wayside and must be cared for by private charity 
 or by the State. The process is cruel in many of its details, but 
 there is also a beneficent aspect in its sifting out of the incompe- 
 tent and in its encouragement of the strong. 
 
 Here, again, the automatic character of the present industrial 
 system manifests itself. It is through competition and bargain- 
 ing in the market that the prices of goods and services are fixed, 
 and it is to the variations in these prices that men look for indi- 
 cations as to what people want. Price is the universal barometer 
 that indicates changes in the demand for goods of all kinds. 
 
 Fair Competition. — Competition has been spoken of as a 
 struggle, a contest, accompanied by success and failure, elation 
 and disappointment. But the State sets limits to the rivalry, — 
 it makes regulations and acts as an umpire to compel fair play. 
 It attempts to eliminate fraud and brute force ; it trains the ris- 
 ing generations for an entrance into the struggle by a system of 
 free education ; it insists that no person shall sacrifice the life 
 and limb of another in the rush for wealth ; and it protects chil- 
 dren and women when they seem compelled to labor under un- 
 heal thful conditions. Those who fail entirely in the struggle it 
 tries to rescue from suffering. Libelous and fraudulent state- 
 ments about a competitor's business are illegal. So are efforts to 
 induce his customers or employees to break their contracts with 
 him. Competition designed to drive a rival out of business is 
 illegal, whatever its methods, if it is prompted by sheer malice or 
 is part of an effort to establish a monopoly. The Federal Trade 
 Commission, established in 1914, is empowered to issue orders 
 restraining the use of unfair methods of competition by persons 
 engaged in interstate commerce. In short, the State aims to 
 
3© OUTLINES OF ECX5NOMICS 
 
 raise the plane or ethical level of competition, changing it from 
 brutal warfare into a contest in which there are prizes for all, but 
 in which the prizes are graded according to the energy and ability 
 of the contestants. 
 
 CoSperation. — The statement that our age is one of competi- 
 tion is misleading if it gives the impression that every individual 
 is always struggling against all of his fellows. On the con- 
 trary, the achievements of modern industrial civilization would 
 be impossible without a far-reaching cooperation between in-, 
 dividuals. Employers and employees may quarrel and bargain 
 about the wage contract, but when they have settled their rela- 
 tions for a week or a year, they become cooperators for that 
 period in the conduct of the business enterprise in which they are 
 engaged. Again, there is an unconscious cooperation between 
 those who work upon ^, commodity in the different stages of the 
 process from raw mat/erial to finished product. The division of 
 labor itself is cooperation on a splendid scale. Competition 
 merely determines the conditions on which the cooperation takes 
 place. If these conditions could be determined in some other 
 manner, it would be possible to conceive of the elimination of 
 competition from our industrial system, but cooperation itself 
 is so vital and fundamental that its elimination would mean a 
 return to barbarism. 
 
 Monopoly. — Everywhere in the industrial field the tendency 
 toward -monopoly is present. Business men endeavor so far as 
 possible to shelter themselves from the effects of the competitive 
 struggle by means of some privilege, but if none is to be found, 
 and if competition becomes very keen, they endeavor to combine 
 with other business men. But while this attempt to escape com- 
 petition is universal, it is only under certain conditions, not gen- 
 erally present, that it is at all likely to succeed. The possibility 
 of success is least in agriculture and in mercantile business, where 
 new enterprises are started rather easily because no special privi- 
 leges stand in the way and because no very large capital is re- 
 quired to work efficiently. It is greatest in mining and trans- 
 portation, where special privileges are present and where large 
 fixed capital is required. Scarcely anywhere is it possible wholly 
 
THE PRESENT ECONOMIC SYSTEM 3 1 
 
 to escape competition, and we are still warranted in speaking of 
 the present era as a competitive rather than a monopolistic age. 
 
 Side by side with the growth of monopoly there is an increase 
 in government control of industry. The desire of the business 
 man is to be uncontrolled, but wherever he succeeds in throw- 
 ing off the control exercised by his competitors, he inevitably 
 substitutes that of the government. 
 
 Cixstom. — Custom plays an important part in our economic 
 activity as well a| in every other department of social life, al- 
 though its sway is not so marked as in former ages or among 
 primitive peoples. The custom of giving gratuities, or tips, to 
 servants is in many places so strong as to have almost the force 
 of law. Again, today much of our personal expenditure is con- 
 trolled by what custom has declared to be proper rather than by 
 any act of our own individual reason. Any attempt to lower 
 . wages which would make impossible the maintenance of a cus- 
 tomary standard of living would be stubbornly resisted. And, 
 as we shall see in a later chapter, the ''' good- will " of a business, 
 which is often a durable source of business profits, is built up, 
 in large measure, on its ability to get people into the habit or 
 custom of trading with it. Custom is the result of habit, and is 
 continually broken into by our tendency to imitate a leader who 
 proposes a new line of action. While custom may have its benefi- 
 cent aspect in preventing hasty and impulsive changes, it fre- 
 quently retards progress and causes our legislation and judicial 
 decisions to lag behind industrial development. 
 
 QUESTIONS AND EXERCISES 
 
 1. Give further illustrations of the difference between positive and nega- 
 tive freedom. 
 
 2. Describe the property relations existing in the Amana Society, or in 
 other communistic groups. 
 
 3. What regulations concerning the inheritance of property are in force 
 in your state ? 
 
 4. To what extent are gambling contracts valid? Why does the law 
 differentiate them from ordinary business contracts ? 
 
 5. Compare the legal freedom of workingmen today with the conditions 
 • described in the Wealth of Nations, Book i, Chap, x, Part ii. 
 
32 OUTLINES OF ECONOMICS 
 
 6. Compare the rights of patentees in Bauer v. O'Donnell, 229 U. S. I 
 (1912), with those allowed in Henry v. Dick Co., 224 U. S. i (1911). 
 
 7. What do you regard as " unfair " advertising ? Give examples. 
 
 REFERENCES 
 
 Bliss, W. D. P. Encyclopedia of Social Reform (new ed.), article on Amana 
 
 Community. See also on same subject, Ely, R. T., in Harper's Monthly 
 
 Magazine, October, 1902. 
 Ely, R. T. Property and Contract, in their Relations to the Distribution of 
 
 Wealth, Vol. i, pp. 94 and ff. ; Vol. ii, pp. 755-821. 
 Green, T. H. "Liberal Legislation and Freedom of Contract," in his 
 
 Works (edited by Nettleship), VoL iii. 
 Lewinski, J. S. The Origin of Property. 
 Mill, J. S. On Liberty, Chap. iv. 
 
 Mill, J. S. Principles 0} Political Economy, Book ii. Chaps, i. and ii. 
 Nicholson, J. Shield. Principles of Political Economy, Vol. i, Book ii, 
 
 Chaps, ii-viii. 
 Reports of the United States Commissioner of Patents. 
 Rogers, E. S. Good Will, Trade Marks, and Unfair Trading. 
 StDGWiCK, Henry. Principles of Political Economy, Book ii, Chap. xii. 
 Stephens, J. F. Liberty, Equality, and Fraternity. 
 
 Webb, Sldney and Beatrice. Industrial Democracy, Vol. ii, pp. 562-572. 
 Wyman, Bruce. The Control of the Market. 
 
CHAPTER III 
 
 THE EVOLUTION OF ECONOMIC SOCIETY 
 
 ' The evolution of economic society ,_is but one of many points 
 of view from which the development of mankind may be consid- 
 ered. The history of literature, the history of government, the 
 history of religion, each treats of man in one line of his activities. 
 Many thinkers have considered the economic activities of man- 
 kind as the one fundamental factor in social progress, deter- 
 mining in the long run even our moral and religious ideas. 
 But human life is complex, and it is improbable that any simple 
 explanation suffices for all of its aspects. The economic factor, 
 however, is clearly of fundamental importance in the sense that 
 the higher things in life cannot be gained if man's entire time 
 is spent in getting a mere subsistence, so that economic progress, 
 or increasing control over the forces of nature, must accompany 
 general social advancement, at least for the mass of the commu- 
 nity. Under primitive methods of production, only a select few 
 can have the leisure which is a necessary condition of a high stand- 
 ard of living. The greater the total social product, the better 
 the possible satisfaction of the true economic wants of all ; 
 and, other things being equal, the more satisfactory the founda- 
 tion on which to rear a high democratic civilization. 
 
 The Economic Stages. — Many attempts have been made to 
 divide economic history into different stages through which 
 mankind passed in arriving at modern industrial civilization. 
 These attempts have been the subject of lively criticism, but 
 it appears that the classification which in the past has been 
 most widely used is still, with some modifications, the most 
 serviceable, and in the main, this will be followed in the present 
 chapter. 
 
 The basis of this classification is the increasing power of man 
 » 33 
 
34 OUTLINES OF ECONOMICS 
 
 over nature. This is the fundamental fact in man's economic 
 development, and his position in the scale of economic civiliza- 
 tion is higher in proportion as this power over nature increases. 
 Increasing control of nature is accompanied by changes in man 
 himself, especially by a growth and diversification of his wants, 
 so that we may say that economic civilization consists largely in 
 wanting many things and in learning how to make and use them. 
 From this standpoint economic history may be divided into the 
 following stages : (I) Direct Appropriation ; (II) The Pastoral 
 Stage; (III) The Agricultural Stage; (IV) The Handicraft 
 Stage ; (V) The Industrial Stage. 
 
 I. Direct Appropriation 
 
 Primitive man depends upon finding things, not upon making 
 them. This does not mean that the lowest examples of man- 
 kind that we know do absolutely nothing in the way of trans- 
 forming the materials of nature for use. The lowest types know 
 the use of fire and have rude tools, but, nevertheless, the farther 
 back we go, the more complete do we find the reliance on nature. 
 One cannot read descriptions of the Negritos, Veddahs, Fuegians, 
 or native Australians without being impressed with the simi- 
 larity between the economy of these peoples and that of the 
 lower animals. But there are many tribes commonly regarded 
 as savages that show a great advancement over those that 
 have been mentioned. Among the North American Indians, 
 for example, we find a rude sort of cultivation of the soil along 
 with hunting and fishing. Such soil cultivation has been termed 
 " hoe-culture," and is to be distinguished from agriculture with 
 the aid of domesticated animals found in a later stage of devel- 
 opment. 
 
 This kind of agriculture is found in its highest state of development among 
 the Negroes of Africa. " The ground for cultivation," says Ratzel, "is cleared 
 by means of fire, or with the hatchet or small ax. On the east coast a broad 
 chopper with a spear-shaped blade and short handle is also used. The 
 lance or spearhead has, in general, to serve many peaceful purposes. Larger 
 trees are killed by barking. Thorny branches are placed as a border to the 
 fields, under the shelter of which close, thick hedges gradually grow up. The 
 
THE EVOLUTION OF ECONOMIC SOCIETY 35 
 
 ground is broken and cleared of weeds with a wooden spade sharpened to an 
 edge at either end. Many peoples have hitherto not ventured to use iron 
 tools, since they keep away the rain. When the ground has been got ready, 
 somewhere about the beginning of the rainy season, the sower walks over 
 the field, scraping a hole with his naked foot at every step, into which he lets 
 some grains fall from his hand ; the foot covers them up, and if the good 
 witch doctor makes rain enough, and the bad one does not keep it back, there 
 is nothing more to be done until harvest, unless to hoe the weeds once. . . . 
 To the present day the plow is practically strange to them." ^ 
 
 The following characterization of the economy of primitive 
 man applies with varying accuracy to the many tribes that may 
 be placed in this first stage. 
 
 Characteristics of Primitive Man. — The range of wants is 
 narrow: the savage is generally satisfied if he obtains mere 
 subsistence of the rudest sort. In the satisfaction of these 
 few wants he is, according to our modern standards, remark- 
 ably inefficient. From even the best natural resources he 
 manages to get but a very poor living, depending as he does 
 largely on the spontaneous products of nature. Magic and 
 ritual are very generally relied upon as aids to wealth produc- 
 tion. He is improvident, for he does not feel keenly the un- 
 certainties of the future, and fails to make provision for them. 
 Hence he has alternate periods of starvation and plenty. 
 Only a small population is possible in this stage, as a tribe 
 must have a large expanse of territory from which to draw its 
 sustenance. The place of abode is easily changed, and warfare 
 with neighboring tribes frequent. Private property in land is 
 absent, although the beginning of the institution of ownership 
 appears in the recognition of the individual's right to articles 
 of personal use. There is little division of labor. What one 
 man can do, all can do. The cultivation of the soil by the 
 women and the specialized work of the medicine man are ex- 
 ceptions. As each tribe produces or finds for itself all that it 
 uses there is little or no trade. The beginnings of slavery are 
 found, but this institution plays no important part in the 
 economy of primitive man, except among the most advanced 
 tribes. 
 
 ^Ratzel, History of Mankind, trans, by A. J. Butler, vol. ii, pp. 380-382. 
 
36 OUTLINES OF ECONOMICS 
 
 II. The Pastoral Stage 
 
 In the older accounts of economic evolution, the impression is 
 given that hunting peoples learned to domesticate animals and 
 then led a pastoral life, later learning to subdue the vegetable 
 kingdom, thus becoming agriculturalists. This is not alto- 
 gether accurate. It is possible that the domestication of 
 animals was developed in regions where considerable progress 
 had been made in hoe-culture. As this knowledge spread, 
 certain tribes became and remained pastoral nomads in regions 
 where agriculture was impossible. But whatever the actual 
 steps may have been, the pastoral peoples represent a type of 
 culture that is lower than that of the agricultural stage (as 
 distinguished from hoe-culture), and higher than that of the 
 hunter. Within this stage also are classed together tribes 
 of varying advancement. Illustrations of existing pastoral life 
 are found in the tribes of central Asia, many of the Arabian 
 and African tribes, and the Todas of India. Attempts have 
 been made to trace the pastoral stage in the early history of 
 the Hebrews, Germans, Greeks, and Britons. 
 
 Characteristics of Pastoral Peoples. — Some marked features 
 of the first stage are found also among pastoral peoples. A 
 fixed abode is not possible, as food must be found for the herds 
 and flocks. Cities do not develop. Moreover, while the land 
 will now support many more inhabitants per square mile than 
 before, much land is still needed for pasture, and there is frequent 
 collision and warfare between neighboring tribes. It follows 
 also that there is very little private ownership of land among 
 these peoples. Tribes as a whole lay claim to certain districts 
 and try to keep other tribes from pasturing their flocks on 
 them. In this stage there are frequently individual accumula- 
 tions of wealth, consisting mostly of herds or flocks, and thus 
 the contrast between rich and poor makes its appearance. Cus- 
 tomary rules regarding the inheritance of wealth are recognized. 
 But this early wealth does not produce commerce to any con- 
 siderable extent, simply because there is little division of labor 
 either between localities or within the tribe. 
 
THE EVOLUTION OF ECONOMIC SOCIETY 37 
 
 III. The Agricultural Stage 
 
 In this stage there is an enormous increase in man's power 
 over nature. The production of wealth is increased especially 
 by the use of animal power in cultivating the soil. One result 
 is increased population. Land which under the more primitive 
 methods of getting a living would give a scanty support to a 
 small tribe for a part of the year will now maintain a whole 
 community with a fixed abode. It is necessary for human 
 development that men should live in definite places and have 
 homes and a country. This results in new relations between 
 men, new duties, new arts, and new possibilities. The beginning 
 of the institution of private ownership in land falls within this 
 stage, although it is difficult to trace the actual steps in the 
 process. 
 
 A most important characteristic of this period is slavery. 
 Slavery begins long before improved agriculture, but it now 
 attains its full magnitude as an institution. Slavery occupies 
 a prominent place in the history of Greece and Rome, and in 
 the Middle Ages develops into serfdom. 
 
 Commercial intercourse is still comparatively slight in this 
 stage. Fixed residence develops village communities, and 
 these are economically self-sufficient. That is, they produce 
 the things that they consume, and do not as a rule have surplus 
 products to dispose of to others. Hence money does not at 
 this time play an important part in the every-day life. The 
 economic condition of Europe during the Middle Ages, before 
 the growth of cities, illustrates the agricultural stage. 
 
 The Manorial Economy in England. — England was almost 
 wholly agricultural for three centuries following the Norman 
 Conquest. In the thirteenth century the population for the 
 most part lived in villages or manors, each controlled by a 
 lord to whom the rest of the inhabitants were bound by custom- 
 ary rules to render certain assistance, as in the cultivation 
 of his land. The villagers were of various classes, according 
 to the amount of land which they held and according to the 
 services which they were required to perform. The land of 
 
38 OUTLINES OF ECONOMICS 
 
 each tenant was not a compact area, but was composed of strips 
 scattered in the three great fields into which the arable land was 
 divided for purposes of crop rotation. 
 
 Some handicraftsmen were also found upon the estate, but they do not 
 occupy an important place in the economy of the village. For the most part, 
 they were probably slaves or household servants. Slaves in England con- 
 stituted at the time of the Conquest about nine per cent of the population, 
 but "in some of the eastern and midland shires do not appear at all, or fall 
 to a percentage of four or five," while they rise to as much as twenty-four 
 per cent in other parts of the country. "We cannot but explain this by the 
 supposition that in the later stages of the English conquest a greater number 
 of the British cultivators were spared, so that in these districts slaves came to 
 form a considerable part of the rural population. Absolute slavery, how- 
 ever, disappeared in less than a century after the -Conquest, and the servi 
 became customary holders of small plots, like the cotters elsewhere, but on 
 more onerous conditions." ^ 
 
 These manors were largely self-sufficient in their economic life. 
 There was, to be sure, some trade. England exported raw 
 products to the continent and received back some of the finer 
 forms of manufacture. But the ordinary needs of the very 
 frugal life which the tenants had to live were supplied by prod- 
 ucts of the manor itself. During the centuries following the 
 Norman Conquest important changes took place in the manorial 
 system: (i) a rapid growth in the number of free tenants; 
 (2) the commutation of customary services into fixed payments 
 in money or kind ; and (3) the appearance of a class of agri- 
 cultural laborers dependent on the wages which they received. 
 
 In contrasting the manorial economy with the village of the 
 present day. Professor W. J. Ashley has pointed out the follow- 
 ing differences : (i) Now English farmers generally live in 
 separate homesteads among the fields they rent, but then all the 
 cultivators lived side by side in the village street. (2) Now 
 each farmer follows his own judgment as to his agricultural 
 operations, but in this early period he took his share in the 
 common method of cultivation, which was regulated by custom, 
 enforced by the manor courts. (3) Today, if the landlord 
 himself engages in farming, his management is independent 
 1 See Ashley, English Economic History, vol. i, pp. 17-18. 
 
THE EVOLUTION OF ECONOMIC SOCIETY 39 
 
 of that of his tenants, but under the manorial system he de- 
 pended almost exclusively upon the labor of his tenants, who 
 contributed plows, oxen, and men. (4) Aside from the great 
 gulf between lord and tenants, there was then no such social 
 separation between the cultivators as there is today between 
 large and small farmers. The manorial economy of England 
 was a type, though somewhat more systematically developed, 
 of conditions on the continent of Europe. 
 
 IV. The Handicraft Stage 
 
 This stage begins with the development of towns as centers 
 of trade and handicraft in the latter part of the Middle Ages 
 and extends to the introduction of power manufacture in the 
 latter part of the eighteenth century. During such a long 
 period many changes took place in the economic life of the 
 people of Europe, but so far as the growth of man's power over 
 nature is concerned the whole period is in marked contrast with 
 the modern era of machine production. 
 
 The Gild System. — The growth of trade brought with it the 
 merchant gild, the purpose of which was to regulate the conduct 
 of trade and to keep a monopoly of it for the merchants of the 
 town. Merchant gilds appeared in all the larger towns of Eng- 
 land in the twelfth century. But a new class was developing in 
 the towns, — the craftsmen who were engaged in the making of 
 things for sale. As this handicraft grew in importance, the 
 merchant gild was superseded by the craft gild, which in England 
 attained its fullest development in the first half of the fourteenth 
 century. Each craft had its gild, which specified in detail how 
 the business should be carried on, how many should be admitted 
 to it, and how the trade should be learned. This growth in spe- 
 cialization meant also a growth in trade, but in this early part of 
 the handicraft period, commerce was much restricted as com- 
 pared with that of the present day. The towns made exchanges 
 mostly with the country surrounding them, there being as 
 yet no national or world market of any importance. Plainly 
 such a general system of exchange could not be carried on by 
 barter, and in this period money became increasingly important. 
 
40 OUTLINES OF ECONOMICS 
 
 The agricultural stage had in the greater part of Europe cul- 
 minated in the feudal system. The nobility maintained order 
 and attended to the fighting while the serfs tilled the soil. The 
 manufacturing cities became the rivals of the feudal lords, who 
 felt their power threatened, and hence they bitterly opposed 
 the cities. The cities were free, and the serfs who fled to them 
 were accepted and made freemen. 
 
 The Domestic System. — With the beginning of the modern 
 period the town system gave way to a larger economy. The 
 towns lost the control of trade. The gild system was gradually 
 succeeded by the domestic system, which developed in the 
 sixteenth and seventeenth centuries and was a characteristic 
 feature of English industry until the middle of the eighteenth 
 century. As in the gild system, industry was carried on by 
 hand in a small way, but the functions of merchant and workman 
 were now separated. The gild master sold the goods which he 
 produced in his shop directly to the customers who were to use 
 the goods, but under the domestic system the workman came 
 to be less independent. He received the raw material from a 
 middleman, to whom he also delivered the finished product. 
 Much of this work was done outside of the towns, the artisans 
 thus being enabled to devote part of their time to agriculture., 
 Defoe, in his tour through Great Britain (1724-1726), describes 
 the methods employed as follows : 
 
 The land "was divided into small inclosures from two acres to six or seven 
 each, seldom more ; every three or four pieces of land had an house belonging 
 to them, . . . hardly an house standing out of a speaking distance from 
 another. . . . We could see at every house a tenter, and on almost every 
 tenter a piece of cloth or kersie or shaloon. ... At every considerable 
 house was a manufactury. . . . Every clothier keeps one horse, at least, 
 to carry his manufactures to the market, and every one generally keeps a 
 cow or two or more for his family. By this means the small pieces of in- 
 closed land about each house are occupied, for they scarce sow corn enough 
 to feed their poultry. . . . The houses are full of lusty fellows, some at the 
 dye-vat, some at the looms, others dressing the cloths; the women or chil- 
 dren carding or spinning, being all employed, from the youngest to the oldest." 
 
 Agricultural Changes. — Many important changes in the 
 agriculture of England took place during the handicraft stage. 
 
THE EVOLUTION OF ECONOMIC SOCIETY 41 
 
 The most prominent of these is the process called inclosure. 
 Under the manorial system the lands in the common fields were 
 the property of a landlord, but his rights were not exclusive 
 and were qualified by rights of the tenants. There existed a 
 certain kind of partnership of landlord and tenant in the culti- 
 vation of the land. Inclosure is the term used to designate 
 the dissolution of the partnership, or the separation of rights. 
 After inclosure the tenant had generally a farm which was in 
 one piece of land, instead of being in scattered strips in different 
 fields, and for this he paid usually a definite money rent. The 
 farmer could make improvements on his own account, which 
 was impossible when he held scattered strips in great fields. 
 Inclosures were made during this whole period and especially 
 during the Tudor period. Farms became larger and when 
 labor was scarce and wages high, sheep farming, requiring few 
 laborers, was rapidly extended. Inclosures resulted in great 
 agricultural improvement, but at the same time they were 
 frequently attended with hardship for the poorer people. Some- 
 times the common rights, especially those of common pasturage, 
 were not fully paid for, although the rule was that of compensa- 
 tion. But the result was to separate many people from the 
 land; frequently the payment received by the poorer people 
 was wasted. The right to pasture a cow meant a definite con- 
 nection with the soil ; the money received in payment for this 
 right might quickly disappear. Even now in English villages 
 it is possible to find those who receive small sums for ancient 
 rights, and these are too often used in dissipation. In Epworth, 
 England, the villagers formerly had a right to cut turf in a field 
 which is now let for a money rent, and this is used to buy coal 
 which is distributed among the people in payment of their an- 
 cient rights. 
 
 Convertible husbandry, rotation of crops, the cultivation of 
 root crops, improved breeds of animals and other forms of 
 agricultural progress accompanied inclosure, which is still 
 going forward, although the process is nearly completed so far 
 as the arable land is concerned. A halt has now been called to 
 the inclosure of forests and common fields, especially when used 
 
42 OUTLINES OF ECONOMICS 
 
 for pasturage, and these are now found scattered over England 
 and used as public parks and playgrounds; but often with 
 certain private rights of pasturage which have descended to 
 their owners by inheritance or which have been acquired other- 
 wise, as by the purchase of a cottage to which the rights are 
 attached. An illustration of a village with extensive common 
 fields is afforded today by S telling Minnis, near Canterbury, 
 England. 
 
 The Mercantile System. — The decay of town authority did 
 not mean that industry and commerce were left to the free play 
 of competition. The supervision of the central government 
 took the place of that of the towns. The national system of 
 regulation has been called the Mercantile System, which pre- 
 vailed in England (and in other countries) from the sixteenth 
 century to the nineteenth. Its essential idea is the guidance of 
 economic affairs in such a way as to increase the commercial 
 and military power of the nation as a whole. The navigation 
 laws which the student has met with in his study of American 
 history were a part of this system. An attempt was made to 
 create a " favorable " balance of trade and to maintain a good 
 supply of the precious metals. Agriculture was fostered with 
 the aim of promoting the growth of population. The mercantile 
 system has often been described as consisting chiefly of trade 
 restrictions, but it is the contention of Professor Schmoller 
 that in its essence the S3^stem meant " the replacing of a local 
 and territorial economic policy by that of the national state." 
 
 It was characteristic of the mercantile system, too, to interfere 
 in the conduct of internal trade. Prices, wages, and the rules 
 of apprenticeship were fixed by public authority. The quality 
 of goods was inspected by public ofiicials. Patents of monopoly 
 on the sale of certain commodities, such as gunpowder, matches, 
 and playing cards, were extensively granted by royal authority 
 to favored individuals or companies, ostensibly to foster new 
 industries. 
 
 "At the Council of York, Charles was obliged to declare many of the 
 industrial patents void; but enough remained to call forth an indignant 
 declamation from Sir. J. Colepepper in the Long Parliament: 'I have but 
 
THE EVOLUTION OF ECONOMIC SOCIETY 43 
 
 one Grievance more to offer unto you ; but this one compriseth many ; it 
 is a nest of wasps, or swarm of vermin, which have overcrept the land, 
 I mean the monopoler and polers of the people. These like the frogs of 
 Egypt, have got possession of our dweUings, and we have scarce a room free 
 from them ; they sip in our cup, they dip in our dish, they sit by our fire ; 
 we find them in the dye-vat, wash-bowl, and powdery tub ; they share with 
 the butler in his box, they have marked us and sealed us from head to foot. 
 Mr. Speaker, they will not bate us a pin ; we may not buy our own cloaths 
 without their brokage. These are the leeches that have sucked the com- 
 monwealth so hard that it is almost become hectical. And some of these 
 are ashamed of their right names; they have a vizard to hide the brand 
 made by that good law in the last Parliament of King James ; they shelter 
 themselves under the name of a corporation; they make bye-laws which 
 serve their turns to squeeze us and to fill their purses ; unface these and they 
 will prove as bad curs as any in the pack. These are not petty chapmen, but 
 wholesale men.'" ^ 
 
 A full account of this stage in English history would deal with 
 (i) the regulation of labor, including the Statute of Artificers 
 passed in the reign of Elizabeth, which provided that all able- 
 bodied men might be compelled to serve as agricultural laborers, 
 and that all artificers, rural or urban, should undergo an appren- 
 ticeship of at least seven years. In this same reign provision was 
 made for the assessment of wages by the Justices of the Peace. 
 Every year in each locality the justices were to assemble, and, 
 " calling to them such discreet and grave persons ... as they 
 shall think meet, and conferring together respecting the plenty 
 or scarcity of the time," they were to fix the wages for every 
 kind of manual labor, skilled or unskilled, by the year, week, or 
 day, and with or without allov/ance of food. A full account 
 would deal also with : (2) the development of systematic poor 
 relief by civil authority ; (3) the encouragement of shipping and 
 of (4) the immigration of foreign artisans to introduce new in- 
 dustries ; (5) the regulation of the corn trade ; (6) the establish- 
 ing of plantations in the colonies ; (7) the regulation of the coin- 
 age; (8) the development of banking, insurance, and foreign 
 commerce, and the decay of the old notions regarding the sinful- 
 ness of interest taking. 
 
 * Cunningham, English Commerce and Industry, Modern Times, Part i, pp. 
 307-308. 
 
44 OUTLINES OF ECONOMICS 
 
 V. The Industrial Stage 
 
 In the latter part of the eighteenth century, the slow-going 
 methods of the handicraft stage were radically changed by the 
 Industrial Revolution. The fundamental feature of this change 
 is the introduction of power manufacture. The industrial revo- 
 lution and the chief features of the industrial stage will be dis- 
 cussed in the following chapter. 
 
 Before proceeding to the consideration of the last stage, it 
 will be well to notice some of the other views which have been 
 expressed concerning the periods of economic development. The 
 German economist, Hildebrand, has taken as his principle of 
 classification the method of exchanging goods, and from this 
 standpoint he gets the following three stages : (i) barter, (2) 
 money, and (3) credit. All three methods of exchanging, to be 
 sure, are in use at the present time, but the extensive use of 
 credit is the new and characteristic thing about present-day 
 exchange. It has been objected that the period before the use 
 of money became prominent is characterized not so much by 
 the barter of goods as by the fact that exchange itself is unim- 
 portant. 
 
 Another writer (Biicher) has divided economic history accord- 
 ing to the nature and size of the normal self-sufficing economic 
 unit, as follows : (i) the independent domestic economy, (2) the 
 town economy, (3) the national economy. 
 
 In the first stage the interval between production and 
 consumption is small. Things are produced where they are 
 consumed, as in the village communities of the early middle 
 ages. In the town economy the interval is somewhat greater. 
 The artisans in the town produce for the consumption of other 
 persons, for the most part in the immediate neighborhood, so 
 that the producer meets the consumer without intermediaries. 
 In the third stage, production is for a national market, so that 
 goods may pass through many hands before reaching the 
 consumer, and the system of cooperative division of labor 
 embraces the whole nation. Possibly, according to this view, a 
 fourth stage might be added, — that of a nascent world economy. 
 
THE EVOLUTION OF ECONOMIC SOCIETY 
 
 45 
 
 Again, we might pay attention chiefly to the condition of 
 labor. Beginning with a condition where there is no distinct 
 laboring class, we pass through slavery and serfdom to free 
 labor, regulated at first by law and custom, then by individual 
 contract, and finally in large measure by group contract or col- 
 lective bargaining supplemented to an increasing extent by 
 legal regulations of a new kind. 
 
 THE ECONOMIC STAGES 
 
 From the 
 Standpoint 
 OF Produc- 
 tion 
 
 From 
 
 BiJCHER'S 
 
 Standpoint 
 
 From 
 Hildeerand's 
 Standpoint 
 
 From 
 THE Labor 
 Standpoint 
 
 Illustrations 
 FROM English 
 History 
 
 I. 
 
 Direct Ap- 
 propriation 
 
 Independent 
 Domestic 
 Economy 
 
 Barter 
 Economy 
 
 Laboring 
 class not dif- 
 ferentiated 
 
 Prehistoric 
 
 2. 
 
 Pastoral 
 
 Before Christ 
 
 3- 
 
 Agricultural 
 
 Slavery and 
 Serfdom 
 
 iith-i4th 
 Centuries 
 
 4- 
 Handicraft 
 
 Town 
 Economy 
 
 Money 
 Economy 
 
 Free Labor 
 governed 
 by Custom 
 
 i3th-i8th 
 Centuries 
 
 5- 
 Industrial 
 
 National 
 Economy 
 
 Credit 
 Economy 
 
 Individual 
 Contract 
 
 Group 
 Contract 
 
 i8th Century 
 to the Pres- 
 ent Time 
 
 These various classifications are not contradictory; on the 
 contrary, they supplement each other. Still other divisions 
 are possible. In the preceding table these various points of 
 view are roughly correlated and applied to the history of 
 England. These divisions of time are in no sense accurate, and 
 are intended merely to be suggestive. 
 
46 OUTLINES OF ECONOMICS 
 
 QUESTIONS AND EXERCISES 
 
 1. Write a description of the economic life of a tribe in one of the first two 
 stages. 
 
 2. What is the difference between slavery and serfdom? 
 
 3. Give an account of the East India Company. 
 
 4. Sketch the development of the woolen industry in England to 1760. 
 
 5. Give an account of the origin of the Bank of England. 
 
 6. Summarize the history of poor relief in England. 
 
 7. It has been held that because economic progress has been continuous, 
 it is incorrect to divide it into " stages. " Discuss this view. 
 
 REFERENCES 
 
 Ashley, W. J. English Economic History, Vol. i ; and The Economic Or- 
 ganization of England, Chaps, i-v. 
 
 BucHER, Karl. Industrial Evolution (trans, by S. M. Wickett). 
 
 Cheyney, E. p. Industrial and Social History of England, Chaps, i to vii. 
 
 Cunningham, Willm.m. Gi-owth of English Industry and Commerce, Vol. i. 
 (Middle Ages) and Vol. ii (Mercantile System). 
 
 Ely, R. T. Evolution of Industrial Society, Part i, Chap. iii. 
 
 Conner, E. C. K. Common Land and Inclosure. 
 
 Hone, N. J. The Manor and Manorial Records. 
 
 LiPSON, EPHiRArM:. An Introduction to the Economic History of England, 
 Vol. i. 
 
 Meredith, H. O. Outlines of the Economic History of England. 
 
 Morgan, L. H. Ancient Society, Chap. i. 
 
 Prothero, R. E. English Farming, Past and Present, Chaps, iii, iv, vii, xi. 
 
 Ratzel, Friedrich. History of Mankind (trans, by A. J. Butler), 3 vols. 
 
 Salzmann, L. F. English Industries of the Middle Ages. 
 
 Schmoller, Gustav. The Mercantile System (Economic Classics, edited by 
 W. J. Ashley). 
 
 Seebohm, Frederic. The English Village Community. 
 
 Stanley, H. M. In Darkest Africa, Vol. i. Chap, xxiii. 
 
 Unwin, George. The Guilds and Companies of London. 
 
 ViNOGRADOFF, Patjl. The Growth of the Manor. 
 
 Wallace, A. R. Russia (edition of 1905), Chap. viii. 
 
CHAPTER IV 
 THE EVOLUTION OF ECONOMIC SOCIETY {Continued) 
 
 The Industrial Revolution. — The passage from the handi- 
 craft to the industrial stage in England is generally known as 
 the Industrial Revolution. It has been objected that this 
 term is misleading because the introduction of the modern fac- 
 tory system required many years and was but the working out 
 of conditions that had been long maturing. It is true that the 
 growth in the division of labor, the expansion of commerce, and 
 the technical progress of former ages were necessary preliminaries 
 to the industrial revolution, but there is little danger of over- 
 emphasizing the importance or the rapidity of the change. 
 The period from 1770 to 1840, the span of a single life, is, after 
 all, a short period from the standpoint of the historian. Yet 
 the changes of this period swept away the inefficient methods 
 that had been used for centuries, and caused profound modifi- 
 cations in social structure. To understand the nature of this 
 movement, we must review the condition of things before it 
 began. 
 
 England in 1760. — England was at this time largely self- 
 sufficing in its economic life, producing for itself its food and other 
 articles of ordinary consumption, although compared with medi- 
 eval days there had been a marked expansion of international 
 and colonial trade. Woolen goods were the most important ex- 
 port. The imports consisted largely of wines, spirits, rice, 
 sugar, coffee, oil, and furs, and some wool, hemp, silk, and linen 
 yarn. Within the nation, too, there was not such a degree of 
 specialization of industry in particular localities as is found at 
 the present day, although the beginning of such localization had 
 clearly been made in the textile and iron industries. On the 
 whole, however, the commerce between the different sections 
 
 47 
 
48 OUTLINES OF ECONOMICS 
 
 of the country was slight. The means of transportation were 
 exceedingly poor, notwithstanding the growth of turnpike roads. 
 The roads were described by a traveler as '' most execrably 
 vile." Such was their condition that pack horses were still a 
 common means of getting goods to market. Rivers were im- 
 portant highways, canal building having barely begun. 
 
 The system of hand manufacture was still in general opera- 
 tion. Although the workmen under the domestic system were 
 no longer owners of the material upon which they worked, yet 
 the tools they used were their property. The beginnings of 
 certain features of the factory system, however, are to be seen 
 long before the use of power machinery, for in some cases work- 
 men were employed in large numbers in buildings owned by 
 the employer, who also furnished the mechanical equipment. 
 But to a large extent manufacturing was combined with agri- 
 culture, not only in the textile trades, but in other branches 
 also. " At West Bromwich, a chief center of the metal trade, 
 agriculture was still carried on as a subsidiary pursuit by the 
 metal workers." 
 
 The medieval system of common field tillage was extensively 
 used, a large part of the land being still uninclosed. The culti- 
 vation was exceedingly poor, but important experiments tend- 
 ing toward a " new agriculture " were being made in the second 
 quarter of the eighteenth century by Jethro Tull and " Turnip " 
 Townshend. Of the whole number of farms, approximately 
 one half " were owned and occupied by the various classes of 
 freeholders and copyholders ; that is, by land-owning farmers." 
 
 The medieval notion of the relation of government to in- 
 dustry was still nominally in force. Detailed and special 
 legislation was supposed to be the means of securing a well- 
 ordered trade, as explained in the preceding chapter. But a 
 tremendous revolt had begun against this whole system. This 
 revolt had its rehgious and political as well as its economic 
 aspect. The same year that Thomas Jefferson wrote the Dec- 
 laration of Independence, asserting that all men are by nature 
 equal, Adam Smith published the Wealth of Nations, the most 
 iiifluential book ever written on economics. 
 
THE EVOLUTION OF ECONOMIC SOCIETY 49 
 
 "Every individual," said Smitli, "is continually exerting himself to find 
 out the most advantageous employment for whatever capital he can com- 
 mand. It is his own advantage, indeed, and not that of the society, which 
 he has in view. But the study of his own advantage, naturally, or rather 
 necessarily, leads him to prefer that employment which is most advantageous 
 to society. . . . What is the species of domestic industry which his capital 
 can employ, and of which the produce is likely to be of the greatest value, 
 every individual, it is evident, can, in his local situation, judge much better 
 than any statesman or lawgiver can for him." ^ 
 
 The Mechanical Inventions. — During the last half of the 
 eighteenth century the progress of invention was exceptionally 
 rapid. Kay's flying shuttle (1738) had facilitated the weaving 
 process to such an extent that it became difficult to secure 
 enough yarn from the spinners. Hand spinning was improved 
 by Hargreave's "jenny" about 1767; Arkwright, in 1771, 
 made a practical success of roller spinning (a method patented 
 long before) , using horse power, and later, water power. Cromp- 
 ton combined these two processes in 1779. After 1785 steam 
 power was applied to cotton spinning, and then it was the weav- 
 ing process that was felt to be too slow. Cartwright began his 
 experiments in 1784, but the power loom did not come into 
 general use until early in the nineteenth century. 
 
 The improvement in the steam engine also made possible 
 great advances in the iron industry, of fundamental importance 
 in an age of machinery. The production of English iron was 
 over seventy-five times as great in 1840 as it had been in 1740. 
 
 The need for better transportation was met by improved 
 roads, by the building of canals (especially 1790 to 1805), and 
 by the development of steam locomotion. The germ of the 
 modern railway is seen in the tramways used in the coal mines. 
 Cast iron rails were used as early as 1738. The first tramway 
 to be used for public purposes was chartered in 1801, the cars 
 to be drawn by horse power. Trevithick made a locomotive 
 in 1803 that was of practical use. In 1814 Stephenson con- 
 structed a locomotive that could draw a load of thirty tons at 
 the rate of three miles an hour. The Stockton and Darlington 
 road was opened in 1825 with a Stephenson locomotive that 
 
 1 A. Smith, Wealth of Nations, Book iv, Chap. ii. 
 E 
 
50 OUTLINES OF ECONOMICS 
 
 made fifteen miles an hour, but two years later the directors of 
 the road considered the advisability of abandoning the use of 
 locomotives. In 1829 the directors of the Liverpool and Man- 
 chester Railroad arranged a prize contest to determine the 
 practicability of steam locomotion. The success of Stephenson's 
 " Rocket " in meeting the requirements of the contest demon- 
 strated that the new method of locomotion had come to stay. 
 
 "A general survey of the growth of new industrial methods in the textile 
 and iron industries marks out three periods of abnormal activity in the evolu- 
 tion of modern industry. The first is 1 780-1 795, when the fruits of early 
 inventions were ripened by the effective application of steam to the machine 
 industries. The second is 1830 to 1845, when industry, reviving after the 
 European strife, utilized more widely the new inventions, and expanded 
 under the stimulus of steam locomotion. The third is 1856-1866 (circa), 
 when the construction of machinery by machinery became the settled rule 
 of industry^" ^ 
 
 Agricultural Changes. — During the Industrial Revolution 
 there were also important changes in agriculture. Bakewell, 
 in the second half of the eighteenth century, improved the breeds 
 of sheep and cattle. The inclosing of the common fields pro- 
 ceeded with great rapidity, not, as in the sixteenth century, for 
 the purpose of sheep raising, but to permit of more efficient 
 tillage of the soil. Between 1760 and 1850 over seven million 
 acres were inclosed in England. The small land-owning farmer 
 was crowded out, partly because more investment per acre was 
 needed with the new agriculture, partly because " gentlemen 
 farmers " (men who had made money in other pursuits and took 
 up agriculture because it was fashionable) bought them out, 
 and because the price of land was greatly increased by the desire 
 of wealthy men to build up family estates. Today practically 
 all English farmers are tenants. The small farmer, who under 
 the domestic system was also frequently a handicraftsman, was 
 thus crushed between the new agriculture and the new industry. 
 
 "Hitherto the rude implements required for the cultivation of the soil, 
 or the household utensils needed for the comfort of daily life, had been made 
 at home. The farmer, his sons, and his servants in the long winter evenings 
 
 ^ Hobson, Evolution of Modem Capitalism, edition of 1907, p. 89. 
 
THE EVOLUTION OF ECONOMIC SOCIETY 5 1 
 
 carved the wooden spoons, the platters, and the beechen bowls, plaited wicker 
 baskets, fitted handles to the tools, cut willow teeth for rakes and harrows 
 and hardened them in the fire, fashioned ox yokes and forks, twisted willows 
 into the traces of other harness gear. Traveling carpenters visited farm- 
 houses at rare intervals to perform those parts of work which needed their 
 professional skill. The women plaited the straw for the neck collars, stitched 
 and stuffed sheepskin bags for the cart saddle, wove the straw and hempen 
 stirrups and halters, peeled the rushes for and made the candles. The 
 spinning wheel, the distaff, and the needle were never idle ; coarse hand-made 
 cloth and linen supplied all wants ; every farmhouse had its brass brewery 
 kettle. . . . All the domestic industries by which cultivators of the soil 
 increased their incomes, or escaped the necessity of selling their produce, 
 were now supplanted by manufactures." ^ 
 
 Effects of the Industrial Revolution. — As has already been 
 indicated, the Industrial Revolution introduces one of the great 
 stages in the development of man's power over nature. But 
 along with the new opportunities came also new dangers and 
 perplexing problems. 
 
 I. The Factory System. — The use of expensive machinery 
 and steam power made it impossible for men to carry on their 
 work in their own homes. The factory supplanted the home as 
 the typical center of production. Instead of working by them- 
 selves or with a few assistants, men now to a much greater 
 extent than before had to congregate in cities, and submit to a 
 new discipline in large groups organized for purposes of pro- 
 duction. This brought with it a new division of society into 
 classes. The machine and the workshop, as well as the raw 
 material and the product, are at no stage in the productive 
 process owned by the men who do the manual work. The 
 masses become wage earners. Now, in some industries not one 
 in a hundred can by exceptional ability become an independent 
 employer, and the workman knows that he is a workman for 
 life. So we have now two industrial classes, laborers and 
 capitalists, with a great gulf between them which comparatively 
 few men can cross, and with interests which often seem irrec- 
 oncilable. What the ultimate effects of the new system of 
 
 ^ Prothero, quoted by Cunningham, Growth of English Industry and Commerce, 
 ■ Modern Times, Part ii, p. 722. 
 
52 OUTLINES OF ECONOMICS 
 
 production will be cannot be stated, but it has been suggested 
 that these changes in external relations are affecting also men's 
 habits of thought. Can we expect the institution of private 
 property to seem as natural and sacred to those who have 
 nothing to do with the buying and selling of products as to those 
 who engage much in pecuniary transactions? It has been 
 suggested that the feeling that we have a right to the product 
 of our own labor is merely a survival of the era of small-scale 
 hand manufacture. 
 
 2. The Expansion of Markets and Industrial Specialization. — 
 Along with the new methods of production there has been a 
 change from restricted local markets to national and even world 
 markets. Improved methods of transportation make it possible 
 for different branches of production to be localized in regions 
 where there are special facilities for raw material or power. This 
 implies greater economic interdependence and greater liability 
 to trade fluctuations and disturbances. One great advantage 
 of the old slow-going system of manufacture and trade was its 
 regularity. As the area of the market increases, manufacturers 
 find it more difiicult to decide what and how much to produce. 
 Trade fluctuations have increased in severity with the growth 
 of large-scale production. This is due not merely to the chang- 
 ing and enlarging demand which cannot be calculated, but also 
 to the fact that manufacture itself is constantly being disturbed 
 by improvements which cannot be foreseen. It is possible 
 that a still larger scale of manufacture hereafter will bring steadi- 
 ness in industry, but whatever the cause of these fluctuations, 
 the effect upon the wage earner is demoralizing. If he were 
 wise enough to save his earnings during good times, and so have 
 something for hard times, he would not suffer so much. But 
 very few people who live in abundance can do this ; how much 
 less those whose condition even in good times is one of meager 
 comfort ! 
 
 Evils of the Transitional Period. — The condition of the 
 English working classes in the latter part of the eighteenth and 
 early nineteenth centuries was undoubtedly worse than in any 
 other period in the history of the country. It is difiScult to 
 
THE EVOLUTION OF ECONOMIC SOCIETY 53 
 
 say to what extent this was due to the introduction of the fac- 
 tory system. In addition to the new methods of manufacture 
 there were wars, peculiar conditions in land ownership, duties, 
 and taxes. There is some evidence that the condition of child 
 workers under the domestic system was often worse than in 
 the factories, their parents proving the hardest taskmasters. 
 
 "The evils and horrors of the industrial revolution are often vaguely 
 ascribed to the 'transition stage' brought about by the development of ma- 
 chinery and the consequent 'upheaval.' But the more we look into the 
 matter, the more convinced we become that the factory system and machin- 
 ery merely took what they found, and that the lines on which the industrial 
 revolution actually worked itself out cannot be explained by the progress of 
 material civiUzation alone ; rather, the disregard of child-life, the greed of 
 child-labour, and the maladministration of the poor law had, during the 
 eighteenth century, and probably much farther back still, been preparing 
 the human material that was to be so mercilessly exploited." ^ 
 
 But whatever the causes, the facts that have been revealed re- 
 garding the conditions in English mines and factories of this 
 period are amazing. The picture includes cruelty to appren- 
 tice children, excessive hours, and unheal thful conditions of 
 work. The evils were worst in the smaller factories, the 
 owners of which were hard pressed by relentless competition. 
 Outside of the factories, also, those who attempted to continue 
 to work in their homes in the old way suffered from irregular 
 employment and low earnings. The distress of the hand-loom 
 weavers affords an illustration. 
 
 Competition and Laissez-faire. — We have seen that Adam 
 Smith advocated liberty. He asserted that every man, if 
 allowed to do as he pleased, would sooner or later do that for 
 which he was best fitted, and would consequently work where 
 he could get the most wages. Every man would buy what 
 suited him best, and, after some experiments, manufacturers 
 would make what was called for. If one line of work was more 
 profitable than another, more men would go into it and by their 
 competition would bring prices down. If men cheated their 
 customers, the customers would go elsewhere, and cheating 
 
 1 Hutchins and Harrison, A History of Factory Legislation, p. 13. 
 
54 OUTLINES OF ECONOMICS 
 
 would not pay. Everywhere men would look out for their 
 own interests and would make the bargain that was most ad- 
 vantageous to themselves. This system of balanced self- 
 interests resulting from competition was the best regulator 
 possible, infinitely better, he claimed, than the old-time laws, 
 which only incumbered the development of industry. If the 
 policy of industrial freedom were adopted, there would be, he 
 prophesied, a great increase in the production of wealth. 
 
 This view gained favor during the Industrial Revolution. 
 Not that a wholesale repeal of the old laws occurred — such things 
 never happen in England, and are difficult anywhere — but 
 there is a quiet and effective way of changing laws by changing 
 men's ideas regarding them and leaving them unenforced. 
 A law that has been long observed has often to be long dead 
 before people gain the courage to repeal it. So the law requiring 
 seven years' apprenticeship before one could enter certain 
 trades quietly died during the eighteenth century, and when, 
 finally, in the labor troubles early in the nineteenth century 
 some workmen discovered the old law and prosecuted employers 
 for violating it, it was first suspended and then repealed, as being 
 plainly ill adapted to the new condition of industry. So, little 
 by little, the old laws were repealed or forgotten, and men were 
 left free to bargain and manufacture as they pleased. 
 
 This policy of laissez-faire, or letting things drift, was very 
 generally accepted by the economic writers who followed Adam 
 Smith, and was clearly reflected in the parliamentary debates. 
 The universal free play of competition came to be the pre- 
 vailing ideal in this first phase of the industrial stage. It was 
 in keeping with this spirit that England became a free-trade 
 nation in this period, the last step being taken when the " corn 
 laws " were repealed in 1846, the act going into effect in 1849. 
 
 The Reaction against the Passive Policy. — It may be said 
 that by 1850 the abandonment of mercantilistic ideas was com- 
 plete in England, but long before this date a new system of 
 legislation for the purpose of controlling industry had been 
 begun. The government could not ignore the actual condi- 
 tions that resulted from competition and the introduction of 
 
THE EVOLUTION OF ECONOMIC SOCIETY 55 
 
 machinery. We have now to consider some of the main lines 
 of development of this modern industrial regulation. 
 
 1. The Quality of Goods. — In repealing the laws for the in- 
 spection of wares it was urged that cheating would not pay 
 and would cure itself. Indeed, it was said that the very in- 
 spection of wares by the government was the cause of fraud; 
 for, the government brand being often put on carelessly, men 
 bought poor goods, because of the brand, which they would 
 have rejected if they had examined them. The abolition of 
 the laws would result in each examining goods for himself, it 
 was asserted. It is hardly necessary to say that these hopes 
 were not realized. Men might be trusted to attend to their own 
 interests if they knew enough to do so, but they do not. Who 
 can tell the quality of baking powder, or ground spices, or 
 patent medicines, or many other things that are misrepresented 
 when offered for sale? For these the ordinary buyer's knowl- 
 edge is worthless; an expert must be employed. Such has 
 been the experience of the English people and also, more re- 
 cently, of the people of the United States, and the law now pro- 
 vides for the inspection by government experts of many articles 
 of food. The notion that men will always ruin their business 
 prospects if they cheat, and so will be deterred from cheating, 
 has been utterly exploded by this English experiment. The rep- 
 utation for honesty is undoubtedly a source of strength to 
 many business houses; but many a man has perpetrated an 
 audacious fraud upon a country for a few years and retired 
 with a fortune when his cheating began to be known. The 
 inspection of goods by the State is a principle now fully rec- 
 ognized, the only question being how far it should be applied. 
 
 2. The Protection of Labor. — As a result of a series of epi- 
 demics of infectious fevers, public attention was called to the 
 condition of the apprenticed children in cotton factories. In 
 1796 the Manchester Board of Health reported upon the un- 
 healthful conditions under which the children worked, pointing 
 out that " the untimely labour of the night, and the protracted 
 labour of the day, with respect to children, not only tends to 
 diminish future expectations as to the general sum of life and 
 
56 OUTLINES OF ECONOMICS 
 
 industry by impairing the strength and destroying the vital 
 stamina of the rising generation, but it too often gives encourage- 
 ment to idleness, extravagance, and profligacy in the parents, 
 who, contrary to the order of nature, subsist by the oppression 
 of their offspring." In 1802 the first factory act was passed to 
 protect the health and morals of pauper children in cotton 
 factories. The apprentices were not to work more than twelve 
 hours by day, and after 1804 not at all by night, but the law 
 was not effectively administered. After much agitation, in 
 which Robert Owen took a prominent part, a second step was 
 taken in 181 9. The act prohibited children under nine years 
 from working in cotton mills, and no person under sixteen 
 was to be employed more than twelve hours per day. As with 
 the act of 1802, the enforcement of the law was left to the justices 
 of the peace. In 1833 regulations as to conditions of work for 
 children and young persons were made for all textile factories, 
 and special inspectors were provided to enforce the law. In 
 the following years the controversy concerning labor legislation 
 was violent and bitter. After a report by a committee revealing 
 shameful conditions in the mines, an act was passed in 1842 
 prohibiting the employment of women and children under- 
 ground. In 1844 women were included in the protective fac- 
 tory legislation and the half-time system for children was 
 enacted. The Ten Hours' Act of 1847 limited the working 
 day to ten hours. Subsequently protective legislation was 
 made to cover industrial establishments generally. These 
 various laws were consolidated in 1878, and again in 1901. 
 
 Another important line of legislation that has been made 
 necessary by the extensive use of machinery deals with the 
 liability of employers in cases of accidents to their workmen. 
 Under the common law a workman was entitled to receive dam- 
 ages when injured as a result of the negligence of his employers, 
 but he was supposed to assume the ordinary risks of the busi- 
 ness. When the injury was caused by the workman's own negli- 
 gence or by the negligence of a fellow-workman the employer 
 was not responsible. The Employers' Liability Act of 1880 
 gave the workman the right to compensation in certain cases 
 
THE EVOLUTION OF ECONOMIC SOCIETY 57 
 
 where the injury was caused by the negligence of other em- 
 ployees, and in 1897, by the Workmen's Compensation Act, a 
 radical departure was made from previous legislation. The 
 employer is now liable to pay damages even when there has 
 been no negligence on his own part, and even when the accident 
 has been due to the neglect of the injured workman himself, 
 except only in cases of "' serious and willful misconduct." This 
 principle now applies also to agriculture, shipping, and mer- 
 cantile and domestic employments, and certain trade diseases 
 have been made to count as accidents. The transition from 
 "employers' liability'' to "workmen's compensation" was thus 
 a change in more than mere name. The law of employers' 
 liability aimed merely at doing justice as between the workman 
 and his employer. Workmen's compensation statutes are 
 based upon a broader social principle, involving the recognition 
 of the facts that industrial accidents are part of the price that 
 has to be paid for the use of modern methods of production; 
 that the worker and his family are ill-equipped to bear the burden 
 of the loss of earning-power that results from such accidents; 
 and that the duty of making adequate compensation falls upon 
 society at large, which may very properly use the employer 
 as its responsible agent for this purpose. 
 
 A newer and larger development of the principle of compensa- 
 tion is found in social insurance, which recognizes and extends 
 the principle of social responsibility, but combines with it an 
 insistence upon the equal importance of the development of 
 habits of individual thrift and self-help. The National In- 
 surance Act of 191 1 provided for compulsory insurance against 
 sickness, and (in certain industries) against unemployment. 
 
 3. Labor Organizations. — Modifications in the working of free 
 competition have also been effected by the voluntary organiza- 
 tions of the workers, not only by their influence upon legislation, 
 but also by direct dealings with employers. We have noticed 
 the gilds, which played a large part in the history of the Middle 
 Ages. These, however, were not like modern trades unions. 
 They were unions of men who worked, but not exclusively of 
 wage earners, nor even chiefly in the interests of wage earners. 
 
58 OUTLINES OF ECONOMICS 
 
 They were formed of masters. But combinations of the wage- 
 earning classes are found long before the Industrial Revolution. 
 They do not become prominent, however, until the nineteenth 
 century. Laws prohibiting the combination of laborers had 
 been passed at intervals since the Middle Ages, and in 1800 
 Parliament, finding that unions were increasing, passed a most 
 comprehensive law to suppress them, declaring illegal " all 
 agreements between journeymen and workmen for obtaining 
 advances of wages, reductions of hours of labor, or any other 
 changes in the conditions of work." Under this law many 
 workmen were prosecuted and severely punished, but in vain. 
 In 1824 Parliament confessed the law a mistake, and repealed 
 it along with previous laws relating to combinations of work- 
 men. Trades unions, thus tolerated, grew at an astonishing 
 rate, but they were still subject to legal persecution. Judicial 
 decisions, especially, were adverse to them, as the courts re- 
 garded them as agreements in restraint of trade. But in 1871 
 a law was passed which declared that the purposes and actions 
 of trades unions were not to be deemed unlawful as being in the 
 restraint of trade, and in 1875 the legality of trades unions was 
 still further recognized by the provision that acts which were 
 not punishable as crimes when done by one person should not 
 be indictable as conspiracy when done by two or more in further- 
 ance of trade disputes, and finally, in igo6, the courts were 
 forbidden to entertain actions for damages against trades unions. 
 In this same year peaceful picketing was legalized. 
 
 4. The Extension of Government Enterprise. — The reaction 
 against a laissez-faire policy is further shown by a growth in the 
 sphere of industry directly managed by the government. We 
 find municipalities operating street railways and furnishing 
 water, gas, and electric light. Municipal enterprise includes 
 also in various places markets, docks, dwellings, baths, race 
 courses, oyster fisheries, slaughterhouses, milk depots, employ- 
 ment bureaus, sewage farms, theaters, and many other lines of 
 activity. The national government conducts the postal sav- 
 ings banks, the parcels post, and the telegraph and telephone 
 systems. 
 
THE EVOLUTION OF ECONOMIC SOCIETY 59 
 
 Summary. — In this chapter a brief sketch has been given of 
 England's attempt to deal with a new set of forces. An im- 
 mense increase in production has taken place, due in part to 
 competition, more to machinery. But the distribution of this 
 wealth, growing directly out of the principles of competition so 
 long as they were unrestrictedly applied, was such that poverty 
 grew rapidly, and some said even faster than wealth, and the 
 laboring population of the realm sank into deeper distress and 
 degradation. The partial benevolence of employers, which 
 would fain have mitigated this disaster, was, as a rule, neither 
 welcome nor tolerated by the competition which had made itself 
 law. Not until this benevolence was formulated, generalized, 
 and enforced by disinterested legislation was the horror of the 
 situation diminished. When we hear the principle of " a fair 
 field and no favor " and " no State intervention " advocated by 
 a man strong in the consciousness of personal advantages, we 
 must remember that he is a century behind his time, and that 
 he has not read or has not profited by one of the most dolorous 
 chapters in human history. The English nation, after a trial 
 of free competition and no interference, as thorough as could 
 well be made, has undeniably returned to the principle of govern- 
 mental activity which she had abandoned, — a principle which 
 recognizes as the function of the State the protection of the 
 citizens, and the furtherance of their material and social well- 
 being, by every law and every activity which offers a reasonable 
 guarantee of contributing to that end. It is to be noticed fur- 
 thermore that, as a matter of fact all this activity of the State 
 contributing to material and social well-being has also increased 
 freedom as a positive, constructive force. It has promoted 
 the growth of individual powers and enlarged the scope of activity 
 of the average citizen. It has not tended to slavery, as Herbert 
 Spencer long ago maintained, but its tendency has been in the 
 direction of the sort of liberty that is really worth while ; namely, 
 liberty as a power of development and of contributing (in the 
 words of the philosopher T. H. Green) to the " common good." 
 The older legislation restricted the individual ; the newer legis- 
 lation enlarges and equalizes opportunities. 
 
6o OUTLINES OF ECONOMICS 
 
 QUESTIONS AND EXERCISES 
 
 1. What is the origin of the term "laissez-faire"} 
 
 2. What laws are in force in your state regarding the inspection of food 
 and other articles offered for sale? 
 
 3. Give a detailed account of the development of one of the great inven- 
 tions. 
 
 4. Give a sketch of the enactment and repeal of the "corn laws." 
 
 5. Give an account of the development of monopolies and trusts in 
 England. 
 
 REFERENCES 
 
 Ashley, W. J. Economic Organization of England, Chaps, vii and viii. 
 
 Beard, C. A. The Industrial Revolution. 
 
 Cheyney, E. p. Industrial and Social History of England, Chaps, viii 
 and ix. 
 
 Cunningham, William. Growth of English Industry and Commerce, Mod- 
 ern Times, Part ii, Laissez-Faire. 
 
 Day, Clive. History of Commerce, Part iii. 
 
 HoBSON, J. A. Evolution of Modern Capitalism, Chaps, iii and iv. 
 
 HuTCHiNS, B. L., and Harrison, A. A History of Factory Legislation, 
 Chap. ii. 
 
 Perris, G. H. The Indtistrial History of Modern England. 
 
 Slater, Gilbert. The Making of Modern England; The English Peasantry 
 and the Enclosure of Common Fields. 
 
 ToYNBEE, Arnold. The Industrial Revolution. 
 
 Veblen, Thorstein. The Instinct of Workmanship, Chaps, vi and vii. 
 
 Warner, G. T. Landmarks in English Industrial History. 
 
CHAPTER V 
 
 THE ECONOMIC DEVELOPMENT OF THE UNITED 
 
 STATES 
 
 Economic Stages in American Industrial History. — The 
 
 transit of civilization from Europe to America, as an American 
 historian ^ has finely phrased it, thrust the European laws, 
 customs, and industrial technique of the seventeenth century 
 into the primitive environment of a wilderness, and for the 
 moment the wilderness dominated. Industry was forced to 
 begin at the beginning and retrace — as the child is said to 
 retrace the mental development of mankind — the industrial 
 evolution of the race. 
 
 The American people have thus, during the comparatively 
 brief historical period which has elapsed since the settlement 
 of this country, run the whole gamut of industrial evolution, 
 passing with striking rapidity through all the stages differen- 
 tiated in the preceding chapters. There was slaughter of cap- 
 tives in the Indian wars, enslavement of Indians, particularly 
 — but not only — in the Spanish colonies, later the introduction 
 of negro slavery and modified serfdom in the indentured servants, 
 then the individual wage contract, still supreme among agri- 
 cultural laborers, and finally, collective bargaining through 
 the great trades unions of the present. In a similar way, 
 practically all the stages differentiated in the table given on 
 page 45 may be traced in the industrial evolution of the United 
 States. 
 
 Naturally it is not to be supposed that American industrial 
 society worked its own way unaided through all those economic 
 stages which the race, with " painful steps and slow," has labori- 
 ously traversed in its upward march. Stimulated by European 
 
 1 Edward Eggleston, Transit of Civilization. 
 6i 
 
62 OUTLINES OF ECONOMICS 
 
 culture, we hurried through the earlier stages, for the most 
 part, retracing them merely as an incident of frontier conditions, 
 and skipping some — such as the pastoral stage — in many 
 sections of the country. On the other hand, it must not be 
 inferred that we have everywhere passed beyond the so-called 
 primitive stages. Barter may still be found in some parts of 
 the country, and there are comparatively few rural districts 
 in which credit transactions have in the main taken the place 
 of money transactions. It is interesting to observe that, owing 
 to the progressive western movement of the population of 
 the country, the stages in the history of man's productive efforts 
 appeared in regular order from west to east. Thus, a few 
 years ago, the country of the frontier was occupied by hunters 
 and trappers ; next were great stretches of country almost 
 entirely devoted to grazing; farther east, agriculture pre- 
 dominated ; trade and commerce were active, especially in the 
 country east of the Mississippi ; manufacture on a large scale 
 was prominent in the North Atlantic and North Central groups 
 of states ; while finally the large industrial combinations which 
 mark the latest step in development were confined (with respect 
 to legal residence at least) to the Atlantic seaboard. "The 
 United States lies like a huge page in the history of society." ^ 
 Sectionalism. — This phenomenon of the contemporaneous 
 existence of several industrial stages, side by side, under the 
 same government, has laid upon this country some of the hardest 
 problems which it has had to solve. The ever present but 
 ever receding frontier has continually created a set of interests 
 antagonistic to those of the settled industrial and commercial 
 communities. Shays's Rebellion in 1786 was in part a protest 
 of the more thinly settled debtor communities against the deter- 
 mination of the commercial centers to introduce the sound 
 currency which a developed commerce requires. The federal 
 Constitution was adopted and the present government created 
 in order, largely, to strengthen national credit, insure taxation, 
 remove trade barriers, and provide a sound currency ; and the 
 opposition to the ratification of the Constitution came largely 
 1 F. J. Turner, The Significance of the Frontier in American History. 
 
ECONOMIC DEVELOPMENT OF THE UNITED STATES 6^ 
 
 from those agricultural and thinly settled communities that 
 wanted to keep paper money, evade debt payment, and resist 
 the collection of taxes. During the earlier history of the coun- 
 try wildcat banking and inflated currency regularly followed in 
 the wake of the frontier. 
 
 Tariff legislation, with its different appeal to the agricultural 
 and industrial sections of the country, has been another prolific 
 source of territorial conflict. After the War of 1812, the manu- 
 facturing centers of the North redoubled their efforts for pro- 
 tection. This was strenuously resisted by the South, where 
 manufactures had practically gained no hold, and the struggle 
 of the sections over the tariff led to Nullification in South Caro- 
 lina and the acceptance by the South of the doctrine of secession. 
 The Civil War itself was largely a sectional quarrel growing out 
 of ceaseless friction between a section which had reached the 
 industrial stage and a condition of free-wage contract with a 
 section which had been held in the agricultural stage by the 
 retention of slavery. As a more recent illustration of sectional 
 conflict arising from the natural clash of districts in different 
 stages of economic development, we have the free-silver cam- 
 paign of 1896, when the mining, agricultural, and debtor com- 
 munities of the West and South arrayed themselves against the 
 industrial and creditor communities of the East and North. 
 The typical political struggles of the past have been territorial, 
 and sectional problems will always remain. Now that the 
 frontier has disappeared, however, the typical political struggles 
 of the future will take the form, probably, of class against class. 
 
 Characteristics of the American People. — Although the 
 frontier has disappeared, the pioneer work of " winning a con- 
 tinent from nature and subduing it to the uses of man " has 
 left an indelible impress upon the American character. In the 
 beginning the dangers and hardships of the frontier acted as a 
 powerful selective force in determining the character of our 
 earlier immigrants, giving us an unusually restless, mobile, and 
 enterprising people. The process of settlement which followed 
 merely emphasized these qualities and added others of a kindred 
 nature. The primitive settler, following the trapper and the 
 
64 OUTLINES OF ECONOMICS 
 
 trader into the wilderness, was forced to depend upon himself 
 for protection and subsistence ; he expected little aid from the 
 government, was unused to the restraints of law, and a little 
 contemptuous of its possibilities, either for good or for evil. 
 The process of settlement, then, merely confirmed the American 
 in that excessive individualism which has made him independent 
 and resourceful, to be sure, but partial to the spoils system, 
 tolerant of lynch law and labor violence, indifferent to waste 
 and weakness in the administration of his government. 
 
 At the same time the great natural wealth of our land and the 
 ease with which it could be secured from the government have 
 taught our people, particularly in the West, to regard nature 
 rather than thrift as the source of wealth, to exploit rather than 
 create, to work and study as we farm, — extensively. As a 
 people, we are optimistic but careless, generous but wasteful, 
 buoyant but boastful. Industrially, we have risen to our ex- 
 ceptional opportunities with spirit, playing the commercial game 
 at times with excessive energy and devotion ; but we have come 
 to emphasize quantity rather than quality, product rather than 
 finish. We " lead the world " in the use of labor-saving 
 machinery, but depend largely upon Europe for our skilled 
 artisans. 
 
 Growth of Population. — The mere growth of the American 
 people has been as striking as it is familiar. In 1640 there were 
 about 25,000 persons, excluding Indians, in British North 
 America; about 260,000 at the end of the seventeenth century 
 according to Bancroft; according to the same authority the 
 million mark was reached in 1743 ; and in 1790 the first federal 
 census showed a population of 3,930,000 in the United States 
 alone. In the next hundred years the population doubled every 
 twenty-five years on an average, and although the rate of in- 
 crease has fallen off somewhat since the Civil War, we are stiU 
 growing at a remarkable pace, the population of continental 
 United States being 91,970,000 in 1910. 
 
 Despite this enormous increase, the population of this coun- 
 try has not multiplied more rapidly than the means of subsistence. 
 This does not mean that every one receives enough to live in 
 
ECONOMIC DEVELOPMENT OF THE UNITED STATES 65 
 
 comfort. On the contrary, great masses of people live in 
 poverty. Neither does it mean that society as a whole produces 
 enough to support every one in comfort, if the wealth produced 
 were equitably or evenly divided. On the latter point there is 
 deep difference of opinion. But with respect to the movement 
 over long periods, say during the preceding century, there can 
 be no doubt that wages and real income have risen, not without 
 interruption, but with comparative steadiness. 
 
 The dismal predictions of overpopulation which were so 
 common in the first half of the nineteenth century have been 
 signally discredited as practical propositions applicable to the 
 American people of this epoch. The exploitation of national 
 wealth, the improvement of business organization, and the inven- 
 tion of labor-saving machinery have more than kept pace with 
 the population ; and it appears that Over long periods prosperity 
 and high wages tend to depress rather than to raise the birth 
 rate, even of the wage-earning population. We are in no danger 
 of a " devastating torrent of children." 
 
 On the contrary, the real problem of the twentieth century, or 
 at least the problem that has evoked the greatest discussion, is 
 found in the steady decline of the birth rate. According to some 
 eminent authorities, the race is dying at the top, the ablest and 
 most successful people have the smallest families ; and this 
 constant sterilization of the ablest stock is, in the opinion of 
 such authorities, second in importance to no problem which 
 Western civilization is called upon to solve. It is not that we 
 want more people. Population is still increasing with sufficient 
 rapidity. The problem lies in the apparent failure of the most 
 efficient individuals to multiply as rapidly as certain classes 
 of the less efficient. Other authorities, it should be added, 
 maintain that this " race suicide " has been going on for cen- 
 turies, that it has not in the past, and will not in the future, 
 lower the vitality or general efficiency of the race. Such writers 
 view with complacency the ceaseless sterilization of the upper 
 classes, maintaining that the process stimulates the ambition 
 of the abler members of the lower classes by creating room at the 
 top, and that so long as the habits and ideals of the upper classes 
 
66 OUTLINES OF ECONOMICS 
 
 remain wholesome, there is no cause for regret that the individ- 
 uals who compose these classes are not self-perpetuating. 
 Social heredity, not personal heredity, the preservation of sound 
 morals, wholesome customs, and habits of social helpfulness, 
 together with the opening up of new opportunities, are accord- 
 ing to these writers the important factors. 
 
 Second only in importance to " race suicide," and intimately 
 connected with it, is the problem created by the rush to the city. 
 In 1790 about 33 Americans in every thousand lived in a city of 
 8000 inhabitants or more, in 1910 approximately 390 in every 
 thousand lived in a city of this size. The mere facts in this 
 connection are familiar to every one and need no elaboration. 
 Their importance lies in the fact that the rush to the city is 
 apparently universal, that it has been going on for centuries, 
 and that it indefinitely complicates and aggravates the social, 
 industrial, and political problems of our time. " Race suicide," 
 for example, is more attributable to social conditions created 
 by city life than to any physical incapacity of the women of 
 this generation to bear children ; the evils commonly charged 
 to the factory system are due as much to city crowding as to 
 the factory system itself; and, speaking generally, whatever 
 plan of reform for existing evils we devise or champion, we must 
 reckon with this deep-rooted and persistent force which draws 
 to the city so much of the best talent and ability which the rural 
 districts produce. 
 
 Slavery and the Negro Problem. — From the earliest period 
 of settlement, one of our fundamental industrial problems has 
 been to get enough labor to exploit the great national wealth of 
 the country. The first solution attempted was by importing 
 bondsmen or indentured servants. " Nearly all the immigrants 
 that came (to Virginia) between 1620 and 1650 were bondsmen," 
 and in 1680 an English official estimated that about 10,000 
 persons were kidnaped or " spirited away " to America every 
 year. This class of indentured servants consisted of runaway 
 apprentices, penniless debtors, kidnaped children, honest 
 laborers, vagrants, and criminals of all kinds. They were some- 
 times subject to the most inhuman treatment, but, because 
 
ECONOMIC DEVELOPMENT OF THE UNITED STATES 67 
 
 they had white skins, soon melted into the free population and 
 never created a race problem. 
 
 The first negro slave landed in Virginia in 1619. For about 
 thirty years they did not increase very rapidly, but after that, 
 and until the close of the eighteenth century, they multiplied 
 with greater rapidity than the white population. In 1790 there 
 were 750,000 negroes or persons of negro descent in this country, 
 constituting 19 per cent of the population. Since 1790 the 
 negro population has steadily declined in relative importance, 
 and in 19 10, numbering 9,830,000 in all, it constituted only 11 
 per cent of the general population. The relative decline of the 
 negro population is probably not due to white immigration, 
 since the natural growth of the white population is markedly 
 greater than that of the negroes in the South, where white 
 immigration has been unimportant. The whites have increased 
 faster than the negroes even in those countries in which the 
 negroes greatly outnumber the whites.^ 
 
 The negro problem to-day, so far as it is an economic problem, 
 arises largely from the ignorance and economic weakness of 
 the negroes and the exploitation to which their ignorance and 
 weakness subject them; from their concentration in certain 
 narrow districts of the South, known as black belts; their 
 dependence upon credit advances; their inability readily to 
 take up diversified farming and, outside of the farming dis- 
 tricts, from the social pressure which confines them to a relatively 
 few occupations, most of which — particularly as they practice 
 them — are neither uplifting nor developmental. In 1900, for 
 instance, 63 per cent of the male and 90 per cent of the female 
 negro breadwinners were employed in unskilled trades. 
 
 This condition of affairs is due in some degree to the economic 
 inertia and shiftlessness of the negroes themselves. Con- 
 sidering the circumstances attendant upon their introduction 
 into this country, it would be surprising if they were not 
 economically backward. But present conditions are also due 
 
 ^The greater increase of the whites "holds generally, though not universally, 
 good in even the most overwhelmingly black of the black counties of the black belt." 
 -^ John C. Rose, in American Economic Review, vol. iv, p. 292. 
 
68 OUTLINES OF ECONOMICS 
 
 in part to race prejudice of their white brethren. There is a 
 strong movement in the South today for enforced segregation 
 of negroes, both in urban and rural communities ; and the trade 
 unions evince a growing disincHnation to receive negroes as 
 members on the same status as white workmen. 
 
 Vigorous efforts, however, are now being made in the South 
 to provide industrial training of a systematic kind for the 
 negroes ; and despite the asserted facts that " only 37 per cent 
 of the negro school population of the South is in school attend- 
 ance," that " in the rural South today not one black child in 
 four is in school," and that "the public school system for 
 negroes in the rural South is worse today than it was twenty 
 years ago, with a smaller percentage of enrollment and smaller 
 proportion of teachers," ^ the economic status of the negro in 
 recent years, particularly that of the negro farmer, shows steady 
 improvement. But yesterday a slave, it is inevitable that the 
 negro should be forced to traverse in the forward path the 
 intermediate steps of serfdom, peonage, and tenancy before 
 becoming farm operative and owner. No class can be trans- 
 formed in a day by legislative enactment from the status of 
 slavery to that of free contract. In the South during the last 
 census decade the number of negro farmers increased more 
 rapidly than the number of white farmers ; the acreage of land 
 operated by white farmers decreased while that operated by 
 negro farmers increased 10 per cent ; the value of farm land 
 and buildings owned by whites increased 117 per cent, but the 
 value of farm land and buildings owned by negroes increased 
 156 per cent ; while the number of negro farm owners increased 
 17 per cent as contrasted with an increase of 12 per cent in 
 the white owners of farms. The negro has been barred from 
 the cotton mill. If the negro farmer can learn to raise some- 
 thing other than cotton and raise it on something other than 
 credit, he will probably have little cause to regret his exclusion 
 from the cotton mill. 
 
 Immigration. — Next in importance to the negro question is 
 
 I W. E. B. Du Bois, Quarterly Publications of the American Statistical Association, 
 vol. xiii, p. S^. 
 
ECONOMIC DEVELOPMENT OF THE UNITED STATES 69 
 
 the problem of immigration. We have always had an immigra- 
 tion problem. " Governor Thomas Dongan, in 1685, made a 
 report to the King of England full of dreadful forebodings as 
 to the future of the ' Royal Province ' of New England unless 
 the tendency to overcrowding were promptly checked. . . . 
 George Washington and Thomas Jefferson are both recorded 
 as opponents of an unrestricted policy of immigration, and it 
 may be safely asserted that no considerable period has elapsed 
 since their day without producing eloquent and forceful advo- 
 cates of a rigid restrictive immigration policy." ^ Owing, how- 
 ever, to the extraordinary increase of immigrants in recent years 
 (the number rose from 3,840,000 in the decade ending in 1900 
 to 8,796,000 in the decade ending in 1910) unusual interest in 
 the subject has been aroused, the restrictive features of our law 
 have been repeatedly strengthened, and on three occasions bills 
 aiming to restrict the general volume of immigration by literacy 
 tests have passed Congress only to be vetoed by the President. 
 Most of the alarm which has recently been expressed, however, 
 is due to the change in character, rather than the increase in 
 volume, of our immigration. Instructive statistics bearing 
 upon this point are given in Table I. Until nearly the last 
 decade of the nineteenth century most of the immigrants came 
 from the United Kingdom, Germany, and northwestern Eiurope, 
 while since that time the arrivals have been largely from south- 
 ern Europe ; and it appears that the new immigrants are more 
 illiterate, much less likely to bring over their families and to 
 remain permanently in this country, display less interest in 
 taking out naturalization papers, and show a larger proportion 
 of unskilled, as well as a smaller proportion of skilled laborers, 
 than the earlier immigrants. " These people," it has been said, 
 " have no history behind them which is of a nature to give en- 
 couragement. They have none of the inherited instincts and 
 tendencies which made it comparatively easy to deal with the 
 immigration of the earlier time. They are beaten men from 
 beaten races, representing the worst failures in the struggle 
 
 1 Commissioner of Immigration, Robert Watchom, in The Outlook, vol. Ixxxvii, 
 p. 900. 
 
70 
 
 OUTLINES OF ECONOMICS 
 
 TABLE I 
 
 Total Number of Immigrants (in Thousands) and Proportion coming 
 FROM Designated Countries by Specified Periods: 1821-1910 ^ 
 
 
 1821 
 1850 
 
 I85I 
 i860 
 
 i86x 
 1870 
 
 I87I 
 1880 
 
 I88I 
 
 1890 
 
 I89I 
 
 1900 
 
 I90I 
 I9I0 
 
 Total Number 
 
 2456 
 
 2598 
 
 2315 
 
 2812 
 
 5247 
 
 3844 
 
 879s 
 
 Per cent 
 Germany 
 
 24.2 
 15.0 
 42.3 
 
 0.7 
 
 36.6 
 16.3 
 
 35-2 
 0.9 
 
 34-0 
 26.2 
 18.8 
 
 5-4 
 
 25.6 
 
 19-5 
 15-5 
 
 8.6 
 
 27.7 
 
 15-4 
 12.5 
 
 12.5 
 
 I4.I 
 8.9 
 10.5 
 
 9.9 
 
 3.9 
 
 Great Britain 
 
 Ireland 
 
 6.0 
 
 3-8 
 
 Norway, Sweden, and 
 Denmark 
 
 S-7 
 
 Total 
 
 Austria Hungary 
 
 Italy 
 
 82.2 
 
 0.2 
 0.1 
 
 89.0 
 
 0-3 
 0.1 
 
 84.4 
 
 0.4 
 
 0.5 
 0.2 
 
 69.2 
 
 2.6 
 2.0 
 1.8 
 
 68.1 
 
 6.7 
 5-9 
 
 43-4 
 
 iS-S 
 17.1 
 
 iS-4 
 
 19.4 
 
 24.4 
 23-3 
 
 Russia and Poland 
 
 18.2 
 
 Total 
 All other Countries . . . 
 Grand Total 
 
 0.3 
 
 17-5 
 
 lOO.O 
 
 0.4 
 
 10.6 
 
 100.0 
 
 I.I 
 
 14-5 
 
 lOO.O 
 
 6.4 
 24.4 
 
 lOO.O 
 
 17.6 
 14-3 
 
 lOO.O 
 
 48.0 
 8.6 
 
 lOO.O 
 
 65-9 
 14.7 
 
 lOO.O 
 
 for existence. Centuries are against them, as centuries were 
 on the side of those who formerly came to us." ^ 
 
 There can be no doubt about the real gravity of the problem. 
 In times past charitable associations, and even certain foreign 
 governments, " assisted " the poorest and neediest of their 
 
 iData from Adams and Sumner, Labor Problems, p. 73, and the Statistical 
 Abstract, 1913, p. 94. These figures are not exact and not altogether comparable, 
 owing to changes in the immigration year, the distinction of nationalities, and the 
 immigration laws. For the effect of these changes, see Boeckh, " The Determina- 
 tion of Racial Stock among American Immigrants," Publications of the American 
 Statistical Association, December, 1906; and Willcox, National Civic Federation 
 Review, November, December, 1906, p. 7. In the year ended June 30, 1914, the 
 nimiber of immigrants (1,220,000) was larger than in any previous year except 
 1907, and Austria-Hungary, Italy, and Russia contributed 67 per cent of the total. 
 
 2 Walker, "Restriction of Immigration," Discussions in Economics and Statistics, 
 vol. ii, p. 447. 
 
ECONOMIC DEVELOPMENT OF THE UNITED STATES 7 1 
 
 TABLE II 
 Proportion of European Immigrants 14 Years of Age or Over Who 
 
 CAN NEITHER READ NOR WrITE : 1899-1909^ 
 
 (Average proportion for all races, 26.6 per cent.) 
 
 Under is Per Cent 
 
 Over is Per Cent 
 
 Race 
 
 Per Cent 
 
 Illiterate 
 
 Race 
 
 Per Cent 
 Illiterate 
 
 Bohemian and Moravian 
 Dutch and Flemish . . 
 
 English 
 
 Finnish 
 
 French 
 
 German 
 
 Irish 
 
 Italian, North .... 
 
 Magyar 
 
 Scandinavian .... 
 
 Scotch 
 
 Spanish 
 
 Welsh 
 
 Not specified .... 
 
 1-7 
 4-7 
 
 I.I 
 1.4 
 
 S-4 
 
 S-i 
 
 2.7 
 
 11.8 
 
 11.4 
 
 0.4 
 
 0.7 
 
 14.6 
 
 2.0 
 
 6.7 
 
 Armenian 
 
 Bulgarian, Servian, and 
 
 Montenegrin .... 
 Croatian and Slovenian . 
 Dalmatian, Bosnian, and 
 
 Herzegovinian . . . 
 
 Greek 
 
 Hebrew 
 
 Italian, South .... 
 
 Lithuanian 
 
 Polish 
 
 Portuguese 
 
 Rumanian 
 
 Russian 
 
 Ruthenian 
 
 Slovak 
 
 Syrian 
 
 Turkish 
 
 24.1 
 41.8 
 
 36.4 
 
 36.4 
 27.0 
 
 25-7 
 54-2 
 48.8 
 
 35-4 
 68.2 
 
 34.7 
 38.S 
 51.0 
 22.1 
 54-1 
 58.9 
 
 citizens to migrate to this country; famine and revolution in 
 Europe spurred the impecunious and the radical to take refuge 
 among us; regularly, also, the tide of immigration has ebbed 
 and risen in close correspondence with the business prosperity 
 of this coimtry, artificially swelling our laboring population in 
 times of industrial activity, encouraging our industrial managers 
 in their spasmodic, jerky methods of production, and thus 
 augmenting the severity of our alternating periods of industrial 
 depression. Moreover, in certain industries the immigrant 
 with his relatively low standard of living has driven out the 
 native workman ; and most of the immigrants have shown an 
 unfortunate tendency to linger in the cities of the eastern sea- 
 
 * Data from Jenks and Lauck, The Immigration Problem, 3d ed., p. 35. 
 
72 OUTLINES OF ECONOMICS 
 
 board, swarming in the slums and intensifying all those social 
 evils which have their origin in urban congestion. 
 
 The problem is chiefly economic, and the social or moral 
 delinquencies of the newer immigrants have been greatly exag- 
 gerated. Thus, the new immigrants are far less given to alco- 
 holic excesses than the old. But the investigations of the United 
 States Immigration Commission, to quote from its report, 
 " show an oversupply of unskilled labor in the industries of the 
 country as a whole," and the Commission recommends that 
 " a sufficient number be debarred to produce a marked effect 
 upon the present supply of unskilled labor." " As far as 
 possible," the report continues, '' the aliens excluded should be 
 those who come to this country with no intention to become 
 American citizens or even to maintain a permanent residence 
 here. ..." A majority of the Commission recommended the 
 literacy test as the " most feasible single method " of properly 
 restricting immigration ; realizing that it would cause occa- 
 sional hardship — as any standard must — and that not 
 all literate immigrants are desirable, and not all illiterate immi- 
 grants undesirable ; but favoring it because it offers a practicable 
 and simple means by which to reduce numbers without impairing 
 quality or discriminating against particular nationalities. Not 
 in individual cases, but in the net result, the literacy test would 
 debar those classes which exploit America rather than strengthen 
 it, and fail to rise to its real opportunities and responsibilities. 
 Back of the demand for restriction is not the " American " 
 snob, but the trade union. 
 
 In the light of history, on the other hand, the immigration 
 problem is far less alarming than it is in the dry light of recent 
 statistics. In the first place, the statistics themselves, as ordi- 
 narily published, are misleading, because they take no account 
 of the large number of immigrants who return to Europe. The 
 most recent census statistics (1910) indicate that about " two 
 fifths oi the immigrants who arrived in the United States during 
 the decade 1900-19 10 either left the United States or died before 
 the end of the decade." In the second place, the importance 
 of the number of immigrants depends largely upon its relation 
 
ECONOMIC DEVELOPMENT OF THE UNITED STATES 73 
 
 to the population of the country ; and relatively to the popula- 
 tion immigration seems to be declining rather than increasing. 
 For instance, the proportion of foreign born in the population 
 has varied very little since i860; and immigration reckoned 
 in proportion to the population was heavier in the period 1850- 
 1855 than in the period 1900-1905. In the next place, it is to 
 be noted that our immigration laws regarding the exclusion of 
 diseased, criminal, immoral, feeble-minded, and indigent persons 
 are constantly becoming stricter and their administration more 
 efficient. In addition to the plainly undesirable classes just 
 noted, Chinese laborers have been excluded since 1882, aliens 
 under contract to take up particular work since 1885, and an- 
 archists since 1903. Finally, and most important, perhaps, 
 agencies for educating, distributing, and Americanizing the 
 immigrants have multiplied with great rapidity in recent years. 
 Social settlements, vocational and night schools have under- 
 taken the work of educating the immigrant ; many important 
 labor unions have learned to organize the immigrants, and so 
 make of them allies and not enemies in the task of maintaining 
 and improving conditions of employment; federal and state 
 bureaus of information assist in the proper distribution of the 
 immigrants, and public employment bureaus in finding work 
 for them ; while a group of powerful and philanthropic immi- 
 grant aid societies like the Italian Immigrant Bureau and the 
 Hebrew Sheltering and Immigrant Aid Society " do effective 
 work in Americanizing the immigrant, finding employment for 
 him at good wages, overcoming tendencies toward congestion, 
 effecting distribution, and promoting acquisition of American 
 standards of living and thinking." ^ 
 
 Surveying the whole history of immigration, three general 
 conclusions may be drawn which must be fully considered by 
 thos'e engaged in the solution of the present problem. 
 
 I. We have, as a people, shown a marvelous ability to assimi- 
 late rapidly people of diverse races, tongues, and religions, amal- 
 gamate them and stamp them with the characteristic qualities 
 of the American. Even at the close of the eighteenth century, 
 
 > Max J. Kohler, American Economic Rmew, vol. iv, p. 107. 
 
74 OUTLINES OF ECONOMICS 
 
 about one fifth of the population spoke some other language 
 than English as their mother tongue, and probably one half of 
 the population were of other than Anglo-Saxon blood. The 
 heterogeneous character of the population is illustrated by the 
 fact that nine of the men most prominent in the early history of 
 New York represented as many different nationalities. 
 
 2. We have failed, however, to amalgamate the Negro and 
 the Chinese ; the incidental feature of a dark skin creates espe- 
 cially difficult problems; and it is this fact which makes it 
 undesirable that Japanese, Chinese, or Hindu laborers should 
 settle here in large numbers, particularly in separate " colonies." 
 Despite the high qualities of some of these peoples, it is con- 
 ceivable that they might come to this country in sufficient 
 numbers to create a problem similar in character and gravity to 
 the negro problem ; and if investigation show that there is real 
 probability of such a result, they should be excluded, even though 
 the danger be attributable to race prejudice of the natives rather 
 than the clannishness and exclusiveness of the immigrants. 
 
 3. In the main, however, the traditional policy of this country 
 has been " to improve rather than to check immigration," 
 and the burden of proof is upon those persons who would restrict 
 immigration by arbitrarily limiting the number of immigrants. 
 
 Natural Resources. — Next to the character of the people 
 with which this continent has been stocked, the most powerful 
 factor in shaping the economic development of the United States 
 has been its enormous natural wealth. With a territory (ex- 
 cluding Alaska and our insular possessions) more than three 
 fourths as large as all Europe, indented, particularly on the 
 eastern coast, with a large number of good harbors, intersected 
 by internal waterways that make communication cheap and 
 easy, endowed with water power that in the opinion of one 
 authority is probably " more valuable than those of all other 
 lands put together," marked by every variety of climate and 
 soil, covered in many places, at least originally, with magnificent 
 forests, and liberally stocked with almost every variety of 
 mineral wealth, it is not surprising that at the present time the 
 United States " leads the world " in the production of iron and 
 
ECONOMIC DEVELOPMENT OF THE UNITED STATES 75 
 
 Steel, cotton, coal, copper, gold, silver, dairy products, corn, wheat, 
 lead, lumber, tobacco, petroleum, and hogs. It would be strange, 
 indeed, with the vast mineral and agricultural resources at our 
 command, if we did not " lead the world " in many things. 
 
 Public Lands. — Of our 2,973,000 square miles of territory 
 about three fourths at one time or another has belonged to 
 the central government. The possession of this vast common 
 treasure by the United States has played an important part in 
 dignifying and strengthening the federal government. But the 
 lavish alienation of the public lands in endowing free schools, 
 subsidizing railways and other internal-improvement com- 
 panies, and in providing free homes for the landless, has been 
 an even more potent factor in hastening our economic develop- 
 ment; though it has led, as has been said with some justifi- 
 cation, " to the ravishment rather than the development of our 
 natural resources." 
 
 Even more important is the influence which " free land " 
 has exerted upon the wages of labor and the distribution of 
 wealth in this coimtry. While it was not until the passage of 
 the Homestead Act in 1862 that land could be legally acquired 
 without cost by simple occupation and cultivation, it is practi- 
 cally true to say that from the seventeenth century until a few 
 years ago any enterprising citizen could, by the exercise of a 
 minimum amount of industry and frugality, secure a homestead 
 large enough to support himself and family. This opportunity 
 offered to the artisan a free choice between wage service and 
 farming, constantly depleted the ranks of mere laborers, operated 
 to keep wages as high as the earnings of a " no-rent " homestead, 
 and kept fresh and vigorous that feeling of independence which 
 has been the distinguishing mark of the American workingman. 
 Up to June 30, 1909, according to President Van Hise, the United 
 States had sold or disposed of to corporations and individuals 
 571,600,000 acres; it had granted to the states for various 
 purposes 153,500,000 acres ; 324,500,000 acres had been reserved 
 for parks, forests, and other public purposes ; while there were 
 363,300,000 acres still unreserved and unappropriated, not 
 counting 378,000,000 acres in Alaska, of which all but about 
 
76 OUTLINES OF ECONOMICS 
 
 10,000,000 acres were unappropriated and unreserved. The 
 lands which were sold brought less than it cost to acquire, survey, 
 and carry them. At the date mentioned 127,000,000 acres 
 had been given away under the Homestead and Timber Culture 
 Acts — supposedly to actual settlers — and 142,000,000 had 
 been given to corporations to stimulate the building of railroads 
 and other internal improvements.^ 
 
 How long the public lands will hold out it is impossible to 
 say. Notwithstanding the fact that the national government 
 is disposing of its lands at the rate of from fifteen to twenty 
 million acres a year, there is still left — if we count Alaska — 
 almost as much territory as we have alienated since the adoption 
 of the Constitution. Most of this is worthless or unavailable ; 
 but irrigation and dry farming are reclaiming certain districts. 
 
 In the East, especially, we have almost certainly entered upon 
 a new era, and it must be remembered that fifteen sixteenths of 
 the population reside in the eastern half of the United States. 
 East of the Mississippi trade and manufactures taken together 
 have outstripped agriculture, and a large majority of the people 
 lack the inclination and necessary training, even if they possessed 
 the courage and energy, to avail themselves of possibly cheaper 
 lands elsewhere. Whatever the quahty of this cheap land, its 
 importance has diminished as an outlet for the population upon 
 whose economic condition it formerly exerted so salutary an 
 influence. Considering the population as a whole, the conclu- 
 sion seems irresistible that we have reached, if indeed we have 
 not already passed, the parting of the ways ; and the assistance 
 that free land has rendered in maintaining wages and restrain- 
 ing the evil tendencies of the modern system of capitalistic 
 production must in the future be secured from other sources. 
 The distinctive Americanism of the past was generated, as has 
 been said, in the performance of our national task " of winning 
 a continent from nature and subduing it to the uses of man " ; ^ 
 it was a product of the frontier. But the frontier has now dis- 
 appeared. 
 
 1 Charles R. Van Hise, The Conservation of Natural Resources in the United States- 
 p. 294. 2 E. L. Bogart, Economic History of the United States, p. i. 
 
ECONOMIC DEVELOPMENT OF THE UNITED STATES ^^ 
 
 QUESTIONS 
 
 1. What peculiar characteristics mark the economic stages of the United 
 States ? 
 
 2. Is the pastoral stage through which the people of our Great Plains 
 have passed essentially different from the pastoral stage through which the 
 people of Israel passed ? 
 
 3. Enumerate the great sectional struggles which have disturbed the 
 United States. Why does radicalism accompany the frontier? 
 
 4. Has the frontier and the work of settlement left a permanent impress 
 upon the American people? Of what kind? 
 
 5 . How rapidly is the population increasing at the present time ? Are the 
 richer or poorer classes multiplying more rapidly? Can you state the 
 reason ? 
 
 6. What are the distinctively economic factors of the negro problem? 
 
 7. When did the immigration problem first alarm residents of this 
 country? What charges are directed against the "newer immigrants"? 
 
 8. Have we shown an abiUty to assimilate all kinds of immigrants? 
 What has been the historical policy of this country toward immigration? 
 
 9. What part did the public domain play in bringing about and preserv- 
 ing the Union? in maintaining wages? 
 
 10. How does the growing size of the coimtry modify the influence 
 exerted by free land ? 
 
 REFERENCES 
 
 BoGART, E. L. Economic History of the United States. Contains bibli- 
 ography. 
 
 Bruce, P. A. Economic History of Virginia (2 volumes). 
 
 Bureau of the Census. A Century of Population Growth. 
 
 Callender, G. S. Selections from the Economic History of the United 
 States. 
 
 CoMAN, Katharine. Industrial History of the United States. Contains 
 bibliography. 
 
 Economic Beginnings of the Far West (2 volumes). 
 
 Commons, J. R. Races and Immigrants in America. 
 
 Emery, H. C. "Economic Development of the United States," in The 
 Cambridge Modern History, Vol. vii, Chap, xxiii. 
 
 Fairchild, H. p. Immigration. 
 
 Hart, A. B. (ed.) The American Nation (37 volurnes). Contains chapters 
 on economic history. 
 
 HoURWiCH, I. A. Immigration and Labor. 
 
 Jenks, J. W., and Lauck, W. J. The Immigration Problem. 
 
 McMaster, J. B. a History of the People of the United States (8 volumes). 
 
 Ross, E. A. The Old World in the New. 
 
 Semple, E. C. American History and its Geographical Conditions. 
 
78 OUTLINES OF ECONOMICS 
 
 Simons, A. M. Social Forces in American History. 
 
 Turner, F. J. "The Significance of the Frontier in American History," in 
 Bullock, C. J., Selected Readings in Economics. First edition in Re- 
 port of the American Historical Association, 1893. 
 
 United States Immigration Commission. Reports (39 volumes, including 
 useful Abstracts of Reports, in 2 volumes). 
 
 Van Hise, C. R. The Conservation of Natural Resources in the United States. 
 
 Weeden, W. B. Economic and Social History of New England (2 volumes). 
 
 Wellington, R. G. The Political and Sectional Influence of the Public 
 Lands. 
 
CHAPTER VI 
 
 THE ECONOMIC DEVELOPMENT OF THE UNITED 
 STATES {Continued) 
 
 In the preceding chapter attention was confined to certain 
 fundamental and peculiarly American conditions which have 
 influenced the economic development of this country. They 
 form the background and setting of the picture. When we 
 come to fill in the details, however, the general effect is very 
 similar to that produced by the description of English industrial 
 development given in Chapter IV. There are differences, of 
 course, — differences important enough to make this separate 
 discussion of American economic evolution necessary. But, 
 on the whole, it is surprising how rapidly we have developed 
 the industrial maladies and economic problems of the Old 
 World. 
 
 Mercantilism in America. — In the American colonies, as in 
 England itself, the Industrial Revolution was preceded by a 
 period in which trade and industry were subject to minute regu- 
 lation by the government. Bounties were freely offered in 
 several colonies for the manufacture of leather, iron, paper, 
 silk, and cloth; land grants were made and taxes remitted, 
 particularly in the support of the iron industry ; and in order to 
 encourage the home manufacture of shoes, for instance, the 
 General Court of Massachusetts in 1640 commanded that 
 every hide " be sent to a tannery under penalty of a £12 fine," 
 while " leather searchers " were appointed to see that the law 
 was obeyed. 
 
 This early colonial regulation was restrictive as well as protec- 
 tive. In the New England colonies, in the seventeenth century, 
 , laws were repeatedly passed prohibiting idleness, fixing the hours 
 
 79 
 
8o OUTLINES OF ECONOMICS 
 
 of labor, and prescribing rates of wages, with appropriate penal- 
 ties for workmen who took or employers who paid more than the 
 legal rate. In the Boston Town Records of 1635, for instance, 
 we find this resolution : " That Mr. William Hutchinson, Mr. 
 William Colborne and Mr. William Breton shall sett pryces 
 upon all cattel, comodities, victuals and labourers and Work- 
 men's Wages and that noe other prises or rates shal be given 
 or taken." But the restrictive laws, in general, failed dismally. 
 The abundance of cheap land and the independent spirit gener- 
 ated by the pioneer life prevented the enforcement of obnoxious 
 colonial laws, and eventually led the colonists into armed resist- 
 ance against the restrictive legislation of the English govern- 
 ment. 
 
 English Colonial Policy and the Navigation Acts. — In 
 accordance with mercantilist views of colonial relationships, 
 English statesmen of this period looked upon a colony as a 
 community which was to supply raw materials for the industries 
 of the mother country, secure its manufactured goods from the 
 mother country, and so far as trade with the rest of the world 
 was concerned, buy and sell through the mother country. In 
 accordance with this general policy England gave bounties 
 for the production in America of raw materials such as flax, 
 indigo, naval stores, barrel staves, and the like, but restricted 
 manufacturing proper — by prohibiting, for instance, the erec- 
 tion of mills for slitting or rolling iron, and furnaces for making 
 steel — and fettered our commerce in a variety of ways. 
 
 The English laws were not so severe as might be inferred 
 from our brief statement of their nature and purpose ; they were 
 laxly enforced; and it is to be remembered that England 
 encouraged some industries while she attempted to destroy 
 others. English colonial policy of this period was not so much 
 malicious as mistaken. The important points for us are these : 
 that it did not seriously hamper the development of American 
 industry in general, while it did strengthen and stimulate in the 
 American people that spirit of individualism which the industrial 
 opportunities of the New World and the frontier conditions of the 
 time combined to create. As a consequence the new nation, 
 
ECONOMIC DEVELOPMENT OF THE UNITED STATES 8l 
 
 created in 1789, was pledged to the doctrine of individual liberty, 
 and its constitution contained specific guarantees of personal 
 freedom not only in matters political, but in industrial and 
 social relationships as well. 
 
 American Industries in 1776. — When the Revolutionary 
 War broke out, American industry was still in a primitive stage. 
 The extractive industries were, relatively, the most advanced. 
 Large quantities of lumber and timber products were exported 
 to Europe ; the fisheries were in a prosperous condition ; and 
 shipbuilding had reached a really remarkable stage of develop- 
 ment, — ^in 1775 " nearly one third of the tonnage afloat under 
 the British flag had been built in American dockyards." Agri- 
 culture, however, was carried on in the most wasteful and un- 
 scientific way, owing to the cheapness and fertility of the soil ; 
 and manufacturing was still in the household stage. In the 
 middle and New England Colonies spinning and weaving, the 
 manufacture of shoes and food products, were carried on within 
 the home ; and, in fact, the typical farm household of this 
 period constituted almost an independent economic unit, rais- 
 ing or making what its occupants consumed, and buying little 
 save salt and a few necessary iron implements. Of manufactur- 
 ing for sale and export, however, there was little worth men- 
 tion. The absence of adequate means of transport was largely 
 responsible for this state of affairs. The roads were little 
 more than widened Indian trails. Some years later, when con- 
 ditions were considerably improved, the roads were still so poor 
 that " Madison spent a week going from New York to Boston 
 by stage, while the cost of cartage of a cord of wood for a dis- 
 tance of twelve miles was three dollars." Agriculture, however, 
 was the dominant industry of the country. In 1787 less than 
 one eighth of the working population was engaged in manu- 
 factures, fishing, navigation, and trade combined. 
 
 The Industrial Revolution in America. — The Industrial 
 Revolution was sudden, and in its consequences momentous 
 in America as well as in England. The Revolutionary War, by 
 interrupting trade with Europe, threw the American people 
 upon their own resources: goods that had hitherto been im- 
 
 G 
 
82 OUTLINES OF ECONOMICS 
 
 ported had now to be manufactured at home ; a large number of 
 new industries sprang up rapidly ; and the idea became prev- 
 alent that the new nation must make itself industrially as 
 well as politically independent of the Old World. The state 
 governments endeavored to foster the new industries by protec- 
 tive tariffs, and this policy was later continued, in a moderate 
 form, by the federal tariff act of July 4, 1789. Prizes were 
 offered by various societies, and even by certain state govern- 
 ments, for the introduction of the new machines and methods 
 which were revolutionizing industry in England. Attracted 
 by one of these offers, Samuel Slater, " the father of American 
 manufactures," who had been apprenticed to a manufacturer 
 of cotton machinery, and was particularly familiar with Ark- 
 wright's machines and processes, came to this country in 1789, 
 and in the following year started the first cotton factory at Paw- 
 tucket, Rhode Island. 
 
 The factory system secured its first real foothold, however, 
 between 1806 and 181 5, when the Non- Intercourse Acts, the 
 Embargo, and the War of 181 2, by suppressing trade with 
 Europe, forced the American people to do their own manu- 
 facturing, and turned large amounts of capital, which had pre- 
 viously been employed in trade and shipping, into manu- 
 factures. The growth during this period of isolation was 
 extraordinary. In 1804 only four cotton mills were in opera- 
 tion. " In 1807 there were fifteen cotton mills running 8000 
 spindles and producing 300,000 pounds of cotton yarn annually. 
 In 181 1 there were eighty-seven mills operating 80,000 spindles, 
 producing 2,880,000 pounds of yarn per year and employing 
 4000 men, women, and children. In 181 5, 500,000 spindles 
 gave employment to 76,000 persons, with a pay-roll of $15,000,- 
 000 per year." ^ When resumption of peace with Great Britain 
 opened the new American industries to the fierce competition 
 of the older English manufacturers, many failures and much 
 suffering ensued, as a consequence of which increased protec- 
 tion was granted in the tariff acts of 1816, 1824, and 1828. 
 A little later, in the Middle Atlantic and New England states, 
 
 ^ Coman, Industrial History of the United States, p. i8i. 
 
ECONOMIC DEVELOPMENT OF THE UNITED STATES 83 
 
 the period of factory production had fully arrived. A separate 
 class of wage earners was appearing, who were especially ap- 
 pealed to by new arguments concerning wages in the tarifiE 
 discussions ; workingmen's parties were organized ; strikes and 
 trades unions multiplied, and the latter were combined into 
 municipal and state federations; in the thirties and forties 
 radical reformers linked the " white slaves " of the North with 
 the negro slaves of the South and worked for the abolition of 
 both " wage and chattel slavery " ; the factory town and the 
 city slum became recognized economic conditions, and the 
 dangers of the latter were multiplied by the heavy immigration 
 after 1845. By the middle of the nineteenth century the 
 Industrial Revolution was in full sway, and the economic 
 triumph of modern capitalism was assured. 
 
 As might be supposed, the Industrial Revolution produced 
 fair less suffering and want in the United States than in England. 
 The evils attributable to the Industrial Revolution in England 
 were of two kinds. One arose from the rapidity and magnitude 
 of the industrial change itself ; the other was due, not to the 
 change, but to the system under which the new industry was 
 conducted — the system of capitalistic industry working in a 
 regime of practically unregulated competition. In our country 
 the evils resulting from transition alone were slight. Our 
 manufacturing industries were scarcely started when the spin- 
 ning jenny, the power loom, and the steam engine were intro- 
 duced, and so almost from the beginning the factory system 
 seemed the natural one. Thus, the change which in England 
 was a revolution was in America an evolution, a process of 
 construction with little destruction. And for a time even 
 those evils inherent in the system itself were mitigated and 
 disguised by the immense natural wealth of this country, the 
 ease with which land could be obtained, and the unusual 
 mobility of our working people which permitted them to take 
 quick advantage of the unusual opportunities open to them. 
 
 But these ameliorating agencies served only to check and 
 delay, not to destroy, the evil possibilities of the new industrial 
 system. As free land has become less and less abundant, the 
 
84 OUTLINES OF ECONOMICS 
 
 wage earners of the East have had forced upon them conditions 
 of Hfe which have kept down, although they have not absolutely 
 lowered, their standard of life. Extremes of wealth and aliena- 
 tion of social classes have become so great as to arouse the appre- 
 hension of all thoughtful men. Labor riots that call for mili- 
 tary interference testify to the fact that we have not escaped, 
 that in the future we can hope less and less to escape, the fric- 
 tion that accompanies all unfraternal relations among men. We 
 have been greatly blest in that we have escaped the worst results 
 so long. 
 
 The Development of Agriculture. — The presence and power 
 of those economic forces which softened the asperities of the new 
 industrial system in America are revealed in a particularly strik- 
 ing way in the history of American agriculture. In England, it 
 will be remembered, the changes in agriculture intensified the 
 evils of the Industrial Revolution, led to the consolidation of 
 small farms into large landed estates, and put the actual busi- 
 ness of farming largely into the hands of tenants. None of 
 these things happened in the United States. The great area 
 of unoccupied land served as an outlet for our rapidly growing 
 population, so that between 1850 and 1900 the number, acreage, 
 and output of our farms increased more rapidly than our popu- 
 lation. Farms were not consolidated but broken up ; even 
 today nearly two thirds of our farms are operated by their 
 owners, and more persons are employed in agriculture than in 
 any other branch of industry. There is a constant migration 
 from the country to the city, to be sure, but this is in no sense 
 due to the consolidation of farms. Thus between 1880 and 1910 
 the proportion of all " breadwinners " (persons ten years of age 
 and over gainfully occupied) engaged in agriculture fell from 
 44.4 to 32.9 per cent. But great improvement in agricultural 
 methods and machinery made it possible for the relatively 
 smaller farm population to satisfy the demand for agricultural 
 produce even more completely at the end than in the middle 
 of the nineteenth century. That is to say, the machine power 
 introduced into farming more than took the place of those 
 persons and their descendants who abandoned agriculture. It 
 
ECONOMIC DEVELOPMENT OF THE UNITED STATES 8$ 
 
 has been estimated, for instance, that in 1895 it actually re- 
 quired only about 120,000,000 days' work to produce the nine 
 principal farm crops of that year, whereas, had they been pro- 
 duced by the methods and machinery of 1850, at least 570,000,- 
 000 days' work would have been required.^ 
 
 But our free land merely served to postpone, it could not per- 
 manently prevent, the appearance in America of some of the 
 agricultural conditions which accompanied the Industrial 
 Revolution in England. The twentieth century ushered in a 
 new era in American agricultural development. Between 1900 
 and 1 9 10 the number and acreage of farms increased far less 
 rapidly than the population, while farm tenancy grew, in 
 close relationship, apparently, with an extraordinary increase 
 in farm values. " The increase during the last ten years 
 (1900-1910) in the value of farm property was equal to the 
 total increase in the value of farm property in the United States 
 from the landing of Columbus until 1900." ^ The value of 
 farm land increased 118 per cent between 1900 and 1910; 
 and the number of farms operated by tenants increased 16.3 
 per cent as against an increase of 8.1 per cent in the number of 
 farms operated by owners. More important still, the average 
 value of land, buildings and equipment per farm increased from 
 $3560 in 1900 to $6440 in 1910. These figures reflect in part 
 a simple change in the value of money; but they indicate as 
 well the increasing importance of capitalistic methods of pro- 
 duction in agriculture, the increasing difficulty of acquiring 
 farm ownership, and the sharp halt which has been called upon 
 the agricultural expansion which marked the last century. 
 " We have now reached a stage in the history of this country 
 when farmers in average years do not produce much more of 
 the raw materials used for food, beverage, and clothing than is 
 needed within the country." ^ 
 
 ^H. W. Quaintance, "The Influence of Farm Machinery on Production and 
 Labor," Publications of the American Economic Association, Third Series, vol. v. 
 No. 4, pp. 27-29. 
 
 * J. L. Coulter, "Agriculture in the United States," Quarterly Journal of Econom- 
 ics, vol. xxvii, pp. 9-13. 
 
 ^ Coulter, loc. cit. 
 
86 OUTLINES OF ECONOMICS 
 
 Manufactures. — In agriculture, however, the passage of 
 time has not brought about a highly capitalized form of indus- 
 try, the typical farm represents only a relatively small invest- 
 ment and is tilled by its owner, there is no sharp distinction 
 between employees, unions of wage earners are practically un- 
 known, and passage from the wage-earning to the employing 
 class is still common. In manufactures, practically all these 
 conditions have been reversed since the end of the eighteenth 
 century. And it is the tone of the manufacturing industry 
 rather than that of agriculture which represents the keynote 
 of the modern economic movement, because agriculture is 
 constantly decreasing while manufacturing and allied industries 
 are constantly increasing in relative importance. At the be- 
 ginning of the last decade of the eighteenth century, seven 
 eighths of the working population were employed in agriculture, 
 and the manufactured products of the country were valued at 
 $20,000,000. Half a century later, in 1840, 77.5 per cent were 
 employed in agriculture, 16.5 per cent in trades and manu- 
 factures alone, and the products of the manufacturing industries 
 were valued at $483,000,000. Fifty years later, in 1890, 35.7 
 per cent were in. agriculture, 24.4 per cent in manufacturing 
 and mechanical pursuits, and the manufactured products 
 were valued at $9,370,000,000. In 1909, to cite the latest 
 figures, 32.9 per cent were in agriculture and 28.3 per cent in 
 manufacturing and mechanical pursuits, while the value of the 
 products had reached the enormous sum of $20,700,000,000. 
 
 The change in the character of the industry has been even 
 more striking than its growth and expansion. In the first 
 place, machinery and capital have become increasingly promi- 
 nent. In 1850, for instance, $556 worth of capital was invested 
 for each wage earner, while in 1909 the average amount of 
 capital per wage earner was $2785. ^ In the second place, the 
 organization of the industry has changed, so that the individual 
 owner and ordinary partnership are rapidly being replaced by 
 
 ^ Owing to variations in the definition of " capital " and other similar changes, 
 the statistical comparisons made in this and the preceding paragraph are not accu- 
 rate, and are to be accepted as illustrations rather than measurements. 
 
ECONOMIC DEVELOPMENT OF THE UNITED STATES 87 
 
 the corporation. At the beginning of the nineteenth century, 
 corporations, though not unknown in commerce and banking, 
 were very uncommon in the manufacturing industries. In 
 1909, incorporated companies employed 75.6 per cent of the 
 wage earners and manufactured 79 per cent of the goods pro- 
 duced in dll the manufacturing industries. 
 
 This change in organization has been a powerful factor in de- 
 stroying the personal relation between the owners of capital 
 and the wage earners who man their plants, and has thus 
 helped to widen the growing breach between capital and labor. 
 It has also contributed greatly to the concentration of industrial 
 control. Law and custom in this country have combined to 
 make the small stockholder in the largest corporations a virtual 
 nonentity so far as practical participation in the management 
 of the corporation is concerned ; and the individual or clique 
 of " insiders " who own a bare majority of the stock too fre- 
 quently rule the business despotically. Incorporation, then, 
 instead of introducing a greater measure of real industrial co- 
 operation and thus democratizing industry, has too often turned 
 out to be an ingenious device by which energetic promoters 
 borrow or secure the spare savings of the community on the 
 most flexible terms and with a minimum of responsibility. The 
 corporation thus, while it appeared to be diffusing the ownership 
 of industry, has in reality worked toward the concentration of 
 industrial control. 
 
 Other forces, moreover, have been working toward industrial 
 concentration, the most powerful of which, perhaps, has been 
 competition itself. For many decades in this country the 
 competition among rival manufacturers was bitter and 
 practically unrestricted. Tied down to their large investments 
 of fixed capital, they were compelled to stand and fight with- 
 out quarter. In every such war the number of combatants 
 tends to decrease. As old rivals are killed off, the successful 
 acquire greater skill and greater power in the conflict. With 
 the passage of time greater and greater equipment is required to 
 give any hope of a successful struggle, and some of the contest- 
 ants, learning prudence from the struggle, combine to increase 
 
88 OUTLINES OF ECONOMICS 
 
 their fighting power. The inevitable result, whether through 
 simple survival of the fittest or through combination, is a marked 
 increase in the size and importance of the industrial unit. Be- 
 tween 1899 and 1909, for instance, the number of establishments 
 in the factory industries increased only 29.4 per cent, but their 
 capital increased 105.3 P^r cent, and the value of their products 
 81.2 per cent. In many of our most important industries the 
 number of establishments is actually decreasing. In the manu- 
 facture of agricultural implements between 1880 and 1909, to 
 take a single illustration of the many that might be cited, the 
 number of estabhshments decreased from 1943 to 640, while 
 the wage earners increased from 39,580 to 50,551, and the value 
 of the products from $68,640,000 to $146,330,000. 
 
 There are industries, of course, in which no such consolida- 
 tion has taken place, but they are unimportant in comparison 
 with those in which it has. The extent to which the giant in- 
 dustry and large-scale production had come to dominate our 
 manufacturing industries in the year 1909 is shown in the follow- 
 ing table, which will repay careful study. Establishments of 
 the largest size, i.e. those whose annual output exceeded $1,000,- 
 000, constituted a little over i per cent of the number of estab- 
 lishments, but manufactured nearly 44 per cent of all the goods. 
 Nearly three fourths of the wage earners were employed in 
 establishments having a capital of more than $100,000 each. 
 
 In the latter part of the nineteenth century the movement 
 toward large-scale industry took on another phase. In addition 
 to concentration or centralization of industry, we are now having 
 a rapidly increasing integration of industry. Large business 
 concerns are finding it profitable to carry on under one manage- 
 ment several closely related industries. For illustration, take 
 the case of the United States Steel Corporation. Here we have 
 united under one management the American Bridge Company, 
 the American Sheet Steel Company, the American Steel Hoop 
 Company, the American Steel and Wire Company, the American 
 Tin Plate Company, the Federal Steel Company, the Lake 
 Superior ConsoHdated Iron Mines, the National Steel Company, 
 the National Tube Company, and the Carnegie Steel Company. 
 
ECONOMIC DEVELOPMENT OF THE UNITED STATES 89 
 
90 OUTLINES OF ECONOMICS 
 
 Of the last itself, Mr. Charles M. Schwab said in his testimony, 
 before the Industrial Commission: ^ " The Carnegie Company 
 were large miners of ore — mined all the ore that they re- 
 quired themselves, to the extent of over 4,000,000 tons per 
 year. They transported a large percentage of it in their 
 own boats over the lakes; they carried a large percentage of 
 it over their own railroad to their Pittsburgh works, and 
 manufactured it there, by the various processes, into a great 
 variety of iron and steel articles — I think perhaps a larger 
 general variety of steel articles than almost any other manu- 
 facturing concern." 
 
 Transportation and Railways. — The industrial concentration 
 of which we have been speaking does not necessarily lessen 
 competition at all. It merely gives the business into the hands 
 of increasingly powerful rivals among whom competition may 
 be all the more bitter because of the size of the contestants. But 
 in the principal transportation industries time has demonstrated 
 that another rule prevails: competition has failed to protect 
 the consumer, and the progress of consolidation has operated 
 to emphasize the monopolistic character of the industry. 
 
 The history of transportation in this country since the estab- 
 lishment of the Union falls into three stages. The " turnpike 
 period " extends from 1790, the year in which the first turnpike 
 was constructed, until 181 6, when steam navigation upon the 
 Ohio River became fairly regular. The second stage, the " river 
 and canal period," ends after the panic of 1837, and is marked 
 particularly by the introduction of steam travel on the Hudson 
 (1807), the Ohio, and Mississippi rivers (1808 to 181 7), and the 
 opening of the Erie Canal in 1825. The last stage, the " period 
 of the railway," extends from about 1842 to the present time. 
 In contrasting these periods, it is not meant to suggest that 
 canals were not built before 1790, or that turnpikes are not im- 
 portant at the present time. As a matter of fact, a canal was 
 built in Orange County, New York, as early as 1750; and the 
 last few years have witnessed a rapid and costly improvement 
 of our highways. These " periods " merely indicate the kind 
 
 1 Report of the Industrial Commission, vol. xiii, p. 448. 
 
ECONOMIC DEVELOPMENT OF THE UNITED STATES 91 
 
 of transportation facilities which at different times have been 
 most prominent in the minds of the people. 
 
 In the development of the railway, certain approximately 
 definite stages may also be distinguished. Between 1830 (when 
 the first important railway — the Baltimore and Ohio — was 
 opened) and 1840, the railways were short local lines used in 
 large degree to supplement or piece out the rivers and canals. 
 In the next period, 1840 to 1870, many new roads were built, 
 and the process of " linear consolidation " — the linking to- 
 gether of local companies into through trunk lines — began. 
 By 1869 both the New York Central and the Pennsylvania 
 had effected through connections with Chicago. In the same 
 year, the completion of the Central and Union Pacific railways 
 linked the Pacific Ocean with the eastern railways, and the 
 continent was spanned. 
 
 The period between 1870 and 1890 is marked by three striking 
 developments. First, it was a period of feverish expansion: 
 the railway mileage of the country increased from 52,000 to 
 160,000 miles, more than 200 per cent. Secondly, the com- 
 pletion of several through routes from the Atlantic seaboard 
 to Chicago brought about a period of destructive competition, 
 which led to discrimination and rebating in through traffic and 
 the overcharging of local or non-competitive traffic. " Wher- 
 ever competition appeared, discrimination followed; and in 
 the scramble for business the stronger shippers were favored 
 at the expense of the weaker. Where there was no competition 
 the public felt that they were being oppressed by a monopoly, to 
 make up for sacrifice rates elsewhere — a feeling which was in- 
 tensified by the absentee ownership of the western roads." ^ 
 Thirdly, this condition of demoralization led to a double re- 
 action. The railways sought to restrain competition by the 
 creation of pools and traffic agreements, while the people sought 
 to protect themselves through legislation and the creation of 
 railway commissions. The Federal or Interstate Commerce 
 Commission was established in 1887. 
 
 The last period, from 1890 to the present time, has been 
 
 ^ H. C. Emery in The Cambridge Modern History, vol. vii, p. 706. 
 
92 OUTLINES OF ECONOMICS 
 
 marked by an unprecedented amount of combination among 
 competing roads, and by a growing belief that the railway indus- 
 try is inherently monopoHstic and must be subjected to public 
 control. Thus, at the same time that the control of the magnifi- 
 cent railway system of this country — greater in extent than 
 all the railways of Europe combined — has fallen into the hands 
 of a comparatively small number of groups, the people them- 
 selves have perfected administrative machinery strong enough, 
 it is hoped, to hold the monopoly in check. Very recently 
 strong efforts have been made to preserve competition in the 
 railway industry, but it is coming to be seen that in the main 
 reliance will have to be placed upon regulation rather than 
 competition. The amendment of the Interstate Commerce Act 
 in 1906 is a public recognition of the fact that the old problem 
 of private competition versus public regulation has given way 
 to the new problem of public regulation versus public ownership ; 
 and public operation may be given a trial in the near future 
 on the thousand miles of railroad which Congress (in March, 
 1914) authorized the President to construct in Alaska. 
 
 It would be almost impossible to exaggerate the part which transportation 
 agencies, and particularly the railways, have played in the economic develop- 
 ment of this country. Ours is a country of " magnificent distances," and 
 because of this fact, it was particularly necessary that superior means of 
 communication and transportation should be early introduced, if the country 
 was to be held together. After the Revolutionary War there was real danger 
 that the settlers west of the AUeghanies would be completely alienated. 
 Washington was quick to realize this fact. "The Western settlers," he wrote 
 to the governor of Virginia, shortly after the Revolutionary War, "stand as it 
 were upon a pivot. The touch of a feather would turn them any way. They 
 have looked down the Mississippi until the Spaniards, very impoliticly, I 
 think, for themselves, threw difiiculties in their way ; and they looked that 
 way for no other reason than because they could glide gently down the 
 stream, without considering, perhaps, the difl&culties of the voyage back 
 again, and the time necessary to perform it in ; and because they have no 
 other means of coming to us but by long land transportations and unim- 
 proved roads." 
 
 This danger was averted by the building of the Cumberland Road, the 
 introduction of steam navigation on the Ohio, and the completion of the Erie 
 Canal. Later it looked as if the use of the Mississippi and other natural 
 avenues of communication would Unk the Middle West more closely to the 
 
ECONOMIC DEVELOPMENT OF THE UNITED STATES 93 
 
 South than the northeastern states, thus giving the South a preponderant 
 influence in the inevitable struggle over slavery. This problem, however, 
 was solved by the railways, which, unlike the rivers, ran east and west rather 
 than north and south. The railway was thus a strong factor in the preser- 
 vation of the Union. And since the Civil War, western settlement has fol- 
 lowed the railway. It has been the great pioneering agency of the last half 
 century, and is entitled to as much credit as the public land policy for the 
 rapid settlement of the West. 
 
 In the development of our transportation facilities, however, the State has 
 been from the very first an active partner of private enterprise. Not only 
 has the State built roads, canals, and railways of its own, but it subsidized 
 the private companies which engaged in similar enterprises, with prodigal 
 liberaUty. Of the total state debts — $170,800,000 in all — contracted 
 prior to 1838, $60,200,000 were chargeable to canals, $42,870,000 to railways, 
 $52,600,000 to banks, $6,600,000 to roads, and $8,500,000 to miscella- 
 neous objects. After the panic of 1837 there was little direct construction 
 by the State of internal improvements, but national, state, and local govern- 
 ments vied with one another in assisting private companies by exemptions 
 from taxation and by grants of land, money, and credit. How much these 
 subsidies amounted to we do not know, but the aggregate must have been 
 enormous, as appears from the statistics of land grants. "During the 
 twenty-one years between 1850 and 1871, at which time land grants were 
 discontinued, more than 159,000,000 acres were placed at the disposal of 
 railroad corporations by the federal government and 55,000,000 by the 
 state governments." ^ In their origin and genesis, therefore, as well as in 
 their essential nature, the railways are quasi-public institutions. 
 
 The Labor Movement. — In the preceding pages we have 
 seen how capitaHstic industry under a regime of free competition 
 passed from an earlier period of cut-throat rivalry to a later 
 period of combination amounting in many cases to monopoly. 
 A similar phenomenon is discernible in the labor movement. 
 At the beginning of the nineteenth century there were probably 
 less than a dozen trade unions in the United States, and we 
 actually know of the existence of only one. Between 1825 and 
 the panic of 1837, however, they multiplied rapidly, and efforts 
 were made to unite the scattered " locals " of separate trades 
 into broader national unions, and to confederate the unions of 
 different trades into municipal and district federations. These 
 efforts were only partially successful, however, and it was not 
 
 ' Bogart, Economic History of ike United States, pp. 195, 308, passim. 
 
94 OUTLINES OF ECONOMICS 
 
 until after 1850 that permanent national unions were established, 
 and not till the organization of the Knights of Labor in 1869 
 that a fairly permanent national federation was created. The 
 Knights of Labor reached the zenith of its power about 1886, 
 and since the panic of 1893 its place has been gradually taken 
 by the American Federation of Labor, with which most Ameri- 
 can unions, except those of the bricklayers and masons, the 
 Railway Brotherhoods, and the Industrial Workers of the 
 World, are affiliated. In 1893 the membership of the American 
 Federation of Labor numbered about 250,000. By 1914 it 
 had grown to 2,020,671. These figures give some idea of 
 the strikingly rapid growth of trade unionism in the last twenty 
 years. As the membership of the American Federation of 
 Labor is usually understated, and as there are probably about 
 750,000 members in organizations not affiliated with the Ameri- 
 can Federation, we conclude that the aggregate membership 
 of American labor organizations at the close of the year 19 14 
 amounted to about 2,750,000 persons, mostly men.^ 
 
 There are at least five periods distinguishable in the history 
 of American trade unionism: the germinal period, 1789-1825; 
 the revolutionary period, 1825-1850, so called because of the 
 close connection in this period between trade unionism and 
 more radical reforms such as socialism and cooperation; the 
 period of nationalization, 1 850-1 865; the period oi federation 
 1865-1897 ; and the period of collective bargaining, 1898 to the 
 present time. We speak of the present epoch as the period 
 of collective bargaining because of the rapid expansion of union- 
 ism, and the estabhshment of many new national or district 
 systems of collective bargaining after the industrial depression 
 of 1 893-1 897 ; and because it is only in recent years that em- 
 ployers and the general public have recognized that the trade 
 union is here to stay, and must be regarded as a permanent 
 institution with which many employers of labor must bargain, 
 whether they like it or not. 
 
 ^ Dr. Leo Wolman, in a recent careful study (Quarterly Journal of Economics, 
 vol. XXX, p. 4g6), estimates the total trade union membership in the United States 
 and Canada in 1910 as 2,223,000. 
 
ECONOMIC DEVELOPMENT OF THE UNITED STATES 95 
 
 The avowed aim of the trade unions is a complete combination 
 of all the workers in a given occupation or industry. The Broth- 
 erhood of Locomotive Engineers, for instance, probably counts 
 among its members more than 90 per cent of all the locomotive 
 engineers in North America, although there are few trades 
 which are so completely organized as this. With the passage of 
 time, moreover, the trade unions have made increasing use of 
 the monopolistic principle of the closed shop — the principle 
 which leads union men to refuse to work with nonunion men, 
 and which finds expression in the trade unionist's new command- 
 ment: "Thou shalt not take thy neighbor's job." 
 
 The development of powerful combinations in the labor world 
 has engendered a counter movement among the employers, which 
 expresses itself concretely in the modern employers^ association. 
 Such organizations are not new; we have record of such an 
 association among the master shoemakers of Philadelphia in 
 1789. But in recent years these associations have become per- 
 manent, formal, and aggressive. They fight the labor organiza- 
 tions with their own weapons, matching the lockout against the 
 strike, the black list against the boycott, and the " labor 
 bureau " against the " unfair list " with which the reader of 
 trade-union journals is familiar. Most of the employers' 
 associations, like most of the trade unions, have associated 
 themselves for common action in a large national federation, 
 the Citizens' Industrial Association of America, with which, 
 in December, 1903, there were affiliated sixty national em- 
 ployers' associations, sixty-six State and district associations, 
 and three hundred and thirty-five local or municipal associations 
 of employers. 
 
 This fight between organized labor and organized capital 
 return has forced the State, in the interest of industrial peace, 
 to inaugurate " Wage Boards " and Boards of Arbitration and 
 Conciliation. Some of these, such as the New Zealand Court of 
 Arbitration, are empowered to enforce their awards upon em- 
 ployers and employees; while others, like the Canadian and 
 some of the American State Boards of Arbitration, have no 
 power to settle disputes authoritatively, although they ma^ 
 
96 OUTLINES OF ECONOMICS 
 
 make " compulsory investigations " and publish their finding 
 as to the equities of the case. These and similar topics, how- 
 ever, are reserved for more detailed discussion in a later chapter. 
 State Regulation of Industry. — The growing interference of 
 the State in the conflict between capital and labor brings us 
 naturally to the general subject of the State in relation to indus- 
 try. When the American colonies were planted, mercantilism 
 was the dominant political philosophy; but, as we have seen, 
 mercantilism gave way to a philosophy of individualism in the 
 eighteenth century, under the combined influence of the reaction 
 against the English Navigation Acts, the natural antipathy 
 of a frontier community to legal restraint, the philosophy of 
 Locke, and in a minor degree the teachings of the French physi- 
 ocrats. The triumph of individualism, as a philosophical 
 system, came at the critical period when our State and federal 
 constitutions were in the making, and it thus became intrenched 
 in the organic law of the nation, giving constitutional sanction 
 to the doctrine of laissez-faire, and establishing a constitutional 
 guarantee of freedom of contract, in accordance with which adult 
 men were left " free " to work as long as they " pleased " (or were 
 compelled), for whatever wages they were " pleased " (or forced) 
 to accept. Under the influence of these doctrines, for instance, 
 our courts have annulled such wholesome regulations as laws 
 prohibiting payment of wages in store orders, and statutes 
 limiting the hours of labor of men in bakeshops, or other ex- 
 hausting occupations. Decades of experience have amply 
 proved that the average wage earner is too weak to protect 
 himself against many evils; but our constitutional law has 
 made it exceedingly difficult for the State to protect him. For- 
 tunately, however, the American people have a fashion of 
 bending their constitutional law to fit the facts, not blinding 
 themselves to the facts by worshiping the law; and in recent 
 years the Supreme Court of the United States has sanctioned 
 laws requiring the semi-monthly payment of wages, prohibiting 
 the payment of wages in goods, and requiring the wages of certain 
 miners to be based upon the weight of the coal before screening. 
 Many of the State courts, however, are far less enlightened. 
 
ECONOMIC DEVELOPMENT OF THE UNITED STATES 97 
 
 It is impossible to show in detail how the free trade and indi- 
 vidualistic tendencies of the Revolutionary period gave way to 
 a constantly growing program of State interference. The 
 doctrine of laissez-faire was never adopted in its entirety, and 
 year by year we have moved farther and farther away from it. 
 State interference began with the adoption of a tariff act in 
 1789, " for the support of the government, for the discharge of 
 the debts of the United States, and the encouragement and 
 protection of manufactures " ; reached almost a maximum in 
 the Embargo Act of 1807 ; showed itself in the policy of internal 
 improvements and State aid to turnpike, canal, and railway 
 companies; brought us the great mass of labor and factory 
 legislation which has been adopted by so many states since the 
 Civil War ; led in turn to the Interstate Commerce Act of 1887, 
 the Sherman An ti- trust Act of 1890, the National Meat In- 
 spection and Pure Food Laws; and finally culminated in the 
 Clayton Anti-trust and the Federal Trade Commission Acts of 
 1914. Excessive competition among laborers, which forced 
 them to accept work under conditions destructive of physique 
 and morals, has led to the factory acts, prohibition of child 
 labor, and limitation of the hours of labor of women ; excessive 
 competition leading to the adulteration of products and their 
 manufacture under insanitary conditions has given us the meat 
 inspection 'and pure food laws ; excessive competition among 
 corporations, leading to combination and oppressive monopoly, 
 has brought us the anti-trust acts and regulation through State 
 and national commissions. The rapid adoption of workmen's 
 compensation and minimum wage laws by the State govern- 
 ments in recent years, is striking evidence that we have entered 
 a new era, in which State interference and control is not unlikely 
 to become excessive. Whether the individualistic character 
 of industrial society endures or disappears, individualists and 
 socialists alike are now agreed that the State must interfere. 
 As a prominent English statesman expressed it, " We are all 
 socialists now," although he merely meant by this statement 
 that the passive theory of government has been wholly dis- 
 credited. 
 
 H 
 
98 OUTLINES OF ECONOMICS 
 
 Up to the present time State interference has had as its princi- 
 pal object the improvement and preservation of competition. 
 The conscientious manufacturer who would not poison con- 
 sumers for the sake of swelling his profits, the high-minded 
 employer who would not " sweat " women and children merely 
 to reduce the cost of production, the delicately scrupulous 
 shipper who would not undermine a rival by forcing a common 
 carrier to pay him rebates, — all these have suffered as much 
 from the abuses of competition as the general public itself. 
 Industry under the competitive regime is a rough game played 
 for high stakes, and if it is to be played fairly, there must be 
 intelligent rules of the game and an umpire powerful enough 
 to enforce them upon all contestants alike. If the manufacturers 
 of Massachusetts are prohibited from employing children under 
 fourteen years of age while those of South Carolina are en- 
 couraged to do so, decency is penalized, and the victory goes to 
 the contestant guilty of the greatest number of fouls. 
 
 State interference, as we have said, has had as its principal 
 object the maintenance of competition upon a higher and more 
 wholesome basis. But this has not been its sole object. Our re- 
 cent regulation of public utility companies aims not to bolster up 
 or preserve competition among such companies, but to introduce 
 a substitute for competition; and it is possible that in certain 
 lines of industry regulated monopoly may prove on the whole 
 more beneficial than regulated competition. Whether it is 
 desirable, whether in the long run it will be possible, to main- 
 tain a competitive as distinguished from a socialistic regime 
 of industrial society, may be said to be the supreme economic 
 problem of the twentieth century. 
 
 QUESTIONS 
 
 1. How do you account for the failure of the early colonial restrictive 
 legislation ? 
 
 2. What was the effect of English colonial policy and the Navigation 
 Acts upon American manufactures? shipbuilding? American political 
 philosophy? 
 
 3. What was the condition of American agriculture in 1776? of manu- 
 factures? shipbuilding? transportation? 
 
ECONOMIC DEVELOPMENT OF THE UNITED STATES 99 
 
 4. Was the Industrial Revolution as important in this country as in 
 England? Was it attended with as much suffering? Why? 
 
 5. What part has been played by war in the tariff and industrial history 
 of the United States? 
 
 6. In what respects has the agricultural development of this country 
 differed from that of England? from that of the manufacturing industry? 
 
 7. What changes have taken place in the organization of manufacturing 
 industries in the last century? 
 
 8. What are the principal causes and effects of industrial concentration? 
 
 9. What is the difference between industrial concentration and integra- 
 tion? between large-scale production and monopoly? 
 
 10. What stages are distinguishable in the history of transportation and 
 railways in this country? 
 
 11. What part did the State play in the development of railways? Is 
 railway consolidation a recent phenomenon? 
 
 12. What movement has the development of trade unionism elicited 
 from employers ? from the State? 
 
 13. How did the doctrine of non-interference secure such a strong foot- 
 hold in American constitutional law? What has been the principal object 
 of State interference up to the present time? 
 
 REFERENCES 
 
 (See also References for Chapter V) 
 
 Beaed, C. a. Contemporary American History. 
 
 Beer, G. L. The Old Colonial System, 1660-1754. 
 
 Bishop, J. L. History of American Manufactures. 
 
 Bryn, E. W. Progress of Invention in the Nineteenth Century. 
 
 Census Reports. Tenth Census, Agriculture, p. 131; Twelfth Census, 
 Manufactures, Part i, Chap, ii, i-iv, xvii, xxxix. 
 
 Cleveland, F. A., and Powell, F. W. Railroad Promotion and Capitaliza- 
 tion in the United States. 
 
 Commons, J. R. (ed.) Documentary History of American Industrial Society. 
 (10 volumes.) 
 
 Dewey, D. R. Financial History of the United States. 
 
 Glesecke, A. A. American Commercial Legislation before lySg. 
 
 Hadley, a. T. Railroad Transportation, its History and its Laws. 
 
 Johnson, E. R. American Railway Transportation. 
 
 Rabbeno, Ujo. The American Commercial Policy. 
 
 Taussig, F. W. Tariff History of the United States. 
 
 Weber, A. F. "The Growth of Cities in the Nineteenth Century," Co- 
 lumbia University Studies in History, Economics, and Public Law, 
 Vol. ii. 
 
 Wells, D. A. Recent Economic Changes. 
 
 Wickware, F. G. (ed.). The American Year Book. 
 
BOOK II 
 PRINCIPLES AND PROBLEMS 
 
PART I 
 
 PRODUCTION AND CONSUMPTION 
 
 CHAPTER VII 
 ELEMENTARY CONCEPTS 
 
 In political economy many of the technical terms employed 
 are often misunderstood because the same words are used in 
 ordinary speech with inconsistency and confusion. Frequently 
 v/e have to choose between the alternatives of being inconsistent 
 and of violating current usage. The present chapter is devoted 
 to a preliminary survey of some of the fundamental notions in 
 political economy. 
 
 The statement is sometimes made that economics is a mere 
 bread-and-butter science, and this charge is not without some 
 foundation, since the science studies men in their endeavor to 
 make a living, but it would be an error to suppose that we are 
 concerned with only the sordid aspects of human nature. This 
 is apparent if we enumerate the motives which impel men to 
 acquire wealth. 
 
 Motives in Economic Activity. — (i) There is, in the first 
 place, the endeavor to satisfy one's strictly personal wants, 
 giving rise to the struggle for food, shelter, comforts, amuse- 
 ment, etc. These things are wanted for their own sake, because 
 of the effect which they produce upon the individual acquiring 
 them. We have here, in short, the motive of self-maintenance 
 and self -development. (2) But every normal individual feels 
 such a degree of affection for certain other people that he is 
 also anxious for their maintenance and development. Striving 
 for the welfare of others is a second motive which impels men to 
 labor for the acquisition of material things, and in many cases 
 is more effective as a spur to endeavor than the first. A man 
 
 103 
 
 / 
 
I04 OUTLINES OF ECONOMICS 
 
 will hold himself to the daily grind more persistently when he 
 feels some one is dependent upon him than when he is standing 
 alone. 
 
 Another motive is (3) the desire to gain the esteem of one's 
 fellows. This motive may take the form of an endeavor to do 
 one's part and to be deserving of the companionship of the 
 class of people whom we admire. But much of our wealth 
 acquisition is motivated by the hope of impressing our fellows 
 with a sense of our own importance, to show that we are success- 
 ful, admirable, enviable. When the income permits, old coats 
 are discarded, not because they cease to give protection, nor 
 because they have become aesthetically objectionable, but 
 because the wearers wish to make a favorable impression upon 
 other people. Part of the pleasure of owning fine houses may 
 come from the fact that most people do not have them. This 
 motive is not always a conscious one, since our standards of 
 beauty or propriety may themselves have been the result in 
 part of this desire for distinction. Somewhat similar to the 
 desire for distinction is (4) the desire for power. Men like to 
 dominate and command their fellows, and this want may be 
 satisfied by means of the dollar as well as with the sword; 
 hence our " Napoleons of Finance," " Captains of Industry," 
 and "Railway Kings." 
 
 Again, (5) the desire for activity for its own sake may be men- 
 tioned. Enforced idleness is as painful as prolonged labor, ex- 
 cept to the degenerate. This desire may result in the production 
 of goods, but almost always it requires the use of goods 
 that have been produced ; as, for example, the implements of 
 athletic exercise. Finally, (6) religion and the ethical sense 
 may be important factors in controlling the economic 
 activity of the individual. Observe, for instance, the difference 
 in the history of the communistic experiments in which religious 
 feeling has been strong and those in which it has been weak. 
 
 In this discussion the use of the word " motive " must not be 
 taken to mean that all of the economic life of the individual 
 is a consciously rational one, in which pleasures are balanced 
 against pains in such a way as to secure the maximum surplus 
 
ELEMENTARY CONCEPTS 1 05 
 
 of satisfactions. Man is, it is true, a rational being, and as 
 such pursues definite lines of action under the influence of con- 
 scious motives ; but he is also a creature of instincts and habits, 
 and much of the economic activity of the individual has to be 
 interpreted as the working out of instinct and habit. We speak, 
 for example, of such things as the " instinct of workmanship," 
 the " habit of industry," the " habit of saving," and the like. 
 The foregoing analysis of the motives in economic activity is, 
 however, broad enough if we remember that " pleasure " is 
 something that is not always consciously sought, but is often 
 to be understood as the result of the functioning of inherited 
 instincts and acquired habits. 
 
 Utility. — As a result of these motives, human beings are 
 striving for the possession of certain things. These we call 
 goods. To understand the meaning of the term " utility " in 
 economics, we must remember that economics is primarily a 
 science of man. Goods may be of interest in chemistry and 
 physics merely as things, but they have no significance what- 
 ever in economics until they come into relation with man. That 
 fact in man which imparts to things a new character and makes 
 them goods is the fact of human wants. Anything that is capa- 
 ble of satisfying a human want is a good, and possesses utility. 
 
 We need here to guard against a misunderstanding which the 
 word " utility " might suggest. Utility is the power to satisfy 
 wants, not the power to confer benefits. Cigars are as " useful " 
 in the economic sense as bread or books, for all three satisfy 
 wants. Economic wants may be serious, frivolous, or even 
 positively pernicious, but the objects of these wants all alike 
 possess utility in the economic sense. 
 
 Free Goods and Economic Goods. — But it is apparent that 
 the wants we have mentioned are very unlike in character. Air 
 and water, for instance, we seldom think of as things we want 
 at all. We usually have them in abundance and without exer- 
 tion, so that, though they satisfy wants as vital as any we 
 know, we seldom spend any time thinking about them or our 
 absolute dependence upon them. These are free goods, that is, 
 goods that exist in quantities sufficient to supply all wants for 
 
lo6 OUTLINES OF ECONOMICS 
 
 them. Land in a new country is frequently a free good. But 
 the list of things that are free is quickly exhausted. Economic 
 goods are those which exist in quantities less than sufficient to 
 satisfy all wants for them. Hence, we must economize in the 
 use of them, are willing to undergo sacrifice to obtain them, 
 and usually they are obtained only by exertion. It is, however, 
 their scarcity as compared to the human wants which they have 
 the power to satisfy, and not the fact that they have cost labor, 
 that makes them economic goods. Land, for example, a free 
 gift of nature, is one of the most important of economic goods 
 at the present time. 
 
 Effort. — Fortunately, the supply of economic goods can, in 
 most cases, be increased by human exertion applied to the ma- 
 terials of nature ; but this exertion, if carried beyond a certain 
 point, is irksome, and this has an important effect upon the con- 
 duct of life. If the labor force of the community were unlimited, 
 a great many of the goods which we now use sparingly would be 
 as free as air. Idealists have pictured for us a condition of the 
 future where a few hours' work per day for each individual (an 
 enjoyable means of working off surplus energy) will be sufficient 
 to supply us with all of the goods that we have time to consume. 
 At present, however, most of us find that our consumption is 
 limited by the pain of additional effort. The end of our eco- 
 nomic activity is, therefore, not only to get the greatest amount 
 of satisfaction, but also to minimize the amount of painful labor. 
 
 Waiting. — Another fact that persists in our economic life 
 is the necessity for waiting. The people of the United States 
 wished to have the Panama Canal, but they could not get it 
 without years of waiting. They were obliged to spend millions 
 of days of labor with no benefit in return for a long time. So 
 in general the production of goods by modern methods, involving 
 the investment of capital, requires waiting as well as effort. 
 
 Risk. — In a society characterized by private enterprise in 
 industry, the risk of business failure is an important fact. 
 The uncertainties of business life are obvious : A factory may be 
 destroyed by fire, crops may be destroyed by storm and hail, 
 a panic may destroy credit at a critical moment, fashions may 
 
ELEMENTARY CONCEPTS 107 
 
 change, or competition may prove too strong. Some of these 
 uncertainties may be eliminated by insurance, but others can- 
 not be so eliminated. The corporation is a device by which 
 the risk assumed by one individual is limited, although not 
 eliminated. The trust and the monopoly tend to reduce the 
 importance of the factor of risk, and under a system of State 
 socialism it might possibly become a negligible factor in our 
 daily economic life. As society is constituted at present, how- 
 ever, the production of goods to satisfy human wants is attended 
 by risk, and, as we shall see later, society has to compensate 
 those who take these inevitable business risks. 
 
 Services. — Goods have been commonly divided into (i) 
 material things, such as food, clothes, and books, and (2) personal 
 services, such as those of physicians, lawyers, musicians, teach- 
 ers, household servants, and pubhc officers. 
 
 The advisability of the distinction has been denied. Actors and singers, 
 it has been urged, sell us perishable material things, i.e. hght and sound 
 waves of a peculiar kind. A recent writer also considers the distinction con- 
 fusing because it obscures the fact that material things render services just 
 as human beings do. The piano yields services as does the singer. From 
 this point of view persons are durable economic goods along with cattle and 
 wheelbarrows. But, on whatever ground the distinction is made, it is im- 
 portant to recognize that among the things that contribute to our weU-being 
 are some — personal services — that are so perishable that they must be 
 used with the direct cooperation of some other human being, while in other 
 cases the services are, as it were, stored up in some inanimate material things, 
 and the relation between the producer and consumer becomes an impersonal 
 one. The service of a musician, for example, is personal and must be used 
 the moment it is rendered; the purchase of a musical instrument, on the 
 other hand, means the purchase at one time of a long series of uses. 
 
 Personal Qualities as Goods. — The central point in our 
 science is the conception of man in his relations to his environ- 
 ment, and hence it does not seem reasonable to include the 
 personal qualities of men under the head of goods. Good health 
 and technical skill make a man's services more valuable and 
 assist him in the acquisition of wealth, but they are a part 
 of him rather than of his possessions. It is his services that he 
 sells, and it is these that we have placed under the head of goods. 
 
Io8 OUTLINES OF ECONOMICS 
 
 When we consider the importance of the priceless heritage 
 which the present generation has received in the shape of knowl- 
 edge and skill, we might make these a separate category as 
 immaterial goods. 
 
 On this point Professor Marshall says: "German economists often lay- 
 stress on the non-material elements of national wealth ; and it is right to do 
 this in some problems relating to national wealth, but not in all. Scientific 
 knowledge, indeed, wherever discovered, soon becomes the property of the 
 whole civihzed world, and may be considered as cosmopolitan rather than a 
 specially national wealth. The same is true of mechanical inventions and 
 of many other improvements in the arts of production; and it is true of 
 music. But those kinds of literature which lose their force by translation 
 may be regarded as in a special sense the wealth of those nations in whose 
 language they are written. And the organization of a free and well-ordered 
 State is to be regarded for some purposes as an important element of national 
 wealth." 1 
 
 But knowledge does not exist in a disembodied state, and we 
 shall omit nothing and avoid some confusion if we divide all 
 goods into material things and personal services. 
 
 Wealth and Income. — Wealth may be looked upon either 
 as a stock of things on hand at a particular time or as a flow of 
 things during a period of time. When we ask how much a man 
 is worth, it is customary in America to answer in terms of the 
 value of his possessions, while an Englishman would answer in 
 terms of annual income. The two ways of looking at the 
 matter are not identical, however: What a man spends in a 
 year may include a good deal spent in hiring other persons to do 
 personal service for him, while an estimate of his possessions 
 could not include the value of those persons unless they were 
 his slaves. 
 
 What is to be considered as a man's income is not easy to say, 
 as our law-makers have discovered in framing income tax laws. 
 In economic discussions we have in mind net and not gross 
 income. We may refer to the economic goods and services 
 enjoyed during a period of time, to the satisfaction derived 
 from these goods and services, or to their money value. Money 
 income is commonly given a broader meaning to cover one's 
 
 ^ Principles of Economics, 6th ed., p. 59. 
 
ELEMENTARY CONCEPTS 1 09 
 
 total net acquisition of money regardless of whether it is spent 
 for consumption goods or is saved. 
 
 Individual Wealth and Social Wealth. — The distinction 
 between the social and the individual standpoint meets us at 
 many points in the study of economics. That which is wealth 
 to the individual is often not wealth to society. An individual 
 holding a government bond finds that he can exchange it for 
 the things he wants almost as readily as though it were gold or 
 some other commodity. He recognizes that the paper itself 
 cannot be used directly for any useful purpose, yet he prizes 
 it because it represents an indisputable claim on the services 
 or commodities of other people. If the bond should be destroyed, 
 the holder as an individual would suffer loss, but society as a 
 whole would be neither richer nor poorer, and society, exclusive 
 of the bondholder, would have gained at his expense. From 
 the social standpoint the bond is not wealth at all, but only an 
 evidence of a legal right to a part of the social wealth. All 
 property rights are simply claims to a part of the social wealth 
 or income. The claims to concrete, material things, such as 
 farms and store buildings, are included by an individual when 
 he enumerates his wealth; and farms and store buildings are 
 social wealth. Again, in making an inventory of his wealth, 
 an individual would not ordinarily include such an item as the 
 post office, which is public and not private property; but, 
 strictly speaking, the post office is owned by him jointly with 
 other members of society. A successful patent is frequently 
 looked upon as an item of wealth, but it is simply a means by 
 which the owner gets more from other people in return for his 
 services. If the patent is declared invalid, others gain what he 
 loses (not counting the lessening of the inducements to inven- 
 tion). Again, " good will " in business is frequently paid for 
 as though it was an economic good, and is wealth from the 
 individual point of view, but it is not social wealth. If a busi- 
 ness man loses his established trade, his competitors are the 
 gainers ; society as a whole is not affected. 
 
 Wealth and Value. — In the preceding paragraphs wealth has 
 been spoken of as consisting of particular things. A lead pencil 
 
no OUTLINES OF ECONOMICS 
 
 and the year's crop of wheat are both wealth. How shall we 
 measure the amount of wealth that these objects represent? 
 Since the items of wealth are composed of very heterogeneous 
 objects, we cannot use such units of measure as bushels, pounds, 
 or feet. We must select a measure that has reference to some 
 quality common to all kinds of wealth. Such a quality is 
 value. This is a subject which will be discussed in detail later, 
 the valuation of goods and personal services being the central 
 problem in economic theory. 
 
 Capital and Other Forms of Wealth. — Some material things, 
 as well as personal services, yield satisfaction to human beings 
 directly. From clothes, dwellings, food upon the table, musi- 
 cal instruments, and the like, we derive enjoyment directly. 
 These are consumption goods. Other goods are of service only 
 indirectly. A plow, we say, is useful, but we cannot eat or wear 
 it. It simply helps to produce the things that we can enjoy. 
 Such articles are production goods. 
 
 The distinction is a matter of degree. Even the food upon the table is not 
 quite ready to be enjoyed. It must be handled with knives and forks. 
 This has led some writers to make no distinction between production and 
 consumption goods. But it has been pointed out that great differences in 
 degree are more important than many differences in kind. The distinction, 
 it may also be noted, is not made on the ground of durability. Consump- 
 tion goods — a painting or a book, for example — may be very durable. 
 
 Production goods, again, are divided into capital goods and 
 land. Land is a gift of nature ; capital goods — machinery, 
 warehouses, raw material, etc. — are produced by man. Other 
 differences between these two classes will be discussed later. 
 
 Capital Goods and Capital Value. — Capital goods, as well as 
 other forms of wealth, are of such a heterogeneous nature that 
 we cannot measure them by such units as pounds or inches. 
 Here, again, we must select some quality that is common to all 
 of them, which is value, and this can be measured in terms of 
 dollars. Very frequently the value of capital goods is confused 
 with the concrete good itself. A typewriter is a tangible, ma- 
 terial capital good ; its weight is measured by pounds ; its bulk 
 by cubic inches ; its value by dollars. In this book the word 
 
ELEMENTARY CONCEPTS 
 
 III 
 
 " capital " is frequently used as a short expression for either 
 of the phrases " capital goods " and " capital value," but it 
 will always be clear from the context which is meant. 
 
 Social and Individual Capital. — The individual may include 
 items in an enumeration of his capital which are not capital 
 from the standpoint of society. The landlord who has dwell- 
 ings to let regards them as part of his capital, but from the social 
 standpoint they are consumption goods. We may call such 
 goods acquisitive capital. Again, a street railway may consider 
 its franchise as a part of its capital, but from the social stand- 
 point a franchise is not capital at all, nor even wealth, but is 
 simply a right to use the streets in a certain manner. Destroy 
 the franchise, and social capital would not be lessened, except, 
 perhaps, in indirect ways. 
 
 Figure i will help to make these various distinctions clear : 
 
 Circle AB represents goods. 
 Circle AC represents economic 
 
 s. 
 Circle AE represents producer's 
 
 Circle AF represents land. 
 
 Zone BC represents free goods. 
 
 Zone CE represents consumer's 
 goods. 
 
 Zone DE represents acquisitive 
 capital. 
 
 Zone EF represents social capi- 
 tal. 
 
 Fig. I. 
 
 The National Wealth and the National Dividend. — Attempts 
 have been made to ascertain the total wealth of a nation. The 
 latest estimate made for the United States by the census authori- 
 ties is given on the following page. 
 
 Such a table is useful, even though it may contain some rather 
 arbitrary estimates, as showing the relative importance of dif- 
 ferent classes of our material equipment. Notice the small total 
 value of the metals used as money and the relatively large value 
 imputed to real property. It is rather surprising that manu- 
 
112 
 
 OUTLINES OF ECONOMICS 
 
 facturing machinery, tools, and implements are worth less than 
 our live stock. But great care should be taken in comparing 
 the total wealth as estimated in this and in preceding census 
 valuations and in drawing conclusions as to the significance of a 
 growth in national wealth measured in dollars. 
 
 Estimates of Wealth for 191 2 and 1900 
 
 Form of Wealth 
 
 1912 
 
 1900 
 
 Total 
 
 $187,739,071,090 
 
 $88,517,306,775 
 
 
 Real property and improvements taxed 
 Real property and improvements exempt 
 
 98,362,813,569 
 
 12,313,519,502 
 
 6,238,388,98s 
 
 1,368,224,548 
 
 6,091,451,274 
 
 2,616,642,734 
 
 16,148,532,502 
 
 4,596,563,292 
 
 223,252,516 
 
 1,081,433,227 
 
 123,362,701 
 
 1,491,117,193 
 
 360,865,270 
 
 290,000,000 
 
 2,098,613,122 
 
 5,240,019,651 
 
 14,693,861,489 
 
 826,632,467 
 
 815,552,233 
 4,295,008,593 
 
 8,463,216,222 
 
 46,324,839,234 
 6,212,788,930 
 3,^06,47^,278 
 
 Farm implements and machinery . . 
 Manufacturing machinery, tools, and 
 
 implements 
 
 Gold and silver coin and bullion . . . 
 Railroads and their equipment . . . 
 Street railways, etc. : 
 
 Street railways 
 
 Telegraph systems 
 
 Telephone systems 
 
 Pullman and other cars not owned by 
 railroads 
 
 Shipping and canals 
 
 Irrigation enterprises 
 
 Privately owned waterworks . . . 
 
 Privately owned central electric light 
 
 and power stations 
 
 All other : 
 
 Agricultural products 
 
 Manufactured products 
 
 Imported merchandise 
 
 Mining products 
 
 Clothing and personal adornments 
 
 Furniture, carriages, and kindred 
 
 749,775,970 
 
 2,541,046,639 
 1,677,379,825 
 9,035,732,000 
 
 1,576,197,160 
 211,650,000 
 400,324,000 
 
 98,836,600 
 537,849,478 
 
 267,752,468 
 
 402,618,653 
 
 1,455,069,323 
 
 6,087,151,108 
 
 424,970,592 
 
 326,851,517 
 
 2,000,000,000 
 
 4,880,000,000 
 
 
 
 In addition to the dii3&culty of getting accurate information 
 on these various items, there are several things to be kept in 
 mind in making use of such an estimate. First, the returns are 
 made in money, so that fluctuations in the value of money will 
 show a change in the total valuation even if there is no real 
 change in the relation between the wants of a community and its 
 
ELEMENTARY CONCEPTS I13 
 
 supply of goods. Again, free goods are not included in such 
 an estimate. Also, a good deal of public property does not have 
 a money estimate put upon it. Who would attempt to say what 
 our rivers and harbors are worth, and yet why should not these 
 be included in the estimate if our canals are ? 
 
 It seems that much that is included in the estimate is wealth 
 from the individual standpoint only, but not from the social, as 
 in the case of the valuation of a business whose value consists 
 largely of patents or monopolistic privileges. In the table above, 
 for example, the value of railway property was obtained by capi- 
 tahzing railway earnings. Is this sum properly included in an 
 estimate of the total amount of wealth in the United States? 
 The inclusion is proper if we are confining "ourselves to a state- 
 ment of the sum of the values of property rights, but it is mis- 
 leading if we wish to show the relative importance of railways 
 and of property in a competitive industry, or if we are discussing 
 railways in relation to the public welfare. A similar line of 
 thought is suggested with reference to land values. Ten years 
 ago we had about the same area and the same quality of land 
 as we now have, so that its high value today cannot mean that 
 we are better equipped with natural resources. 
 
 We must be on our guard against attaching improper signifi- 
 cance to estimates of total wealth. Changes in total value are 
 not an accurate index of changes in well-being. It is possible 
 that an increase in concrete material goods will actually decrease 
 the total quantity of wealth measured in dollars. A hundred 
 bushels of wheat at $1 per bushel have a higher selling value 
 than two hundred bushels at 40 cents per bushel. If by some 
 magical process all goods could be made free as air, there would 
 be no value whatever. An estimate of the value of our stock of 
 wealth also necessarily omits to take account of personal serv- 
 ices. It is obvious also that per capita wealth has more 
 significance for well-being than has total wealth. Individual 
 wealth and value connote scarcity; well-being implies abun- 
 dance. Nevertheless, under present conditions, it is probable 
 that an increase in per capita individual wealth, when not due 
 to fluctuations in the value of money, also indicates an increase 
 I 
 
114 OUTLINES OF ECONOMICS 
 
 in well-being. There is no likelihood of our being able to in- 
 crease the quantity of economic goods to such an extent as to 
 render them free and hence valueless ; and, on the other hand, 
 as will be more fully explained later, new wants are constantly 
 developing, and value springs from the power to minister to 
 unsatisfied wants. 
 
 The national income is a concept which takes account of the 
 services rendered directly by persons as well as of the material 
 things that are used. The national income, objectively consid- 
 ered, is a gigantic stream of food, clothes, comforts, personal serv- 
 ices, etc., which is used up in the direct satisfaction of wants in a 
 specified period, such as a year, by the millions of individual 
 acts of consumption. Some writers would include also the 
 additions to our industrial equipment, such as new machines; 
 but these may be regarded as promises of an enlarged future in- 
 come of society, not as part of its present real income. Thus 
 we may distinguish between the annual national product and the 
 annual national income. 
 
 It has been estimated that the average income per family 
 was about $1500 in the United States in 1910.^ The margin of 
 error in this average may be very great, but even if it could be 
 taken as accurately measuring the per family income of that 
 year, it would not necessarily be an index of how well we might 
 live under some organization of society that attempted an equal 
 or nearly equal distribution of income. The effect upon the 
 efficiency of management, the hours of labor, and the intensity 
 of effort might be disastrous. On the other hand, there might 
 be much saving from an elimination of wasteful and unnecessary 
 expenditure without a reduction of real enjoyment, and there 
 might be a fuller utilization of productive forces now going 
 to waste. We refrain from entering this realm of speculation. 
 
 The national income may be looked upon as the national 
 dividend, the sum total of good things to be divided among the 
 various families or individuals. The forces determining the 
 size of this dividend and the manner of its division are the 
 main topics for discussion in political economy. 
 
 ^ W. I. King, The Wealth and Income of the People of the United States, Chap. ix. 
 
ELEMENTARY CONCEPTS II5 
 
 QUESTIONS AND EXERCISES 
 
 1. Does the following statement agree with the definitions in the text? 
 "The true basis for an estimate of a nation's wealth is to be fomid in the en- 
 joyments of its members." Hadley, Economics, p. 4. 
 
 2. Are the following wealth : air? whisky? a copyright? Lake Michigan? 
 skill as a carpenter ? good health ? 
 
 3. Discuss the following: "Among the motives which lead men to 
 accumulate wealth, the primacy, both in scope and intensity, therefore, 
 continues to belong to this motive of pecuniary emulation." Veblen, 
 Theory of the Leisure Class, p. 34. 
 
 4. State the significance of the following : "A horse is not wealth to us if 
 we cannot ride, nor a picture if we cannot see, nor can any noble thing be 
 wealth except to a noble person." Ruskin, Munera Pulveris, p. 10. 
 
 5. Discuss the following statement : "In 1770 Arthur Young reckoned the 
 income of England to be £120,000,000; in 1901 the income may be roughly 
 set down at £1,600,000,000. Making correct allowances for population 
 and for prices, this growth of income would signify a large increase of com- 
 modities per head ; but would it tell us that we are working and living some- 
 what better than our ancestors?" Hobson, The Social Problem, p. 43. 
 
 6. How does the Federal Income Tax law (as interpreted by the Treasury 
 Department) define a person's income? 
 
 REFERENCES 
 
 Cannan, Edwin. Wealth, Chap. i. 
 
 Clark, J. B. The Philosophy of Wealth, Chaps, i and iii. 
 
 Ely, R. T. Property and Contract, Vol. i. Chap. iii. 
 
 Fkher, Irving. The Nature of Capital and Income, Chaps, i and ii. 
 
 Hadley, A. T. Economics, pp. i-io. 
 
 Hobson, J. A. The Social Problem, Book i. Chap. ii. 
 
 King, W. I. The Wealth and Income of the People of the United States, 
 
 Chaps, ii and v. 
 Leslie, T. E. C. Essays in Political Economy, Chap. i. 
 Marshall, Alfred. Principles of Economics, 6th ed., Book ii. 
 Mitchell, W. C. "Human Behavior and Economics: A Survey of 
 
 Recent Literature," Quarterly Journal of Economics, Vol. xxix, pp. 1-47. 
 PiGou, A. C. Wealth and Welfare, Part i. Chaps, i and ii. 
 RusKiN, John. Munera Pulveris, Chap. i. 
 
 SiDGWiCK, Henry. The Principles of Political Economy, Book i, Chap. iii. 
 Smart, William. Studies in Economics, Chap, viii; and Distribution of 
 
 Income, Book ii. 
 Taussig, F. W. Principles of Economics, YolA, Chap. i. 
 Veblen, Thorstein. The Theory of the Leisure Class, esp. pp. 24-34 ; and 
 
 The Instinct of Workmanship, Chap. i. 
 Special Census Reports on Wealth, Debt, and Taxation. 
 
CHAPTER VIII 
 PRODUCTION 
 
 Production Defined. — Man creates no new matter. Neither 
 the farmer nor the merchant adds one atom to the existing 
 material of the earth. Yet they are both properly called pro- 
 ducers because they increase economic utility. Production, 
 then, means the creation of economic utilities by the application 
 of man's mental and physical powers to the materials of nature. 
 The act of production can be reduced to the following three 
 operations : (i) changing the form of things, or combining or 
 rearranging them, (2) changing their place, and (3) keeping 
 them until such times as they are wanted; in other words, 
 production adds to the materials of nature, form or composition 
 utility, time utility, and place utility. Production thus defined 
 includes the rendering of direct personal services. 
 
 It has seemed to some that the farmer is more truly 
 a producer than the manufacturer, and the manufacturer than 
 the merchant; but such is not at all the case. All of these 
 industrial classes help at some stage in the process of getting 
 the materials of nature ready for consumption. The miner 
 gets iron ore from the ground, the manufacturer transforms 
 it into stoves, the railway company transports them, and the 
 merchant acquires a stock of them and keeps them until they 
 are wanted. One stage is as essential as another if wants for 
 stoves are to be satisfied. It may well happen that the utilities 
 produced by the merchant could be produced with a smaller 
 expenditure of economic force, and that by a better organization 
 of the factors of production saving could be effected ; but this 
 is no justification whatever for the popular impression that he is 
 not a productive worker. Things are not fully " produced " 
 until they are in the form in which they are wanted, at the place 
 at which they are wanted, and at the time when they are wanted. 
 
 116 
 
PRODUCTION 117 
 
 In books on political economy we are likely to find that much 
 more is said about the distribution of wealth than specifically 
 about its production. The reason for this is partly that the 
 problems of production are to a very considerable extent a 
 matter of technical progress. How to increase the yield per 
 acre is not specifically an economic problem. Nevertheless 
 the economist is interested in the volume of production compared 
 with the growth in population and in changes in the character 
 of production. Misdirected production is thought to have some- 
 thing to do with economic crises, and changes in the production 
 of gold may explain widespread changes in prices, so that 
 production has in reality received a good deal of attention from 
 economists in connection with their discussion of other sub- 
 jects. In this book, for example, the relation of population to 
 agriculture is considered in the chapter on Wages. 
 
 The close relation between production and distribution may be 
 further illustrated by the subject of " scientific management " 
 in industry. This means such an arrangement of work, selection 
 of methods, and measuring of individual efficiency within a 
 factory or elsewhere as to produce the maximum output per 
 man. Take the simple operation of shoveling coal or cinders, 
 where this must be done by hand. It has been found that the 
 amount handled per day per man will depend on the weight of 
 the shovel, its size, the amount taken at each lift, and the number 
 of movements per hour. The largest shovelful is not likely to 
 be the most economical. Such inquiries obviously have a rela- 
 tion to the wages which may equitably be paid to different 
 workmen, and representatives of trade unions have looked upon 
 the movement toward the utilization of scientific management 
 with considerable suspicion and hostility as a system of driv- 
 ing men to greater exertion. It would seem that if there is 
 cooperation between managers and trade union ofl&cials, total 
 production may be increased and wages may be increased by 
 scientific management without detriment to the individual 
 workingman. 
 
 On the whole, it is probably true that the subject of production 
 has in recent years been unduly neglected by economists. The 
 
Il8 OUTLINES OF ECONOMICS 
 
 conservation movement, looking toward the less wasteful utiliza- 
 tion of our natural resources, had its origin outside of economic 
 circles. In recent years, however, the economists are very 
 properly placing more emphasis upon the obvious fact that 
 economic progress depends upon increasing the annual per 
 capita production of wealth as well as upon improving the way 
 in which wealth is distributed among its producers. 
 
 The Production of Values. — We have said that production 
 means the increasing of economic utility. This is precisely 
 equivalent to saying that it means the rendering of services 
 that lead directly or indirectly to the satisfaction of human 
 wants. And since we are not willing to pay for things that we 
 do not want, it follows that every service for which we are 
 willing to pay must be classed as productive. All money-mak- 
 ing pursuits are, therefore, productive. Except through in- 
 heritance or gift or gambling or fraud or theft one cannot gain 
 an income unless one gives a quid pro quo by rendering productive 
 services or by permitting the use of some productive agent 
 which one owns or controls. But it does not follow that 
 money-making is a measure or gauge of the amount of productive 
 service rendered or that production and acquisition always go 
 hand in hand. For the amount of money that will be paid for 
 commodities and services will depend upon their value rather 
 than upon their utility; and scarcity, as well as utility, is a 
 factor in determining the value of things. 
 
 Men can sometimes increase the value of things by curtaihng 
 the supply of them, although, of course, this decreases their 
 aggregate utility. In the case of a monopoly, where the power 
 to control the supply of a product is lodged in the hands of a 
 single producer or group of producers, this often becomes a 
 matter of much importance. The case of the Dutch East 
 India Company, which is said to have destroyed half of its 
 spice crop, because the remaining half would have a greater 
 value than the whole would have had, has been cited by many 
 economists. In some fishing centers part of an unusually large 
 catch is destroyed or sold as fertilizer in order that the market 
 price may not be unduly lowered. Most commonly, of course, 
 
PRODUCTION 119 
 
 limitation of supply is effected by merely producing less than 
 might have been produced and sold at a price high enough 
 to cover expenses. In competitive enterprises, however, no 
 one producer can control the supply of the product, so that in 
 general the only way in which a producer can increase the value 
 of his output is by increasing its quantity and, consequently, 
 its utility. But it should be clear that we may get very different 
 results if we measure the results of productive effort in terms of 
 values from what we should get if we used utility as our measure. 
 From the point of view of social welfare, the production of 
 utilities is, of course, what we are interested in. But we have 
 to recognize that in our modern exchange economy the produc- 
 tion of values is what producers are mainly interested in. In 
 later chapters we shall have to consider more carefully the 
 extent to which these two principles of production are in har- 
 mony, and the ways in which they are in conflict.^ 
 
 Factors of Production. — It has been customary to speak of 
 three factors of production — nature, labor, and capital. Under 
 nature are included all forces external to man, as the wind, the 
 movement of water, attraction of gravitation, cohesion, etc. 
 Frequently these things furnished by nature are called simply 
 land, because, of what belongs to external nature, it is with land 
 that we have principally to do in political economy. 
 
 Of the total land surface of the United States all but about 
 15 per cent had been appropriated or reserved in 19 13. The 
 unappropriated and unreserved portions were largely in Nevada, 
 Arizona, Wyoming, and New Mexico. Of the total land sur- 
 face, 46.2 per cent was in farms in 1910, and of these farms only 
 54.4 per cent consisted of improved land; that is, only 25.1 
 per cent of the total land area was improved farm land. " Im- 
 proved farm land includes all land regularly tilled or mowed, 
 land pastured and cropped in rotation, land lying fallow, land 
 in gardens, orchards, vineyards, and nurseries, and land occupied 
 by farm buildings." If all of the improved land were equally 
 
 1 In a literal sense neither utility nor value is "produced." The things produced 
 are commodities and services, which have utility and value because they satisfy 
 human wants that would otherwise be unsatisfied. 
 
I20 
 
 OUTLINES OF ECONOMICS 
 
 distributed, there would be about five acres for each person in 
 the United States. This figure has decreased sHghtly in the 
 last quarter of a century, although the historical comparison is 
 made somewhat uncertain by the fact that woodland at the 
 census of 1900, 1890, and 1870 was included in improved land, 
 but was not so included in 1880 and 19 10. The production of 
 the leading cereals per acre has not changed much since 1890 
 and on the whole the per capita production of wheat and corn 
 measured in bushels has not increased since 1880. 
 
 In other lines of production the per capita story is quite dif- 
 ferent, as will be seen from the following table: 
 
 Per Capita Production of Selected Commodities^ 
 1880-1913 
 
 Commodity 
 
 1880 
 
 1890 
 
 1900 
 
 1910 
 
 8.992 
 
 7-732 
 
 8.32s 
 
 7-352 
 
 29.769 
 
 29.483 
 
 26.722 
 
 30.341 
 
 .663 
 
 .824 
 
 .676 
 
 .716 
 
 1.378 
 
 2.257 
 
 3.14s 
 
 4.671 
 
 .114 
 
 .123 
 
 .I3t> 
 
 .144 
 
 .074 
 
 .129 
 
 .192 
 
 .266 
 
 
 1227 
 
 1799 
 
 2626 
 
 I9I3 
 
 Per Capita 
 
 Wheat production — bushels 
 Corn production — bushels . . 
 Number of cattle on farms . . 
 Coal production — long tons 
 Cotton production — 500 lb. bales 
 Pig iron production — long tons 
 Ton-miles of freight .... 
 
 7.868 
 
 2S.220 
 -58 3 
 
 •152 
 .319 
 3106 
 
 Labor, as a factor of production, includes human activities of 
 every sort, intellectual as well as physical, which have economic 
 significance. We might better, perhaps, substitute man for 
 labor as the second factor. Labor is supplied by human beings 
 and is different from material goods because it is always con- 
 nected with a personality. Moral and intellectual qualities 
 increase its productiveness. Temperance, trustworthiness, 
 skill, alertness, quick perception, a comprehensive mental grasp, 
 — all these and other qualities belonging to the soul of man are 
 of paramount importance. Man's mere physical strength in 
 itself is a poor thing, being surpassed by that of the lower animals, 
 
 1 Compiled from "Statistical Record of the Progress of the United States, 1800 to 
 1913," in Statistical Abstract of the United States, 1913. Where possible, five-year 
 averages have been used with the census year as the center. 
 
PRODUCTION 121 
 
 but man is far more productive, and even as a slave sold for 
 more than the lower animals. 
 
 Man can get but little directly from nature with his unaided 
 hands. The instruments which assist him, as we have seen, 
 are called capital; in other words, capital is every product which 
 is used or held for the purpose of producing or acquiring wealth. 
 By this definition, land is evidently excluded from the category. 
 The nation's capital, then, consists of tools, machinery, busi- 
 ness buildings, transportation systems, raw material, etc.^ 
 Capital cannot be looked upon as an independent factor of 
 production, since it is derived from the labor of man applied to 
 nature. This fact has led some persons to say that capital is 
 simply stored-up labor, but this overlooks the important ele- 
 ment of time required for production with the aid of capital. 
 When we say that to print a book according to present-day 
 methods requires the cooperation of labor and capital, we do 
 not deny that the type-setting machines and printing presses 
 which are used are themselves the product of other kinds of 
 labor applied to nature. To substitute capital for labor may 
 seem to be simply substituting one kind of labor for another. 
 But a long time elapses between the digging of the iron ore and 
 the actual using of the machines in printing, and this means 
 waiting for results on the part of some one. Capitalistic produc- 
 tion, as distinct from simple hand labor, is merely a different 
 method — a roundabout method — of applying human labor 
 to the materials of nature. It is this time element which gives 
 rise to the problem of interest to be discussed in a later chapter. 
 
 " Capital is an intermediate product of nature and labor, nothing more. 
 Its own origin, its existence, its subsequent action, are nothing but stages in 
 the continuous working of the true elements, nature and labor. They, and 
 they alone, do everything from beginning to end in bringing consumption 
 goods into existence. The only distinction is that sometimes they do it all 
 at once, sometimes by several stages. In the latter case the completion of 
 each stage is marked outwardly by the appearance of a fore-product or inter- 
 mediate product, and capital has emerged. But, let me ask, is a thing any 
 
 1 We may here again caution the reader against confusing these concrete goods 
 with their value. A factory building might sell for $100,000, but the capital is the 
 building itself, not its money value. 
 
122 OUTLINES OF ECONOMICS 
 
 the less the work of its author that it is not produced all at once, but in in- 
 stallments? If today, by allying my labor with natural powers, I make 
 bricks out of clay, and tomorrow, by all3dng my labor with natural gifts, 
 I obtain lime, and the day after make mortar and so construct a wall, can it 
 be said of any part of the waU that I and the natural powers have woi made it? 
 Again, before a lengthy piece of work, such as the bmlding of a house, is 
 qtiite finished, it must naturally be at one time a fourth finished, then a half 
 finished, then three quarters finished. What, now, wotild be said if one were 
 to describe these inevitable stages of the work as independent requisites of 
 house-building, and maintain that, for the building of a house, we require, 
 besides building materials and labor, a quarter-finished house, a half- 
 finished house, a three-quarters finished house? In form perhaps it is 
 less striking, but in effect it is not a whit more correct, to elevate those 
 intermediate steps in the progress of the work, which outwardly take the 
 shape of capital, into an independent agent of production by the side of 
 nature and labor." ^ 
 
 For some purposes it is important to distinguish fixed capital, 
 which lasts for a succession of operations, from circulating 
 capital, which is used up in one act of production. Coal used 
 in a locomotive is an example of circulating capital; the car 
 in which the coal is hauled is fixed capital. The difference 
 is one of degree only.^ 
 
 Saving and Capital Formation. — From the individual stand- 
 point, saving means the postponement of consumption. To 
 lend to another, and thus secure a claim on his services for the 
 future, is an act of individual saving, but this does not necessarily 
 result in saving from the social standpoint. An act can be 
 termed social saving only when the total social income in the 
 future will be increased thereby. It is conceivable that this 
 might take the form of merely hoarding up finished consumption 
 goods in anticipation of a famine, but that is not the kind of 
 saving that is typical of modern industrial nations. It is true, 
 
 1 Bohm-Bawerk, Positive Theory of Capital (trans, by W. Smart), p. g6. 
 
 2 The difference between fixed and circulating capital has to be recognized in 
 the accounting systems of business undertakings. Since the unit of time for which 
 accounting attempts to state costs and profits accurately is usually a year, items of 
 capital which are ordinarily acquired and disposed of ("turned over") within a 
 year are called "current assets," while items of capital whose period of normal use 
 is more than a year are called "capital assets." Both kinds of assets are, of course, 
 capital in the economic sense, except that land is always included in "capital assets." 
 
PRODUCTION 123 
 
 however, that we frequently produce durable consumption 
 goods which will be used for a long time in the future. The 
 construction of a public library building thus involves real 
 social saving. 
 
 But true social saving may also take the form of bettering 
 the industrial equipment of society. To provide more and 
 better machines it is necessary to use some of the labor which 
 might be used to increase our present income. If all of the 
 labor now used in the construction of new milling machinery, 
 ovens, etc., were employed in turning into bread all of the 
 flour we now have on hand, we could doubtless greatly increase 
 temporarily our present income in bread, but it would be at the 
 expense of the future income. Thus the saving which results 
 in the formation of social capital requires two things: (i) 
 abstaining from the largest possible income today, and (2) 
 using part of our labor in bettering the industrial equipment. 
 
 Organization of the Productive Factors. — The three factors, 
 land, labor, and capital, must be brought together for purposes 
 of production. In the case of many farmers and small-scale 
 manufacturers, all three are furnished by the same person, but 
 under our system of private property, a marked differentiation 
 of ownership takes place as industrial development becomes 
 more complex. In a large-scale establishment it is the ex- 
 ceptional case where the majority of the laborers have any share 
 in the ownership of the capital, but generally the owners of the 
 capital are also the owners of the land. In American agri- 
 culture, ownership of the land and the capital by the same person 
 is also common, but in England at the present time it is the 
 rule that the landowner and farmer are different persons. On 
 the other hand, factories are frequently built upon leased ground, 
 and much land is farmed in America by tenants who furnish 
 their own capital. Separation in the ownership of the produc- 
 tive factors makes necessary a distinct valuation of the services 
 of each one of the factors. 
 
 The Entrepreneur, or Undertaker. — The one who manages a 
 business for himself was formerly called an undertaker, or ad- 
 venturer, but the first word has been appropriated by one small 
 
124 OUTLINES OF ECONOMICS 
 
 class of business men, and the latter has acquired a new mean- 
 ing, carrying with it the implication of rashness and even 
 dishonesty. We have consequently been obliged to resort to 
 the French language for a word to designate the person who 
 organizes and directs the productive factors, and we call such a 
 one an entrepreneur. The entrepreneur also assumes a large 
 measure of business risks and uncertainties. 
 
 The function of the entrepreneur has become such an im- 
 portant one in modern society that it is often convenient to 
 regard him as a fourth factor in production, distinct from other 
 classes of laborers. He has been well called a captain of in- 
 dustry, for he commands the industrial forces, and upon him 
 more than any one else rests the responsibility of success or 
 failure. A business which has achieved magnificent success 
 often becomes bankrupt when, owing to death or other causes, 
 an unfortunate change in the entrepreneur is made. The 
 prosperity of an entire town has sometimes been observed to 
 depend upon half a dozen shrewd captains of industry. 
 
 Division of Labor. — A characteristic feature of the organiza- 
 tion of the factors is what is commonly called a division of labor, 
 but this term suggests a number of related ideas which must be 
 distinguished, (i) We may mention first a separation of occupa- 
 tions, each one being independent of the other, as is shown, for 
 example, in the splitting up of medical work into various special- 
 ties, and again, entirely new occupations are continually appear- 
 ing. (2) We also find production divided into stages, each 
 one giving rise to a commercial product, but not to a finished con- 
 sumption good. This becomes clear if we think of the history 
 of almost any article of daily use: the making of bread pre- 
 supposes the flour and wheat stages. (3) We have in the third 
 place what is most commonly referred to by the term " division 
 of labor," where the productive process is divided into minute 
 parts, and one part given to each laborer. The organization 
 of a cotton mill affords an excellent illustration : 
 
 In cotton mills, as in all other textile mills, there are men of skill and ex- 
 perience who superintend or oversee the work in various buildings and in 
 the rooms and yards. These supervisory employees have assistants, and 
 
PRODUCTION 125 
 
 the division of superintendence is carried down to the sections of rooms, so 
 that all sections have their supervisors, known variously as section bosses, 
 section hands, section girls, and third hands. The following Hst of occupa- 
 tions wiU indicate the extent to which division of labor is carried in this 
 industry : alley boys (or girls) ; bundle boys ; filling and roving carriers ; 
 belt makers, blacksmiths, carpenters, machinists, masons, painters, steam 
 fitters, and other mechanics, including sometimes electricians and battery- 
 men ; roll coverers ; helpers ; laborers (unskilled) ; bale openers ; picker 
 hands or cotton shakers; lap tenders; card brushers; first and second 
 breaker hands; finisher pickers; card boys; card hands; waste hands; 
 wastemen ; card clothiers ; card strippers ; card grinders ; combers ; lap- 
 head hands ; doublers ; drawing-frame tenders ; railway-head tenders ; slub- 
 bers ; speeders, fly-frame tenders ; jack tenders ; rovers ; spinners ; bobbin 
 boys; yam pourers; piecer and doffer; back boy; band boys; doublers 
 and twisters ; winders ; yarn untanglers ; spool boys, white spoolers ; warp- 
 ers; slasher tenders; size makers; reel hands; dye-house hands (with 
 further subdivisions) ; beamers and splitters ; beam carriers ; warp drawers ; 
 harness menders ; harness brushers ; handers-in ; twisters-in ; loom fixer ; 
 pattern makers ; putters-up of samples ; cloth weavers ; weavers of designs ; 
 yam carriers ; smash piecers ; spare weavers ; inspectors ; trimmers. The 
 finishing of the cloth is a separate industry .^ 
 
 This form of the divison of labor may also exist without the 
 use of complex machinery, as in the slaughtering and meat- 
 packing industry. 
 
 "It would be difficult to find another industry where division of labor has 
 been so ingeniously and microscopically worked out. The animal has been 
 surveyed and laid off Hke a map ; and the men have been classified in over 
 thirty specialties and twenty rates of pay from 16 cents to 50 cents an hour. 
 The 50-cent man is restricted to using the knife on the most delicate parts of 
 the hide (floorman) or to using the ax in sphtting the backbone (splitter) ; 
 and wherever a less skilled man can be slipped in at 18 cents, i8| cents, 20 
 cents, 21 cents, 22^ cents, 24 cents, 25 cents, and so on, a place is made for 
 him and an occupation mapped out. In working on the hide alone there are 
 nine positions at eight different rates of pay. A 20-cent man puUs off the 
 tail, a 22I cent man pounds off another part where the hide separates readily, 
 and the knife of the 40-cent man cuts a different texture and has a different 
 * feel ' from that of the 50-cent man. Skill has become specialized to fit the 
 anatomy." ^ 
 
 * From the Glossary of Occupations in the volume on Employees and Wages. 
 Twelfth Census, Special Reports, 1903. 
 
 * Commons, Trade Unionism and Labor Problems, p. 224, in a chapter appearing 
 originally in the Quarterly Journal of Economics, vol. xix, p. i. 
 
126 OUTLINES OF ECONOMICS 
 
 Advantages of Division of Labor. — The advantages of a 
 division of labor have been enumerated as follows : (i) A gain 
 of time. A change of operations costs time. Less time is 
 also consumed in learning one's business, as the labor of each is 
 more simple. (2) Greater skill is acquired, because each person 
 confines himself to one operation. (3) Labor is used more 
 advantageously. Some parts of an industrial process can be 
 performed by a weak person, others require unusual physical 
 strength; some require extraordinary intelligence, some can 
 be performed by a man of very ordinary intellectual powers. 
 Special capacities are best utilized, and work is found for all, 
 young and old, weak and strong, stupid and intelligent. (4) 
 Inventions are more frequent, because the industrial processes 
 are so divided that it is easy to see just where an improvement 
 is possible. Besides this, when a person is exclusively engaged 
 in one simple operation, he often sees how the appliances he 
 uses could be improved. Workmen have made many important 
 inventions. (5) Capital is better utilized. Each workman uses 
 one set of tools, or one part of a set, and keeps that employed 
 all the time. When each workman does many things, he has 
 many tools, and some are always idle. (6) Finally, where the 
 division of labor results in the simplification of operations, it 
 facilitates the substitution of machinery with mechanical 
 power in place of direct human labor. It would, for example, 
 probably be impracticable to make a machine which would 
 directly convert leather into finished shoes. But it has been 
 found a relatively simple matter to devise machines which will 
 successfully accomplish each of the successive steps in shoe- 
 making. Such a subdivision and simplification of manufacturing 
 processes is only possible when they are conducted on a large 
 scale. " It is the largeness of markets, the increased demand 
 for great numbers of things of the same kind, and in some cases 
 of things made with great accuracy, that leads to subdivision of 
 labor; the chief effect of the improvement of machinery is to 
 cheapen and make more accurate the work which would any- 
 how have been subdivided." ^ 
 
 1 Marshall, Principles of Economics, 6th ed., p. 255. 
 
PRODUCTION 127 
 
 Effects upon the Worker. — The effect of the introduction of 
 machinery upon wages will be discussed in a later chapter, but 
 here some attention must be given to the effect of division of 
 labor and machinery upon the life of the worker. It is fre- 
 quently said that when labor is rendered simple it loses both its 
 attractiveness and its educational value. A man can enjoy his 
 work when he manufactures a whole watch, bearing the impress 
 of care and skill, but who can like the mere routine of feeding 
 material into some machine? A workingman becomes a mere 
 cog in a great mechanism, driven at a certain speed, day after 
 day, with no further interest in the result of his labor than that 
 it is the source of his daily wage. But much may be said on the 
 other side. To a large extent the heaviest labor is done with 
 mechanical appliances, and those movements which are very 
 simple and regular are precisely the ones which are likely to be 
 taken over by machinery, leaving to human beings the work 
 which requires intelligence and skill. 
 
 "Looked at broadly, is the average work of a laborer in a machine industry 
 less dignified, less agreeable, less humanizing than it was before the industry 
 reached the machine stage? From the nature of the question, it is danger- 
 ous to dogmatize, because neither the affirmative nor the negative is capable 
 of being demonstrated. The negative view seems to rest mainly upon the 
 assumption that it is more dignified to be occupied with a great many purely 
 mechanical operations than with a very few. The old-fashioned shoe- 
 maker, for example, was largely occupied with purely mechanical opera- 
 tions, most of them of a very elementary nature, such as a machine can do 
 quite as weU as a man. Each of these operations required great concen- 
 tration of attention, leaving him very little opportunity for other forms of 
 mental activity. He was the slave of each particular task as truly as a 
 modern machine worker can be said to be the slave of his single task. But 
 the old-fashioned shoemaker had to turn from one kind of work to another. 
 This increased the difficulty, and, on the whole, required of him a greater 
 amount of concentration than is now required of the operator of a machine. 
 The latter, who has but one routine task to learn, learns it easily, and can 
 carry it out without very intense concentration of mind. His mind, there- 
 fore, would seem to be freer than that of the old hand worker, though there 
 was more variety to the work of the latter. Whether this greater variety 
 is to his advantage or disadvantage would be difficult to determine off- 
 hand. It looks as though the operator of a machine in a shoe factory, 
 being relieved of the necessity of acquiring several forms of specialized 
 
128 OUTLINES OF ECONOMICS 
 
 manual dexterity, would be in a better position for free mental activity than 
 the old-fashioned shoemaker." i 
 
 It seems that those who declaim against factory life do not 
 always distinguish those things which are temporary from 
 things which are inherent in the system. Long hours, insanitary 
 conditions of work, and frequent industrial accidents need not 
 be inevitable accompaniments of the use of machinery. It is 
 the efhciency of machine methods that makes leisure possible 
 for the workingmen, and when they learn to use that leisure 
 sanely, their condition will be far in advance of what it could 
 be under more primitive methods of production. 
 
 The charge is also brought against machine production that it 
 is antagonistic to the development of art. Machine production 
 means uniform production. It is possible that a growth in the 
 desire for what is beautiful rather than cheap will limit the use 
 of machinery in some directions (e.g. we may insist upon more 
 hand work in the making of furniture) , but an extensive use of 
 machinery as a servant of art will always be necessary, and 
 that in two ways : (i) For an appreciation of art there must be 
 leisure, or at least leisurely work, and without machine methods 
 this is not possible for the masses. (2) There is much work that 
 is preliminary to the work of the artist, and that can be done by 
 machinery. Will a building be less artistic because much of the 
 heavy work of dressing the stone is done by machinery ? Taken 
 as a whole, however, we have probably been too much inclined 
 to view progress as something that causes tons per capita to 
 increase by leaps and bounds, rather than as something that 
 improves the quality of our enjoyments. 
 
 Territorial Division of Labor. — The concentration of a certain 
 industry in a particular region is often called the territorial 
 division of labor, or the localization of industry. Illustrations 
 are seen in the prominence of the boot and shoe industry in 
 Massachusetts ; the collar and cuff manufacture in Troy, New 
 York ; oyster canning in Baltimore ; the manufacture of gloves 
 in Gloversville and Johnstown, New York ; of coke in the Con- 
 
 ^T. N. Carver, "Machinery and the Laborers," Quarterly Journal of Economics, 
 vol. xxii, p. 230. 
 
PRODUCTION 
 
 129 
 
 nellsville district, Pennsylvania; of brassware in Waterbury, 
 Connecticut ; of carpets in Philadelphia ; of jewelry in Provi- 
 dence, Rhode Island, and Attleboro and North Attleboro, Massa- 
 chusetts ; slaughtering and meat packing in Chicago ; the man- 
 ufacture of plated and britannia ware in Meriden, Connecticut ; 
 and of silk in Paterson, New Jersey. The following causes 
 of localization have been mentioned : (i) proximity to raw 
 material, (2) accessibility of markets, (3) presence of water 
 power, (4) favorable climate, (5) availability of labor, (6) 
 availability of capital, and (7) the momentum of an early start. 
 The explanation of how these causes have operated in particular 
 instances is left as an exercise for the student.^ 
 
 Productive Organization of the American People. — Accord- 
 ing to the Census of 19 10 about two fifths of the total population 
 and about one half of the population ten years of age and over 
 are engaged in gainful occupations. In the following table 
 the extent to which persons in each age group are gainfully em- 
 ployed is shown for each sex : 
 
 TABLE I 
 
 NtJMBER AND PERCENTAGE ENGAGED IN GAINFUL OCCUPATIONS FOR SPEC- 
 IFIED Age Groups of Males and Females: 1910^ 
 
 
 Males of Specified Age 
 
 Females of Specified Age 
 
 Age 
 
 Number 
 
 Engaged in Gainful 
 Occupations 
 
 Number 
 
 Engaged in Gain- 
 ful Occupations 
 
 
 Number 
 
 Per 
 
 Cent 
 
 Number 
 
 Per 
 Cent 
 
 10-13 years 
 14-15 years 
 16-20 years 
 21-44 years ^ 
 45 years and 
 over . . 
 
 3,665,779 
 1,798,449 
 
 4,564,179 
 17,848,843 
 
 9,149,308 
 
 609,030 
 
 744,109 
 
 3,615,623 
 
 17,262,209 
 
 7,860,593 
 
 16.6 
 41.4 
 79.2 
 96.7 
 
 85-9 
 
 3,593,239 
 
 1,770,898 
 
 4,632,821 
 
 16,331,449 
 
 8,224,305 
 
 286,946 
 
 350,140 
 
 1,847,600 
 
 4,302,969 
 
 1,288,117 
 
 8.0 
 19.8 
 
 39-9 
 26.3 
 
 iS-7 
 
 10 years and 
 over . . 
 
 37,027,559 
 
 30,091,564 
 
 81.3 
 
 34,552,712 
 
 8,075,772 
 
 234 
 
 ^ Consult Hall, "The Localization of Industry," Census Bulletin No. 244 (also 
 found in Twelfth Census, Manufactures, Part i, p. cxc), and Ross, "The Locali- 
 zation of Industry," Quarterly Journal of Economics, vol. x, p. 247. Also the 
 Federal Census of Manufactures for 1905, vol. i, Chap. xii. 
 
 'Thirteenth Census, vol. iv, p. 69. ^ Includes persons of unknown agfc 
 
I30 
 
 OUTLINES OF ECONOMICS 
 
 The following table shows the distribution of the gainful 
 workers among the five main classes of occupations. The most 
 striking facts are the decline in the relative importance of agri- 
 cultural pursuits and the increase in the relative importance of 
 trade and transportation. 
 
 TABLE II 
 
 Distribution by Main Classes of Persons Engaged in Gainful Occu- 
 pations 
 
 Class of Occupation 
 
 1910 
 
 1900 
 
 1890 
 
 1880 
 
 Agricultural pursuits 
 
 Professional service 
 
 Domestic and personal service . . 
 Trade and transportation .... 
 Manufacturing and mechanical pursuits 
 
 32.9 
 4.8 
 
 14.0 
 19.9 
 28.3 
 
 35-7 
 4-3 
 19.2 
 16.4 
 24.4 
 
 39-2 
 
 4.0 
 
 18.1 
 
 14-3 
 24.4 
 
 44-3 
 3-5 
 19.6 
 10.8 
 21.8 
 
 All occupations 
 
 100. 
 
 100. 
 
 100. 
 
 1 00.0 
 
 The broad territorial division of labor is seen when these per- 
 centages are given separately for groups of states : 
 
 TABLE III 
 
 Percentage Distribution of Persons 10 Years of Age and Over En- 
 gaged IN Gainful Occupations, by Geographic Divisions : 1910 ^ 
 
 
 
 
 ^ 
 
 
 
 
 Ed 
 
 
 § f^ 
 
 6 
 
 Division 
 
 1 
 
 
 
 H 
 < 
 
 < 
 
 i 
 
 P4 
 
 H 
 
 
 
 
 
 ij 
 
 
 < 
 
 g 
 
 § 
 g 
 
 < 
 
 H 
 
 H 
 
 ^^0 
 
 
 3 rt 
 w 
 
 PS P< 
 
 New England . . . 
 
 10.4 
 
 0.3 
 
 49.1 
 
 6.5 
 
 10.6 
 
 1-7 
 
 4.8 
 
 10.7 
 
 5-9 
 
 Middle Atlantic . . 
 
 lO.O 
 
 4.2 
 
 40.6 
 
 8.0 
 
 12.0 
 
 1.4 
 
 4.9 
 
 11.8 
 
 7-1 
 
 East North Central . 
 
 25.6 
 
 2.6 
 
 33-2 
 
 7.6 
 
 10.6 
 
 I.I 
 
 4.8 
 
 9.2 
 
 S-S 
 
 West North Central . 
 
 41.2 
 
 1.8 
 
 20.0 
 
 7.8 
 
 10.4 
 
 I.I 
 
 S.2 
 
 8.^ 
 
 3-9 
 
 South Atlantic . . . 
 
 =;i-4 
 
 1.8 
 
 18.6 
 
 H-o 
 
 6.1 
 
 I.O 
 
 3-0 
 
 10. ■; 
 
 2.6 
 
 East South Central 
 
 63.2 
 
 I.Q 
 
 12.4 
 
 4.0 
 
 S-3 
 
 0.6 
 
 2.6 
 
 8.4 
 
 1-7 
 
 West South Central . 
 
 60.1 
 
 0.7 
 
 12.6 
 
 ^.2 
 
 7.0 
 
 0.8 
 
 3-3 
 
 8.1 
 
 2.1 
 
 Mountain .... 
 
 32.4 
 
 9-4 
 
 19.5 
 
 10.3 
 
 8.7 
 
 1-7 
 
 5-2 
 
 Q.I 
 
 3-6 
 
 Pacific 
 
 22.6 
 
 2.4 
 
 27.2 
 
 10.3 
 
 12.6 
 
 2.0 
 
 6.0 
 
 II-3 
 
 ';■'? 
 
 United States . . . 
 
 33-2 
 
 2-5 
 
 27.9 
 
 6.9 
 
 9-5 
 
 1.2 
 
 4.4 
 
 9.9 
 
 4.6 
 
 1 Thirteenth Census, vol. iv, p. 45. 
 
PRODUCTION 131 
 
 QUESTIONS 
 
 1. Is the employee in a planing mill in a worse position than the old-time 
 carpenter who has to do his planing by hand? 
 
 2. Is the keeper of a gambling estabUshment a producer of wealth? 
 
 3. Is an insurance agent a producer of wealth? 
 
 4. What would happen if there should be too much saving? 
 
 5. Why is Massachusetts the center of the boot and shoe industry? 
 
 6. Write a survey of national resources and production in the United 
 States from data in the Statistical Abstract of the United States. 
 
 REFERENCES 
 
 Ely, R. T. Property and Contract, Vol. ii, Appendix iii. 
 
 Fisher, Irving. The Nature of Capital and Income, Chaps, v and vi. 
 
 HoBSON, J. A. The Social Problem, Book ii, Chap, ii ; and Work and Wealth, 
 
 Chaps, iv-viii. 
 Marshall, Alfred. Principles of Economics, 6th ed., Book iv. 
 National Conservation Commission, Report (1909). 
 Thirteenth Census, Reports. 
 Statistical Abstract of the United States (annual). 
 Taussig, F. W. Principles of Economics, Vol. i. Chaps, ii-v. 
 Van Hise, C. R. Conservation of Natural Resources in the United States. 
 Veblen, Thorstein. The Theory of Business Enterprise, Chaps, ii and iii. 
 
CHAPTER IX 
 CONSUMPTION 
 
 Consumption Defined. — Consumption means, in economics, 
 
 the use of goods in the satisfaction of human wants, directly or 
 indirectly. It is the chief incentive to economic activity, but 
 it is not the sole incentive, for such activity is to a certain extent 
 an end in itself. Nevertheless, in economic society as it is 
 organized to-day we are justified in looking upon the consumption 
 of material goods in the satisfaction of human wants as the 
 essential motive and purpose of the production of such goods. 
 Wants are so far from satisfied that most men must work, not 
 because of the pleasure they may derive from the exercise of 
 their capacities, or to utilize fully their natural energies of 
 brain or muscle, but because they need or crave the goods 
 which their wages will buy. Regarded as an incentive to 
 economic activity, consumption should, of course, be defined 
 so as to include the use made of direct personal services as well 
 as of material goods. 
 
 The philosophy of the consumption of wealth falls only partly 
 within the domain of economics, for the use of wealth is a large 
 part of the problem of life. Passing judgment on the rational 
 standards according to which the true importance of different 
 wants should be measured does not directly concern us in the 
 study of economics. 
 
 Productive and Final Consumption. — When used without 
 qualification, the word " consumption " in economics is com- 
 monly taken to refer to the use of goods or services to satisfy 
 wants directly. But some goods, such as machines and raw 
 materials, are used up in the production of other goods. This 
 we may call productive consumption, while that consumption 
 which results directly in the satisfaction of wants is final con- 
 sumption. It is now less necessary than it was in the days of 
 
 132 
 
CONSUMPTION 133 
 
 Carlyle and Ruskin to insist that food consumed by laborers 
 is not productive consumption. It is true that some analogy 
 lies between the consumption of fuel by an engine and the con- 
 sumption of food by a worker, but there is the very important 
 difference, that the engine is specifically adapted to render 
 economic service and cannot be conceived to derive any benefit 
 whatever from its consumption of fuel, while in the case of the 
 worker the consumption of food is determined with primary 
 reference to his natural appetites and individual welfare. Man 
 is our final term. 
 
 Human Wants. — In the study of human wants as a starting 
 point in economic theory, two facts stand out prominently : the 
 expansion in the number and variety of wants, and the satiability 
 of any particular one of them. As man has progressed from 
 savagery to civilization, the variety of things he desires and even 
 considers necessary to his existence has expanded enormously. 
 His interests become more varied, his capacity to enjoy becomes 
 larger, and he lives a fuller and more complex existence. There 
 are indeed those who would have us " return to nature " and 
 live a simple life, but taking the world as it is, the expansion of 
 human desires with passing time appears to be without limit. 
 
 But when we turn to consider some specific want by itself, as 
 it is at any particular time, the matter is different. Our nerves 
 weary of a repeated stimulus, and any attempt to continue 
 indefinitely the enjoyment of some sensation results in satiation. 
 A phonograph record grows stale after a number of repetitions. 
 An apple has differing degrees of utility for any one of us, vary- 
 ing from the highest degree, if we are on the point of starvation, 
 to disgust, if a considerable number have just been consumed. 
 
 Law of Diminishing Utility. — The fact that the intensity of 
 our desire for additional units of a commodity decreases as we 
 acquire successive units is of fundamental importance in economic 
 science. And this " law of diminishing utility," as it is called, 
 rests upon a broader basis of human experience than the mere 
 satiability of the appetite for a particular kind of food, or the 
 growing weariness of the nerves under the repetition of a partic- 
 ular stimulus. The truth is that most commodities serve a 
 
134 OUTLINES OF ECONOMICS 
 
 multitude of different needs and different purposes, and that 
 these needs and purposes vary greatly in their importance. It 
 is better to have two suits of clothes than to have one, but it is 
 by no means twice as important. And a third, or a fourth, 
 or a tenth suit, are, in order, of rapidly decreasing importance. 
 How large shall my building lot be? How many rooms shall 
 I have in my house? How much electric current shall I use 
 for lighting purposes? How many motor cars shall I own? 
 How many servants shall I employ? Questions such as these 
 at once suggest the way in which a certain minimxim amount of 
 a given commodity or of a given service may be deemed ex- 
 ceedingly important for our purposes, and how a diminishing 
 importance is attached to successive additional portions or 
 increments. So far as any one commodity is concerned it is 
 in general less important to have more than to have some. 
 
 To guard against possible misunderstanding a word of caution 
 is necessary at this point. With passing time the use of a partic- 
 ular commodity often cultivates a taste for it, so that an increased 
 supply is more urgently desired than were the earlier increments. 
 Thus familiarity with good books or good pictures or good 
 music may increase the pleasure that we find in such things, and 
 so may intensify our desire to have more. And bad habits, 
 like good ones, are prone to " grow on us." Such, for example, 
 is the case in the use of habit-forming drugs. But these facts 
 do not contradict the law of diminishing utility. For that law 
 relates only to the consumer as he is at any given time, with 
 whatever possessions, habits, desires, and aversions are his at 
 that time. Men change and their wants change, and the 
 character of a man's consumption is, of course, a very important 
 factor in changing his wants. But just now we are considering 
 men as potential buyers of more goods or sellers of surplus goods 
 in a given market at a given time, and for men so considered 
 the law of diminishing utility expresses a fundamental truth of 
 very great significance. 
 
 A thoughtful reader may object that in view of the considerations urged 
 in the preceding paragraph such illustrations as that of the satiety resulting 
 from eating a number of apples are not exactly to the point, for when the 
 
CONSUMPTION 13S 
 
 hungry eater of apples becomes a satiated eater of apples, he is, in that 
 respect, a "changed person." It is true that some expositions of the prin- 
 ciple of diminishing utihty attach altogether too much importance to what 
 have been called "dinner-table illustrations." But the real point in the 
 matter is that the satiation of the appetite is a familiar fact of experience, 
 which has an important bearing upon the character of our wants as they 
 manifest themselves at any otie time. If I am hungry, but have six apples, 
 I wiU give less for another apple than if I had only one. 
 
 Marginal Utility. — It must be evident, therefore, that to 
 say that a certain thing possesses utility is very indefinite. That 
 merely tells us that it is capable of satisfying some want, per- 
 haps important, perhaps unimportant. And, furthermore, 
 one may use some units of a commodity in the satisfaction of 
 very important wants, and other units of the same commodity 
 in the satisfaction of relatively unimportant wants. This 
 amounts to saying that for any one person different units of 
 the same commodity may possess very different degrees of 
 utility. The utility of the final or marginal unit of a person^ s 
 stock of a given commodity is called the marginal utility of that 
 commodity to that person. If, for example, a boy has six apples, 
 the marginal utility of apples to him is simply the utility (or 
 want-satisfying capacity) of the sixth apple. This does not 
 mean the utility of any particular apple, but does mean (if the 
 apples are all alike) the utility dependent on the possession of 
 any one apple of his stock of six. This will be less than if he 
 had fewer apples, and more than if he had a larger number. 
 So with a householder who has a stock of ten tons of coal for 
 his winter's supply. The tenth ton (any one ton of the ten) 
 is the marginal ton ; and the utility it adds is the marginal utility 
 of coal to the householder. Marginal utility thus depends upon 
 the intensity of the want dependent for its satisfaction upon the 
 possession of one unit of a commodity. The larger one's supply 
 of a commodity, the smaller in general will be the importance 
 one attaches to the possession of any one unit of the supply. 
 
 Some writers prefer to define marginal utility as the utility of an addi- 
 tional unit of a commodity rather than as the utility of the last unit of one's 
 present stock. In some applications of economic analysis it is convenient 
 to think of the successive units or increments in the supply of a commodity 
 
136 
 
 OUTLINES OF ECONOMICS 
 
 as indefinitely small. In this case the difference beween the "last unit" 
 and an "additional" unit becoines neghgible. But for many purposes it is 
 more convenient to think of the size of our successive increments as being 
 that of the ordinary units in which goods are customarily bought and 
 sold. In such cases whether the "last unit" or the "additional unit" should 
 be considered the marginal unit depends upon whether we think of the 
 individual concerned as a possible seller or a possible buyer. If the boy 
 with the apples is weighing the desirability of having yet another apple 
 against that of some peanuts he would have to part with in exchange for 
 it, the marginal utility of apples to him may properly be said to be the 
 utility of the additional apple, for this is the basis of its subjective impor- 
 tance for the purpose in hand. But if he is contemplating the exchange of 
 an apple for additional peanuts the marginal utility of apples to him depends 
 upon the importance of the sixth apple. It is always accurate to identify 
 marginal utility with the utility of the last unit of a stock, if we remember 
 that in some cases it is the last unit of an existing stock and in other cases 
 the last unit of a (possibly) increased stock. 
 
 Marginal Utility Illustrated. — A clearer notion of marginal 
 utility may be given with the help of Figure i, following. We 
 
 take for our illustration 
 the consumption of water, 
 which has numerous uses 
 of various degrees of im- 
 portance. We have marked 
 off different portions of the 
 base line representing quan- 
 tities of water available for 
 man's use. The first quan- 
 tity, ab, is just enough for 
 drinking purposes. Sup- 
 pose this is all the water 
 to be had. There will be no question of sprinkling lawns or 
 even of bathing under such circumstances. What will be the 
 utility of water? Evidently the extent of the service which 
 it renders us, and as this is the preservation of our life we cannot 
 estimate it. We will indicate it by the area above the line ab 
 which runs upward indefinitely as the curved line fails to close 
 in. What will be the importance of another portion of water 
 at this point of supply? As this additional portion which we 
 
 Fig. I 
 
CONSUMPTION 137 
 
 desire is not needed for drinking but for a less important pur- 
 pose, the marginal utility of the water will now depend upon 
 the urgency of this less-important want. Now suppose we 
 have three portions of water, represented by the lines ab, 
 be, and cd. We now have enough for all our wants, down 
 to sprinkling the lawn and the street. We are willing to 
 pay something for more water for this purpose, but how 
 much? As much as when we had only water enough to drink? 
 By no means. The next want on our list is comparatively 
 unimportant, and of course we appraise an increased supply 
 accordingly. With two or three more portions of water all 
 our wants are satisfied, and the marginal utility of water 
 wUl have become zero. As the amount of water is increased, 
 the utility falls according to the curved line hi, till finally it 
 touches the base line, where the marginal utility of the water 
 vanishes. 
 
 Subjective Value. — As we proceed in our study we shall see 
 that the most important problem of economics is that of as- 
 certaining the laws which determine the prices of different goods 
 and services. To some goods and some services more impor- 
 tance is attached than to others, and larger quantities of the less 
 important goods and services can be obtained in exchange for 
 smaller quantities of the more important goods and services. 
 This is a matter of prime significance, since it determines the 
 way in which the different persons who contribute goods and 
 services to the aggregate wealth-product of the community will 
 be able to secure shares in it. 
 
 We are not yet ready to attack the general problems of value, 
 but we can take an important step forward at this point by 
 grasping the meaning of subjective value. 
 
 The subjective value of a good is not, of course, a definitely 
 measurable objective quality of the good, like weight or exten- 
 sion. It is, as the word " subjective " implies, purely psycholog- 
 ical, and may be different for different persons. It is, moreover, 
 purely relative. The subjective valuation of things always 
 implies the choosing of some things rather than others. In 
 other words, it involves a determination of their comparative 
 
138 OUTLINES OF ECONOMICS 
 
 importance for one's own purposes. More formally stated, the 
 subjective value of a good to any person is that person's estimate of 
 the importance of possessing that good as compared with the im- 
 portance of possessing other goods. 
 
 But we do not value things in the abstract, or in indefinite 
 quantities. In buying coal or sugar or oranges we do not have 
 to confront the alternatives of either doing entirely without such 
 commodities or acquiring an indefinitely large supply. If we 
 decide to buy at all, we may buy as little as we please. Our 
 choices, in practice, resolve themselves into questions of more 
 or less. Even in the case of an indivisible good — an auto- 
 mobile, for example — one may choose between having more or 
 less of certain desirable qualities, such as size, or power, or 
 attractive finish. And it is evident that whether the importance 
 that we attach to the possession of an additional unit of a cer- 
 tain good is greater or less than the importance that we attach 
 to an additional unit of some other good will depend, very 
 largely, upon the extent to which our wants for each of the 
 goods in question are satisfied without the possession of the 
 additional unit. Put in other words, the question is: Which 
 good has the higher marginal utility? 
 
 Subjective value, then, involves a balancing or comparison 
 of marginal utilities. In fact, we may say that the subjective 
 value of a good is the expression of its relative marginal utility. In 
 this statement the word relative is used in order to emphasize 
 the element of comparison or choice. 
 
 The Subjective Value of a Stock of Goods. — It should be 
 carefully noted that marginal utility tells us nothing about the 
 total subjective value of one's whole stock of the commodity. 
 It refers solely to the present value of an additional unit, or 
 the sacrifice that would be occasioned by the loss of a unit. We 
 cannot get the total subjective value of a stock of goods by mul- 
 tiplying the marginal utility by the number of units, even though 
 they be all alike. The very term " marginal " tells us that the 
 conception implies successive additions, and the present im- 
 portance of one unit tells us nothing definite about the im- 
 portance of the other units. If we wish to ascertain the total 
 
CONSUMPTION 
 
 139 
 
 subjective value of a stock of a commodity, we have simply to 
 treat it as one large unit, and ask what would be lost if it were 
 taken away. By this test all air would be found to have an 
 immeasurable utility, at the same time that the subjective value 
 of an additional cubic foot would be nothing. Thus it will be 
 seen that the cause of subjective value is utility under a condi- 
 tion of scarcity ; that is, such a limitation of the supply that not 
 all Wants can be satisfied. 
 
 The Economic Order of Consumption. — What has been said 
 regarding the way in which our individual estimates of the im- 
 portance of a commodity are determined will help to explain 
 how we make our choices in attempting to obtain the largest 
 
 la 
 
 
 
 lb 
 
 
 
 Ic 
 
 
 
 Id 
 
 le 
 
 2a 
 
 2h 
 
 2e 
 
 2cl 
 
 2e I 
 
 Fig. 2 
 
 Fig. 3 
 
 amount of satisfaction with the income at our disposal. Evi- 
 dently we must spend each succeeding dollar for purchasing that 
 commodity of which a dollar's worth will give the greatest 
 satisfaction. Let Figures 2 and 3 show the declining impor- 
 tance of two commodities which an individual is consuming, and 
 suppose that each unit of each commodity costs one dollar. If 
 the individual has ten dollars to spend upon these two commodi- 
 ties, his order of consumption will be as follows : he would begin 
 with 2a, but another unit of commodity 2 would give him less 
 satisfaction than a unit of commodity i. Hence, his consump- 
 tion will continue as follows : 
 
 la, 2&, 2c, i5, IC, iJ, 2J, 26, le. 
 
140 
 
 OUTLINES OF ECONOMICS 
 
 In this illustration it was assumed that a unit of each com- 
 modity had the same cost. In this case, the unit consumed is 
 always the one that has the largest utility. But where the 
 cost of the units is different, cost must be considered also, 
 and we commonly do so by asking ourselves whether the thing 
 we are buying is worth as much as other things which could be 
 obtained with the same expenditure. Thus we are constantly 
 abstaining from the further consumption of one thing, not 
 because our wants for it are fully satisfied, but because some- 
 thing else of equal cost appears at that moment to be more 
 important. 
 
 Future Wants. — Not all of the goods for which we strive are 
 wanted for present consumption. We recognize that we shall 
 
 K 
 
 fa 
 
 \ 
 
 2b 
 
 2c 
 
 Fig. 4 
 
 Fig. 5 
 
 have needs next month or next year, and we attempt to make 
 some preparation for them. These future needs, it is true, 
 usually appeal to us less vividly than if they were present, but 
 we attach a present importance to them and grade them, and 
 they enter into our calculations when we spend money, modifying 
 the order of our consumption. This will be seen from Figures 
 4 and 5. Let us suppose that in Figure 4, a, b, c, d, e represent 
 the diminishing importance of successive units of a commodity 
 for present consumption, and that Figure 5 shows the present 
 importance attached to the future consumption of similar units. 
 Then an individual would consume la, i.e. in the present. 
 But a second unit for present use would rank lower in present 
 esteem than a unit saved for future use. The unit 2a would 
 
CONSUMPTION 141 
 
 then be saved, and then the order would be as follows : ib, 
 2b, ic, etc. Thus this individual has saved two out of five 
 units, i.e. 2a and 26, with the same sort of mental calcula- 
 tion as he would use in deciding to spend a nickel for a 
 peach rather than for a pear. But if some one should ask him 
 to spend his fifth dollar for 2c instead of for ic, he would require 
 some extra inducement to induce him to postpone at ruling 
 prices. It thus appears that a certain amount of saving is done 
 without payment, but if saving is to be carried beyond a certain 
 point, it must be given some special premium or compensation. 
 This, as we shall see later, has a very important bearing upon 
 the problem of interest. 
 
 The Margin of Consumption. — Either by a conscious balancing against 
 each other of the pleasures to be obtained from two or more possible pur- 
 chases, or oftener, by simply buying the things which we want more than we 
 want other things, we tend to keep our unsatisfied wants in a state of ap- 
 proximately equal intensity. We apportion our expenditures so that our 
 money will "go as far as possible"; that is, so that it will provide those 
 things that have the strongest present appeal to us. Every person thus has a 
 margin of consumption, which is measured by the utility obtained in return 
 for the final or marginal dollar expended for any one of the things that he 
 consumes. If he unwisely expends too much for any one thing, his more 
 important unsatisfied wants for other things press upon him urgently, and 
 he is apt to try to restore the balance or equilibrium in his expenditures, 
 or, in other words, to bring his margin of consumption into alignment. 
 
 An individual's margin of consumption depends primarily on his income, 
 but also on his tastes and habits, his disposition to save, and the relative 
 emphasis which he places upon his present and his future wants. Then, 
 too, one's desires are constantly changing under the influence of whim, 
 fashion, satiety, sellers' advertising, education, travel, reading, and new 
 experiences of all kinds. Expenditures of all kinds are thus called into 
 being by the necessity of maintaining the level of the margin of consumption. 
 
 The margin of consumption is different for different persons. This is 
 partly a matter of differences in individual tastes and purposes, but it is 
 more largely a matter of differences in incomes. The larger one's income, 
 the lower, of "course, is one's margin of consumption, in the sense that one 
 is able to acquire goods in larger quantities and thus to satisfy wants of 
 less urgency. And, of course, a larger variety of commodities can be con- 
 sumed, so that as one's income increases one's margin of consumption is 
 normally extended downward and outward, including more things, but things 
 of less importance. 
 
142 OUTLINES OF ECONOMICS 
 
 Consumption and Saving. — It is dijB&cult to say just where 
 consumption should stop and saving begin, to secure the best 
 results for society as a whole, but the principle is clear. So 
 much, and only so much, should be saved as will conduce to a 
 maximum total service over long periods of time. The present 
 generation might deny itself everything except the barest neces- 
 sities, and labor to increase the productive equipment to be used 
 in the future ; but the next generation could not pursue the same 
 policy, for some one must consume the products of the factories 
 built today, otherwise the building of them is wasted effort. 
 
 Alleged Present Consumption of Future Products. — We 
 often hear of consumption in advance of production. It is 
 said people live on the future. It is frequently argued that 
 during the American Civil War we were consuming faster than 
 we were producing. It is alleged that the government borrow- 
 ings at that time represented the consumption of future earnings. 
 But it must be apparent that it is impossible to consume faster 
 than we produce unless we consume past savings by not replacing 
 worn-out equipment, or by failing to maintain the customary 
 stocks of goods, or unless we borrow from other nations. We 
 cannot eat today the wheat or potatoes of tomorrow, nor can 
 we wear coats before they are made. What is alleged can never 
 be true except of the individual consumer within the nation, 
 or of the nation as a whole when the capital or other wealth 
 of the country is diminishing, or when its foreign debt is in- 
 creasing. What really happened at the time of the Civil War 
 was this: we as a nation became indebted to some extent 
 to foreigners, and within the nation some of us gained while 
 the rest were losing. Government borrowings do not represent 
 a present consumption of future wealth, but a special present 
 use of purchasing power for which a government agrees to re- 
 munerate its owners in the future. If war can be carried on 
 with the aid of borrowings, it can, — leaving out of considera- 
 tion what foreigners send, — with a sufhciently perfect taxing 
 machinery, conceivably always and practically sometimes, be 
 carried on without borrowing. It is only a question of how to 
 get hold of the means of producing powder and bullets and the 
 
CONSUMPTION 143 
 
 necessaries of life. War was formerly carried on without bond 
 issues ; they are a comparatively recent contrivance. Consump- 
 tion can never anticipate future production for the nation as a 
 whole taken by itself ; it can only anticipate future ownership. 
 
 Luxury. — Luxury is the name of a vague something which 
 society has always viewed with a sense of mingled tolerance 
 and condemnation. What is its meaning? In the first place, 
 it is clear that people ordinarily consider as luxuries many things 
 in themselves innocent and desirable, as handsome dresses, 
 jewels, pictures, etc. No one but an ascetic will condemn as 
 wrong in themselves things that appeal to taste and finer appre- 
 ciations, and yet we feel that the use of such things is not always 
 justifiable. Second, the popular idea of luxury recognizes a 
 difference in persons. We cannot help condemning in one 
 person what we approve in another. Third, we judge luxury 
 differently at different times. There is a continual transfer 
 of articles from the list of luxuries into that of comforts and 
 necessities. This transfer is brought about by the consensus 
 of social judgment, and is increasingly acquiesced in by all. 
 So we see that the term " luxury " does not apply to goods of a 
 certain character, but to certain goods in their relation of time 
 and person. For the purpose of discussion, we shall define 
 luxury simply as excessive personal consumption. 
 
 Our definition of luxury as excessive consumption necessarily 
 condemns it as unjustifiable, but this should not be taken as a 
 condemnation of an enjoyment of more than the simplest kind of 
 life. There would be little purpose in producing wealth in 
 larger and larger volume if it did not mean a higher and better 
 standard of life. But this meaning does not justify the 
 squandering of immense sums on passing caprices whose satis- 
 faction cannot be justified from the standpoint of what is a 
 sane life. Nor does it constitute a defense of ostentatious ex- 
 penditure. Extravagant expenditure is sometimes condoned 
 on the ground that it gives employment to labor, but obviously 
 just as much employment would be given to labor by an equiv- 
 alent expenditure for laudable purposes. Expenditures for 
 any present gratification can be made only by reducing the 
 
144 OUTLINES OF ECONOMICS 
 
 amount either of other expenditures or of savings. Rarely in 
 these days are savings hoarded : they are used for gainful, often 
 for socially productive, purposes. Extravagant expenditures, 
 therefore, may divert productive agencies into employments 
 less beneficial to society. Moreover, to look upon expenditure 
 as desirable because it gives employment to labor, or " puts 
 money in circulation " and " makes trade good," is to forget 
 that, ethically viewed, production is justified only through the 
 satisfaction of human wants, and so far as the wants satisfied 
 are trivial or worse the necessary productive effort is virtually 
 wasted. 
 
 Harmful Consumption. — We have been careful to avoid 
 the impression that luxury consists in the use of pernicious goods. 
 It is a common query, " Why should I not have this if it does 
 me no harm? " This we have tried to answer in the preceding 
 paragraphs. A luxury may be a positive good in itself, a satis- 
 faction which society may well hope to make general, but it is 
 a good which society cannot yet afford, because other and greater 
 wants are yet unsatisfied. But there is another kind of con- 
 sumption which is objectionable in an entirely different way, 
 not because it is excessive or premature, but because it is harmful 
 in itself. Aside from the fact that such consumption usually 
 tends to diminish the sum total of the durable satisfactions that 
 the consumer gets out of life, it ordinarily lowers his productive 
 efficiency, and this involves a further loss to himself, to any who 
 may be dependent upon him, and to the whole community. 
 
 Statistics of Consumption. — Instructive investigations have 
 been made as to the relative importance of the leading items 
 in the family budget. The late Ernst Engel, the former dis- 
 tinguished head of the Prussian Statistical Bureau, advanced 
 the theory that it might be possible by a careful study of a suffi- 
 cient number of family budgets for a period of years to indicate 
 the broad changes in consumption, and thus by a sort of social 
 signal service to predict the coming of industrial storms. Noth- 
 ing has been so far accomplished along this line, but Engel's 
 tables are important in other ways. From Table I (page 145) 
 he deduces the following four propositions : 
 
CONSUMPTION 
 
 145 
 
 1. The greater the income, the smaller the relative percen- 
 tage of outlay for subsistence. 
 
 2. The percentage of outlay for clothing is approximately 
 the same, whatever the income. 
 
 3. The percentage of outlay for lodging or rent, and for fuel 
 and light, is invariably the same, whatever the income. 
 
 4. As the income increases in amount the percentage of out- 
 lay for sundries becomes greater. 
 
 TABLE I 
 
 Engel's Statistics — Saxony 
 
 Items of ExPENDiTtfKE 
 
 Per Cent of the Expenditure of the 
 Family of 
 
 A Workingman 
 
 with an Income 
 
 of from $225 
 
 to $300 a year 
 
 A Man of the 
 Middle Class 
 with an Income 
 of from $4.50 
 to $600 a year 
 
 A Man in Easy 
 Circumstances 
 with an Income 
 
 of from $750 
 to $1000 a year 
 
 1. Subsistence 
 
 2. Clothing 
 
 3. Lodging 
 
 4. Heat and light .... 
 
 5. Education, pubKc worship, 
 
 etc 
 
 6. Legal protection .... 
 
 7. Care of health 
 
 8. Comfort, mental and bodily 
 
 recreation 
 
 Total 
 
 62.0 
 16.0 
 12.0 
 5-o| 
 
 2.0 
 i.o 
 
 I.O 
 
 9S-0 
 
 S-o 
 
 5S-0 
 18.0 
 12.0 
 5-o| 
 
 3-5 
 
 2.0 
 2.0 
 
 2-S 
 
 90.0 
 
 50.0 
 18.0 
 12.0 
 
 5-5 
 3-0 
 3-0 
 
 3-5 J 
 
 85.0 
 
 15.0 
 
 The reader will perceive that if Engel's table, published in 
 1857, had been constructed in recent years, somewhat different 
 limits would have to be set for " middle class " incomes even 
 in Germany. 
 
 Subsequent investigations in the United States have confirmed 
 in a general way the conclusions of Engel, but the correspondence 
 is not exact, as will be seen from Table II, from the reports of 
 the United States Bureau of Labor, summarizing the expendi- 
 ture of over two thousand families in 1891 and over eleven 
 thousand in 1903. 
 
 L 
 
146 
 
 OUTLINES OF ECONOMICS 
 
 Table III gives the results of a careful study of the budgets 
 of 383 families in New York. 
 
 TABLE II 
 
 Expenditures of American Families Investigated by the United 
 States Bureau of Labor 
 
 (From the Seventh [1891] and Eighteenth [1903] Annual Reports) 
 
 
 
 Per Cent of Total Expenditure 
 
 Income Group 
 
 Food 
 
 Clothing 
 
 Rent 
 
 Fuel and 
 Light 
 
 Miscella- 
 neous 
 
 
 1891 
 
 1903 
 
 1891 
 
 1903 
 
 1891 
 
 1903 
 
 1891 
 
 1903 
 
 1891 
 
 1903 
 
 Under $200 
 $200-300 . 
 $300-400 . 
 $400-500 . 
 $500-600 . 
 $600-700 . 
 $700-800 . 
 $800-900 . 
 $900-1000 
 $1000-1100 
 $1100-1200 
 $1200 or over 
 
 
 49.6 
 44-3 
 45-6 
 4S-I 
 43-8 
 41.2 
 
 38.9 
 38.1 
 34-3 
 34-7 
 30-7 
 28.6 
 
 50-9 
 47-3 
 48.1 
 46.9 
 46.2 
 
 43-5 
 41.4 
 41.4 
 
 39-9 
 38.8 
 
 37-7 
 36.5 
 
 12.8 
 
 14-3 
 14.1 
 14.4 
 15-3 
 15-9 
 16.3 
 
 16.8 
 17-5 
 16.S 
 iS-7 
 
 8.7 
 8.7 
 
 lO.O 
 
 11.4 
 12.0 
 12.9 
 13-5 
 13-6 
 14.4 
 
 iS-i 
 14.9 
 
 iS-7 
 
 IS-S 
 14.7 
 15.0 
 
 15-3 
 
 15.2 
 
 15-5 
 15-6 
 16.1 
 14.9 
 
 I5-I 
 12.2 
 12.6 
 
 16.9 
 18.0 
 18.7 
 18.6 
 18.4 
 18.5 
 18.1 
 17.1 
 17.6 
 
 17-5 
 16.6 
 17.4 
 
 8.1 
 7.6 
 7.0 
 6.6 
 6.6 
 5-9 
 5-3 
 S-3 
 4-7 
 4-5 
 3-9 
 3-0 
 
 8.0 
 7.2 
 
 7-1 
 6.7 
 6.2 
 5-8 
 5-3 
 5-0 
 S-o 
 4.9 
 4-7 
 S-o 
 
 14.0 
 19.2 
 18.3 
 18.6 
 19.I 
 21.6 
 
 23-9 
 
 25-5 
 29.1 
 28.1 
 
 36-7 
 40.1 
 
 15-6 
 18.8 
 16.1 
 16.S 
 17.2 
 19.4 
 21.6 
 23.0 
 23.2 
 
 23-7 
 26.1 
 
 25-4 
 
 AU . . 
 
 
 41.4 
 
 43-1 
 
 15-3 
 
 13.0 
 
 I5-I 
 
 18.1 
 
 5-9 
 
 5-7 
 
 22.7 
 
 20.1 
 
 Consumption and Sacrifice. — Over against the enjoyment 
 resulting from wealth consumption lies the discomfort of wealth 
 
 production. Enjoyment, we 
 have seen, grows less and less 
 as' the consumption of a partic- 
 ular good is continued, but the 
 irksomeness of producing it, on 
 the contrary, grows greater and 
 greater the longer labor is con- 
 tinued. Let us take the case of 
 Robinson Crusoe picking berries. We may represent the 
 diminishing utility of the berries to him by the line ah (Fig. i), 
 and the increasing irksomeness of picking them by the line cd. 
 
 Fig. I 
 
CONSUMPTION 
 
 147 
 
 TABLE III 
 
 Expenditures of Families in New York City : 1907 ^ 
 
 
 •3 
 
 •la 
 
 
 
 
 EXPENI 
 
 IXUKES 
 
 
 
 
 Income 
 Group 
 
 Food 
 
 Cloth- 
 ing 
 
 Rent 
 
 Fuel 
 and 
 Light 
 
 Insur- 
 ance 
 
 Health 
 
 Carfare 
 
 Sun- 
 dries 
 
 
 13 Pm 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Percent 
 
 Per cent 
 
 Percent 
 
 Percent 
 
 Percent 
 
 Per cent 
 
 Per cent 
 
 Per cent 
 
 $400-499 
 
 8 
 
 40.8 
 
 13.0 
 
 26.8 
 
 S-6 
 
 1.2 
 
 3-1 
 
 2.6 
 
 6.9 
 
 $500-599 
 
 17 
 
 44.4 
 
 12.4 
 
 25-9 
 
 S-9 
 
 1-3 
 
 1.9 
 
 1.8 
 
 6.4 
 
 $600-699 
 
 72 
 
 44.6 
 
 12.9 
 
 23.6 
 
 5.B 
 
 2.0 
 
 2.1 
 
 1-7 
 
 7-3 
 
 $700-799 
 
 79 
 
 45-6 
 
 13-4 
 
 21.9 
 
 5-0 
 
 2-5 
 
 1.9 
 
 i-S 
 
 8.2 
 
 $800-899 
 
 73 
 
 44-3 
 
 14.0 
 
 20.7 
 
 5-0 
 
 2.2 
 
 2-7 
 
 2.0 
 
 9.1 
 
 $900-999 
 
 i>3 
 
 44-7 
 
 14.6 
 
 19.0 
 
 5-1 
 
 2.6 
 
 2.6 
 
 i-S 
 
 9.9 
 
 $1000-1099 
 
 31 
 
 44-7 
 
 15-5 
 
 18.I 
 
 4-5 
 
 2-5 
 
 1-5 
 
 1.8 
 
 11.4 
 
 $1100-1199 
 
 18 
 
 45-6 
 
 14.9 
 
 16.2 
 
 3-« 
 
 2-5 
 
 3-^ 
 
 1.9 
 
 II-5 
 
 $1200-1299 
 
 8 
 
 45 -o 
 
 15-2 
 
 19.8 
 
 3.« 
 
 2.2 
 
 1-3 
 
 2.2 
 
 10.5 
 
 $1300-1399 
 
 8 
 
 43-6 
 
 13-7 
 
 16.8 
 
 3-0 
 
 4.9 
 
 I.I 
 
 I.I 
 
 15.2 
 
 $1500-1599 
 
 6 
 
 36.8 
 
 16.8 
 
 16.3 
 
 4.1 
 
 2-3 
 
 7-4 
 
 1.2 
 
 iS-i 
 
 He would not pick more than Ox, because the xth berry costs him 
 just as much pain as it yields him pleasure, and any further 
 continuance of gathering fruit would result in an excess of 
 pain. The degree of utility represented by mx, then, repre- 
 sents, at the moment that the xth berry is picked and eaten, both 
 the marginal utility and the marginal disutility, or marginal 
 pain or sacrifice. 
 
 Each of us has sometimes made such comparisons — bal- 
 ancing the pleasure of further consumption against the pain of 
 further production. Many persons who are working eight or 
 ten hours a day could increase their income somewhat by work- 
 ing twelve hours, but the additional discomfort is greater in 
 their estimation than the additional fruits of their labor would 
 be worth. To be sure, much of our economic action goes on 
 unconsciously. We accept a position, comparing its advantages 
 and its disadvantages in a general way with those of other 
 openings, but once we enter upon the work, we accept the 
 daily grind as inevitable, and, in spending our income, think 
 
 * R. C. Chapin, The Standard of Living in New York City, p. 70. 
 
148 OUTLINES OF ECONOMICS 
 
 not of the sacrifices it has cost us, but simply of how we can 
 get the maximum satisfaction from it. 
 
 In discussing future wants we saw that postponing the con- 
 sumption of goods from the present to the future came to re- 
 quire compensation only after a certain amount had been saved. 
 Under present methods of production, it was explained in the 
 preceding chapter, a large amount of this postponement of 
 consumption is required. Machines must be made, and the 
 result of this labor cannot be enjoyed until these machines have 
 been used up in making finished products. This means that 
 some one must wait for the result, and in many cases be paid 
 to do it. Thus production may require, in addition to com- 
 pensation for labor, a payment for waiting. This is a point 
 which will be discussed further in the chapter on interest. 
 
 Cost of Production, Expense of Production, and Opportunity 
 Cost. — The preceding paragraphs explain one important 
 sense in which the term " cost of production " is used, i.e. (i) 
 the subjective cost of irksome labor or reluctant waiting. But (2) 
 the phrase is also commonly used to refer to the expense of 
 production, that is, the amount of money spent in producing a 
 commodity. (3) A third meaning is also found, which has been 
 termed opportunity cost. Let us say that a person is confronted 
 by the alternative of engaging in either of two occupations. 
 He may become a lawyer or he may become a merchant, but 
 he has not the time to be both. If he chooses to be a lawyer, 
 he sacrifices his opportunity of being a merchant. Cost in 
 this sense is sometimes called " alternative cost," or " displace- 
 ment cost." This is not an ultimate cost, but it probably has 
 a more direct and more important influence upon most of our 
 economic choices and decisions than has any other kind of cost. 
 Moreover, in the actual conduct of life opportunity cost and 
 direct cost are generally inextricably blended. The increasing 
 irksomeness of Crusoe's task of picking berries, for example, 
 may be deemed to have been caused in large measure by the 
 pressure of other demands upon his time. We haven't time 
 enough to do all the things we should like to do, and so we have 
 to apportion our time according as we think that one use of 
 
CONSUMPTION 149 
 
 it or another is the more important. And, in general, we try- 
 so to apportion our time that the fruits of the last or marginal 
 increment of time devoted to any one purpose shall have no 
 more or no less utility than those of the marginal unit of time 
 devoted to any other purpose. 
 
 Taking " leisure " as a collective name for all of the non- 
 economic uses of time, that is, for all uses of time for other than 
 productive or money-making purposes, it appears clearly that 
 a worker with free command of his time will carry his chosen 
 line of effort up to the point (or margin) where leisure attracts 
 him as much as the products of his exertion, or, in modern 
 economic life, as the things he can acquire with the money he 
 earns. As in the expenditure of money, so in the expenditure 
 of time and effort : we tend to bring our expenditures up to 
 margins where utilities gained and utilities sacrificed or foregone 
 are equal. 
 
 QUESTIONS AND EXERCISES 
 
 1. If you had four sacks of corn all alike, could you tell which is the 
 marginal one? 
 
 2. May one properly speak of the marginal utility of an indivisible good, — 
 a house, for example? 
 
 3. If an individual estimates his present wants as 10, 8, 6, 3, i, and his 
 future wants as equivalent to the present value of 9, 7, 5, 2, o, and if he has 
 $g, and if each want is satisfied with $1, how many dollars wiU he save? 
 
 4. Give as many expressions as possible that are equivalent to the term 
 "subjective value." 
 
 5. Comment on the following: "Doubtless the best thing to do about 
 them (the spendthrifts) is to do nothing — not even to worry about their 
 waste of money. Their waste of money, in fact, is the least silly thing they 
 do, for the money is in constant flux and serves its purpose." World's 
 Work, June, 1906. 
 
 6. Comment on the following words of Adam Smith : "Nothing is more 
 usefiil than water; but it will purchase scarce anything; scarce anything 
 can be had in exchange for it. A diamond, on the contrary, has scarce any 
 value in use, but a very great quantity of goods may frequently be had in 
 exchange for it." Wealth of Nations, Book I, Chap. iv. 
 
 7. Point out the differences in the tables of consumption statistics quoted 
 in the text. How do they modify Engel's statements ? Suggest explanations 
 of these differences. 
 
I50 OUTLINES OF ECONOMICS 
 
 REFERENCES 
 
 Bohm-Bawerk, E. von. Positive Theory of Capital, Book iii, Chaps, iii 
 
 and iv. 
 Chapin, R. C. The Standard of Living in New York City. 
 Davenport, H. J. Economics of Enterprise, Chaps, vii, viii. 
 HoBSON, J. A. The Social Problem, Book ii, Chap. vii. 
 Jevons, H. S. Essays in Economics, Chaps, ii, iii. 
 Marshall, Alfred. Principles of Economics, 6th ed.. Book iii. 
 Mayo-Smith, Richmond. Statistics and Economics, Book i, Chap. ii. 
 More, L. B. Wage-Earners' Budgets. 
 RowNTREE, B. S. Poverty, Chaps, vi-viii. 
 Streighthoff, F. H. The Standard of Living among the Industrial People 
 
 of America, Chap. ii. 
 Urwick, E. J. Luxury and Waste of Life, Chap. iii. 
 Veblen, Thorstein. The Theory of the Leisure Class. 
 Watkins, G. p. Welfare as an Economic Quantity, Chaps, i, iv. 
 WiCKSTEED, P. H. The Common Sense of Political Economy, Book i, Chaps. 
 
 i, iii. 
 Withers, H. Poverty and Waste, Chap. viii. 
 
PART II 
 VALUE AND EXCHANGE 
 
 CHAPTER X 
 VALUE AND PRICE 
 
 If every family produced all the goods needed to supply the 
 wants of its members, most of the problems which today con- 
 front economic science would not exist. Most of the world's 
 workers are, however, contributing their services either directly 
 or indirectly (through the production of goods) toward the 
 satisfaction of the wants of others. One's economic well- 
 being today depends primarily on two things : the money in- 
 come which can be got from others in return for one's services 
 or for the use of one's land or capital, and the amount of things 
 that can be bought with this money income. The federal census 
 of 1 910 showed that about 93 per cent of the men over twenty 
 years old and about 18 per cent of the women of corresponding 
 age were employed in money-making occupations; and this 
 number does not include those landlords and capitalists whose 
 income was derived entirely from their investments. The work 
 of the housewife and the services of friendship embody utilities, 
 that is, satisfy human wants, just as do money-making activities, 
 but they are not reported in terms of dollars and cents. The 
 production of wealth is in these days mostly " for the market," 
 and wants are satisfied very largely by goods obtained from the 
 market. In the vast interlocking system of modern economic 
 life most goods get from those who produce them to those who 
 use them by the processes of exchange. 
 
 The Meaning and Significance of Value. — It rarely happens 
 nowadays that goods are directly exchanged for other goods. 
 
 151 
 
152 OUTLINES OF ECONOMICS 
 
 Goods are usually sold for money/ and the seller uses the money 
 in the purchase of other goods. The amount of money for which 
 a unit of a given commodity exchanges is the price of that commodity. 
 Since prices vary, when we wish to name the actual price of 
 any commodity we must specify the price in a given market at a 
 given time. 
 
 From this simple and familiar concept of price there has been 
 developed the more general concept of exchange value. If a 
 hat sells for two dollars, a pair of shoes for four dollars, and a 
 pocket knife for fifty cents, we say that the exchange value of 
 the hat is half that of the pair of shoes and four times that of the 
 knife. It thus comes about that we attribute exchange values 
 to goods in accordance with their relative potency in exchange, 
 as shown by the prices at which they sell. In this way values 
 come to be thought of as magnitudes. Just as weight and 
 volume are physical magnitudes by which we express the rela- 
 tive heaviness and the relative bulk of different objects, so ex- 
 change values are economic magnitudes or, more specifically, 
 exchange magnitudes. The exchange value of a good is thus 
 the resultant of its exchange relations with other goods. 
 
 Exchange value is a purely relative or comparative magnitude, 
 and there is no way of expressing or measuring the exchange 
 value of a good except in terms of its command over other goods. 
 In such a measurement exchange value can be expressed either as 
 a quantity or as a ratio. We can say (i) that the value of a pair 
 of shoes is that of eight knives or (2) that the value of the shoes 
 is to the value of a knife as eight is to one. We thus express the 
 exchange value of any good either by stating the quantity of 
 other goods that can be obtained for it or by stating its ratio 
 of exchange with other goods. The exchange value of any one 
 commodity can, of course, be expressed in terms of any other 
 commodity. Price is a statement or expression of exchange 
 value in terms of money. To say that the price of a pair of 
 shoes is four dollars amounts to saying that the value of the pair 
 of shoes is four times the value of a dollar. When the words 
 
 1 In this chapter the word " money " is used in its broadest sense, thus including 
 credit instruments, which are, of course, merely promises to pay money. 
 
VALUE AND PRICE 153 
 
 " value " and " price " are used interchangeably, as will some- 
 times be our practice in this book, there is implied the assump- 
 tion that the value of money as expressed in terms of other things 
 than the particular commodity we are discussing is constant, — 
 an assumption which, of course, does not entirely correspond 
 with the facts. 
 
 Exchange values are determined by what may be called 
 the "price process." This term is used in a narrow sense as 
 referring to the fixing of the money values of commodities; 
 in a broader sense it includes also the determination of the 
 different rewards received by those who have contributed to the 
 production of these commodities. In this broad sense the prob- 
 lem of prices is the problem of the distribution of wealth. 
 Imagine the case of a mechanic employed at a particular time in 
 the manufacture of machinery that will be used in a flour mill. 
 The final product of the mechanic's labor — the only product 
 directly useful in the satisfaction of human wants — is the flour, 
 or bread made from the flour. To the making of this final prod- 
 uct thousands besides our mechanic — farmers, agricultural la- 
 borers, railway ofiicers and employees, other mechanics, and so 
 on in a practically endless list — have contributed. What deter- 
 mines the price of the final product? What proportion of this 
 price goes to the mechanic ? What is his share worth to him as 
 the means of getting the necessaries of life ? Of these three ques- 
 tions, the first and third fall within the problem of the prices 
 of commodities ; the second, relating to the wage-price of the 
 mechanic's services, falls within the problem of the distribution 
 of wealth. At present we are concerned only with prices in their 
 narrower sense, although the principles to be developed apply 
 also in the case of the prices paid for the services of the factors in 
 production. The significance of the subject of value in economic 
 science lies in the fact that, within the conditions set by existing 
 institutions, and within the limits set by the total production of 
 wealth, human welfare, so far as it is dependent upon the pos- 
 session of economic goods, is largely determined by the process 
 of fixing price relations. 
 
 The Market. — It is conceivable that the prices of goods 
 
154 OUTLINES OF ECONOMICS 
 
 might be fixed by public authority, or that the production of 
 the most important commodities might be monopoHzed. Then, 
 too, it is possible to imagine a condition of society in which 
 custom should have such power that prices, when once estab- 
 lished, would be changed very infrequently. Still another 
 possibility is a regime of competition in which every man is 
 left free to buy and sell as he pleased at such prices as he can 
 get. The first three factors — public authority, monopoly, 
 and custom — are among the things which determine the ratios 
 at which goods are actually exchanged today ; but the dominant 
 factor is the fourth one mentioned — the free competition of 
 the market. 
 
 In this connection we mean by the market, not a particular 
 place for buying and selling, but the general field within which the 
 forces determining the price of a particular commodity operate. For 
 some commodities, especially perishable ones, like fresh milk and 
 cream, the market is distinctly a local one. In the case of great 
 staple commodities like wheat and cotton, the market is a world 
 market, for it is impossible that the prices of wheat or cotton in 
 Europe should differ for any considerable time from their prices 
 in America by more than the expense of transport. So-called 
 " international " securities, such as government bonds and the 
 stocks and bonds of certain great corporations, afford even a 
 better example of goods for which the market is a world market. 
 Some commodities are used only in a particular locality or 
 country, although produced in many different places. The 
 American consular reports frequently contain advice to Ameri- 
 can manufacturers as to special kinds and varieties of goods used 
 in different foreign countries. The cotton mills of England, 
 Germany, and the United States all make special grades of 
 cotton cloth designed especially for the Oriental market. Much 
 more numerous, however, are the goods which, although of 
 wide and general consumption, are produced in but few localities. 
 This is especially evident in the case of agricultural and mineral 
 products, but it is increasingly noticeable in manufactures. 
 
 Along with this localization of industry there has been a 
 broadening of the field of consumption of many commodities. 
 
VALUE AND PRICE 155 
 
 Among the factors which have contributed to this result may be 
 mentioned, first, the increasingly cosmopolitan character of 
 modern life, — a result of more generally diffused facilities for 
 higher education, as well as of the growing ease of travel and 
 communication; and secondly, what has been called the 
 " standardization of taste," — a result in part of modern ad- 
 vertising methods and of the standardization of products 
 which is one of the fundamental features of modern machine 
 industry. Notwithstanding the barriers which still exist in 
 the form of protective tariffs and local prejudices, a dominant 
 feature of modern markets is the increasing localization of 
 production and the extension of the field of consumption. 
 
 Exchange Value and Subjective Value, — Exchange value is 
 often called market value or objective value, and is sharply to be 
 distinguished from subjective value, which, it will be remem- 
 bered, is the relative importance attached by an individual to 
 a particular unit of a commodity. Exchange value is an objec- 
 tive, ascertainable fact of the market. Subjective value is a 
 matter of individual feelings and preferences, and is different 
 for different individuals. An error which we must especially 
 guard against is that of thinking that exchange values are in 
 any accurate sense the expression of the subjective values of 
 different goods to society at large. Exchange value is the out- 
 come, the resultant, of the individual subjective valuations of 
 many different persons, the poor and the rich, the wise and the 
 foolish, but it does not correspond to " social subjective value," 
 or " social marginal utility," for these two last phrases are 
 meaningless. It is true, of course, that our own valuations 
 are largely socially determined in the sense that, lacking much 
 real independence of judgment, we follow and imitate other 
 people in making our own estimates of the relative desirability 
 of different commodities, and that we are even prone to judge 
 of the relative importance of different things for our own pur- 
 poses by their costliness, that is, by their exchange values, 
 rather than by an independent analysis of our own needs. But 
 the differences in our tastes and the differences in our powers 
 to gratify our tastes are quite as important factors in determining 
 
156 OUTLINES OF ECONOMICS 
 
 the exchange values of things as are our similarities. Just 
 what is the point of connection between subjective values and 
 exchange values we shall discover in the analysis of supply 
 and demand. 
 
 Supply and Demand. — The only goods which are valued in 
 the market are economic goods ; that is, such goods as combine 
 the characteristics of utility and scarcity. This statement is 
 a truism, for no one will pay for things that he does not want or 
 for things that can be obtained freely. Utility and scarcity 
 affect the market value of goods through the operation of the 
 forces of demand and supply. The general " common-sense " 
 explanation of the valuation of goods takes the form of the 
 statement that values are determined by supply and demand. 
 When rightly interpreted, this statement cannot be criticized, 
 but it is often used in a misleading way. Producers do not 
 usually throw a " supply " of goods unreservedly on the market, 
 accepting any price that can be got for them, nor do consumers 
 generally demand definite amounts of goods, without reference 
 to the price of them. An entirely accurate statement, and one 
 that is less apt to be misinterpreted, is that prices are among the 
 factors determining supply and demand. It may seem, accord- 
 ingly, something like arguing in a circle to attempt to explain 
 exchange value by using the formula of supply and demand; 
 but the fact is that the explanation is to be sought in the action 
 of mutually dependent forces, rather than in any one principle. 
 
 The Nature of Demand. — Mere desire for a commodity is 
 not demand for it. The desire of the poor man for the counter- 
 part of his wealthy neighbor's motor car is in no sense demand. 
 Elective demand is sometimes defined as desire coupled with the 
 ability to pay. But to make demand really eft'ective there 
 must be added to these the inclination to buy : desire must be 
 intense enough to lead to purchase. 
 
 If I purchase a certain quantity of a particular commodity, it 
 is because I desire it at least as intensely as anything else I can 
 purchase with the same amount of money. When I ask myself 
 whether a certain contemplated purchase is " worth its price " to 
 me, I am comparing the importance of the purchase in question 
 
VALUE AND PRICE 157 
 
 with the importance of other uses of the money which the 
 price represents. It is, in other words, a matter of my subjec- 
 tive valuations. Now my subjective valuations, it will be 
 remembered, depend not only upon my tastes and my purposes, 
 but also (on account of the law of diminishing utility) upon the 
 extent to which I am already supplied with goods like that 
 whose purchase I am considering, as compared with the extent 
 to which I am supplied with other things. In choosing and 
 picking among the different alternatives open to me as a pur- 
 chaser, in buying one thing rather than another, in acquiring 
 more of this and less of that, I merely express my subjective 
 valuations. A certain minimum supply of one commodity — 
 a necessity of life, perhaps — may be more important to me, 
 may possess a higher utility, than any possible amount of some 
 other commodity, — a luxury, for example. But I may deem 
 it less important to have a large supply of the first commodity 
 than to have some of the second commodity. If I push my 
 expenditures for any one purpose too far, I sacrifice the satis- 
 faction of more important wants for the satisfaction of less 
 important wants. Think of one's purchases as being divided, 
 not into such units as pounds, bushels, yards, and dozens, but 
 into units defined by the quantity one can purchase for a dollar, 
 — into "dollar's worths." Each of us, by buying the things 
 he wants more than he wants other things, tends to keep the 
 subjective values of the last or marginal dollar's worths of all 
 the different kinds of goods he consumes equal, one to another. 
 As our tastes and desires and purposes change we alter our 
 scheme of expenditures accordingly, but always so that our 
 marginal dollar's worths are kept, as it were, in equilibrium. 
 But even if our desires were constant, changes in prices would in 
 themselves effect continual alterations in the proportions of 
 various things that make up our purchases. The various dollar's 
 worths become larger or smaller and acquire larger or smaller 
 subjective values. If the price of a commodity decreases to 
 such an extent that an additional dollar's worth gains a subjec- 
 tive value greater than that of other dollar's worths, we normally 
 purchase it. If the price rises, we normally curtail our ex- 
 
158 
 
 OUTLINES OF ECONOMICS 
 
 penditures for this particular commodity, and may even, under 
 some circumstances, become sellers of it (as in the case of the 
 householder who has bought a large supply of coal at five dollars 
 per ton, and who, when the price rises to ten dollars, is willing to 
 sell part of it). Some of the foregoing discussion may seem to 
 be a statement of what is obvious and commonplace, but the 
 neglect of these seemingly obvious factors is responsible for 
 more than one erroneous explanation of the way in which prices 
 are determined. 
 
 The Demand Curve. — The relations between price and de- 
 mand may be shown concretely by the analysis of the condi- 
 tions in a hypothetical market. Imagine the case of an isolated 
 
 community in which wood 
 is used as a fuel. The 
 conditions might be such 
 as are represented graphi- 
 cally in Figure i. In this 
 diagram distances meas- 
 ured from O along the 
 horizontal line OX rep- 
 resent different amoimts 
 of wood, while distances 
 measured vertically from the line OX represent prices. Assum- 
 ing that the conditions of demand were as represented in the 
 diagram, if the price of wood were MP dollars a cord, OM cords 
 of wood would be bought. If MP represents a relatively high 
 price for wood, this might mean that many families would 
 choose to go without wood, using other kinds of fuel instead. 
 Others would be content with a scanty supply. If, however, 
 the price were reduced to M'P' dollars per cord, some of the 
 families who would have refused to buy at the higher price would 
 purchase wood, while others would increase their purchases, so 
 that OM' cords would be bought. Similarly, at the price 
 M"P", the amount bought would be OM" cords. Other pos- 
 sible prices might be indicated on the diagram, so that, in 
 general, the curve DD' (which we may call the demand curve) 
 represents the relation between price and the amount purchased. 
 
VALUE AND PRICE 
 
 159 
 
 
 p 
 
 P' 
 
 
 
 
 
 "~""~~~^i>' 
 
 M 
 
 31' 
 
 Fig. 
 
 More definitely, the demand curve represents the amount of a 
 given commodity which can be sold in a given market at each 
 of all possible . 
 prices. 
 
 The Elasticity 
 of Demand. — 
 By the elasticity T> 
 of demand we 
 mean the extent 
 to which the 
 amounts pur- 
 chased vary 
 with changes in 
 price. In every 
 family in poor 
 
 or moderate circumstances the housewife carefully economizes 
 in the use of eggs during periods when they are high in price, 
 using them more freely when the price is lower. The demand for 
 eggs is therefore elastic. Relatively inelastic are the demands 
 
 of most families for such 
 things as flour and salt. 
 Other commodities, such as 
 sugar, may occupy an inter- 
 mediate position. Figures 
 2 and 3 represent, respec- 
 tively, elastic and inelastic 
 conditions of demand. It 
 should be understood that 
 the demand curves for most 
 commodities are probably 
 not so smooth and regular 
 in their slope as are these 
 diagrams. It may often 
 happen that the elasticity 
 of demand is different for different portions of the demand 
 curve. The demand for bread, for example, would probably 
 be much more elastic at very high prices than at very low 
 
l6o OUTLINES OF ECONOMICS 
 
 prices. The demand for salt, on the contrary, would prob- 
 ably be less elastic at prices so high that it would be used only 
 as a food than at prices low enough to permit its use (as at pres- 
 ent) for various industrial purposes. Without giving further 
 concrete examples, the following propositions respecting elas- 
 ticity of demand may be stated: (i) Demand for necessities 
 is in general less elastic than demand for luxuries. (2) Demand 
 for commodities the use of which constitutes a habit is less 
 elastic than demand for commodities the use of which is gen- 
 erally a matter of conscious decision. (3) The more adequate 
 the substitutes for a particular commodity, the more elastic 
 will be the demand for it. (4) The demand of persons of large 
 income is less elastic than that of persons in poor or moderate 
 circumstances. (5) A corollary of proposition four is that the 
 higher the general level of well-being in a community, the less 
 elastic will be the demand for most commodities. 
 
 The rectangle OMPA (in any one of the three diagrams) 
 represents the total amount buyers pay for a certain commodity 
 when the price is MP, just as the rectangle OM'P'A' represents 
 the total amount paid when the price is M'P'. If the demand 
 for the commodity is distinctly inelastic, this total value will be 
 less when the price is low than when the price is high.^ At 
 the lower price less money will be expended for this particular 
 commodity and more money will be available for other uses. If, 
 on the other hand, the relations between price and demand are 
 such that the rectangle OM'P'A' is larger than the rectangle 
 OMPA, a drop in price from MP to M'P' will result in a 
 curtailing of expenditures for other things. This might involve 
 only a decreased use of direct substitutes, such as coal in place 
 of wood ; generally, however, it would mean a diminished con- 
 sumption of a number of other things. But this is a gain, not 
 
 1 Elasticity of demand may be represented mathematically by a fraction whose 
 denominator is the relative (or percentage) decrease in price and whose numerator 
 is the corresponding relative increase in the amount demanded. Following the nota- 
 tion used in Figures 2 and 3, this is the ratio of MM'/OM to AA'/AO. When the 
 elasticity of demand, thus expressed, is equal to MM'/OM + i, the rectangles 
 OMPA and OM'P'A' are equal; that is, the same total amount is expended for 
 the commodity when the price is MP as when the price is M'P'. 
 
VALUE AND PRICE l6l 
 
 a loss. For the lower price would not be accompanied by the 
 purchase of a larger quantity, if the additional purchases did 
 not satisfy more intense wants than other things that might 
 have been purchased with the money. Larger " dollar's 
 worths " will have been substituted for smaller ones. 
 
 In this way the demand for any one commodity is affected 
 by changes in the prices of other commodities. The competition 
 of the market thus embraces not only the buying and selling 
 of one commodity, but also the buying and selling of all com- 
 modities. In this sense the wood dealers compete with the 
 grocers and the tailors, as well as with the coal dealers and with 
 each other. 
 
 Consumers' Surplus. — Whatever the price of a competitively produced 
 commodity may be, there are almost always some buyers who would have 
 paid more if it had been necessary. Referring to Figure i, if the price is 
 M'P', those who are just willing to pay that price, who would either have 
 bought less or bought none if the price had been higher, may be called the 
 marginal buyers. These are relatively few in number, however, as compared 
 with those who would have bought even if the price had been higher. The 
 utility of the marginal purchases to the buyers is but little more than the 
 utility of other things that could have been bought with the same amount of 
 money : in such cases the utility of the purchase only about equals the sacri- 
 fice involved. In the case of all other purchases, however, there is a surplus 
 of utility over costs (whether costs are measured as money costs or as the 
 utility of the other possible purchases which are given up) which is called 
 consumers' surplus (or sometimes consumers' rent, or buyers' gains). 
 
 It might be supposed at first thought that if the price were, for example, 
 M'P' (Fig. i), the area included between the horizontal Une A'P' and the 
 curve DP^ would represent consumers' surplus. This is not exactly true, 
 however, and that for two reasons : in the first place, the satisfaction of 
 additional wants which a lower price makes possible may make the more 
 important wants less intense. A man might be willing to give ten dollars 
 for a cord of wood in order that at least one room in his house could be heated 
 during the winter. He might also be willing to give seven dollars a cord for 
 two cords, so as to heat two rooms, but the heating of the second room might 
 render the heating of the first room less important to him. He might not 
 be willing, for example, to give ten dollars plus seven dollars in order to 
 have the two rooms heated. In the second place, utility itself is to a large 
 extent affected by price. So far as our purchases satisfy what has been 
 called the desire for distinction, or represent what Professor Thorstein 
 Veblen has called "conspicuous consumption," a lowering of the price of a 
 M 
 
1 62 OUTLINES OF ECONOMICS 
 
 commodity would lessen its utility to us. The successful production of 
 artificial diamonds at a low cost would lessen the desire which most people 
 have for natural ones. If touring cars were less an indication of one's 
 ability to spend money freely, they would be less esteemed by not a few 
 people. On the other hand, it might occur in some cases that a certain 
 amount of decrease in the price of a commodity, permitting a more general 
 consumption of it, would increase the esteem in which it is held by those 
 who are glad to follow fads. In general, we must say that even if we had 
 absolutely complete statistics of the actual relation of prices to demand, 
 consumers' surplus would stUl be an incommensurable thing. It is neverthe- 
 less a real thing, and is especially significant as constituting one of the differ- 
 ences between real income and money incomes. 
 
 It should be noted, however, that consumers' surplus relates only to one's 
 consumption of a particular commodity, taken by itself, for, as we have seen, 
 the amount which we are willing to spend in the purchase of any one com- 
 modity depends not only on the price of that commodity, but also on the 
 prices of the other commodities that make up our purchases. The surpluses 
 which a consumer gets in his different lines of consumption cannot be 
 added together to form a total. I might, for example, be willing to pay 
 as much as four dollars for a hat that I can get for two dollars. And if I 
 pay only two dollars for the hat I might be willing to pay as much as six 
 doUars for a pair of shoes that I can get for four dollars. But it does not 
 follow that I should be wUling to pay four dollars for the hat and six dollars 
 for the shoes. 
 
 The Nature of Supply. — The amount of goods that will be 
 supplied in a given market at a given time depends, like the 
 amount demanded, on the price. " Forced sales," in which 
 goods are offered for whatever can be got for them, form about 
 the only important exception. The effect of price on supply 
 varies, however, according to the length of time that is taken 
 into consideration. The work that is being done today in the 
 extension of old factories and the building of new ones, the con- 
 struction of railways, the taking up of new land, is based on 
 estimates of future prices, the present prices of agricultural and 
 manufactured products and of railway transportation being of 
 significance only so far as they indicate what future prices will 
 be. The merchant's stock in trade is bought on an estimate of 
 future business conditions; the amount of land the farmer 
 allots to wheat and corn, respectively, depends on his estimate 
 of the relative prices the two will bring after the harvest. In a 
 
VALUE AND PRICE 
 
 163 
 
 similar way the amounts of goods that can be supplied to the 
 market today are limited by the estimates which business men 
 and farmers have made in the past of the prices which buyers 
 are willing to pay today. It would be possible, though not 
 necessary for our purposes, to analyze the way in which the 
 amount of the capital and labor which have thus been applied 
 to the production of things that will satisfy present wants was 
 partially determined by conditions which existed still farther 
 back in the past, and so on in an indefinitely receding series. 
 
 The amount of goods available for the market of today is 
 thus determined not only by past estimates and conditions, but 
 also by present estimates of future conditions. Every seller has 
 the option of selling at the present price or of waiting for possibly 
 higher future prices — an option which is limited only by the 
 perishability of his goods and the urgency of his need for money. 
 And the most urgent need for money does not necessarily force 
 an immediate sale if his opinion as to the future value of his 
 goods is a reasonable one, for in this case it is usually easy to 
 borrow money on the strength of the marketable value of the 
 goods. 
 
 The Supply Curve. — In the analysis of the conditions of 
 supply existing in a particular market at a particular time we 
 do not have to take account of 
 the limitations imposed by the 
 forms which productive efforts 
 have taken in the past. At 
 any given time a certain defi- 
 nite amount of a commodity is 
 available for the market : this 
 forms what may be called the 
 potential supply. The propor- 
 tion of this potential supply 
 that sellers will be willing to 
 part with at a particular time will depend primarily on the prices 
 they can get. If the price of a unit of a commodity is M' P' 
 (Fig. 4), the sellers will be willing to sell a certain number of 
 units of it, which may be represented by OM'. If the price were 
 
164 
 
 OUTLINES OF ECONOMICS 
 
 as low as PM, however, some sellers would prefer to wait for 
 higher prices, the amount thus withheld from the market bemg 
 represented by MM'. At the price M" P" , however, an addi- 
 tional supply {M'M") of the commodity would be forthcoming 
 from sellers who were not tempted by the price M'P'. In gen- 
 eral, the supply curve SS' represents the relations between price 
 and the amount that will be supplied in a particular market 
 and at a particular time. 
 
 The Determination of Price. — The foregoing discussion of 
 the nature of demand and of supply makes it possible to ad- 
 vance another step in 
 our analysis of the de- 
 termination of price, by 
 asking ourselves what 
 will be the result of the 
 simultaneous operation 
 of the forces of demand 
 and supply. This con- 
 dition is represented 
 graphically in Figure 5, 
 where the demand curve 
 and supply curve are 
 combined in one diagram. If the curve DD' represents the 
 potential demand in a particular market at a particular time, 
 and the curve SS' represents the potential supply, the price 
 which would be fixed by the free working of competitive forces 
 would be PM, located at the point where the two curves cross. 
 At this point demand and supply are equal, both being rep- 
 resented by OM. It is impossible that the price should be 
 fixed at any other point, M'P', for example. For if M"Q be 
 drawn so as to equal M'P', it will be evident that at this price 
 OM" units will be demanded, while only OM' units will be sup- 
 plied. Most of the buyers, however, are willing to pay more 
 than M'P' if necessary, so that in order to secure their share 
 they will bid the price up until an equilibrium is reached. 
 This is what John Stuart Mill meant when he said that " value 
 always adjusts itself in such a manner that the demand is equal 
 
VALUE AND PRICE 165 
 
 to the supply," — a statement which has often been misinter- 
 preted, and consequently unjustifiably criticized. 
 
 The prices for which goods are sold in a competitive market 
 are thus the outcome or resultant of the individual valuations of 
 all who buy and sell in the market. Each buyer or seller, 
 taken by himself, affects only inappreciably the price at which 
 he buys or sells. All that he can do is to buy or sell or refuse 
 to buy or sell, or to buy or sell more or less. For each individual 
 trader the market price is something beyond his own control. 
 And yet each has a part in that collective supply and demand 
 which is the controlling factor in making the price whatever it 
 happens to be. 
 
 Producers^ Surplus. — Just as the area APD (Fig. 5) has sometimes been 
 considered, not altogether accurately, to represent a "Consumers' Surplus" 
 (of utility over costs), so the area APS has been considered to correspond to 
 what has been called "Producers' Surplus" or "Sellers' Gains." This sur- 
 plus should not be thought of as corresponding to the actual profits of the 
 sellers ; that is, as being in any way a surplus of receipts over and above the 
 expenses of production. That part of the supply which had been produced 
 at the smallest expense is not necessarily the part which its owners would 
 be willing to sell at the lowest price. It cannot be too strongly emphasized 
 that the analysis of demand and supply thus far presented relates only to 
 the conditions existing in a particular market at a particular time. All that 
 we can say is that when OM units are sold at the price of MP per unit, the 
 total receipts of the sellers are represented by the rectangle OMPA ; while 
 the area OMPS represents what they would have been willing to seU the 
 same amount of goods for, had they not been able to get a larger return. 
 There is, as we shall see, a relation between the prices of things and the ex- 
 pense of producing them, when a considerable period of time is taken into 
 consideration. At any given time, however, sellers are mainly governed 
 by the relative profitableness of selling at existing prices or waiting for 
 higher ones. The only kind of surplus which the area APS represents is 
 an intangible, hypothetical thing, — the difference between actual receipts 
 and the amount which would have been received if each seller had sold each 
 portion of his supply for the minimum price he would have been willing to 
 take for that portion. 
 
 QUESTIONS 
 
 1. Is there such a thing as "intrinsic value"? What is usually meant 
 when the expression is used? 
 
 2. How can one buy more or less of a non-divisible good, like a house ? 
 
1 66 OUTLINES OF ECONOMICS 
 
 3. Does the tendency of each individual to maintain the equiHbrium of 
 his margin of consumption result in the maximum satisfaction of his wants? 
 
 4. What relation is there between the amounts which a college student 
 pays for room rent, for food, for clothing, for books, and for athletics? 
 
 5. Which of your customary purchases would you still make if prices 
 were doubled? Which would you curtail? Which would you omit? 
 
 6. Illustrate the propositions relating to elasticity of demand (p. 160) by 
 concrete examples. 
 
 7. Construct an imaginary demand "schedule," showing in parallel 
 columns (i) six or eight different possible prices of wood per cord, and (2) 
 the number of cords which an imaginary purchaser would buy at each stated 
 price. Construct in the same way other demand schedules for each of four 
 other possible purchasers. Combine these five individual demand schedules 
 into a collective demand schedule showing the total amount of wood that 
 could be sold at each price. Construct in a similar way individual supply 
 schedules and a collective supply schedule for four sellers of wood. Assum- 
 ing that all the wood sold is sold at a uniform price, how much wood will 
 be sold and at what price ? 
 
 8. "For some years the supply of Brazilian coffee was greater than 
 the demand for it." Criticize and amend this statement. 
 
 REFERENCES 
 
 Bohm-Bawerk, E. von. Positive Theory of Capital, Book iv, Chaps, i-vi. 
 
 Carver, T. N. Distribution of Wealth, Chap. i. 
 
 CuNYGHAME, Henry. Geometrical Political Economy, Chaps, iii and iv. 
 
 Davenport, H. J. Economics of Enterprise, Chaps, v-vii. 
 
 Fetter, F. A. Economic Principles, Part i. 
 
 Marshall, Alfred. Principles of Economics, 6th ed.. Book iii and Book 
 
 v, Chaps, i and ii. 
 Mill, J. S. Principles of Political Economy, Book iii. Chaps i and ii. 
 Taussig, F. W. Principles of Economics, Vol. i. Chaps viii-x. 
 Wieser, F. von. Natural Value, Book ii, Chaps i-v. 
 
CHAPTER XI 
 VALUE AND PRICE {Continued) 
 
 Some of the most important factors in the determination of 
 exchange values are not revealed by an analysis of the conditions 
 of supply and demand which happen to exist at a particular 
 time. In the preceding chapter we assumed the existence 
 of a certain potential demand and a certain potential supply, 
 and explained how these result in the equilibrium of actual de- 
 mand and supply at a certain price. Our next task is to 
 inquire into the influences which determine potential demand 
 and potential supply. For this purpose we shall need to pass 
 from the study of the way in which the preferences and choices 
 of individual buyers and sellers react upon and fix the par- 
 ticular market price which exists at any one time to an inquiry 
 into the operation of certain slowly acting movements and 
 tendencies. 
 
 The demand side of this problem need not detain us. De- 
 mand will change with changes in incomes, tastes, fashions, 
 and the like. The effect of these influences is so obvious that 
 it may be taken for granted. The supply side of the problem, 
 however, needs further study. The potential supply of the 
 present is limited by conditions set by past industry. The 
 amounts of different kinds of consumption goods that are 
 ready for present use depend upon the direction which the 
 work of production has taken in the past. What, in the long 
 run, is the relation between supply and exchange value? 
 
 Prices and the Expenses of Production. — The dominant 
 motive that guides farmers and business men in their invest- 
 ments of labor and capital is the desire for money profits. (By 
 profits we here mean the difference between the expense in- 
 volved in producing goods and the money that is obtained for 
 them.) If it were always an easy matter for business men to 
 
 167 
 
1 68 OUTLINES OF ECONOMICS 
 
 change their interests and their energies from one Hne of pro- 
 duction to another, and if capital and labor could likewise be 
 freely transferred from one undertaking to another, it is hard 
 to see how profits in any one competitive industry could be for 
 any length of time much higher than in other competitive 
 industries. Managerial ability, labor, and capital would gravi- 
 tate always toward those employments which promise the 
 greatest profits. The effect would be a continual movement 
 toward equality of advantage in different fields of industry. 
 This does not necessarily mean an equality of profits as between 
 individuals in any given line of business, for the amount of 
 profits depends largely upon the ability and enterprise of the 
 individual business man. But in a state of free competition, 
 with alternative business opportunities as free and open as we 
 have assumed, the profits of any business undertaking would 
 hardly be larger, for any period of time, than the business man 
 could get as salary by working for others, — for if working for 
 others offered a greater return than assuming the risks of busi- 
 ness for himself, he would naturally choose the salaried position, 
 and vice versa. Purely competitive profits, under conditions of 
 this absolute " fluidity " of business ability, of labor, and of 
 capital, would thus tend to adjust themselves according to the 
 ability of the individual business man; that is, to equal what 
 we shall later describe as the " wages of management." If we 
 include the value of the business man's services, thus measured, 
 among the expenses of production, we may, obviously, state 
 the tendency which we have described as a tendency toward the 
 equality of the prices received for the products of any particular 
 industry and the expenses of producing them. 
 
 The assumptions we have made do not, however, exactly cor- 
 respond to the conditions of actual business. Managerial 
 ability, labor, and capital are all specialized to a greater or less 
 extent, so that they cannot be changed from one employment 
 to another without loss of efficiency. But it is not necessary 
 for the validity of our analysis that all managerial ability, all 
 labor, and all capital should be fluid enough to change from 
 industry to industry economically. There are always many 
 
VALUE AND PRICE 169 
 
 business men who are anxiously watching for the most inviting 
 business opportunities; there is always a certain amount of 
 labor awaiting the most remunerative employment, and there 
 is always a certain amount of money awaiting investment in 
 those forms of capital goods which promise the greatest return. 
 These facts are enough to give substantial truth to the state- 
 ment that in any competitive industry the price of the com- 
 modity produced tends to equal the cost of producing it. When 
 the price of bicycles was high, as compared with the expense of 
 producing them, existing bicycle factories were extended and 
 new ones were built. The supply of bicycles was thus so 
 increased that they could not be sold except at a much lower 
 price. On this account and because of the cessation of demand, 
 the profits in the manufacture of bicycles became relatively 
 low, and many former bicycle factories are now used for other 
 purposes. If the excess of the price of wheat over the expense 
 of producing it promises to be greater than the excess of the 
 price of corn over the expense of producing it, farmers will 
 raise less corn and more wheat, and the result will be higher 
 prices for corn and lower prices for wheat. 
 
 Normal Price. — Because the market price of a commodity 
 cannot get very far away from the expense of producing it 
 without resulting in abnormally high or abnormally low profits, 
 and because the existence of abnormally high or abnormally low 
 profits sets forces at work which are very sure to move the price 
 closer to the expense of production, the name normal price is 
 given to that price which is just equal to the expense oj producing 
 a unit of a commodity. 
 
 The effectiveness of the tendency of actual competitive prices 
 to equal normal prices depends very largely upon the length 
 of the period of time that is taken into consideration. The 
 longer the period of time, the larger will be the proportion of 
 managerial ability, labor, and capital that can be shifted from 
 the less profitable to the more profitable undertakings. To 
 build and to equip new factories and to extend old ones takes 
 time; the supply of skilled labor in any occupation can often 
 be increased but slowly, for many trades involve an appren« 
 
lyo OUTLINES OF ECONOMICS 
 
 ticeship of three or more years. In the undertakings that are 
 becoming less profitable, although capital specialized in the 
 form of machines may not be useful for other purposes, yet such 
 machines need not be replaced as they wear out ; while a skilled 
 laborer cannot take up another trade without loss of efficiency, 
 yet an increasing proportion of the incoming supply of laborers 
 may begin their apprenticeship in those occupations in which 
 there is a greater demand for labor. 
 
 While the conditions of long-period supply are thus such as 
 to result in a constant movement toward the equalization of 
 market price and normal price, it may easily happen that the 
 two will never become identical. For market prices them- 
 selves are constantly changing under the influence of changing 
 demand. And the increase in the output of an especially profit- 
 able product is often overdone. Periods of losses or of low 
 profits may succeed periods of high profits. In short, the goal 
 toward which business enterprise directs productive efforts is 
 constantly shifting. 
 
 Different Conditions of Supply. — A fact of prime im- 
 portance is that the expense of production {per unit) often varies 
 as the amount produced is larger or smaller. But this relation 
 between the amount of goods produced and the expense of 
 producing them is different for different industries. In partic- 
 ular, three forms of productive undertaking may here be dis- 
 tinguished : those in which increased production is accompanied, 
 in the long run, with (i) increasing, (2) decreasing, or (3) con- 
 stant expense per unit of product. 
 
 I. If transportation facilities, the knowledge of agricultural 
 methods, and other controlling conditions remain imchanged, 
 the amount of wheat raised in the United States cannot be sub- 
 stantially increased without resort to lands less well adapted 
 to the production of wheat, or the more intensive cultivation of 
 lands already in use. Either alternative requires (as will be 
 shown in a later chapter in more detail) the use of relatively 
 more labor and capital per bushel in producing the additional 
 wheat than was required iox the wheat produced under the for- 
 mer conditions. This means that the production of wheat 
 
VALUE AND PRICE 171 
 
 cannot be substantially increased except at an increased ex- 
 pense per bushel. When this condition of increasing expense is 
 met with — and it holds true generally in agriculture — normal 
 price increases with an increase in production. If the price 
 of the product is not high enough to repay the cultivation of the 
 poorest lands used, they will cease to be cultivated. If the 
 price of the product is appreciably higher than the expenses of 
 cultivation, farmers will find it profitable to push cultivation 
 still farther, up to the point where the expense equals the price. 
 2. In some industries, however, an increase in production 
 will often bring forces into operation that will result in smaller 
 expenses of production per unit of product. Where this condi- 
 tion of decreasing expense is found, a general increase in produc- 
 tion brings, in the long run, a decrease in the normal price of 
 the product. What is the nature of these economies that some- 
 times attend an increase of production? We rule out of con- 
 sideration such things as new inventions and the general prog- 
 ress of industrial knowledge and technique, for although these 
 things reduce the expenses of production, they are in no direct 
 way a necessary result of an increasing output. They play 
 a part, moreover, in agriculture (where they help to counteract 
 the effects of the rule of increasing expenses) as well as in in- 
 dustries of decreasing expenses. Additions to our knowledge 
 of ways of producing things are undoubtedly stimulated by the 
 growth of production, which gives increased scope and impor- 
 tance to improvements in industrial technique ; but for the 
 purposes of the present inquiry we must put these things aside 
 and merely assume a given state of industrial knowledge. The 
 economies that create the condition of decreasing expenses are, 
 properly understood, only such as are brought about, in a 
 fairly direct way, by the increase of production itself. Here we 
 must distinguish two things: first, economies in the general 
 organization of whole industry, and, second, economies result- 
 ing from an increase in the size of the individual business 
 establishments within the industry.^ 
 
 1 These are named by Professor Alfred Marshall "external economies" and 
 "internal economies." 
 
172 OUTLINES OF ECONOMICS 
 
 The most important of the first of these two classes of econo- 
 mies is a greater specialization or division of labor within the 
 industry. The different processes in the operations of the in- 
 dustry may be separated and apportioned to different specialized 
 plants, located, perhaps, at particularly advantageous points. 
 Opportunity is given for a more thoroughgoing and more 
 efficient specialization of labor and for the use of highly special- 
 ized machinery. Subordinate industries may be developed, 
 supplying machinery and other equipment; improved trans- 
 portation facilities of one kind and another may be secured. It 
 becomes, in general, more feasible for the industry to utilize 
 what are known to be the best and most economical methods of 
 production and to keep pace with the advance of technical 
 knowledge. Indirect, roundabout ways of doing things, involv- 
 ing a thoroughgoing subdivision of processes and the use of 
 large amounts of fixed capital in the form of elaborate plants 
 and expensive machinery are advantageous only when the 
 industrial output is large. All these things have played an 
 important part in the progress of most of the great manufac- 
 turing industries, and in making their products cheaper. 
 
 Unless some obstacle, some countervailing force, prevents, 
 these economies are sufficient to make almost any large and 
 growing industry one of decreasing expenses. And about the 
 only obstacle that can stand in the way is the limitation of 
 the supply of one of the necessary factors in production. The 
 supply of capital has (as shown by the interest rate) kept pace 
 with industrial demands. The industrial output has increased 
 more rapidly than has the supply of labor, but in most industries 
 this has not been sufficient to offset the movement toward 
 decreasing expenses. But the supply of land and of natural 
 products of various kinds is definitely limited. This is why 
 agriculture, despite the fact that it benefits by some of the 
 economies of specialization, is not an industry of decreasing 
 expenses. For the same reason the lumber industry and petro- 
 leum industry have had to contend, in recent years, with in- 
 creasing expenses. 
 
 The second class of econbmies — those connected with the 
 
VALUE AND PRICE 1 73 
 
 increasing size of the individual business unit — are usually- 
 named " the economies of large-scale production." These are 
 of interest to us at the present stage of our study only in so far 
 as large-scale production is in itself a result of the general growth 
 in the volume of the output of an industry. Other things, such 
 as the invention of new and effective " large-scale " methods of 
 production and the cheapening of transportation (broadening 
 the market open to a particular plant), have cooperated in 
 stimulating the growth of large establishments. Our present 
 inquiry is merely into the relation between the increase in the 
 total amount of goods produced and the expense of producing 
 them; that is, into the long-run relation between supply and 
 normal price. And so our question is: Does a larger output 
 for an industry at large encourage the growth of large individual 
 establishments by increasing any advantages they may have 
 over smaller establishments? It is clear that there is no in- 
 variable rule here, for in agriculture and in some special fields 
 of manufactures and trade the average size of the individual 
 undertaking is not increasing, despite the rapid growth of the 
 total volume of output. But in nearly all the industries in 
 which we have any reason to suspect the presence of the rule of 
 decreasing expenses we find that the average establishment has 
 been growing larger. This must mean that in many industries 
 the first class of economies, already described, can best be util- 
 ized by relatively large establishments. 
 
 Whatever the real " economies of large-scale production " 
 may be (and they will be discussed in the following chapter), 
 they cannot in themselves be adequate to bring about, in any 
 competitive industry, the general condition of decreasing ex- 
 penses. Wherever the advantages of large-scale production 
 are increasing, the principal effect must be merely to divide the 
 aggregate operations of the industry among a somewhat smaller 
 number of establishments than would otherwise be found. But 
 the growth of the size of the business establishment has no direct 
 bearing upon the existence of the condition of decreasing ex- 
 penses in the industry at large, except in so far as an increase 
 in the size of the individual establishment is found to be one 
 
174 
 
 OUTLINES OF ECONOMICS 
 
 of the ways of utilizing to best advantage the various economies 
 made possible by the increased industrial product. Large- 
 scale production does not create the condition of decreasing 
 expenses, but it may be an indication, a manifestation of the 
 presence of that condition.^ 
 
 3. In many hand industries, such as tailoring and cigar 
 making, the expense of production per unit does not vary to any 
 great extent with the amount produced. These are, therefore, 
 industries with constant expenses. 
 
 Figures i, 2, and 3 illustrate the relation of changes in supply 
 to changes in price under the conditions of increasing, decreas- 
 ing, and constant expenses, re- 
 spectively. These diagrams 
 must be carefully distinguished 
 from the supply curve described 
 in the preceding chapter, which- 
 related only to the conditions 
 of supply at a particular time. 
 They indicate the way in which 
 an increased output, evoked by 
 an increase in demand, will, in 
 the long run, be offered to the 
 market at higher, lower, or constant prices, depending upon the 
 conditions existing in different classes of industries. In an in- 
 dustry of decreasing expenses (Figure 2), for example, OM 
 units of product per year cannot be supplied to the market at 
 a lower price per unit than PM. But, allowing time for the 
 necessary reorganization of the industry, OM' units per annum 
 can be supplied at a lower price, P'M'. In an industry of in- 
 creasing expenses this relation between price and amount of 
 output is reversed. 
 Fixed and Variable Expenses. — There is no better illustra- 
 
 * We have thought it worth while to emphasize the merely indirect relation be- 
 tween the economies of large-scale production and the so-called "law" of decreasing 
 expenses (or "increasing returns"), because there is much confusion of thought on 
 this matter. Only when an industry is controlled by a monopoly, are the real econo- 
 mies of a large industrial output identical with the "economies of large-scale pro- 
 duction." 
 
 Fig. 
 
VALUE AND PRICE 
 
 175 
 
 Fig. 
 
 tion of the necessity of keeping definite periods of time in mind 
 when discussing problems relating to valuation than that 
 furnished by the problem of the apportionment of specific 
 expenses of production to par- y- 
 ticular units of products. In 
 almost any industrial establish- 
 ment, any increase in product 
 will be attended by some specific 
 increase in expenses : more raw 
 material and more labor will be 
 used, possibly more power; 
 although the increased expenses 
 for labor and power may not 
 be proportionate to the increase 
 in production. Such expenses are called variable expenses, and 
 are to be contrasted with fixed expenses, which remain approx- 
 imately the same, no matter what the amount produced is. 
 The interest on the funds invested in the factory building 
 and its equipment of machinery is a fixed expense ; the expense 
 of management and general office expenses will not usually 
 be increased proportionately by an increase in the annual 
 product of an establishment. 
 
 It is often assumed that wherever only a part of the expenses 
 
 varies with the amount pro- 
 duced, the establishment is 
 ipso facto one in which large- 
 scale production is especially 
 economical. Whether this as- 
 sumption holds true or not 
 often depends on the scale of 
 production we have in mind. 
 Factories and other plants are 
 built with a certain maximum 
 capacity, and until that maxi- 
 mum capacity is utilized, production may be increased without a 
 proportionate increase in expenditure. But when the maxi- 
 mum is reached, more equipment, and often more buildings, will 
 
176 
 
 OUTLINES OF ECONOMICS 
 
 T\ 
 
 be needed before there can be a further increase in product 
 There is often a certain most efficient size of plant ; an increase 
 in business beyond the capacity of the most efficient size of plant 
 necessitates either a curtailing of the business or a duplication 
 of the plant. When business conditions are such as to warrant 
 temporarily pushing the output of a plant beyond its normal 
 capacity, the result usuaUy is, as every manufacturer knows, 
 that this increased output is produced uneconomically, that is, 
 at relatively increased expenses of production. 
 
 Many seemingly constant expenditures (like interest on the 
 cost of the plant) are variable in the long run. Such expendi- 
 tures increase, but only at considerable intervals of time, as 
 
 additional invest- 
 ments in fixed cap- 
 ital are made. A 
 long-period supply 
 curve correspond- 
 ing to the condi- 
 tions of production 
 in such a business 
 might be some- 
 thing like Figure 
 4. This diagram 
 should be inter- 
 preted as follows: 
 The total expense of producing a certain output, OM, is repre- 
 sented by the area OMPS. MP (considered not as a mere line, 
 but as an indefinitely narrow area) represents the variable ex- 
 pense which would not be incurred if the volume of production 
 were a little smaller than OM units. MP, then, represents the 
 marginal expense, in this particular establishment, of producing 
 OM units. Thus the irregular curve SS' represents the way in 
 which the aggregate expenses of production are increased as the 
 output (measured on the line OX) grows. When the product 
 reaches OM' units, and again when it reaches OM" units, 
 fresh investments of large amounts of capital are necessary. 
 From the long-time point of, view, such a business might very 
 
 M 
 
 M' 
 
 M" 
 Fig. 4 
 
 -X 
 
VALUE AND PRICE 1 77 
 
 possibly be one of approximately constant expenses ; although 
 of course some of the real economies of large-scale production 
 might be present and might result in decreasing expenses. 
 
 The Relation of Fixed and Variable Expenses to Price. — The 
 fact that, within limits, the expenses of a business undertaking 
 do not increase proportionately as the output increases has an 
 important bearing upon competitive price-making. The pro- 
 prietors of a business establishment will feel justified in in- 
 creasing their output, provided the additional output will sell 
 for enough to afford some profit above the actual amount by 
 which it increases their expenses. If the full capacity of their 
 plant is not already utilized, they will count as profit any addi- 
 tional income they can secure above the necessary increase in 
 variable expenses. If they are producing some staple commod- 
 ity for the general market, so that they cannot discriminate 
 in the prices at which they sell to diiferent buyers, they will 
 find it difficult to make much use of this possibility of cutting 
 prices on part of their output. But if they are producing a 
 variety of goods, if they are making highly specialized products 
 " to order," or if they are selling in two or more widely separated 
 markets, they may often be able to increase their output by 
 accepting prices too low to contribute anything to the payment 
 of their fixed expenses. This is often the explanation of the 
 " dumping " of part of a manufacturer's product on a foreign 
 market at a lower price than he charges at home. Railways are 
 able to take advantage of the fact that (for the time being) 
 only part of their expenses vary with their traffic, for they do 
 not have to charge a uniform rate per ton per mile, but can 
 classify their rates according to the origin, destination, and 
 nature of the traffic. The rates charged by electric plants are 
 often less for current used at certain hours of the day when the 
 capacity of the plant is only partly utilized. The reader will 
 probably be able to supplement these illustrations with others 
 based upon his own observation. 
 
 If a business establishment is hard pressed by competition, 
 or if for any other cause, such as a dull season, its sales are 
 small, its proprietors may decide to cut prices on their whole out- 
 
178 OUTLINES OF ECONOMICS 
 
 put to a point that will cover the variable expenses and possibly 
 contribute something toward meeting the fixed expenses. Some 
 fixed charges, like depreciation, interest, rent, insurance, taxes, 
 will continue even if the output is little or nothing. It will very- 
 likely be sound business policy to make the best of a bad situa- 
 tion by getting what little income can be had over and above 
 the variable expenses of production. Much money may have 
 been irrevocably invested in the business, and although possibly 
 under no conditions can it be made to yield the return that had 
 been expected at the time when the investment was made, 
 matters will not be bettered by letting the plant lie idle. It may 
 be that the prices which the proprietors of the business thus 
 reluctantly decide to accept are high enough to pay all the ex- 
 penses of production, fixed and variable, in some competing 
 plants, better organized or more favorably located. Or it 
 may be that some or all of the competing plants also find it 
 necessary to accept prices that do not cover their fixed expenses. 
 Sometimes the fact that it is more profitable to produce at 
 prices which cover merely the variable expenses than not to 
 produce at all leads some one establishment to cut prices. Other 
 establishments have to reduce prices in order to protect them- 
 selves, and a period of cut-throat competition may ensue. 
 
 Though at any given time it may be the variable rather than 
 the aggregate expenses of production per unit of product which 
 fix the price at which some or all of the different establish- 
 ments in an industry are selling their products, it should not be 
 inferred that it is the variable expenses alone which measure 
 the normal price of a product. For in the long run prices have 
 to be high enough to induce the replacement of fixed capital as 
 it wears out and (in a growing industry) to attract new perma- 
 nent investments of capital. That is, in the long run, prices 
 have to be high enough to cover both variable expenses and 
 fixed expenses, — which last, as we have seen, are generally 
 variable as seen through a sufficiently long period of time. As 
 a matter of fact, the prices in any large competitive industry 
 are usually high enough to more than cover the expenses of 
 production in the most e^cient establishments, but are rarely 
 
VALUE AND PRICE 1 79 
 
 high enough to cover all such expenses in the least efficient 
 establishments. For the time being the weaker establishments 
 may continue in operation, but sooner or later they are sure 
 to be forced out. The better establishments will be enlarged, 
 and new and possibly yet more efficient ones will be built. If, 
 however, none of the establishments in an industry is able to 
 cover all of its expenses, the volume of output must eventually 
 decline to a point where prices can be secured that will cover 
 interest, depreciation, and the other fixed expenses that must be 
 provided for if the recurrent needs of the industry for fresh 
 investments in fixed capital are to be met. It is in these ways 
 that the tendency of prices to equal the expenses of production 
 manifests itself. 
 
 Joint Expenses of Production. — When the production of one 
 commodity is inevitably accompanied by the production of one 
 or more other commodities, it is often impossible to assign a 
 definite part of the total expense of production to any one of 
 the commodities. It is impossible to separate the expenses of 
 producing tenderloin steaks from the expenses of producing 
 soup bones, or either one of these from the expenses of producing 
 hides. Mutton and wool, cotton and cotton seed, coal gas and 
 coke, are familiar examples of commodities produced under 
 conditions of joint expense. Modern methods for the utiliza- 
 tion of industrial by-products have greatly increased the list of 
 commodities produced under such conditions. 
 
 What is the normal price of these jointly-produced commod- 
 ities? Take first the simplest case: that in which all the 
 expenses of producing two commodities are joint expenses. 
 Neither commodity can be said to have a normal price of its 
 own, for neither commodity has specifically assignable expenses 
 of production of its own. But the two commodities, taken 
 together, have what may be called a collective normal price. 
 Suppose, for example, that the production of every unit of one 
 commodity is necessarily accompanied by the production of 
 two units of the other commodity. It is evident that in order 
 to induce the production of these commodities the price of a unit 
 of the first commodity plus the price of two units of the second 
 
l8o OUTLINES OF ECONOMICS 
 
 commodity must cover the joint expense of producing these 
 three units. This joint expense, then, measures the collective 
 normal price of the three units. Just how the market prices 
 which, in their sum, will tend to approximate this collective 
 normal price, will be fixed, will depend upon the conditions of 
 demand for each of the two commodities. Sometimes one or 
 both of the jointly produced commodities will have to compete 
 in the market with substitute commodities produced under 
 other conditions, and this, of course, tends to limit the possible 
 range of price variation. 
 
 When, as often happens, two commodities are produced under 
 conditions of partially joint expenses, further processes being 
 necessary to fit each commodity for the market, the price must 
 in each case cover the specific or assignable expense. The 
 joint expenses will be assigned to one or the other of the commod- 
 ities, or apportioned between them, according to the relative 
 demand for them. So far as the expenses are joint they are in 
 some respects similar to the fixed expenses of any establishment 
 producing under the ordinary conditions of fixed and variable 
 expenses. In a sense all fixed expenses are the joint expenses 
 of producing the different units of output, while all variable ex- 
 penses are specifically assignable to the different units of the 
 product. But this analogy must not be pushed too far, and that 
 for two reasons: (i) Most establishments with fixed and va- 
 riable expenses have to accept one uniform price for the different 
 units of their product. Their fixed charges, unlike true joint 
 expenses, cannot be covered by the price of one portion of the 
 output and disregarded in the price of another portion. (2) Even 
 if an establishment is producing two or more different commodi- 
 ties or is able to sell one commodity in two or more different 
 markets at different prices, its fixed expenses are not true joint 
 expenses except in so far as its output is necessarily accompanied, 
 without additional expense, by the production, or partial pro- 
 duction, of another part of their output. The importance of 
 this is that, as we have seen, an increase or decrease in the 
 aggregate product of an industry must ultimately increase or 
 decrease the fixed expenses of that industry. Fixed expenses 
 
VALUE AND PRICE l8l 
 
 thus enter in the long run into the determination of the normal 
 price of all portions of the industry's output. This is not true of 
 joint expenses, for these afEect only what we have termed the 
 collective normal price of the joint products. Thus neither steaks 
 nor hides have a separate normal price. But each standard 
 grade or type of product in the output of the furniture industry 
 has a normal price of its own. 
 
 The Surplus of Bargaining. — Demand and supply do not 
 always fix price at a definite point. The price of horses of any 
 given grade, for example, is fixed only approximately by market 
 conditions. In the sale of a horse there is room for considerable 
 latitude of opinion as to the price that should be paid. If 
 the lowest price that the seller will take is considerably below 
 the highest price that the buyer will give, just where between 
 these limits the actual price will be finally fixed will depend 
 upon the relative skill at bargaining of the seller and buyer. In 
 the case of a horse trade, this opportunity for the " higgling of 
 the market " has become proverbial, and in many other kinds 
 of exchanges the efficient bargainer has an opportunity to get 
 for himself a surplus above his minimum selling price, or below 
 his maximum buying price. Real estate transactions furnish 
 a good example. In the case of the great commodities of the 
 world market, like wheat, cotton, and iron, the price is set so 
 accurately by market conditions that the gains of bargaining 
 are relatively small. In general, the wider the market, the more 
 general the use of the commodity, the greater the ease with which the 
 commodity can he sorted into standard grades (as in the case of 
 wheat and cotton) , the more accurately will competitive forces fix a 
 definite price. Goods which cannot he standardized, each unit of 
 which possesses some unique qualities, give most scope for the varia- 
 tions in the valuations of individual huyers and sellers. In such 
 cases supply and demand do not fix a price point, but only cer- 
 tain limits within which the price must fall. The widening of 
 the market, however, and the increasing standardization of 
 commodities — an effect of machine production — are bringing 
 a larger and larger proportion of goods into the field where 
 uniform market valuations dominate. 
 
l82 OUTLINES OF ECONOMICS 
 
 Non-reproducible Goods. — Some economic writers have 
 made a special class of such goods as great works of art. These 
 are absolutely unique, in that no copy can have anything like 
 the value of the original. The price of such non-reproducible 
 goods has an upper limit fixed by the highest subjective valua- 
 tion set upon it by any possible buyer. The lower limit will 
 be either the seller's own subjective valuation, or the second 
 highest valuation set by any competing buyer, according as 
 one or the other of these two is the higher. Between the upper 
 and lower limit the exact fixing of the price is a matter of pure 
 bargaining. Such cases should not be confused with monopoly 
 price, as has been done by some writers. The products of almost 
 all the industrial handicrafts, as well as the products of the 
 avowedly artistic pursuits, possess a non-reproducible element 
 of individuality, that removes them to a greater or less extent 
 from the operations of the law of normal price. A commodity 
 may possess this quality of uniqueness to such an extent that 
 it is not affected at all by the forces determining the value of 
 the general class of goods to which it belongs, and in this case 
 its owner may be said to have a monopoly of it. But it is 
 better to look upon the valuations of such non-reproducible 
 goods as determined by individual valuations and the process 
 of bargaining. The " normal " price of such goods is simply the 
 highest price that can be got for them — a statement which 
 does not hold true of most monopoly goods. For monopoly 
 goods are not necessarily unique or non-reproducible. They 
 differ from ordinary competitive goods, however, in that they 
 cannot be reproduced except by the monopolist. 
 
 Retail Prices. — The retail prices paid by the individual con- 
 sumer do not always respond to all the variations in wholesale 
 prices brought about by changes in supply and demand. There 
 are sometimes tacit or explicit local price agreements between 
 local merchants, which apply even to competitively produced 
 goods. Some retailers consistently sell a few kinds of goods at 
 less than cost to attract custom for the goods on which they 
 may make a profit. Merchants who make a specialty of a 
 high class of goods, and thus cater to a wealthy clientele, are 
 
VALUE AND PRICE 183 
 
 apt to exact higher prices for ordinary goods than do those 
 merchants who have to deal with a poorer class of customers. 
 Custom has more effect on retail than on wholesale prices. The 
 prices of various articles sold as " men's furnishing goods " 
 form a good example of the influence of custom. Retail prices 
 are also governed by the value of the coins that are in general 
 use, and are generally expressed in round numbers. In the 
 long run, demand and supply govern retail prices, but they do 
 not set a definite price point so accurately as they do in the case 
 of wholesale prices. 
 
 Public Authority and Value. — In the Middle Ages there was 
 considerable speculation by theologians and legists about the 
 subject of " just price " — the value at which things ought to 
 exchange for other things. This idea denotes an important 
 difference between the medieval and modern concept of value. 
 Professor Ashley has put it clearly in these words : " With Aqui- 
 nas, the greatest of the medieval schoolmen, it [value] was some- 
 thing objective ; something outsidc'of the will of the individual 
 purchaser or seller; something attached to the thing itself, 
 existing whether he liked it or not, and that he ought to rec- 
 ognize. And as experience showed that individuals could not 
 be trusted thus to admit the real value of things, it followed that 
 it was the duty of the proper authorities of state, town, or gild 
 to step in and determine it, and what the just and reasonable 
 price really was." This " just and reasonable price " was very 
 often thought to be that price which would afford a reasonable 
 compensation for the labor of the producer. When in more 
 modern times theological speculations began to yield prece- 
 dence to inquiries into " natural laws," the idea of just price 
 was supplanted by the idea of " natural price." Sometimes 
 this was interpreted as determined by the value of the labor put 
 into a commodity (this was the dominant idea during the eight- 
 eenth century), but the growth of capitalistic production 
 necessitated the recognition of the other elements in the expense 
 of producing a commodity as part of its natural price. Modern 
 economic science, as we have seen, applies the term " normal 
 price " to the expense of producing a thing, but interprets it 
 
l84 OUTLINES OF ECONOMICS 
 
 only as an important factor controlling the long-period fluctua- 
 tions of market prices. The adjective " natural," with its mis- 
 leading implications, has been abandoned. Yet the competitive 
 system is today so thoroughly accepted as the " natural " 
 economic order, that there is, as we have previously noted, a 
 deep-seated conviction that normal competitive prices (meas- 
 ured by the expenses of production) are natural and just prices. 
 This conviction is, however, brought face to face with the fact 
 of the growth of a large industrial field in which monopoly, 
 rather than competition, rules. The question of just price is 
 again a live issue — as it was before the growth of the com- 
 petitive system. Public authority is frequently invoked to 
 insure that the prices fixed by holders of municipal franchises 
 and other monopolists are just and reasonable. The chief 
 fundamental test which our courts are able to apply to the 
 reasonableness of any particular price is its conformity to what 
 the price would have been under competitive conditions. Thus 
 it is often asked if a particular monopoly charge gives a more 
 than normal return upon the capital invested. The deter- 
 mination of what the expense of producing a particular com- 
 modity or service really is, is often a difficult, or even impossible, 
 task (the distinction between constant and variable expenses 
 being frequently a stumbling-block), but, given the general 
 acceptance of the competitive system, it is hard to see what 
 other standard could be used. Moreover, the general consensus 
 of recent court decisions is that the Fifth and Fourteenth Amend- 
 ments to the Federal Constitution, prohibiting the taking of 
 property without due process of law, prevent federal and state 
 governments from going farther than this in the regulation of 
 monopoly charges. And even this power is not conceded, 
 except in the case of businesses affected with a distinct public 
 interest, such as those conducted by so-called public-service 
 corporations. In fixing prices for its own services, such as 
 postal charges, the government is controlled by other considera- 
 tions. These will be discussed in the chapters on public finance. 
 Imputed Value. — The only things to which market valuations 
 actually apply are the specific units of goods that are actually 
 
VALUE AND PRICE 185 
 
 bought and sold. We are accustomed, however, to impute these 
 market prices to all other existing goods of the same kinds. 
 When wheat is sixty cents a bushel, the only bushels of wheat 
 actually valued by the market at that price are the ones actually 
 sold at that price. Yet we impute or ascribe the same value 
 to all other bushels of the potential supply of wheat in the same 
 market. 
 
 Notwithstanding the hypothetical nature of this imputed 
 value, it is often treated as though it were a real thing. Statis- 
 tical attempts to state the wealth of a nation in terms of dollars 
 and cents are only estimates of the sums of these imputed values. 
 A merchant's inventory of his stock in trade is often accompanied 
 by an estimate of its value. Whether this value will be realized 
 or not depends upon the constancy of business conditions, the 
 caprices of fashion, and whether it can be sold in the regular course 
 of trade or whether it has to be disposed of at a forced sale. 
 Many kinds of consumption goods, such as household furniture, 
 are not customarily thought of by the owner in terms of ex- 
 change value. It is often necessary for purposes of taxation to 
 ascribe value to them, but this is frequently a difficult and 
 somewhat arbitrary process. 
 
 The Prices of Production Goods. — Throughout our analysis of 
 exchange value it has been assumed that the commodities valued 
 were wanted by consumers for the satisfaction of their wants ; 
 that is, that they were consumption goods. It is not altogether 
 incorrect to say that producers' goods — capital and land — 
 have a marginal utility, which varies with the importance 
 attached to the possession of them. While one could thus, with 
 substantial accuracy, include producers' goods in the scope of 
 the foregoing analysis, there is a more instructive way of ap- 
 proaching the problem of the prices of land and of capital. 
 Consumption goods have value because they satisfy human 
 wants; that is, they yield an income of satisfactions, while 
 production goods are valued because they have the power of 
 gaining a money income for the owner. Just as the values of 
 consumers' goods vary with the intensity of the wants they 
 satisfy, so the values of producers' goods vary with their power 
 
l86 OUTLINES OF ECONOMICS 
 
 to yield a money income. The problem of the prices of pro- 
 ducers' goods will, accordingly, be discussed in the chapters 
 on the rent of land and the interest on capital. 
 
 Other Theories of Value. — The older economists used to em- 
 phasize the relation between the price of a thing and the amount 
 or the expense of the labor spent in producing it, — a relation 
 much closer under the old methods of hand production than it 
 is at present. The development of a systematic labor theory 
 of value was, however, the work of Karl Marx, the founder of 
 modern " scientific " socialism. This theory is, in essence, that 
 labor produces all value and that the interest on capital and the 
 rent of land are deductions from the real wages of labor — de- 
 ductions that are made possible only by the existence of the 
 system of private property in producers' goods. It is so ob- 
 vious that things do not exchange today in proportion to the 
 amount of labor involved in producing them, that to point this 
 out in detail, as some economists have done, is unnecessary. 
 Karl Marx himself recognized that his " values " were not 
 measured by the actual prices of the market. They seem to 
 have been conceived as some mysterious essence or quality in 
 things. But the only economic values that can be recognized 
 from the modern scientific point of view are the values that 
 really exist — the actual values of the market. Nor can we 
 say that things ought to exchange in proportion to their labor 
 costs, without begging the whole question in favor of the aboli- 
 tion of private property in land and capital. Moreover, it 
 will be shown later that rent and interest would not be elim- 
 inated, although they might be changed in form, by a change 
 from private to common ownership of producers' goods. Al- 
 though the labor theory of value is still held by many followers 
 of Marx, its place in the creed of scientific socialism is diminish- 
 ing in importance. 
 
 The relation between price and the expenses of production 
 has sometimes been stated in such a way as to lead to the infer- 
 ence that cost of production is the cause of value. The expense 
 of production theory of price, when so stated, is open to much 
 the same objections as the labor theory. Suppose I perfect a 
 
VALUE AND PRICE 187 
 
 machine at the expense of ten thousand dollars which will blow 
 soap bubbles at the rate of a thousand an hour. Will it be 
 worth ten thousand dollars? Certainly not; but why not? 
 The theory of costs will not explain it. To say that the labor 
 and materials have not been wisely used is simply to say that 
 the machine has no value, which is just what we are trying to 
 explain. As a fact, it is not worth ten thousand dollars simply 
 because no one is willing to give ten thousand dollars for it. 
 The expenses of production do not create value, but there is a 
 sense in which price is the cause of the expenses of production. 
 That is, men think it worth while to expend money in producing 
 things because they think that the products will sell for 
 enough to recompense them for the expenses of production. 
 
 Many of the economists who have written in the past about 
 the subject of price took the facts of demand for granted, and 
 devoted most of their treatment of the subject to an examina- 
 tion of the relation between price and the expenses of produc- 
 tion. This was in part an expression of a general tendency to 
 regard the production of wealth as something to be desired for 
 its own sake ; the fact that the satisfaction of human wants is 
 the real goal of most economic efforts being underemphasized. 
 In more recent years economic writers have developed the analy- 
 sis of human wants ; the fact that utility in the economic sense 
 is not utility in general, but the utility of a particular unit of a 
 commodity, being the most significant point in this new analysis. 
 Some writers have even gone so far as to take the facts of supply 
 for granted, and to assume that price is explained when mar- 
 ginal utility is described. As a determining cause of price, 
 utility has a logical priority over scarcity, in the sense that 
 demand is usually the cause of supply. Yet in the analysis of 
 the actual price-making process we have to recognize that util- 
 ity and scarcity, demand and supply, are forces operating simul- 
 taneously, neither of which can be neglected without obscuring 
 the fundamental facts of the market. 
 
l88 OUTLINES OF ECONOMICS 
 
 QUESTIONS 
 
 1. Is there any relation between the price of a lead pencil and the expense 
 of producing it ? 
 
 2. What elements of a farmer's expenses are "constant"? What are 
 "variable"? 
 
 3. What different possible standards of just price can you suggest? 
 
 4. Combine demand curves with long-period supply curves like those 
 shown on page 175 (the general conditions of demand being assumed to 
 be constant) and interpret the meaning of the resulting diagrams. 
 
 5. Are the passenger service and the freight service of a railway joint 
 products ? 
 
 6. What different possible meanings can be attached to the expression 
 "natural value"? 
 
 7. Discuss the following statement : 
 
 "The fact is that labor once spent has no influence on the future value of 
 any article ; it is lost and gone forever. In commerce bygones are forever 
 bygones; and we are always starting clear at each moment, judging the 
 value of things with a view to future utihty." — Jevons, Theory of Political 
 Economy, p. 164. 
 
 REFERENCES 
 
 Chapman, S. J. Outlines of Political Economy, Chaps, xv-xvii. "' 
 
 Flux, A. W. Economic Principles, Chaps, iv and v. 
 
 Marshall, Alfred. Principles of Economics, 6th ed., Book v, Chaps. 
 
 ii-viii, xi. 
 Mill, J. S. Principles of Political Economy, Book iii, Chaps, iii and iv. 
 Taussig, F. W. Principles of Economics, Vol. i. Chaps, xii-xiv, xvi. 
 WiESER, F. VON. Natural Value, Book v, Chaps, i-vi. 
 
CHAPTER XII 
 MONOPOLY 
 
 The Idea of Monopoly. — One of the economic terms most fre- 
 quently used nowadays is monopoly, and at the same time it 
 is one of those terms which are peculiarly vague and ill-defined 
 in popular discussion. Even in law and economics, contradic- 
 tory meanings have been attached to the term, although recently 
 there has been a marked clarification of thought both on the part 
 of economists and jurists. While there has been confusion of 
 thought with respect to monopoly, all have agreed that some- 
 thing to be called monopoly has existed, and that it has been 
 the cause of perplexing scientific and practical problems. 
 
 In economics, as in life, categories shade off into each other, 
 and at the boundaries discrimination is difficult. It is best, 
 therefore, to find highly developed, plainly marked types to fur- 
 nish us the subject-matter for definition and to compare one type 
 with another. This is an especially desirable mode of procedure 
 in the present case, because the term " monopoly " at once sug- 
 gests the term " competition," with which it is inevitably con- 
 trasted. When monopoly exists, competition is thought of as 
 absent. A state of full and free competition, on the other hand, 
 is incompatible with monopoly. 
 
 Competition means a market with rival sellers and buyers, 
 and prices determined, on the one hand, by efforts of sellers, 
 acting independently of one another, to dispose of commodities 
 and services, and on the other hand, by efforts of purchasers, 
 acting independently of one another, to secure commodities and 
 services. We have seen the forces that under competition limit 
 producers and purchasers, and thus determine prices, and we 
 have seen that competitive prices are beyond the control of any 
 one buyer or seller. 
 
 189 
 
190 OUTLINES OF ECONOMICS 
 
 Monopoly, as the term contrasted with competition, means 
 combination and unified action, signifying restraint on the free 
 offering of commodities and services by rival sellers and on the 
 free purchase of these commodities and services by rivals who 
 desire to secure them. The word " monopoly " itself means a 
 condition in which there is a single seller or a single purchaser, 
 and signifies unity in management of some kind of business in 
 some essential particular. 
 
 The particular in which unity is secured in the case of monop- 
 oly may be in production, it may be in sales, it may be in pur- 
 chases ; or it may be in any two or all three of these particulars. 
 This use of the term " monopoly " gives us a clear scientific 
 concept which is workable ; and on its basis we may then formu- 
 late this definition of monopoly : Monopoly means that substan- 
 tial unity of action on the part of one or more persons engaged in 
 some kind of business which gives exclusive control, more particu- 
 larly, although not solely, with respect to price. 
 
 This definition of monopoly is in accordance with good English 
 usage, and is also in harmony with the meaning given to the 
 corresponding word in other modern languages by those who 
 use these languages with discrimination. In legal utterances, 
 too, though they have been contradictory and inconsistent in 
 various particulars, we find, nevertheless, a sound tendency to 
 emphasize unified control of business as an essential character- 
 istic of monopoly.^ 
 
 The Idea of Monopoly and Industrial Evolution. — But the 
 meanings of economic categories change with industrial evolu- 
 tion. Even such terms as freedom and liberty have to be newly 
 interpreted with every new stage and even with every marked 
 
 1 Lord Coke, in the seventeenth century, said that monopoly consisted of power 
 granted "to any person or persons, bodies politic or corporate, for the sole buying, 
 selling, making, working, or using of anything, whereby any person or persons, bodies 
 politic or corporate, are sought to be restrained of any freedom or liberty that they 
 had before, or hindered in their lawful trade " (3 Institutes, 181). Blackstone, in his 
 Commentaries on the Laws oj England, gave almost precisely the same definition in 
 the following century. The Supreme Court of the United States {National Cotton 
 OH Co. V. Texas, 197 U. S. 129) has accepted the definition of monopoly given in 
 the text, above. 
 
MONOPOLY 191 
 
 phase in a stage of economic life. Naturally monopoly has 
 acquired a new significance, requiring new interpretation. The 
 earlier legal definitions made monopoly proceed from an express 
 grant of public authority. Lord Coke says : "A monopoly 
 is an institution or allowance by the king, by his grant, commis- 
 sion, or otherwise " ; and Blackstone uses similar language in 
 defining monopoly " as a license or privilege allowed by the 
 king." 
 
 Historically, this source of monopoly power is of paramount 
 importance. From early times, English sovereigns granted mo- 
 nopolies either for public or private reasons, and they became a 
 grievous burden. Queen Elizabeth, in particular, sinned in this 
 respect, regarding the right to grant monopolies as " one of the 
 fairest flowers " in her prerogative, and it was not long before 
 the citizen found himself restrained and shut in on every side by 
 a privileged class of monopolists. In 1603, it was decided, in a 
 famous case, with respect to one of Queen Elizabeth's grants : 
 " That it is a monopoly and against the common law. All 
 trades as well mechanical as others which prevent idleness (the 
 bane of the Commonwealth) and exercise men and youth in labor 
 for the maintenance of themselves and their families, and for 
 the increase of their substance to serve the Queen when occasion 
 shall require are profitable for the Commonwealth, and therefore 
 the grant to have the sole making of them is against the common 
 law and the benefit and liberty of the subject." Parliament, in 
 1624, passed a statute declaring that " all monopolies are alto- 
 gether contrary to the laws of this realm and are and shall be 
 void and of no effect." Exceptions to this rule were sometimes 
 made upon one ground or another, but the general principle of 
 the illegality of special grants of monopoly became thoroughly 
 established in English law. 
 
 Our forefathers were so deeply impressed with the evils which 
 they had suffered at the hands of the monopolists in old England 
 that in the Bills of Rights and elsewhere in the early constitutions 
 of our commonwealths they frequently inserted severe denun- 
 ciations of monopolies, and prohibited them unqualifiedly ; and 
 these declarations and prohibitions still last in several states. 
 
192 OUTLINES OF ECONOMICS 
 
 Two illustrations will sufi&ce. We read the following utterance 
 in Article 39 of the Declaration of Rights which forms part of the 
 constitution of Maryland : " Monopolies are odious, contrary to 
 the spirit of a free government and the principles of commerce, 
 and ought not to be suffered." And the people of Texas still 
 cherish Section 26 of Article i of their constitution, which among 
 other things declares that " monopolies are contrary to the genius 
 of a free government, and shall never be allowed." 
 
 While the spirit of monopoly is as old as man, there was until 
 this century comparatively little opportunity for monopoly on 
 any large scale save as it proceeded from express grants of public 
 authority. These grants were sometimes made for public pur- 
 poses, and sometimes they proceeded from mere abuse of 
 monarchical power, and were given to favorites of royalty. 
 We cannot now stop to discuss their merits and demerits, but 
 call attention to the fact that they became odious, and were 
 prohibited both in England and in this country, exception being 
 made of patents and copyrights. At the present time, however, 
 monopolies proceed from the nature of industrial society, and 
 are of far greater significance in our economic and political life 
 than ever before. The really serious monopolies of our day are 
 far more subtle, and have for the most part grown up outside 
 of the law, and even in spite of the law. Framed with a view 
 to only one kind of monopoly, our law was at first wholly inade- 
 quate to cope with these new and varied manifestations of 
 monopoly.^ 
 
 Things Sometimes Confused with Monopoly. — We must dis- 
 tinguish sharply between a condition of monopoly and other 
 conditions, if we are to think clearly and accurately. One thing 
 which does not yield monopoly is mere limitation of supply, 
 
 1 Modern industrial monopolies are often quite as much akin to the offense known 
 in the old English law as "engrossing" as they are to the old notion of a monopoly 
 granted as a special privilege. The engrosser was one who bought large stocks of 
 goods in a market or on their way to a market with the purpose of seUing them later 
 at a higher price. The opposition to engrossing seems to have been based partly 
 on hostiUty to unnecessary middlemen and partly on the fear of temporary monopo- 
 lies, created by "cornering the. market." Later, the terms engrossing and monop- 
 oUzing came to be generally used as S3^onymous in court decisions. 
 
MONOPOLY 193 
 
 and it is strange that even an economist of the ability of John 
 Stuart Mill should have found the essential feature of monopoly 
 in this limitation ; for this at once makes monopoly cover the 
 entire field of economic activity, inasmuch as economic activity 
 is for the acquisition of valuable things, and things lack value 
 whenever their supply is adequate for the satisfaction of all 
 wants. It is only things limited in proportion to human desires 
 that have exchange value. 
 
 Nor may we say that a valuable thing is monopolized because 
 its supply is limited and also graded in quality. Land exists in 
 quantities to which physical nature has assigned limits, and the 
 supply of land exists in grades varying in fertility and desirability 
 of situation, and as a consequence of this limitation and grada- 
 tion we have the rent of land. Land is not, however, a monopoly, 
 and it is misleading to speak of it as a natural monopoly. No- 
 where do we find monopoly either in the ownership or in the 
 cultivation of land, but everywhere competition — competition 
 among unequals, to be sure, but still competition. 
 
 Land rent is a differential gain, a gain due to the superiority of 
 the land owned by rent receivers over that cultivated by those 
 who are making use of land which affords nothing beyond returns 
 to labor and to capital. We must distinguish between the 
 broad concept of differential gains enjoyed by those in competi- 
 tive pursuits, and the monopolistic gains which are based on the 
 absence of competition. 
 
 Just as sharply must we distinguish between competitive busi- 
 nesses of large magnitude and monopolies. Department stores 
 in no city in the world enjoy monopolies, but are subjected to the 
 steady, permanent pressure of competition. There are those 
 who call every business operating on a vast scale monopoly, and 
 would put in the same economic category a gasworks without a 
 competitor and a huge retail dry-goods establishment with rivals 
 at every hand, ready to seize every opportunity for an advantage 
 over it, and certain to ruin it if its managers relax their intense 
 activity and watchfulness. 
 
 Classification and Causes of Monopolies. — Monopoly ap- 
 pears to-day in so many different forms and results from so many 
 
194 OUTLINES OF ECONOMICS 
 
 different causes that the classification of monopolies is a neces- 
 sary preliminary to clear thinking in this field. 
 
 In the first place, we must note that there are (i) public 
 monopolies, owned and operated by some political unit, for the 
 benefit of the community, and (2) private monopolies, owned by 
 private persons, firms, or corporations, and operated primarily 
 for their own benefit. 
 
 In the second place, monopolies may be (i) local, (2) national, 
 or (3) international. This classification is more or less arbitrary, 
 but it suggests that the area of the operation of a monopoly 
 is a matter of much importance. There may be only one seller 
 of shoes on a particular street or in a particular building. We 
 do not call this monopoly, because the area in which this shoe 
 dealer is without competitors is much smaller than the area in 
 which the forces which fix the retail price of shoes operate. It 
 is not sufficient that one should be the only seller or buyer in a 
 certain definite area. For monopoly to exist it is necessary 
 that the unified control of the buying or selling of a particular 
 commodity or service should extend throughout the area of the 
 market, whatever that area may happen to be. The supply of 
 gas, or of street railway transportation, is in most cities a real 
 monopoly, because the market in such cases is merely local. 
 Two young men in Chicago some years ago cornered the market 
 on eggs, and thereby cleared $15,000. The weather was so 
 cold that eggs could not be shipped to the city, and thus the 
 speculators had a temporary local monopoly. A protective 
 tariff or other impediments to international trade may some- 
 times enable a monopoly to exist in one country when the same 
 article or service is not monopolized in another country. Various 
 attempts have been made to establish international monopolies, 
 but none of these has been entirely successful. Agreements 
 restricting competition between the producers of different na- 
 tions are known to have been effected in the steel trade and 
 in the petroleum trade. 
 
 We pass now to a third classification of monopolies, according 
 to the source of monopoly ^power. This classification is especially 
 important, because we shall not know how to deal effectively 
 
MONOPOLY 195 
 
 with monopolies until we understand just why and how the 
 different kinds of monopolies have come into being. 
 
 A. Social Monopolies. 
 
 I. General welfare monopolies. 
 
 1. Patents. 
 
 2. Copyrights. 
 
 3. Public consumption monopolies, 
 
 4. Fiscal monopolies. 
 
 II. Special privilege monopolies. 
 
 1. Those based on public favoritism. 
 
 2. Those based on private favoritism. 
 
 B. Natural Monopolies. 
 
 I. Those arising from limitation of supply of raw ma- 
 terial. 
 II. Those arising from secrecy. 
 
 III. Those arising from peculiar properties inherent in 
 
 the business. 
 
 Social Monopolies. — Businesses are social monopolies ^ when 
 
 they are made monopolies not by their own inherent properties, hut 
 
 either by legislative enactment or by special advantages or privileges 
 
 granted to them by other monopolies. 
 
 Social monopolies cannot exist without the acquiescence of 
 society. There is no reason, therefore, why social monopolies 
 should be permitted, except in so far as particular social monop- 
 olies are deemed to be advantageous means of achieving 
 socially desirable ends. 
 
 The exclusive privileges conferred (for limited periods) by 
 patent and copyright laws are justified by the stimulus they have 
 given to invention and authorship. Patents lead to several 
 different kinds of monopolies. In some instances the monopoly 
 is limited to the control of the supply of the patented article 
 itself. In other cases the use of a patented machine or process 
 in the manufacture of some other product may give advantages 
 important enough to create a monopoly in the supply of that 
 product. Sometimes the owner of a patent endeavors to extend 
 the scope of his monopoly by refusing to sell his patented prod- 
 ^ Sometimes called " artificial monopolies." 
 
196 OUTLINES OF ECONOMICS 
 
 ucts except on the condition that other commodities, used in 
 connection with the patented product, be purchased from him 
 and not from his competitors. Such agreements have been en- 
 forced in the sale of mimeographs and of shoe machinery. These 
 " tying contracts " were made illegal by the Clayton Anti- 
 Trust Act of 1 914. Again, the patent system sometimes operates 
 so as to perpetuate a monopoly already established. Some new 
 inventions cannot be profitably utilized except in connection 
 with machines or processes which have previously been patented. 
 For this and other reasons it frequently happens that an exist- 
 ing monopoly affords the only market for the improved machines 
 and processes adapted to some particular industry. This has 
 been an important factor in the telegraph, telephone, and elec- 
 trical industries. But although our patent laws need careful 
 revision,^ the policy of granting inventors a temporary monop- 
 oly continues to meet with general social approval. Copyrights 
 stand upon even firmer ground. To do away with copyrights 
 would not only lessen the incentives to authorship, but it would 
 also prevent the publication of many good books. 
 
 Trademarks, like patents, are monopolies in the strictly legal sense that 
 no one else may use them. But, unlike patents, they do not lead to a 
 monopoly in the economic sense of giving exclusive control of one sort of 
 business. They are used largely in competitive business undertakings as 
 a help in establishing and maintaining what is termed good-will. The law 
 also forbids the fraudulent imitation of established brands, firm names, and 
 distinctive forms of packages. In so far as a successful business man in a 
 competitive field is able to induce people to believe that it is better to pur- 
 chase his particular brand of goods than to take the chance of getting a 
 possibly inferior quality by purchasing his competitor's products, he may 
 be able to lift himself a little above the "dead level" of competition. He 
 may even find that he can increase his net profits by putting the price of his 
 goods somewhat higher than that at which precisely similar goods are sold 
 in the market. By thus successfully marking off his product as something 
 distinct from and possibly superior to his competitor's goods, he is able to 
 obtain what might be termed a quasi-monopoly. But because his power 
 to control the price of his product is in general much more limited than that 
 of the true monopolist, and because competition limits and conditions his 
 activities in other ways, his business is more properly called competitive 
 than monopolistic. 
 
 1 See p. 23, above. 
 
MONOPOLY 197 
 
 Public consumption monopolies and fiscal monopolies are to be 
 distinguished the one from the other only by the object which 
 the government has in view in establishing them. If the govern- 
 ment manages for itself or grants to another a monopoly of the 
 liquor traffic with the object of regulating the consumption, the 
 monopoly is a public consumption monopoly. If, on the other 
 hand, the chief object is not regulation, but revenue for the 
 government, the monopoly is a fiscal one. Often the two objects 
 are blended. The production of salt has at one time or another 
 been a fiscal monopoly in many different countries. The sale 
 of tobacco is a fiscal monopoly in France. In recent years 
 Japan has established a number of fiscal monopolies. 
 
 The old monopolies established by special grant of the sovereign 
 were in some cases fiscal monopolies, a heavy tax or royalty being 
 paid by the monopolist. In other cases, however, they were 
 based merely on public favoritism. A monopoly in one country, 
 protected by a high tariff from the competition of producers in 
 other countries, is rightly said to be based, so far as all or part 
 of its monopoly power is concerned, on public favoritism. Mo- 
 nopolies based on private favoritism derive their monopoly power 
 from special advantages granted them by other monopolies, 
 especially natural monopolies. Railroad rebates have been in 
 the past a fruitful source of monopoly. 
 
 Natural Monopolies. — These depend for their existence on 
 natural forces as distinguished from social arrangements. They 
 grow up independently of man's will and desire and sometimes 
 even in direct opposition to it. The words we have used to 
 designate the first two classes of natural monopolies are self- 
 explanatory. Natural mineral waters and certain wines made 
 from grapes that are grown only in restricted areas are often 
 good examples of monopolies derived from special limitations 
 in the supply of raw materials. 
 
 The Kimberley mines, of South Africa, virtually controlling 
 the amount of annual additions the world's stock of diamonds, 
 constitute a monopoly of this class. The limited area in which 
 anthracite coal is produced in the United States is an important 
 contributing cause of the monopolistic control of that industry. 
 
198 OUTLINES OF ECONOMICS 
 
 Monopolies based on secrecy are no longer of great importance, 
 although the use of secret processes remains in some instances 
 a source of monopoly. 
 
 By far the most important of all monopolies are natural monop- 
 olies of the third class, arising from peculiar properties inherent 
 in the business. Among such monopolies are roads and streets, 
 canals, docks, bridges and ferries, waterways, harbors, light- 
 houses, railways, telegraphs, the post office, electric lighting, 
 waterworks, gas works, and street railways of all kinds. What 
 are the properties inherent in such businesses that make them 
 naturally monopolistic? In some instances it will be found that 
 the possession of peculiarly favorable spots or lines of land may 
 give advantages important enough to create monopoly. This 
 may be true, for example, of harbors, docks, street railways, 
 rights of way through mountain passes or along narrow river 
 valleys, and railway terminals in large cities. Often these 
 are things which cannot be duplicated at all or can be dupli- 
 cated only at a practically prohibitive expense. Monopolies 
 created by the presence of such conditions are similar to natural 
 monopolies of the first class. 
 
 Natural monopolies of this third class are, however, more 
 often rooted in conditions that make competition self -destructive. 
 These conditions are three in number, and the presence of all of 
 them is generally necessary to create monopoly : (i) The com- 
 modity or service rendered must be of such a nature that a small 
 difference in price will lead buyers to purchase from one pro- 
 ducer rather than from another. (2) The business must be of 
 such a nature as to make the creation of a large number of com- 
 petitive plants impossible. Either because the business 'is one 
 in which special advantages attach to large-scale production or 
 because there are actual physical difficulties in the way of the 
 multiplication of competing plants, there must be fairly definite 
 limits to the possible increase of the number of plants among 
 which the business might be divided. (3) The proportion of 
 fixed to variable expenses of production must be high. 
 
 These conditions, tne reader will note, are conspicuously 
 present in the operation* of railways and of the so-called local 
 
MONOPOLY 199 
 
 public utilities, as well as in other industries in which natural 
 monopoly prevails. The principal reason why competition 
 cannot be maintained in this field is that under the conditions we 
 have listed competition fails to fix a normal price remunerative 
 enough to attract the recurrently necessary fresh investments 
 of capital. Competition succeeds when either, first, the ex- 
 penses of production are largely variable expenses, or, second, 
 the total output of the industry comes from a large number of 
 competing business units, some successful, others, very likely, 
 operating on the narrowest possible margin of profits. When 
 either of these two conditions is present in an industry, the 
 aggregate amount of the output will be delicately sensitive 
 to changes in market price. If the price rises, the output will 
 be increased ; if it falls, the total output, and with it the total 
 expenses of production, will be diminished. In either event 
 the change in price will be checked, and through this process, 
 market prices will, in the long run, be kept just about high 
 enough to induce the industry to maintain an output of whatever 
 size may be justified by the demand for it. That is, the forces 
 which fix a normal price will operate effectively. 
 
 But if there are, at the most, only relatively few competing 
 establishments in an industry, if fixed expenses are relatively 
 large as compared with variable expenses, and if the market for 
 the commodity or service produced is quick to take advantage 
 of price cutting on the part of one or more of the establishments, 
 it will be difficult to maintain competitive conditions. What 
 would happen if one of the railways running between Chicago 
 and New York should reduce its freight rates ? First, it would 
 immediately get a large share of the traffic. Second, the other 
 railways would be forced to lower their rates, so that if the first 
 railway desired to retain its increased traffic it would be forced 
 to cut rates again. Third, it is clear that there is no stopping 
 point in this process of competitive rate cutting, so long as the 
 rates, suffice to cover variable expenses. Fourth, since fixed 
 expenses must, however, be paid, the competing railroads have 
 to choose between (a) ultimate bankruptcy, and (h) the main- 
 tenance of rates at a level fixed by joint agreement. This second 
 
200 OUTLINES OF ECONOMICS 
 
 alternative means unity of action, or monopoly. Where com- 
 petition is thus self-destructive, monopoly is inevitable. The 
 operation of this principle has been exemplified many times in 
 the history of American railways. A new " competing" rail- 
 road has been built, it has cut rates to attract a share of the 
 trafi&c ; a rate war has ensued ; and the end has always been mo- 
 noply in the form of a combination or rate agreement, A simi- 
 lar situation is found in the case of local public service companies. 
 Twenty or thirty years ago many of our cities adopted the mis- 
 taken policy of trying to force competition into this naturally 
 monopolistic field. But very often it was found that the mere 
 threat of competition was sufiicient to bring about combination 
 and monopoly. 
 
 It is believed by some that the advantages of large-scale production 
 increase so long as the size of the business establishment increases. If 
 this were true, it would give production on the largest possible scale advan- 
 tages so great that monopoly would result in all parts of the industrial field. 
 Some socialists believe that this movement is so strong that it must result 
 in the final disappearance of competition and the triumph of monopoly 
 everywhere. Certain other students of the problem think that it is only in 
 certain industries that the economies of large-scale production are sufiicient 
 to lead to monopoly. But in such fields, they hold, "capitalistic monop- 
 olies" are sure to appear. 
 
 It should be remembered, however, that the very large business establish- 
 ment has disadvantages as well as advantages ; and it seems probable that 
 beyond a certain point the disadvantages of a further increase in size grow 
 more rapidly than the advantages. In most industries the point of maxi- 
 mum efficiency is reached long before the point of monopoly is reached. 
 It is difficult, and perhaps impossible, to find a single instance of successful 
 monopoly in which one or more of the definite and specific sources of 
 monopoly, mentioned in the foregoing classification, are not to be found. 
 Our conclusion, then, may be stated as follows : There is a great and grow- 
 ing field of industry in which competition is not natural or permanently 
 possible ; there is another field within which monopoly does not exist, and 
 in which it cannot exist except in the form of social (or artificial) monopolies. 
 
 Monopoly Price. — The chief peculiarity of monopoly price 
 is found in the power of the monopolist over supply. This is 
 what gives the monopolist the ability to secure surplus profits. 
 In competitive industry the supply is not within the control of a 
 
MONOPOLY 20I 
 
 single producer, and, as a result, prices tend to be controlled or 
 limited by the expenses of production. The competitive pro- 
 ducer cannot increase his profits by limiting the supply, and it 
 is on this account that the law regards competition as one of the 
 main pillars of our present social order. 
 
 The monopolist will normally endeavor to fix his output at 
 such a point that, given the existing state of demand, he will 
 secure the highest possible net returns. On the one hand he has 
 to face the fact that although he can increase his gross receipts 
 up to a certain point, by increasing his output, yet the increase 
 in gross receipts will not be proportionate to the increase in out- 
 put, for the simple reason that the increased output will not find 
 buyers except at a lower price per unit. On the other hand an 
 increase in his output will always increase his aggregate expenses 
 of production, although here again the increase (in expense) 
 may not be proportionate to the increase in output. In par- 
 ticular there are likely to be some permanently fixed expenses 
 which will be the same for a small output as a large one, and there 
 may be other expenses which will not increase unless the output 
 should be made much larger than would be profitable. Indeed, 
 it may often happen that the fact that a large output would make 
 it necessary to increase certain expenses which would otherwise 
 be fixed (such as the cost of the plant) may lead the monopolist 
 to choose to produce a relatively small quantity of goods. The 
 following table shows in parallel columns the number of sales of a 
 monopolized good at different prices, the total resultant receipts, 
 the variable expenses, the fixed expenses, the total expenses, and, 
 finally, the net revenue or monopoly profit. For the sake of 
 simplicity it is assumed that all of the fixed expenses are perma- 
 nently constant, at least for such possible increase of output as 
 the monopolist cares to consider. 
 
 Study of the table will show that, in the case assumed here, 
 the monopoly price will stand at six cents. It would be possible 
 for the monopolist to produce 5,500,000 units, for this would give 
 him a net profit of $5000. But since he can control the supply, 
 he will limit his output to 2,500,000 units, giving him the maxi- 
 mum net return, $25,000. 
 
202 
 
 OUTLINES OF ECONOMICS 
 
 Price 
 
 PER Unit 
 
 Number 
 Sales 
 
 Total 
 
 Earnings 
 
 Variable 
 Expenses 
 PER Unit 
 
 Total 
 Variable 
 Expenses 
 
 Fixed 
 
 Expenses 
 
 Total 
 Expenses 
 
 Net 
 Renenue 
 
 $.IO 
 
 600,000 
 
 $ 60,000 
 
 1.03 
 
 f 18,000 
 
 $50,000 
 
 $ 68,000 
 
 -$8,000 
 
 .09 
 
 800,000 
 
 72,000 
 
 •03 
 
 24,000 
 
 50,000 
 
 74,000 
 
 — 2,000 
 
 .08 
 
 1,200,000 
 
 96,000 
 
 •03 
 
 36,000 
 
 50,000 
 
 86,000 
 
 + 10,000 
 
 .07 
 
 1 ,800,000 
 
 126,000 
 
 •03 
 
 54,000 
 
 50,000 
 
 104,000 
 
 + 22,000 
 
 .06 
 
 2,500,000 
 
 150,000 
 
 •03 
 
 75,000 
 
 50,000 
 
 125,000 
 
 +25,000 
 
 •05 
 
 3,500,000 
 
 175,000 
 
 •03 
 
 105,000 
 
 50,000 
 
 155,000 
 
 + 20,000 
 
 .04 
 
 5,500,000 
 
 220,000 
 
 •03 
 
 165,000 
 
 50,000 
 
 215,000 
 
 + 5>ooo 
 
 But the case assumed here is in many ways far simpler than 
 the cases presented by real life. The monopolist may not be 
 able easily to hit upon just the price that will yield maximum 
 net profits. He may, by experimenting a little, approach more 
 closely to it, but at best he can hardly hope to reach more than 
 an approximate maximum. Or it may be that the monopoly 
 is one in which the price is fixed by custom or convenience (as 
 is in some measure true of street railway transportation), so that 
 the monopolist can vary only the quality of the commodity or 
 service he sells at the established price. Moreover, it should be 
 noted that the price most profitable for the present may not 
 prove the most profitable price in the long run. The monopolist 
 may choose to forego some of his possible profits this year in 
 order to extend the field of demand for his product and to lay 
 the foundation of a long-continuing period of profitable produc- 
 tion. Furthermore, in view of the possibility of the public reg- 
 ulation or public ownership of his business, he may deem it ex- 
 pedient not to arouse public hostility, and so may decide to sell 
 at a price lower than what would, for the time being, be the most 
 profitable price. 
 
 The Effect of a Tax. — Our numerical illustration may be 
 made to convey a lesson regarding the influence of taxation upon 
 monopolies and monopoly price. Fixed expenses have no in- 
 fluence in determining the price. If, therefore, a fixed tax, 
 say of $5000 a year, were to be laid upon this monopoly, it would 
 not result in an increase of price. A study of the table v^rill show 
 
MONOPOLY 203 
 
 that with such a tax the net revenue at price .08 would be $5000 ; 
 at price .07, $17,000 ; at price .06, $20,000 ; at price .05, $15,000; 
 at price .04, nothing. Thus price .06 will still be the point of 
 maximum net revenue, and hence the monopoly price. On the 
 other hand, a variable tax, for instance a tax of one cent per 
 unit, would result in this case in raising the monopoly price. In 
 our illustration, such a tax would make the net revenue at the 
 price .08, — $2000 ; at the price .07, $4000 ; at the price .06, 
 nothing ; at the price .05, — $1 5,000. Thus, though the monop- 
 oly would find its profits greatly curtailed by such a tax, con- 
 sumers would be compelled to pay one cent more per unit for the 
 monopoly product. The possible advantage which society 
 might draw from the tax would therefore be wholly or in part 
 offset by the increased cost of the commodity. We may conclude, 
 therefore, that fixed taxes, or taxes on the net revenue of a mo- 
 nopoly, cannot be shifted wholly or in part by a change in price ; 
 while taxes laid in proportion to the amount of business, since 
 they contribute an addition to the variable expenses, may be 
 wholly or in part shifted by a change in price. 
 
 Relation of Demand to Monopoly Price. — There are certain 
 conditions on the side of demand which have a decisive influence 
 in determining monopoly price. The most important of these 
 is the degree of elasticity of the demand for the monopoly prod- 
 uct. The more inelastic the demand for the monopolized commodity 
 or service, the higher will he the monopoly price which will yield 
 the greatest net returns. If a commodity is a necessity of life, 
 and is so habitually consumed that people cling with intensity 
 to it, monopoly will, other things being equal, be more profitable 
 than if the commodity were one which consumers thought they 
 could easily dispense with. This helps to explain why salt and 
 tobacco have been chosen as fit objects for public fiscal monopo- 
 lies. The more adequate the substitutes for a commodity, the 
 smaller will be the opportunity for surplus profits which a monop- 
 oly of that commodity will give. Finally, the higher the general 
 average of economic well-being, and the more readily money is 
 generally expended, the higher will be the monopoly price 
 which will yield the largest net returns. 
 
204 OUTLINES OF ECONOMICS 
 
 Thus monopoly, without any effort of its own, shares in the in- 
 creasing wealth of a country, and absorbs a considerable part of 
 it. It is, for example, among other influences, the larger wealth 
 per capita and the greater willingness to spend freely that makes 
 monopoly more profitable in the United States than in Germany 
 or other European countries. 
 
 Class Price. — Thus far we have assumed that the monopolist 
 charges one uniform price and sets the price at the point which 
 yields him the largest net returns. But it is obvious that his 
 gains will be increased if he is able to vary his price. His gains 
 would be highest if he could charge each individual that price 
 which would yield the largest net returns, taking into account the 
 number of sales and profits on each. A rich man might pay 
 double the current rates for gas or electric light without dimin- 
 ishing his consumption in the least. But in the case of any large 
 modern business it is obviously impracticable to fix a price for 
 each individual, even were there no legal difficulties in the way, 
 as there are in the case of the great monopolistic businesses such 
 as gas and electric lighting and railway transportation. The 
 next best thing for the monopolist is to divide his public into 
 classes, and to charge to each class that price which will yield 
 the largest net returns. In the table already given, we found 
 that six cents was the monopoly price on the hypothesis of one 
 uniform price, but obviously, if the eight-cent and seven-cent 
 prices could be secured, and six cents reserved as a price for sales 
 that could not be made at eight or seven cents, the profits would 
 be still higher. This gives rise to what, in its broad, general 
 terms, we call class price. The monopolist seeks in every pos- 
 sible way to divide his community into classes and to secure 
 from each the highest possible price. We observe a remarkable 
 development of class price in the case of our railways ; and, unless 
 legal obstacles are interposed, this development will doubtless 
 go still farther. We have special trains with an extra charge. 
 We have privately owned railway coaches ; our drawing-rooms 
 and single seats in " parlor cars " ; our ordinary first-class 
 tickets ; and our second-class tickets, the purchasers of which 
 frequently ride in the " day coach " with the first-class passen- 
 
MONOPOLY 205 
 
 gers. Then we have single tickets, fifty-trip family tickets, 
 monthly commutation tickets, etc., with enormous variations 
 in price. We may go farther and say that the American rail- 
 way rate system of "charging what the trafi&c will bear " is a 
 consummate example of monopoly prices. 
 
 Nor need it be supposed that in all its ramifications class price 
 is a bad thing. It is, when ignorance and need are exploited by 
 a special high price ; frequently it works well when an attempt 
 is made to reach a class of limited means with a very low price, 
 as in the case of early and late workingmen's trains, etc. 
 
 Monopoly price will vary with use also ; and this is one special 
 subhead under class price, and may be designated as use price. 
 The typical instance is that of two prices sometimes charged for 
 gas : a higher when it is used for illuminating purposes ; a lower 
 when it is used for fuel. 
 
 Monopoly Price High Price. — It is often said, and frequently 
 even in judicial decisions, that the monopolist can charge any 
 price that he pleases. We have already seen that this is not 
 the case. The law of monopoly price shows that the price, even 
 in the case of monopoly, is determined by economic forces. It 
 is conceivable that there may be cases in which monopoly price 
 will exactly coincide with competitive price, although the prob- 
 abilities would be against a frequent coincidence of this kind. 
 There are also cases where monopoly price may be even lower 
 than competitive price. If a monopolist should be able to effect 
 great savings as compared with the expense of doing business 
 under competition, it could happen, in theory, that the price 
 which would yield the largest net returns would be a lower price 
 than would be possible under competition. Probably, and in 
 fact almost certainly, under a condition of competition, letters 
 could not be carried as cheaply as they are. 
 
 Generally there are strong reasons for the position that mo- 
 nopoly price is high price. Monopoly is formed for the sake of 
 gain. Gain may be secured in two ways by monopoly: first, 
 through economies of production ; and it is alleged by trust pro- 
 moters that these economies are a chief motive in their activity. 
 There are some gains of this kind, but what their magnitude 
 
2o6 OUTLINES OF ECONOMICS 
 
 may be in a particular case is highly uncertain. When we com- 
 pare a monopolistic business with a competitive business organ- 
 ized on such a scale as to secure the maximum of efficiency, the 
 gains of competition in alertness and inventiveness, stimulated 
 by rivalry, have recently been too little considered. 
 
 The principal source of gain in monopoly is found in the ability 
 to get a high price. In confirmation of the position that monop- 
 oly price is high price, we may refer to history, the utterances of 
 which seem to be clear and distinct. At any rate, there can be 
 no doubt that, in the opinion of historians who have treated the 
 subject, monopoly means high price. Hume, in his treatment of 
 monopoly in his History of England, speaks of the price of 
 monopolized articles as exorbitant, and cites the price of salt, 
 the price of which had been raised by monopoly tenfold and 
 even more. It is generally conceded that in most cases of a 
 government monopoly of the production or sale of salt the price 
 has been so extremely high as to be a real popular grievance ; 
 and it is generally necessary to inflict severe penalties to pre- 
 vent the people from securing the salt at a lower price from 
 non-authorized sources. But of still greater significance are the 
 results of the investigations of the Industrial Commission of 
 the United States. It was there made evident that when 
 monopoly appears in a form at all clear and well defined, the 
 tendency is plain to increase the margin between the prices of 
 finished products and raw materials.^ 
 
 The courts of the world have made it clear in their judicial ut- 
 terances that they regard monopoly price as high price ; and, as 
 their opinions are based upon cases actually brought before them, 
 we cannot do otherwise than attach great importance to their 
 view. 
 
 Wherever commissions have been formed with power to regu- 
 late monopoly price, and these commissions have been comprised 
 of independent and strong men, there has been a marked tend- 
 ency to reduce monopoly price; because unregulated monop- 
 
 1 See report by Professor J. W. Jenks on "Industrial Combinations and Prices," 
 Report of the Industrial Commission, Vol. i, pp. 39-57 ; and also the same author's 
 work, The Trust Problem, Chap. viii. 
 
MONOPOLY 207 
 
 oly price has very often been found to be excessive and unjust. 
 The opinions of the Railroad Rate Commission of Wisconsin 
 afford many illustrations. This Commission has authorized a 
 higher price in a few cases, but generally has been forced to lower 
 prices, although in a notable case of passenger rates it did not 
 go so far as the legislature subsequently did. The same state- 
 ment holds true in large measure of the decisions of other state 
 public utility commissions and of the Interstate Commerce 
 Commission. 
 
 Monopolies and the Distribution of "Wealth. — We have not 
 the precise statistical data which will enable us to state the exact 
 influence of monopoly upon the distribution of wealth. We have, 
 however, sufficient data to warrant the opinion that the high 
 monopoly prices and the gains resulting from the exclusive posi- 
 tion of the monopolist give us a large privileged class in countries 
 of modern civilization, and especially in the United States. Even 
 when the increment of price is comparatively small, it has large 
 significance in the case of the sale of a vast number of units of 
 services or commodities. The difference between a four-cent 
 street-car fare and a five-cent street-car fare may not appear to 
 be great, but it is a difference of 25 per cent and leads to an 
 enormous difference in earnings. 
 
 All the many investigations that have been made recently in 
 various lines of business (especially in railways, the beef industry, 
 the steel industry, coal mining, etc.) point to monopoly as a 
 prime cause of the so-called swollen fortunes of this country. 
 In this and other countries some histories of families distin- 
 guished for wealth have been written, and probably few if any 
 cases could be found in which some monopoly element had not 
 entered. Various lists of rich men have been published, among 
 them one published by the New York Sun in 1855, and one 
 published by the New York Tribune in 1892. These lists can- 
 not by any means be presumed to be accurate, and yet they do 
 afford very considerable evidence of the sources of large for- 
 tunes, and point to monopoly as a prime source of the enor- 
 mous fortunes of today. This is a subject which in itself would 
 require a larger book than the present one for adequate treat- 
 
2o8 OUTLINES OF ECONOMICS 
 
 ment. The student should attempt by observation and study 
 to carry forward the lines of investigation and thought here 
 suggested. 
 
 Public Policy with Respect to Monopolies. — As many mo- 
 nopolies have come as a result of underlying laws of industrial 
 evolution, they cannot all be abolished. Experience, and the 
 analysis of industries like railways, gas works, etc., falling under 
 the head of " public utilities," so called, should be conclusive. 
 We must have monopoly in these cases, and the only question 
 we are concerned with is, " What kind of monopolies shall we 
 have ? ' ' We must admit that unregulated monopolies in private 
 hands have always been odious and are opposed to the principles 
 of the laws of civilized nations. They are opposed to that 
 endeavor to secure equality of opportunity which is fundamental 
 in modern democracy and which manifests itself as a red thread 
 running through American history. Even George Washington, 
 generally looked upon as calm and self-contained, denounced 
 monopolizers and wished they might be " hunted down as pests 
 of society " and " hanged on a gallows five times higher than the 
 one prepared for Haman." ^ It is not so much high price that 
 disturbs the modern man as it is inequality of opportunity ; and 
 this general sentiment has been very clearly and forcibly ex- 
 pressed in court decisions. In the field in which monopoly is 
 natural and inevitable, therefore, we cannot permit unregulated 
 special privilege, and to this end we must choose between pub- 
 lic monopoly — government ownership — and public control of 
 monopolies privately owned and operated. This opens up so 
 vast a subject for discussion that we cannot enter into it here. 
 It should be noted, however, that the considerations which must 
 govern our choice differ for different types of natural monopolies. 
 Municipal waterworks and the federal post office are in most 
 respects efficiently and successfully managed. But in the case 
 of many other natural monopolies the problems of management 
 are more complex and difficult in many ways. Just now the 
 method of public control rather than of public ownership is be- 
 ginning to be given a thorough test. Our policy in the future 
 * C. J. Bullock, Essays on the Monetary History of the United States, p. 67. 
 
MONOPOLY 209 
 
 will undoubtedly be determined in large measure by the results 
 of that test. Public control, to secure equality of opportunity, 
 must so regulate monopolies and limit price that the gains will 
 be no higher than those produced by equally wise investments 
 and equally wise and prudent management in the field of com- 
 petition.^ Sometimes it is stated that owners of railways and 
 other monopolistic enterprises should have a competitive return 
 upon all the money that they have invested. This would give 
 them a position of special privilege, inasmuch as in the competi- 
 tive field a great deal of money is lost. It is only wise invest- 
 ment and careful management in the field of competition that 
 can secure returns equal or superior to the current rates of in- 
 terest. Imprudently invested capital is lost in the field of com- 
 petition ; and when it is imprudently and unwisely invested in 
 the field of monopoly, it cannot justly claim any return. 
 
 When we turn to the field of social monopolies we find that the 
 problems of public control are simpler, but more diverse. These 
 monopolies exist only by the approval or tolerance of society, 
 and each particular one can be judged on its own merits. The 
 problem of social monopolies, therefore, resolves itself into such 
 problems as those of the economic effects of the patent system, 
 the best way of controlling the consumption of liquors and 
 other harmful commodities, and the most expedient means of 
 raising public revenues. With respect to one class of social 
 
 1 This does not mean that in the case of old enterprises price must always be so 
 reduced that the gains shall yield a competitive return only on the physical value 
 of a plant. The principle of vested rights or interests has to be given a certain 
 role. These have often been created by society rather than by private persons, and 
 faith must be kept. In the case of railways and the telegraph, the American nation 
 and states have deliberately encouraged a wasteful policy of competition which 
 is in large measure responsible for high capitalization. It would not be right 
 to place upon holders of these properties all the burdens of a mistaken pubhc policy 
 in the past. What is needed is to declare a public poUcy for the future and to base 
 returns for the future upon future actual investments in the case of public utilities. 
 In any case, our federal and state governments are acting wisely in insisting upon 
 physical valuations of railways, gas works, and other similar monopolies as a help 
 in determining fair prices for present and future. Now and here we can do no more 
 than to throw out these suggestions in regard to a pressing present problem of great 
 magnitude. A further discussion of some aspects of the problem will be foxmd in 
 Chap. XXVII (Transportation). 
 P 
 
2IO OUTLINES OF ECONOMICS 
 
 monopolies society has reached a very definite conclusion : There 
 must be no needless extension of the field of monopoly through 
 either public or private favoritism. The possibility of obtaining 
 monopoly through special privilege is clearly inconsistent with 
 the maintenance of equal opportunity in the industrial field. 
 
 The problem of the public control of monopoly is sometimes 
 confused with the " trust problem " ■ — the problem of the public 
 control of large industrial combinations. But the trust problem 
 is only in part a problem of monopoly. It will be discussed in 
 the following chapter. 
 
 QUESTIONS AND EXERCISES 
 
 1. Has bigness anything to do with monopoly ? Do you know any small 
 business which is a monopoly ? Do you know any very large business which 
 is keenly competitive? Contrast a state of competition with a state of 
 monopoly. 
 
 2. Define monopoly and discuss each point in the definition. 
 
 3. Contrast land ownership with monopoly. 
 
 4. Explain the importance of classification of monopolies, and especially 
 of distinguishing between private and public monopolies, and social and 
 natural monopolies. 
 
 5. State the main classes of monopolies, and give the divisions and sub- 
 divisions in each class. 
 
 6. A public tobacco monopoly exists in France and produces large rev- 
 enues. The business is generally said to be well managed. Do you see 
 any benefits that would accrue from the establishment of such a monopoly in 
 the United States ? any evil effects ? 
 
 7. Define monopoly price and show how it is determined. 
 
 8. What does class price mean? Explain use price. 
 
 9. Why do we think of monopoly price as high price ? Do you know any 
 monopoly price which is a low price? What do you mean by high price? 
 by low price ? 
 
 10. What relation has monopoly to large fortunes? to small fortunes? 
 What, if any, to poverty ? 
 
 11. What is the best public policy with respect to monopolies? 
 
 REFERENCES 
 
 Brown, W. J. The Prevention and Control of Monopolies. 
 
 Ely, R. T. Monopolies and Trusts, Chaps, i-iv. 
 
 HoBSON, J. A. Evolution of Modern Capitalism, revised ed.. Chap. ix. 
 
MONOPOLY 211 
 
 Levy, Hermann. Monopoly and Competition. 
 
 Marshall, Alfred. Principles of Economics, 6th ed., Book v, Chap. xiv. 
 
 PiGOU, A. C. Wealth and Welfare, Chaps, ix-xiii. 
 
 Price, W. H. The English Patents of Monopoly. 
 
 Taussig, F. W. Principles of Economics, Vol. i, Chap. xv. 
 
 United States Industrial Commission. Report, Vols, i and ii. 
 
CHAPTER XIII 
 BUSINESS ORGANIZATION 
 
 The Meaning of " Business." — The dominance of " busi- 
 ness " in our present social economy is so familiar and common- 
 place a thing that we are apt to forget its real significance. 
 " Business " means profit seeking. It does not cover so broad 
 a field as does " production," nor is it quite the same thing as 
 " production for the market." Business is acquisitive rather 
 than productive, and while acquisition usually involves produc- 
 tion, this is not invariably the case. Business operations con- 
 sist, fundamentally, in buying or hiring things and in selling 
 them or using them for the purpose of gaining a profit. Among 
 the things thus bought or hired are land, labor, capital goods, 
 and business privileges or advantages, such as franchises, patents, 
 copyrights, and " good-will." The economic world, in its busi- 
 ness aspect, is a world of buying and selling rather than of making 
 and using things ; it is a world in which prices, expenses, debts 
 and credits, and contractual relations are the dominating things 
 rather than the technical processes of production or the ultimate 
 costs of production as measured in human effort and sacrifice. 
 Commerce and manufactures have each in turn been brought 
 under the dominion of business enterprise ; business methods and 
 motives are also of the first importance in agriculture, although 
 in this last field production for home use continues hand in hand 
 with production for profit. 
 
 The Nature of Business Units. — The business world is made 
 up of profit-seeking units, — entrepreneurial units. We are apt 
 to think of business units as composed of individual men or 
 groups of men. In an ultimate sense this is not incorrect, but 
 for present purposes we may more profitably view business units 
 
BUSINESS ORGANIZATION 
 
 213 
 
 as merely the centers or foci of the contractual and other rela- 
 tions that bind the business world together. These relations are 
 recorded and stated more or less fully in the accounts of each 
 business unit; ultimately, however, they are matters of legal 
 fact, and, as we shall see, the legal aspect and the accounting 
 aspect of these relations are not always identical. 
 
 The Business Unit in Accounting. — The simplest general 
 way in which a business unit can be described by its accounts 
 is by means of the balance sheet, which is the statement of the 
 assets or resources and the liabilities or obligations of the busi- 
 ness unit as they exist at a particular time. The following is a 
 simplified form of balance sheet for a small manufacturing 
 establishment : 
 
 Assets 
 
 Land and buildings . . $190,000 
 Machinery and fixtures . 50,000 
 Raw materials, goods in 
 
 process, and finished 
 
 goods on hand . . . 40,000 
 
 Accounts receivable . . 28,000 
 
 Cash on hand and in banks 7,000 
 
 Total assets .... $315,000 
 
 Liabilities 
 
 Original capital invested 
 Income reinvested . . 
 Accounts payable . . 
 Profits 
 
 Total liabilities 
 
 $200,000 
 70,000 
 20,000 
 25,000 
 
 $315,000 
 
 The itemized assets explain themselves, but the meaning of 
 the various liabilities may not be so clear. In this statement all 
 the items of the liabilities except " accounts payable " are liabil- 
 ities of the business unit, conceived as a separate thing, to its 
 owner or owners, — the amount which would be left if the 
 business were sold as a whole at a price just equal to the total 
 estimated value of the assets minus the actual outstanding obli- 
 gations (the accounts payable).^ It v/ill be noted that the item 
 called " profits " is the variable by which the account is bal- 
 anced. 
 
 1 The form of balance sheet given in the text is a simple adaptation of the kind 
 of balance sheet used in the pubHshed statements of corporation accounting. But 
 if the individual proprietor of a small business keeps an accurate ledger accovmt 
 with himself, the result is the same so far as the independence of the business as an 
 accounting unit is concerned. 
 
214 OUTLINES OF ECONOMICS 
 
 On such a showing as this the owners might decide to take $5000 out of 
 the business as dividends, or personal profits, as the case may be. This 
 would reduce the "cash" to $2000 and correspondingly reduce "profits." 
 They might decide, also, permanently to retain $10,000 of their earnings 
 in the business. "Profits" would then be reduced to $10,000, and the 
 "income reinvested" would be increased to $80,000. In the case of cor- 
 porations the "original investment" item is called "capital" and repre- 
 sents the par or nominal value of the corporation's stocks and bonds, whether 
 or not the corporation has received this amount in return for them. Sur- 
 plus profits in such cases can be easily converted into "capital" by means 
 of "stock dividends." 
 
 The business unit is pictured in the balance sheet as the owner 
 of various kinds of valuable property and of valuable claims 
 against those indebted to it. But on the other hand, as the 
 balance sheet also shows, there are rights or claims of equal 
 amount against the business unit on the part of its own creditors 
 and proprietors. The liabilities side of the balance sheet shows 
 how the ultimate rights or equities in the property and credits 
 shown as assets are distributed among creditors and proprietors. 
 The business unit, as a thing apart from its proprietors, has 
 only an imaginary existence. But it is convenient to think 
 of it as having valuable rights or assets of its own, and to think 
 of the claims against these rights as being distributed in the form 
 of obligations or liabilities. This explains the statement that 
 business units are the centers or foci of business relations. 
 
 In its legal aspect, however, the business does not always have 
 so distinct a unity of its own. This varies with the form of 
 business organization, of which there are three important 
 types : the individual entrepreneur, the partnership, and the 
 corporation. 
 
 The Individual Entrepreneur, — Any individual may set him- 
 self up as a business man, an entrepreneur, without any legal 
 formality other than the payment of the license fee which most 
 states impose on some kinds of business undertakings, such as 
 liquor dealing, and which some states, especially in the South, 
 impose upon many kinds of undertakings. The individual en- 
 trepreneur still dominates the field in agriculture, in small retail 
 trade, and in local " shop industries." 
 
BUSINESS ORGANIZATION 215 
 
 In the legal aspect the obligations of a business conducted by 
 an individual entrepreneur are the personal obligations of the 
 entrepreneur. All of his possessions — of whatever kind ^ — are 
 jeopardized by his business risks. If the entrepreneur conducts 
 two distinct business undertakings, the assets of one may be 
 seized, if necessary, to secure the liabilities of the other. The 
 personal liability of the individual entrepreneur is accordingly 
 said to be unlimited. The usefulness of this kind of business 
 organization is limited, obviously, to small undertakings, where 
 the capital and credit of the individual man are adequate. 
 
 Partnerships. — A " firm " or partnership represents a joint 
 undertaking by individual entrepreneurs. Partnerships are 
 most common in mercantile Undertakings of moderate size, in 
 small manufacturing establishments, and in the professions. 
 This joining of interests makes larger undertakings possible, but 
 relatively increases the personal liability of the individual mem- 
 bers of the firm. For each member is personally liable for all of 
 the obligations contracted by the firm, including those contracted 
 in the ordinary course of business by any other one member of 
 the firm.2 The partners may have a contract binding among 
 themselves as to their respective contributions (of money or 
 time), shares in profits, and liabilities. But a member released 
 from personal liability by an agreement of this kind is still liable 
 for all obligations incurred by the firm. The agreement only 
 gives a basis for instituting legal proceedings to recover the 
 amount of his personal losses from the other members of the firm. 
 
 Aside from (i) the excessive personal liability involved, the 
 partnership is open to objection from the business man's point 
 
 ^The "exemption laws" of some states constitute an exception which does 
 not affect the principle involved. 
 
 ^ This refers to the status of the ordinary partnership under common law. The 
 statutes of most of the states provide for a special form of limited partnership, in 
 which one or more of the partners are special partners, who are not personally 
 liable, save for their investment in the business, and who are allowed to take no 
 active part in the management of the business. In a few states there is a special 
 form called a limited partnership association, in which the hability of all the partners 
 is limited. These are practically joint-stock companies with non-transferable 
 shares. The partnership in commendam, which still exists in Louisiana as a heritage 
 of the civil law, is essentially Uke the statutory limited partnerships of other states. 
 
2l6 OUTLINES OF ECONOMICS 
 
 of view, because : (2) It is impossible for a partner to retire from 
 a firm without dissolving the partnership and, possibly, break- 
 ing up the business. The death or insolvency of any partner has 
 the same effect. (3) A new member cannot enter the firm nor 
 can a member transfer his interests to another person without 
 the consent of all the members of a firm, — requirements which 
 naturally follow from the nature of a partnership. (4) The 
 partnership form of organization is not adapted to undertakings 
 requiring large investments of capital and hence requiring the 
 cooperation of a large number of persons. What advantages the 
 partnership has come from the ease with which it can be organ- 
 ized and dissolved, and from its elasticity, — that is, the ease 
 with which the contractual relations among the partners, bind- 
 ing as among themselves, can be altered to suit any contingencies 
 that may arise. 
 
 The Business Corporation. — The federal census of 1909 
 showed that, although only about one fourth of the manufactur- 
 ing undertakings included in that enumeration were organized 
 as corporations, yet these produced nearly four fifths of the total 
 manufacturing product (measured in money value). Most 
 banks and insurance companies are corporations, while in the 
 field of railway transportation corporations are in almost exclu- 
 sive control. And a large and growing number of mercantile 
 undertakings are organized as corporations. 
 
 In the case of the corporation the legal view and the account- 
 ing view of the business unit are practically identical. While 
 the ordinary partnership is in law merely a group of individual 
 entrepreneurs, the corporation is regarded, for some purposes, as 
 a " person." To the incorporated business unit, — an abstract 
 thing, as we have seen, — the law imputes some of the attributes 
 of personality, — and of a personality distinct from that of the 
 individual men who are the stockholders of the corporation.^ 
 
 1 Several states authorize the organization of " joint-stock companies " which 
 are Uke corporations in many particulars. In theory they are partnerships with 
 transferable shares and (in some cases) with limited Kability. Joint-stock com- 
 panies are also organized under the common law in some states. In England and 
 the English colonies the name " joint-stock company " is applied to a statutory 
 
BUSINESS ORGANIZATION 217 
 
 Municipalities, universities, monasteries, guilds, etc., were commonly 
 incorporated by royal charter long before business corporations of the 
 modern kind arose, — for this did not occur until the rise of "capitalism" 
 in the sixteenth and seventeenth centuries. The great trading and coloniz- 
 ing companies, such as the British East India Company, the Virginia Com- 
 pany, the Guinea Company, etc., were the prototypes of the modern business 
 corporation. In connection with these trading companies the joint-stock 
 principle, which had already been used in a few isolated instances of banking, 
 was developed. This was the practice of issuing certificates to those who 
 made contributions to the "joint stock" (or capital) of a company, which 
 entitled the holder to a proportionate share in the profits accruing to the 
 joint stock. The modern business corporation, like these early trading 
 companies, is based essentially on the combination of the joint-stock prin- 
 ciple with the legal recognition of the business unit as a distinct entity. 
 
 At the beginning of the nineteenth century what few corporations there 
 were in America were, for the most part, banks, insurance companies, or 
 canal and turnpike companies. The introduction of railways in the third 
 decade of the century greatly stimulated the organization of corporations, 
 because these new undertakings required larger investments of capital than 
 could be furnished by any individual or firm. State enterprise, it is true, 
 promised at one time to be an important factor in canal and railway buUding, 
 but such state undertakings were usually planned with the purpose of de- 
 veloping natural resources, attracting immigration, and building up the 
 trade of particular districts and particular cities rather than of getting money 
 profits. Most of these state undertakings had succumbed by 1840, so that 
 the field was left open for business enterprise. In the general expansion and 
 reorganization of business that followed the Civil War the corporation form 
 of organization began to be more generally used for all kinds of business 
 undertakings. The growing importance of corporations in business life is 
 partly an effect and partly a cause of the growing size of the business unit. 
 
 The Corporation Charter. — The corporation is a creature of 
 the state, its right to exist being dependent on a charter or on 
 articles of incorporation, granted or approved by the state. In- 
 corporation formerly necessitated a special act of the legislature 
 in each case. This gave opportunity for favoritism and monop- 
 oly and subjected corporations of all kinds to hostility and 
 suspicion. Most corporations are now organized under general 
 laws, whereby any group of men can secure a corporation 
 
 limited-liability association, essentially like the American business corporation, 
 while the word " corporation " is usually applied only to municipal corporations 
 and certain long-established companies, created by special charters. 
 
2l8 OUTLINES OF ECONOMICS 
 
 charter by complying with certain prescribed conditions. In 
 fact, all but six states now have constitutional provisions 
 against the granting of charters to business corporations by 
 special act. 
 
 It was formerly a common practice to grant corporation char- 
 ters in perpetuity, but the decision of Chief Justice Marshall in 
 the Dartmouth College case (1819), whereby the corporation 
 charter was declared to constitute a binding contract between the 
 state and the corporation, which could not be altered or amended 
 by the state except with the consent of the corporation, has led to 
 the general practice of limiting the life of corporations to terms 
 of from twenty to one hundred years, fifty years being a common 
 period. The corporation may, of course, secure a new charter 
 at the expiration of the old, but the limited term gives the 
 state the opportunity to change the requirements of the 
 charter from time to time, or to refuse reincorporation alto- 
 gether, as may seem most desirable. Most states, moreover, 
 now specifically reserve the right to alter or amend the corpora- 
 tion charter at pleasure. 
 
 Corporation charters, or articles of incorporation, usually con- 
 tain details relating to such matters as the purpose or purposes 
 for which the corporation is formed, its principal place of busi- 
 ness, the number of its directors, and the amount of its capitali- 
 zation. 
 
 Lack of Uniformity in State Laws. — Many difficulties in the 
 public control of corporations have arisen from the fact that 
 while charters are granted by individual states, the activities of 
 many business corporations extend over the boundaries of many 
 states. Moreover, some states are much more lenient than 
 others in such matters as the control of capitalization, require- 
 ments as to publicity, limitations on the scope of activity of a 
 single corporation, taxes and fees, etc. New Jersey has become 
 known as the " home of corporations " despite the fact that some 
 states have had even more lenient laws than New Jersey. New 
 Jersey has been favored, however, on account of the proximity 
 of New York City — the real home of most of the greater cor- 
 porate interests of the country — as well as on account of its 
 
BUSINESS ORGANIZATION 219 
 
 early start and the adaptability of its laws to great combinations 
 of corporations.^ 
 
 Other states, with stricter laws, could not prevent corporations 
 organized under lax laws from doing business within their terri- 
 tory so far as that business is interstate. So far, however, as a 
 corporation organized under the laws of one state carries on any 
 part of its business wholly within the borders of another state, 
 the latter state has the right of refusing to recognize it as a cor- 
 poration ; that is, the right to treat it as a mere partnership. In. 
 practice, however, one state freely recognizes the corporations of 
 another state under the rule of " interstate comity." In fact, 
 many corporations transact practically all of their business out- 
 side the borders of the state which chartered them. The real 
 standards, therefore, are the laxest standards, not the highest. 
 More use on the part of American states of the power of exacting 
 certain standards from " foreign corporations/' as they are 
 called, is much to be desired. 
 
 Corporation Capital and Capitalization. — The business world 
 uses the term " capital " in two ways. It speaks of the total 
 permanent investments — the amount of money ''tied up" in a 
 business unit — as its capital. This is the better and more 
 common usage. But it also speaks of the total selling value of 
 the business unit as a whole as its capital. This last will depend 
 not so much upon the amount of the investment as upon its 
 profitableness. It is roughly measured by the " capitalized " 
 earning capacity of the business, or by the market value of the 
 corporation's stock and bonds. 
 
 The capitalization of a corporation should not be confused with 
 its capital. In a strictly legal sense its capitalization is the 
 amount of its authorized capital stock. The capitalization cor- 
 responds, in theory, to the amount of money actually invested 
 in the business by the original stockholders. As a matter of 
 fact, the full amount of the authorized capital is rarely paid in at 
 the organization of a new corporation. The capitalization is 
 apt to be, in practice, a somewhat arbitrary thing, — a nominal 
 
 ^ In igi3 the corporations laws of New Jersey were revised so that they offer 
 fewer advantages to large corporations than they previously did. 
 
220 OUTLINES OF ECONOMICS 
 
 money sum divided into units or shares, the relative holdings of 
 different individuals being measured by the number of shares 
 they own. 
 
 Corporation stock is divided into two general classes, — pre- 
 ferred stock and common stock, although many corporations issue 
 only the latter. Preferred stock represents a prior claim on the 
 earnings of the corporation. A corporation which has " 6 per 
 cent preferred stock " outstanding can pay no dividends to its 
 common stockholders until it has paid 6 per cent dividends on 
 its preferred stock. Preferred stock may be cumulative (in which 
 the prior claims to dividends accumulate from year to year, if 
 unpaid) or non-cumulative. It may or may not have any claim 
 on any part of the surplus profits remaining after a stated rate 
 of dividend has been paid on the common stock. 
 
 In the popular use of the word the capitalization of a corpora- 
 tion includes also its funded debt. The funded debt is represented 
 by bonds, which are interest-bearing promises to pay certain sums 
 of money at definite times in the future. There are many differ- 
 ent kinds of bonds, but three principal classes are : (i) ordinary 
 mortgage bonds, (2) collateral trust mortgage bonds, (3) income 
 and debenture bonds. The first class is based on a mortgage 
 of all or of a specific part of the real property of a corporation. 
 Collateral trust mortgage bonds are secured by the pledge of 
 securities issued by other corporations, but owned by the corpo- 
 ration issuing the bonds. They have been much used in financ- 
 ing railway consolidations. Income and debenture bonds are 
 usually secured only by the earning capacity of the business. 
 Industrial corporations make less use of bonds than do railways, 
 and confine themselves usually to the mortgage bond type, — 
 of which, however, there are many subordinate varieties. In 
 the case of many corporations the mortgage security behind an 
 issue of bonds is in itself not of great importance, for the property 
 mortgaged is apt to be worthless except as an integral part of a 
 unified business establishment. The mere power of foreclosure, 
 however, gives mortgage bondholders a position of strength 
 in the reorganization of insolvent corporations. 
 
 Bonds are sometimes said to represent " creditor interests," 
 
BUSINESS ORGANIZATION 221 
 
 and stock " proprietorship interests." This statement is sug- 
 gestive and is not inaccurate. In a more general sense, however, 
 stock and bonds are merely different kinds of equities in a busi- 
 ness unit, — conveying the right to receive income, to share in 
 the distribution of the assets in case of insolvency, and to have a 
 voice in the management. Stockholders alone participate in 
 the management of the corporation, although bondholders 
 are often able to dictate policies when the affairs of a corporation 
 are in a precarious condition. Bonds differ from stock in being 
 terminable at a definite period of time in the future. In practice, 
 however, the bonds of great corporations are usually replaced 
 by new issues as rapidly as they mature. 
 
 Overcapitalization. — Much has been said about the over- 
 capitalization of corporations, — " stock watering," as it is 
 called. Only a few states require that all the nominal capitaliza- 
 tion of corporations organized under their laws shall represent 
 capital actually invested. In most states, moreover, it is not 
 difficult for a corporation to increase its capitalization from 
 time to time so as to secure funds from the sale of securities, 
 or (as in the case of stock dividends) in order to afford a basis 
 for the distribution of surplus profits without employing an 
 excessively high dividend rate. 
 
 On the one hand it is urged that capitalization is a nominal 
 thing, that it is immaterial whether a corporation pays 12 per 
 cent dividends on $1,000,000 of capital stock or 6 per cent 
 dividends on $2,000,000 of capital stock. On the other hand it 
 is said that capitalization should not be a merely nominal thing, 
 but that it should correspond to the actual amount of the invest- 
 ment; that, without regard to the amount of capitalization, 
 regularly recurring dividends of 12 per cent suggest excessive 
 profits in a way that 6 per cent dividends do not. 
 
 The argument in favor of a closer correspondence between 
 capitalization and real investment is especially strong in the 
 case of railways and other transportation corporations with 
 quasi-public functions, municipal public service corporations, 
 and corporations enjoying natural monopolies of all kinds. For 
 there is a growing feeling that such corporations are in a peculiar 
 
222 OUTLINES OF ECONOMICS 
 
 sense social trustees, to whom have been committed certain 
 public economic functions that might very properly be per- 
 formed by the State, if that course were deemed the more advan- 
 tageous. That such corporations should be restricted to the 
 payment of a reasonable dividend on reasonable capitalization 
 would seem scarcely to be open to question.^ Yet excessive 
 profits are what make excessive dividends possible, and whether 
 profits are excessive or not can be determined in most cases 
 without reference to capitalization by the compulsory use of 
 adequate accounting methods. Even where accounting methods 
 used in the past have been inadequate, the amount of the in- 
 vestment entitled to a return can usually be determined with 
 rough accuracy by means of a ''valuation" or appraisal of a 
 company's properties, coupled with an examination of the prin- 
 cipal facts of its financial history. There is a growing use of 
 this method on the part of both federal and state governments. 
 
 There is a prevalent but entirely mistaken belief that over- 
 capitalization is often the cause of exorbitant charges. It is 
 thought that the desire to pay dividends on an inflated capitali- 
 zation leads corporations to exact a higher return for their prod- 
 ucts or their services than they otherwise would. But it can 
 easily be seen that such cannot often be the case. For whether 
 its capitalization be high or low the corporation will desire to 
 fix its charges at the level which will yield the greatest possible 
 profits. The magnitude of the corporation's capitalization will 
 have no bearing upon the determination of the most profitable 
 level of charges. The charges which would be most profitable 
 under a low capitalization will also be the most profitable under 
 a high capitalization. 
 
 A weightier indictment of overcapitalization is that it has 
 opened the door to a number of reprehensible practices in cor- 
 poration promotion and management. Where there is no defi- 
 nite correspondence between capitalization and investment it 
 is difiicult to make sure that some persons will not be able to 
 acquire the securities of a given corporation on much easier 
 
 1 It is better to curtail excessive profits by public control of rates, prices, and 
 services than by arbitrarily limiting the dividend rate. 
 
BUSINESS ORGANIZATION 223 
 
 terms than others. Overcapitalization always makes available, 
 for example, what may be termed a surplus of stock, and this 
 surplus, instead of being distributed equally among the differ- 
 ent stockholders, may be used in a disproportionate and extrava- 
 gant payment to the promoter (or organizer) of the corporation, 
 or the bankers who have assisted in marketing its securities. 
 Or a group of men in control of a corporation may reap an unfair 
 advantage at the expense of other security holders by turning 
 over to the corporation properties of which they themselves are 
 the owners in return for an exorbitant amount of the corpora- 
 tion's securities. Operations of this kind have only too fre- 
 quently attended the organization of great industrial combina- 
 tions in this country. American railway history, also, is full of 
 examples of extravagant sums paid by operating companies to 
 " construction companies " which had been organized for the 
 purpose of building the roads and selling them to the operating 
 companies. These payments were usually made in bonds or 
 stock, and burdened the operating company with either a heavy 
 load of fixed charges or an inflated amount of capital stock. In 
 fact, the time is not long past when it was frequently said of 
 representative American railroads that the whole amount of 
 the actual investment in their properties was represented by 
 their bonded debt, while their stock issues represented nothing 
 but prospective surplus earnings. In the promotion of industrial 
 combinations it was common practice to issue enough preferred 
 stock to cover the actual expense of acquiring the various proper- 
 ties brought into the consolidation and to issue in addition a 
 large amount of common stock representing nothing except 
 whatever increase in earning power might result from combina- 
 tion. The common stock, at whatever price it could be sold, 
 represented, in fact, the profits of promotion ; and these usually 
 went to promotors and other " insiders." In both the railway 
 and industrial field, however, conditions are much improved. 
 In many cases large additional investments have been made out 
 of earnings without a corresponding increase in capitalization ; 
 in certain other cases corporations have been reorganized, 
 with reduced capitalization. But, nevertheless, there are recent 
 
224 OUTLINES OF ECONOMICS 
 
 instances of unfair and even fraudulent use of excessive capitali- 
 zation as a means of securing special profits for those in control 
 of a corporation's policies.^ 
 
 The situation is clearly one that needs mending. Two very- 
 different methods of regulation have been proposed. The first 
 of these two methods involves the definite limitation of a cor- 
 poration's capitalization to an amount corresponding to the 
 sum of money actually received by the corporation and invested 
 in its business. If securities are issued in exchange for property 
 turned over to the corporation or for services rendered it, a full 
 account must be rendered of all of the circumstances attending 
 such transactions, and an official appraisal of their value may 
 even be required. Such, in general, have been since 1884 the 
 conditions under which joint-stock companies in Germany issue 
 their shares, and it does not appear that these requirements have 
 hindered the organization or growth of such companies in that 
 country. 
 
 Under the second method of regulation, corporations are left 
 free to issue their securities in such quantities as they deem best, 
 it being required merely that publicity shall be given to the 
 prices at which the securities are sold, to the price placed upon 
 any property or services paid for in securities, and to the disposi- 
 tion made of all money obtained by the issue of securities. This 
 kind of regulation is adopted, in principle, in the British Com- 
 panies Act, but the mechanism provided to enforce it is not very 
 effective. At best, however, even the most thoroughgoing 
 publicity respecting the conditions under which securities are 
 issued cannot be a wholly adequate safeguard against the real 
 evils of over-capitalization. Publicity might tend to curb ex- 
 travagant allowances for personal services, but it would not al- 
 ways prevent the overvaluation of large properties taken in 
 exchange for securities. To think otherwise is to count too 
 much upon the knowledge and alertness of the individual stock- 
 holder. Certain American railroads have openly paid exorbi- 
 tant prices for branch lines and other properties, without re- 
 
 * See the special reports of the Interstate Commerce Commission on the St. 
 Louis and San Francisco and tht New York, New Haven, and Hartford railroads. 
 
BUSINESS ORGANIZATION 225 
 
 ceiving any protests, at the time, from stockholders and creditors 
 injuriously affected by these transactions. 
 
 We have done very little in the United States in the regulation 
 of the capitalization, or the other conditions of promotion, of 
 ordinary industrial corporations. Some states, however, now 
 exercise a fairly rigid control over the new security issues of rail- 
 ways and other public service corporations. This regulation, 
 however, does not have as its primary motive the protection of 
 minority stockholders. It is to be interpreted as part of a gen- 
 eral attempt to limit the earnings of such corporations to a fair 
 return upon a reasonable capitalization. 
 
 It has been suggested ^ that in order to guard against the very prevalent 
 misunderstanding of the real nature of corporation shares, the "dollar mark" 
 should not appear on them, or, in other words, that they should have no "par 
 value." They would then become, in form as in fact, merely certificates of 
 the ownership of certain fractional equities in a corporation's business. 
 There is much that is attractive about this proposal. If the issue of securi- 
 ties is to be as unregulated as it has been in the past, it would be better to 
 make it impossible for investors and the general public to attach any ficti- 
 tious importance to the amount of a corporation's capitalization. But if 
 we are to have the regulation of promotion and capitalization that we need, 
 there would be nothing gained by the change suggested. And the "dollar 
 mark" on stock certificates is convenient in many ways. 
 
 Form of Capitalization. — A significant feature of recent de- 
 velopment in corporation finance is the multiplicity of types of 
 corporate securities. It is no uncommon thing, for example, for 
 the equities in a railway corporation (in addition to the floating 
 debt, or accounts payable) to be divided among a dozen or 
 twenty varieties of bonds and two or three varieties of stock. 
 This multiplicity of securities is of advantage to the corporation 
 in that it enables it to offer to investors and speculators a care- 
 fully graded assortment of risks, and this makes the total selling 
 value of a corporation's securities greater than it would other- 
 wise be. This complex kind of capitalization has, however, some 
 undesirable features. If the owners of a particular security — 
 the common stockholders, perhaps — control the corporation, 
 
 > Most recently by the very able federal Railroad Securities Compiission of 191 1. 
 The state of New York now permits the issue of corporate shares without par value, 
 Q 
 
226 OUTLINES OF ECONOMICS 
 
 they may desire to increase the value of their securities for specu- 
 lative purposes by the payment of unearned dividends, — a pro- 
 ceeding which would be opposed to the interests of the holders 
 of all the other securities of the corporation. Or the holders of 
 preferred stock may wish to put some of the earnings of the cor- 
 poration back into improvements in its plant, so as to safeguard 
 its future earning capacity, while the holders of common stock 
 may prefer that all the earnings be paid out in dividends. More- 
 over, in cases of insolvency and reorganization, it is a difficult 
 matter to untangle and to adjust equitably the rights of the 
 holders of the different kinds of securities. 
 
 In times of prosperity corporations often pay for extensions of 
 their plants from the proceeds of bond sales, because it is esti- 
 mated that the earning power of such extensions will more than 
 suffice to pay the interest on the bonds and will afford a hand- 
 some surplus for the stockholders. Corporations thus accumu- 
 late in prosperous times an unwieldy load of fixed charges in the 
 form of interest on bonds, — a fact which is apt to be a source 
 of difficulty in less prosperous years. In periods of financial 
 stringency these fixed charges are a common cause of insolvency, 
 receiverships, and consequent reorganizations, from which the 
 bondholders are apt to emerge as stockholders, and in which 
 the stockholders are apt to lose their holdings. The legal restric- 
 tion of the securities issued by any one corporation to one kind 
 of stock and three or four varieties of bonds is both feasible and 
 desirable. Nor should the bonded debt usually be allowed to 
 exceed the amount of the paid-up capital stock. 
 
 Corporation Management. — The management of business cor- 
 porations is, as a rule, in the hands of boards of directors, elected 
 by the stockholders from among their own number. The details 
 of management are in the hands of officers, chosen usually by the 
 directors. In principle this system achieves something like rep- 
 resentative government of the affairs of the corporation. In 
 practice, in the larger corporations, some of the directors are apt 
 to be " dummy directors," — men exercising no real power or 
 responsibility, made dir.ectors in order to complete the number 
 prescribed in the charter, — or are the representatives of great 
 
BUSINESS ORGANIZATION 227 
 
 financial interests, and often of competing interests. Directors 
 of this latter sort are not primarily concerned with the manage- 
 ment of a corporation in the interests of its stockholders and 
 bondholders. They are directors for the purpose of guarding 
 special interests, and in many cases for the purpose of preventing 
 competition from becoming anything more active than an armed 
 peace. In some cases the real direction of a corporation's 
 policies is in the hands of an " executive committee " or " finance 
 committee " of three or more directors representing the person 
 or persons in actual control of the corporation. 
 
 The proper adjustment of the rights and duties of the various 
 members of a corporation is a matter of general public concern. 
 This is partly because the shares in a corporation are freely trans- 
 ferable. A new member cannot protect himself by making 
 special contracts with the other members, but must accept the 
 conditions fixed by the by-laws of the corporation and by the 
 laws of the state which chartered it. Moreover, the ordinary 
 shareholder in a large corporation has little opportunity to par- 
 ticipate in any way in the conduct of the affairs of the corpora- 
 tion, even for the purpose of protecting his own interests. The 
 general theory upon which the law of corporations is based is 
 that the corporation is a democracy with a representative gov- 
 ernment. That is, the directors are supposed to represent the 
 interests of the stockholders. For many small local corpora- 
 tions this theory undoubtedly corresponds fairly well with the 
 facts. But large corporations, with hundreds or thousands of 
 stockholders, living in different parts of the country, and even 
 in different countries, cannot accurately be pictured as rep- 
 resentative democracies. Outside of a group of holders of 
 large blocks of stock, the stockholders, whether a minority 
 or a scattered majority, are likely to be not only powerless but 
 voiceless. It is difficult and probably undesirable to change 
 this general situation. The growth of large corporations 
 means necessarily the growth of widespread participation in 
 large business undertakings. But the participators, whether 
 stockholders or bondholders, are to be regarded as investors 
 rather than active partners. What is needed in our corporation 
 
228 OUTLINES OF ECONOMICS 
 
 Statutes, therefore, is a frank recognition of this situation. In 
 many cases directors cannot, in any real way, "represent " the 
 stockholders. For this reason their responsibility as trustees 
 for the stockholders should be emphasized in our laws.^ 
 
 Advantages of the Corporation as a Form of Business Organ- 
 ization. — From the point of view of the business man the cor- 
 poration presents decided advantages over the partnership for 
 all undertakings of considerable size. Some of its points of 
 superiority are : (i) Stockholders usually have no personal lia- 
 bility for the corporation's obligations except so far as the full 
 par value of their stockholdings has not been paid up.^ (2) The 
 relative permanence and stability of the corporation are of de- 
 cided advantage, especially in undertakings requiring large in- 
 vestments of capital in relatively fixed and permanent forms. 
 (3) The concentration of executive power in the hands of direc- 
 tors and officers leads to efficiency in management. (4) The 
 transferability of corporation securities makes it possible for 
 stockholders to enter or leave the undertaking at pleasure. 
 (5) The division of the securities into small units and into differ- 
 ent grades and classes affords opportunities to all kinds of inves- 
 tors, — the small and the large, the conservative and the ven- 
 turesome. (6) All of the advantages named make it easier for 
 the corporation to attract and to use efficiently large amounts of 
 capital, furnished by many different investors. 
 
 Social Aspects of the Growth of Corporations. — That corpora- 
 tions do possess desirable features, from the point of view of 
 
 'On this account the recent development of "express trusts" as business or- 
 ganizations, especially in Massachusetts, is of particular interest. These have 
 "trust deeds" in place of articles of incorporation, "trustees" in place of directors, 
 and "beneficiaries" in place of stockholders. In simplicity, adaptability, and in 
 the protection of investors and creditors, this form of business organization has 
 some real advantages over the corporation. But it has not yet been subjected to 
 adequate public control,, and there are some minor difficulties in its working. It 
 may prove to be, however, the germ of an important development in business or- 
 ganization. 
 
 2 Exception should be made of banking and insurance corporations, in the case 
 of which " double liability " on the part of the stockholders is common. A few 
 states impose some measure of personal liability upon the stockholders of all 
 corporations organized under their laws. 
 
BUSINESS ORGANIZATION 229 
 
 business interests, is a fact clearly evidenced by the unprece- 
 dented growth of this form of business organization. In the 
 main, efficiency for business purposes, for money-making, means 
 efficiency from the social point of view, productive efficiency also. 
 But, nevertheless, the two points of view are not identical, and 
 what is desirable from one point of view is not always desirable 
 from the other. 
 
 The gap between money-making and service to society (never 
 quite identical things) is distinctly widened when those in control 
 of a corporation's policies subordinate the profits to be obtained 
 by the sale of its products to the profits to be obtained by specu- 
 lation in its securities. Many of our greatest corporations are 
 directed by men to whom fluctuations in capital values (as repre- 
 sented in the prices of securities) are a much more important 
 source of personal income than are the net earnings of such 
 corporations. The payment of unearned dividends, the non- 
 payment of earned dividends, the direction of a corporation's 
 policy for the benefit of the holders of one kind of security among 
 the different ones issued by the corporation, the effecting of cor- 
 porate combinations and reorganizations that will affect the stock 
 exchange rather than the produce market, — these are some of 
 the more obvious results of the unfortunate relation between cor- 
 poration management and speculation in corporation securities. 
 
 It should also be noted in this connection that the growth of 
 corporations is bringing with it a subtle but very significant 
 change in the nature of the institution of private property. So 
 far as a large and increasing proportion of productive wealth is 
 concerned, we are losing that direct relation of ownership be- 
 tween men and goods which Arthur Young had in mind when he 
 said, " The magic of property turns sand into gold." We often 
 have, instead, several layers of corporation securities interposed 
 between the ultimate owners and the ultimate objects of owner- 
 ship. The effect of this will undoubtedly be to bring about the 
 more thorough domination of business principles in the business 
 world. Sentiment, the honored traditions of long-established 
 firms, the " pride of ownership," the joy of workmanship (which 
 may be felt by the employer who turns out a good product, as 
 
230 OUTLINES OF ECONOMICS 
 
 well as by the workman) are bound to yield yet more completely 
 to the sway of the cold logic of corporation accounts and stock 
 market quotations. The adequacy of purely business principles 
 as the foundation of our economic life will be tested more thor- 
 oughly under the corporation form of organization than ever be- 
 fore. 
 
 Trusts. — A distinctive feature of the economic development 
 of the past few decades has been the combination of individual 
 corporations into larger concerns, or trusts. The " trust," in the 
 technical sense, involved either giving a board of trustees the 
 absolute control of the actual properties of the different con- 
 cerns in the combination, or what amounted to the same thing, 
 assigning to them the stock of each corporation, with its voting 
 power, in exchange for " trust certificates," on which dividends 
 were paid. The Standard Oil Trust of 1882 was the first impor- 
 tant combination of this kind, but it was speedily followed by 
 several others. In 1890, in a case brought by the state of New 
 York against the sugar trust, the trust agreement was held to be 
 illegal under common law.^ Corporate combinations were not 
 destroyed by this decision. They changed, however, to a more 
 definitely coherent form, — that in which a single great corpora- 
 tion dominates the consolidation. 
 
 In most cases, this corporation, which is usually organized 
 for the purpose, does not own the actual plants of the various 
 concerns in the combination, but simply owns all or a majority of 
 the stock of each. It is accordingly called a " holding company." 
 The holding company exchanges its own securities for the securi- 
 ties of constituent companies, or, when necessary, it buys the 
 securities of the constituent companies with funds secured from 
 the sale of its own securities, — sometimes by the sale of bonds 
 secured by the pledge of the securities of constituent companies 
 as collateral. Not only in industrial consolidations,^ but also in 
 
 ^People V. North River Sugar Refining Co., 121 N. Y. 582. A similar decision 
 was rendered two years later by the Supreme Court of Ohio in Stale v. Standard 
 Oil Co., 4Q Ohio St. 137. 
 
 2 A very complete list of "trusts," prepared by Mr. Byron W. Holt for the World 
 Almanac (1908), contained the names of about 250 industrial combinations, most 
 of which were holding companies. ' 
 
BUSINESS ORGANIZATION 231 
 
 railway and electric railway mergers has the holding company 
 device become important. 
 
 From the point of view of business organization the holding 
 company is simply an extension of the principle of the corpora- 
 tion. The holding company needs for purposes of control only 
 a majority interest in the stocks of its subsidiary corporations. 
 Various holding companies may in turn be combined by means 
 of one larger holding company, and the process may, and does, 
 go even further. A group of capitalists may, by an investment 
 of $1,000,000, for example, control a holding company with 
 a stock issue of $2,000,000, which in turn may control corpora- 
 tions with $4,000,000 of stock outstanding,^ — and some of 
 these last may in their turn be holding companies. The result 
 is a tremendous concentration of industrial and financial power, 
 with the minimum of liability. The uncontrolled use of the 
 holding company device leads to neglect of the interests of the 
 minority stockholders in the various corporations concerned ; to 
 difficulty in fixing the legal responsibility for corporate mis- 
 deeds ; to an undesirable complexity in the economic and legal 
 relations of the holders of securities in the different corporations, 
 and to the subordination of industrial to speculative ends. 
 
 The " trust problem," however, has attracted more attention 
 as a problem of monopoly than as a problem of business organiza- 
 tion. Combination and monopoly, it is important to note, are 
 not identical things ; we may have either one without the other. 
 But the movement toward combination originated in the efforts 
 of business men to escape from the restraints imposed upon them 
 by competition. Use has often been made of simpler forms of 
 combination than the trust and the holding company. Agree- 
 ments to sell only at certain prices, agreements to limit output, 
 the employment in common of one selling agent, pooling (the 
 distributions of orders or of profits to the parties to the agree- 
 ment in predetermined proportions), and other devices have 
 
 ^ It is assumed, for convenience, that the stock in each case is worth par and 
 that the ownership of half of it will give substantial control. In the case of indus- 
 trial combinations ownership of all the stock of the subsidiary companies by the 
 holding company is not uncommon. 
 
232 OUTLINES OF ECONOMICS 
 
 been used. Such combinations are formed by contracts entered 
 into by a number of individual firms, each of which retains its 
 own autonomy in all other respects. These contracts are un- 
 enforceable at common law — being held to be "contracts in 
 restraint of trade " and hence contrary to public policy — so that 
 it was difficult to be sure that any one firm would abide by the 
 contract any longer than it deemed it to be to its own individual 
 advantage. Combinations of this sort still persist. Railroad 
 rate agreements are, for example, both universal and necessary. 
 
 But the movement toward combination which has played so 
 important a part in the economic history of the past thirty years 
 has been characterized especially by the organization of combina- 
 tions of a more thoroughly unified type, in which each individual 
 firm brought into the combination yields up its own autonomy 
 and is absorbed by a corporation, usually a holding company, 
 organized for the purpose. These unified combinations, it was 
 thought, would be valid at common law, and would be less 
 vulnerable under the new anti-combination statutes that were 
 being enacted. Their management could be made more effec- 
 tive, and their comparative permanence and dependability 
 made possible the adoption of business policies based on long- 
 time considerations. Moreover, so long as there was public 
 confidence in their success, they afforded an inviting opportunity 
 for promoters to reap profits. 
 
 The Causes of Combination. — The specific motives usually 
 mentioned as the most important causes of corporate combina- 
 tions are (i) the economies of large-scale business; (2) the 
 elimination of purely competitive expenses (some kinds of ad- 
 vertising, for example) ; (3) the power to limit output and con- 
 trol prices. 
 
 The first of these factors suggests the difficult question of the 
 most profitable size of the business unit. The question should 
 not be confused with that of the most economical size of the 
 industrial plant. Many of our present-day business units are 
 so large that they operate a number of practically duplicate 
 plants. To that extent, at least, they are larger than is necessary 
 to secure the maximum technical efficiency of the plant. Nor 
 
BUSINESS ORGANIZATION 233 
 
 should the question be confused with that of the factors which 
 bring about the condition of decreasing expenses in an industry 
 at large. Certain productive advantages sometimes attributed 
 to great industrial combinations — such as the power of utilizing 
 highly specialized plants, equipped with highly specialized ma- 
 chinery and located at the most favorable points — are advan- 
 tages which do not have to wait upon combination, but which are 
 not only available but certain to be developed in any large and 
 growing competitive industry. Much has been said of the com- 
 bination's ability to buy its raw materials on the largest scale, and 
 therefore most cheaply, and of its ability to ship its products in 
 large quantities, and therefore most economically. But it has 
 not been shown that the combination has a marked advantage 
 in these particulars over large competitive establishments, 
 unless we should take account of the unfair discriminations that 
 railway companies have too often made in favor of the large 
 combinations. 
 
 The real problem is whether the mere fact of combination, 
 taken by itself, brings with it any real net economies in produc- 
 tion. It probably very often happens that combination does 
 effect some real savings. Uniform systems of accounting and 
 cost-keeping can be introduced ; noteworthy economies found;in 
 any one of the plants can be introduced in all the plants of the 
 same type ; high and uniform standards can be enforced by the 
 central administration. Especially in combinations of the 
 " integrated " type,^ there are undoubtedly real economies in 
 the general coordination of the different successive stages of the 
 industrial process, in the nice adjustment of the supply of raw 
 materials and intermediate products to the demand for finished 
 products, and in the adaptation of transportation facilities to 
 the needs of the industry. The Standard Oil Company un- 
 doubtedly effected great economies in the transportation of oil 
 by its use of pipe lines, and these could hardly have been con- 
 structed on so large and effective a scale if the industry had re- 
 mained competitive. 
 
 On the other hand, however, great combinations have certain 
 
 1 See p. 88, above. 
 
234 OUTLINES OF ECONOMICS 
 
 disadvantages inseparable from their size. Their economies 
 are largely those of systematization and standardization, and 
 these are prone to degenerate into inflexible and deadening 
 routine. The very losses of competition may sometimes be in 
 the long run a real social advantage. Fo'- they result in part 
 from variety of experimentation and from the free scope given 
 to individual initiative and individual planning. In competitive 
 industry there is a continuing natural selection of the fittest men 
 and the fittest methods. Nor are the best results always 
 achieved by a hierarchical organization of industry, in which 
 corporation ofi&cials, managers, and superintendents watch 
 only over the larger and more general aspects of an industry 
 and depend upon an army of subordinate employees (no matter 
 how scientifically organized and directed) to attend to all de- 
 tails. There is sometimes no effective substitute for intimate 
 personal supervision on the part of those primarily responsible 
 for the success or failure of a business undertaking. 
 
 Passing to the second and third general classes of motives 
 that are advanced as causes of corporate combinations, it is suffi- 
 cient here to note that whether purely competitive expenses and 
 competitive prices are eliminated by combination depends upon 
 whether the combination has any real basis of monopoly power 
 over and above the mere fact of combination, which, taken alone, 
 can give at most only a temporary monopoly. For a combina- 
 tion without some real source of monopoly power to attempt 
 to secure monopoly profits is to invite new enterprise and new 
 capital to come into the industry. In other words, it is to induce 
 latent competition to become active competition. 
 
 It is plain, however, that if any or all of these three classes of 
 advantages do exist in the case of a particular combination, the 
 earning power of the combination will be greater than the total 
 earning power of the separate concerns before consolidation, — 
 a difference which will be reflected in the value of the securities 
 of the holding company. It is this increment in capital value, 
 due to the real or expected advantages of consolidation, that has 
 been the chief cause of suqh combinations. The organization of 
 trusts has in many cases been effected by professional pro- 
 
BUSINESS ORGANIZATION 235 
 
 meters, whose connection with an undertaking does not con- 
 tinue any longer than is necessary in order to secure the profits 
 of consolidation. A few great trusts like those which have 
 figured in the oil, sugar, steel, and tobacco industries have been 
 conspicuously successful in a business way. Many others were 
 " made to sell " ; that is, were organized only in order that profits 
 might be gained through the sale of their securities, and have 
 been weighted down by a capitalization not justified by their 
 actual earning capacity. Some of these have already fallen to 
 pieces ; others have been reorganized, with diminished capitaliza- 
 tion. 
 
 " When judged in terms of the promises of their promoters their histories 
 stand as striking acknowledgments of the inadequacy of mere consoUdation 
 as a basis of economic efficiency. Two separate and distinct sets of causes 
 can be discovered to explain why the overwhelming majority of these indus- 
 trial combinations failed to prove as successful as their promoters had an- 
 ticipated. One set was psychological in character and concerned with the 
 difficulties attending the administrative management of a large business. 
 The other was economic in character and concerned with the difficulties 
 attending the creation of a business organization sufficiently powerful to 
 dominate an industry in the presence of actual or potential competition." ^ 
 
 It can hardly be held, then, that great industrial combinations 
 are, what they have sometimes been called, "the natural products 
 of economic evolution." Even where one has succeeded in so 
 dominating a field as to establish a substantial monopoly, it has 
 generally been found either that it possessed one or more of the 
 specific sources of monopoly power, or that it was enabled by its 
 size to avail itself of peculiarly destructive methods of com- 
 petition. 
 
 Anti-trust Laws. — Most states have statutes and some have 
 constitutional provisions against " combinations in restraint 
 
 1 A. S. Dewing, Corporate Promotions and Reorganizations, p. 558. Dr. Dewing's 
 conclusion, quoted above, is based on a very careful study of the more important 
 reorganizations of industrial combinations. He finds the following specific causes 
 of inefEciency : (i) diffusion of responsibility; (2) lack of knowledge of individual 
 employees ; (3) lack of loyalty of officers and directors ; (4) lack of attention to the 
 laborious parts of the business by higher officials ; (5) prejudice of customers against 
 " trusts." 
 
236 OUTLINES OF ECONOMICS 
 
 of trade." These are aimed primarily against large combina- 
 tions of the kind already described, although if strictly con- 
 strued they also make illegal the whole mass of price agreements 
 and trade restrictions, general and local, which are a much more 
 common and characteristic feature of modern business than is 
 generally supposed. State anti-trust statutes have accomplished 
 but little, partly because they have often been aimed at forms 
 rather than at facts, at symptoms rather than at fundamental 
 causes, and partly because they have been used only sporadically. 
 The experience of the federal government has shown that if the 
 prosecution of illegal combinations is to be conducted success- 
 fully, there must be thoroughgoing preliminary researches into 
 the history and business methods of the combinations. The 
 state governments have been poorly equipped for this kind of 
 work. 
 
 The Sherman Anti-trust Act of 1890 is a federal statute, based 
 upon the federal power to control interstate commerce. It 
 declares illegal " every contract, combination in the form of 
 trust or otherwise, or conspiracy, in restraint of trade or com- 
 merce among the several states, or with foreign nations." It 
 also makes it a misdemeanor for any person to " monopolize, 
 or attempt to monopolize, or combine or conspire with any other 
 person or persons, to monopolize any part of the trade or com- 
 merce among the several states, or with foreign nations." The 
 most important aspect of the statute is that it gave the federal 
 courts jurisdiction in these matters. The government can 
 proceed under the statute in either or both of two ways : (i) by 
 bringing criminal prosecutions against persons entering into 
 unlawful combinations ; (2) by instituting proceedings to pre- 
 vent and restrain violations of the law. A number of criminal 
 prosecutions have been made, but most of these have been un- 
 successful. It has been found difi&cult to get a jury to convict 
 for an offense so abstract and general and, possibly, so common, 
 as " restraint of trade." The more important results of the 
 law have come from proceedings for the dissolution of unlawful 
 combinations, and it is these only that we shall discuss. 
 
 There has been much discussion of the precise meaning of the 
 
BUSINESS ORGANIZATION 237 
 
 phrase " restraint of trade " as used in the Sherman Act. This 
 phrase was taken from the common law, in which its usual appli- 
 cation was to contracts by which a man agreed not to compete 
 with certain others. When the restraint of trade involved in 
 such agreements was merely incidental to some legitimate pur- 
 pose, and necessary in order to carry out that purpose, the con- 
 tracts have usually been deemed valid at common law. Thus, if 
 two competitors form an ordinary partnership, or if one man sells 
 his business to another, agreeing not to set up another business 
 undertaking of the same kind (so as to protect the sale of the 
 good-will of his former business), the restraint of competition 
 involved in such contracts does not necessarily render them ille- 
 gal. But if the direct purpose of a contract is restraint of trade 
 it is invalid and unenforceable and under some circumstances 
 criminal. 
 
 Although the Sherman Act was intended to be primarily a 
 weapon against great industrial combinations, it has been held 
 by the courts to apply also to labor unions and railway combina- 
 tions. It has never been held, however, that labor unions are 
 illegal under the act because of any alleged restraint of competi- 
 tion in the supply of labor. But certain activities of labor unions, 
 particularly strikes and boycotts, have been condemned by the 
 federal courts because such activities " interfere with the free 
 flow of commerce from state to state." ^ This, it will be noted, 
 is a very different thing from restraint of trade in the old com- 
 mon-law sense. 
 
 In 1897 the Supreme Court held that railroad rate agreements 
 were in violation of the Sherman Act.^ An important point in 
 these decisions was that neither the fact that railroad rates 
 agreements had been defended by the Interstate Commerce 
 Commission nor the claim that the rates agreed upon were rea- 
 sonable was allowed to stand as a defense. If the direct purpose 
 of such agreements, said the court, is restraint of competition, 
 
 ' United States v. Workingmen's Amalgamated Council, 55 Fed. 605 ; the Railway 
 Strike Cases, 64 Fed. 30, 749, and 67 Fed. 705 ; Loewe v. Lawlor (the Danbury 
 Hatters' Case), 208 U. S. 274. 
 
 ^ United States v. Trans-Missouri Freight Association, 166 U. S. 290; United 
 States V. Joint Traffic Association, 171 U. S. 505 (1898). 
 
238 OUTLINES OF ECONOMICS 
 
 they are illegal, whether reasonable or not. Railroad rate agree- 
 ments still exist, but no more of them have been attacked by the 
 government. An epoch-making decision was that which in 1904 
 ordered the dissolution of a New Jersey corporation, a holding 
 company, organized to hold the stock of the Great Northern 
 and Northern Pacific railroads, two " parallel and (supposedly) 
 competing " lines. ^ The importance of the decision is that for 
 the first time the holding company, as an instrument for restrain- 
 ing competition, was shown to be vulnerable to legal attack. 
 But the application of the Sherman Act to railway combina- 
 tions is in many ways unfortunate. Under the Interstate Com- 
 merce Act we have since 1887 regulated railway rates on the as- 
 sumption that railways are natural monopolies, and this has 
 proved a much more effective method of dealing with unfair 
 rates than has the attempt to force competition into the railway 
 field. The good accomplished by the dissolution of railway com- 
 binations lies in the inroads these dissolutions have made into 
 the use of the holding company device, with its undue concen- 
 tration of financial power and its opportunities for the unfair 
 treatment of minority stockholders. But this is only an inci- 
 dental result of these decisions, and lies quite outside the general 
 purpose of the Sherman Act. Many large holding companies, 
 in both the railroad and the manufacturing fields, are wholly 
 invulnerable to prosecution as " combinations in restraint of 
 trade." 
 
 For twenty years the Sherman Act was least effective in the 
 very field to which it had been particularly designed to apply. 
 A few industrial pools and price agreements were declared illegal 
 by the federal courts, but in the only case involving a trust of 
 the modern type that came before the Supreme Court the deci- 
 
 ^ United States v. Northern Securities Co., ig3 U. S. ig7. A similar decision, 
 in igi2, involving interests of even greater magnitude, dissolved the merger of the 
 Union Pacific and Southern Pacific railroads (226 U. S. 61). In the St. Louis Termi- 
 nal Railroad case (224 U. S. 283), also decided in 1912, a corporation owned by fif- 
 teen railroads, and possessing a monopoly of railroad terminal facilities in St. Louis, 
 was not dissolved, but was merely directed so to reconstruct its organization that 
 new companies might participate in ks ownership and be given the advantages of 
 its services on equal terms with railroads then in control of it. 
 
BUSINESS ORGANIZATION 239 
 
 sion was for the defendant corporation.^ For many years 
 there were few prosecutions of industrial combinations. The 
 government lacked properly equipped bureaus of research and 
 investigation, and the government officials were apparently 
 apathetic. But both of these conditions were changed during 
 President Roosevelt's administration. Finally, in 19 10, the 
 government was successful in suits brought for the dissolution 
 of two of the greatest of industrial combinations, the Standard 
 Oil Company ^ and the American Tobacco Company.^ Possi- 
 bly the most important thing in these decisions was the emphasis 
 the Supreme Court placed on certain business practices of these 
 companies as evidence of their monopolistic intent. Each com- 
 pany had achieved a dominating position in its field, and the 
 Standard Oil Company, at least, had a virtual monopoly. 
 Helped at first by railroad rebates, it had consistently pursued 
 a policy of monopolization, either absorbing its competitors 
 or driving them out of business. The evidence showed that 
 it had acquired from 85 to 97 per cent of the business of trans- 
 porting, manufacturing, and selling petroleum and its products, 
 and such competition as there was seems to have existed by 
 its sufferance. It did not have a natural monopoly, for only 
 about one ninth of the total national production of crude oil 
 came from its own wells. It had certain advantages over its 
 competitors, especially in its control of pipe lines and in the low 
 railroad rates given to points at which its refineries were located. 
 Yet it did not have a full measure of monopoly power. Ac- 
 tive competition was always possible and was kept down only 
 by the use of what have come to be called unfair competitive 
 methods. 
 
 Unfair competition has come to play a very important part 
 in the trust problem. It includes the use of such devices as 
 (i) cutting prices below cost in a locality in which competition 
 
 * United States v. E. C. Knight Co., 156 U. S. The decision in this case, in- 
 volving the American Sugar Refining Company, was to the effect that a monopoly 
 in the manufacture of sugar could not be held to be a monopoly in interstate com- 
 merce. 
 
 2221 U. S. I. 
 
 ' 221 U. S. 181. 
 
240 OUTLINES OF ECONOMICS 
 
 appears ; (2) discriminating in favor of merchants who agree 
 to refuse to handle or to discriminate against competitors' prod- 
 ucts; (3) the use of threats and other forms of intimidation, 
 (4) the employment of spies to ascertain the details of competi- 
 tors' business transactions ; (5) the production of special brands 
 of goods, sold at very low prices for the purpose of driving 
 competitors' products out of the market ; (6) the use of sub- 
 sidiary companies as bogus independent concerns. Most of 
 these methods were not in themselves illegal. Some of them, 
 including price-cutting on one or more parts of an establishment's 
 output, are common in ordinary competitive trade. But when 
 used by large industrial combinations such methods have come 
 to be called " unfair," because of the purposes prompting their 
 use and because of their effects. There is a very important 
 difference between an effort to gain as much business as one can 
 under competitive conditions and an effort to destroy competi- 
 tive conditions. And methods that may be harmless when 
 used by an enterprise of ordinary size become dangerously 
 destructive weapons in the hands of great industrial combina- 
 tions. The combination is able to wage a destructive competi- 
 tive warfare because it can stand a loss at one point or on one 
 part of its output large enough to send its smaller competitor 
 into bankruptcy. The use of unfair methods of competition 
 by the Standard Oil Company and the American Tobacco 
 Company was deemed by the Supreme Court weighty evidence 
 of the purpose of those combinations to monopolize "trade and 
 commerce " in their respective fields. 
 
 These decisions showed that the Sherman Act could be used 
 as an efficient tool for the dissolution of great industrial com- 
 binations organized and conducted with monopolistic intent. 
 Since 1910 a number of successful suits have been brought for 
 the dissolution of other trusts, while yet others have voluntarily 
 reorganized in accordance with plans approved by the govern- 
 ment.^ It is too early to judge of the ultimate effects of these 
 dissolutions. There can be no doubt, however, that in a number 
 of industries, including the oil and tobacco industries, there is 
 
 ^ See the Annual Reports of the Attorney General, for igio and subsequent years. 
 
BUSINESS ORGANIZATION 241 
 
 a larger measure of normal competition than before the disso- 
 lutions. 
 
 The reorganization of industrial combinations in such a way as to comply 
 with the law often presents difficult problems. Where the trust is a holding 
 company it is impossible to distribute its stock holdings to the original 
 owners or their heirs, for many of the holding company's own securities 
 will have changed hands since its organization. At first the courts merely 
 directed that the securities owned by the holding company be distributed 
 pro rata among its own stockholders. But where a majority of the stock of 
 the holding company was closely held by a small group of men, and where 
 the holding company held a substantial majority of the stock of its more 
 important subsidiary companies, this method of dissolution was unlikely 
 to result in the prompt restoration of normal competitive conditions in the 
 industry. More recently the dissolution plans have been more carefully 
 worked out, so that no one group of stockholders is left in control of all 
 the different constituent parts of the former combination. 
 
 In 1914 Congress enacted two new statutes, the Clayton 
 Anti-trust Act and the Federal Trade Commission Act, The 
 Clayton Act is designed to accomplish a number of different 
 things. We can mention only its more important provisions: 
 
 1. It definitely legalizes those activities of labor unions 
 which had been declared illegal under the Sherman Act. This 
 topic is discussed elsewhere in this volume. "• 
 
 2. It prohibits the acquisition by one corporation of stock 
 in another corporation when the effect may be "to substan- 
 tially lessen competition " between such corporations, or " to 
 tend to create a monopoly." It also makes it illegal for a man 
 to serve (i) as a director or ofl&cer of a bank in the Federal 
 Reserve system and at the same time as a director or officer 
 of any other bank or as a private banker, when one bank has 
 liabilities of more than $5,000,000 or when both are located 
 in a large city ; (2) as an officer or director of a common carrier 
 and at the same time as an ofi&cer or director of a firm having 
 large dealings with the carrier in securities, supplies, or contracts 
 for construction or maintenance (unless under publicly super- 
 vised competitive bidding) ; (3) as a director of two or more 
 industrial corporations engaged in interstate commerce, if one 
 
 1 Chap. XXIII. 
 
 R 
 
242 OUTLINES OF ECONOMICS 
 
 has an aggregate "capital, surplus, and undivided profits "of 
 more than $1,000,000 and if they are, "by virtue of their busi- 
 ness and location of operation, competitors." These provi- 
 sions against " interlocking " directors and officers, like the 
 provision against intercorporate stockholding, have a whole- 
 some purpose and may accomplish some good in particular 
 cases. But so far as their effect upon industrial combinations 
 is concerned they add little to the Sherman Act, as now inter- 
 preted by the courts. It will be noted, however, that intercor- 
 porate stockholdings and intercorporate directorates are pro- 
 hibited by the Clayton Act when they may tend to lessen 
 competition between the corporations directly concerned, 
 even though general competitive conditions may continue in 
 the industry in which the corporations are engaged. 
 
 3. The Clayton Act prohibits certain trade practices, in- 
 cluding (i) unjustifiable discrimination in the prices charged 
 to different purchasers, (2) leases or sales of goods made with 
 the understanding that the lessee or purchaser shall not use 
 or deal in the goods of a competitor of the lessor or seller, as 
 well as special discounts or rebates made upon such conditions. 
 In cases under the Sherman Act the courts, as we have seen, 
 had already counted the use of such practices among the evi- 
 dences of an illegal purpose to monopolize an industry. And 
 injunctions against their further use have been included in the 
 decrees in some of these cases. If follows that in these particu- 
 lars, also, the Clayton Act adds little to the Sherman Act. 
 
 The Federal Trade Commission, established in 1914, is com- 
 posed of five members, appointed by the President. It suc- 
 ceeds the Bureau of Corporations, which was established in 
 1903 for the primary purpose of making special investigations 
 of particular corporations and combinations and of the condi- 
 tions existing in particular industries. The Federal Trade 
 Commission not only has large powers of investigation, but it 
 has the further power to require annual or special reports from 
 interstate corporations in such form and relating to such matters 
 as it may prescribe. At the request of the Attorney General 
 it is to investigate any cprporation alleged to be violating the 
 
BUSINESS ORGANIZATION 243 
 
 anti-trust laws, and to make recommendations for the read- 
 justment of its business. In suits brought under the anti- 
 trust acts the Commission may be asked by the court to pre- 
 pare an appropriate form of decree, which is, of course, subject 
 to rejection or change by the court. The importance of this 
 provision is in its bearing upon the outcome of dissolution pro- 
 ceedings under the Sherman Act. The drafting of a wise plan 
 of reorganization for an offending combination is often an ex- 
 ceedingly difficult matter, requiring not only care and judg- 
 ment, but also a large amount of technical information about 
 the general condition of the industry affected. Furthermore, 
 the Commission is authorized to make investigations of the 
 manner in which decrees in suits under the anti-trust acts are 
 carried out. 
 
 The most important power of the Federal Trade Commission 
 is undoubtedly that of issuing orders restraining the use of 
 " unfair methods of competition in commerce." So far as 
 such methods are used as part of a general attempt to monop- 
 olize an industry, the new statute adds nothing to the Sherman 
 Act except a new, prompt, and efficient method of procedure. 
 If this power is wisely used it should be possible in many cases 
 to put a stop to aggressive monopolizing in its early stages, 
 before much harm has been done. But the power committed 
 to the Federal Trade Commission has even wider aspects. It 
 is to be hoped that the Commission may be able to build 
 up and maintain higher standards for competitive business 
 methods in general ; that it may fix the lines beyond which 
 one should not go in the attempt to divert trade from one's 
 competitors. 
 
 Public Policy towards Industrial Combinations. — Our 
 anti-trust laws express what is undoubtedly the dominant 
 public sentiment in the United States with respect to large 
 industrial combinations formed with the purpose of obtaining 
 a monopoly. Our policy has been one of repression, of compul- 
 sory disintegration. Undoubtedly we have made many blun- 
 ders in the ways in which we have formulated and enforced this 
 policy. We have, in some cases, attempted to force competition 
 
244 OUTLINES OF ECONOMICS 
 
 into the field of the natural monopolies ; we have often attrib- 
 uted too large a significance to the mere fact of combination ; 
 we have in particular attempted to cure by a sweeping prohi- 
 bition of " restraint of trade " and " monopolizing " many- 
 evils that are, in their more important aspects, matters of cor- 
 poration finance, rooted in the laxity of our statutes in respect 
 to the organization and management of corporations. But 
 this does not mean that our general policy has been fundamen- 
 tally mistaken. Monopoly has yet to prove itself more eflQcient 
 than competition. And, moreover, it is not entirely a ques- 
 tion of economic efi&ciency. There are differences between 
 monopoly and competition in their effects upon the distribu- 
 tion of wealth, upon the equality of economic opportunity, and 
 upon a host of economic and social relations ; and in most of 
 these particulars, it is generally believed, the advantage rests 
 with competition. At any rate, we are proceeding along sound 
 lines in endeavoring to raise the level of competitive methods 
 and to eliminate any advantages which large combinations may 
 have in their power of destructive competition. This will give 
 a fairer field for experimentation with respect to the forms of 
 business organization really best fitted for survival. 
 
 There are some who believe that our general policy has been 
 wholly mistaken ; that we should permit and even encourage the 
 formation of large combinations ; that we should place monopoly 
 power in their hands, and that we should then subject their 
 prices and their products "to public control of the kind that now 
 exists in the railway field. Now there is, in fact, no good reason 
 why our notions of what constitutes a " public calling," or a 
 " business affected with a public interest," properly subject 
 to rigid public control, should not be extended so as cover all 
 natural monopolies. But to regulate prices in any industrial 
 field, not naturally monopolistic, would be an exceedingly diffi- 
 cult and complex undertaking. It would also be difficult to 
 define the terms on which new capital and new enterprise might 
 come into the " regulated " industry. And there is, as yet, 
 no proof that this proposed change in policy would, if put into 
 effect, result in any large' economic or social gains. 
 
BUSINESS ORGANIZATION 245 
 
 Federal Control of Corporations. — The unfortunate effects 
 of the lack of uniform state requirements in such matters as 
 purposes of incorporation, corporate powers, qualifications 
 and responsibilities of promoters and directors, capitalization, 
 and the like could in large measure be remedied by federal 
 action. The Clayton Act touches only incidentally upon this 
 field. Its provisions relating to incorporate stockholdings 
 and interlocking directorates were framed with reference 
 merely to the problem of the preservation of competitive con- 
 ditions. What is needed is a federal statute dealing thoroughly 
 and systematically with the promotion, organization, and 
 management of corporations engaged in interstate commerce. 
 Canal, railway, and bridge companies have in the past been 
 chartered by the federal government, just as national banks are 
 now. It would be legally possible and economically advisable 
 to require at least a, federal license from all corporations engaging 
 in interstate commerce. Moderate and just requirements as 
 to publicity, capitalization, and other things might very well 
 be imposed as the price of federal license. Aside from the 
 present lack of uniformity in state laws, the mere size of modern 
 business corporations and the interstate scope of their opera- 
 tions make it difiicult for any individual state or states to 
 control them efiiciently. 
 
 Industrial Combinations in Other Countries. — A move- 
 ment toward combination in some form has manifested itself 
 in practically every country which has large industries of the 
 modern type. In England, however, the movement has made 
 much less headway than in the United States. This may be 
 attributed in part to the fact that England's " company laws " 
 are not so lax as are the corporation laws of many of our states, 
 in part, possibly, to the absence of a protective tariff, and in 
 part to the highly specialized character of English industries. 
 During the past twenty or thirty years, however, a number of 
 important combinations have been formed in England, but 
 only a few of these have been successful. An English combina- 
 tion, it may be noted, has an international monopoly of sewing 
 cotton. England has no statute forbidding combinations, 
 
246 OUTLINES OF ECONOMICS 
 
 but the contracts by which " combinations in restraint of trade " 
 are formed will not be enforced by the courts. 
 
 In Germany and in certain other countries of continental 
 Europe the dominant form of combination is the Kartell. 
 This resembles a pool more than it does the thoroughly central- 
 ized industrial combinations of the United States. The Kartell 
 itself is, however, usually organized as a joint-stock company. 
 The individual companies constituting its membership continue 
 as independent producing establishments. The Kartell con- 
 trols sales, prices, output, and the distribution of orders and of 
 profits. Opinions in Germany with respect to the success of 
 the Kartells is greatly divided. On the one hand it is claimed 
 that they have eliminated many of the wastes of competition and 
 that they have been especially active and successful in securing 
 sales in foreign markets. On the other hand it is charged that 
 they have discriminated against home consumers by selling 
 abroad at lower prices than they charge at home, and that they 
 even go so far as to sell at very different prices in'different part 
 of Germany, utilizing, as far as possible, the principle of "charg- 
 ing what the traffic will bear." In 1906, when a government 
 investigation was made, there were 384 Kartells in Germany, and 
 many new ones have been organized in subsequent years. Note- 
 worthy among the German Kartells have been the Rhenish- 
 Westphalian Coal Syndicate (of which the Prussian govern- 
 ment, as a large mine owner, was for a short time a member) 
 and the Steel-works Association. 
 
 QUESTIONS AND EXERCISES 
 
 1. What are the terms under which corporations are chartered in your 
 own state? What an ti- trust laws are in force there? 
 
 2. Explain the various items in the pubUshed balance sheet of some in- 
 dustrial corporation. 
 
 3. What Umitations should be attached to the statement that "a cor- 
 poration is a fictitious person " ? 
 
 4. Does the word "capital" mean the same thing in accounting and in 
 economics ? 
 
 5. Report on the history of one of the following : United States Steel 
 Corporation; American Sugar Refining Company; American Tobacco 
 
BUSINESS ORGANIZATION 247 
 
 Company; International Harvester Company; United States Leather 
 Company; Rhenish-Westphalian Coal Syndicate. 
 
 6. What advantages has a large plant? a large business unit? a 
 monopoly ? 
 
 7. What special burdens are imposed upon corporations? Has the 
 corporation any other disadvantages as a form of business organization ? 
 
 8. In what respects do the Clayton Anti-trUst Act and the Federal Trade 
 Commission Act cover the same ground? 
 
 REFERENCES 
 
 Bureau of Corporations. Special Reports on various industries. 
 
 Carter, G. R. The Tendency towards Industrial Combinations. 
 
 Clark, J. B. and J. M. The Control of Trusts. 
 
 Dewing, A. S. Corporate Promotions and Reorganizations. 
 
 DuRAND, E. D. The Trust Problem. 
 
 Federal Trade Commission. Annual and Special Reports. 
 
 Gerstenberg, C. W. (editor). Materials of Corporation Finance. 
 
 Haney, L. H. Business Organization and Combination. 
 
 Jenks, J. W. The Trust Problem. 
 
 Lough, W. H. Corporation Finance. 
 
 Lyon, W. H. Capitalization, a Handbook of Corporation Finance. 
 
 Meade, E. S. Trust Finance; Corporation Finance. 
 
 Orth, S. p. (compiler). Readings on the Relation of Government to Prop- 
 erty and Industry, Parts iv, viii, ix. 
 
 Railroad Securities Commission. Report. 
 
 Ripley, W. Z. Railroads : Finance and Organization; (editor) Trusts, 
 Pools, and Corporations. 
 
 Stevens, W. S. (editor). Industrial Combinations and Trusts. 
 
 Van Hise, C. R. Concentration and Control. 
 
 Wyman, Bruce. The Control of the Market. 
 
 Young, A. A. "The Sherman Act and the New Anti-trust Legislation," 
 Journal of Political Economy, vol. xxiii, pp.2i(>-22o, 305-326, 417-436. 
 
CHAPTER XrV 
 MONEY 
 
 The vast system of exchange, which is the most characteristic 
 single feature of present-day economy, rests upon the use of 
 money. We have seen that some economic writers have pic- 
 tured an imaginary primitive state of " barter economy " ; in 
 which, before the use of money, goods were exchanged directly 
 for goods. But what little definite information there is on this 
 point leads us to the belief that about as soon as men began to 
 exchange things, and consequently to attribute exchange value 
 to them, they began to use some kind of money — some commod- 
 ity or commodities for which things were generally exchanged, 
 and in terms of which the values of other things were generally 
 stated. 
 
 The earliest forms of money were crude and simple, but they 
 sufiiced to meet simple needs. As exchange economy has ad- 
 vanced to the present complex division of labor, the monetary 
 system has developed pari passu, the most conspicuous feature 
 of this development in modern times being the growing impor- 
 tance of credit as a means of effecting exchanges. Industrial and 
 commercial progress has led to monetary progress, and has, in 
 turn, been stimulated and made possible by it. 
 
 Metallic Money. — The earliest and simplest forms of money 
 were commodities. Particular commodities came to serve as 
 money, not because they were arbitrarily designated as such 
 by king or chieftain, but because they possessed some properties 
 which made them exceptionally exchangeable. In some cases 
 a primitive community came to use a commodity as money be- 
 cause it was something for which they had a dependable " for- 
 eign market " — something, that is, which they customarily soki 
 to other communities in exchange for their products. In other 
 
 248 
 
MONEY 249 
 
 cases a commodity which a community did not itself produce, 
 but which it got only in the course of trade with other com- 
 munities, became the money commodity- Or, if for any reason 
 a particular commodity came to be particularly esteemed as a 
 mark of wealth or a badge of social prestige, it was likely to used 
 as money. But whatever the original ground of the choice, a 
 commodity which a community once began to think of as money 
 had its exchangeabihty, and consequently its suitability for 
 monetary uses, increased in a cumulative way, just as today 
 most of us are willing to accept anything as money which we 
 think we can use as money. 
 
 A great variety of commodities have at one time or another 
 been used as money. Some typical examples are cattle, grain, 
 furs, oil, salt, tobacco, ivory, shells, and tea. But with the ad- 
 vance of political and economic civilization the metals have, 
 through the process of the survival of the fittest, proven them- 
 selves everywhere to be preeminently and indisputably the best 
 money commodities. Copper, silver, and gold have each in turn 
 been chosen as the principal money metal of the civilized world, 
 the transition from the cheaper to the dearer metals indicating 
 the growth of exchange and of wealth and the consequent need 
 pf larger money units. 
 
 Metals, and especially the precious metals, have certain quali- 
 ties that give them a peculiar fitness to serve as money. They 
 are durable, easily recognized and tested, and may be divided 
 into homogeneous units of convenient form and weight. More- 
 over, as compared with most other commodities, the precious 
 metals are relatively stable in value. This arises in part from 
 their durability, for any one year's output of the mines makes but 
 a comparatively small addition to the total stock of metallic 
 money, and in part from the nature of their non-monetary uses, 
 for the demand for commodities that minister to our tastes for 
 ornament and display is much more elastic than the demand for 
 necessaries of life. 
 
 Coinage. — When metals were first used as money, they passed 
 from hand to hand simply by weight, or, in some cases, in the 
 form of ornaments. Coinage speedily developed, however, as 
 
250 OUTLINES OF ECONOMICS 
 
 a convenient way of certifying to the weight and fineness of 
 money units.^ 
 
 Such a guarantee is naturally of little avail unless it is generally 
 recognized as authoritative. On this account the coinage of 
 money has almost universally been regarded as a prerogative of 
 the sovereign. In England, even under the divided sovereignty 
 of the Middle Ages, the coining of gold and silver was generally 
 a privilege belonging to the king alone. The lesser feudal lord 
 and the chartered cities issued token coins, made of the baser 
 metals, and intended especially for local use, but if they possessed 
 the right of coining the precious metals, it was through a special 
 grant of the king. 
 
 The Meaning of " Money." — In modern economic life 
 many things in addition to coined metals are included, and 
 properly included, under the name of money. There is, how- 
 ever, no definite line of demarcation between the things which 
 are money and the things which are not money, consistently 
 followed in common usage, or even in economic writings. But 
 we may agree, to begin with, that money is what we exchange 
 for things when purchasing them, and that sellers are willing to 
 accept it, at stated prices, in exchange for their goods. Then, 
 however, we have to take account of the fact that many ex- 
 changes are credit transactions ; that is, that the immediate 
 equivalent given in exchange for a thing is a promise to pay a 
 certain amount of money. This suggests that we should dis- 
 tinguish between " money " and " credit instruments." But 
 when we push our analysis a little further we find that the ele- 
 ment of credit is found in many of the things that we ordinarily 
 call money, even, as we shall see, in some kinds of metallic 
 money. 
 
 A useful and important distinction, however, is implied in the 
 very common practice of restricting the use of the name 
 " money " to those instruments of general acceptability which 
 
 1 The names of many ancient coins and of some modern ones are also the names 
 of weights, although it has generally happened that through successive debasements 
 of the coinage these names have lost their original significance. The Greek talent, 
 the Jewish shekel, the Roman as, the Chinese tael, the English pound, and the 
 French livre are famiUar examples. 
 
MONEY 251 
 
 pass freely from hand to hand as media of exchange. The particu- 
 lar things thus to be counted as money vary for different periods 
 and for different countries. In the United States this generally 
 acceptable medium of exchange includes the metallic money 
 coined by the federal government, the paper money issued by it, 
 and bank notes. Checks drawn by individuals upon their bank 
 accounts are not money, or money instruments, in this sense, 
 because they do not pass freely from hand to hand as media 
 of exchange. They can be used only in making payments to 
 persons who have confidence in the honesty and solvency of the 
 one who tenders the check for payment. Some things that 
 are part of the generally acceptable media of exchange are them- 
 selves promises (on the part of the government or of banks) 
 to pay certain other forms of money on demand. But the 
 important point is that the acceptability of such things does not 
 depend upon the honesty or solvency of the person who tenders 
 them in payment. So long as we have confidence in the solvency 
 of the government and the banks, their coins and notes, issued 
 in convenient and easily recognizable forms and denominations, 
 are generally acceptable media of exchange, and, as such, are 
 money. This meaning of the word has the sanction of a very 
 common and prevalent usage ; it corresponds, moreover, to the 
 technical definition given to the word by many economic writers, 
 and to the official usage of the United States Treasury. In this 
 chapter the word " money " will be employed in this restricted 
 sense of money instruments of general acceptability. 
 
 But the word is also often used in a much broader sense. We 
 speak of " money funds," the " money market," " money ex- 
 penditures," " investments of money," etc. And yet the 
 " money market " is not primarily a place in which the generally 
 acceptable media of exchange are bought and sold, nor is the 
 fact that one's " money expenditures " amount to a given sum 
 to be interpreted as meaning that one has actually paid out this 
 amount in the generally acceptable media of exchange. Money, 
 in this broad sense, includes credit in the form of rights to receive 
 money (in the narrower sense just defined) on demand. It is 
 these rights that are bought and sold in the money market and 
 
252 OUTLINES OF ECONOMICS 
 
 it is by transfers of these rights that a very large proportion of 
 the aggregate annual payments for goods and services are made. 
 A payment made by a bank check is, for example, a transfer 
 of a right of this kind. 
 
 The Media of Exchange. — Some writers have made a distinc- 
 tion between the function which money performs as a medium oj 
 exchange, and its function as a measure of value. These are not, 
 however, two different functions, but merely two different 
 aspects of the same thing. By the very process of exchanging 
 a commodity for money, we of necessity " measure " its value 
 in terms of money, and only as a medium of exchange does money 
 measure value. We may speak of a pound weight as an instru- 
 ment used in weighing or as a measure of weight, but we would 
 all recognize that these are merely two aspects of one function. 
 
 In the United States the actual media of exchange in terms of 
 which we " measure values " (or more accurately, state prices) 
 comprise a variety of coins, made from different metals, together 
 with several kinds of paper money of many different denomina- 
 tions. But all these different forms of money are alike in name, 
 
 — that is, they are dollars, or multiples or fractions of a dollar, 
 
 — and moreover, these various kinds of dollars are not distin- 
 guished, one from another, in the price lists. This familiar and 
 very satisfactory condition of uniformity in the units in which 
 we state prices does not, however, suggest to us the real nature 
 of money in the way that a less perfect monetary system would. 
 
 It would be possible to have a number of different monetary 
 units, just as the weight or size of an object may be stated in 
 terms of either the metric system or the English system of 
 weights and measures. In fact, before the United States had an 
 adequate monetary system of its own, the actual media of ex- 
 change consisted largely of English, French, Spanish, and Portu- 
 guese coins, and there were as many different ways of stating 
 prices as there were varieties of money .^ Nor does the mere 
 
 1 An instructive bit of monetary experience may be found in the efforts of some 
 of the colonies to reduce this foreign money, especially Spanish money, to the 
 English system of pounds, shillings, and pence, in which accounts were generally 
 kept. They were not content with a simple official statement of the actual ratios 
 between the different value units, but sought to give an artificially enhanced value 
 
MONEY 253 
 
 name of " dollar " give to different pieces of money a uniform 
 purchasing power. The silver dollar of Mexico will buy only 
 about half as much as the silver dollar of the United States, al- 
 though it is of approximately the same size. More significant, 
 however, is the fact that in the United States we have had at 
 different times " dollars " of unequal purchasing power. 
 
 What is it, then, that gives uniformity to the dollar as a price- 
 recording unit in our present monetary system? To say that 
 various kinds of money are equal in value because they will pur- 
 chase the same amounts of goods is, obviously, to argue in a circle. 
 But the answer is found in the fact that they are interchangeable, 
 and so long as any number of kinds of money, all named in dollar 
 units, are freely exchangeable, dollar for dollar, it is impossible that 
 domestic prices stated in terms of one kind of money should be 
 higher or lower than domestic prices stated in terms of any other 
 kind of money. We do not refer here to the fact that different 
 kinds of money are exchanged for each other at par in business 
 transactions and in banking, for this is a result, rather than a 
 cause, of their parity. The exchangeability that underlies the 
 parity of our different kinds of money is maintained by the 
 federal government. 
 
 All coins smaller than a dollar are by law exchangeable at the 
 United States Treasury for " lawful money," which includes gov- 
 ernment notes, silver dollars, and gold coins. Government 
 notes, in turn, are simply promises to pay, which are redeemable 
 in gold at the government treasury. While there is no definite 
 legal mandate requiring the redemption of silver dollars in gold, 
 yet the currency act of 1900 makes it the duty of the Secretary 
 of the Treasury to maintain all other forms of money at a parity 
 with gold — a requirement which means that he would have to 
 redeem sUver dollars in gold if such action should at any time be 
 
 to the foreign coins by increasing the number of shillings to which they were to be 
 considered equivalent. The result was not, however, an increase in the value 
 of the coins, but a decrease in the value of the nominal "shilling" in which accounts 
 were kept. This was the origin of the now rapidly vanishing use of the word " shil- 
 ling" as equivalent to 12^ cents in some localities and to i6| cents in others. The 
 student may find an instructive parallel in this experience and the ofiScial statement 
 of coin values by which sovereigns tried to retain their seigniorage profits. 
 
254 OUTLINES OF ECONOMICS 
 
 Money in the United States: June, 30, 1915^ 
 
 
 In Treasury, 
 
 Mints, and 
 
 Federal 
 
 Reserve Banks 
 
 In Other Banks 
 
 AND IN 
 CiRCrLATION 
 
 Total 
 
 Gold coin and bullion . 
 Silver dollars .... 
 Subsidiary silver . . . 
 
 $1,395,405,553 
 
 503,624,499 
 
 26,164,295 
 
 $590,133,619 
 
 64,647,156 
 
 159.265,955 
 
 11,985,539.172 
 568,271,655 
 185,430,250 
 
 Total metallic . . . 
 
 $1,925,194,347 
 
 $814,046,730 
 
 $2,739,241,077 
 
 United States notes . . 
 Federal reserve notes . 
 National bank notes 
 
 $14,338,770 
 
 3,885,850 
 
 33,880,546 
 
 $332,342,246 
 
 80,374,650 
 
 785.393,047 
 
 $346,681,016 
 
 84,260,500 
 
 819.273.593 
 
 Total notes .... 
 
 $52,105,166 
 
 $1,198,109,943 
 
 $1,250,215,109 
 
 Aggregate metallic 
 and notes . . . 
 
 $1,977,299,513 
 
 $2,012,156,673 
 
 $3,989,456,186 
 
 Gold certificates . . . 
 Silver certificates . . . 
 Treasury notes of 1890 
 
 Total certificates and 
 
 $100,861,170 
 
 11,488,605 
 
 9.313 
 
 $1,072,847,819 
 
 481,970,395 
 
 2,244,687 
 
 — 
 
 notes 
 
 $112,359,088 
 
 $1,557,062,901 
 
 — 
 
 Aggregate 2 .... 
 
 — 
 
 $3,569,219,574 
 
 $3,989,456,186 
 
 needed to maintain their parity. Gold certificates and silver cer- 
 tificates are simply a mechanism for putting gold and silver money 
 into circulation in convenient form. They are analogous to ware- 
 house receipts, because they represent gold coins and silver dollars 
 that are stored in the government treasury to the full amount of 
 the certificates issued, and which may be obtained at any time in 
 exchange for the certificates. Bank notes (including federal 
 reserve notes and national bank notes) are redeemed by the fed- 
 eral treasury, which for this purpose acts as an agent of the 
 banks which have issued the notes. In practice the government 
 is continually receiving all kinds of money, including silver dol- 
 
 1 Finance Report, igis, p. 314. 
 
 *This aggregate does not include "minor coins," principally bronze one-cent 
 pieces and nickel five-cent pieces, of which there were about $60,000,000 outstand- 
 ing on June 30, 1915. 
 
MONEY 255 
 
 lars, and exchanging other kinds of money for them. The sig- 
 nificant thing is that all other kinds oj money are exchangeable, 
 directly or indirectly, for gold coin. 
 
 The Monetary Standard. — In the case of gold coin, there is 
 a further kind of exchangeabihty — the unlimited and free con- 
 vertibility of gold coin and gold bullion. So long as any one can 
 secure gold coin from the mints in any amount for the same weight 
 of gold bullion of standard fineness, and so long as gold coin can 
 be freely melted down into gold bullion, it is impossible that there 
 should be any appreciable difference between the value of a gold 
 coin and the value of its metallic content. We have, then, not 
 only the interchangeability of all parts of the circulating medium, 
 but also the positive physical identity of one part of it and the 
 material of which this part is made. 
 
 Gold coins, because their value as bullion is equal to their value 
 as coins, constitute standard money. The gold dollar weighing 
 25.8 grains, and containing 23.22 grains of fine gold is by law the 
 monetary unit, that is, the dollars in terms of which prices are 
 stated are gold dollars or are maintained at a parity with gold 
 dollars. The coinage of the gold dollar was discontinued in 
 1890, but the gold coins that are minted contain precisely this 
 amount of gold per dollar. Gold, whether in coin or bullion, 
 constitutes the monetary standard, for the value of any dollar must 
 be equal to the value of the gold in a gold dollar. The recording 
 of prices in terms of dollars through the exchange of goods and 
 services for money of different sorts, the maintenance of the 
 parity of dollars in all varieties of money through their exchange- 
 ability, and the automatic equating of the value of the dollar 
 to the value of 25.8 grains of gold bullion ; — these are the fun- 
 damental facts of our monetary system. 
 
 Seigniorage. — Sovereigns have in the past very often viewed 
 the monopoly of coinage as an opportunity for personal profit. 
 By calling in the stock of metallic money in the country for re- 
 coinage, they have frequently reduced the weights of coins with- 
 out changing their names, thus increasing the number of coins, 
 so that a handsome profit was netted for the royal treasury. 
 Debasement of the currency was a favorite financial expedient 
 
2S6 OUTLINES OF ECONOMICS 
 
 of Henry VIII, of England, and of Philip the Fair and Louis XIV, 
 of France. 
 
 Somewhat less reprehensible in theory, although amounting to 
 about the same thing in its effects, was the common practice of 
 making a charge for the coinage of standard money, called 
 seigniorage. This practice was based on the idea that it was 
 possible to maintain a difference between the value of a coin and 
 the value of the bullion put into it.^ A great deal has been 
 written about the possibility of seigniorage, for the subject is one 
 that involves considerations that are fundamental in monetary 
 theory. It has been often said, for example, that it is the 
 " government stamp," rather than the metallic content, that 
 gives value to a coin. Leaving aside the matter of limited or 
 subsidiary coinage (which will be considered presently), we may 
 dispose of this statement by saying that if it means that the use 
 of certain metals as money creates a demand for them that would 
 not otherwise exist and thus increases their value, it is a truism ; 
 but if it means that in coinage we can add an arbitrary and in- 
 tangible element of value to the value of the metallic content 
 of standard coins, the statement is a misleading doctrine that 
 has been disproved by the monetary experience of almost every 
 country. 
 
 There is, however, a stronger statement of the theory of seign- 
 iorage. If the only way in which I can convert bullion into a 
 medium of exchange is by being content with 750 ounces of 
 money for every 1000 ounces of bullion I take to the mint, will 
 not the coins have a value one third greater than that of the 
 metal they contain? May not their "metallic content" be 
 said to be, in a figurative sense, one third more than their weight 
 because they cost me that much more in bullion? If their bul- 
 lion value sinks below this point, bullion will not be brought to 
 the mint, as it will be worth more than the coins one can get 
 for it ; just as when the value of the coins rises above this point 
 the supply of bullion would be stimulated so that as a result the 
 value of the coins would tend to maintain this fixed relation 
 
 1 Under Philip the Fair, the seigniorage charge went as high as 50 per cent. 
 Charges of from 2 to 15 per cent were more common. 
 
MONEY 257 
 
 to the value of bullion. As a matter of fact, it is probable that in 
 a completely isolated community a strong and stable govern- 
 ment could, through wise and careful regulations, maintain a 
 constant rate of profit on the coinage, without endangering the 
 stability of the monetary system. 
 
 The fundamental difficulty with seigniorage, however, was 
 found in practice to be that in foreign trade coins passed current 
 only as bullion, so that when seigniorage was charged, the prices 
 of imported goods, expressed in money, were necessarily higher 
 than their prices expressed in bullion, by an amount equal to 
 the seigniorage. It was impossible that one ratio of exchange 
 could long be maintained between coined money and bullion in 
 domestic trade and another ratio of exchange in foreign trade. 
 The interdependence of the prices of all kinds of goods prevented 
 that. Money prices, in general always rose ; that is, the value 
 of the coins sank to the level of the value of the bullion they 
 contained. Under these conditions no one would voluntarily 
 undergo the loss inseparable from taking bullion to the mint 
 for coinage, and with the cessation of coinage the profits from 
 coinage stopped. Every possible expedient, short of the abso- 
 lute prohibition of foreign trade, was tried by sovereigns in their 
 efforts to retain their profits.^ But market forces were found to 
 be stronger than royal regulations, which at best only served to 
 retard somewhat the depression in the value of the official coin- 
 age. About the only effective way of getting profits from the 
 coinage was for the sovereign to admit that the coins in circula- 
 tion possessed only their bullion value, and then to call in the 
 currency for recoinage into smaller pieces, in the manner that 
 has already been mentioned, thus starting afresh with a new 
 
 1 The use of any other circulating medium than the official one was prohibited ; 
 no one was allowed to sell imported gold or silver, whether in buUion or coin, save 
 to the royal mint; if there were mines within the country, they were sometimes 
 prohibited from disposing of their products except to the royal mint ; goldsmiths 
 were forbidden to melt down coin or to purchase more bullion than they needed, and 
 this they were forbidden to buy at less than the mint price ; restrictions were placed 
 on the export of buUion ; these and other similar methods were tried, but all to no 
 avail. Cf. W. Lexis, article "Miinzwesen," in Handwbrterbuch der Staatswissen- 
 schaften. 
 
 S 
 
258 OUTLINES OF ECONOMICS 
 
 seigniorage charge. The result was invariably a repetition of the 
 process of a more or less rapid depreciation in the purchasing 
 power of the coins, leading often to further debasements of the 
 currency. 
 
 Modern nations have abandoned the attempt to secure profits 
 from their monopoly of the coinage. Since 1666 England has 
 made no charge whatever for coining bullion into standard 
 money.^ Most of the countries of continental Europe make a 
 charge just sufficient to cover the expense of coinage. This 
 charge is sometimes called seigniorage, but it is usually, and 
 more properly, called brassage. The United States made no 
 coinage charge until 1853, when a charge of one half of 
 I per cent was made for coining standard money. This was 
 reduced in 1873 and was abandoned entirely in 1875. At pres- 
 ent the United States exchanges gold coins, weight for weight, 
 for bullion of standard fineness (nine tenths gold, one tenth cop- 
 per) brought to the mint in lots of one hundred dollars or more 
 in value. For crude bullion, or bullion not of standard fineness, 
 gold coins are exchanged containing as much fine gold as is 
 contained in the bullion, less a trifling charge for assaying, re- 
 fining, and for the alloy.^ 
 
 Instead of viewing coinage as a profitable prerogative of the 
 government, we have come to view it as a government duty, to be 
 performed at government expense. The question of seigniorage 
 versus gratuitous coinage is no longer a live issue. But the stu- 
 dent who has grasped the significance of the lesson contained in 
 
 1 In practice most of the gold bullion coined in England is supplied to the mint 
 by the Bank of England, wliich is required by law to purchase it at the minimum 
 price of £3 17s. gd. per ounce. An ounce of bulUon makes £3 17^. lo^d. in gold 
 coin, the difference going to compensate the bank for the delay involved in getting 
 the bullion coined at the mint. In the United States the waiting devolves upon 
 the government, for gold coins, or, at the option of the depositor, checks upon 
 United States subtreasuries or upon depository banks are paid to depositors as soon 
 as their bullion can be weighed and assayed. 
 
 2 The coinage mints are at Philadelphia, San Francisco, and Denver. In addi- 
 tion there are bulhon-purchasing mints (not now operated as coinage mints) at 
 New Orleans and Carson City, and assay offices at New York, Boise, Helena, St. 
 Louis, Deadwood, Salt Lake City, and Seattle, which receive bullion on the same 
 terms as the mints, plus an additional charge of one eighth of i per cent. 
 
MONEY 259 
 
 the history of seigniorage has taken an important step toward 
 the understanding of monetary theory. The coinage of standard 
 money is now in law, and always has been in fact, a device for 
 dividing the standard money metal into convenient units of cer- 
 tified weight and fineness. 
 
 Limited Coinage. — Gold is the only metal which is made into 
 coins by the United States government for any one who deposits 
 bullion at the mints or assay offices. All other coins are made 
 from metal purchased from time to time for that purpose as Con- 
 gress may direct. In none of these coins is the bullion worth as 
 much as the coin. In 1878, when the United States began the 
 limited coinage of sUver dollars, the value of the 371! grains of 
 pure silver in a silver dollar was about 89 cents. The value of 
 silver declined steadily until 1902, when 371 j grains of silver were 
 worth only 41 cents. Since that time there has been a slight 
 upward movement, but nevertheless in 191 5 the bullion value of 
 a silver dollar was only about one half its value as a coin. The 
 bullion value of the smaller silver coins is still less, for they con- 
 tain but 347.22 grains of silver to the dollar, while the bullion 
 value of our nickel and bronze coins is yet smaller, relatively. 
 
 Such coins are sometimes called " token coins," the implica- 
 tion being that the fact that they pass from hand to hand at their 
 full nominal value is merely a matter of habit or usage, supported 
 by general acquiescence. More accurately, however, they are 
 credit coins, because the excess of their coin value over their 
 bullion value depends ultimately, as we have seen, upon the good 
 faith and credit of the government, evidenced by their redeem- 
 ability in gold. If, for example, a catastrophe should overthrow 
 the present federal government, and if the new government 
 should refuse to recognize the obligations of the old, nothing 
 could prevent these coins from sinking to their bullion value. 
 
 A very considerable profit accrues to the government from this 
 limited coinage. The difference between the amount paid for 
 silver bullion from 1878 to 1907, and the value of the coins made 
 from it, amounted to $143,000,000. In the accounts of the fed- 
 eral treasury this profit is called seigniorage, but it should be 
 carefiily distinguished from real seigniorage, — a charge ex- 
 
26o OUTLINES OF ECONOMICS 
 
 acted for the conversion of standard bullion into standard coin. 
 If the federal government should issue a general balance sheet of 
 the kind used in corporation accounting, the credit element in 
 its outstanding limited coinage would properly appear as a liabil- 
 ity, which might be greater or less than the profits that had ac- 
 crued on such coinage, depending upon whether the present value 
 of the bullion in the coins happened to be greater or less than the 
 prices which the government had paid for it. 
 
 Bimetallism. — A monetary system like the present one of the 
 United States is a single standard system, because only one com- 
 modity is used as a monetary standard. The double standard sys- 
 tem, under which two different commodities serve concurrently 
 as legal monetary standards, has, however, been used in the past 
 by many governments, including our own, and its superiority 
 over the single standard system has been alleged by many advo- 
 cates. Practically the only commodities that civilized nations 
 have used as monetary standards in modern times are gold and 
 silver. The question of the double standard resolves itself, 
 accordingly, into the question of the bimetallic standard, which 
 means in practice the unlimited coinage of both gold and silver. 
 
 Bimetallism does not mean, in theory, as might be supposed, 
 the establishment of two different monetary units of different 
 names, one defined as a certain amount of silver, the other de- 
 fined as a certain amount of gold, prices being stated accord- 
 ing to convenience in terms of either unit. On the contrary, 
 it contemplates the establishment of one nominal unit, such as 
 the dollar, to be defined at the same time as either a definite 
 amount of gold or a definite amount of silver. More concretely, 
 this means the opening of the mints to the unlimited coinage of 
 both gold and silver into dollars, or dollar multiples, the amount 
 of sUver in a sUver dollar and the amount of gold in a gold dollar 
 being established by law. 
 
 Many of the arguments that have been advanced by bimetal- 
 lists have related to the alleged immediate advantages to be 
 secured from the adoption of the double standard under particu- 
 lar conditions of time and place. One argument, however, of 
 more general significance is based on the probable greater stabil- 
 
MONEY 261 
 
 ity of prices under the double standard. Silver and gold are pro- 
 duced under somewhat different conditions, and are used for 
 somewhat different purposes. It has been maintained that 
 tendencies toward fluctuations in prices stated in silver and in 
 prices stated in gold would, therefore, be as apt to be in opposite 
 directions as in the same direction, and that so far as they were 
 in opposite directions they would tend to counterbalance each 
 other. 
 
 Most opponents of bimetallism, while admitting that, if 
 feasible, it might possess some advantages, deny its possibility. 
 The difficulty is, they maintain, that while the ratio of the weight 
 of gold in the monetary unit to the weight of silver in the mone- 
 tary unit has to be fixed and definite, the ratio at which gold 
 exchanges for silver is not fixed and definite, but is subject to the 
 fluctuations of the market. If one metal is relatively underap- 
 praised and the other relatively overappraised by the legal ratio, 
 the result will be that only the overappraised metal will be 
 brought to the mint for coinage, for the underappraised metal 
 will be worth no more than the overappraised one as coin, but 
 will be worth more as bullion. The actual result will be, in such 
 a case, not a bimetallic standard, but a single standard composed 
 of the metal which, at the mint ratio, is the cheaper. Moreover, 
 if, by a change in the market ratios of exchange of the two metals, 
 this one in turn becomes underappraised by the mint ratio, the 
 standard coins composed of that metal that are already in use 
 will disappear from circulation, being hoarded, melted down, or 
 exported, and the other metal will take its place as the actual 
 standard of value. 
 
 The opponents of bimetallism claim, in short, that it en- 
 counters a formidable obstacle in the principle known as 
 Gresham's law, which is usually summarized with rough accuracy 
 in the statement that " bad money drives out good," or that 
 " the cheaper money drives out the dearer." More definitely, 
 this means that domestic payments will be made, as far as pos- 
 sible, in the money which can be used to less advantage for other 
 purposes, and that no one will exchange relatively expensive 
 buUion for coins at the mint when coins of an equal nominal 
 
262 OUTLINES OF ECONOMICS 
 
 value and (for most purposes) of equal purchasing power can be 
 obtained in exchange for relatively cheaper bullion. Sir Thomas 
 Gresham is said to have come to this conclusion as a result of 
 his observations of the difficulties encountered by Queen Eliza- 
 beth in her attempts to improve the condition of the debased, 
 worn, and mutilated coinage bequeathed to her by her prede- 
 cessors. But the operation of the principle had previously been 
 noted by various writers. 
 
 All but the most extreme bimetallists would admit the impossi- 
 bility of establishing and maintaining a coinage ratio between the 
 two metals that would differ by any wide margin from the initial 
 ratio at which they exchanged in the market, but they maintain 
 that a mint ratio established as nearly as possible to the prevail- 
 ing market ratio will have a steadying influence upon the latter 
 that will tend to prevent any wide divergence between the two. 
 If the market ratio should change to such an extent that it 
 would not pay to use one of the metals as money, more of the other 
 metal would be used for monetary purposes, thus decreasing 
 the supply of it available for other uses and consequently en- 
 hancing its relative value. The net effect of this " compensa- 
 tory action of bimetallism" would be, it is claimed, a tendency 
 toward the equilibrium of the market ratio of exchange of the 
 two metals at the coinage ratio. 
 
 The appeal to history has been used both by bimetallists and 
 their opponents. The claim of the monometallists that legal bi- 
 metallism is apt to mean actual monometallism, with the rela- 
 tively cheaper metal as the standard, has been substantiated 
 many times in the monetary experience of different nations. 
 The automatic change from one single standard to the other, 
 following a change in market rates of exchange, is also a phenom- 
 enon that has been illustrated by a large number of concrete 
 cases. On the other hand, the bimetallists are able to point 
 to some fairly successful bimetallic systems, such as that of 
 France in the first half of the nineteenth century. But it is a 
 significant fact that no real bimetallic system has been able to en- 
 dure for any considerable time except when the annual produc- 
 tion of gold and silver was relatively small and relatively stable, 
 
MONEY 263 
 
 and where international trade was a relatively unimportant item. 
 There is no scientific student of monetary problems who believes 
 that it would be possible for any nation independently to main- 
 tain the double standard under the present conditions of a large 
 and fluctuating annual production of the precious metals, coupled 
 with an international commerce of vast proportions. 
 
 International bimetallism, that is, the adoption by most of the 
 leading nations of a bimetallic standard, at a ratio fixed by inter- 
 national agreement, has had many supporters, even among those 
 who do not believe in the practicability of national bimetallism, 
 and representatives of different nations have assembled in several 
 international monetary conferences for the discussion of this 
 subject. International bimetaUism would remove one difficulty 
 experienced in the attempts made by different nations to main- 
 tain independent bimetallic systems at even slightly differing 
 ratios, — and that is the tendency for each metal to flow from 
 the countries in which it is relatively underappraised in the mint 
 ratio to the countries in which it is relatively overappraised. 
 Other difficulties, however, would still remain, and the possi- 
 bility of maintaining an actual bimetallic standard even under 
 international agreement, supposing that were possible, is open 
 to very serious doubt. 
 
 The waning of public interest in the question of bimetallism in 
 recent years is of great significance, because it indicates that the 
 real moving forces behind the bimetallist propaganda have not 
 been any real or assumed points of superiority of general sig- 
 nificance that may be imputed to a double standard, but rather 
 that certain specific results that would flow from the adoption of 
 bimetallism at a particular time and place have been desired. 
 More specifically, bimetallism has been supported by those who 
 have desired " cheaper money," and these have been particu- 
 larly active when the money in actual use has been increasing 
 in its purchasing power, that is, when prices in general have been 
 decreasing. The recent great increase in the world's production 
 of gold has, temporarily at least, taken bimetallism out of the 
 list of economic problems of general public interest. 
 
 Bimetallism in the United States. — The national monetary 
 
264 OUTLINES OF ECONOMICS 
 
 system was established by act of Congress in 1792.1 The mint 
 was opened to the free and unhmited coinage of both gold and 
 silver, the silver coins containing 37 1| grains of fine metal per 
 dollar, and the gold coins 24! grains per dollar, the ratio of 15 
 to I being thus established. It was soon found, however, that 
 gold was worth in the market slightly more than fifteen times as 
 much silver, and as a consequence but little gold was brought 
 to the mint for coinage, while such gold as was coined illustrated 
 Gresham's law by speedily disappearing from circulation. 
 
 Silver dollars, too, disappeared from circulation, but for another reason. 
 They were somewhat lighter than the Spanish dollars which were in general 
 circulation at the time, and would, under the operations of Gresham's law, 
 have driven the latter out of circulation, had it not been that the Spanish 
 dollar commanded a slight premium over the American dollar in ordinary 
 purchases. But the American dollars, on account of their new and attractive 
 appearance, could be used as advantageously as the Spanish dollars in trade 
 with the Spanish possessions in America. They were consequently taken 
 from the country for that purpose, while Spanish dollars were brought back 
 and were sometimes recoined into a larger number of American doUars. 
 This wasteful coinage of silver dollars was stopped in 1806 by order of 
 President Jefferson, leaving the mint open to the coinage only of gold, smaller 
 silver coins, and minor coins. As a matter of fact American coins made up 
 only an insignificant part of our circulating medium before 1834. 
 
 Realizing the impossibility of maintaining a gold coinage under 
 such conditions. Congress, in 1834, changed the legal ratio to 
 16 to I by reducing the weight of the gold dollar. By this step, 
 however, it went too far in the other direction, for gold was not 
 worth in the market quite sixteen times as much as silver, and 
 while the number of gold coins increased, but little silver was 
 brought to the mint, and silver coins quickly disappeared from 
 circulation. In order to secure a supply of small change. Con- 
 gress was forced, in 1853, to abandon the principle of the un- 
 
 1 The act of 1792 followed in detail the recommendations of a Report on the 
 Establishment of a Mint, by Alexander Hamilton, then Secretary of the Treasury. 
 Hamilton incorporated some of the recommendations contained in earlier reports 
 by Robert Morris and Thomas Jefferson. Hamilton's Report has been frequently 
 reprinted, but it, together with the reports of Morris and Jefferson and other perti- 
 nent documents, may be conveniently found in the Report of the International 
 Monetary Conference of 1878. 
 
MONEY 265 
 
 limited coinage of silver coins smaller than a dollar, and to order 
 that they should be coined, as at present, only from bullion 
 purchased by the government at the market price. At the same 
 time the weight of these subsidiary coins was reduced by one 
 seventh to insure their being retained in circulation. 
 
 The discovery of gold in California, in 1848, and in Australia, 
 in 1 85 1, suddenly increased the world's supply of gold by an 
 unprecedented amount. In fact, the careful estimates of Dr. 
 Soetbeer indicate that as much gold was produced in the third 
 quarter of the nineteenth century as in the preceding three cen- 
 turies and a half following the discovery of America. The result 
 was to increase the discrepancy between the mint ratio and the 
 actual market ratio of exchange of gold and silver, although the 
 production of silver had also been greatly increased. Gold was 
 brought to the mint for coinage in enormous amounts — a con- 
 dition that lasted even after 1861, when paper currency began to 
 be used almost exclusively as the medium of exchange. 
 
 In a general revision of the coinage laws, enacted in 1873, the 
 silver dollar was dropped from the list of coins that could be 
 manufactured at the mint. Although this action was almost un- 
 noticed at the time, a fictitious significance has, in subsequent 
 years, been attached to it. Silver was practically " demone- 
 tized," that is, its free and unlimited coinage was actually pre- 
 vented, by the establishment of the ratio of 16 to i in 1834. The 
 act of 1873 gave legal recognition to an existing fact. 
 
 But a sudden depreciation in the value of silver, which began 
 at about this time, brought the question of bimetallism again 
 into the foreground. Since the seventeenth century the market 
 ratios of gold and silver had fluctuated only between relatively 
 narrow margins, and in no year since the establishment of the 
 United States mint had the average annual price of an ounce of 
 gold been less than 15 or more than i6| times the price of an 
 ounce of silver. In 1875, however, the market ratio fell to 16 
 to I ; by 1878 it was 18 to i ; by 1886 it was 20.8 to i ; and in 
 1894 it was 32.6 to i.^ It is evident that if the opportunity for 
 
 'The causes of this unprecedented decline in the relative value of one of the 
 precious metals were complex and intricate. The following may be mentioned, 
 
266 OUTLINES OF ECONOMICS 
 
 the free and unlimited coinage of silver at the ratio of i6 to i 
 had still existed, there would have been another sudden change 
 in the actual monetary standard. Gold would have been under- 
 appraised by that ratio, and would have disappeared from cir- 
 culation, and silver would have taken its place. It was the 
 realization of this fact, coupled with the knowledge that the 
 silver standard would mean a " cheaper dollar," that led to a pop- 
 ular agitation for the free and unlimited coinage of silver which 
 continued for more than twenty years. 
 
 The first tangible result of this agitation was a compromise 
 measure, the Bland-Allison Act, passed by Congress in 1878, 
 which instituted the limited coinage of silver dollars by authoriz- 
 ing the Secretary of the Treasury to purchase at market prices 
 not less than $2,000,000 nor more than $4,000,000 worth of silver 
 bullion per month, and to coin it into dollars. The results of 
 this enforced coinage were satisfactory to neither party to the 
 controversy. The amount of silver coined was in excess of the 
 demand for that bulky kind of money, even though as much as 
 ' possible was put into circulation in the form of silver certificates, 
 and although the government tried to favor the distribution of 
 silver by paying the expense of transporting it to the localities 
 where it was wanted. The movement in favor of the unlimited 
 coinage of silver continued to gain in strength, however, its ad- 
 vocates claiming that " more silver," rather than less, was 
 needed. 
 
 A second compromise was effected in the Sherman Silver-Pur- 
 chase Act of 1890, which provided for an increase in the amount 
 of silver purchased to 4,500,000 ounces each month, which was 
 to be paid for in treasury notes. These treasury notes were 
 to be full legal tender, and were redeemable in gold or silver coin 
 at the discretion of the Secretary of the Treasury. The silver 
 was to be coined only so rapidly as was found necessary for the 
 redemption of the treasury notes. The increase in the amount 
 
 however, as contributing circumstances : (i) Cessation of an extraordinary de- 
 mand for silver in India which had existed since 1850; (2) Stoppage of the unlim- 
 ited coinage of silver in several European countries; (3) Discovery of large silver 
 mines in the United States; (4) Increase in the value of gold, as evidenced by a 
 general decrease in the prices of commodities. 
 
MONEY 267 
 
 of silver purchased was a concession to the advocates of the un- 
 limited coinage of silver ; the fact that the circulating medium 
 based immediately on these purchases was composed of treasury 
 notes, which were injected into circulation in proportion to the 
 market price of the silver purchased, was a concession to their 
 opponents. 
 
 The soundness of the principles embodied in the Sherman Act 
 was soon tested by a period of financial and industrial depression. 
 Gold had to be exported to Europe in large quantities to settle an 
 adverse balance of trade, and the government found difficulty in 
 maintaining its own gold reserve, which was already seriously 
 threatened by a decline in customs receipts, accompanied by an 
 increase in federal expenditures. The gold reserve was at that 
 time simply the amount of gold in the treasury that was available 
 for the redemption of other forms of money, — especially the 
 United States notes, or greenbacks, that had been first issued 
 during the Civil War, but which did not become actually redeem- 
 able in gold until 1879. During this scarcity of gold the banks 
 were able to secure gold for their own reserves or for export by 
 presenting United States notes at the treasury for redemption 
 in gold. Under the law the notes had to be immediately reis- 
 sued, and were used in government payments, but no sooner 
 was this done than they were again returned by the banks for 
 redemption in gold. 
 
 The workings of this " endless chain " by which gold was 
 pumped from the government treasury were aggravated by the 
 fact that the treasury notes authorized by the Sherman Act were 
 used for the same purpose. Although they were payable either 
 in gold or silver coin, they were actually redeemed on demand 
 in gold. This was at the urgent insistence of President Cleve- 
 land, who believed, with good reason, that a refusal to redeem 
 them in gold would probably have forced the silver standard 
 upon us, by destroying the exchangeability of silver and gold 
 and thus putting an end to their parity, and that it would cer- 
 tainly have injured the credit of the government and put it to 
 a disadvantage in the bond sales that were needed to replenish 
 the gold reserve. Under the operations of the Sherman Act 
 
268 OUTLINES OF ECONOMICS 
 
 the government was virtually exchanging gold coin for silver 
 bullion at a time when gold was sorely needed when the gold 
 value of the purchased silver was steadily depreciating. 
 
 The gold reserve sank from $190,000,000 in 1890 to $95,000,000 
 in 1893. In June of the latter year the closing of the mints of 
 India to the unlimited coinage of silver gave an added impetus 
 to the downward movement of the price of that metal. These 
 facts led Congress, in a special session called in 1893 for that 
 purpose, to order, though with obvious reluctance, that the pur- 
 chase of silver under the Sherman Act should be stopped. 
 
 The agitation for the free and unlimited coinage of silver continued, 
 however, and with increased vigor, and it was made the sole issue in the 
 presidential campaign of 1896. It was alleged that the yet continuing indus- 
 trial depression could be alleviated only by "more money" and "cheaper 
 money." It was claimed by many intelligent people that the unlimited 
 coinage of silver would not drive gold from circulation, but would increase 
 the value of silver and decrease the value of gold until they met at a parity 
 established by the desired legal ratio of 16 to i. The most effective argu- 
 ment of the protagonists of silver was found, however, in the admitted fact 
 that the value of gold, as shown by changes in the general price level, had 
 been increasing. All indications pointed toward a continued decrease in 
 the annual production of gold, and a consequent further decrease in prices. 
 This, it was argued, was a hardship to those who had borrowed money on 
 long time obligations, such as mortgages, because they would be forced to 
 repay in value or purchasing power more than they had borrowed.^ 
 
 This agitation was, in fact, simply one of a series of cheap money move- 
 ments that have characterized the economic development of the United 
 States, and which have sprung from the fact that the opening up and develop- 
 ing of new lands have called for expenditures in amounts far beyond the 
 resources of the actual settlers. Newly settled regions have usually been 
 debtor regions, and there is more than mere coincidence in the fact that de- 
 mands for cheap money have always been voiced most loudly on the frontier.^ 
 This does not mean that a cheap money movement is essentially dishonest ; 
 that it represents the conscious attempts of debtors to escape the payment 
 of their lawful debts. The life and vigor in this movement for the unHmited 
 coinage of silver was put into it by men who saw the imputed value of their 
 assets sinking and the difficulty of paying their debts increasing in a financial 
 crisis for which they were not individually responsible. Money funds were 
 
 1 This argument raises the problem of the standard of deferred payments, which 
 is to be considered in Chapter XVI. 
 
 * Cf . C. J. Bullock, Essays in the Monetary History of the United States, Part i. 
 
MONEY 269 
 
 hard to get because personal credit, the foundation of bank credit, was 
 lacking. This scarcity of money funds was confused, naturally, if erro- 
 neously, with the scarcity of "money" in the sense of standard money, — 
 gold; and the remedy was sought in an action that would give more and 
 cheaper standard money. 
 
 The defeat of the advocates of bimetallism in 1896 would probably not 
 have stopped the agitation for the unlimited coinage of silver, had it not been 
 for the return of prosperous conditions, coupled with an enormous increase 
 in the world's annual production of gold, which has brought with it a general 
 increase in prices. 
 
 The single gold standard was formally and definitely recog- 
 nized by law in 1900. All of the silver bullion purchased under 
 the Sherman Act has been coined, and silver dollars sufficient in 
 amount to retire the treasury notes have been set aside for that 
 purpose. These treasury notes (which should not be confused 
 with the United States notes, or greenbacks) are accordingly on 
 substantially the same basis as silver certificates. Up to June 
 30, 1915, their amount had been reduced from $156,000,000 to 
 $2,250,000. No silver dollars have been coined since 1904, and 
 under the present law no more can be coined unless Congress 
 should authorize the special purchase of bullion for that purpose. 
 
 The Gold-Exchange Standard. — Within the past twenty 
 years gold has been accepted more generally and more definitely 
 than ever before as the standard money metal of the world. The 
 change from a silver standard to the gold standard is often a 
 difficult and expensive national undertaking, but it brings the 
 advantages of a more stable unit of value and of increased 
 facility in making international payments. In 191 5 the silver 
 standard prevailed only in China, Persia, Paraguay, and three 
 Central American countries.^ 
 
 In a number of places in which it is impossible, for one reason 
 or another, to introduce gold as part of the actual medium of 
 exchange, the silver standard has been replaced by the gold- 
 exchange standard. Where this standard exists the currency 
 of the country consists largely of silver coins, put into circula- 
 tion by a system of limited coinage. These coins are maintained 
 at a fairly definite gold value, higher than that of their bullion 
 
 1 Report of the Director of the Mint, in Finance Report, 1915, p. 456. 
 
270 OUTLINES OF ECONOMICS 
 
 content. This is not accomplished, however, by making them 
 always and necessarily redeemable in fixed quantities of gold. 
 Instead the government agrees to sell exchange on one or more 
 gold-using countries at a maximum fixed price in terms of the 
 local coins. ^ That is, while the local currency is not necessarily 
 redeemable in gold within the home country, it is redeemable 
 in bills of exchange or drafts payable in gold in some foreign 
 country. It is necessary, of course, for the home government 
 to maintain funds for this purpose in a gold-using country. The 
 gold-exchange standard has been adopted in India, the Philip- 
 pines, Mexico, Panama, Siam, Indo-China, the Straits Settle- 
 ments, and (in a modified form) in Java. 
 
 Where carefully administered it has worked well, and has 
 brought to the countries using it practically all of the advantages 
 of the gold standard without the expense of introducing and 
 maintaining a gold currency and sometimes without making 
 it necessary for the people to familiarize themselves with a new 
 kind of money. It has even been suggested by certain writers 
 that the great nations of the world might wisely adopt the gold- 
 exchange standard, making their local currencies redeemable 
 at fixed rates in drafts upon some one country in which the bulk 
 of the gold reserves of the world would be kept. A change like 
 this is impracticable so long as wars, with their interruptions of 
 international comnierce and international gold payments, re- 
 main possible. Nor would it be particularly advantageous. 
 The general adoption of the gold-exchange standard would, it 
 is true, greatly decrease the amount of gold needed to carry on 
 the world's business transactions at present prices. But the ul- 
 timate result, there is good reason to believe, would merely be a 
 
 1 Since iSgs the mints of India have been closed to the free coinage of silver. 
 Silver rupees, coined from bullion purchased by the government, are now main- 
 tained at a gold value of approximately one shilling and four pence per rupee by 
 the government's practice of selhng, when necessary, bills of exchange payable in 
 London at a price not higher than is. 3|| d. per rupee. The peso of the Philippines, 
 containing only about three fourths as much silver as the silver dollar of the United 
 States, is maintained at a gold value of approximately fifty cents by the insular 
 government's accepting it at that price (minus a small charge) in exchange for drafts 
 payable in New York. 
 
MONEY 271 
 
 general increase in prices, so that the aggregate volume of pay- 
 ments (measured in money units) would increase and more 
 gold would be needed in the world's gold reserves. The world 
 as a whole does not profit by " economizing in the use of gold," 
 even though particular countries may be able to save by avoid- 
 ing the expense of introducing a gold currency. 
 
 Government Paper Money. — In metallic money of limited 
 coinage, there is, as we have seen, a considerable element of 
 credit. In paper money the element of credit is alone present. 
 Government paper money is composed of instruments which bind 
 the government to pay, and usually to pay on demand, equiv- 
 alent amounts of metallic money, — usually standard money. 
 
 Government paper money also differs from metallic money of 
 limited coinage in respect to the motives which give rise to and 
 regulate its issue. Subsidiary coins are issued by the govern- 
 ment in response to the demand for circulating medium for use 
 in smaU transactions and in making change. The public con- 
 venience is the first consideration ; the profit accruing to the 
 government on such coinage is a secondary thing. In issuing 
 government paper money, however, fiscal motives have predomi- 
 nated. When hard pressed to swell the government income to 
 cover an increase in expenditures, those responsible for the finan- 
 cial policies of a government have often deemed it advisable for 
 the government to make use of its own notes, promises to pay, 
 in discharging its obligations. 
 
 These differ from government bonds, which are often issued in 
 similar circumstances, in that the bonds bear interest, are sold to 
 voluntary buyers, and are usually payable at a definite time in 
 the future, while government notes are usually non-interest 
 bearing, represent a forced rather than a voluntary loan, and are 
 usually, in form at least, payable on demand, or in practice, at an 
 indefinite time in the future. They are, moreover, issued in 
 convenient form for monetary use, and are usually made legal 
 tender, so that they pass from hand to hand as a medium of ex- 
 change. The forced loan which they represent is therefore 
 shifted from those who first receive the notes from the govern- 
 ment for their goods or their services. 
 
272 OUTLINES OF ECONOMICS 
 
 Colonial and Revolutionary Bills of Credit. — Paper money 
 issues have frequently been used in the United States as a means 
 of meeting fiscal emergencies, especially those springing from the 
 extraordinary expenditures occasioned by wars. The expense of 
 sending troops to the Indian wars was one of the things that led 
 most of the American colonies to issue paper money. The his- 
 tory of these colonial " bills of credit," as they were called, illus- 
 trates two dangers that seem to be inseparable from the use of this 
 financial and monetary device. In the first place, it was very 
 easy to succumb to the temptation of paying ordinary as well as 
 extraordinary expenditures in this easy way. Some of the colo- 
 nies got entirely out of the habit of taxing themselves to meet 
 current public expenses. The refusal to levy taxes was a prolific 
 cause of disputes between colonial assemblies and royal gov- 
 ernors. 
 
 In the second place, because no money was raised for the pur- 
 pose, these bills of credit were not redeemed promptly. Their 
 purchasing power fell because people lost confidence in their 
 redeemability. As prices rose it took continually larger issues 
 to meet the government expenditures, and each increase in the 
 amount in circulation led to a further fall in purchasing power. 
 After the currency had become practically worthless, it was a 
 common practice to repudiate it in whole or in part, and to start 
 afresh with bills of a " new tenor." Any attempt to restrict 
 this reckless use of public credit was met with determined resist- 
 ance from the " cheap money " advocates of that day. There 
 were frequent complaints of the scarcity of money, especially 
 from the more newly settled districts. The greater the quantity 
 of money issued, the more insistent was the demand for still 
 further issues. In short, this colonial experience in itself gives 
 sufficient basis for the inference that from the monetary as well 
 as the fiscal point of view, the use of paper money easily de- 
 generates into a bad habit. 
 
 Again, in the Revolutionary War, paper-money issues were 
 made, — this time by the Continental Congress as well as by the 
 individual colonies. The Continental Congress was really 
 driven to this action by its lack of the power of levying taxes. 
 
MONEY 273 
 
 Its bills became practically worthless, although every effort was 
 made to maintain their parity with metallic money by appeals 
 to patriotic sentiment. After the formation of the national 
 government a few of them were redeemed at one cent on the 
 dollar. 
 
 It was our unfortunate colonial and revolutionary experience 
 with paper money which led to the insertion of the wise provision 
 in the federal Constitution which forbids the individual states to 
 issue bills of credit or to make anything but gold and silver legal 
 tender in payment of debts. 
 
 The Greenbacks. — The federal government made no impor- 
 tant issues of paper money until the Civil War.^ It was not 
 generally foreseen that that conflict would be so long continued 
 and intense as it was, and Congress consequently neglected to 
 make adequate provision for taxes that would help to meet the 
 increased expenditures and to sustain the government credit in 
 the borrowing operations that were necessary. In 1861 the 
 Secretary of the Treasury was authorized to issue at his discre- 
 tion $50,000,000 in " demand notes," which, although they were 
 not legal tender, could be used in all payments to the government. 
 These were redeemed promptly on demand until the end of the 
 year, when the withdrawal of gold from the banks by depositors 
 for hoarding, and by the government for its own uses, led first 
 the banks and then the government to suspend specie payments, 
 — that is, to refuse to pay their current obligations in gold. 
 
 In February, 1862, moved by the absolute necessity of provid- 
 ing some kind of money for the federal treasury. Congress 
 authorized the issue of $150,000,000 in legal tender notes,^ or 
 greenbacks, as they came to be called. It was hoped, moreover, 
 that this increase in the circulating medium would improve the 
 market for government bonds for which the greenbacks were at 
 first made convertible at par. This action was not taken without 
 
 * The federal government issued treasury notes in the war of 1812 and the Mexi- 
 can War, and during the panics of 1837 and 1857. Most of these issues were interest 
 bearing, however ; in no case were they legal tender, nor did they get into common 
 use as media of exchange. 
 
 ' Including the "demand notes," which were now made legal tender. 
 T 
 
274 OUTLINES OF ECONOMICS 
 
 Strenuous opposition on the part of those who foresaw some of 
 the disastrous consequences of large paper money issues. But 
 as in earher American experience with paper money, succeeding 
 issues met with less and less resistance. All together, green- 
 backs to the amount of $450,000,000 were issued during the war. 
 
 It was the general expectation when the greenbacks were is- 
 sued that they would be retired as soon as possible after the con- 
 clusion of the war. But when such action became possible, it 
 was opposed by many who thought that the reduction of the cir- 
 culating medium would decrease prices, impose additional bur- 
 dens upon debtors, injure business interests, reduce the public 
 revenues, and hamper the government in the refunding of its 
 public debt. In 1866, however. Congress authorized the gradual 
 retirement of the greenbacks, but repealed the act in 1868. The 
 amount in circulation in 1874 was $382,000,000, and in that year 
 a bill requiring the definite increase of the issue to $400,000,000 
 was prevented from becoming law and thus establishing a 
 dangerous precedent only by the veto of President Grant. 
 Some greenbacks were retired under the provisions of an act of 
 1875, but in May, 1878, there were $346,681,000 outstanding, 
 and as a law then enacted provides for their constant reissue 
 after being received or redeemed at the treasury, the amount 
 still stands at that figure.^ The part that they played in the 
 financial difficulties of 1890- 1893, together with the history of the 
 treasury notes of 1890, has been described in connection with 
 the discussion of bimetallism. 
 
 At present the greenbacks constitute a useful and acceptable 
 part of the stock of money. But if another financial crisis should 
 deplete the government treasury, they would very likely prove 
 again to be a source of difficulty. Their retirement is feasible 
 under present conditions, but would be most difficult to accom- 
 plish under the very financial conditions under which they would 
 be most dangerous. The currency act of 1900 provides for a 
 gold reserve of $150,000,000, to be held against them to insure 
 their redeemability. If the reserve falls below $100,000,000, 
 the Secretary of the Treasury is directed to replenish it from the 
 ^ Since igoo they have been reissued only in exchange for gold. 
 
MONEY 27s 
 
 proceeds of bond sales. Although this gold reserve also con- 
 stitutes part of the real security behind our silver dollars, it could 
 safely be diminished in amount if the greenbacks were retired. 
 Moreover, if a great national emergency should ever again 
 make the issue of government paper money necessary, it would 
 be highly advantageous to have the greenbacks out of the way. 
 
 Economic Effects of the Greenbacks. — The greenbacks are in 
 form promises to pay, but they are not promises to pay on de- 
 mand, nor at any specific time. During the period of the sus- 
 pension of specie payments they were not actually redeemable 
 in gold, nor was gold in general circulation as a medium of ex- 
 change except on the Pacific coast. Gold was, however, in addi- 
 tion to its industrial uses, employed as money in international 
 trade, in the payment of interest on government bonds, and for 
 customs duties (for which the greenbacks were not legally re- 
 ceivable). There was thus a constant demand for gold money, 
 which was met by its sale as a commodity in the New York mar- 
 ket. The gold market was highly speculative, the daily and 
 even the hourly fluctuations in the price of gold in greenbacks 
 being considerable. Notwithstanding these speculative features 
 the prices paid for gold indicated very accurately, in the long run, 
 how much, in the expert judgment of market specialists, the 
 greenbacks should be discounted as compared with gold. 
 
 Everything that was thought to affect the probability of the 
 ultimate redemption of the greenbacks in gold influenced their 
 price. Among these factors were the quantity of greenbacks 
 issued, the condition of the federal treasury, the military suc- 
 cesses and reverses of the Union cause, and, in later years, the 
 prospects for the resumption of specie payments. Greenbacks 
 reached a parity with gold two weeks before the resumption of 
 specie payments on January i, 1879. A fact of special signifi- 
 cance is that until July, 1863, the greenbacks were convertible 
 at par into 6 per cent gold bonds. These bonds formed an ac- 
 tual standard of value for the greenbacks, and although them- 
 selves depreciated, exercised for the time being a steadying 
 influence upon their price. 
 
 As the common medium of exchange consisted almost entirely 
 
276 OUTLINES OF ECONOMICS 
 
 of greenbacks ^ and of bank notes convertible only into green- 
 backs, prices were stated in greenback " dollars " and naturally- 
 rose as the gold value of the greenback depreciated. Reference 
 to the table on the next page will show a rough correspondence 
 between changes in the general level of prices, expressed in green- 
 backs, and changes in the price of gold, also expressed in green- 
 backs. But the wholesale prices of commodities rose relatively 
 higher than did the price of gold, and declined less rapidly .^ 
 Retail prices, in turn, declined less rapidly than did wholesale 
 prices. Wages advanced more slowly than prices ; maximum 
 wages were not paid until 1872, — seven years after retail prices 
 and eight years after wholesale prices had reached their maxi- 
 mum. 
 
 That there was not a closer correspondence between the movement in gen- 
 eral prices and the changes in the gold value of the greenback was due to two 
 sets of influences : (i) Even if greenbacks had not been issued, and if prices 
 had been expressed in gold, there would have been marked fluctuations in 
 prices, — not only such as continually occur in normal years, but also those 
 due to such exceptional things as the withdrawal of a large number of men 
 from industry and agriculture to military service, the shifting of productive 
 effort in response to the enormous demand for military supplies, the period 
 of extraordinary business activity, of railway building, and of agricultural 
 and industrial expansion that followed the war, the reaction and financial 
 crisis in 1873, and the return of prosperous conditions in the last years of the 
 greenback period.* (2) The depreciation in the gold value of the greenback 
 was recorded quickly and accurately in the gold market, but the movement 
 of prices was hampered by habit, custom, existing contracts, local influences, 
 etc. Retail prices are less sensitive to changing market conditions than are 
 wholesale prices. Wages, in turn, are usually less mobile than retail prices. 
 
 1 Subsidiary coins did not go out of circulation until 1862, when the value of 
 the greenback dropped below the value of the bullion in these coins. Postage stamps 
 and notes and tokens issued by cities and by business firms were for a while used 
 as small change. In 1862 the situation was helped by the issue of fractional paper 
 currency in denominations as low as three cents. 
 
 2 The more detailed figures, of which the table given here is only a summary, 
 show that the prices of commodities also advanced more slowly than did the price 
 of gold. For an illuminating discussion of these price changes see Mitchell, Gold, 
 Prices, and Wages under the Greenback Standard, Chap. v. 
 
 ' This statement is subject to the limitation implied in the fact that general 
 commercial conditions were themselves caused in part by the influence of the cheap 
 and fluctuating medium of exchange. 
 
MONEY 277 
 
 TABLE I 
 
 Prices and Wages in the Greenback Period^ 
 
 Year 
 
 Average 
 
 Annual Price 
 
 OF Gold in 
 
 Greenbacks 
 
 Wholesale 
 Prices 2 
 
 Average Annual Prices' 
 
 Average 
 Wages < 
 
 
 Wholesale 
 
 Retail 
 
 i860 
 
 — 
 
 100 
 
 100 
 
 100 
 
 100 
 
 1861 
 
 — 
 
 95 
 
 94 
 
 107 
 
 99 
 
 1862 
 
 II3-3 
 
 120 
 
 109 
 
 131 
 
 104 
 
 1863 
 
 145-2 
 
 155 
 
 148 
 
 168 
 
 119 
 
 1864 
 
 203.3 
 
 236 
 
 225 
 
 215 
 
 142 
 
 1865 
 
 157-3 
 
 183 
 
 224 
 
 219 
 
 155 
 
 1866 
 
 140.9 
 
 191 
 
 203 
 
 208 
 
 164 
 
 1867 
 
 138.2 
 
 170 
 
 177 
 
 193 
 
 167 
 
 1868 
 
 139-7 
 
 165 
 
 180 
 
 190 
 
 170 
 
 1869 
 
 133-0 
 
 158 
 
 172 
 
 177 
 
 179 
 
 1870 
 
 114.9 
 
 14s 
 
 156 
 
 166 
 
 179 
 
 1871 
 
 III. 7 
 
 137 
 
 144 
 
 155 
 
 184 
 
 1872 
 
 112. 4 
 
 139 
 
 138 
 
 151 
 
 185 
 
 1873 
 
 113.8 
 
 140 
 
 143 
 
 148 
 
 183 
 
 1874 
 
 III. 2 
 
 138 
 
 144 
 
 145 
 
 175 
 
 187s 
 
 1 14.9 
 
 129 
 
 134 
 
 140 
 
 163 
 
 1876 
 
 III. 5 
 
 118 
 
 120 
 
 135 
 
 153 
 
 1877 
 
 104.8 
 
 114 
 
 117 
 
 134 
 
 143 
 
 1878 
 
 100.8 
 
 99 
 
 99 
 
 127 
 
 142 
 
 1879 
 
 lOO.O 
 
 98 
 
 93 
 
 123 
 
 139 
 
 All these things interacted. Wages, to give only one example, constitute an 
 important part of the expenses of producing commodities, and the sluggish 
 movement of wages kept the expenses of production from advancing, and 
 later from falling, as rapidly as wrould otherwise have been the case, and 
 must have had a corresponding effect on the prices charged for commodities. 
 
 Aside from these general changes, the minor fluctuations, the 
 short-time variations in prices, were unusually wide and numer- 
 
 1 Compiled from Gold, Prices, and Wages under the Greenback Standard, by Wesley 
 C. Mitchell. The figures in the price columns are obtained by counting the price 
 of each commodity in each year as a percentage of its price in 1 860, and then averag- 
 ing the various relative prices thus obtained for each year. The figures in the wage 
 column are computed in a similar way. In the "price of gold" column parity be- 
 tween greenbacks and gold is represented by 100. 
 
 ^ 92 commodities. ^ 21 commodities. * For 78 establishments. 
 
278 OUTLINES OF ECONOMICS 
 
 ous, — a fact which may be attributed to the uncertain future 
 of the medium of exchange. Such fluctuations were apt to up- 
 set all business calculations ; chance became more important and 
 foresight less important as a factor in profits. Under such condi- 
 tions an intense and reckless spirit of speculation was bred, with 
 unfortunate effects on business morality as well as on economic 
 conditions. 
 
 As a fiscal expedient, the greenbacks led to results as disastrous 
 as those which attended their use as money. The government 
 was forced to sell bonds for depreciated greenbacks, but in order 
 to maintain its credit it had to pay the interest and ultimately 
 the principal of these bonds in gold. Supplies for the army were 
 paid for in depreciated greenbacks, but these greenbacks had to 
 be ultimately redeemed in gold. It has been estimated that 
 the use of the greenbacks increased the expense of the Civil War 
 by nearly $600,000,000.^ 
 
 Fiat Money. — After"i873 the advocates of cheap money were 
 not content with merely opposing any reduction in the quantity 
 of the greenbacks. They went so far as to urge that the amount 
 of paper should be greatly increased, and that the use of metallic 
 money should be definitely and permanently abandoned. Bank 
 notes were also attacked because they were issued by " privileged 
 corporations." The question came to be an important political 
 issue, and in 1876 it brought about the organization of the Green- 
 back party, which figured in three presidential campaigns, 
 and which polled more than a million votes in the congressional 
 elections of 1878. In more recent years similar demands were 
 voiced by the Populist party. 
 
 The theory of money which formed the basis of the contention 
 of the members of the Greenback party is sometimes called the 
 " fiat money " theory. Those who held this theory of money 
 saw no significance in the fact that the greenbacks were in form 
 promises to pay and that they were generally regarded as only 
 
 1 This estimate applies only to the increased expense to the government, and conse- 
 quently to its taxpayers. The real economic costs of the war were not greatly 
 affected by the use of the greenbacks. Bondholders gained, for example, a large 
 part of what taxpayers lost. 
 
MONEY 279 
 
 temporarily irredeemable. In their view they were simply 
 '' dollars," made such by the expressed will of the government. 
 Nor did they see any significance in the fact that during the 
 seventeen years of the suspension of specie payments over 
 $500,000,000 in United States gold coins issued from the mints. 
 As a matter of fact the fiat money advocates were misled by what 
 some logicians have called the " jingle fallacy." That the 
 " dollar " of the ordinary medium of exchange and the " dollar " 
 as a standard monetary unit were difEerent things did not occur 
 to them. 
 
 If they had succeeded in eliminating the credit element in the 
 paper currency by ceasing to print " promises to pay "(as they 
 actually proposed to do) , and had instituted a new name for the 
 money unit, — possibly (to reverse the spelling )" rallod," — 
 they would perhaps have encountered difficulty in getting people 
 to use pieces of printed paper, informing them that " This is a 
 rallod,'" as money. It is hard to see how " the supply of money 
 as compared with the demand for it," on which the fiat money 
 advocates counted to fix the purchasing power of their money 
 units, would have helped matters very much. Nor would the 
 redeemabUity of fiat money in interest-bearing bonds, which was 
 suggested by some, have given us a monetary standard. For the 
 bonds would have been merely promises to pay certain sums of 
 fiat money, with interest at a certain rate, also in fiat money. 
 The difficulties that would have been encountered in international 
 trade would alone have sufl&ced to make fiat money impossible. 
 
 This should not be taken to mean, however, that irredeemable 
 paper money, issued in familiar denominations, may not under 
 favorable circumstances circulate for some time among people 
 accustomed to its use, even if there is no prospect of its ever 
 being redeemed. The most important of the necessary " favor-, 
 able circumstances " is the absence of complications in foreign 
 trade, such as have already been discussed in connection with 
 the subject of seigniorage. But, at best, there would be a host 
 of practical difl&culties in the way of getting the right amount 
 of money, and only the right amount, into circulation. 
 
280 OUTLINES OF ECONOMICS 
 
 QUESTIONS 
 
 1. Would wheat make a satisfactory money commodity? iron? plati- 
 num? diamonds? 
 
 2. Would it be possible to maintain a seigniorage of lo per cent on United 
 States gold coinage? What would be the effect on the prices of imported 
 commodities? of domestic commodities? 
 
 3. Report on the following questions not answered in this chapter : 
 (i) What is the "limit of tolerance" ? (2) On whom does the loss from the 
 wear of gold coin fall? (3) To what extent are different kinds of United 
 States money legal tender ? 
 
 4. If the United States had adopted the free and unlimited coinage of 
 silver in 1896, how would prices have been affected? 
 
 5. Is the actual monetary standard pure gold or gold of standard fineness ? 
 
 6. What elements of truth are there in the statement that "coins get 
 their value from the government stamp"? 
 
 7. In the table printed on page 254, why are not gold certificates, silver 
 certificates, and treasury notes of 1890 included in the statement of the 
 aggregate amount of money in the United States? 
 
 8. Interpret the statement : "The value of the greenbacks depreciated." 
 Explain in particular the meaning of the words value and depreciated as thus 
 used. 
 
 9. Do you make a loan to the government when you receive greenbacks 
 in payment for goods or services? 
 
 REFERENCES 
 
 Bullock, C. J. Essays in the Monetary History of the United States. 
 Commission on International Exchange (1904). Report on the Introduction 
 
 of the Gold Exchange Standard. 
 Dewey, D. R. Financial History of the United States. (See index.) 
 Director of the Mint. Annual Report. 
 
 DoDD, A. F. History of Money in Great Britain and America. 
 Hepburn, A. B. History of American Currency. 
 Huntington, A. T., and Mawhinney, R. J. (Compilers). Laws of the 
 
 United States Concerning Money, Banking, and Loans, 1778-IQOQ. 
 Jevons, W. S. Money and the Mechanism of Exchange. 
 Johnson, J. F. Money and Currency. 
 Kinley, David. Money. 
 Knox, J. J. United States Notes. 
 Laughlin, J. L. History of Bimetallism in the United States; The Principles 
 
 of Money. 
 Mitchell, W. C. History of the Greenbacks; Gold, Prices, and Wages 
 
 under the Greenback Standard. 
 Scott, W. A. Money and Banking, Chaps, i-vi, xiv, xv. 
 
MONEY 281 
 
 Taussig, F. W. Principles of Economics, Vol. i, Chaps, xvii-xxiii. 
 
 Treasurer of the United States. Annual Report. (This, together with ab- 
 breviated forms of the reports of the Director of the Mint and the 
 Comptroller of the Currency, is printed as an appendix to the Report 
 of the Secretary of the Treasury in the bound edition of the annual 
 Finance Report.) 
 
 Walker, F. A. Money; Money in its Relation to Trade and Industry. 
 
 Watson, D. K. History of American Coinage. 
 
 White, Horace. Money and Banking. 
 
CHAPTER XV 
 CREDIT AND BANKING 
 
 Credit Transactions. — Thus far, in our discussion of money, 
 we have failed to take account of the fact that the greater part 
 of exchanges are credit transactions, which do not directly or 
 immediately involve the use of money (in the sense of generally 
 acceptable money instruments). A credit transaction is a 
 transfer of goods, services, or money for a future equivalent. 
 In a " cash " transaction there are only two elements, — the 
 goods sold and the money paid for them. But in a credit trans- 
 action a third element — time — is added. The introduction 
 of this third element leads to exceedingly important results. 
 In the first place it makes possible an enormous number of ex- 
 changes in which the buyer is either unable or disinclined to ren- 
 der a present equivalent. In the second place it obviates, to a 
 very large extent, the necessity of using money. 
 
 Suppose, for example, that A and B are the only inhabitants of 
 an isolated community. Three ways of making exchanges are 
 open to them. They can use a system of direct exchange or 
 barter, which will prevent A from getting goods from B unless he 
 has some equivalent which he is willing to give up and which B 
 is willing to accept. Or, they may use one commodity as money, 
 in which case the purchasing power of either A or B at any given 
 time will be governed by the amount of that particular commod- 
 ity he possesses, rather than by the total amount of all his posses- 
 sions. But by combining a system of credit with their use of 
 money, they will be able to make transfers freely, for in an occa- 
 sional balancing of accounts most of the payments due each other 
 will cancel, leaving only a relatively small amount to be paid in 
 money. 
 
 282 
 
CREDIT AND BANKING 283 
 
 Something very much like this third process is continually 
 going on in contemporary economic life. The process is more 
 complex, however, because A actually sells things to one person 
 or group of persons, and buys them from other persons. And it 
 is very likely that these two groups, the sellers and the buyers 
 in A's transactions, have no direct business transactions with 
 each other in which their respective claims against A and debts 
 to A can be canceled. If, however, we take all buyers and all 
 sellers into account, and if we could push our analysis of the com- 
 plex network of credit relations far enough, we would find points 
 of contact between A's credits and his debts. That is, if A gives 
 a promissory note in exchange for a purchased good, this promis- 
 sory note might be passed on from hand to hand until it got into 
 the possession of someone who is indebted to A, — if the path it 
 should take were known. The difiiculty is that the path is not 
 known. The institution of hanking, however, provides clearing 
 centers, where credits and debts are balanced against each other 
 and canceled. 
 
 A, for example, has a " deposit " in a local bank, which means 
 that he has the right to demand money from it at any time up to 
 the amount of his deposit. He usually makes a payment to B, 
 not by money or by a promissory note, but by a check, — an 
 instrument ordering the bank to pay B the specified amount. 
 This check will be presented for payment by B at a bank where he 
 has a deposit, but the "payment " will usually be made by add- 
 ing the amount of the check to B's deposit. If it is the bank 
 where A also has his deposit, the transaction is settled by the 
 simple process of debiting A's deposit and crediting B's. If 
 it is another bank in the same town, and if the town is a small one, 
 the check will enter into the daily exchange by the two banks 
 of such claims against each other, the daily balance in favor of 
 either bank being usually settled in money. 
 
 In the larger cities a further economy in the use of money is 
 achieved by means of the clearing house, to which a representa- 
 tive of each bank brings daily all of the checks drawn against 
 other local banks which it has received since the last " clearing." 
 At the clearing house the checks are turned over to the repre- 
 
284 OUTLINES OF ECONOMICS 
 
 sentatives of the banks against which they are drawn, but bal- 
 ances are not settled between the individual banks. Instead, 
 a balance is struck between the total sum of each bank's claims 
 against other banks and the total claims of other banks against 
 it. Each bank then pays to the clearing house, usually in money, 
 or receives from it, as the case may be, the amount of balance 
 due to it or from it. This system achieves a great economy of 
 both time and money.* 
 
 If the banks in which A and B keep their deposits are in differ- 
 ent towns, A's check will probably be sent by B's bank to a bank 
 in a neighboring large city, in which B's bank has its own deposit 
 account. If A's bank is also in the territory tributary to this 
 same city, the check may be sent by the city bank directly to 
 A's bank for collection, or to its own correspondent bank in the 
 same town. If A's bank is in another part of the country, the 
 check will be sent to a bank located in a large city in that region, 
 which will attend to its collection.^ Thus a check drawn on a 
 local bank in California, deposited in a local bank in Illinois, will 
 very likely be collected via Chicago and San Francisco. The 
 balances of credits and debits which are thus created between 
 city and country banks are settled to a very large extent by 
 means of crediting and debiting deposit accounts in city banks, 
 thus obviating by that much the necessity for frequent shipments 
 
 ^ Over $90,840,000,000 in checks and drafts passed through the New York Clearing 
 House in the year ending September 30, 1915. The money balances paid amounted 
 to $5,340,000,000, or less than 6 per cent of the total clearings. The average cash 
 payments required during the last sixty -two years have amounted to less than 5 per 
 cent of the clearings. In times of financial stringency clearing houses sometimes 
 permit payment of balances in "clearing house loan certificates," issued to individual 
 banks upon the basis of approved securities deposited with the clearing house. In 
 some cases the banks have temporarily put such certificates into general circulation 
 as emergency currency. 
 
 2 The London Clearing House clears for all England in a very simple and eflBcient 
 way. A country bank sends its daily receipts of checks on banks in other towns 
 to the London bank in which it keeps a deposit. In a daily "country clearing" 
 these checks are distributed to the London banks where the banks on which the 
 checks are drawn keep accounts. The mere territorial extent of the United States 
 makes such a scheme unworkable here. The federal reserve banks, however, 
 hope to develop a system of regional and inter-regional clearings for their member 
 banks. 
 
CREDIT AND BANKING 285 
 
 of money. In general, we have in the United States a continuous 
 balancing and cancellation of debts and credits, first, in each 
 locality ; second, between each important city and its tributary 
 territory, and, third, between the different important cities. 
 Much the same process is characteristic of international exchange, 
 but that is a topic which will be treated in another chapter. 
 
 Personal Credit. — If a man does not hoard money on the one 
 hand, or fail to pay his debts on the other hand, his expenditures 
 (including investments) are bound to be, in the long run, approxi- 
 mately equal to his income. But for a business man a continuous 
 equality of income and expenditure is impossible. At some 
 times his deposit account will be built up more rapidly than he 
 checks it out ; at other times his need for means of making pay- 
 ments will outrun his receipts. If, for example, he is a con- 
 tractor, whose expenses of production are fairly constant, but 
 whose product is paid for only when completed, or a merchant, 
 who replenishes his stock of goods twice a year but whose sales 
 are distributed throughout the year, or a farmer who must pay 
 his harvest expenses before he sells his crops, he may find it nec- 
 essary to utilize his credit. This he does by giving to others 
 rights to demand money from him in the future. Now, the extent 
 to which he can utilize his personal credit, his power of purchasing 
 things without immediate money payment, will depend to some 
 extent on his personal ability and integrity. But, nevertheless, 
 the fundamental measure of his credit will be the amount of his 
 realizable wealth. This, however, may consist in part of prop- 
 erty that is not " for sale," — his stock of consumption goods 
 and his income-yielding land or capital, and in part of things that 
 he hopes to sell in the normal course of business. 
 
 These things do not have to be sacrificed immediately in order 
 to acquire the present means of payment. To meet a temporary- 
 need they may be made the basis of credit, through the process 
 of hypothecation, a name which means the conditional transfer 
 of property rights. The hypothecation may be definite and 
 formal, as when a mortgage is given on specific items of property 
 or when valuable credit instruments of various sorts (such as 
 government or corporation bonds, bills of lading, warehouse 
 
286 OUTLINES OF ECONOMICS 
 
 receipts, etc.) are put into the actual possession of the creditor 
 as " collateral security " ; or it may be simply implied, as in 
 the case of an " unsecured " personal note, for practically all of 
 the property of a borrower, over and above the items specifi- 
 cally hypothecated for certain debts is, in legal fact, hypothe- 
 cated for his remaining debts. It is important to note, too, that 
 future values, rather than present values, constitute the basis of 
 present credit. The lender's interest is in the question of the 
 adequacy of the money value of the security at the time when 
 payment becomes due. Present prices being equal, a borrower 
 can secure a larger amount of credit when market conditions are 
 improving than when they are declining. 
 
 A man's probable future income and the probable future 
 money value of his property, then, constitute the real measure 
 and foundation of his personal credit. His personal credit, 
 however, is of limited use to him as a means of payment. Some 
 difficulties in the way of using personal notes as media of ex- 
 change have already been suggested.^ There is another diffi- 
 culty in the fact that his personal notes will not be willingly 
 accepted by others in lieu of money payments unless they know 
 him, the value of his property, and the extent to which it is 
 already hypothecated. Moreover, these same difficulties stand 
 in the way of such notes being passed from hand to hand, even 
 with successive indorsements. 
 
 Bank Credit. — In order to acquire a readily available medium 
 of exchange, personal credit has to be exchanged for bank credit. 
 
 * It is true, of course, that business men often accept their customers' notes in 
 payment of accounts, or as an equivalent for goods purchased. These notes, 
 however, do not usually pass any farther as a medium of exchange, but are in- 
 dorsed by the business man and presented to a bank for discount. Such notes, 
 often known as "trade paper," constitute a large part of the securities of many 
 commercial banks. In recent years, however, an increasing proportion of banlt 
 loans have been made upon " one-name paper." Buyers find it advantageous ta 
 secure the discounts for cash payments usually given by manufacturers, whole-> 
 salers, and jobbers, obtaining the necessary funds by borrowing from the banks 
 on their own notes. The federal reserve banks are attempting to increase the use 
 of paper bearing the names of both buyer and seller, and in particular to develop 
 a larger use of bills of exchange (drafts) in place of promissory notes. The pur- 
 pose is to make it easier to distinguish those borrowings which arise from " actual 
 commercial transactions." 
 
CREDIT AND BANKING 287 
 
 Instead of using his own note as a medium of exchange, a business 
 man will normally have it " discounted " by his banker. If the 
 note is for sixty days, for example, the business man yields the 
 right to demand a specific amount of money from him in sixty days, 
 in exchange for a deposit credit, — the right to receive on demand 
 the same amount of money less the discount} The business man 
 adds the note to his liabilities and the deposit to his assets. The 
 bank adds the note to its assets and the deposit to its liabilities. 
 
 Having exchanged his personal credit for a bank deposit, the 
 business man can now use the latter as a means of payment 
 through the checking system that has been described. Ordinary 
 commercial banking consists, in large part, of this purchase of 
 personal credit and sale of banking credit. The bank builds 
 up assets in the form of loans and discounts at the same time that 
 it builds up its obligations in the form of deposits. 
 
 The security behind the deposit liabilities of any bank consists 
 of : (i) loans and discounts, which in turn rest back upon per- 
 sonal credit or upon specifically hypothecated property (as in 
 the case of loans on collateral security) ; (2) bonds, mortgages, 
 and other securities owned by the bank, which, if necessary, 
 may be sold for the benefit of the depositors, unless specifically 
 pledged as security for bank note issues ; (3) the bank's own de- 
 posits in other banks, together with the checks or similar claims 
 against other banks that are in its possession ; (4) its other 
 property (building, fixtures, etc.) ; (5) (in national banks and 
 some state banks) the personal liability of the bank's stock- 
 holders ; 2 (6) its stock of money. 
 
 1 Discount is simply one form of interest. Banker's discount differs from ordi- 
 nary interest in that it is computed as a certain per cent of the total amount that 
 is repaid, while ordinary interest is computed as a per cent of the amount that is 
 lent. Discount is deducted from the principal of the loan in advance; interest 
 is paid at the maturity of the loan or (on long time loans) at stated intervals. On 
 demand or "call" loans and on time loans on collateral security "interest" rather 
 than "discount" is charged. 
 
 ^ Even in case some of the bank's loans or securities prove worthless there is a 
 margin of safety for the depositors in the fact that some of the assets of the bank 
 represent the original investments of the bank's stockholders {^'■capital") or profits 
 which they have put back into the business {"surplus"), and on such assets the 
 depositors have the first claim. Moreover, in national banks and some state banks 
 
288 
 
 OUTLINES OF ECONOMICS 
 
 But that these assets should suffice to cover the deposit lia- 
 bihties of a bank is not in itself sufficient to maintain its solvency. 
 Much depends upon the character of the assets, — the amount 
 of money included in them, and the ease and quickness with 
 which other parts of the assets can be converted into money. 
 Each deposit account is an obligation of the bank to pay in 
 actual money if it is demanded. The depositor cannot use 
 checks for all kinds of payments, but will often have to draw on 
 his deposit account for money. Even when payments are 
 made by checks, those who receive them will often prefer to cash 
 them rather than to deposit them. Moreover, the process of the 
 cancellation of credit obligations is, as we have seen, not alto- 
 gether perfect. Balances arise between individual banks in the 
 same city, between city and country, between different cities, 
 and between different nations that very often have to be settled 
 in money. 
 
 Statement of the Condition of a National Bank in a Small Town 
 
 Resources 
 
 Liabilities 
 
 Building and fixtures . . $45,000 
 Government bonds . . 50,000 
 Other securities .... 30,000 
 Loans and discounts . . 460,000 
 Due from other banks . 42,000 
 Cash 35,000 
 
 Capital stock .... $ 50,000 
 
 Surplus 25,000 
 
 Notes outstanding . . 48,000 
 
 Deposits 531,000 
 
 Due to other banks . . 3,000 
 Undivided profits . . . 5, 000 
 
 Total resources . . . $662,000 
 
 Total liabilities . . $ 662,000 
 
 A bank accordingly has to keep enough actual cash on hand to 
 enable it to meet any demands that may be made upon it for 
 money. As deposits constitute the most important cash obliga- 
 tions of most banks, the size of this money reserve, as it is called, 
 is normally fixed for safety's sake at a certain per cent of the 
 amount of the deposits. This proportion varies according to 
 
 the stockholders are in addition personally liable up to an amount equal to the 
 par value of their holdings. 
 
CREDIT AND BANKING 289 
 
 the location of a bank and the nature of its business. In prac- 
 tice it varies in different commercial banks from as low as 5 per 
 cent to as high as 35 per cent of the deposits. 
 
 If its reserve increases, a bank is at liberty to increase its de- 
 posits by extending its loans and discounts, attracting these, 
 possibly, by lowering the discount rate. If the reserve is de- 
 creasing, the bank must, for safety, contract its deposits by re- 
 stricting its loans and discounts, or by taking measures (such as 
 the sale of securities for money) that will replenish the reserve.^ 
 In order that the ratio of reserve to deposits may be maintained 
 near the point where the right balance is struck between profit- 
 ableness on the one hand and safety on the other hand, it is nec- 
 essary that the bank's assets should be as fluid as possible. This 
 is best accomplished by confining most of the loans or discounts 
 to notes or bills of exchange that are payable in thirty, sixty, or 
 ninety days, or, at most, in four or six months, so that a constant 
 flow of maturing obligations makes it possible for a bank to ex- 
 pand or contract its loans and discounts, and hence its deposits, 
 as seems most advisable. 
 
 There has been in the larger cities of the United States, es- 
 pecially in New York, a growing use of bank loans payable on 
 demand. This enables the banks to keep their outstanding 
 loans much closer to the maximum allowed by the state of their 
 reserves than would otherwise be the case, but the practice has, 
 as we shall see presently, other effects that are not so desirable. 
 
 By the " money market " is usually meant the market for 
 freely exchangeable rights to receive money on demand ; that is, 
 in reality, the bank credit market. The amount of bank credit 
 available, the freedom with which banks will make loans on cer- 
 tain kinds of securities, and the interest and discount rates 
 charged for bank credit are among the things that make up what 
 is called " the state of the money market." But it should be 
 clear to the reader that the state of the money market depends, 
 
 ^ Some banks maintain a "bond reserve" of high grade securities that may be 
 sold to enable the bank to meet an extraordinary demand for money or to enable 
 it to extend its loans and discounts when necessary. Such investments are nor- 
 mally made by commercial banks when the demand for loans does not absorb the 
 funds at the bank's disposal, that is, when money reserves are unprofitably large. 
 U 
 
290 OUTLINES OF ECONOMICS 
 
 primarily, on two things : first, the amount and nature of the per- 
 sonal credit that can he exchanged jor hank credit, and second, the 
 amount of money in the hank reserves. 
 
 Bank Notes. — There is one way, however, in which banks can 
 meet some of the demand for money without drawing on their re- 
 serves and thus reducing their power of extending credit. This 
 is by the issue of bank notes, which are simply the promises of 
 banks to pay money on demand, issued in convenient and famil- 
 iar form for use as paper money. These notes are paid as money 
 to customers of a bank who want the proceeds of their borrowings 
 in cash, and to depositors and to holders of checks who prefer 
 money to deposit credit. Bank notes pass readily from hand 
 to hand as money, and at the present time constitute an impor- 
 tant part of the circulating medium in most countries. 
 
 Bank notes are like deposits in that both are demand liabilities 
 of banks. Bank notes, however, circulate among persons who 
 have no means of informing themselves as to the solvency of the 
 banks issuing them. The holders of bank notes are accordingly 
 usually given special protection by laws which regulate the con- 
 ditions of their issue and redemption. 
 
 State Banks of Issue. — Before the Civil War the actual circu- 
 lating medium of the United States consisted in very large part of 
 notes issued by banks operating under state laws. The notes 
 issued by some of these banks were as " good as gold " because 
 the banks redeemed them promptly in gold, — a fact which was 
 due in some cases to wise and rigid state regulation of banking, 
 and in other cases, fewer in number, to conservative use of the 
 too extensive privileges granted by lax state laws. But the notes 
 of other banks were depreciated and in many cases were abso- 
 lutely worthless. 
 
 Public ignorance of the real nature of banking gave rise to the 
 supposition that wealth could be mysteriously manufactured by 
 means of a bank charter and a printing press (the fiat money 
 theory applied to bank notes). This and the ever recurring de- 
 mand for cheap money were responsible for the situation. Pro- 
 hibited by the Constitution from issuing their own bills of credit, 
 many of the states, especially in the South and West, responded 
 
CREDIT AND BANKING 291 
 
 to the clamor for cheap money by making it possible for their 
 citizens to organize " banks " and issue their own bills of credit, 
 imposing few or no requirements as to the actual investment of 
 capital, the accumulation of assets, or the restriction of note issue.^ 
 In the panics of 1814, 1837, and 1857 but few banks maintained 
 specie payments. Even so late as i860, although the hard 
 lessons of experience had brought some improvements, especially 
 in the older states, the bank note circulation was of decidedly 
 varying quality. " Bank note reporters " and " counterfeit 
 detectors " had to be issued periodically in order to give to busi- 
 ness men the latest quotations and information relating to the 
 depreciated currency they had to receive in the ordinary course 
 of business. After 1861 the suspension of specie payments led 
 to a general depreciation of bank notes as compared with gold, 
 because most of them were thereafter redeemable only in green- 
 backs. 
 
 The National Banking System. — The successful state bank- 
 ing system of New York was the model after which Congress, 
 following the recommendations of Secretary Chase, patterned 
 the national banking system which it established in 1863. The 
 primary, although not the only, motive that led to this action 
 was the desire to provide an artificial market for government 
 bonds, which at the time were a drug on the market. National 
 banks were required to use government bonds as the assets be- 
 hind note issues, and furthermore, the national banks were, 
 in 1866, given a monopoly of the note issue privilege by the im- 
 position of a prohibitive tax of 10 per cent per annum upon the 
 note issues of state banks. 
 
 The details of the national banking law have been amended 
 from time to time, but the general principles of the regulation 
 of the note issue remained unchanged until Congress passed the 
 Aldrich Act in 1908. As the law has stood since 1900, national 
 banks may not be organized unless the stockholders contribute 
 a minimum capital, varying from $25,000 for places of less than 
 
 * Some states circumvented the constitutional prohibition mentioned by estab- 
 lishing their own banks for the manufacture of paper money. The Bank of Ken- 
 tucky was the most famous of these. 
 
292 OUTLINES OF ECONOMICS 
 
 3000 population to $200,000 for places of more than 50,000 popu- 
 lation. Three limitations are put on the ordinary issue of cir- 
 culating notes : (i) They must not exceed in amount the capital 
 stock of the bank, (2) United States government bonds have 
 to be purchased by the bank in amount sufficient to equal, dollar 
 for dollar, the quantity of the notes issued, and these bonds have 
 to be deposited with the treasurer of the United States as secur- 
 ity for the redemption of the notes. (3) Each bank must main- 
 tain in the United States treasury a redemption fund in " lawful 
 money " equal to 5 per cent of its note issue. As this last re- 
 quirement indicates, bank notes are redeemable at the federal 
 treasury. They may also be used in all payments to the govern- 
 ment except customs duties, although they are not legal tender. 
 
 The Reserve System. — While the note holder is thus pro- 
 tected by a special kind of security set aside for the purpose, the 
 depositor in a national bank is protected only by its general 
 assets. These, however, are regulated to some extent by the 
 federal government. There are restrictions, for example, in- 
 tended to prevent the bank from tying up its funds in long-time 
 investments, from lending too much to one person or firm, or to 
 directors or officers of the banks. Five times a year national 
 banks have to furnish full statements of their condition to the 
 comptroller of the currency at Washington. Each bank is also 
 examined twice a year, without notice, by federal bank examiners. 
 
 But the most important requirement relates to the money re- 
 serves that must be held by national banks. Until the Federal 
 Reserve Act was passed in 19 13, banks in '' central reserve 
 cities " (New York, Chicago, and St. Louis) were required to 
 maintain a " lawful money reserve " ^ equal to at least 25 per 
 cent of their deposits. Banks in other " reserve cities " (in- 
 cluding at present about fifty cities) were also required to main- 
 tain 25 per cent reserves, but their deposits in the national banks 
 of the central reserve cities might be counted for one half of this 
 amount. In all other places the banks were required to hold 
 a 15 per cent reserve, three fifths of which might consist of de- 
 posit accounts in banks in central reserve cities or other reserve 
 
 ^ Including all kinds of United States money except minor coins and bank notes. 
 
CREDIT AND BANKING 
 
 293 
 
 cities. In all cases the funds kept by the banks with the United 
 States treasurer for the redemption of their notes were counted 
 as part of their legal reserves. 
 
 The New York Money Market. — Under the operations of this 
 system the cash reserves of the national banks were centered 
 in New York. This appears clearly in Table I, which shows that 
 on the date specified (which may be taken as fairly representa- 
 tive of conditions in recent years) more than a third of the cash 
 reserves of the 6544 national banks in the United States were in 
 
 TABLE I 
 
 Deposits and Reserves of National Banks: August 22, 1907* 
 
 
 No. OF 
 Banks 
 
 Deposits 2 
 
 Reserve 
 
 Classification of Reserve 
 
 Location 
 
 a 
 =1 
 
 
 1 
 
 1 
 
 Lawful 
 
 money in 
 
 banks 
 
 Due from 
 reserve 
 agents 2 
 
 
 New York . . . 
 Chicago .... 
 St. Louis .... 
 Other reserve cities 
 Country banks . . 
 
 38 
 
 14 
 
 8 
 
 306 
 
 6178 
 
 825.7 
 
 262.9 
 
 116.8 
 
 1423.4 
 
 2627.2 
 
 221.3 
 
 66.6 
 
 27.6 
 
 362.3 
 
 443-5 
 
 26.8 
 
 25-3 
 23.6 
 
 25-5 
 16.9 
 
 218.8 
 
 66.1 
 
 26.8 
 
 190.3 
 
 199.6 
 
 165.7 
 226.7 
 
 2.6 
 
 o-S 
 
 0.7 
 
 6.3 
 17.2 
 
 Total .... 
 
 6544 
 
 5256.1 
 
 II 2 1. 4 
 
 21.3 
 
 701.6 
 
 392.4 
 
 27-3 
 
 the vaults of thirty-eight New York banks. ^ These figures do 
 not, however, convey an adequate idea of the national impor- 
 tance of the New York bank reserves. New York is the great 
 wholesale market for foreign exchange, the chief center of gold 
 movements to and from Europe, the principal importing and 
 exporting center for commodities, — in short, the chief market 
 place of the continent and the focus of financial operations. All 
 state banks, private banks, and trust companies of importance 
 find it to their advantage to maintain deposit accounts in New 
 
 1 Compiled from Report of the Comptroller of the Currency, 1Q07, pp. 222-224. 
 
 * Millions of dollars. ^ pgr cent. 
 
 * The bulk of the deposits of out of town banks was in from twelve to twenty 
 banks which have made a specialty of this kind of business. 
 
294 OUTLINES OF ECONOMICS 
 
 York, both for their own use, and in order that they may supply 
 New York exchange to their customers. Even the deposit ac- 
 counts of national banks in New York were in the aggregate 
 considerably larger than the amount they were allowed to count 
 as part of their reserves. 
 
 All together the deposits of other banks have usually consti- 
 tuted more than half of the aggregate deposits in New York 
 national banks. Moreover, something very much like this re- 
 serve system existed (and still exists) among other than na- 
 tional banks, the banks in smaller places keeping deposits in 
 national or other banks in larger cities, which in turn keep de- 
 posits in New York. The trust companies, and some of the 
 state banks,^ keep in general very much smaller reserves in their 
 own vaults than are required of national banks, — a fact which 
 made the strain on the New York bank reserves all the greater. 
 
 Like an inverted pyramid upon its apex, the great structure of 
 bank credit in the United States has rested, in large measure, 
 upon the money reserves of the New York banks. Every im- 
 portant change in the demand for money or credit in any part 
 of the country has had an effect on the New York money market ; 
 similarly, every important disturbance in the New York money 
 market has affected financial conditions throughout the country. 
 
 The central reserve system effects a great economy in the use 
 of money, and, what is more important, it mobilizes the cash 
 resources of the country in such a way that variations in the local 
 supply of bank credit in different regions resulting from differ- 
 ences in the local supply of money available for bank reserves 
 are minimized. It seems to be a natural and necessary feature 
 of modern banking, for something like it is found in all the lead- 
 ing commercial nations. But in the United States the central 
 reserve system has worked badly. This has been attributable 
 in part to other defects in our national banking laws and in part 
 to some unfortunate features of the reserve system itself. Specifi- 
 cally, the principal sources of difficulty have been the following : 
 
 1 Savings banks keep reserves that average for the United States only four fifths 
 of one per cent of their deposits. On account of the nature of their business, which 
 is not banking in the commercial sense, they are a negligible factor in this connection. 
 
CREDIT AND BANKING 29$ 
 
 (i) the dominance of speculative influences in the New York 
 money market ; (2) the independent treasury system ; (3) the 
 lack of elasticity in our bank note issues ; (4) the rigidity of our 
 legal reserve requirements ; (5) the absence of any one central 
 authority, responsible for the custody and maintenance of the 
 central reserves. We now proceed to the discussion of these 
 matters. 
 
 Speculation and the New York Money Market. — As Table II 
 shows, a large proportion of the loans of New York banks have 
 not been based on " commercial paper " ; that is, on the notes 
 and bills of exchange that arise in the ordinary course of business, 
 but have been either time loans on collateral security or demand 
 loans, nearly all of which are secured by collateral. Most of 
 these collateral securities are the stocks and bonds of corpora- 
 
 TABLE II 
 
 Loans and Discounts of New York National Banks on Specified 
 
 Dates ^ 
 (In millions of dollars) 
 
 Character of Loan 
 
 1890 
 
 1901 
 
 1906 
 
 1912 
 
 On demand 
 
 102 
 
 43 
 
 152 
 
 279 
 129 
 203 
 
 303 
 149 
 249 
 
 344 
 223 
 
 391 
 
 On time, with collateral security 
 
 On time, without collateral security 
 
 tions, and the loans, especially the demand or " call " loans, are 
 used for the greater part in financing speculation in such securi- 
 ties. This system has been partly responsible for the excessive 
 and useless expansion of speculation over and above the amount 
 that is necessary to secure the best results for the economic in- 
 terests of the country. Here we are concerned, however, with 
 its effects on the money market. 
 
 The supply of call loans depends primarily on the amount of 
 the surplus reserves of New York banks ; that is, the excess of 
 the reserves over and above the legal minimum percentage of 
 1 Compiled from Reports of the Comptroller of the Currency. 
 
296 OUTLINES OF ECONOMICS 
 
 the amount of their deposits. If the weekly statement of the 
 clearing house banks shows a relatively large surplus reserve, 
 this means that the banks can safely expand their loans, and the 
 knowledge of this fact has a stimulating effect on speculation. 
 If, however, the surplus reserve is low, the banks are bound to 
 restrict their loans of all kinds and to " call " some of their de- 
 mand loans. When the reserve is below the legal limit, demand 
 loans have to be called in large quantities in order to enable 
 the banks to meet pressing demands for credit on the part of 
 their regular customers. The precipitate calling of demand 
 loans by some banks simply increases the demand for credit at 
 other banks, which in turn have to curtail their loans. Such a 
 condition of the money market leads to a depression in the price 
 of speculative securities, which is increased by the forced sales 
 of securities in order to obtain the money funds that had pre- 
 viously been lent on them ; the fall in the prices of securities 
 leads brokers to demand more " margins " from the customers 
 for whom they have bought securities, and it leads the banks to 
 demand more securities as collateral for their outstanding loans. 
 Under such conditions the interest rate on call loans has some- 
 times gone as high as 125 per cent, or even higher.^ 
 
 If the ruling prices of speculative securities have been higher 
 than industrial conditions would warrant, such a disturbance 
 of the money market is apt to be long continued, and might 
 easily develop into a general financial crisis. The call loan 
 market is essentially speculative, and it is unfortunate that the 
 condition of the supply of credit for the normal commercial needs 
 of the country should have been periodically unsettled on ac- 
 count of this fact. In no other great money center of the world 
 
 * That is, the rate on what may be called marginal call loans, effected at the 
 stock exchange by bankers' agents, or by individuals or corporations. Many 
 banks continue to make call loans to their regular customers at such times at rates 
 not exceeding 6 per cent. Under normal conditions the rate on call loans is lower 
 than the rate on time loans. For the period i9oi-igo6 the bank rate on call loans 
 averaged 3.3 per cent as against an average rate of about 4.5. per cent on time 
 loans. Excessive variability is the chief characteristic of the call loan rate. Cf. 
 W. A. Scott, "Rates on the New York Money Market," Journal of Political Econ- 
 omy, vol. xvi, pp. 273-298. 
 
CREDIT AND BANKING 297 
 
 do call loans occupy the important place that they do in New 
 York. 
 
 The Independent Treasury System. — The United States 
 government has for many years been to a very large extent its 
 own banker. It has kept its own money in its own strong boxes, 
 quite after the fashion of a medieval monarch. The strong 
 boxes in this case have been, however, the vaults of the treasury 
 in Washington and of nine sub treasuries located in important 
 cities. Apart from the fact that the government revenue and 
 the government expenditures are naturally not distributed 
 evenly throughout the year, the government has the further 
 difficulty that a close balance of revenues and expenditures for 
 any given year must be wholly accidental. Even if the federal 
 budget were carefully and scientifically constructed, as it is not, 
 the public revenues would be liable to uncertain fluctuations, — 
 a result in part of the importance of customs receipts among 
 them. The government, furthermore, receives a large part of 
 its income in money, not in bank credit instruments. When a 
 surplus accumulates in the government treasury, that much 
 money is taken out of circulation. This reduces bank reserves, 
 and contracts the amount of bank credit available. And it 
 usually happens that the government revenues are largest when 
 business is most prosperous, and when, consequently, maximum 
 bank reserves are needed. 
 
 The government is permitted, however, by the national bank 
 act of 1863 to deposit money in selected national banks. Some 
 secretaries of the treasury have made little use of this privilege, 
 but in recent years such deposits have become more common. 
 
 Until 1902 banks had always been required to deposit government bonds 
 with the federal treasury as security for federal deposits, but in that year 
 and again in 1906 Secretary Shaw offered to accept approved state and 
 municipal bonds in lieu of a certain amount of government bonds, on condi- 
 tion that the latter should be immediately used as security for increased 
 note issues. Subsequently the banks have also been permitted to use 
 "prime commercial paper," endorsed by the banks, as collateral. In 1897 
 only 168 banks were government depositories. In 1914 there were 1584, 
 which held on June 30 of that year about half of the $170,000,000 constitut- 
 ing the government's cash surplus at that date. Part of this increase is 
 
298 OUTLINES OF ECONOMICS 
 
 attributable to the effect of a law enacted in 1907 allowing customs receipts 
 to be deposited in banks. Prior to this deposits could only be made from the 
 proceeds of internal revenue duties and miscellaneous receipts. In recent 
 years the banks have been required to pay 2 per cent interest on govern- 
 ment deposits. 
 
 The government has, on several occasions, come to the rescue of the banks 
 by cash purchases of its own bonds. The decline in the market price 
 of government bonds in periods of financial stringency makes the purchases 
 relatively advantageous to the government. The periodic shifting of govern- 
 ment deposits to localities where money is most needed, the temporary de- 
 posit of gold in New York banks equal in amount to their engagements 
 of gold for transportation from Europe, and even the arbitrary withdrawal 
 of government money from the banks when it was "not needed," in order 
 that it might not be made the basis of speculative activities but kept until 
 it "was needed," have been notable features of the recent relations of the 
 treasury and the money market. 
 
 In favor of this system it may be said that a surplus in the government 
 treasury constitutes a real cash reserve, the wise use of which by the Secre- 
 tary of the Treasury might avert a serious crisis. But there are dangers in 
 intrusting so much financial power to one man. If used without discretion 
 it is bound to do more harm than good. Moreover, these treasury operations 
 have not always been free from the suspicion of favoritism to certain banks. 
 Then, too, the knowledge that the government surplus will, in time of 
 necessity, be put at their disposal tends to encourage unsound banking by 
 relieving the banks of the proper responsibility for the maintenance of 
 their own reserves. 
 
 Finally, it should be noted, the use of the independent treasury system 
 has prevented the government from securing for itself any large measure 
 of the various economies and advantages that business firms find in keep- 
 ing bank accounts. 
 
 The Movement of Money. — The demand for loanable funds 
 (rights to receive money on demand) varies locally, according 
 to the business conditions that exist in different parts of the 
 country. These differences make loans worth more in some lo- 
 calities than in others, and result in some shifting of bank credit. 
 New York banks, for example, sometimes invest in " out of 
 town " commercial paper when this is more profitable than 
 employing their funds at home. More frequently, interior 
 banks place loans in New York, either through their correspond- 
 ent banks there, or by the purchase of securities from note 
 brokers. This shifting of credit, however, is unimportant as 
 
CREDIT AND BANKING 299 
 
 compared with the movement oj money itself. Money is con- 
 tinually flowing from New York to the interior and from the 
 interior to New York, according as it can be more profitably em- 
 ployed in bank reserves in one place or the other. Similar move- 
 ments take place between the various cities of the country. This 
 movement, it will be noted, is not one that is apt to disturb 
 financial conditions. On the contrary, it tends to prevent ex- 
 treme local fluctuations in money market conditions by leading 
 to the expansion of credit where it is most needed, and similarly, 
 to the contraction of credit where it is least needed. 
 
 There is another kind of money movement, however, which is 
 not so fortunate in its effects upon the money market. This is 
 the movement of money out of bank reserves into general cir- 
 culation and out of general circulation into bank reserves. The 
 amount of money needed as an actual hand-to-hand medium of 
 exchange varies for different seasons and for different localities. 
 The demand for money to serve as the basis of credit in bank 
 reserves and the demand for money as an actual medium of ex- 
 change are different and competing demands. When more 
 money is needed as a medium of exchange, reserves have to 
 yield and credit has to be contracted. 
 
 The most important movement of this sort is in response to the 
 annual demand for money to be used in " moving the crops." 
 Harvest expenses are very largely wages, and these have to be 
 paid in cash. Many farmers, moreover, insist on receiving 
 money payments when they sell their crops. The cotton crop 
 of the South and the grain crop of the West annually necessitate 
 the conversion of bank deposits in those regions into money, and 
 the negotiation of loans on the security of the crops, the proceeds 
 of which are also largely taken in cash. The banks in these sec- 
 tions of the country in turn secure money from the banks in 
 which they have deposits, and in large part this money is obtained 
 directly and indirectly from the New York bank reserves. The 
 movement of money from New York to the South and West 
 usually commences in August of each year and continues through 
 November, when the return movement sets in, continuing usu- 
 ally till February. Despite the fact that the New York bankers 
 
300 OUTLINES OF ECONOMICS 
 
 are forewarned of this movement, it always reduces their surplus 
 reserves and leads to stringent and sometimes precarious condi- 
 tions in the New York money market, — conditions which are 
 frequently reflected in difficulties in the money market through- 
 out the country. 
 
 To the arbitrary flow of money to and from the treasury, and 
 to its movement to and from bank reserves and hand-to-hand 
 circulation, there must be added the movement of gold between 
 this and other countries. This will be discussed in another 
 place; it is sufficient to note at this point that this external 
 money movement is at the same time a cause and an effect of 
 changing money market conditions. 
 
 Inelastic Currency. — That these money movements have af- 
 fected the supply of bank credit as they have is partly at- 
 tributable to the inelastic character of our bond-secured bank 
 currency. Under the provisions of the national banking law that 
 have been described, the variations in the amount of bank notes 
 outstanding have borne a close relation to variations in the price 
 of government bonds, — and these variations are affected by 
 many other things than money market conditions, and in re- 
 cent years have been very small. 
 
 As will be seen in Table III, the creation of the two per cent 
 bonds, payable in 1930, stimulated the issue of bank notes, be- 
 cause the federal tax is only one fourth of one per cent semi- 
 annually on bank notes secured by two per cent bonds as against 
 one half of one per cent on notes secured by bonds paying a 
 higher rate of interest. The relative stability of the amount 
 issued in recent years has been noticeable, what increase there 
 was being a natural result of the increasing number and size of 
 banks. Nor has the amount of note issue responded in any 
 marked degree to the regular seasonal demands for money to 
 move the crops or to the less regular operations of the treasury 
 department or of the foreign exchanges. 
 
 Students of banking problems have for many years thought 
 that the national banks should have been permitted to issue 
 part, if not all, of their notes on the security of their general 
 assets, thus placing them on the same basis as deposits. It is 
 
CREDIT AND BANKING 
 
 301 
 
 TABLE III 
 
 Amounts of Bank Note Circulation Secured by Specified Classes 
 OF Bonds: 1900-1915^ 
 
 SEcuRirr 
 
 March 13, 1900 
 
 Oct. 31, 1903 
 
 Oct. 31, 191S 
 
 Loan 1908, 3's . . 
 Loan 1907, 4's . . 
 Loan 1925, 4's . . 
 Loan 1904, 5's . . 
 Loan 1891, 2's . . 
 Consols 1930, 2's . 
 Panama Canal, 2's . 
 
 
 
 $56,164,820 
 
 130,302,250 
 
 14,697,850 
 
 21,996,350 
 
 20,490,150 
 
 $1,797,580 
 
 2,797,200 
 
 1,410,100 
 
 718,650 
 
 376,003,300 
 
 $20,377,720 
 32,304,800 
 
 600,678,600 
 81,614,420 
 
 Total .... 
 
 $243,651,420 
 
 $382,726,830 
 
 $734,975,540 
 
 clear that if this had been done any sudden increase in the de- 
 mand for money as a circulating medium might have been met 
 by exchanging bank credit in the form of bank notes for per- 
 sonal credit, or by the shifting of bank credit from the form of 
 deposits to the form of note issues. " Asset banking," as this 
 is called, is used in Canada, and enables the banks there to fur- 
 nish money for crop moving purposes without endangering their 
 reserves. Most of the great national banks of continental 
 Europe also issue notes on the security of their general assets. 
 Under such a system, it is clear, the supply of bank notes 
 can expand automatically with an increase in the supply of 
 personal credit in the form of discountable notes and bills of 
 exchange, in just the way that bank deposits expand. To 
 achieve real elasticity, however, it is necessary to provide for 
 the ready contraction of note issues v/hen the special demand for 
 money is over as well as to provide for their ready expansion in 
 time of need. 
 
 Inelastic Reserves. — Under our national banking law, banks 
 have to stop lending when their reserves fall below the legal 
 minimum. The central reserves in New York have accordingly 
 
 1 From Reports of the Comptroller of the Currency, Finance Reports, 1907, p. 390 ; 
 iQiS, p. S7i. 
 
302 OUTLINES OF ECONOMICS 
 
 been real reserves only in the sense that they have made it pos- 
 sible for the banks to meet extraordinary demands for ready 
 cash. So far as the extension of credit is concerned they have 
 constituted, not a reserve, but a dead line.^ 
 
 This has often had serious consequences. It is a well-tested 
 principle of sound banking practice that about the worst thing 
 that can happen when bank reserves are low is for the banks to 
 stop lending. Business men, otherwise solvent, are not able 
 to secure bank credit, and so cannot meet their own obligations 
 or exchange their claims against their debtors for bank credit. 
 Forced sales result ; the prices of securities and other forms of 
 property fall ; the banks " call " their demand loans or ask for 
 larger deposits of collateral securities ; more sales are forced, and 
 the pressure on the banks for loans increases. In short, a general 
 money market panic may come from suddenly curtailing loans 
 at a time when bank reserves are relatively low. The wiser 
 banking policy is to lend freely on good security, but at in- 
 creased interest rates, thus automatically restricting loans to the 
 more necessitous borrowers. 
 
 The Bank of England, for example, permits its reserves to 
 fluctuate between very wide limits, and often protects them 
 against possible depletion by reason of withdrawals of gold to 
 other countries by the simple process of raising its discount 
 rate. Since the official Bank of England rate governs the 
 general " open market rate " at which London banks discount 
 commercial paper ,2 the effect is not only that the amount of do- 
 mestic borrowing is decreased, but also that the quantity of for- 
 eign bills of exchange (normally bought in large quantities by 
 London banks) sent to London for discount is decreased. Then, 
 
 1 In practice the law has not been rigidly enforced,"a warning from the Comptroller 
 of the Currency being generally the only penalty exacted for a small temporary 
 deficit in the reserves. Nevertheless, the New York bank reserves have not often 
 fallen more than one or two points below the legal minimum. 
 
 2 Sometimes, in order to make its increased rate "efiective" in the London money 
 market, the Bank borrows money or sells securities so as to decrease the available 
 supply of loanable funds in the market, thus compelling the other London banks 
 to increase their discount rate. Another device often used by the Bank in protecting 
 its reserves is that of slightly increasing the price at which it buys gold 
 
CREDIT AND BANKING 303 
 
 as the foreign bills already held in London mature into rights to 
 demand money from other money markets, these offset claims 
 of other money markets against London which would otherwise 
 have to be paid by shipping gold. 
 
 Absence of Centralized Control. — It may have occurred to 
 the reader that some elasticity might have been given to bank 
 reserves in the United States if the banks holding the central 
 reserves had made it their practice normally to hold reserves 
 considerably larger than the minimum required by law, — re- 
 serves equal to 40 or 50 per cent of their deposits, for example. 
 This would have given a margin sufficient to enable them to 
 meet withdrawals of gold for domestic use or for export without 
 suddenly contracting the supply of loanable funds. All this 
 is undoubtedly true, but it must not be supposed that such a 
 policy could voluntarily have been followed by the New York 
 banks. The difficulty was that the banks holding the central 
 reserves were merely large commercial banks, interested pri- 
 marily in securing maximum profits for their own stockholders, 
 and with no one of thern individually responsible for the main- 
 tenance of adequate surplus reserves. For any one bank to 
 have attempted to remedy the situation would have helped 
 but little. It would only have put itself at a disadvantage as 
 compared with its competitors. And then there were other 
 factors in the situation that helped to keep the reserves pared 
 down to a minimum. It is not economical for country banks to 
 hold a much larger amount of actual money on hand than they 
 need to comply with the law. Moreover, the New York banks, 
 competing with one another for the deposits of other banks, 
 pay 2 per cent interest on such deposits. In recent years about 
 half of the aggregate amount of lawful money in the possession 
 of the national banks of the country has been in the vaults of 
 New York banks. What surplus reserves were created from 
 time to time by importations of gold, by the transfer of money 
 from the subtreasuries, by the reduction in the amount of money 
 in hand-to-hand circulation, or by a contraction in the total 
 volume of bank deposits, speedily found their way to the New 
 York banks. And the New York banks speedily found ways of 
 
304 OUTLINES OF ECONOMICS 
 
 utilizing the additional lending-power created by these surplus 
 reserves. Stock exchange speculation, in particular, could 
 generally be depended upon to absorb in the form of call loans a 
 large part of the increased amount of available bank credit. 
 In short, the operation of the system was such as continually 
 to keep the ratio of reserves to deposits as close to the legal 
 minimum as possible. Any " slack " that might appear was 
 quickly taken up. 
 
 These rigid and inelastic reserves were undoubtedly the worst 
 features of our banking system. With more elastic reserves the 
 evils of the independent treasury system and of inelastic cur- 
 rency would not have been so great. Money could have flowed 
 into reserves and out of them without often bringing conse- 
 quences more serious than fluctuations in discount rates. 
 
 Steps toward Reform. — The national banking system has 
 in some particulars been highly successful. National bank 
 notes have always been thoroughly sound, and depositors, too, 
 have been well protected, for failures of national banks have 
 been relatively few. The high standards which the national 
 banking system has set have had a marked influence upon 
 the betterment of state banking laws and upon their enforce- 
 ment. But the defects which have just been discussed made it 
 both inadequate and, in its larger aspects, unsafe. Students 
 of banking problems had for many years urged the need of re- 
 form. Some advocated the establishment of a central hank, 
 of the type that is found in almost every country of Europe. 
 These banks hold the central banking reserves of their respec- 
 tive countries, hold the government deposits, have (usually) a 
 monopoly of bank note issue, and are subject to a special meas- 
 ure of government control. But ever since the days of the 
 Second Bank of the United States the establishment of a central 
 bank in this country has probably been politically impossible. ^ 
 
 iThe United States Bank (17Q1-1811) and the Second Bank of the United 
 States (1816-1836) were large institutions, with numerous branches. But although 
 they issued notes and held the treasury funds, they were not "central banks" in the 
 modern sense. They did not have a monopoly of note issue, for state banks also 
 issued notes, nor did they hold central banking reserves. In each case Congress re- 
 fused to recharter the bank at the expiration of its original twenty-year charter. 
 
CREDIT AND BANKING 305 
 
 More interest has been aroused, however ,'in the matter of elastic 
 currency, and various plans for permitting national banks to 
 issue notes secured only by their general assets have from time 
 to time been embodied in bills introduced in Congress. But 
 Congress, the business men of the country, and, it must be said, 
 the bankers themselves, were for the most part apathetic. 
 
 General interest in the matter was finally aroused by the panic 
 of 1907, in which the worst features of our banking system stood 
 out in clear relief. Banks throughout the country found them- 
 selves unable to meet the large and increasing withdrawals of 
 money by their depositors and were unable in turn to get 
 money from the banks in New York and the other central reserve 
 cities in which they themselves had deposits. The payment of 
 money to depositors had to be suspended or restricted, and 
 many banks with perfectly sound assets found themselves, for 
 the time being, technically insolvent. Money was at a premium. 
 Clearing-house loan certificates — virtually joint obligations of 
 the banks associated in the clearing house, issued to individual 
 member banks upon the deposit of adequate security — were 
 used (as in former panics) in the payment of clearing-house 
 balances. In many cities the clearing-house loan certificates 
 were issued in small denominations and got into general circula- 
 tion by being paid to depositors in lieu of money. Cashier's 
 checks and other credit instruments were also used as money. 
 The total amount of improvised currency issued during the 
 panic is estimated to have been over $500,000,000.^ The whole 
 situation was such as to impress upon thoughtful men the im- 
 perative need of banking reform. 
 
 The first tangible result was the so-called Aldrich-Vreeland 
 Act of 1908, which made temporary provision for such emer- 
 
 In each case, also, this occurred when the country was temporarily under the domi- 
 nance of a strong democratic sentiment opposed to political or financial centraUza- 
 tion in any form. Jealousy on the part of state banks was, however, the immediate 
 cause of the demise of the first United States Bank, while the second succumbed to 
 the yet more potent hostility of Andrew Jackson. 
 
 ^ A. P. Andrew, "Substitutes for Cash in the Panic of 1907," Quarterly Journal oj 
 Economics, Vol. xxii, p. 515. For an excellent account of the general situation at 
 the time see O. M. W. Sprague, History of Crises under the National Banking Systenw 
 Chap. V. 
 
 X 
 
3o6 OUTLINES OF ECONOMICS 
 
 gencies as that of 1907 by permitting national banks to issue 
 notes, under a heavy tax, upon other security than government 
 bonds. The methods utihzed were, in part, those which had 
 been developed by the banks themselves in issuing clearing- 
 house certificates. 
 
 Under this measure banks might increase their note issues in one or both 
 of two ways. First, on the security of approved state, county, or municipal 
 bonds deposited with the Treasurer at Washington. Second, on the security 
 of bonds of the kinds just mentioned, of corporation bonds, or of commer- 
 cial paper, deposited with "National Currency Associations," which last 
 were voluntary organizations, modeled upon clearing-house associations, 
 although provision was made for their organization in country districts. 
 These issues were limited in amount and were to be taxed at the very heavy 
 rate of 5 per cent for the first month and i per cent for each additional 
 month up to a maximum of 10 per cent. The act, it is evident, did not 
 provide for a really elastic currency, varying with business needs, but 
 only for an emergency currency. In 1913 the rate of taxation was reduced 
 to 3 per cent for the first month, with a maximum of 6 per cent. 
 
 For several years no notes were issued under this statute, but in 1914 the 
 outbreak of the European war led to large shipments of gold to Europe and 
 to a small-sized panic in the money market. The issue of emergency cur- 
 rency possibly averted a more serious panic. Altogether, emergency notes 
 to the amount of $386,000,000 were issued by 1363 different banks. All 
 of these had been retired before the Act expired, by limitation, on June 30, 
 1915- 
 
 The Aldrich-Vreeland Act also created a National Monetary 
 Commission, composed of senators and congressmen, to devise 
 a plan for the general revision of the banking system. The plan 
 recommended by this commission was one sponsored by Senator 
 N. W. Aldrich of Rhode Island. It provided for a hierarchical 
 organization of the banks of the country, with a central bank, 
 the " National Reserve Association," at the top. Banks were 
 to be grouped into local reserve associations, with functions not 
 unlike those of the national currency associations of the Aldrich- 
 Vreeland Act. The whole system was to be controlled by the 
 banks rather than by the government. The widespread dis- 
 cussion of the Aldrich plan undoubtedly did much to awaken 
 interest in the problem and to make the adoption of the federal 
 reserve system possible. 
 
CREDIT AND BANKING 307 
 
 The Federal Reserve System. — A revolutionary change in 
 the banking system of the United States was brought about by 
 the Federal Reserve Act of 1913. Under the provisions of this 
 act the country has been divided into twelve districts and a cen- 
 tral bank, named a Federal Reserve Bank, has been established 
 in each district.^ The system is under the general supervision 
 and control of the government. At its head is the Federal Re- 
 serve Board, comprising five members appointed by the Presi- 
 dent, together with the Secretary of the Treasury and the Comp- 
 troller of the Currency. The stock of the various federal re- 
 serve banks is owned by local banks in the respective districts, 
 called " member banks." National banks were required to be- 
 come member banks, while state banks and trust companies 
 are permitted to become member banks, provided they comply 
 with certain standards imposed upon national banks by the na- 
 tional banking law and with other requirements set by the Fed- 
 eral Reserve Board. Each member bank subscribes to the 
 stock of the federal reserve bank in an amount equal to 6 per 
 cent of its own capital and surplus. Half of this must be paid 
 for, and the other half remains subject to call. Any earnings of 
 the federal reserve banks over a 6 per cent dividend to their 
 member banks go, first, to accumulate a surplus equal to 40 per 
 cent of the paid up capital stock, and, beyond that, to the 
 United States Treasury. Each federal reserve bank is governed 
 by a board of nine directors, six being elected by the member 
 banks, and three appointed by the Federal Reserve Board. 
 
 Relations of Federal Reserve Banks and Member Banks. — The 
 federal reserve banks are " bankers' banks " ; that is, they do 
 not accept the deposits of individuals nor do they lend directly 
 to individuals. Their most important relations are with their 
 member banks, and these may be summarized under the heads 
 of (i) reserves, (2) rediscounts, and (3) note issues. 
 
 I. The federal reserve banks hold the central reserves of the 
 
 ^ The twelve federal reserve banks are located at New York, Boston, Philadelphia, 
 Richmond, Atlanta, Cleveland, Chicago, Minneapolis, St. Louis, Kansas City, 
 Dallas, and San Francisco. The Atlanta bank has a branch at New Orleans (with 
 a special district assigned to it) and other branches may be established. 
 
3o8 OUTLINES OF ECONOMICS 
 
 system. Three years are allowed for the gradual transfer of 
 reserves from the banks which have held them in the past. After 
 that period the requirements are as follows: A member bank 
 may count as reserve only (i) money in its own vaults and 
 (2) deposit credits with the federal reserve bank. Member 
 banks in central reserve cities must maintain reserves equal 
 to 18 per cent of their demand liabilities, of which at least one 
 third must be money in their own vaults and at least seven 
 eighteenths deposits in the federal reserve bank. In other re- 
 serve cities member banks must maintain 15 per cent reserves, of 
 which at least one third must be in their own vaults, and at least 
 six fifteenths must be a federal reserve bank deposit. Banks 
 in other cities or rural districts must keep 12 per cent reserves ; 
 at least one third in their own vaults and at least five twelfths 
 in the federal reserve bank. The federal banks, in turn, have to 
 keep minimum reserves of 35 per cent of their deposits. 
 
 These provisions for minimum reserves of definite size must be 
 interpreted as being, in part at least, a concession to American 
 habits and prejudices. But the Federal Reserve Board is 
 authorized to suspend temporarily any of these reserve require- 
 ments, imposing a graduated tax upon the amounts by which 
 the reserves fall below the stated minimum limit. It is to be 
 expected, moreover, that the federal reserve banks will normally 
 hold reserves much larger than those required by law. This 
 in itself will introduce a large measure of elasticity into the situa- 
 tion. 
 
 2. Rediscounting means the purchase by one bank of notes 
 and bills of exchange held by another, the purchasing bank being 
 protected by the selling bank's endorsement of the discounted 
 paper. Rediscounting has not been a common feature of Ameri- 
 can banking practice, and there has even been a distinct prejudice 
 against it, although it is very common in Europe. The new law 
 makes it an essential part of the federal reserve system. Federal 
 reserve banks may rediscount (for their member banks) short- 
 time notes and bills of exchange " issued or drawn for agricul- 
 tural, industrial, or commercial purposes," and conforming 
 to certain specifications which have been carefully formulated 
 
CREDIT AND BANKING 309 
 
 by the Federal Reserve Board. The privilege of rediscount is 
 not extended to notes and bills of exchange issued " for the 
 purpose of carrying or trading in stocks, bonds, or other invest- 
 ment securities, except bonds and notes of the United States." 
 The purpose of this restriction is not only to prevent the resources 
 of the federal reserve banks from being used to finance specula- 
 tion, but also to limit their rediscounts to so-called " self -liqui- 
 dating paper," that is, to notes and bills of exchange held against 
 loans which the borrowers will, in the ordinary course of business, 
 be able to repay from the proceeds of the sales of the goods pro- 
 duced or purchased with the aid of the borrowed funds. 
 
 The most important general advantage of this new redis- 
 counting system is the help it will give in the development of a 
 thoroughly elastic supply of deposit credit, expanding and con- 
 tracting with the number and magnitude of business transac- 
 tions. When, for example, the reserves of certain member 
 banks are too low to permit them to advance deposit credits 
 to their customers in the desired quantities upon even the sound- 
 est instruments of personal credit, they may replenish their 
 reserves by sending part of their holdings of bills and notes to the 
 federal reserve banks for rediscount. In order to equalize the 
 supply of bank credit in different parts of the country the Fed- 
 eral Reserve Board may permit and even require certain federal 
 reserve banks to rediscount commercial paper for other federal 
 reserve banks. The Federal Reserve Board also has general 
 supervising power over the whole rediscounting system, includ- 
 ing power to revise the rediscount rates of the different federal 
 reserve banks. 
 
 3. Under the new system, national banks may still continue 
 to issue notes, as in the past, if they wish. The existing national 
 bank notes, constituting about one fifth of the aggregate amount 
 of money in the country, could not be suddenly withdrawn from 
 circulation without serious consequences. But the Federal 
 Reserve Act provides that the national banks may gradually 
 get rid of their note-issue liabiHties by selling the government 
 bonds they hold as security for their notes to the federal reserve 
 banks at par. The federal reserve banks, if they wish, may 
 
3IO OUTLINES OF ECONOMICS 
 
 Utilize these bonds as security for the issue of federal reserve 
 bank notes, which in all essentials are like national bank notes. 
 The extent to which national banlcs will give up their note issues 
 will depend very largely upon the price of government bonds. 
 
 More important, however, are federal reserve notes, issued by 
 the federal reserve banks (i) in exchange for gold, thus becoming 
 virtually gold certificates, and (2) upon the security of redis- 
 counted paper held by them. A 100 per cent reserve is held 
 against notes issued in exchange for gold ; a 40 per cent reserve 
 has to be held against notes issued on the security of rediscounted 
 paper. This last reserve requirement may, in emergency, be 
 waived by permission of the Federal Reserve Board, a graduated 
 tax being imposed upon deficiencies in the reserve. This makes 
 it possible, it will be seen, for member banks to secure currency for 
 their own borrowers and depositors by sending paper to the 
 federal reserve banks to be rediscounted, taking the proceeds 
 of such rediscounts in federal reserve notes. This means that 
 when the country needs more money for hand-to-hand circula- 
 tion it can get it by exchanging personal credit instruments for 
 federal reserve notes. Bank credit in the form of bank notes 
 can now be expanded quite as readily as bank credit in the form 
 of deposits. But it is not yet certain that an adequate mecha- 
 nism has been provided for the speedy contraction of the note issue 
 when the special needs that called for its expansion have passed. 
 Federal reserve notes are redeemable at the issuing banks and 
 (out of a redemption fund maintained by the banks) at the treas- 
 ury in Washington, and no federal reserve bank which has re- 
 ceived the notes of another federal reserve bank is permitted 
 to pay them out, but must return them promptly to the issuing 
 bank " for credit or redemption." Much depends then, so far 
 as contraction is concerned, upon the rapidity with which federal 
 reserve notes find their way back to some federal reserve bank. 
 
 Other Functions of the Federal Reserve Banks. — In addition 
 to being " bankers' banks," the federal reserve banks, it is 
 expected, will be bankers for the federal government. They 
 may, under the law, be used as depositories for all the general 
 funds of the government and may serve as " fiscal agents " of 
 
CREDIT AND BANKING 311 
 
 the government in various treasury operations. This will make 
 it possible for the government to use modern and economical 
 methods in caring for its receipts and making its payments, and 
 should also prove of advantage in its borrowing. 
 
 The federal reserve banks are also empowered to buy, sell, and 
 borrow gold coin and bullion, the securities of the federal govern- 
 ment, and the warrants and other short-time obligations of states 
 and municipalities. They may also buy and sell bills of exchange 
 arising out of either foreign or domestic trade. This last -power 
 enables them, in case of need, to come to the relief of banks not 
 members of the system. Buying bills of exchange from other 
 banks differs from " rediscounting " only in that in the latter 
 process the bills to be rediscounted are normally and usually 
 exchanged for deposit credits or bank notes. Under the law, 
 federal reserve notes cannot be issued upon the security of " pur- 
 chased " paper, but only upon paper " rediscounted " for member 
 banks, nor can federal reserve banks give deposit credit to banks 
 not in the system. This means that since " purchases " will 
 usually involve a direct drain upon the reserves of the federal 
 banks, their power of " purchase " is much more restricted than 
 their power of " rediscount." 
 
 But there is a yet more important aspect of these authorized 
 " open-market operations " in commercial paper. Only through 
 the use of this power can the federal reserve banks hope to make 
 their discount rates " effective " in the money market. Only 
 in this way can they expect to " put on the brakes " when they 
 think that bank credit is being expanded with dangerous rapidity 
 or encourage free lending on the part of the banks when condi- 
 tions are such as to make that policy seem desirable. Only in 
 this way, moreover, can they protect their gold reserves by the 
 use of devices similar to those which the Bank of England and 
 other European banks have found effective. The existence of 
 an " open market " for commercial paper means merely that 
 commercial paper, instead of being held till maturity by the 
 bank first discounting it, may be bought and sold freely, and 
 may move from one city to another and even from one country 
 to another, according to differences in prevailing discount rates. 
 
312 OUTLINES OF ECONOMICS 
 
 In the United States open market operations of this kind are not 
 yet of sufficient magnitude to give the federal reserve banks any 
 large opportunity for exerting their influence. They are con- 
 sequently endeavoring to stimulate the growth of open-market 
 operations. 
 
 The federal reserve system has been very carefully devised 
 for the purpose of getting rid of the principal evils inherent in 
 the national banking system as it was. If given a thorough and 
 fair test, it should accomplish that purpose. There is some 
 danger that the new system may make possible a too easy and 
 too rapid expansion of bank credit in periods of business pros- 
 perity, ending perhaps in reaction and crisis. But this danger 
 is inseparable from any really elastic system of bank credit. 
 With a wise exercise of the powers which the Federal Reserve 
 Board has over discount rates and reserves, the alternations of 
 periods of business prosperity and periods of business depression 
 should be less frequent and less violent than in the past. 
 
 The most formidable obstacle to the success of the federal reserve system 
 now apparent is the possible lack of cordial cooperation on the part of the 
 banks — especially the smaller banks — of the country. Very few state banks 
 and trust companies have become member banks, while a few member banks 
 have given up their national bank charters and have withdrawn from the 
 system. Despite the fact that the Federal Reserve Act modified the na- 
 tional banking law by permitting national banks to engage in various kinds 
 of banking operations which had previously been prohibited, some of the 
 bankers feel that membership in the system decreases their banking profits. 
 Member banks no longer get interest on their reserve deposits (although 
 this is compensated for, at least in part, by the reduction in the size of the 
 required reserves) and, if they utilize the federal reserve banks as clearing 
 and collection agencies for checks drawn upon other banks in the system, 
 they lose some of the profits from certain charges that had previously been 
 made for collections and exchange. The advantages of the system to in- 
 dividual banks will appear most clearly at time of crisis. But lessons of 
 periods like that of 1907 are soon forgotten. The greatest advantages of 
 the system, however, are its effects upon the commercial interests of the 
 country as a whole. A particular banker may feel that he can share in 
 many of the general advantages of the system without membership in it. 
 It is to be hoped that this absence of a sense of individual responsibility for 
 the general banking situation may not develop so far as to prevent the fed- 
 eral reserve system from attaining its maximum usefulness. 
 
CREDIT AND BANKING 
 
 313 
 
 TABLE IV 
 
 Combined Resources and Liabilities of the Federal Reserve 
 Banks: July 21, 19161 
 
 (In thousands of dollars) 
 
 Resources 
 
 Liabilities 
 
 Total reserve . . . . . 
 
 377,343 
 
 Capital paid in . . . 
 
 55,183 
 
 Five per cent redemption 
 
 
 Government deposits . 
 
 54,277 
 
 fund against federal re- 
 
 
 Member bank deposits . 
 
 492,000 
 
 serve bank notes . . . 
 
 450 
 
 Federal reserve notes ^ . 
 
 10,120 
 
 Bills discounted for mem- 
 
 
 Federal reserve bank 
 
 
 bers 
 
 28,937 
 
 notes 
 
 1,692 
 
 Bills bought in open mar- 
 
 
 Other liabilities . . . 
 
 . . .251 
 
 ket 
 
 85,382 
 
 
 
 United States bonds . . 
 
 49,746 
 
 
 
 One-year treasury notes . 
 
 7,190 
 
 
 
 Municipal warrants . . 
 
 27,723 
 
 
 
 Federal reserve notes, net 
 
 20,014 
 
 
 
 Other resources .... 
 
 16,738 
 
 
 
 Total 
 
 613,523 
 
 Total 
 
 613,523 
 
 The Present Position of State and Private Banks. — The 
 figures in Table V give only a partial idea of the present posi- 
 tion of banking in the United States, for while they are com- 
 plete as to national banks, there were, in 1915, over 3000 
 other banks which failed to make reports to the Comptroller 
 of the Currency. 
 
 "State banks," in the narrow sense, include only corporations chartered 
 by the individual states to conduct a general commercial banking business. 
 In a broader sense savings banks and trust companies incorporated tmder 
 state law may be said to be state banks. 
 
 ^ Compiled from statements in Federal Reserve Bulletin, Vol. ii, pp. 426, 427. 
 
 2 Federal reserve notes to the amount of $175,219,000 were outstanding at this 
 date but a large porportion of these were covered by gold set aside for the purpose 
 (and not included in the statement of resources) and others remained in the hands 
 . of issuing banks. The amount in circulation was $154,038,000. 
 
314 
 
 OUTLINES OF ECONOMICS 
 
 TABLE V 
 
 Number of Banks and Amount of Deposits in Specified Kinds of 
 
 Banks: 1915^ 
 
 
 Number 
 OF Banks 
 
 Deposits 2 
 
 State banks 
 
 14,598 
 2,159 
 1,036 
 1,664 
 7,605 
 
 $3,277,772,000 
 
 4,997,706,000 
 
 134,410,000 
 
 4,204,596,000 
 
 6,569,859,000 
 
 Savings banks 
 
 Private banks 
 
 Loan and trust companies 
 
 National banks 
 
 
 Total 
 
 27,062 
 
 $19,184,343,000 
 
 
 Savings banks do not usually do a commercial banking business ; that is, 
 they are not engaged in the sale of bank credit in a form that can be used in 
 making payments. Their deposit accounts are not usually transferable by 
 means of checks. They receive deposits of small savings and invest them 
 in long time securities, such as real estate mortgages and bonds of various 
 sorts. They perform an important social service by stimulating saving and 
 by increasing the financial power of small investors through concentrating 
 and combining their resources. Savings banks are organized either as cor- 
 porations or as mutual societies managed by a board of trustees acting for 
 the depositors. The latter type is especially common in the eastern states. 
 
 Trust companies were at first organized to take charge of trust funds and 
 to act as executors and administrators of estates. They have, however, 
 developed the functions of both savings banks and commercial banks, and 
 have even entered such specialized banking fields as foreign exchange and 
 the underwriting of corporation secvirities. They have thus the character 
 of free lances in the banking field. Their banking functions have developed 
 so rapidly that in many states they have been put tmder no such rigid control 
 as is exercised over state and savings banks. 
 
 Private banks are of two very distinct types. Some are small unincor- 
 porated banks in country towns. Others are great concerns in the financial 
 centers which deal in investment securities, buy and sell foreign exchange, 
 finance great corporate undertakings, and, in some cases, act as brokers in 
 the stock market. 
 
 It is impossible, in fact, to draw a definite line between "banking" and 
 
 ^ Compiled from Report of Comptroller of the Currency, Finance Report, 191S, 
 
 pp. S33, 595- 
 
 2 Exclusive of inter-bank deposits and postal-savings deposits. 
 
CREDIT AND BANKING 315 
 
 other financial iindertakings. Building and loan associations, private money 
 lenders, note brokers, dealers in investment securities, life insurance com- 
 panies, etc., frequently perform functions which are very much like some 
 kinds of "banking." But banking as the institution which converts per- 
 sonal credit into bank credit in the form of deposit accounts and bank notes 
 is a clearly defined thing, and has a distinct economic significance of its own. 
 
 QUESTIONS 
 
 1. Explain the various items in the published "statement" of a na- 
 tional bank. 
 
 2. Because a national bank can buy interest-bearing government bonds 
 and use them as security for its own issues of paper money, advocates of 
 government paper money issues have alleged that it gets "double interest 
 on its money." Is this true? 
 
 3. How should one compare the profitableness of issuing notes with the 
 profitableness of extending deposit credit? 
 
 4. What restrictions does your state impose on state banking corpora- 
 tions ? 
 
 5. Report on the note-issue systems of the Bank of England, the Bank 
 of France, the Imperial Bank of Germany, and the Canadian banks. 
 
 6. Report upon the relative advantages of the promissory note and the 
 biU of exchange as instruments of commercial credit. 
 
 7. Compare the provisions of the Aldrich plan with those of the federal 
 reserve system. 
 
 8. Does the supply of bank credit involve the sacrifice of "waiting" 
 on the part of anyone ? Who are the real or ultimate lenders ? 
 
 9. What are bank acceptances? trade acceptances? commodity paper? 
 
 10. Are bank notes more closely analogous to government paper money 
 or to bank deposits? 
 
 11. What points of superiority have bank notes over government paper 
 money? 
 
 REFERENCES 
 
 (See also references for Chapter XIV.) 
 
 Comptroller of the Currency. Annual Reports. 
 
 CoNANT, C. A. History of Modern Banks of Issue. 
 
 Conway, Thomas, and Patterson, E. M. The Operation of the New Bank 
 
 Act. 
 Dunbar, C. F. Chapters on the Theory and History of Banking. 
 Federal Reserve Board. Annual Reports; Federal Reserve Bulletin (monthly). 
 HoiDswoRTH, J. T. Money and Banking. 
 Knox, J. J. History of Banking in the United States. 
 •Laughlin, J. L. (editor). Banking Reform. 
 
3l6 OUTLINES OF ECONOMICS 
 
 National Monetary Commission. Publications. (A series of over forty mono- 
 graphs by different authors, giving as a whole the best available history 
 of banking in the United States and the best accoimts in English of the 
 banking institutions of other countries.) 
 
 Pratt, S. S. The Work of Wall Street. 
 
 Sumner, W. G. History of Banking in the United States. 
 
 Willis, H. P. The Federal Reserve; American Banking. 
 
 Withers, Hartley. The Meaning of Money. 
 
CHAPTER XVI 
 
 OTHER PROBLEMS IN MONEY AND BANKING 
 
 The Value of Money. — We have not as yet answered one 
 very important question, and that is, '^ What determines the 
 value of money? " Now by the " value of money " we mean 
 the purchasing power of money as reported or expressed by 
 the money prices of other things. There is no such thing in 
 fact as " the general purchasing power of money," although we 
 have found it convenient to use that and similar expressions. 
 Money has, in reality, a large number of different values, ex- 
 pressed by the different quantities of different things that it 
 will purchase. If the price of wheat is one dollar per bushel, 
 then one value — the wheat value — of money is a bushel per 
 dollar. Similarly, the purchasing power of money in sirloin 
 steaks may be four pounds per dollar. But how are we to 
 blend sirloin steaks, wheat, and other things into one concept? 
 The notion of the general value of money is simply a useful 
 abstraction, based on a broad view of all its different specific 
 values. 
 
 When we fix our attention upon changes in the various pur- 
 chasing powers of money, however, we are able to make a dis- 
 tinction between changes that are widespread and general, 
 and changes that affect only one or two commodities. For 
 example, a new invention may decrease the price of a particular 
 commodity, without affecting the prices of other things except 
 (if the demand for the commodity is elastic) by shifting demand 
 from other things to the commodity in question, — an effect 
 which would usually be slight so far as the price of any one of 
 these other things is concerned, for the demand would very 
 likely be shifted from many different lines of consumption. Or, 
 if the demand for the commodity in question is relatively in- 
 
 317 
 
3l8 OUTLINES OF ECONOMICS 
 
 elastic, a diminution in its price may increase the demand for 
 other things. But there are, on the other hand, price fluctua- 
 tions which are widespread and which show a general trend in 
 one direction or the other, and these we may call, with substan- 
 tial accuracy, changes in the value of money. What are the 
 underlying causes of these general changes in the values of 
 money? 
 
 The Nature of the Problem. — Our first impulse, perhaps, 
 is to suggest that there is no new problem here, that the value 
 of money is to be determined in the way that other values are 
 determined, and to seek to frame an explanation in terms of 
 marginal utility and the general laws of supply and demand. 
 But the task is not so simple as that. The analysis of marginal 
 utility, it is true, formed the basis of our explanation of the 
 shifting of demand from one commodity to another, but it does 
 not help us to explain the demand for money. Marginal 
 utility depends upon the capacity of things to satisfy human 
 wants, and money does not directly satisfy a single human 
 want, except the abnormal wants of the miser. We want 
 money only as we want the things that money will buy for us. 
 
 And when we turn to " supply and demand " we find at first 
 little help. For, it will be remembered, when we were discuss- 
 ing the relations between the prices of things and their supply 
 and demand, we arbitrarily limited ourselves to the consider- 
 ation of one commodity at a time. That is, we assumed that 
 the money price of the one commodity we were considering was 
 alone variable, and that the prices of all other things remained, 
 for the time being, constant. The consumer whom we pictured 
 as willing to buy a certain amount of a commodity at a certain 
 price or a larger amount at a lower price, was, by our premises, 
 merely comparing variable dollars' worths of the commodity in 
 question with fixed dollars' worths of other things. All the 
 values of money, save one, were held constant, so that the 
 imaginary consumer simply had to compare the utihty of larger 
 and smaller marginal dollars' worths of the one commodity 
 with their cost measured in a dollar that represented perfectly 
 definite amounts of all other things. Now the problem of the 
 
OTHER PROBLEMS IN MONEY AND BANKING 319 
 
 value of money (understood as the problem of general changes 
 in the different values of money) cannot be approached in 
 that way. For the problem of the value of money is merely 
 the obverse of the problem of the money values of all other 
 things. If we were studying the wheat value of money we 
 could assume the sirloin-steak value of money to be held 
 constant. But our present problem is that of the wheat value 
 of money and the sirloin-steak value of money and all other 
 values of money. We can't resort to the strategy of breaking 
 the sticks in our bundle one by one. 
 
 The Quantity of Money and the Values of Money. — All 
 this does not mean that there is no such thing as a " demand 
 for money." Using the word money in its broadest sense, 
 including all " rights to receive money " that are used in mak- 
 ing payments, it is clear that every sale of a commodity may 
 be viewed as a purchase of money, and every purchase of a 
 commodity as a sale of money. Going a step farther, and 
 remembering that one wants money only because of the things 
 money will buy, we may say that every sale of one commodity 
 is a purchase of the power of acquiring other things. A seller 
 cares nothing about the quantity of money — the number of 
 dollars — he gets in exchange for his goods, except in so far as 
 these dollars have certain exchange relations with other things, 
 including the things he buys as a consumer and the tilings he 
 pays for under the head of " expenses of production." Simi- 
 larly, a buyer cares not how much money he parts with in ex- 
 change for a definite quantity of goods, except in so far as the 
 money has alternative uses of greater or less importance. The 
 quantity of money — the number of dollars in the aggregate 
 supply of the instruments in which payments are made — has 
 no significance apart from the values of the dollars. 
 
 These two things — quantity and value — are in the case 
 of money bound together in a peculiar way. They are, in a 
 very real sense, not only interdependent but interchangeable. 
 A small amount of money of high purchasing power per unit 
 will meet the needs of both buyer and seller just as well as a 
 larger amount of money of lower purchasing power per unit. 
 
320 OUTLINES OF ECONOMICS 
 
 What are the conditions under which a general change in the 
 values of dollars is possible? Let us simplify the problem by- 
 assuming that the change is absolutely general and uniform; 
 that if, for example, the price of a bushel of wheat is seventy-five 
 cents and the price of a bushel of corn is fifty cents, an increase 
 in the price of wheat to a dollar and a half is accompanied by 
 an increase in the price of corn to a dollar, and by a similar 
 doubling of the money prices of all other commodities and 
 services. Things retain, we shall assume, precisely the same 
 exchange relations as before, except with reference to money. 
 If prices have thus increased, all the values of money have di- 
 minished by one half. As an intermediary, then, as a means of 
 obtaining other things, money has only half its former potency. 
 Sellers are demanding and receiving twice as many dollars 
 as before for given quantities of goods ; buyers are offering and 
 paying twice as many dollars as before per unit of goods pur- 
 chased. Remembering now that we are using the word money 
 in its broadest sense, including exchangeable credit instru- 
 ments, it is evident that twice as much money as before passes 
 from buyer to seller in exchange for every unit of everything 
 else that passes from seller to buyer. But this means that 
 one of two possible conditions must exist. Either (i) fewer 
 exchanges are being made, or (2) exactly twice as much money 
 as before is being exchanged for goods and services. So we 
 reach the very important conclusion that there must be a 
 definite relation between general changes in the values of 
 money and changes in its quantity. We need not as yet con- 
 cern ourselves with the question of which of these two related 
 things is cause and which is effect. But that these two things 
 are inseparably bound up, the one with the other, should now 
 be clear. 
 
 We may now state this principle in a somewhat broader 
 form : // the number of units of goods and services of every sort 
 annually exchanged for money remains constant, any increase or 
 decrease in the amount of money used in making payments must 
 he accompanied by an exactly proportionate general increase or 
 decrease in prices. It is not necessary for the truth of this 
 
OTHER PROBLEMS IN MONEY AND BANKING 32 1 
 
 theorem that all prices should change in the same proportion. 
 The general change in prices may, for example, be upward, 
 but some prices may rise by a smaller proportion or may even 
 fall, provided these are offset by sufficiently large increases 
 in the prices of other things. An " exactly proportionate " 
 general change in prices merely means such changes in specific 
 prices as will make possible an unchanged volume of transac- 
 tions with the increased or decreased number of dollars used in 
 making payments. A general increase or decrease in price is 
 of course identical with a general decrease or increase in the 
 various specific values of money. 
 
 The Equation of Exchange. — Some aspects of the general 
 relation between prices and the quantity of money can be con- 
 veniently represented by using algebraic symbols. Let M 
 represent the total amount of money in circulation, and let V 
 represent its rate of turnover, or velocity of circulation, that 
 is, the average number of times the various dollars in circulation 
 are exchanged for goods or services during the year. Then 
 MV will represent total money payments, measured in money 
 units. Let T represent the total volume of trade, or, more 
 accurately expressed, the total number of units of commodities 
 and services exchanged for money during the year. Finally, 
 let P represent the average price per unit paid for these com- 
 modities and services. The equation of exchange may now be 
 stated in its simplest form : 
 
 MV = PT. 
 
 This equation, it is obvious, amounts to the statement that 
 the quantity of money in circulation, multiplied by its average 
 rate of turnover, is equal to the average price per unit paid for 
 commodities and services, multiplied by the number of units 
 sold. This, in turn, is equivalent to the yet simpler statement 
 that the total amount of money paid for things during the year 
 equals the sum of the prices of all the units purchased. Stated 
 in this w^-Yj the equation of exchange is readily seen to be 
 necessarily true. In fact, it is a truism, — an identity, almost, 
 rather than an equation. But it is none the less significant, 
 
322 OUTLINES OF ECONOMICS 
 
 for the truism which it states is one which has very often been 
 forgotten. 
 
 Up to this point we have simphfied our problem by counting 
 as '' money " everything, including credit instruments, expressed 
 in terms of dollars and accepted in payment for other things. 
 But there are some important problems connected with the 
 relation of changes in the quantity of the generally accepted 
 media of exchange (money in the " narrower sense ") to changes 
 in prices. So we shall now let M represent the quantity of the 
 generally acceptable media of exchange, including metallic 
 money, government paper money, and bank notes. The sym- 
 bol M' will be used to represent the quantity of the trans- 
 ferable " rights to demand money " that are used in making 
 payments. These consist, almost entirely, of bank deposits 
 subject to check. Then the equation of exchange becomes : 
 
 MV + M'V' = FT. 
 
 This is a statement in algebraic symbols of the fact that the 
 amount of money in circulation, multiplied by its rate of turn- 
 over, together with the amount of bank deposits subject to 
 check, multiplied by their average rate of turnover, must be 
 equal to average unit prices, multiplied by the number of units 
 of things exchanged for money or for deposit credit. This equa- 
 tion is identical with the other one, except that a distinction is 
 now made between money and bank deposits. The principal 
 advantage of the use of the equation of exchange, in fact, is 
 that it enables us to discuss the relations between general 
 changes in prices and changes in the amount of metallic and 
 paper money without becoming involved in difi&culties of analy- 
 sis and of exposition that would otherwise be very formi- 
 dable. The problem becomes simply that of the relations be- 
 tween M and P in the equation of exchange. 
 
 If M and M' increase in equal proportion, while V, V, and 
 T remain fixed, P must also increase proportionally. That is, 
 all other things being equal, an increase in the amount of money 
 in circulation and in bank deposits must be accompanied by a 
 proportionate increase in prices. To what extent, in fact, are 
 
OTHER PROBLEMS IN MONEY AND BANKING 323 
 
 these " other things " likely to remain equal? In\he first place 
 a sudden increase in the amount of money in circulation is 
 very sure to increase T, the total volume of trade, by leading 
 to increased purchases. But in the long run the increase or 
 decrease of the total volume of trade must depend upon the 
 natural resources of the country, the productive energies of the 
 people, and the degree to which division of labor has been 
 achieved. It can have no permanent dependence upon the 
 amount of money in circulation. In the second place, a sud- 
 den increase in the supply of money is likely to bring about a 
 temporary decrease in F, its velocity of circulation, because a 
 larger amount of money may, for the time being, be kept idle. 
 But, with a given volume of transactions at given prices, V 
 must in the long run depend very largely upon the habits of 
 the people with respect to the amount of " pocket money " 
 usually kept on hand. Changes in habits of this kind are 
 slow, and may safely be neglected in studying the movement 
 of prices through even a considerable number of years. 
 
 When, in the third place, we come to consider the effect of an 
 increase in M upon the magnitude of M', the amount of bank 
 deposits subject to check, we find that these two things are 
 necessarily connected. For an increase in M, the amount of 
 money in circulation, is very sure to be accompanied by an 
 increase in bank reserves. Additions to the country's stock of 
 money will distribute themselves, ultimately, between bank 
 reserves and hand-to-hand circulation, and the proportions of 
 the country's monetary stock allotted to these two uses usually 
 fluctuate only between more or less definite, even if gradually 
 changing, limits. But an increase in bank reserves normally 
 brings with it an increase on M' , the amount of bank deposits 
 subject to check. Even in the absence of minimum reserve 
 laws, the ratio of aggregate bank reserves to aggregate bank 
 deposits is found, for the time being, to fluctuate around an 
 approximately constant proportion. An increase in M, there- 
 fore, is very sure to result in an increase in M' . 
 
 It follows, then, that despite a certain amount of variability 
 m the other factors in the equation of exchange, an increase in 
 
324 OUTLINES OF ECONOMICS 
 
 M, carrying with it a roughly proportionate increase in M', 
 must normally have as its most important concomitant a 
 similar general increase in prices. This, it will be noted, is in 
 harmony with the conclusion we had already reached without 
 the aid of the equation of exchange. But that conclusion was 
 stated in terms of the " amount of money (and credit instru- 
 ments) exchanged for goods and services," the volume of trade 
 being constant. We now see that a similar conclusion holds 
 true when stated in terms of the quantity of money in circula- 
 tion, the only qualifying factors being probable changes of 
 greater or less importance in (i) the rate of turnover of money, 
 (2) the ratio of the amount of money in bank reserves to the 
 total amount of money in circulation, (3) the ratio of bank 
 reserves to bank deposits, and (4) the rate of turnover of bank 
 deposits. Allowing for the influence of these qualifying factors, 
 an increase or decrease in the quantity of money, the volume of 
 trade being constant, must he accompanied by a proportionate 
 general increase or decrease in prices. This principle, known 
 as " the quantity theory of prices," has long been one of the 
 most important theorems of economics.^ 
 
 General changes in prices must, of course, accompany changes in any of 
 the factors in the equations of exchange, unless these happen to counteract 
 one another. If the volume of trade increases more rapidly than the supply 
 of money, and other things remain equal, prices must decrease. This is 
 the apparent explanation of the general fall in prices between 1873 and 1897. 
 The growing use of checks in making payments is substantially like an 
 increase in the supply of money. It increases the ratio of money in bank 
 reserves to money in hand-to-hand circulation, and thereby increases the 
 ratio of M' to M. Unless offset by changes in other factors, this must be 
 
 1 Professor Irving Fisher, by making skillful use of such statistics as are available, 
 has estimated the magnitude of the various items in the equation of exchange for 
 each year since 1896. For one factor, the total volume of trade, Professor Fisher 
 had to be content with relative figures, showing merely the estimated percentage 
 changes in the volume of trade from year to year. By using merely his figures for 
 M, V, M', V, and T, Professor Fisher was able to get values showing the relative 
 year-by-year changes in P which agreed very closely with figures derived from 
 the statistics of actual price movements. Similar estimates, based on somewhat 
 less complete statistics, had previously been made by Professor E. W. Kemmerer. 
 See Fisher, The Purchasing Power of Money; and Kemmerer, Money and Credit 
 Instruments in their Relations to General Prices. 
 
OTHER PROBLEMS IN MONEY AND BANKING 325 
 
 accompanied by rising prices. An improvement in the organization of the 
 banking system, making possible a smaller normal ratio of aggregate bank 
 reserves to aggregate bank deposits must also tend to increase prices. 
 Along with a phenomenal increase in the quantity of money in the past 
 twenty years there has been, in fact, a large increase in both the ratio of 
 deposits to money and in the rate of turnover of deposits. 
 
 The Mechanism of General Changes in Prices. — Thus far 
 we have considered only the mathematically necessary relations 
 between changes in the quantity of money and general changes 
 in prices. The quantity theory of prices, even when stated in 
 the form of the equation of exchange, tells us nothing about the 
 process of general price changes ; nothing, that is, about the 
 mechanism by which a change in the quantity of money oper- 
 ates to bring about general changes in prices. No one has ever 
 given a complete description or analysis of this process, and 
 doubtless no one description would fit all instances of general 
 price changes brought about by changes in the quantity of 
 money. But some aspects of the matter are tolerably clear. 
 
 Take an artificially simple case. Imagine an isolated com- 
 munity with no foreign trade and with no banks. Suppose 
 that a group of men find a long-forgotten hoard of gold, large 
 even as compared with the existing stock of gold in circulation. 
 Without increasing their own activities as producers the finders 
 are now able to purchase larger quantities of goods. These 
 additional purchases, it is important to note, are the direct 
 result of the increase in the supply of money, and could not have 
 been made without it. The merchants into whose hands the 
 money comes in turn expend it to replenish their stocks and for 
 other purposes. And so the money passes from hand to hand, 
 increasing the number of exchanges — the volume of trade — 
 just about proportionately to the increase in money. 
 
 But this increase in the volume of trade cannot be the end 
 of the process. More goods than before are passing into the 
 possession of their ultimate consumers. The country's stock 
 of exchangeable goods is being depleted more rapidly than it 
 can be replenished out of the country's normal agricultural and 
 industrial output. In short, the purchasing power of the com- 
 
326 OUTLINES OF ECONOMICS 
 
 munity, at the old level of prices, is now more than sufficient to 
 buy the current output. Under the pressure of competing 
 purchasers, desiring to exchange money for goods, prices will 
 rise. And if the industrial output cannot be permanently in- 
 creased the rise in prices will be proportionate to the increase 
 in the money supply, so that finally the larger supply of money 
 will have brought with it no permanent increase in the number 
 of exchanges. 
 
 The conditions under which general price changes resulting 
 from an increase in the quantity of money occur in actual life 
 are much more complex, and yet there is no reason to suppose 
 that in its fundamentals the process is essentially unlike that 
 which we have just outlined. There is, however, the difference 
 that additions to the supply of money usually find their way at 
 first into bank reserves, where their immediate effect is to lower 
 the discount rate. This leads to increased bank lending and 
 to larger bank deposits, and the immediate purchasing power 
 of the community, in the form of its power to draw bank checks, 
 is correspondingly increased. Increased purchases will be 
 made, and so far as the immediate effect upon prices is con- 
 cerned, it is immaterial that a large part of the increase may be 
 in purchases of labor, raw materials, and supplies, i.e. in expen- 
 ditures for " productive " rather than for " final " consump- 
 tion. Prices must rise, and this will draw a larger amount of 
 money into hand-to-hand circulation. With higher prices 
 people will find it convenient to keep somewhat larger amounts 
 of money on hand as " pocket-money." Finally, unless new 
 disturbing factors appear, equilibrium will be reached between 
 the amount of money in bank reserves and the amount of money 
 in hand-to-hand circulation. It seems probable, then, that 
 the sequence of processes by which an increase in the supply of 
 money actually brings about a general increase in prices may 
 often be (i) larger bank reserves, (2) lower discount rates, 
 (3) larger bank deposits, (4) more purchases, (5) higher prices, 
 (6) more money drawn into hand-to-hand circulation. Prices 
 get their initial upward impetus from the larger bank re- 
 serves, but the increase in the amount of money in hand-to- 
 
OTHER PROBLEMS IN MONEY AND BANKING 327 
 
 hand circulation helps to support and maintain the higher 
 price-level.^ 
 
 Thus far, however, we have neglected to take account of the 
 very important facts, (i) that gold has other than monetary 
 uses, (2) that the production of gold will itself depend in part 
 upon its purchasing power, and (3) that international gold ship- 
 ments are also partly dependent upon the relative purchasing 
 power of money in one country and another. Leaving the last 
 of these three topics for treatment in the following chapter in 
 connection with the general subject of international trade, we 
 pass now to the discussion of the other two. 
 
 The Relation of the Industrial Uses of Gold to Prices. — 
 From the estimates of the Director of the Mint it appears that 
 in recent years from one fourth to one third of the world's 
 annual production of gold finds its way into industrial uses. 
 The United States mints and assay offices refine nearly all the 
 crude gold bullion produced in or brought to this country, 
 and allow the depositor to take the proceeds in money or in 
 bars of gold for industrial use, as he prefers. But even without 
 this convenient arrangement there would be a constant balanc- 
 ing or comparison of the relative advantages of the industrial 
 and monetary uses of gold. The number of dollars which can 
 be got by selling gold for money and by actually converting 
 gold into money must, of course, always be approximately 
 equal. 
 
 More than that, there are two things quite distinct from 
 the direct process of selling gold bullion for money which help to 
 fix the ratios of exchange between gold and other things. Con- 
 sumers, on the one hand, are constantly weighing the marginal 
 utility of objects made from gold against the marginal utility 
 of other things. Producers, on the other hand, are. weighing 
 the relative profitableness of producing things made from gold 
 and things made from other materials. It is clear that gold will 
 be distributed between its industrial and monetary uses in such 
 a way as to equalize the exchange ratios of gold and other 
 
 ^ Cf. the testimony of Professor Alfred Marshall before the British Gold and 
 'Silver Commission of 1888, in Appendix to Final Report, p. 3. 
 
328 OUTLINES OF ECONOMICS 
 
 things for the two uses.^ If, for example, an increase in the 
 stock of money (whether gold or not) results in increased prices 
 {i.e. in decreased purchasing values of gold), a relatively larger 
 amount of the gold annually brought to the mints will tend 
 to flow into industrial uses, and thus to limit the increase in the 
 amount of money and the consequent rise in prices. 
 
 The Relation of the Expenses of Gold Production to Prices. — ■ 
 There is another way in which society makes direct compari- 
 sons between the value of gold and the value of other things. 
 Mining, like agriculture, is subject to the law of increasing 
 expenses, and the tendencies of prices to equal the maximum 
 expenses of production per unit holds true for both indus- 
 tries. Not only are there marginal mines, mines which it just 
 pays to operate, but in the most productive mines there are 
 margins, — certain depths, for example, beyond which the 
 expense of mining more than eats up the value of the product. 
 Through the operators of mines, society is continually compar- 
 ing the cost in labor and capital of the production of gold with 
 the cost, similarly measured, of the things that can be bought 
 with the produced gold. If the gold produced at the margin 
 will purchase things which consumers deem of less importance 
 than other things which might have been produced with the 
 use of no more capital and labor, capital and labor will grad- 
 ually be shifted from their marginal use in gold mining to the 
 production of other things. Here, then, as in the case of the 
 balancing between the monetary and industrial uses of gold, 
 we have a direct value-comparison of gold and other things. 
 
 Some years ago the Bureau of the Mint undertook an investi- 
 gation into the relation of the expense of gold mining to the 
 amount of gold produced. The conclusion reached is worth 
 quoting in this connection : 
 
 In every mining district there are mines producing at good profits, mines 
 producing at small profits, mines barely paying expenses, and mines oper- 
 ated at a loss, but with the hope that they will do better. Every increase 
 in costs would submerge the latter more deeply, add to the list of the un- 
 
 ^ The expense of transforming bullion into jewelry, etc., is left out of account, 
 as it does not affect the principle under consideration. 
 
OTHER PROBLEMS IN MONEY AND BANKING 329 
 
 profitable, and probably close some of them. ... A higher scale of work- 
 ing costs will bring losing experiments to an earlier conclusion, reduce profits, 
 and make mining ventures generally less attractive, and thus diminish the 
 output.! 
 
 To summarize : Marginal utilities and subjective values are 
 found in the industrial uses of gold. The particular form of the 
 law of normal price that is operative in agriculture also holds 
 true in gold mining (although it has to be stated in a somewhat 
 different way) . An increase in the supply of gold diminishes its 
 marginal utility in industrial uses. This is bound to decrease 
 the values of gold as money, on account of the ease with which 
 the supply of gold can be shifted to one use or the other. Such 
 a rise of prices, however, cannot continue indefinitely. The 
 increase of prices and wages brings increasing expenses in 
 gold mining, and, unless new gold mines are found or cheaper 
 ways of getting gold from old mines are invented, the output 
 of gold will have to decrease. 
 
 These things have a steadying influence upon prices. Tend- 
 encies toward extreme fluctuations in prices are held in check 
 by the resulting changes in the expense of mining gold and by 
 the automatic changes in the proportions of the annual gold 
 product that flow into monetary circulation and into industrial 
 uses. It is in these ways that the significance of the fact that 
 the monetary standard is itself a commodity appears. 
 
 The Increase in the Production of Gold. — Although prob- 
 ably more gold was produced between 1850 and 1875 than from 
 1492 to 1850, yet, as Table I shows, the annual production of 
 gold since 1896 has been from two to three times as large as it 
 was between 1850 and 1875. Most of this great output of gold, 
 as Table II indicates, comes from relatively few countries. 
 At present the British empire supplies over one half and the 
 United States (including Alaska) nearly one fourth of the total 
 product. The causes of this enormous increase were, in part, 
 the opening up of new gold fields in South Africa, Canada, 
 Alaska, and Colorado, and in part the improvements in methods 
 of extracting gold from low grade and refractory ores, in which 
 
 ! Report on the Production of the Precious Metals, 1904, p. 41. 
 
330 
 
 OUTLINES OF ECONOMICS 
 
 TABLE I 
 
 Production of Gold in the World since 1841 
 
 (From 1 841 to 1885 the estimate is from a table of averages for certain periods, 
 compiled by Dr. Adolph Soetbeer; for the years 1886 to 1912 the production is the 
 annual estimate of the Bureau of the Mint.) 
 
 
 Annual Average for Period 
 
 Period 
 
 
 
 
 Fine Ounces 
 
 Value 
 
 1841-1850 
 
 1,760,502 
 
 t 36,393,000 
 
 1851-1855 
 
 6,410,324 
 
 132,513,000 
 
 1856-1860 
 
 6,486,262 
 
 134,083,000 
 
 1861-1865 
 
 5,949,582 
 
 122,989,000 
 
 1866-1870 
 
 6,270,086 
 
 129,614,000 
 
 1871-1875 
 
 5,59i>oi4 
 
 115,577,000 
 
 1876-1880 
 
 5,543,110 
 
 114,586,000 
 
 1881-1885 
 
 4,794,755 
 
 99,116,000 
 
 1886-1890 
 
 5,461,282 
 
 112,895,000 
 
 1891-1895 
 
 7,882,56s 
 
 162,947,000 
 
 1896-1900 
 
 12,446,939 
 
 257,301,100 
 
 1901-1905 
 
 15,603,730 
 
 322,619,800 
 
 1906-1910 
 
 20,971,575 
 
 433,520,900 
 
 1911 
 
 22,348,313 
 
 461,939,700 
 
 1912 
 
 22,549,335 
 
 466,136,100 
 
 TABLE II 
 
 Recent Production of Gold in Different Countries ^ 
 
 Country 
 
 Africa 
 
 Australia 
 
 United States and Alaska 
 
 Russia 
 
 Canada 
 
 British India .... 
 
 Mexico 
 
 China ...... 
 
 All others 
 
 Total 
 
 1897 
 
 355 
 
 1900 
 
 88 
 
 13 
 
 129 
 
 97 
 
 III 
 
 132 
 
 86 
 
 119 
 
 121 
 
 35 
 
 31 
 
 37 
 
 9 
 
 42 
 
 25 
 
 12 
 
 14 
 
 18 
 
 II 
 
 13 
 
 19 
 
 9 
 
 8 
 
 7 
 
 26 
 
 35 
 
 35 
 
 38s 
 
 523 
 
 1 From Journal of Political Economy, vol. x, p. 580, and Finance Report, 1907, 
 p. 363. The figures are given in thousands of kilograms. 
 
OTHER PROBLEMS IN MONEY AND BANKING 331 
 
 connection the development of the " cyanide process " has 
 been of special importance.^ Dredging for gold in the beds of 
 rivers which drain gold-yielding lands, is a very recent devel- 
 opment of considerable importance. Notwithstanding the de- 
 crease in the value of gold, the bulk of the gold produced in 
 California today is from ore bodies that twenty-five or thirty 
 years ago were generally considered worthless. 
 
 The effects of this enormous output have been felt in both 
 Europe and America in a general increase of both prices and 
 wages. There are some who expect that the values of gold will 
 continue to depreciate for a long time in the future. Account 
 must be taken, however, of the automatic check which the 
 increase in wages and prices is bound to put on the production 
 of gold by increasing mining expenses. On the other hand, 
 still further economies in productive methods are possible. 
 
 Some Economic Effects of Changes in the Values of Money. 
 — We have seen that an increase in the amount of money 
 available for bank reserves leads to the expansion of credit, 
 stimulates business, and increases prices. The same results 
 are achieved, although not in the same way, by a sudden debase- 
 ment of the standard of value, or by the introduction of irre- 
 deemable paper money as the medium of exchange. Prices 
 are gradually increased under such conditions, there being an 
 unmistakable tendency to adjust them to the change in the 
 " dollar " or other unit of the medium of exchange.^ The 
 rising prices stimulate business by increasing profits. Profits 
 
 ^ "There are many mines in operation now at a profit which could not have been 
 worked at a profit ten years ago. There has been an important addition to the 
 gold and silver product by the recovery of these metals from lead and copper ores 
 by modern processes. The most important gains seem to have come, however, 
 through economies in management, particularly by enlarging the scale of operations 
 and by more complete extraction of the values from the ores treated." — Report on 
 the Production of the Precious Metals, igo4, p. 41. 
 
 ^ Possibly the effect upon other prices of the increased prices (measured in the 
 depreciated money) that have to be paid for imported commodities and that are 
 received for exported commodities is the key to this problem, just as it was undoubt- 
 edly the chief cause of the rise of prices to fit the bulUon value of coins from which 
 seigniorage had been taken. This is the explanation of the rise of prices under 
 the greenbacks suggested by Professor W. C. Mitchell, the historian of that move- 
 ment. 
 
332 OUTLINES OF ECONOMICS 
 
 are increased because most of the expenses of production are 
 incurred before the goods are sold, so that the rise in prices 
 increases the margin between prices and the expenses of pro- 
 duction, and because, moreover, some of the expenses of pro- 
 duction do not usually rise as rapidly as do prices. An expan- 
 sion of business activity of the kind already described is apt to 
 be the result, and this is not generally soon restrained by in- 
 sufficient bank reserves, for depreciated money is usually, 
 though not always, money that is coined or issued in large 
 quantities. 
 
 That periods of prosperity induced in this way are inevitably 
 short-lived and usually end in severe crises does not make them 
 any the less real. Nor should the fact that such artificial condi- 
 tions of business enterprise are apt to be accompanied by exces- 
 sive speculation and other unhealthy features blind us to the 
 fact that they accomplish some good. The encouragement 
 given to venturesome undertakings leads to the trial of new 
 methods of production, to the development of new natural 
 resources, to undertakings of vast proportion, to a general free- 
 ing of industrial organization and methods from the restraints 
 of habit and tradition. The foundations of modern large-scale 
 industry in the United States were laid in the period between 
 the Civil War and the panic of 1873. The period of state bank 
 note inflation preceding the panic of 1837 was a period in which 
 the industrial map of the United States was almost wholly 
 changed, and, in the long run, for the better. 
 
 A rapid increase in the supply of standard money may have a 
 similar effect. A tremendous expansion of international trade 
 followed the gold discoveries in California and Australia. In 
 the sixteenth century, increases in the supply of the money 
 metals, historians are agreed, hastened the fall of the medieval 
 economic system. The almost unparalleled development of 
 industry and industrial organization in the United States since 
 1897 must, with its good features as well as its bad, be at- 
 tributed in part to the increased supply of gold. 
 
 Business prosperity, however, does not always coincide with 
 the real economic welfare of the masses of the people. If 
 
OTHER PROBLEMS IN MONEY AND BANKING $$$ 
 
 prices are rising faster than money wages, real wages are ob- 
 viously declining. A period of falling prices is very apt to be 
 a period of increasing well-being for those whose incomes are 
 wages or salaries, although here we have to remember that 
 even if daily or weekly wages do not fall so rapidly as prices, 
 an increase of unemployment may affect total yearly incomes 
 adversely. 
 
 Crises. — Crises are frequently recurring phenomena of cur- 
 rent economic life. They are of all degrees of severity, but 
 are generally characterized by a scarcity of bank credit, a 
 sudden drop in prices, a subsequent period of industrial depres- 
 sion, lack of employment for wage earners, and kindred symp- 
 toms. 
 
 Crises are frequently attributed to " over production," or, 
 when that expression is criticized (because human wants are 
 never fully satisfied) to " under consumption." The two ex- 
 pressions are different ways of describing the same thing, and 
 both are misleading because they put the emphasis in the wrong 
 place. Production and consumption have to do with quanti- 
 ties of things and their fitness to satisfy human wants. Crises 
 spring from mishaps in the price process ; they relate to what 
 might be called the dollars and cents aspect of economic life. 
 It is difficult, even impossible, for observers to analyze all the 
 factors entering into a particular crisis, and it is even more 
 difficult to formulate a theory of crises that will be of general 
 applicability. There are some important things about crises, 
 however, that are relatively well known, and these will form 
 the basis of our discussion. 
 
 It is a significant fact that crises generally occur only as sharp 
 interruptions of periods of business prosperity, when credit is 
 abundant, prices relatively high, and employment plentiful. 
 Whatever may be the cause of a period of exceptional business 
 prosperity, it is apt to contain within itself the seeds of its own 
 destruction. The point will appear clearly if we put together 
 two conclusions that were reached in the preceding chapter : 
 first, that the supply of loanable funds in the form of bank 
 credit is a function of two variables, — the supply of personal 
 
334 OUTLINES OF ECONOMICS 
 
 credit and the supply of money available for bank reserves; 
 second, that personal credit is based on the probable amount 
 of future money incomes and probable future prices of property. 
 Suppose, for example, that business conditions are pros- 
 perous and promise to continue so, and that there is a plentiful 
 supply of money in the bank reserves. Expected prices and 
 expected profits are large, expected interest payments seem 
 certain. The power to get this future income depends, how- 
 ever, upon the possession of land, capital goods, franchises and 
 other privileges, the established business relations that give 
 rise to " good-will values," or upon the possession of income- 
 yielding securities, such as mortgages, bonds, stocks, etc. 
 Under such conditions, these things command good prices in 
 the market and may easily be hypothecated, either formally or 
 implicitly, in order to secure purchasing power, — bank credit. 
 The bank credit thus created is put into further investments 
 of capital and into the creation of further business opportunities. 
 These things serve in turn, so long as their income-yielding 
 power seems certain, as the basis of further extensions of bank 
 credit, and thus the process of business expansion continues 
 in a cumulative fashion. Overproduction, it is true, is present, 
 but it is the overproduction of the means of production and of 
 acquisition, — of railways, factories, and business schemes, — 
 and it is accompanied by the overappraisal, the overcapitaliza- 
 tion, of these things. An extensive period of increasing pros- 
 perity of this kind is, however, scarcely possible unless the 
 supply of money is increasing ; for bank reserves as well as the 
 amount of expected personal incomes condition the supply of 
 purchasing power. Very often, in fact, it may be a sudden 
 increase in the supply of money available for bank reserves that 
 gives the initial impetus to the rapid expansion of business. 
 Larger reserves, lower discount rates, larger investments, an 
 increased volume of trade, is as we have seen, the normal 
 sequence in such cases. Periods of rising prices are periods of 
 rising profits, for fixed charges, the rate of interest (even on 
 new borrowings), and wages do not usually rise as rapidly as 
 prices. These rising profits are, of course, the direct cause of 
 
OTHER PROBLEMS IN MONEY AND BANKING 33$ 
 
 the overinvestment in production goods and the overcapitaHza- 
 tion of business opportunities. 
 
 Any one of a number of things may be sufficient to precipitate 
 a panic under such conditions. The whole business structure 
 may fall to pieces through sheer topheaviness. That is, so much 
 production today is indirect, so large a share of productive 
 effort is devoted to forwarding in indirect ways the production 
 of goods that will be ripe for human use only in the compara- 
 tively distant future, that the mere operations of supply and 
 demand among business men themselves may maintain pros- 
 perous business conditions for some time. But in the long run 
 the maintenance of the values of producer's goods and privi- 
 leges depends on the demand, and hence on the income, of 
 ultimate consumers. Wages do not usually rise as rapidly as 
 prices in periods of business expansion. This simple fact may 
 in itself keep the average purchasing power of consumers 
 from expanding rapidly enough to furnish a solid support for the 
 growing structure of capital values. 
 
 Crop failures may precipitate a panic by diminishing the pur- 
 chasing power of those engaged in agriculture, and, possibly, by 
 reducing exports and thus necessitating the taking of gold from 
 the bank reserves to ship to Europe in payment for our imports. 
 When the credit situation is at all strained, the failure of one im- 
 portant bank may be enough to precipitate a panic. The bank's 
 creditors are prevented from meeting their own obligations; 
 the solvency of others is in turn dependent upon them, and thus 
 losses in expected and often already hj^othecated income are 
 transmitted from firm to firm and from industry to industry 
 in a constantly widening circle. The reduction of bank re- 
 serves by reason of the flow of money into hand-to-hand cir- 
 culation in order to effect exchanges at the higher level of prices 
 may itself be a contributing cause of a panic. 
 
 In fact, whatever may be the immediate cause of a panic, it is 
 bound to grow, in a condition of inflated capital values, with 
 tremendous rapidity. The collapse of credit leads to forced 
 sales of property in order that credit obligations may be met. 
 These reduce prices, lessen the security on which credit is 
 
336 OUTLINES OF ECONOMICS 
 
 founded, and render banks less able and less willing to make 
 loans. Moreover, the hoarding of money, which is apt to be a 
 feature of a panic, has a destructive efifect on bank reserves. In 
 a serious panic the liquidation of obligations has to work itself 
 out. Then the industrial process starts afresh, with lowered 
 values imputed to capital goods and to business opportunities, 
 and with property rights shifted, in some measure, to creditors. 
 
 Crises seem to be unpreventable so long as competition and 
 the credit system dominate in industry. Yet there are some 
 recent developments that may make them less frequent, and 
 possibly less serious. 
 
 The " integration of industry," whereby a whole series of pro- 
 ductive processes, from the production of the raw material to the 
 sale of the finished product, are brought together under one 
 management, decreases the number and complexity of credit 
 relations between producers, and tends to prevent the undue 
 expansion of those parts of the productive process that are 
 farthest removed from the consumer. The strong position of 
 the steel industry in the United States is a case in point. The 
 improvements in the bargaining power of wage earners result- 
 ing from their organization have enabled them partly to pre- 
 vent the widening of the gap between wages and prices in pros- 
 perous times, as recent American statistics show. On the 
 other hand, crop failures are and always will be a factor of 
 uncertainty. The best way of softening the rigors of a panic 
 and of restoring normal conditions promptly is through a wise 
 use of the lending power inherent in a system of really elastic 
 bank reserves, just as the best way of preventing panics is 
 through a firm control of discount rates when all other condi- 
 tions are ripe for a period of business inflation. It is in these 
 ways, perhaps, that the new federal reserve system can best 
 serve the country. 
 
 The Standard of Deferred Payments. — The relation of 
 changes in the purchasing power of money to long-time debts 
 and credits has some very important aspects. If prices increase, 
 the principal of a loan represents less purchasing power at the time 
 of repayment than at the time the loan was made. If prices 
 
OTHER PROBLEMS IN MONEY AND BANKING 337 
 
 decrease, the reverse is, of course, true. In periods of cheap 
 money agitations the additional burdens imposed upon debtors 
 in a period of decreasing prices are emphasized. An important 
 function of money, then, is found in its use as a standard of 
 deferred payments. 
 
 There is a partial, but only partial, compensation for the in- 
 justice to debtors and creditors resulting from general changes 
 in prices in the fact that the interest rate usually increases 
 when prices increase and decreases when prices decrease. This 
 is largely because rising prices increase profits, thus inducing 
 business men to pay higher interest rates in order to secure larger 
 supplies of funds for investment; while falling prices decrease 
 profits and lessen the demand for loanable funds. The result 
 of this is that the changing purchasing power of the principal 
 of a loan is to some extent offset or discounted by changes in 
 the rate of interest. The decline in interest rates as prices fall 
 makes it possible for debtors to pay off their old obligations with 
 funds borrowed at a lower rate of interest. Creditors cannot 
 so easily take advantage of the fact that interest rates are in- 
 creasing when the purchasing power of the principal of their 
 outstanding loans is decreasing. Nevertheless, more emphasis 
 has been given to the question of the standard of deferred pay- 
 ments in periods of declining prices, when debtors are in- 
 juriously affected, than in periods of rising prices, when credi- 
 tors are the losers. The United States is rapidly ceasing to be 
 a " debtor nation," and the farmers, in particular, are becom- 
 ing less distinctively a " debtor class." We may expect, 
 therefore, that in a future period of declining prices we shall 
 hear less about the injustice of our variable standard of deferred 
 payments. 
 
 Index Numbers. — General changes in prices are indicated 
 statistically by the use of index numbers. An index number, 
 in the most general sense, is some magnitude which varies with 
 some other magnitude or complex of magnitudes, and whose 
 variations can therefore be taken as representing or indicating 
 the other variations. In studying the variations of the price 
 ■ of some specific thing we need no index number ; but when we 
 
338 OUTLINES OF ECONOMICS 
 
 have to deal with the variations of many different prices, we 
 find the use of index numbers necessary. 
 
 The simplest way to form an index number of general changes 
 in prices is, first to select a list of things whose prices are to be 
 taken into account, next to ascertain the average price per 
 unit paid for each of these things in each successive month or 
 year of the period being studied, and finally to take the sum of 
 these unit prices in each of a number of successive months or 
 years as the index numbers. Such index numbers show the 
 variations in the total expense of a purchase consisting of one 
 unit each of the commodities included in the list. Thus if 
 bananas of a certain grade sell at a certain time for 15 cents a 
 dozen, oranges at 40 cents, and peaches at 25 cents ; and if a 
 month later the prices are 20 cents for bananas, 50 cents for 
 oranges, and 20 cents for peaches, the summed prices used as 
 index numbers are 80 cents and 90 cents respectively. This 
 means merely that the total money cost of a dozen each of these 
 fruits has increased by i2|- per cent. 
 
 For some purposes we get more significant results by weight- 
 ing the specific prices in accordance with the relative impor- 
 tance of the different commodities. If, for example, we think 
 that twice as many bananas as peaches are ordinarily used, and 
 three times as many oranges as peaches, we may take as our 
 weighted sum at the earlier date, .25 plus (2 X .15) plus (3 X .40), 
 or $1.75. For the later date the weighted sum is $2.10, indi- 
 cating a general rise of 20 per cent in the retail prices of this 
 small group of commodities. Accurate weighting is thus of 
 great importance in forming index numbers from a small list 
 of price quotations. If a very large list of prices is used, weight- 
 ing becomes of less importance, for there is no necessary con- 
 nection between the importance of a commodity and the 
 degree to which it has risen or fallen in price. Errors due 
 to the lack of weighting or to imperfect weighting thus 
 tend to offset each other. But even with a large and 
 thoroughly representative list of prices, the highest degree of 
 accuracy in index numbers cannot be reached without careful 
 weighting. 
 
OTHER PROBLEMS IN MONEY AND BANKING 339 
 
 Index numbers are, however, more often constructed as 
 averages than as sums. Thus the ordinary arithmetic averages 
 of the prices of these kinds of fruit at the two dates are .80 -j- 3 
 and .90 -^ 3, or .27 and .30 respectively. The weighted arith- 
 metic averages are 1.75 -f- 6 and 2.10 -^ 6, or .29 and .35. 
 The averages, of course, indicate the same proportionate gen- 
 eral change in prices as do the sums, but when the price list is 
 large the use of the average makes the series of price changes 
 somewhat more easy to inspect and interpret. 
 
 It is a common practice in making index numbers to substi- 
 tute relative prices for actual prices before summing or averag- 
 ing them. The price of each commodity at each date is set 
 down as a per cent of its price at some one specific date (or of its 
 average price during a certain period). Thus, in the illustra- 
 tion already given, if we use the earlier date as the " basing 
 period," the price per dozen of each kind of fruit is set down as 
 100. The relative prices in the later period then are : bananas, 
 133; oranges, 125; peaches, 80. This gives an unweighted 
 sum of 338, and an unweighted arithmetic average of 113, 
 indicating an average relative change in prices of 13 per cent. 
 Relative prices may also, of course, be combined by means of 
 weighted sums and averages. Index numbers utilizing relative 
 prices should be constructed and interpreted with great cau- 
 tion, because the results will vary according as one period or 
 another is used as the basing period. If, for example, in the 
 illustration already given, prices at the later date are used as the 
 basing prices, average relative prices at the earlier date become 
 93, indicating an average increase of only a little over 7 per cent 
 instead of the 13 per cent indicated when the earlier prices 
 were used as bases. When a large price list is used this particu- 
 lar source of error becomes of less (though not of negligible) im- 
 portance. But there remains the difi&culty that for periods 
 remote from the basing period this method exaggerates a rise in 
 prices and understates a fall.^ It is accordingly sometimes de- 
 sirable to use chain index numbers, in which the relative prices 
 
 * This grows out of the fact that a price cannot fall by more than 100 per cent 
 but can rise without definite limit. 
 
340 OUTLINES OF ECONOMICS 
 
 for each successive period are stated or expressed as per cents 
 of the prices in the period immediately preceding. That is, 
 the base is repeatedly shifted from one period to the next. 
 
 In constructing an index number from relative prices, other 
 kinds of averages than the ordinary arithmetic average may 
 sometimes be wisely used. The median relative price is the 
 one which divides all of the relative prices for a given date 
 into halves, — one half being lower and one half higher than 
 the median. The median is easy to find and easy to interpret. 
 Less used are the mode, — the relative price that occurs most 
 frequently at a given date, and therefore shows what is in a 
 way the most " characteristic " price change, — and the geo- 
 metric average, — the nth. root of the relative prices of n com- 
 modities. The geometric average has a number of advantages. 
 It gives less weight to extreme price variations than does the 
 arithmetic average ; geometric averages of relative prices show 
 just the same general price changes as geometric averages of 
 actual prices; and the results obtained are alike whether one 
 date or another is chosen as the basing period. It is, in prin- 
 ciple, the correct average to use when the problem is not that 
 of finding the change in the aggregate purchasing power of 
 money, but the (mathematically) different problem of finding 
 the general change in the different ratios oj exchange between 
 money and other things. 
 
 In general, whether one kind of index number is better than 
 another usually depends upon the character of the available 
 data and the use that is to be made of the results. For example, 
 if the problem is that of measuring the change in the cost of 
 living of the laboring classes, the best index number is a sum or 
 average of actual prices, weighted in accordance with the rela- 
 tive importance of the different items in the expenditures of 
 typical laboring-class families. Sometimes changes in prices 
 bring about such changes in the relative amounts of different 
 things purchased that if, for example, we are comparing the 
 cost of living in two periods rather far apart, we shall get differ- 
 ent results according as we weight our index numbers in accord- 
 ance with expenditures in one period or the other. 
 
OTHER PROBLEMS IN MONEY AND BANKING 341 
 
 TABLE III 
 
 Index Numbers of Wholesale Prices, Wages, and the Cost of 
 LrvLNfG IN the United States: 1890-19 12 
 
 Year 
 
 Wholesale 
 Prices ^ 
 
 Wages 2 
 
 Cost of Living 
 
 112. 9 
 
 100.2 
 
 105.6 
 
 III. 7 
 
 100.5 
 
 105.8 
 
 106. 1 
 
 101.8 
 
 103-7 
 
 105.6 
 
 101.6 
 
 104.6 
 
 96.1 
 
 96.7 
 
 98-3 
 
 93-6 
 
 98.2 
 
 96.0 
 
 90.4 
 
 99 -o 
 
 94-6 
 
 89.7 
 
 99-3 
 
 94-7 
 
 93-4 
 
 99.6 
 
 97.1 
 
 101.7 
 
 103.0 
 
 99-S 
 
 110.5 
 
 107.0 
 
 105.3 
 
 108.5 
 
 110.2 
 
 107.5 
 
 112.9 
 
 114.4 
 
 112. 6 
 
 113.6 
 
 119.8 
 
 "4-5 
 
 113-0 
 
 122.6 
 
 115.0 
 
 iiS-9 
 
 125.5 
 
 "5-3 
 
 122.5 
 
 132.0 
 
 120.0 
 
 129.5 
 
 137-I 
 
 125.8 
 
 122.8 
 
 133-5 
 
 125.4 
 
 126.5 
 
 132.9 
 
 130.0 
 
 131.6 
 
 137-6 
 
 I3S-2 
 
 129.2 
 
 141.0 
 
 133-3 
 
 133-6 
 
 145.2 
 
 141.0 
 
 1890 
 
 I89I 
 
 1892 
 
 1893 
 
 1894 
 
 189s 
 
 1896 
 1897 
 1898 
 1899 
 
 1900 
 I90I 
 1902 
 
 1903 
 
 1904 
 
 1905 
 
 1906 
 
 1907 
 
 1908 
 
 1909 
 
 I9I0 
 I9II 
 I9I2 
 
 ^ Bulletin of the United States Bureau of Labor Statistics, No. 173, p. 126. An 
 unweighted arithmetic average of the (relative) average yearly wholesale prices 
 of about 240 commodities. Price quotations used are so chosen as to constitute 
 in themselves a rough and unsystematic weighting. Average actual prices from 
 i8go to iSgg are used as bases. 
 
 * From W. I. King, The Wealth and Income of the People of the United States, p. 
 195. Weighted average of the relative average wages per hour for male wage earners 
 in various manufacturing industries, railroad transportation, mining, and agri- 
 culture. By reason of paucity of data these index numbers and those of the cost of 
 living are subject to wider margin of error than those for wholesale prices. The 
 basing period includes the years from 1890 to 1899. 
 
 'From King, op. cit., p. 180. A weighted average of statistics for (i) retail 
 prices of food, (2) cost of fuel and hght, (3) cloth and clothing, (4) house furnishing 
 ■ goods, and (5) miscellaneous items. Relative prices are used throughout and are 
 per cents of average prices in the period from 1890 to 1899. 
 
342 OUTLINES OF ECONOMICS 
 
 It is often important to know the distribution as well as the 
 general trend of price changes. The range of variation of the 
 different relative prices might, for example, be comparatively 
 large above the average and comparatively small below it. 
 These are various ways of measuring and stating the distri- 
 bution of price changes but their adequate consideration would 
 lead us into matters too technical for discussion here. The 
 whole matter of index numbers is full of subtle difficulties, some 
 of them mathematical, but more of them demanding primarily 
 a clear-headed analysis of the economic problems involved. 
 
 Index numbers of prices and wages are available for the 
 United States for the period since i860, and some figures have 
 been compiled for earlier years. For the period 1 860-1 880 
 Mitchell's^ are the best; the period from 1890 to the present 
 is covered by the United States Bureau of Labor Statistics ^ and 
 for the gap from 1880 to 1890 Falkner's are available.^ Several 
 financial journals also publish tables of price changes.^ 
 
 Some writers have suggested the possibility of a tabular mon- 
 etary standard, to be maintained by frequently changing the money 
 unit in accordance with the showings of an officially kept sys- 
 tem of index numbers. To do this by periodically altering the 
 amount of bullion in standard coin would be impracticable,^ 
 
 1 In his Gold, Prices, and Wages under the Greenback Standard. 
 
 2 In various numbers of the Bulletin of the Bureau of Labor Statistics. 
 
 3 In "Aldrich Report" on Wholesale Prices, Wages, and Transportation, Senate 
 Doc, 32d Cong., 2d Session, No. 1394. 
 
 4 For an account of modern index numbers of wholesale prices see Bulletin of the 
 Bureau of Labor Statistics, No. 173 (July, 1915), Part ii. 
 
 ^Professor Irving Fisher has suggested that the dollar might be "stabiUzed" 
 by making the real monetary standard a variable amount of gold bulHon. Accord- 
 ing to his plan, gold coins of the present weight might be retained, but if the oiEcial 
 index number should show advancing prices, the mint price (in gold bulhon) of gold 
 coins would be shghtly increased and at the same time the gold coins in circulation 
 would be made redeemable at the treasury in (nearly) as much gold bulhon as con- 
 stitutes the increased mint price of the coin. If prices show a continued tendency 
 to increase, the gold dollar would virtually become a gold certificate for a consider- 
 ably larger amount of gold bullion than it contains. This plan could be so oper- 
 ated, Professor Fisher beheves, as practically to eliminate general price changes. 
 It is clear that no one nation could introduce such a plan, because it would cause 
 highly objectionable fluctuations in the price of foreign exchange and in the domestic 
 prices of imported goods and of impTirtant exports. It could be adopted for inter- 
 
OTHER PROBLEMS IN MONEY AND BANKING 343 
 
 while to abandon the use of a standard commodity and to 
 attempt to regulate prices by issuing fiat money and controlling 
 the amount in circulation would be, as we have seen, chimerical. 
 A tabular standard of deferred payments might be put in opera- 
 tion by laws providing for the increase or diminution of the 
 principal of debts according to changes in prices. It is prob- 
 able, however, that this would be satisfactory to neither debtors 
 nor creditors. Moreover, should the tabular standard of 
 deferred payments be adjusted according to changes in the 
 prices of commodities, or according to changes in wages and 
 other incomes, or according to general changes in the prices of 
 commodities and services ? The really essential thing is to have 
 a commodity standard of value that shall be as stable as pos- 
 sible, and to maintain the convertibility of all other forms of 
 money with it. With gold as the standard of value, and with 
 all other forms of money redeemable in gold, changes in prices 
 are not apt to be rapid enough to work much injustice to either 
 debtor or creditor. The compensating influence of changes 
 in the interest rate must also be taken into account. The ques- 
 tion of the grievances of debtors and creditors has been over- 
 emphasized as compared with the really important economic 
 problems growing out of general changes in prices. These are, 
 as we have seen, first the effect on business enterprise, and 
 second, the effect on the purchasing power of money wages 
 and other forms of money incomes. 
 
 QUESTIONS 
 
 1. Construct simple index numbers for wholesale prices, in one city, 
 covering a period of a few weeks. (Use the market quotations in a daily 
 paper as data.) 
 
 2. How should one construct index numbers that would show the fluctua- 
 tions of P, in the equation of exchange ? 
 
 3. If half the money in the world were destroyed, would prices be doubled ? 
 If half the gold in the world were destroyed? 
 
 national use, as Professor Fisher shows, in the form of a (variable) gold-exchange 
 standard. But there are many practical difiQculties in the way of such a change. 
 
344 OUTLINES OF ECONOMICS 
 
 4. Would an increase of $1,000,000,000 in bank notes have the same 
 effect on prices in this country as the importation of $1,000,000,000 in 
 gold? 
 
 5. Explain the mechanism by which a decrease in the quantity of money 
 affects prices. 
 
 6. Report on the changes of prices, of bank reserves, and of bank deposits 
 accompanying the crises of 1893 and 1907. 
 
 7. Report on the socialistic explanations of crises. 
 
 REFERENCES 
 
 (See also references for Chapters XIV and XV.) 
 
 Davenport, H. J. The Economics of Enterprise, Chaps, xvi, xvii. 
 
 De Launay, L. The World's Gold. 
 
 Fisher, Irving. The Purchasing Power of Money; Why the Dollar is 
 Shrinking. 
 
 Jones, E. D. Economic Crises. 
 
 Kemmerer, E. W. Money and Credit Instruments in their Relation to 
 General Prices. 
 
 Mitchell, W. C. Business Cycles; "The Making and Using of Index 
 Numbers," Bulletin of the U. S. Bureau of Labor Statistics, No. 173. 
 
 Moore, H. L. Economic Cycles. 
 
 Veblen, Thorstein. The Theory of Business Enterprise, Chap. v. 
 
 Walsh, C. M. The Measurement of General Exchange Value; The Funda- 
 mental Problem in Monetary Science. 
 
CHAPTER XVII 
 INTERNATIONAL TRADE 
 
 The supply of gold, the development of trade, money, bank- 
 ing and credit, in short all the economic forces and institutions 
 discussed in the chapters immediately preceding, take on special 
 complexity when they become international in scope. The 
 fundamental principles underlying international trade and credit 
 are the same as those underlying domestic trade and credit — a 
 truth too frequently forgotten — but trade between two coun- 
 tries in which language, banking institutions, monetary units, 
 and monetary legislation are different presents special problems 
 which call for separate treatment. 
 
 Foreign Exchange. — In the beginning a brief description 
 must be given of the mechanism of foreign exchange. In in- 
 ternational as in domestic trade, only a small amount of money 
 is used, compared to the enormous money values of the goods 
 exchanged. Purchase is set against sale, debt canceled by 
 credit, and money is employed only for the occasional settlement 
 of balances. This cancellation of offsetting claims is effected 
 by the banks and bankers who engage in foreign exchange. 
 Their work is indispensable in the development of foreign trade. 
 The European War, for instance, by interrupting trafi&c between 
 Europe and South America opened up large export possibilities 
 to American manufacturers ; but it was found impossible to 
 take large or immediate advantage of this opportunity, partly 
 because the necessary banking and credit connections had not 
 been established between South America and this country. 
 
 As illustrative of the processes of foreign exchange, let us take 
 our trade with England. Ordinarily, an American exporter 
 who has sold goods to England draws an order — a hill oj ex- 
 change — on the English debtor, directing him to pay the claim 
 
 345 
 
346 OUTLINES OF ECONOMICS 
 
 at some specified time and place in London. American im- 
 porters, on the other hand, commonly pay their foreign balances 
 by buying bills of exchange or drafts on London, and sending 
 them to their English creditors. In this way American debts 
 and credits are balanced in London without transferring any 
 money at all, except occasionally to settle the balance of in- 
 debtedness. 
 
 Bills of exchange drawn on a commercial debtor are usually 
 accompanied by bills of lading, insurance receipts, certificates 
 of weight and origin, and all the documents necessary to give 
 the purchaser of the bill full title to the goods until the bill is 
 accepted or paid. They are accordingly referred to as " docu- 
 mentary bills " or " commercial bills," to distinguish them from 
 ^' bankers' bills " and other instruments of international credit 
 described hereafter. Documentary bills are freely negotiable, 
 passing from hand to hand by indorsement, and gathering 
 strength with each new indorsement. It is important, also, 
 to note the difference between " sight bills " and " long bills," 
 the former calling for payment upon presentation, the latter 
 usually for immediate " acceptance " by the drawee ^ and pay- 
 ment after thirty, sixty, or ninety days. The price of long bills 
 is fixed by the price of sight bills and the discount rate in 
 London. 
 
 We may now enlarge our simplified illustration to something 
 like life size. Documentary bills drawn by exporters or creditors 
 all over the country are sold by the drawers to bankers, usually 
 New York bankers, who may be called the " wholesalers of 
 exchange." The sale may be either direct or through exchange 
 brokers, " the jobbers of exchange." These documentary bills 
 are sent by the New York banks to their foreign correspondents 
 
 1 "Acceptance" of a bill definitely obligates the acceptor to pay it. Many im- 
 porters arrange to have bills drawn upon them accepted by some bank, protecting 
 the accepting bank by a deposit of collateral and paying it a commission for 
 its services. Bills accepted by banks ("bankers' acceptances") command a very 
 low rate of discount, and are for many reasons very desirable elements in an "open 
 discount market." The federal reserve banks are seeking to develop the use of 
 bankers' acceptances in the United States. National banks are now empowered 
 to accept bills of exchange originating in foreign trade. 
 
INTERNATIONAL TRADE 347 
 
 for collection (in the case of sight bills) or acceptance (in the 
 case of long bills). The balances thus built up abroad by the 
 New York banks constitute the fund against which they draw 
 their own bills. These are sold directly or through smaller 
 banks — the " retailers of exchange " — located in all parts of 
 the country. Foreign exchange is sold in a great variety of 
 forms — bankers' drafts, travelers' checks, travelers' letters of 
 credit, commercial letters of credit, cable transfers, and the 
 like — descriptions of which may be found in the references 
 given at the end of the chapter. 
 
 The illustrations used above, while typical of a large part of 
 the foreign exchange of this country, fail to represent adequately 
 the complexity which marks some of the interactions of inter- 
 national credit. An illustration of the more complex class is 
 found in the " three-cornered " or " triangular exchange." 
 We import from, very much more than we export to, South 
 America. A part of the debit balance — though possibly not 
 the larger part at the present time — is settled by the transmis- 
 sion of London drafts to our South American creditors, who can 
 use them advantageously in the settlement of their debts in 
 Europe. Our rate of exchange with any particular foreign 
 country is therefore controlled not by our trade with that 
 country, but by our dealings or general balance with the rest 
 of the world ; and London " clears " for the world as New 
 York " clears " for America and Paris for France. Just as 
 the net balance of our domestic trade is struck in New York, 
 so final international balances are cleared or settled in London, 
 although London's preeminence in international exchange is not 
 now so striking as it has been in the past. The European war 
 transferred, for the time being at least, a considerable amount 
 of this business to New York. 
 
 The question next arises how the price or rate of exchange is 
 determined. The factors controlling the price or rate of ex- 
 change are as numerous and as difficult to trace as the influences 
 which affect the price of any economic good of world-wide 
 purchase and sale. However, to facilitate discussion, we may 
 classify them as : (i) the amount of pure gold in the monetary 
 
348 OUTLINES OF ECONOMICS 
 
 units which are to be exchanged, (2) the cost of shipping gold, 
 and (3) " general credit conditions." 
 
 An English pound sterling contains as much fine gold as 4.866 
 American dollars, and when exactly this amount must be paid in 
 New York for a draft or order for one pound payable in London, 
 exchange is said to be at par. Sterling exchange and German 
 exchange are usually quoted in dollars and cents, i.e. the amount 
 of American money required to buy one pound or four marks 
 respectively. Consequently, they rise or become dear when 
 exchange mounts above par. French exchange, on the contrary, 
 is usually quoted in francs, the number of francs purchasable 
 with one dollar ; and it is consequently cheap when above par 
 and dear when below par. Exchange between the United States 
 and countries with silver or paper standards lacks the steadying 
 influence of a par determined by the actual mass of fine gold in 
 the respective units of value, and hence fluctuates much more 
 than exchange between countries on a gold basis. In order to 
 be as brief and clear as possible, the following discussion will 
 be confined to exchange between countries on a gold basis. 
 
 Fluctuations in the rate of exchange depend chiefly upon the 
 " general credit conditions " mentioned above, but it is plain 
 that upper and lower limits to these variations are established 
 by the actual cost of shipping gold. Suppose, for a moment, 
 that it costs two cents to transport $4,866 worth of gold bullion 
 between New York and London. Except under unusual cir- 
 cumstances, then, sterling exchange could not rise above $4,886, 
 nor fall below $4,846. Such limits are frequently spoken of 
 as the " gold points," " specie points," " shippmg points," or 
 " export and import points " ; and it is necessary to mention 
 them because of their frequent employment in discussions of 
 foreign exchange. But they are usually defined in much too 
 definite terms. The cost of shipping gold varies with the size 
 of the shipment, with freight, insurance, and interest rates, 
 and in some degree with the steamer and the season of the year. 
 Furthermore, gold is so important as the basis of bank credit in 
 all parts of the world that it is frequently imported regardless 
 of the rate of exchange. During the war between Russia and 
 
INTERNATIONAL TRADE 349 
 
 Japan, for instance, the Bank of France imported large quanti- 
 ties of American gold in this semiarbitrary way in order to pro- 
 tect reserves. The " gold points," then, while in one sense very 
 real, represent extreme limits and are in themselves variable. 
 
 Within these extreme limits set by the cost of shipping gold, 
 the rate of exchange varies according to general credit condi- 
 tions, i.e. with the supply of and dem'and for bills of exchange, 
 with discount rates here and abroad, and the innumerable forces 
 which influence discount rates. Suppose, for instance, that our 
 imports of merchandise in a given season greatly exceed our ex- 
 ports of merchandise. The demand for bills on London would 
 greatly exceed the supply of bills on London, and the price 
 of sterling exchange would rise very high if no other factors were 
 involved. But it may happen at the same time that interest 
 rates in New York are higher than in London, and under these 
 circumstances our foreign creditors may prefer to lend their 
 balances in New York in order to earn the high rate of interest 
 obtaining there. The placing of these loans in New York will 
 in turn reduce the demand for foreign exchange, and thus moder- 
 ate both the interest rate and the rate of exchange. 
 
 After the beginning of the European War, conditions became 
 exactly the reverse of those assumed in the preceding illustra- 
 tion. Europe bought enormous quantities of goods in this 
 country, there was an unprecedented excess of exports over 
 imports and a corresponding drop in the rate of exchange. We 
 loaned large sums to Europe, extending credits to foreign pur- 
 chasers and buying government securities. We also bought 
 back a very considerable quantity of American securities. All 
 this is indicative of the dependence of international trade upon 
 international credit and banking, of the fact that if we sell to 
 foreigners we must buy from them or give them credit, of the 
 interdependence of foreign exchange, interest rates, and the 
 territorial distribution or placing of credit. But it is more in- 
 dicative, perhaps, of the facts that the stock of gold is a world 
 stock, that the credits resting upon it tend to flow to the point 
 where they command the highest price, that the foreign ex- 
 changes evince normally a strong aversion to the actual move- 
 
3SO OUTLINES OF ECONOMICS 
 
 ment of gold, and that trade balances are for the most part 
 settled by the shifting of credits and securities. 
 
 This interaction of the domestic and the international money- 
 markets gives rise to a number of complex transactions which 
 can only be suggested here. In discussing, on page 347, the 
 sale of foreign exchange, American bankers were described 
 as drawing against credit balances which they had built up 
 abroad. Some bankers' bills, however, the so-called '' finance 
 bills," are drawn in excess of the foreign balances, and thus repre- 
 sent borrowings abroad. Finance bills are used (i) to tide 
 over the time before a plentiful supply of documentary bills is 
 available; and (2) to take advantage of low discount rates 
 abroad, e.g. in London, by borrowing in London and lending the 
 proceeds in New York. Under the latter circumstances, finance 
 bills payable in London at sixty or ninety days are sold in large 
 quantities in New York, the sellers commonly covering their 
 risk by the purchase of future drafts calling for the payment 
 of the same amounts in London at the dates when the bills 
 mature. The finance bill is thus one of many credit instruments 
 used to bring the loanable funds of the world to the market where 
 they will command the highest rate of interest ; and it is hardly 
 necessary to add that it assumes at times a highly speculative 
 character. " Bankers sometimes purchase outright entire new 
 issues of securities from corporations with proceeds obtained by 
 the issue of finance bills, sell the securities to investors during 
 the currency of the finance bills, and apply the proceeds realized 
 through the sale of the securities to the payment of the bills at 
 maturity." ^ 
 
 Regulation of the Gold Supply. — As explained above, com- 
 paratively little gold is used directly in international trade. 
 Yet there is nearly always some movement of gold. In the 
 regular course of her foreign trade, London is constantly shipping 
 and receiving gold, and the same is true in a general way of this 
 country. In January, 1914, for instance, $10,442,373 in gold 
 was imported, while the exports of gold in the same month 
 amounted to $6,914,056. 
 
 1 A. W. Margrafi, International Exchange, p. 41. 
 
INTERNATIONAL TRADE 351 
 
 In normal times, the discount rate is frequently used to regu- 
 late the distribution of gold, particularly in countries having 
 central banks. International banking houses keep funds in 
 both the United States and Europe, and they are constantly 
 shifting their money to the market in which it will earn the high- 
 est rate of interest. The means employed to move their funds 
 may vary, as has been explained, all the way from the simple 
 sale of foreign exchange to the actual importation of gold. So 
 great is the influence exercised by the discount rate over the 
 gold supply that the Bank of England, as we have seen, usually 
 finds it necessary to do nothing more than raise its discount 
 rate when it desires to attract gold to England or discourage its 
 exportation. But it is important here not to confuse the causal 
 relationship. The discount rate does not control the flow of 
 gold any more truly than the flow of gold controls the discount 
 rate. The two are mutually dependent, and both in turn are 
 subject to other independent influences. 
 
 The ordinary price level, that is, of merchandise, similarly 
 affects the rate of exchange and the movement of gold. When 
 prices abroad are high compared with American prices, foreign 
 countries increase their purchases, the supply of American 
 bills increases, sterling exchange falls, and if it goes low enough, 
 may cause the shipment of gold to this country. Such a condi- 
 tion of affairs, for instance, is likely to occur in the autumn 
 months, when large exportations of American cotton, wheat, 
 and agricultural products create a plethora of bills on London, 
 and other things being equal, depress the price of sterling ex- 
 change. 
 
 There can be no doubt, then, that the price level does influence 
 the movement of gold. It seems equally clear that the gold 
 movement influences prices. Some opponents of the " quantity 
 theory " of prices hold that it does not, maintaining that before 
 a drain of gold, for instance, could raise prices, it would so ele- 
 vate the discount rate that the drain would be checked. In their 
 view, the discount rate acts as a safety valve, through whose 
 variations any protracted gold movement which threatens to 
 disturb the price level is checked and reversed before it acquires 
 
352 OUTLINES OF ECONOMICS 
 
 the momentum requisite to accomplish the larger task. But 
 this assertion is for present purposes irrelevant. It makes little 
 difference whether the supply of gold acts through the discount 
 rate or directly. It acts. And we may be sure at least that if 
 the movement of gold continued indefinitely, prices would un- 
 questionably be affected. Nor should it be forgotten that a 
 low discount rate itself affects the price level. In any event no 
 country need fear the exhaustion of its specie. A protracted 
 excess of imports over exports commonly arouses apprehen- 
 sions on the point. Such fears are groundless. A continued 
 outflow of gold raises discount rates, tends to reduce prices, 
 and so draws back the specie through either new loans or 
 new purchases or both. 
 
 The gold supply thus adjusts itself automatically to the respec- 
 tive demands of the various districts of the world. This truth 
 is important because it establishes a prima facie presumption 
 against laws or policies which interfere with the normal distri- 
 bution of the precious metals. This presumption is only an 
 initial one, however. It does not follow that " artificial " inter- 
 ference with the distribution of the gold supply is never war- 
 ranted. Gold is purchasing power, representing universal and 
 instantaneous command over men and things, and as the foun- 
 dation of bank credit it is not too much to say that upon it 
 modern industrial civilization rests. The governments of to-day 
 are dependent in many ways upon the banks, and for this 
 reason the movement of gold must continue to be as responsive 
 to national political demands as to interest rates and prices. 
 Gold may be obtained not only in the course of international 
 trade, as that term is ordinarily understood, but by liquidating 
 international debts. From the period just preceding the Balkan 
 War until the outbreak of the European conflict, Europe steadily 
 liquidated or sold back its American securities, inspired either 
 by a general feeling of political insecurity or by definite prevision 
 of approaching hostilities. Gold moved in this case in obedience 
 to forces at once political and commercial ; the regulation was 
 both '' natural " and " artificial." 
 
 In times of war, panic, or severe financial stringency, extraor- 
 
INTERNATIONAL TRADE 353 
 
 dinary expedients for obtaining gold are sometimes used which, 
 like the heroic remedies employed in desperate illness, are necessi- 
 tated by the exigencies of the situation. In the scramble for 
 gold which precedes a war or attends a panic, the country or the 
 individual who stands aloof and waits for the normal laws of 
 distribution to bring him " his " share of the gold supply may 
 have cause to regret his inaction. Nevertheless, it is true that 
 such expedients, like strong drugs, are to be used with great 
 caution. They are frequently employed when the situation 
 does not demand them, their use tends to become a fixed habit, 
 and they seldom accomplish more than the postponement of the 
 crisis. An expedient of the kind described was employed by 
 Mr. Shaw, then Secretary of the Treasury, in the spring of 1906. 
 The following critical account of the action of the Secretary may 
 be unjust to him, for it must be remembered that the financial 
 stringency of the time threatened to become dangerous ; but it 
 illustrates in a striking way the subtle modern devices sometimes 
 used to increase the supply of gold. 
 
 " On April 14 it was officially announced for the first time, that the Sec- 
 retary would allow any depositary bank which engaged to import gold to 
 anticipate the arrival of the gold by withdrawing a like amount in cash from 
 the Treasury upon pledge of savings-bank collateral as security. The sum so 
 withdrawn was to be regarded as a temporary loan, and to be returned to the 
 Treasury as soon as the gold arrived. In providing such an arrangement, Mr. 
 Shaw virtually reduced the cost of importing gold by the amount of interest 
 during transit, and raised by so much the 'gold import point.' In other 
 words, he endeavored to make it profitable for the depositary bank to 
 import gold without waiting for sterling exchange to fall to the normal 
 'gold point.' ... In accomplishing this, Mr. Shaw temporarily elimi- 
 nated, so far as the national banks were concerned, one item of expense in 
 their foreign exchange operations. He gave them an advantage, for the 
 time being, over aU other firms engaged in the same business; and his 
 action naturally excited criticism among the private bankers who found 
 themselves discriminated against. Critics also attacked his method of 
 announcing his decision. It appeared that several days before the public 
 or the other banks were informed of his intention, Mr. Shaw had seen fit 
 to make private arrangements with two New York banks for gold imports 
 imder the plan . . . Nor was hostile criticism mitigated by the general 
 publication at this moment of the fact, which had not been widely known 
 before, that one of these same banks had been favored by the Treasury for 
 
 2A 
 
354 OUTLINES OF ECONOMICS 
 
 several weeks, and possibly months, preceding, with virtually the same 
 privilege under a different guise. This had been accomplished by allowing 
 the bank in question to count as part of its reserve its importations of gold 
 during their period of transit to New York. The imported gold had thus 
 been made practically available as a basis for loans from the moment of its 
 purchase abroad, and the item of time cost in such imports had been as 
 completely eliminated as under the subsequently adopted plan. . . . His 
 [Secretary Shaw's] statement issued at the time seemed to indicate that, 
 in his opinion, the natural movement of gold was toward this country, but 
 that the flow was being lured to other markets by the practices of European 
 banks. He apparently hoped to overcome what he took to be an artificial 
 diversion of gold from the United States by adopting, through the agency 
 of the Treasury, measures similar to those which were being employed by 
 the French and German central banks." ^ 
 
 It is this fear of panic and fear of war that to a large degree 
 explain the actual shipment of gold, with its risk, expense, and 
 loss by abrasion. If we could be assured of permanent peace 
 and had a perfect credit system most of the gold movement 
 would be unnecessary. If London were entitled to a gold 
 balance from New York, a negotiable instrument evidencing 
 that debt would under most circumstances suffice ; or the gold 
 could actually be set aside in the vaults of the New York sub- 
 treasury, marked with a London label and held until an opposite 
 state of exchanges made it necessary to change the labels. 
 
 The Balance of Trade. — Although credit devices make it 
 unnecessary to settle current trade balances with gold, the notion 
 still persists that an excess of merchandise exports is a good 
 thing and an excess of merchandise imports a bad thing. We 
 still speak of the former as a " favorable " and of the latter as an 
 " adverse " balance. To sell abroad as much, and to buy 
 abroad as little as possible still seems the ideal of many well- 
 meaning legislators and intelligent journalists. 
 
 Suppose for the purposes of discussion that the United States 
 succeeded in prohibiting imports for a long period, while at the 
 same time it succeeded in selling a large amount of merchandise 
 to foreign purchasers. What would happen? Evidently a 
 large portion of the money of the world would accumulate in 
 
 1 A. P. Andrew, Quarterly Journal of Economics, Vol. xxi, pp. 544-546. 
 
INTERNATIONAL TRADE 355 
 
 the vaults of American bankers, interest rates would fall, — 
 possibly to rise again later, — and eventually, if the process 
 continued long enough, the prices of American commodities 
 would ascend to such a level that foreign nations would be un- 
 able to continue buying in this country. At this point, evidently, 
 our hypothesis breaks down, and we are forced to conclude that 
 the original supposition was an impossible one. 
 
 This hypothetical case and its reductio ad absurdum are sufi&- 
 cient to establish certain important pratical conclusions. The 
 first is that a country cannot permanently sell goods for money 
 alone. If it produces large quantities of the money metals, it 
 will regularly sell those metals for the goods and services of other 
 nations. If it produces no gold or silver itself, it will secure them 
 through exchange; although, even in this case, gold and silver 
 are likely to constitute only a minor part of its imports. Perhaps 
 the gravest error one can commit in studying an international 
 trade balance is to treat it as an exchange of goods for money. 
 It is not even an exchange of goods for goods. The true inter- 
 national balance is one of claims against obligations, of credits 
 against debits. The complete statement is that the goods, 
 moneys, and services rendered by one country to other countries, 
 plus its claims and credits of all kinds, will be balanced by the 
 goods, moneys, and services received by the same country plus 
 its debts and obligations of all kinds. Or, to put the matter 
 concretely, we must include, along with the exports and imports 
 of merchandise and bullion, the invisible exchanges, loans which 
 the country makes or receives, annual interest payments on 
 loans and capital invested abroad, repayment of loans or the 
 purchase of securities, earnings of ships, insurance premiums, 
 and commissions of all kinds for international services, govern- 
 mental expenditures in foreign countries for diplomatic service, 
 payment of subsidies and war indemnities, remittances of im- 
 migrants, expenditures of travelers, and a thousand and one 
 other items, all tending, according as they depress or raise the 
 price of foreign exchange, to bring about the importation or ex- 
 portation of gold for the occasional balancing of the account. 
 
 A mere glance at this list of items entering into foreign trade is 
 
356 OUTLINES OF ECONOMICS 
 
 sufficient to puncture the old mercantilist idea that a " favor- 
 able balance of trade " or an excess of merchandise exports 
 brings about an increase of the money supply. This idea is as 
 fully refuted by commercial statistics as by economic analysis. 
 In the thirty- three years, 1 874-1 906, for instance, we had a large 
 excess of merchandise exports in all except four years, but there 
 was an excess of gold imports in only sixteen years. So, similarly, 
 there was probably little truth in the statement heard so fre- 
 quently when the previous edition of this work was published 
 (1908), that our then " favorable balance " indicated that the 
 United States was settling its indebtedness to foreign capitalists, 
 repurchasing American securities owned abroad, and thus bring- 
 ing the control of American enterprises more completely into 
 the hands of Americans. It may have meant this, to be sure, 
 but it more probably meant that we were paying England in 
 goods for carrying and insuring our exports, or that foreign 
 owners of American securities were taking in this form the annual 
 interest or profits due to them. That excess of exports repre- 
 sented the continuance of indebtedness rather than its liquida- 
 tion. 
 
 For the same reasons an " unfavorable balance of trade " or 
 an excess of merchandise imports is open to a variety of different 
 interpretations. It may mean that foreign capital is investing 
 more heavily in the country under discussion, or that the latter 
 country is taking, in the form of consumable commodities, 
 interest and profits on investments which it has previously made 
 abroad, or that it is selling its holdings in foreign enterprises 
 and taking the proceeds in the form of consumable goods. An 
 " unfavorable balance " of trade may thus be, in reality, highly 
 encouraging; and a " favorable balance " indicative of national 
 waste and extravagance. The precise meaning of any partic- 
 ular balance can be determined only after the most careful 
 study, and no dependence should be placed upon the offhand 
 interpretations of casual investigators. The great truth is that 
 there must be some sort of balance between the credits and 
 liabilities of any country, and that in practice a nation must be 
 willing to buy if it is anxious to sell. 
 
INTERNATIONAL TRADE 357 
 
 A scholarly analysis of the foreign trade of the United States, with a careful 
 interpretation of the meaning of the trade balance at various periods, may 
 be found in the North American Review for July, 1901, from the pen of 
 Professor C. J. Bullock. Professor Bullock's explanation of the balance in 
 two or three periods may be given, in order to illustrate the variety of factors 
 which must be taken into account when dealing with this subject. In the 
 period 1789-1820 the imports of merchandise and specie exceeded the cor- 
 responding exports by $511,000,000, and our obhgations were further in- 
 creased by interest on foreign capital invested in the United States to the 
 amount of $200,000,000 approximately. This total indebtedness of some- 
 thing over $700,000,000 was offset by the earnings of the American mer- 
 chant marine, estimated at about $800,000,000 for the period in question. 
 "So far, then, from the country being drained of its money in payment for 
 the balance of imported merchandise, the banks held not less than $20,000,- 
 000 of specie in the year 1820; while Gallatin and Crawford estimated that 
 there had never been more hard cash in circulation." 
 
 In the decade 1831-1840, owing to the high prices current in this country, 
 imports exceeded exports by $159,700,000; the imports of specie also ex- 
 ceeded the exports by $50,650,000 ; and the earnings of our merchant marine, 
 $90,000,000, sufficed only to reduce this "unfavorable balance" to about 
 $120,000,000. This remaining balance is accounted for by new foreign 
 investments in the United States, in particular by foreign purchases of state 
 bonds. "Our large imports of merchandise and specie had been made 
 necessary by the movement of foreign capital toward the United States." 
 
 In the decade 1851-1860 the merchandise imports again exceeded the 
 exports by $355,800,000 ; the net amount due to foreign creditors was some- 
 where between $100,000,000 and $130,000,000; and to offset these adverse 
 balances our merchant marine earned in this period only $158,000,000. The 
 remaining balance in this case was covered by our large excess of specie 
 exports, which amounted to $417,608,000, and was due to the discovery of 
 gold in California. "The United States had become one of the leading gold- 
 producing regions, and the course of the exchanges was inevitably altered." 
 
 In the periods briefly described above, the striking factors in our inter- 
 national trade were, respectively, the earnings of our merchant marine, new 
 investments of foreign capital in the United States, and large specie exports 
 following the discovery of gold in California. In the last period, from 1874 
 to 1896, our exports both of merchandise and specie greatly exceeded our 
 imports. "This meant simply," concludes Professor Bullock, "that the 
 country had assumed its normal position as a debtor nation on the various 
 items of invisible exchanges, and was paying annually something like $122,- 
 500,000 on such accounts." 
 
 The movement just preceding the European War was marked by features 
 of unusual interest. From 1910 to 1914 this country had a normal excess 
 of exports. In April, 1914, however, an "adverse" balance showed itself, 
 
358 OUTLINES OF ECONOMICS 
 
 and in the same month gold began to flow to Europe; the $50,000,000 
 mark was reached in the middle of June and by the end of November the 
 excess of gold exports amounted to $175,000,000. In the beginning the 
 outflow of gold was attributed to the Underwood tariff, which stimulated 
 imports by reducing duties. But gold continued to flow for a considerable 
 time after the excess of merchandise imports had given way to an unprec- 
 edented excess of exports. As a matter of fact the continued exodus of 
 gold was due far more to a wild scramble for gold abroad, particularly on 
 the part of Russia; to the forced "importation" of American securities 
 from Europe ; and to large European loans placed in this country than to 
 the excess of merchandise imports in the spring of 19 14. The movement 
 of American securities, it may be noted, began long before the declaration 
 of war and may possibly have marked the initial preparations for that 
 conflict. 
 
 Despite the continuance of heavy European borrowings, our decreased 
 importations from Europe and our heavy exports, especially of munitions, 
 turned the tide in December. The excess of gold imports over gold exports 
 grew month by month, being nearly $80,000,000 in October alone. For 
 the year 1915 the excess of gold imports amounted to $420,500,000. 
 
 Restriction of International Trade, — In ancient times among 
 many nations, such as the Hebrews and Chinese, contact with 
 other peoples was feared and foreign trade was practically pro- 
 hibited. In Greece and Rome the greatest thinkers entertained 
 a profound contempt for trade, based in part upon the belief 
 that in exchange one party is usually cheated ; and this prejudice 
 was partially justified by the character of the primitive trader, 
 who was part sailor, part pirate, part merchant, and took all 
 the profit he could possibly extort in every transaction as in- 
 surance against the great risks of his calling. 
 
 At a later date, in the Middle Ages, when commerce between 
 the semi-independent cities of western Europe increased, trade 
 came to be highly prized by the average citizen, although it was 
 still condemned by the philosophic schoolmen; and it was 
 regulated in the most exclusive spirit. 
 
 "Every effort was made to keep trade as much as possible in the hands 
 of native citizens. For example, the Venetians forbade the Germans from 
 engaging in trade with the East by way of Venice, and the citizens of Liibeck 
 strove to keep the Baltic trade from the Dutch. . . . Foreigners were 
 mistrusted and partnerships with them were forbidden. Foreign visitors 
 were restricted in many ways in their commercial dealings with native citi- 
 
INTERNATIONAL TRADE 359 
 
 zens. Many occupations were closed to them; the length of their sojourn 
 and the number of their visits were limited ; they could not pass a town with- 
 out exposing their wares for sale and paying the required market dues. The 
 wants of the consumer took precedence over those of the producer or mer- 
 chant. At the weekly markets consumers could supply their needs before 
 the baker or merchant was allowed to make purchases. There was a com- 
 munity interest in the supplies of necessities, and often their exportation 
 was prohibited. The trade of neighboring peasants was restricted to the 
 home city, and laws regulating price, weight, measure, and quality were 
 common. This restrictive municipal policy was very much relaxed at the 
 great fairs which were held periodically in various parts of Europe." ^ 
 
 In the early modern period Mercantilism became dominant. 
 Commercial policies were controlled by the desire to get and keep 
 the precious metals. At first the exportation of specie was pro- 
 hibited; merchants trading abroad were compelled to bring 
 home cash for the goods they had taken out with them ; foreign 
 merchants trading within the home country were compelled to 
 exchange their cash for domestic goods before they departed; 
 exportation — except the exportation of raw materials needed 
 in the manufacturing industries — was encouraged ; and impor- 
 tation — except in the case of the precious metals and the skilled 
 artisans who were encouraged to immigrate — was discouraged 
 or prohibited. When it became apparent that the supply of 
 money had to be secured through international trading, the 
 greatest emphasis came to be laid upon the " favorable balance 
 of trade " ; and means, ranging all the way from bounties to 
 war, were vigorously employed to secure the carrying trade for 
 native ships. 
 
 Much mercantilistic legislation was immoderate, some of 
 it barbarous, most of it marked by short-sighted national 
 jealousy. Adam Smith has held it up to scorn. Some later 
 writers have defended it as in the main necessary. No verdict 
 on the subject needs to be given here. It accompanied the weld- 
 ing of the great modern states; and the consoKdation of the 
 smaller autonomies probably removed more restriction and 
 more petty mercantilism than the new consolidation called 
 into being. 
 
 1 G. M. Fisk, International Commercial Policies, pp. 15, 16. 
 
360 OUTLINES OF ECONOMICS 
 
 In a large historical sense Mercantilism was merely a cry 
 elicited by one of the sharpest of the world's great growing pains. 
 It was a symptom more than a cause or an explanation. It 
 marked the establishment of the division of labor on a territorial 
 basis, and recorded the replacement of the independent economy 
 of the Middle Ages by the modern economy of exchange. For 
 the latter, money was indispensable, and had to be secured at 
 any cost. 
 
 The mercantilist period has been followed — after a brief 
 laissez-faire reaction in some countries — by the period of pro- 
 tection in which we still linger. The extensive taxation of im- 
 ports still continues; but trade prohibitions and export and 
 transit duties have been largely abandoned in the more advanced 
 countries. In the United States export duties are prohibited by 
 constitutional law. But few nations have wholly risen above 
 mercantilist practices. Canada prohibits the importation of 
 oleomargarine and similar substitutes for butter ; Great Britain 
 prohibits the importation of sugar from countries paying 
 bounties on its production; Switzerland levies an export tax 
 on cattle, hides, and skins shipped from the country ; Norway 
 and Sweden tax the exportation of timber; and Russia still 
 attempts to control the Persian trade by levying transit duties 
 upon goods passing through her territories destined for Persia. 
 But export and transit duties in their old mercantilist uses have 
 nearly disappeared. 
 
 Extensive use is still made of export taxes for revenue purposes in South 
 America and the Orient; and trade prohibitions based upon grounds of 
 sanitation, morals, and what is generally called the "police power," are in- 
 creasing rather than decreasing. Turkey, for instance, levies an ad valorem 
 tax of I per cent upon all exports; and in general the most important 
 tropical products are still subject to export taxes. As for trade prohibitions 
 the continued necessity for their occasional employment is illustrated by our 
 federal law authorizing the President to suspend the importation of any 
 article which he regards as "dangerous to the health or welfare of the people 
 of the United States." 1 
 
 1 For a more complete enumeration of modern export duties and trade prohibi- 
 tions, see G. M. Fisk, International Commerical Policies, Chap. vi. 
 
INTERNATIONAL TRADE 36 1 
 
 Nature and Advantage of International Trade. — It is obvious 
 that there must be some restriction of foreign trade. Fiscal 
 necessity, for instance, forces most countries to raise a large 
 part of their national revenue by import duties. Until a few 
 years ago, " free-trade " England raised more national revenue 
 from customs than any other single source of taxation. Trade 
 restrictions have existed as long as international trade itself, 
 and the real problem is not whether there shall be any restriction 
 but where and when particular varieties of restraint are justifi- 
 able. To answer that question it is necessary to make some 
 examination of the nature and advantage of international trade. 
 
 By far the most important truth in this connection is the 
 simple fact that trade is a necessary part of the process of pro- 
 duction. Production consists of the creation of utility. The 
 production of time and place utility is the primary function of 
 trade. Trade, therefore, is as beneficial, as truly productive, as 
 agriculture or manufactures. The American people are just as 
 truly engaged in production when they buy pulp from Norway 
 as when they cut down their own spruce trees to be manufactured 
 into '' yellow journals." 
 
 Trade is not only productive in the sense that it creates 
 utilities, but it is an indispensable part of the division of labor. 
 Men specialize in the production of those things in which they 
 excel. A manufacturer of shoes may be a skilled cabinetmaker 
 as well, but except for recreation he will not make his own furni- 
 ture. By specializing in shoes he can buy with shoes, or the 
 proceeds of their sale, more and better furniture than he could 
 make with his own hands. An individual who makes anything 
 for himself must figure as part of the cost of production what his 
 labor could be sold for in other fields; and he obviously loses 
 money if on this reckoning the thing he makes costs more than 
 it could be bought for on the open market. The same is true 
 of communities. The city that by grants of land or the remis- 
 sion of taxes manufactures within its own borders things that it 
 could buy more cheaply outside, loses by the transaction. Not 
 only individuals but communities and nations must specialize 
 if the maximum productivity is to be secured. There is a 
 
362 OUTLINES OF ECONOMICS 
 
 territorial as well as a personal division of labor, and trade is 
 of the essence of both. 
 
 Exchange remains profitable, even though one of the parties 
 is superior in all-around productive efficiency. A good lawyer 
 may be able to do better work on the typewriter than his 
 typist. But it will still pay the lawyer to specialize in law 
 and to buy the stenographic service which he needs. Suppose 
 that we were suddenly brought into contact with a country 
 over which we had a universal productive advantage. Every- 
 thing would be cheaper here ; competition would force the other 
 country to buy from us in all lines ; gold would flow from that 
 country to this ; prices would fall there and rise here ; in time 
 an equilibrium would be reached and the other country would 
 sell to us the things in which our productive advantages were 
 least important. Articles of export and import would sell at 
 the same prices in both countries except for the cost of carriage. 
 Wages and the prices of non-transportable commodities might 
 differ widely in the two countries, even after the new equilibrium 
 had been reached. The question is not how much wages labor 
 receives, but what it costs in money to produce transportable 
 goods; and these costs may be identical (transport costs in- 
 cluded) while wages differ widely, owing to differences in the 
 productive efficiency of labor in the two countries. Each 
 country manufactures the product in which it has a comparative 
 advantage and buys with these products other goods which it 
 needs. It specializes in the production of those things in which 
 the comparative cost is lowest. This is the law of comparative 
 costs. If a group of individuals insist on making something 
 which they could buy for less than it costs them to make it — 
 counting their labor as cost at what it would bring in other 
 lines of industry — there is a comparative loss. 
 
 But what of the non-transportable goods, — houses and the 
 like? Assume a state of civilization in which the sole articles 
 of consumption and production are flour, cloth, and houses. 
 Assume that the United States produces flour and houses, buying 
 its cloth from England, and securing by such specialization or 
 division of labor more cloth than we could otherwise secure. 
 
INTERNATIONAL TRADE 363 
 
 Suppose the trade in cloth to be closed and the United States 
 forced to manufacture the cloth it needs. Capital and labor 
 would be diverted from the production of flour and houses to 
 the production of cloth. More houses and more flour would 
 have to be paid for a given quantity of cloth. A given quan- 
 tity of flour or house accommodation would buy less cloth than 
 formerly. In general there would necessarily be less flour, 
 cloth, and houses than before ; the general productivity of labor 
 and capital would be reduced ; and houses would be affected 
 exactly like flour and cloth by the lowering in the general 
 level of productivity. Non-exportable goods might be cheap 
 or costly ; that would depend upon the productivity of labor 
 and capital in each country. But that productivity is directly 
 affected by the productivity of labor engaged in the production 
 of export goods, and if the productivity of the latter is lowered 
 the productivity of the former will also be reduced. 
 
 The fundamentals of the problem are not changed by the 
 introduction of money. When the importation of cloth was 
 stopped England for a time would continue to buy flour ; but, 
 the price of cloth being raised, our purchases would fall off at 
 once ; specie would move from England to this country ; prices 
 would rise here and fall there ; capital and labor would be at- 
 tracted to the production of cloth ; wages as well as prices would 
 rise here. This is the initial and obvious effect of trade restric- 
 tion. For a time it raises prices and money wages and gives a 
 fillip to trade by making it profitable to start a new industry. 
 It is no wonder that protection is so popular. It is an industrial 
 stimulant. 
 
 But the sequel is different. The flow of specie from England 
 reduces wages and prices there, including the price of flour, and 
 in time England will be forced to produce more flour for herself. 
 This means a stimulus to the flour industry in England and a 
 corresponding decline of the flour industry in this country. 
 England's " stimulant " comes later. Trade restrictions tend 
 therefore, in the first instance, to raise wages and prices in the 
 . country imposing them ; but in the long run they produce al- 
 ternating periods of depression and activity in both countries, 
 
364 OUTLINES OF ECONOMICS 
 
 and enable one country to injure another by forcing the latter 
 to readjust her industries and even to produce things she would 
 prefer to secure by purchase. Tariff tinkering is one of the most 
 fertile sources of international friction and unquestionably one 
 of the major provocatives to war. 
 
 Up to this point our consideration has been confined to two 
 countries in the same stage of development, with no great differ- 
 ences in wages and interest. What if one country is newer, less 
 exploited, and has a higher level of wages and interest? 
 
 It will be noted in this case that labor and capital would be 
 migrating from one to the other, with or without tariff restric- 
 tion. If, however, the country with higher wages imposes 
 a tariff on cloth, as assumed above, the migration of capital 
 and labor would be hastened. The development of the cloth 
 industry in the younger country would draw some of the labor 
 and capital previously engaged in producing cloth in the older 
 country. The subsequent decline of the flour industry in the 
 younger country, however, would probably not send capital 
 and labor back to the old, because there would be better op- 
 portunities in the younger country. We can see no escape from 
 the conclusion that trade restrictions of this kind do tend to 
 hasten migration to the country where real wages are on the 
 higher level. The effect of such migration is curious and inter- 
 esting. Many writers hold that it does not permanently in- 
 crease the population of the newer country, but merely substi- 
 tutes immigrants and their offspring for descendents of the older 
 pioneers ; while in the older country population is not reduced 
 owing to the infinite expansibility of the labor supply within 
 the limits determined by the accustomed standard of living. 
 But these phenomena need not be considered here. Whatever 
 happens will be due chiefly to the fact that real wages and in- 
 come are higher in the one country than in the other. Tariff 
 restrictions exercise only a minor influence in this connection. 
 
 What if the older country had a positive tariff policy, with 
 import duties on some products, when the new country was dis- 
 covered and began to develop a foreign trade? In accordance 
 with the reciprocal influence upon the division of labor noted 
 
INTERNATIONAL TRADE 365 
 
 above, existing trade barriers would unquestionably exercise 
 an influence, probably a deleterious influence, upon the dis- 
 tribution of capital and labor in the younger country. If the 
 older country had heavy import duties on agricultural products, 
 the expansion of agriculture in the newer country would be 
 retarded and the development of manufactures stimulated. 
 There can be no doubt about the power of one country in- 
 juriously to affect the division of labor in another. But will it 
 pay the younger country to adopt countervailing or retaliatory 
 duties ? Can it secure the ideally perfect distribution of labor 
 and capital by retaliatory restrictions? 
 
 In theory this is partially possible. Revert to the illustration 
 in which under normal conditions the younger country would 
 produce flour, the older country cloth, and both countries houses. 
 Suppose the older country to place a tariff on flour so that more 
 flour and less cloth would be produced there. In all prob- 
 ability the older country would be forced to continue the im- 
 portation of some of the flour which it consumed. Under this 
 hypothesis the younger country could set in motion partiafly 
 corrective forces by placing an export duty on the shipment of 
 flour, by giving a bounty on the production of flour, or by 
 levying an excise duty on the production of cloth within its 
 borders. It is interesting to note in this connection that 
 England, in order to counteract the protective influence of the 
 import duties which fiscal necessity forces her to use, imposes 
 an excise duty of equivalent burden on the same goods produced 
 within her border, thus counteracting as far as possible any in- 
 fluence which the import duties might otherwise exercise on 
 production. 
 
 In practice, however, such corrective measures are nearly 
 useless. No country knows what the ideal or normal division 
 of labor for her would be. Moreover, export duties and boun- 
 ties are costly to administer and liable to abuse. Conceivably, 
 of course, trade interference by one country may become so 
 unreasonable, so unsettling, so capriciously injurious, that other 
 countries may be forced to protect themselves. For instance, 
 one country may deliberately adopt the policy — by giving 
 
366 OUTLINES OF ECONOMICS 
 
 bounties or preferential freight charges and the Hke — of pre- 
 venting the development in another country of an industry in 
 which the former is specially interested. Under such circum- 
 stances other countries may be justified in protecting an estab- 
 lished industry by the necessary retaliatory legislation. 
 
 The general political and social aspects of protection are dis- 
 cussed in the next chapter. They furnish, as will be seen, some 
 theoretical justification for trade restriction. Surveyed as a 
 purely commercial question of dollars and cents, however, the 
 profitableness of the unregulated territorial division of labor is 
 beyond all question of doubt, in the opinion of the authors; 
 and the history of international trade fully confirms the bald 
 theory here outlined. That theory has been exposed to the 
 most searching practical test to which any economic theory 
 could be subjected, and it meets the test successfully. If the 
 theory of comparative costs is correct, it follows that so long as 
 the comparative costs of producing goods vary among the 
 different nations of the world, so long there will be some inter- 
 national trade. Furthermore, since it is impossible to conceive 
 that the costs of producing all kinds of transportable goods will 
 ever be exactly proportional in the several countries of the world, 
 it is evident that international trading is bound to continue. 
 International trade can be permanently suppressed only by 
 raising freight charges to prohibitive level, or by deliberately 
 manipulating tariffs so as to suppress every new international 
 trade connection as soon as it springs up, or by the complete 
 destruction of industry in other parts of the world. According 
 to theory, then, international trade is for practical purposes 
 irrepressible and the ideal of an exclusive home market is a 
 delusion. 
 
 This theory, as stated above, has been subjected to the most 
 searching test. During the last fifty years trade restriction has 
 been piled on trade restriction and protective tariff walls have 
 been built higher and higher. But there has been no diminution 
 in international trade. On the contrary, it has increased and 
 developed by leaps and bounds. 
 
INTERNATIONAL TRADE 367 
 
 QUESTIONS 
 
 1. In what respects does foreign exchange differ from exchange between 
 two American cities? 
 
 2. What are the principal influences which ailect the rate of exchange? 
 
 3. Is the gold supply distributed according to the needs or the respective 
 demands of the various countries? Are needs and demands in this connec- 
 tion identical ? 
 
 4. Mention as many methods as you can by which governments have 
 endeavored to increase the supply of gold. 
 
 5. What is meant by the law of comparative costs? Is the American 
 custom of importing the finer textile fabrics and manufacturing the coarser 
 ones an effect of this law? 
 
 6. If a widow needs money so badly that she is willing to pay 200 per 
 cent a year for its use, is it wrong for a money lender to charge this rate ? 
 
 7. What is the real nature of the balance of trade? Does our excess of 
 exports (merchandise) mean that we are paying off our foreign indebtedness, 
 or merely that we are paying interest on our foreign indebtedness ? 
 
 REFERENCES 
 
 Bastable, C. F. Theory of International Trade. 
 
 Brown, H. G. International Trade and Exchange. 
 
 Clare, George. The ABC of the Foreign Exchanges ; The Money Market 
 
 Primer. 
 Escher, Franklin. Elements of Foreign Exchange. 
 FiSK, G. M. International Commercial Policies. 
 Glffen, Robert. "The Use of Export and Import Statistics," in Economic 
 
 Inquiries and Studies, Vol. i, Chap. ix. 
 GoscHEN, G. J. Theory of the Foreign Exchanges. 
 Laughlln, J. L. The Principles of Money, Chap. x. 
 Margraff, a. W. International Exchange. 
 
 Mill, J. S. Principles of Political Economy, Book iii, Chs. xvii-xx. 
 Spalding, W. F. Foreign Exchange and Foreign Bills. 
 Taussig, F. W. Some Aspects of the Tarif Question, Part i. 
 Withers, Hartley. Money Changing. 
 
CHAPTER XVIII 
 PROTECTION AND FREE TRADE 
 
 We are now in a position to reviev/ intelligently the pros and 
 cons of the modern tariff controversy. Because of the limita- 
 tions of space, the discussion will be confined almost wholly 
 to American conditions, although most of the arguments are 
 applicable to other countries as well. 
 
 The Case for Protection. — i. One of the most captivating ar- 
 guments for protection is the assertion that it promotes national- 
 ism, which is held to be a good thing. Domestic trade, it is 
 claimed, draws the citizens of a country together, while interna- 
 tional trade is cosmopolitan and tends to their separation. 
 Upon the creation of our federal government, state tariffs 
 were abolished and their place taken by a national tariff designed 
 partly to protect the whole of the country against the rest of 
 the world. The introduction of national protection thus went 
 hand in hand with the promotion of internal free trade ; and 
 Professor SchmoUer even maintains the general thesis that, 
 historically, this double process of internal abolition and external 
 extension of tariffs marks the formation of new states, partic- 
 ularly federal states. Protection against foreign competition, 
 he asserts, is thus historically coincident with the enfranchise- 
 ment of internal trade ; and has as its main object the creation 
 of a strong national economic unity, without which permanent 
 political unity, he thinks, is impossible. The validity of this 
 argument, it will be noted, depends largely upon the truth of 
 the assumption that the development of a strong feeling of 
 national unity is a thing to be desired. 
 
 2. Government should, the protectionists say, foster infant 
 industries in order to develop our natural resources and to pro- 
 
 368 
 
PROTECTION AND FREE TRADE 369 
 
 duce diversity in industrial pursuits. It is admitted that pro- 
 tection is temporarily expensive, but so is the prohibition of 
 child labor temporarily expensive. We prevent children from 
 earning a little while they are young in order that they may earn 
 more when they are old. For the same reasons trade unions 
 rightfully insist that apprentices shall be given a broad knowl- 
 edge of the trade they are learning, although it is more profit- 
 able for the employer to have them specialize early in some 
 narrow branch of the work. So, similarly, protection prevents a 
 nation from specializing too exclusively in its undeveloped stage, 
 in order that it may the sooner arrive at industrial manhood. 
 
 Economists have generally admitted that there is a certain 
 amount of truth in this argument. If an industry gets an early 
 start in a given district, this locality is likely to retain its advan- 
 tage because of the concentration there of capital and labor ac- 
 quainted with the requirements and possibilities of the industry. 
 Thus 63.3 per cent of all the needles, pens, hooks and eyes, manu- 
 factured in this country are made in Connecticut, for no other 
 reasons that one can see than those suggested in the explana- 
 tory phrase — " the momentum acquired by an early start." 
 And this localization of industry is artificially fostered by the 
 practice, common to exporters all over the world, of selling 
 abroad more cheaply than at home. The export trade seems 
 to be universally coddled. Of course, such localized industries 
 can be maintained only when the cost of transporting the article 
 is small; and when other districts do not possess unusual 
 natural advantages in the way of accessibility to superior raw 
 material, power, or skilled labor. The census studies in the lo- 
 calization of domestic industries ^ seem to indicate that while 
 the industrial inertia of which we have been speaking is an im- 
 portant factor, it is not so important as the opposing forces 
 making for territorial diffusion of industry. 
 
 A most interesting illustration of an attempt to crush the "infant indus- 
 tries" of a competing nation is found in the effort of English manufacturers 
 
 ^ Special Census Report, Manufactures, 1905, Part i, p. cck. Cf. also, Twelfth 
 Census, Manufactures, Part i, pp. cclx-ccxiv; and Thirteenth Census, Vol. viii, 
 ■ Chap. vii. 
 
370 OUTLINES OF ECONOMICS 
 
 after the War of 1812, to recover the American market of which they had 
 been temporarily deprived by the long period of nonintercourse. "English 
 manufacturers, eager to regain control of the lost markets, sent in ship- 
 loads of cotton and woolens and iron manufactures, which they offered on 
 the most liberal terms to their agents in this country. The goods were 
 taken on credit and disposed of at auction. The object was to imdersell 
 at any cost, and thus break down the infant industries. Lord Brougham 
 justiiied the speculative character of this trade on the ground that 'it was 
 well worth while to incur a loss upon the first exportation, in order, by the 
 glut, to stifle in the cradle those rising manufactures in the United States 
 which the war had forced into existence contrary to the natural course of 
 things.' " 1 
 
 3. Closely connected with the preceding arguments is a de- 
 fense of protection based upon grounds of war and military 
 necessity. Industrial independence, it is asserted, prepares a 
 nation better for international war. There is unquestionably a 
 great deal of truth in the argument. Germany has deliberately 
 used protective tariffs to preserve herself at least in part as an 
 Agrarstaat, and there has already been striking evidence of the 
 wisdom of her policy of maintaining a large measure of economic 
 self-sufficiency. Certainly a wise nation will see to it that within 
 its boundaries factories exist which can manufacture arms and 
 all the necessary munitions of war. Success in war is not de- 
 pendent upon arms and ammunitions alone. There must be a 
 plentiful supply of money, and whatever use may be made of 
 credit, enormous amounts of money must be raised by taxation.^ 
 The source of taxation is a flourishing condition of private in- 
 dustry; and the industry of the average nation dependent 
 upon international trade cannot flourish in times of war. But 
 even the ability to secure public revenues in adequate quantities 
 is less important in time of war than the ability of a nation to 
 feed and clothe its people and its armies when international trade 
 is suddenly cut off. The failure of the South in the Civil War 
 was very largely due to her industrial dependence upon the 
 cotton export trade. A sufficient diversification of industry to 
 
 1 Coman, Industrial History of the United States, p. 185. 
 
 ^ For a classic explanation of the dependence of both public credit and taxation 
 upon a flourishing condition of private business in times of war, see Henry C. Adams, 
 Public Debts. 
 
PROTECTION AND FREE TRADE 37 1 
 
 prevent industrial paralysis and to insure an adequate supply 
 of the necessaries of life in times of war is, we believe, mani- 
 festly desirable. 
 
 4. The home market argument for protection naturally follows. 
 Much that is said in defense of this claim is childish or silly. 
 One distinguished American economist seriously maintained 
 that a country can remain permanently prosperous only on 
 condition that what is taken from the soil shall be returned in 
 manure and other kinds of fertilizers, and that this will be ac- 
 complished only when the products of the soil are consumed 
 at home. A much stronger application of the argument, how- 
 ever, is found in the assertion that the home market is superior 
 because it is a surer market. A foreign market is usually a pre- 
 carious market. It is likely to be closed by war or by capricious 
 changes in tariff policy. Protection is unquestionably expen- 
 sive to the country that protects, but in the long run it is worth 
 paying something to keep industries in continuous operation. 
 
 5. This brings us to the argument for protection as a defense 
 against " dumping." By dumping is meant the sale of products 
 abroad at prices lower than those charged at home. Dumping 
 arises in a variety of ways. Export bounties may be granted 
 by the home country for the specific purpose of encouraging 
 foreign trade ; or a monopoly may find it profitable to dispose of 
 a surplus abroad at prices which would be needlessly low in the 
 highly protected home country; or manufactures may avail 
 themselves of the difference between fixed and variable expenses 
 of production to secure some profits over the specific or variable 
 expenses of production by selling abroad at prices which would 
 not be remunerative if applied to their entire output. More- 
 over, there is good reason to believe that many manufacturers for 
 the export trade make it a practice to sell abroad at unusually 
 low prices whenever they believe that their foreign market is 
 threatened. As was stated above, the custom of " coddling " 
 the export trade seems to be very general. 
 
 Now if the reduction of prices were permanent, the country 
 in which the products are dumped would have no real cause for 
 .complaint. On the contrary, it might logically regard itself as 
 
372 OUTLINES OF ECONOMICS 
 
 the beneficiary of the costly bounties of the other nation. But 
 real dumping is not, and in the nature of things cannot be, 
 permanent. So far as it may be said to have a rational object, 
 it aims to secure foreign markets by selling temporarily at prices 
 which in the long run would not be profitable ; and when the 
 market is secured, prices will be raised. So true is this that 
 economists have generally indorsed import taxes and other tem- 
 perate retaliatory measures designed to abolish dumping. 
 Canada, for instance, has authorized the levy in such cases of a 
 special dumping duty " equal to the difference between the 
 selling price of the article for export and the fair market value 
 thereof for home consumption." A few years ago the beet- 
 sugar industry of France and Germany was so stimulated by 
 bounties that even England, the principal dumping ground 
 of the product, was forced to threaten reprisals in the shape of 
 countervailing import duties. England's resolute attitude, it 
 may be added, led finally to the virtual abolition of sugar 
 bounties at the International Sugar Conference of 1903. In 
 general, there seems to be ample justification for protective 
 duties that are honestly used to ward off destructive attacks upon 
 home industries which, if subjected only to legitimate competi- 
 tion, would be able to maintain themselves in the long run. It 
 is evident that we have here returned to the substratum of truth 
 contained in the infant industry and home market arguments. 
 
 Dumping has been more productive of arguments against protection than 
 of arguments for protection, in the United States ; and the opponents of pro- 
 tection have laid great emphasis upon the fact that many articles of Ameri- 
 can manufacture are sold abroad more cheaply than at home. That this is 
 a fact is now generally admitted. But the protectionists maintain that 
 most of this can be explained by the rebates allowed to American exporters 
 under our drawback laws. Ex-Secretary of the Treasury Shaw estimates 
 that in 1906, owing to these drawbacks, about $140,000,000 of American 
 manufactures might have been legitimately sold abroad at less than domestic 
 prices.^ 
 
 6. Intimately related to the arguments which we have been 
 considering is the claim that the utilization of labor and capital 
 
 * Leslie M. Shaw, Current Issues, Chap. xxi. 
 
PROTECTION AND FREE TRADE 373 
 
 of a free-trade nation is subject to the control, and indeed, one 
 may say, to the whim and caprice oi foreign nations. Industries 
 differ in their effect upon the physique and character of the 
 people who pursue them. The builder, the skilled engineer, the 
 electrical worker, are benefited intellectually, physically, and 
 morally by their occupations. But the tailor, the maker of 
 ready-made clothing, and the sweat-shop worker are probably 
 harmed rather than elevated by the nature of their employment. 
 Now if foreign nations subsidize by protection and bounty the 
 desirable industries, they may leave to the free-trade nation 
 only those industries which the protected nations do not wish 
 to maintain. 
 
 7. Finally, protectionists appeal to the wage-earning classes 
 with the argument that protection increases wages by diversify- 
 ing industry and thus stimulating the demand for labor. Indeed 
 the typical protectionist goes farther than this, and maintains 
 that every American industry is entitled to an amount of pro- 
 tection equal to the difference between the wages which it pays 
 and the wages paid by its most efficient foreign competitor. The 
 latter variety of this argument seems to be plainly absurd, or at 
 least obviously inconsistent with the initial assertion that pro- 
 tection raises wages. For, taken together — and they are 
 frequently advanced in company — they result in this magnifi- 
 cently cumulative plea for ever increasing tariffs: protection 
 raises wages — but high wages put the American manufacturer 
 at a disadvantage in competing with foreign producers — and 
 the home producer must be protected to the extent of the differ- 
 ence in wages — therefore every advance in protective duties 
 laid for the benefit of the wage earner must be accompanied 
 by an additional advance for the benefit of the manufacturer — 
 and so ad infinitum. 
 
 8. That protective duties should be used to " equalize costs of 
 production " here and abroad, has been widely advocated as 
 the modern and scientific basis of protection. It would be hard 
 to find a more unscientific proposal. In the first place it is 
 vague and uncertain. Costs of production are not uniform, 
 either here or in foreign countries. What costs are to be 
 
374 OUTLINES OF ECONOMICS 
 
 equalized ? — costs to the most efficient producer here and the 
 most efficient producer abroad, or costs to the " typical " 
 producer here and the " typical " producer abroad, or costs to the 
 least efficient producer here and the most efficient producer 
 abroad? In the second place, certain costs, such as rent and 
 even wages, are more or less dependent upon tariff duties them- 
 selves, so that the proposal to determine duties by costs merely 
 get us into the vicious circle noted above. Furthermore, there 
 is no logical or natural limit to this process. If we are to equalize 
 costs in the textile and steel industries, why not equalize costs 
 in the production of bananas, coffee, and tea ? 
 
 As a matter of fact if this program could be carried out it 
 would stop all trade and so wipe out the whole gain from the 
 international division of labor. But fortunately the program 
 cannot be carried out. Economic goods take on a thousand 
 forms. We bar the importation of one variety only to find an 
 equivalent exchange springing up in another variety. This is 
 what we should expect from the theory of international trade, 
 and theoretical expectations are amply confirmed by history 
 and statistics. 
 
 Arguments of Free Traders. — In the first place, we may dis- 
 miss a number of arguments which are so extreme as to weaken 
 rather than strengthen the cause of free trade. 
 
 1. For instance, it is frequently alleged that protective 
 tariffs violate the assumed natural right of every man to 
 buy his goods where he will arid sell his products wherever 
 he sees fit, untrammeled by human laws. The futility of 
 arguments based upon an assumption of natural rights has 
 been sufficiently exposed elsewhere, and needs no elaboration 
 at this point. 
 
 2. It has also been claimed that protective tariffs in the United 
 States are unconstitutional, but this argument is idle ; it would 
 be most unfortunate and anomalous if nowhere in our country 
 were lodged the power to pass such regulations regarding in- 
 ternational commerce as might appear to be required for the 
 promotion of the public welfare. Furthermore, the charge of 
 unconstitutionality does not correspond to the opinion of our 
 
PROTECTION AND FREE TRADE 375 
 
 best jurists and there are no decisions of the Supreme Court 
 which in any way tend to support this claim. 
 
 3. In a similar vein protectionism has been called socialism, 
 but this epithet is so generally applied to whatever a person in- 
 competent to argue a cause does not like that it will scarcely 
 terrify any one. 
 
 The really able arguments of free traders are those which 
 aim to show either that protection actually does positive harm, 
 or that it fails to accomplish its ends, or that those ends may be 
 better accomplished without protection. 
 
 I. The natural starting point of the free- trade argument, and 
 the goal to which it inevitably returns, is the theory of comparative 
 costs laid down on page 362, the proposition that, so long as 
 there are relative, not necessarily absolute, differences in the cost 
 of producing cheaply portable articles in various countries of 
 the world, so long will there be international trade in those 
 articles. Protective tariffs, therefore, merely divert capital and 
 labor from intrinsically more productive to intrinsically less pro- 
 ductive industries. To revert to our simile of the lawyer and his 
 stenographer, protection aims to induce the lawyer to write his 
 own letters, on the general grounds that lawyers are more intelli- 
 gent people than stenographers, and if sufficient encouragement 
 be held out to them they may, in the course of time, be educated 
 up to the point of operating their own typewriting machines 
 better than the stenographers whom they have previously hired. 
 
 Temperate advocates of " freer trade " do not contend that 
 this law of comparative costs demonstrates the desirability of 
 complete free trade under all circumstances. They admit that 
 it may occasionally be profitable for a country to pay enormous 
 bounties — this is what protection amounts to — for the de- 
 velopment of certain industries. But they do contend that it 
 establishes free trade as the general rule, every departure from 
 which should require the most positive justification. More par- 
 ticularly, they hold, that at the present time, after a century of 
 industrial development that obviates any military necessity for 
 a further diversification of industry, capital and labor should be 
 freely allowed to take themselves to those employments in 
 
376 OUTLINES OF ECONOMICS 
 
 which they can reap the largest natural reward, a reward, that is 
 to say, which is not artificially enhanced by subsidies wrung from 
 the general body of consumers. 
 
 2. Moreover, it is not clear that protection is necessary to 
 diversify industry in a country with such varied natural resources 
 as the United States. The claims of the protectionists at this 
 point may be tested by examining conditions within the wide 
 borders of our own country, within which trade is wholly free. 
 Now, if protection were necessary to foster infant industries 
 and bring them to maturity, the manufacturing industries of this 
 country would still be concentrated in the northern states of 
 the Atlantic seaboard where they first gained a foothold. But 
 they have not been so confined. The early establishment of the 
 textile industries in New England has not prevented their recent 
 development in the South. Indeed, the so-called " center of 
 manufactures " moved steadily west from south-central Pennsyl- 
 vania in 1850 to central Ohio in 1900; and the increase, at the 
 present time, is much more rapid in the South and West than 
 in the older sections of the country. Internal free trade has not 
 prevented the diversification of industry in the United States, 
 and has not delayed it longer than was desirable. For who shall 
 say that the Dakotas and other typical agricultural states of the 
 Union have greatly suffered from the absence of grimy factory 
 towns? 
 
 3. The inevitable spread of manufactures throughout the 
 United States suggests the essential weakness of the home 
 market argument. International trade expands just as inevitably 
 as the manufacturing area. It might be desirable to confine 
 domestic producers to the more certain home market, which 
 cannot be destroyed by tariff wars or international complications. 
 But, as a matter of fact, home products will seek foreign markets, 
 and the nation that sells abroad must buy abroad. Since the 
 Civil War we have protected home producers with extremely 
 high tariffs. But in the last thirty years our foreign trade has 
 increased at a rate unequaled by any of the other great commer- 
 cial countries of the world.^ Protective tariffs can cripple and 
 
 1 Special Reports of the Census Office, Manufactures, 1905, Part i, p. ccc. 
 
PROTECTION AND FREE TRADE 377 
 
 harass and distract foreign trade, but they cannot permanently 
 suppress it. No tariff can make the costs of producing all the 
 articles common to commerce precisely proportional in all 
 quarters of the globe. 
 
 4. The protectionistic appeal to the wage earner seems par- 
 ticularly inconclusive. One reason for distrusting it is the 
 double-faced way in which it is manipulated to suit the partic- 
 ular requirements of time and place. France wants protection 
 in order to protect her low-paid workmen against the greater 
 skill and efficiency of America's highly paid workers. The 
 United States, on the other hand, must have protection in order 
 to shield her highly paid employees from competition with the 
 " pauper labor of Europe." When first used in the United States 
 the argument was that wages were already so high in this country 
 as compared with England, that it was impossible for manufac- 
 turers in this country to pay the American rates and continue 
 to compete with English manufacturers. Later, cause and 
 effect, as related in the earlier syllogism, were reversed, and it 
 was asserted that the high wages in this country were due to 
 protection, from which it followed naturally that in order to 
 raise wages higher, still more protection would have to be given. 
 
 We cannot arrive at any useful conclusions concerning wages, 
 however, without considering the efficiency of labor and the pro- 
 ductivity or favorableness of the environment in which the 
 laborer works. The reason why American labor may receive 
 higher wages and yet have nothing to fear from the competition 
 of less highly paid workmen in Europe is found in the great pro- 
 ductivity of American labor (though this greater productivity 
 may depend more upon the natural wealth of this country than 
 upon any innate technical superiority of the American workmen). 
 The average American workman is in no more danger from the 
 goods produced by the " pauper labor" of Europe than the highly 
 paid workman of Montana is threatened by the products of his less 
 remunerated fellow-workmen of New England and the South. 
 Labor competes with labor, not with commodities. Conse- 
 quently, if it is really desired to protect labor, the logical way 
 would be to place a tax on imported labor, or by other measures 
 
378 OUTLINES OF ECONOMICS 
 
 to reduce immigration. If this were done, those who desire labor 
 would be obliged to pay heavily for it, as actually happened in 
 England after the " Black Death " in the fourteenth century had 
 killed off a large part of the laboring population. Indeed, if our 
 tariff makers are sincerely anxious to benefit labor, they should, 
 after rendering labor scarce and dear by restricting immigration, 
 encourage the importation of such commodities as are consumed 
 primarily by wage earners, in order that labor may secure an 
 abundance of them cheaply. 
 
 No intelligent free trader would deny that there are now dependent upon 
 protection many industries which pay high wages, nor that the sudden aboli- 
 tion of protection would throw many wage earners out of work. Their con- 
 tention in the first case is merely that by taxation and by diverting capital 
 and labor into naturally unproductive industries, protection lowers the gen- 
 eral level of real wages. Their reply to the second point is that protection 
 affects the industrial organism much as the alcoholic habit affects the human 
 organism. To abandon the habit suddenly would certainly be painful and 
 probably dangerous — but this is suiificient reason neither for increasing 
 the dram nor delaying the gradual abandonment of the habit. 
 
 5. Turning to ih^ fiscal aspects of the question, the free trader 
 asserts that there is little or nothing to be said in favor of protec- 
 tion. The protective import duty, as compared with the import 
 duty " for revenue only," is a poor tax. It is uncertain and 
 viciously variable, and in the great majority of cases is borne 
 by the home consumer. To the extent that it does not prevent 
 importation it affords no protection; and in so far as it does 
 protect, it yields no revenue to the government. If it raises the 
 price of the article upon which it is levied, however, the increase 
 constitutes a tax upon one class of society — the consumer — 
 for the benefit of another class — the producers of the article. 
 One authority, perhaps the foremost authority, upon the Ameri- 
 can tariff problem, estimates that the tariff upon sugar imposed 
 by the Payne- Aldrich Act of 1909 resulted in an annual tax 
 upon American consumers of $101,000,000, of which $52,400,000 
 went into the treasury and $48,600,000 into the hands of sugar 
 producers principally resident in Hawaii, Porto Rico, and Cuba.'- 
 
 1 Professor F. W. Taussig, in the Atlantic Monthly, March, 1908, p. 342. 
 
PROTECTION AND FREE TRADE ■ 379 
 
 In answer to this charge that protection involves the taxa- 
 tion of one class for the benefit of another class, it is not sufl&cient 
 to reply that everybody is free to take advantage of the subsidy 
 and engage in a protected industry. Everybody is not free to 
 establish a rolling mill or a silk factory or a tin-plate plant. 
 Protection means the taxation of the less acute, the less enter- 
 prising, the less educated, and the poorer classes in order to 
 create additional commercial opportunities for the abler, 
 wealthier, and better-educated classes, thus reversing the whole 
 spirit of modern taxation which contemplates — so far as it 
 may be done without danger — rather the taxation of the rich 
 for the assistance of the poor than the taxation of the poor for 
 the benefit of the rich. It is not implied, of course, that pro- 
 tection involves class legislation of an unlawful character, nor 
 that taxes are collected from one class and handed over in cold 
 cash to the members of another class. The point turns upon 
 the relative ability of the various social classes to take advantage 
 of artificial opportunities created by the state at enormous 
 expense to all. 
 
 6. This brings us naturally to the ethical criticism of protec- 
 tion, the charge that by making the temporary prosperity of 
 influential classes dependent upon government bounty, protec- 
 tion encourages those classes to exert a demoralizing pressure 
 upon federal legislation. So great is the stake of private in- 
 terests in tariff legislation, that systematic lobbying, log rolling, 
 and corruption of the voter follow as inevitable consequences. 
 The beneficiary of the tariff sacrifices his disinterested convic- 
 tions concerning the general welfare, in order to preserve his own 
 little subsidy from the government. Neither the citizen nor 
 the legislator can vote purely, when his pocketbook is so vitally 
 affected. Even if we admit what is probably true, that protec- 
 tion has resulted in comparatively little direct bribery of legis- 
 lators, there seems no escape from the conclusion that it creates 
 a kind of interest in legislation which is inherently dangerous 
 and exceedingly difficult to keep within legitimate bounds. 
 The weightier arguments for protection all imply that tariff laws 
 should be scientifically adapted to secure the real national 
 
380 OUTLINES OF ECONOMICS 
 
 purposes of protection. The impossibility of getting a " scien- 
 tific tariff " under the political conditions that protection 
 creates is possibly one of the strongest arguments against pro- 
 tection. 
 
 7. Finally, it is alleged that protection fosters monopoly. 
 This contention forms the subject matter of a particularly 
 heated dispute, the exact truth of which is difficult to determine. 
 Certain modifications of the more extreme charge, however, are 
 hardly open to question. Protectionists confessedly take it for 
 granted that if foreign competition is shut off or lessened, home 
 producers will still compete. Nevertheless, highly protective 
 duties are still levied, or until the passage of the Underwood 
 tariff were levied, upon the import of commodities whose manu- 
 facture in the United States had fallen under the substantial 
 control of monopolies. It is furthermore admitted that such 
 monopolies frequently sell their products at lower prices in 
 foreign countries than in the United States ; while it is impossible 
 to deny that — whether the monopoly was created by protection 
 or not — the abolition of the duties, by giving foreign producers 
 a chance to compete in this country, would tend to reduce prices, 
 and thus give the American public a valuable ally in their 
 struggle against monopoly. It is not asserted that the tariff 
 has been " the mother of the trusts." Other and more impor- 
 tant forces are mainly responsible for the development of the 
 trust. But protective tariffs have unquestionably deprived 
 the American people of a strong weapon against the trusts. 
 
 Some General Considerations. — Before attempting to sum 
 up the preceding arguments and strike a practical working bal- 
 ance, it is necessary to call attention to certain general considera- 
 tions which have not figured in the foregoing " starched proces- 
 sion " of pros and cons. In the first place, it is necessary to 
 remember that the federal government must secure a large rev- 
 enue from tariff duties, and that in consequence the question 
 which we are discussing is not one of protection versus free trade, 
 but of protection versus freer trade. In the second place, 
 the economic importance of the whole controversy has unques- 
 tionably been exaggerated. We find a country like England 
 
PROTECTION AND FREE TRADE 381 
 
 prosperous under free trade ; we find countries like France and 
 the United States prosperous under protection. It is of real 
 but not of vital importance. Our internal trade vastly exceeds 
 our foreign trade in every way. The domestic trade of the 
 Mississippi Valley alone is far greater than our entire foreign 
 commerce. In the third place, the American tariff is a historical 
 growth, and, bad as it may be in many respects, it has taken 
 deep root. During the last century it has become part of our 
 life, and cannot be suddenly eradicated with impunity. If it 
 is true that American labor would be better off without it, it 
 does not follow that it ought to be removed suddenly in the 
 interests of American labor. If the industrial growth is ab- 
 normal, it is none the less true that adjustment to normal 
 conditions is a painful process and should be conducted cau- 
 tiously. Displacements of labor and capital cause suffering 
 and loss, and it is clear that any reform of the tariff must be 
 conservative and careful, a movement toward freer trade, not 
 the sudden withdrawal of protection. 
 
 Conclusions. — Most of the arguments enumerated above, 
 both for and against protection, contain a measure of truth. 
 Historically, protection was inevitable in the United States, 
 and, in the early period of the country's development, beneficial. 
 During the three great wars which seriously threatened the 
 stability of this country, many new industries sprang up which, 
 upon the cessation of war and the resumption of internal trade, 
 were seriously threatened by foreign competition. Many of 
 these industries were so suited to our soil and our people that 
 only a short period of protection was needed to make them self- 
 supporting. Under the circumstances it would have been unwise 
 to permit the sacrifice of the capital invested in these industries ; 
 and whether it would have been unwise or not, human nature is 
 such that the desired protection was sure to be granted. In 
 short, there is a large measure of real truth in the infant industry 
 argument. 
 
 Circumstances, however, have radically changed in the last 
 few decades. Our quondam infant industries have, for the most 
 part, attained a very vigorous maturity, and in some instances 
 
382 OUTLINES OF ECONOMICS 
 
 have become belligerent and prone to monopolistic bullying; 
 our manufactures have become sufiSciently diversified to remove 
 all danger of industrial collapse in time of war ; and, above all, 
 we are rapidly entering the economic stage in which, according 
 to the ablest exponent of protection that economic science has 
 ever known, — Friedrich List, — protection is a hindrance 
 rather than a help. That is to say, we are rapidly building up 
 an extensive export trade in manufactured articles; year by 
 year raw materials constitute a larger proportion of our imports 
 and a smaller proportion of our exports ; and we have already 
 become the greatest exporting country of the world. All this 
 means that in the near future our manufacturers themselves 
 will look with kindlier eyes upon the withdrawal of the protec- 
 tion they do not need, which in fact actually increases the cost 
 of some of their raw materials, and incites foreign governments 
 to retaliatory taxation upon goods imported from the United 
 States. Our growing export trade will itself bring a wider ap- 
 preciation of those fundamental principles which have led 
 economists, with but few exceptions, to condemn protection as 
 a permanent policy applicable to all stages of economic develop- 
 ment. 
 
 QUESTIONS 
 
 1. Distinguish what you believe to be the sound from what you believe 
 to be the fallacious reasons for protection, briefly stating your reasons. 
 
 2. Why is a home market believed to be superior to a foreign market? 
 Does this apply in all cases? 
 
 3. Explain the argument against dumping. Is dumping more or less 
 prevalent than it used to be? 
 
 4. Explain how one country may influence the selection of industries 
 in another country. Is this argument sound? What are the limits of its 
 truth? 
 
 5. Can a protective tariff increase money wages? real wages? Ex- 
 plain. 
 
 6. State the reasons for, as well as those against, the proposal to use 
 tariff duties for the purpose of equalizing costs of production here and 
 abroad. 
 
 7. Distinguish what you believe to be the sound, from what you believe 
 to be the fallacious, arguments for free trade, briefly stating reasons. 
 
PROTECTION AND FREE TRADE 383 
 
 8. What is the difference between a " tariff for revenue" and a protective 
 tariff? Do protective duties make good taxes ? Explain. 
 
 9. What effect has protection on legislation ? What machinery is pro- 
 posed to remedy this evil? 
 
 10. Explain the connection, if any, between high tariffs and monopoly. 
 
 REFERENCES 
 
 Ashley, Percy, Modern Tariff History, 2d ed. (Germany, United States, 
 
 and France). 
 Ashley, W. J. The Tariff Problem. 
 Chomley, C. H. Protection in Canada and Australasia. 
 Dawson, W. H. Protection in Germany. 
 FiSK, G. M. International Commercial Policies. 
 FucHS, C. J. The Trade Policy of Great Britain and her Colonies. 
 George, Henry. Protection or Free Trade. 
 HiGGiNSON, J. L. Tariffs at Work. 
 Laughlin, J. L., and Willis, H. P. Reciprocity. 
 List, Friedrich. National System of Political Economy. 
 Meredith, H. O. Protection in France. 
 Patten, S. N. The Economic Basis of Protection. 
 Rabbeno, Ugo. The American Commercial Policy. 
 Smith, Adam. The Wealth of Nations, Book iv. Chap. ii. 
 Stanwood, Edward. American Tariff Controversies in the Nineteenth 
 
 Century. 
 Taussig, F. W. Tariff History of the United States, 6th ed. ; Some Aspects 
 
 of the Tariff Question; (editor) State Papers and Speeches on the Tariff. 
 
PART III 
 
 DISTRIBUTION 
 
 CHAPTER XIX 
 DISTRIBUTION AS AN ECONOMIC PROBLEM 
 
 It has already been remarked that the production and the dis- 
 tribution of the annual income of society cannot be sharply sepa- 
 rated, and more or less has already been said about the four parts 
 into which the total social income is usually divided ; namely, 
 wages, interest, rent, and profits. The greater part of distribu- 
 tion might undoubtedly be considered under the general heading 
 " Production," but, on the other hand, it is frequently asserted 
 that distribution is " the true center of all economic inquiries," 
 and it would be possible to treat nearly the whole of production 
 from the standpoint of distribution. The truth is that these 
 old traditional divisions of our subject matter indicate different 
 points of view, and on this account it seems desirable to retain 
 them. Wlien we pass from production to distribution, we do 
 not enter an entirely new field, but we look at an old field of 
 investigation from a new point of view. 
 
 The center of interest in the practical applications of economic 
 principles has shifted from production to distribution. The mer- 
 cantilistic writers of the seventeenth and eighteenth centuries 
 were primarily interested in the most efficient ways of increasing 
 the sum total of a nation's wealth. Even Adam Smith, as the 
 title of his great work, An Inquiry into the Nature and Causes 
 of the Wealth oj Nations, indicates, had chiefly in mind the 
 same problem, although he emphasized the fact that the real 
 well-being of a nation consists in the well-being of the great 
 body of its people. During the past century the production of 
 
 384 
 
DISTRIBUTION AS AN ECONOMIC PROBLEM 385 
 
 wealth has increased beyond all precedent, the chief factors 
 contributing to this result being the factory system, the ex- 
 ploitation of vast natural resources (made possible only by 
 modern methods of transportation), and the free scope given to 
 the initiative of the individual business man. Yet poverty 
 still exists, and its harsh features are thrown into sharper relief 
 by contrast with the fact that the present production of wealth 
 per capita is indisputably the highest that the world has ever 
 known. Moreover, while the social discontent arising from in- 
 equalities in the distribution of wealth is a very old thing, it is 
 only in modern times that democracy has given it an adequate 
 opportunity for formulated, organized expression. A large 
 share of the economic problems which are felt to press upon 
 society today for solution relate directly or indirectly to the 
 distribution of wealth. 
 
 It should be noted, however, that we have to discuss under the 
 name " distribution " two different processes. The first and 
 inclusive meaning of the term is the distribution of the wealth 
 or income of society among individuals and families; in other 
 words, the question of individual fortunes, poverty, and wealth. 
 The second kind of distribution is the apportionment of the 
 product to the different factors of production. This is not a 
 question of wealth versus poverty, but of wages versus interest, 
 profits, and rent. Of course, this kind of distribution affects 
 the personal distribution of wealth, but it is by no means the 
 same question. To explain why lots in New York City com- 
 mand high rents is one thing ; to explain why a large amount of 
 these rents goes to the Astor family is another thing. In the 
 case of wages, however, the two kinds of distribution amount to 
 about the same thing. There is another sense in which the 
 word is not used in this chapter. We do not mean by distribu- 
 tion the moving of goods from the place where they are produced 
 to the place where they are consumed. When we speak of 
 railways or merchants as " distributive agencies," we are using 
 the term " distribution " in a sense very different from that of 
 the technical economic term " distribution." Distribution is a 
 question of ownership, not a question of the location of goods. 
 
 2C 
 
386 OUTLINES OF ECONOMICS 
 
 Distribution controlled by Existing Institutions. — The statement that 
 distribution is a matter of ownership suggests at once the relation of private 
 property to distribution. Individual wealth is, fundamentally, a sum of 
 property rights. Every extension of property rights by society, as, for ex- 
 ample, in permitting the private ownership of the rights to supply cities with 
 water, electricity, or transportation facilities, extends the field of private 
 gain and correspondingly affects the distribution of wealth. The income 
 received by the successful manager of a municipal waterworks plant is un- 
 doubtedly a very different thing from the income the same individual would 
 receive if he were the owner of a franchise permitting him to conduct the 
 business of supplying the city with water as a private undertaking. The 
 policy of leasing, rather than selling, public lands, which has been adopted 
 by some of the newer American states, is bound to have an appreciable, 
 even if not a very important, effect upon the distribution of wealth. 
 
 In the institution of inheritance we have an instrument which once in a 
 generation redistributes the property rights in existing wealth. It is not 
 strange that those who wish to limit or retard the growth of large individual 
 fortunes have looked to the control and especially to the taxation of inherit- 
 ances as a means to this end. Doubtless the prevalence of large landed 
 estates in England is closely connected with the English law of primogeniture, 
 just as the predominance of small holdings in France is in part due to the 
 French law forbidding the disinheritance of any of one's children. 
 
 Personal freedom, as a legally guaranteed institution, is also of funda- 
 mental importance. The factors determining the income of the free work- 
 ingman are very different from those determining the portion of the slave. 
 It should be remembered, too, that the actual processes by which wealth is 
 distributed are today largely controlled by the institution of contract. 
 What rent, wages, or interest one gives or receives is no longer fixed mainly 
 by custom, as in the Middle Ages, but is a matter of agreement between 
 individuals. So far as society limits the right of contract, as in the case of 
 legislation regulating the employment of women and children, it corre- 
 spondingly affects the distribution of wealth. 
 
 These fundamental institutions are discussed more fully elsewhere in this 
 treatise. They are mentioned in this connection in order to emphasize more 
 definitely the fact that the distribution of wealth takes place under the con- 
 ditions imposed by the existing social order. Even the most radical advo- 
 cates of greater equality in the distribution of wealth do not propose an 
 arbitrary leveling down of fortunes. They direct their attacks against one 
 •or more of these fundamental institutions, such as inheritance, private prop- 
 erty in land, or private property in production goods. Then there are many 
 persons who are willing to accept the conditions imposed by the existing 
 social order, as a field for the operation of competitive forces in wealth distribu- 
 tion, but who object to monopoly and special privilege. This suggests that 
 the forces bringing about distribution on the basis of the existing social order 
 
DISTRIBUTION AS AN ECONOMIC PROBLEM 387 
 
 are in themselves amenable to social control. If those who secure the chief 
 prizes in the economic struggle may plume themselves on the fact that they 
 are the victors in a game that is open to all, it is none the less^true that 
 society lays down the rules of the game. 
 
 A large part of the complex of institutions and regulations through which 
 society controls distribution work smoothly and silently, their action, so far 
 as society at large is concerned, being unconscious. It is only when obvious 
 conflicts arise between some of the effects of this unconscious control on the 
 one hand and present-day ideals of social welfare on the other hand, that the 
 significance of any part of this fundamental institutional control becomes 
 generally felt. It is not the least of the merits of the study of economics that 
 it emphasizes the fundamental character of that part of the social control 
 of wealth production and wealth distribution which lies below the horizon 
 of social consciousness. 
 
 Money Incomes. — If each family produced all that it con- 
 smned, as most families still do in part, there would be no 
 problem of distribution, except whatever problems might arise 
 respecting the factors determining the amount produced by each 
 family. But since most men today are working in more or less 
 specialized employments, and for money incomes, the fact is, as 
 was suggested in a previous chapter, that distribution takes 
 place through a process of price-fixing. Some men (manu- 
 facturers, merchants, farmers) make a money income by selling 
 goods for more than it costs them to produce them or to buy 
 them from others, while other men (laborers, salaried employees, 
 professional men, capitalists, landowners) get a money income 
 by selling their services or by selling the use of their capital or 
 land. In the first case, the money income takes the form of 
 profits ; in the second case, it is wages, interest, or rent, as the 
 case may be. 
 
 A man's real income consists of the commodities and services 
 that satisfy his wants ; and the extent to which his money in- 
 come can be transmuted into real income depends on the prices 
 of these things. One always has the option, of course, of in- 
 vesting part of his money income in production goods rather 
 than in consumption goods, thus giving up part of his present 
 real income for a larger future income. However, since different 
 men have to pay about the same prices for the same kinds of 
 goods, a discussion of the factors determining money incomes 
 
388 OUTLINES OF ECONOMICS 
 
 wilj be, ipso facto, a discussion of the factors determining real 
 incomes, except as it is found that certain kinds of incomes are 
 changed more readily to meet the conditions imposed by changes 
 in prices than are other kinds of income. 
 
 It is obvious that one person may be the recipient of more than 
 one kind of income. The American farmer who owns the land, 
 buildings, farm machinery, and hve stock that make up his pro- 
 ductive equipment, and who does part of his own work, is at the 
 same time entrepreneur, landlord, capitalist, and laborer; and 
 his income is made up of different proportions of profits, rent, 
 interest, and wages. The net income of a tenant farmer, 
 utilizing only borrowed capital, and employing only hired labor, 
 would, on the other hand, consist entirely of profits. The 
 economic analysis that seeks to determine the rules governing 
 the apportionment of the annual dividend under the categories 
 of profits, wages, rent, and interest, bears only indirectly upon 
 the question of the personal distribution of wealth. The in- 
 come that any individual receives depends primarily upon his 
 efficiency and success as a wage earner or as an entrepreneur, or 
 upon the amount and the income-yielding capacity of the capital 
 and land which he owns. His ownership of capital and land 
 may have come about through the thrifty husbanding of por- 
 tions of his income in previous years, or it may have come about 
 through gifts or inheritance. 
 
 The Law of Diminishing Productivity. — To explain the 
 prices paid for personal services is to explain wages ; to explain 
 the prices paid for the use of land and capital is to explain rent 
 and interest. Certain special and distinguishing characteristics 
 enter into the determination of each of these three classes of 
 prices. The conditions governing the supply of labor are, for 
 example, very different from the conditions governing the supply 
 of land. Yet there are some fundamental facts that are common 
 to all three classes of prices. The most important of these com- 
 mon factors is the law of diminishing productivity. 
 
 Assume as an illustration that a certain farm is cultivated by a 
 farmer who uses only his own labor, together with a small amount 
 of capital in the form of draft animals and agricultural imple- 
 
DISTRIBUTION AS AN ECONOMIC PROBLEM 389 
 
 ments. Let us assume further that his land is devoted ex- 
 clusively to the growing of one crop, — corn, for instance. His 
 money income will depend on the amount of corn he can pro- 
 duce and the prices he can get for it. At given prices he can 
 increase his income only by increasing his product. 
 
 But his product may be increased by the use of any one of a 
 number of different methods. In the first place, he can hire 
 a farm laborer to assist him. The two men, working together, 
 will undoubtedly be able to get a larger product from the farm 
 than one man could. In some cases they may be able to get 
 double, or even, through the advantages of cooperation, more 
 than double, what the farmer could produce working alone. 
 More often, perhaps, the employment of the second man will 
 not double the total product. However that may be, it is 
 absolutely certain that if the farmer employs a third, a fourth, 
 or even more men, he will sooner or later reach a point where 
 it will be found that the employment of the last man has not 
 increased the product as much as it was increased by the last 
 previous laborer. That is, the addition of the third man may 
 not have increased the product as much as the employment of 
 the second man did, or the fourth man may not have increased 
 the product as much as the third man did. 
 
 This point is called the point of diminishing productivity,^ for 
 after this point is once reached it will be found that, save under 
 the most exceptional conditions, each successive additional 
 laborer will increase the aggregate product by an amount less 
 than the last previous laborer added to it. This is not because 
 of any differences in the laborers, whom we assume to be of 
 equal efficiency. It means simply that as the productive possi- 
 bilities of the farm with its equipment of capital become more 
 fully exploited through more careful tillage, it requires in- 
 creasingly greater efforts, in the form of still more careful and 
 thorough tillage, to increase the product by a given amount. 
 
 ^ In some economic writings what is here called "diminishing productivity" 
 is termed "diminishing returns." It seems preferable to reserve the latter term 
 for its more famiUar application to the phenomenon of the increasing expenses 
 incurred in enlarging the total agricultural product under the pressure of a popula- 
 tion growing in numbers or in wealth. 
 
390 OUTLINES OF ECONOMICS 
 
 This is a fact of such common observation that it needs no statis- 
 tical proof; although various agricultural experiment stations 
 have made records of the effect of different degrees of thorough- 
 ness of cultivation upon the yield of different crops. 
 
 The Marginal Product of Labor. — One might imagine, at 
 first thought, that after the point of diminishing productivity 
 had been reached, it would not pay the farmer to hire additional 
 laborers. But the only question that directly concerns the 
 farmer in this connection is whether an additional laborer will 
 " earn his wages," — that is, whether the added product will 
 sell for enough to cover the additional expense incurred for wages. 
 It will pay the farmer to extend his employment of labor up to 
 the point where the addition of another laborer to the working 
 force would increase the product by an amount too small to 
 sell for enough to pay the wages of the laborer, and where the 
 deduction of a laborer from the working force would decrease 
 the product by an amount at least sufficient to pay the wages of 
 the laborer. If the farmer stops short of this point, he is not 
 making all the possible profits; if he goes beyond it, he is 
 cutting down his profits by employing labor which does not 
 " earn its wage." The last laborer employed (not necessarily 
 any particular laborer, nor the last in point of time, but merely 
 any one laborer of the total number employed) is the marginal 
 laborer, and the increase in the total product attributable to the 
 marginal laborer (the part which would be lost if one less laborer 
 were employed) is the marginal product of labor. If the farmer 
 has estimated product and prices accurately, it will be found, of 
 course, that the money value of the marginal product of labor 
 will be approximately equal to the wages of the marginal laborer. 
 Or, since the laborers are supposed to be of equal efiiciency, and 
 hence to receive uniform wages, the statement may be put in the 
 broader and more significant form that wages and the marginal 
 product of labor will tend to equal each other. 
 
 The diagrams illustrate the principle of the diminishing productivity of 
 labor, developed in the foregoing analysis. In Figure i the rectangle OM 
 represents the amount of corn that the farmer could raise on his land if work- 
 ing alone, with his given equipment of capital. The rectangle AN represents 
 
DISTRIBUTION AS AN ECONOMIC PROBLEM 
 
 391 
 
 the increase in the product effected by the addition of another worker. Simi- 
 larly, BP, CQ, DR, and ES represent respectively the additions to the product 
 
 H - 
 
 
 
 N 
 
 P 
 
 
 
 
 
 
 
 
 
 
 
 
 Q 
 
 
 
 
 
 
 
 
 w 
 
 B 
 
 
 
 
 
 
 
 
 c 
 Fig. 
 
 resulting from the employment of a third, fourth, fifth, and sixth laborer. 
 If DR bushels of corn — the increment in the product attributable to the fifth 
 laborer — sells for about enough to pay the wages of one laborer, the farmer 
 will refuse to employ the sixth laborer, while the employment of the fifth 
 would be a matter of indiiiference. If the fifth laborer were employed, the 
 proceeds of the sale of 
 that part of the total 
 product represented by 
 the rectangle OERH 
 would be used up in the 
 payment of wages (in- 
 cluding payment for the 
 farmer's own work as a 
 laborer), while the part 
 of the product repre- 
 sented by the small rec- 
 tangles above the fine 
 HW would be left to 
 recompense the farmer 
 for the use of his land, 
 for the interest on and wear and tear of his capital. If any surplus is left 
 after these demands are satisfied, it would, of course, constitute the farmer's 
 profits. If the conditions were as assumed, the fifth laborer would be the 
 marginal laborer, and the product represented by the rectangle DR would 
 be the marginal product of labor. 
 
 If we were dealing with a very large undertaking, in which many laborers 
 are employed, the successive rectangles representing the increments in the 
 
 Fig. 2 
 
392 OUTLINES OF ECONOMICS 
 
 product attributed to the hypothetical addition of successive laborers could 
 be conceived as indefinitely narrow, so that the graphic representation would 
 take the form represented in Figure 2, where the line AM is> located at the 
 point of diminishing productivity, and where the line BN represents the mar- 
 ginal product of labor. In this case the rectangle OBHN represents the part 
 of the total product which will just suffice to pay the wages of all the la- 
 borers employed. 
 
 The Marginal Products of Capital and Land. — Thus far 
 we have supposed that the farmer is content to get along with 
 his original amount of land and capital, and to increase his 
 product by means of an increased use of labor. Other possibili- 
 ties are, of course, open to him. It might happen that he would 
 be content to do without additional laborers, using instead an 
 increased equipment of capital. By purchasing more draft 
 animals, more labor-saving machinery, improved fertilizers, or 
 possibly by installing drains or irrigation ditches, as the case may 
 be, he may be able to raise considerably more corn than he could 
 without such investments. But here, again, he will find the 
 possibility of increasing his product subject to the same limita- 
 tions that would have prevailed had he increased his labor force. 
 With a team of horses he will be able to accomplish more than 
 he could with one horse ; two teams of horses may still further 
 increase the total product of the farm ; a third would probably 
 be of very little advantage, and a fourth team still less useful. 
 So with investments of capital in other forms: the law of 
 diminishing productivity is a remorseless physical fact which 
 the farmer has to reckon with. 
 
 The concrete form in which the problem presents itself to 
 him is this : Will a further investment of money in a specific kind 
 of capital goods pay me? Here the farmer has to make on 
 the one hand the best estimate he can of the amount which the 
 proposed capital goods will add to his annual product, and of 
 the probable selHng value of the increased product. On the 
 other hand, he has to count his increased annual expenses. 
 These will include (i) the original cost of the additional equip- 
 ment, divided into annual costs according to its probable dur- 
 ability (each year's costs being properly only the wear and tear, 
 
DISTRIBUTION AS AN ECONOMIC PROBLEM 393 
 
 or " depreciation " attributable to that year's use) ; (2) the 
 maintenance or upkeep (including such things as ordinary 
 repairs on machinery and the cost of feeding horses), and (3) 
 the interest on the investment (what the farmer has to pay if he 
 borrows the necessary funds from some one else, or what he 
 might have lent his money for to some one else if he uses his 
 own funds). Guided by these estimates, the farmer will 
 naturally increase his equipment of capital goods so far as the 
 returns from the added product would more than suffice to 
 cover his increased costs. Beyond this point he could not 
 wisely go. The last increment of capital — which just suffices 
 to pay for itself — is the marginal increment of capital, and the 
 added product attributable to it is the marginal product of capital. 
 
 The diagrams portraying the operation of the law of the diminishing pro- 
 ductivity of labor will serve as well to illustrate the diminishing productivity 
 of capital. Assuming that the amount of land and the amount of labor to 
 be utilized are definite in quantity, the successive rectangles in Figure i rep- 
 resent the increase in the gross product attributable to each of successive 
 increments of capital. Figure 2 represents the same conditions, except that 
 each increment of capital is assumed to be indefinitely small. 
 
 If (in Figure 2) BN represents the marginal product of capital, the whole 
 return imputed to capital is, of course, represented by the rectangle OBNH. 
 The area above the line HN represents the part of the product which is avail- 
 able for rent and wages, the farmer's profits being derived from any surplus 
 that is left after these demands are satisfied. 
 
 There is one difficulty in the foregoing analysis, however, that may have 
 been noted by the reader. What is meant by an "increment of capital"? 
 In the case of labor the "increment of labor" can be interpreted as the labor 
 of one man ( for any definite period of time that may be chosen), the one man 
 being assumed (for the purpose of simplicity in the analysis) to be of equal 
 efficiency with aU others constituting the labor supply. It is just as prac- 
 ticable, of course, to assume that one horse is, for the farmer's purposes, just 
 as efficient as another horse, that only one kind of plow is available, and that 
 one bushel of fertilizer is exactly like any other bushel of fertilizer; but this 
 does not help us out of our difficulty. For how can we blend horses, plows, 
 and fertilizers into one concept, and divide them into "increments of capital " ? 
 One way of getting around the difficulty is to think of the capital which the 
 farmer combines with his labor and his land in terms of its money value. In 
 this sense an increment of capital might be a dollar's worth of capital, or ten 
 dollars' worth of capital, without reference to the different kinds of concrete 
 production goods really composing it. This device is useful for some pur- 
 
394 OUTLINES OF ECONOMICS 
 
 poses, but it obscures the fundamental fact that capital gets its value from its 
 ability to secure an income for its owner. The purpose of this analysis of 
 diminishing productivity is to open the way for a discussion of the prices paid 
 for the services of land, labor, and capital. To use the term " capital " in the 
 sense of capital value at this stage in the discussion would only lead us into 
 circular argument. This point cannot be further elaborated here, but should 
 be kept in mind by the reader in connection with the discussion of interest in a 
 subsequent chapter. As a matter of fact the law of diminishing productivity 
 holds for each specific kind of capital the farmer uses. For example, imagine 
 that the farmer is limited to the use of a fixed amount of all forms of capi- 
 tal except one, — horses, for instance. Then the successive rectangles in 
 Figure i would represent very weU the increments of product gained by the 
 use of additional horses, while if the product added by the use of a fifth 
 horse is just about enough to pay for the increased expense, the rectangle DR 
 would represent the marginal product. The illustration can, by a similar 
 process, be made to apply to any other kind of capital. The farmer wiU 
 normally make use of each specific kind of capital up to the marginal point. 
 The same is true for each specific kind of labor or each specific use of labor. • 
 The use of the tripartite classification of the factors in production in 
 explaining the principle of diminishing productivity is merely a matter of 
 convenience. 
 
 A third way of increasing his product is also open to the farmer. 
 He may think it wiser to get along with his original equipment of 
 capital and his own labor, and to increase his product by utilizing 
 more land. The adoption of this procedure would mean a less 
 intensive cultivation per acre of land. The use of labor and 
 capital would have to be distributed more thinly over the larger 
 acreage. This would result in a smaller product per acre, but 
 the procedure would be warranted if the increase in the annual 
 product should sell for more than the annual cost of the addi- 
 tional acreage. By the annual cost of additional land we mean 
 the rent which the farmer has to pay for the land if he leases 
 it, or the interest on the amount of the purchase price, if he 
 buys it. It is obvious, however, that the combination of more 
 and more land with a fixed amount of labor and capital will 
 result in a smaller and smaller return per acre of land, and that a 
 point will soon be reached beyond which it will not pay the 
 farmer to go. In other words, the law of diminishing produc- 
 tivity rules when land is considered as the variable factor, just 
 as it does when labor or capital is considered as the variable. 
 
DISTRIBUTION AS AN ECONOMIC PROBLEM 395 
 
 The diagrams already used may be adapted to the illustration, of the present 
 hypothesis by assuming that equal areas, if successively combined with a 
 given amount of labor and capital, would yield increments of product as 
 represented by the successive rectangles in Figure i , or by the curve in Fig- 
 ure 2. It is assumed for the sake of simplicity in the illustration that the dif- 
 ferent acres of land available for the farmer's use are of equal fertility. 
 
 The Actual Operation of Diminishing Productivity. — It has 
 
 been assumed thus far that the farmer of our illustration has to 
 be content with a fixed quantity of two of the three factors in 
 production, but that he is at Hberty to increase his use of the 
 third factor up to the point where maximum profits will be 
 gained for himself. Assuming in turn that each of the three 
 factors in production was the variable one, we found that in 
 each case the law was the same — the most advantageous ad- 
 justment was reached when the product added by the last in- 
 crement of the variable factor would sell for just enough ^ 
 to cover the increased expense. 
 
 In one way, however, this assumption does not correspond 
 with the facts. The farmer is at liberty to increase his product 
 by increasing his utilization, not only of any one, but of any 
 two, or all of the three, factors of production. He may, for 
 example, purchase more draft animals and more machinery, 
 employ more labor, and at the same time acquire more land. To 
 a certain extent the use of one factor may lessen the use of 
 another (as in the case of labor-saving machinery and labor). 
 More often, however, the reverse is true. The acquisition of 
 machinery may necessitate the use of more horses, while the 
 acquisition of more land will often make profitable the use of 
 more labor as well as more capital — a fact which is itself im- 
 plied in the law of diminishing productivity. Although the 
 employment of labor, capital, and land can thus be increased 
 simultaneously, the significance of the law of diminishing pro- 
 ductivity is in no wise diminished. The farmer, in deciding 
 upon the purchase of a particular kind of capital good, has to 
 
 ' Whether this last unit, which just pays for itself, will be added, is of course 
 a matter of indifference. The margin is consequently sometimes called the " margin 
 of indifference." 
 
396 OUTLINES OF ECONOMICS 
 
 take into account his present and, to some extent, even his prob- 
 able future supply of other kinds of capital goods, as well as of 
 land and labor, before he can form a judgment as to the amount 
 which the use of the particular capital good will add to his annual 
 product. Moreover, he has to choose between additional 
 investments in labor as against additional investments in land, 
 or additional investments in different kinds of capital. But 
 his effort to get maximum profits will lead him to make those 
 investments which promise to result in the greatest additions 
 to his product. The result of this will be, normally, that each 
 factor in production will be utilized up to the marginal point — 
 the point where further utilization would add a product so 
 small as to sell for less than the increased expenses. 
 
 It is not only in agriculture that the law of diminishing produc- 
 tivity is the fundamental thing in determining the proportions in 
 which the factors of production are combined. Every manufac- 
 turer has the option of using either relatively more machinery 
 and relatively less labor, or relatively less machinery and rela- 
 tively more labor in order to produce a certain quantity of 
 goods. He may have to decide, also, between building a six- 
 story factory covering an acre of ground, and a one-story fac- 
 tory covering six acres of ground — a problem which is paralleled 
 by the farmer's problem of deciding between the cultivation of a 
 relatively large acreage and the more intensive cultivation of a 
 smaller acreage. The entrepreneur in every kind of undertaking 
 has to decide as to the advisability of a particular investment in 
 land, capital, or labor, with reference to the fundamental ques- 
 tion, " Will it pay? " And the profitableness of any such in- 
 vestment is always a matter of the cost of the unit of land, 
 labor, or capital, as compared with the selling value of the 
 quantity which it will add to the entrepreneur's total product. 
 
 In order to achieve maximum profits, each entrepreneur will en- 
 deavor, so far as is practicable, to apportion his use of land, labor, 
 and capital so that the value of the increment of product attributable 
 to the marginal unit of each class of productive agents will about 
 equal its expense. 
 
 The significance of the law of diminishing productivity in rela- 
 
DISTRIBUTION AS AN ECONOMIC PROBLEM 397 
 
 tion to the distribution of wealth now becomes apparent. If a 
 given class of laborers in a given employment receive like wages, 
 their wages (being the same as the wages of the marginal laborer) 
 will tend to equal the marginal product of labor. The expense 
 incurred by the entrepreneur for any unit of a certain kind of 
 capital goods will tend to equal the value of the marginal product 
 of that particular kind of capital goods. The rent which the 
 farmer will pay for any acre of a quantity of land of uniform 
 quality will tend to equal the value of the marginal product of 
 land of that quality. But so far as competition works freely, 
 different entrepreneurs in the same market will have to pay 
 the same wages for the same kind of labor, the same price for 
 the same kind of capital goods, and the same rent for the same 
 kind of land ; and they will get the same prices for the same kinds 
 of products. Moreover any one unit of the aggregate amount 
 of a productive agent of any one kind employed at any one time 
 may be deemed to be the marginal unit. So it is possible to 
 state in more general terms that the money remuneration of 
 each specific unit of the agents of production in production 
 tends to equal the selling value of the amount of product depend- 
 ent upon the use of that unit. 
 
 It is not necessary for the validity of this specific productivity 
 theory of distribution, as it is called, that in any particular 
 undertaking at any given time the proportions in which the 
 factors of production are actually combined should be adjusted 
 with the nicety which the theory seems to imply. The amount 
 of land which the farmer holds at any one time is apt to be fixed 
 by his estimate of his future rather than of his present produc- 
 tion, while custom, pride of ownership, and the chance of gain 
 through an increase in land values (which is not to be confused 
 with the motives guiding his activity as a producer) have their 
 influence. Moreover, the size of the government homesteads 
 into which a large part of the public domain was divided has 
 had an important effect on the size of the farmer's holding in a 
 large section of the United States. The average American 
 farmer undoubtedly holds more land than he would if he were 
 looking for maximum present profits. The practical problem 
 
398 OUTLINES OF ECONOMICS 
 
 for him is apt to be how intensively he shall cultivate it : how 
 much labor and capital he shall combine with it. That is, he 
 is apt to use relatively more land and relatively less labor and 
 capital than he would use if every additional acre of land used 
 meant an additional expense for land. This conclusion is not 
 altered by the fact that his land is probably not of uniform 
 quality, and that some of it may not repay cultivation under 
 present conditions. In a similar way the manufacturer builds 
 his factory for the future, and may even equip it with a larger 
 complement of some kinds of machines (such as boilers and 
 engines) than present requirements justify. On the other 
 hand, a sudden and probably temporary increase in demand 
 for a product will be met by the manufacturers by the employ- 
 ment of more labor (even at the high rate paid for overtime 
 or night work) rather than by the installation of more labor- 
 saving machinery, even though the latter might, in the long run, 
 be more economical. In general, when considerations which 
 take into account a period of years dominate, land and the more 
 permanent forms of capital goods will be used more freely, labor 
 and the less permanent forms of capital goods less freely. When 
 short-time considerations are dominant, the reverse will be 
 true. 
 
 These limitations do not invalidate the law of the equality of 
 the remuneration of the agents in production and the prices of 
 their specific products any more than the fact that a feather 
 does not fall through the atmosphere as rapidly as a stone invali- 
 dates the law of gravitation. This law, like other economic 
 laws, is the statement of a fundamental tendency, which, in 
 this case, is bound up with the universal desire of entrepreneurs 
 to get for themselves the largest possible profits. 
 
 Marginal Productivity and the Prices of Production Goods. — 
 The reader who has firmly grasped the concept of marginal 
 utility will find that a recognition of some similarities in the 
 roles which marginal utility and marginal productivity play in 
 the price process will help him to grasp the significance of the 
 latter concept. The prices paid for specific units of consumption 
 goods depend upon their relative capacity to yield an " in- 
 
DISTRIBUTION AS AN ECONOMIC PROBLEM 399 
 
 come of satisfactions " ; the prices that will be paid for produc- 
 tion goods depend upon their capacity to yield a money income 
 to the entrepreneur. In the one case the law of diminishing 
 utility is dominant ; in the other case, the law of diminishing 
 productivity. Just as we cannot speak of the utility of a com- 
 modity in general, but only of the utility of particular concrete 
 units of a commodity, so we cannot speak of the productivity 
 of land, labor, or capital in general, but only of the productivity 
 of particular concrete units of land, labor, and capital. The 
 consumer is getting the maximum of satisfaction of his wants 
 when the final dollar spent for one commodity satisfies just as 
 intense wants as the final dollar spent for any other commodity, 
 and he apportions his expenditures accordingly. The entre- 
 preneur is not making maximum gains if his final expenditure 
 for any one kind of productive agent adds more to his product 
 than his final expenditure (of equal amount) for any other 
 productive agent, and he tends to apportion his employment 
 of land and of different classes of labor and capital accordingly. 
 But it must not be supposed that the statement that the prices 
 paid for land, labor, and capital tend to equal the value of their 
 marginal products is a complete explanation of the valuation 
 of the services of the factors in production any more than the 
 principle of marginal utility is a complete explanation of the 
 valuation of consumption goods. In fact, from one point of 
 view, marginal productivity itself depends upon the prices which 
 the entrepreneur has to pay for the services of the factors in 
 production. The prices of productive services are like the prices 
 of vendible commodities in that each buyer (entrepreneur) 
 and each seller (laborer, capitalist, landlord) has to buy and sell 
 at prices which, being established by the aggregate demand and 
 supply of the market, are beyond his own control. Yet this 
 aggregate demand and supply is the net result of the decisions 
 made by individual buyers and sellers with respect to the 
 amounts which they will buy or sell at one price or another. 
 
 The demand for the use of land, labor, and capital is ulti- 
 mately a demand for their products — the goods that satisfy 
 human wants. The entrepreneur's task is to anticipate and 
 
400 OUTLINES OF ECONOMICS 
 
 meet this demand — a problem that takes the concrete form of 
 producing goods that will sell for more than the expense of 
 production. On the one hand he has to estimate the quantities 
 which he can sell at certain prices ; on the other hand, he has to 
 take account of the quantities which various units of land, 
 labor, and capital will contribute to his product, together with 
 the prices (rent, wages, cost of capital goods, and interest) that 
 he has to pay for these units. Through his mediation the de- 
 mand of society for want-satisfying goods becomes a demand 
 for the services of certain quantities of land, labor, and capital, 
 combined in certain proportions. And the principle that guides 
 the entrepreneur's transformation of the community's demand 
 for the products of land, labor, and capital into his own demand 
 for the services of these factors in production is the principle of 
 marginal productivity. The wages, rent, and interest that are 
 actually paid for the services of the factors in production are the 
 resultants of the demand of entrepreneurs, on the one hand, 
 and of the supply of these factors on the other hand. The 
 forces determining these prices are focused at the margin. 
 
 The principle of marginal productivity is an illuminating way 
 of stating the problem of the distribution of wealth, rather than 
 a solution of it. Just how supply and demand operate in the 
 case of each factor in production is a topic to be considered in 
 later chapters. Just as utility is at the same time the cause and 
 effect of price, so marginal productivity is at the same time the 
 cause and effect of wages, rent, and interest. From one point 
 of view it is seen that the competition of producers makes it 
 necessary that specific units of land, labor, and capital should 
 get a reward proportionate to the selling price of the amounts 
 which they contribute to the social dividend ; from another 
 point of view it is equally clear that the necessary expenditures 
 for land, labor, and capital are, in the long run, potent factors 
 in determining the prices of the things that make up the social 
 dividend. 
 
 The Meaning of " Productivity." — Furthermore, we should 
 not forget that the word " productivity " as used in economics 
 (and generally in current discussions of economic topics) has a 
 
DISTRIBUTION AS AN ECONOMIC PROBLEM 401 
 
 distinctly limited meaning. To digress for a moment in order 
 to make the point clearer : In the theory of consumption we 
 emphasize the fact that many of the most important human 
 wants are satisfied by " free goods," which, simply because they 
 are free, lie outside the proper field of economic investigation. 
 But the enjoyment of these free goods is usually dependent 
 upon the possession of economic goods. Air is a free good, — to 
 any one who can demand the economic goods necessary to life. 
 The glorious scenery of our national parks is a free good, — 
 to any one who can afford traveling expenses and hotel bills. 
 In general, the enjoyment of many of the finer pleasures of 
 life, involved in the common human relations of an individual 
 to his physical and social environment, are " free," but free 
 only to the individual who can afford the leisure and the 
 economic goods without which many of these " free " pleasures 
 are impossible. 
 
 For present purposes, however, the important point is that 
 there axtfree production goods as well as free consumption goods. 
 Nature furnishes some of these. The oceans and lakes furnish 
 free pathways for commerce ; natural forces of all kinds are 
 freely utilized by men in the work of production. But we do 
 not call these things productive, because no part of the annual 
 product is dependent on the utilization of any particular unit oj 
 them. In this technical sense the wind is not productive, but 
 windmills are. In order to utilize the ocean we have to invest 
 money in vessels and docks. We have to impute productivity 
 to these things because they will not be furnished unless it is 
 estimated that they will yield a remunerative income, and be- 
 cause the annual product will obviously be reduced if they are 
 not furnished. Much has been written about the " produc- 
 tivity " of the Panama Canal. But we would have to impute 
 productivity to the Strait of Gibraltar if England were able to 
 charge a toll for its use! 
 
 Somewhat analogous to these " free productive goods " is 
 society's fund of accumulated knowledge of productive methods, 
 — the heritage of centuries of economic evolution. This 
 accumulated industrial experience is an infinitely more precious 
 
 2D 
 
402 OUTLINES OF ECONOMICS 
 
 possession than the existing store of productive goods. Compare 
 the productive possibilities of a community of men possessing 
 this knowledge, but forced to begin work absolutely without a 
 ready-made stock of capital goods, with those of a tribe of 
 savages suddenly and miraculously equipped with all the 
 productive appliances of modern civilization. Yet this vast 
 fund of productive knowledge, so far as it is common property, 
 is not thought of as " productive." The social dividend is 
 continually being increased as a result of the discovery of new 
 natural forces, or new ways of harnessing and utilizing natural 
 forces. Secrecy or government patents make it possible for 
 those who first introduce these new methods of production to 
 reap an income from the temporary advantage it gives to them 
 as producers. For the time being these new methods themselves 
 have to be regarded as " productive," although they contribute 
 much more to the increase of the social dividend after they have 
 become matters of common knowledge and use, and hence have 
 ceased to be called " productive." Disinterested scientists, 
 especially those in the employment of the government or of 
 universities, have often given the results of their improvements 
 in industrial methods freely to the world, thereby swelling the 
 social dividend, but not reaping for themselves the pecuniary 
 reward which goes to those who patent their improvements 
 and thereby render them " productive." Moreover, many of 
 the world's greatest advances in the technique of production 
 have been made possible only by the patient researches of in- 
 vestigators in the " unproductive " field of pure science, working 
 solely for love of the work, and without hope of pecuniary 
 reward.^ 
 
 We impute productivity only to goods or services which are the 
 objects of property rights or of analogous rights of control, — such 
 as a man's power to dispose of his own labor. The fact is that 
 just as the benefits of free consumption goods are bound up with 
 the possession of larger or smaller quantities of economic goods, 
 so the utilization of free productive agencies is possible only in 
 
 ^ See a note on this point in Merz, History of European Thought in the Nine', 
 teenth Century, Vol. i, p. 92, note. The list there given could be greatly extended. 
 
DISTRIBUTION AS AN ECONOMIC PROBLEM 403 
 
 combination with labor, waiting, and scarce and appropriable 
 natural objects, — and these have to be paid for. We harness 
 natural forces for the work of production, but we impute produc- 
 tivity only to the harness. We continually learn better and 
 better methods of doing our productive work, but we impute 
 productivity only to the expenses involved in utilizing these 
 methods, — not to the methods themselves. Productivity im- 
 plies merely a relation of dependency between the amount of the 
 product and the use of a particular unit of one of the agents in 
 production. 
 
 It is important that the reader should see the truth in the 
 statement that the laborer, the landlord, and the capitalist get 
 paid in proportion to their respective products. It is equally 
 important that he should see clearly that there are definite 
 limitations to the meaning and significance of the statement. 
 
 The statement that rewards tend to equal products has no ethical sig- 
 nificance, and should not be interpreted as a justification of the present eco- 
 nomic order, — and this for the following reasons among others : (i) That dis- 
 tribution ought to be according to productivity is itself a debatable proposi- 
 tion. Some socialists, for example, maintain that distribution according to 
 needs is a higher ideal. (2) The ethical side of the problem of distribution 
 relates to personal distribution, while the marginal productivity doctrine 
 relates to the determination of the incomes going to the different agents in 
 production. To state that the rent of an acre of land tends to equal the value 
 of its product is not to say that the landowner has "earned" his income. 
 The private receipt of rent depends upon such social institutions as private 
 property and inheritance, and these have to be judged from the broad 
 point of view of social welfare. (3) The efi&ciency of the individual laborer, 
 which is one of the things determining his productivity, often depends upon 
 the opportunity he has had to "make the most of himself." But opportu- 
 nity depends largely on environment, and this in turn is to a large extent 
 amenable to social control. (4) The amount of the marginal product of any 
 one factor in production is itself a resultant of all the forces affecting the 
 supply of all the factors in production and of all the conditions that affect 
 their fitness to serve in the production of the things that consumers are 
 demanding. (5) This theory is only a statement of a normal tendency. It 
 does not, properly imderstood, conflict with the fact that such things as 
 custom and other forms of economic friction and inertia, the higgling of the 
 market, the conscious efforts of social classes to better their condition, 
 imperfections in the monetary system, short-sighted selfishness on the one 
 hand, altruism on the other, as weU as the conscious social control expressed 
 
404 OUTLINES OF ECONOMICS 
 
 in labor legislation, usury laws, and the like, all have important effects upon 
 the incomes actually received by those who furnish labor, capital, and land for 
 the work of production. Actual wages may differ from the normal wages 
 measured by marginal product just as contractual rent may differ from 
 economic rent. (6) We can imagine an economic order very different from 
 the present one in which it would still be true that incomes would tend 
 to equal products. If, for example, wages were arbitrarily increased 50 per 
 cent by law, while one result would undoubtedly be an increase in unem- 
 ployment, it would still be true that wages would tend to equal the marginal 
 product of labor, or, rather, that the marginal product of labor would tend to 
 equal wages. To attempt to avoid this difficulty by assuming that the 
 present order, or a purely competitive order, is the " natural " order of things, 
 is to beg the whole question in favor of the existing status. 
 
 Social Aspects of Diminishing Productivity. — Since the 
 entrepreneurs are only the intermediaries between society viewed 
 
 'as a body of consumers and society viewed as a body of pro- 
 ducers, we may, for present purposes, leave them out of con- 
 sideration, in order to fix our attention upon some of the more 
 general results of the fact of diminishing productivity. 
 
 If the number of laborers within the boundaries of a nation is 
 increased by immigration, without a corresponding increase in 
 
 -capital or in the amount of land available for use, the result will 
 be an increase in the total amount of goods produced, which 
 means an increase in the amount of wealth produced per unit 
 of land and capital, but (on account of the operation of the law 
 of diminishing productivity) a decreased amount per laborer; 
 a higher marginal product for land and capital, and a lower 
 marginal product for labor; consequently, higher rent and 
 higher interest, but lower wages. If the supply of capital within 
 a country is increased, while labor and land remain constant, 
 the result will be higher wages and higher rents, but a smaller 
 remuneration for capital. Similarly, if the available supply of 
 land be increased (as by improvements in transportation facili- 
 ties), rent will absorb relatively less, and wages and interest 
 relatively more, of the value of the total product. 
 
 In a very real sense the same laborer is more productive in a 
 country where land is relatively plentiful than in a country 
 where land is relatively scarce. A laborer may gain no technical 
 
DISTRIBUTION AS AN ECONOMIC PROBLEM 405 
 
 efficiency by migration from Europe to America, but the in- 
 crement of product attributable to his work is apt to be con- 
 siderably larger in the United States than it was in Europe. 
 Here he really creates a larger product and earns a larger wage. 
 The migrations of labor and capital from one region to another, 
 or from one country to another, are guided by the endeavors of 
 capitalists and laborers to get the maximum remuneration, — 
 which will always be found where the price of the marginal 
 product of capital or labor is a maximum. 
 
 In a prosperous country it is apt to be the case that the supply 
 of labor and the supply of capital are being increased simultane- 
 ously, though not necessarily with equal rapidity, while more 
 land is at the same time being made available through improve- 
 ments in transportation. Save under such exceptional condi- 
 tions of railway building as prevailed in the United States 
 during" the forty years following the Civil War, the available 
 supply of land is apt to increase more slowly than the other 
 factors in production increase. In general, the law of diminish- 
 ing productivity will necessitate a continual increase in the 
 proportion of the product set aside for the remuneration of 
 each unit of the most slowly increasing factor in production ; 
 while, of the other two factors, the one that increases more 
 rapidly will receive, per unit, a relatively smaller and smaller 
 proportion of the value of the total product. 
 
 QUESTIONS 
 
 1. Do you know of any instances where the distribution of wealth has 
 been affected, directly or indirectly, by conscious social action ? 
 
 2. Prepare tables or diagrams roughly illustrating the operation of the 
 law of diminishing productivity in some industry with which you are familiar. 
 
 3. Why is the same laborer more productive in America than in Europe? 
 Is this a condition that will probably continue indefinitely? 
 
 4. Why do lands in Belgium produce more per acre than similar lands in 
 the United States? 
 
 5. Is the fact that the average wheat crop per acre is larger in Europe 
 than in the United States an indication that European agricultural methods 
 are superior? 
 
 6. Which is the more significant : product per acre or product per man ? 
 
 7. Why are twenty-story office buildings not erected in small cities? 
 
4o6 OUTLINES OF ECONOMICS 
 
 8. Can an entrepreneur increase his product indefinitely by using con- 
 tinually larger amounts of all the agents in production? 
 
 9. What is the relation of the discussion in this chapter to the socialist 
 contention that labor produces all wealth ? 
 
 10. Discuss the following statement : 
 
 "Each man, taking account of his own means, will push the investment 
 of capital in his business in each several direction until what appears in his 
 judgment to be the outer limit, or margin, of profitableness is reached ; that 
 is, until there seems to him no good reason for thinking that the gains 
 resulting from any further investment in that particular direction would 
 compensate him for his outlay. The margin of profitableness is not to be 
 regarded as a mere point on any one fixed line of profitable investment ; but 
 as a boundary line of irregular shape cutting one after another every possible 
 line of investment." Alfred Marshall, Principles of Economics, 6th ed., 
 P- 356. 
 
 REFERENCES 
 
 Carver, T. N. The Distribution of Wealth, Chap. ii. 
 Clark, J. B. The Distribution of Wealth, Chaps, vii-xiii. 
 Commons, J. R. The Distribution of Wealth, Chap. iii. 
 Davenport, H. J., Economics of Enterprise, Chaps, ix, x, xxiii, xxiv. 
 Marshall, Alfred. Principles of Economics, 6th ed.. Book v, Chap, viii, 
 Book vi. Chaps, i, ii. 
 
CHAPTER XX 
 THE RENT OF LAND 
 
 Rent is the price paid for the services of land. In common 
 usage the meaning of the word is, however, much less exact. 
 That which one pays for the use of durable goods of any kind 
 owned by another is commonly called rent. The payment for 
 the use of a house or a business building is, for example, counted 
 as rent. , We shall see that in this case the so-called rent really 
 consists of two elements, — one a ground rent, or rent proper, 
 the other capital rent. If this distinction seems fanciful, it is 
 only because we are accustomed to see the two united under 
 one ownership. But in most large cities separate ownership 
 is common. Sometimes one man owns the land and leases it 
 for a long term of years to another who erects buildings upon 
 it, which, either with or without payment, become the property 
 of the landowner at the expiration of the lease, unless it is 
 renewed, and if it is renewed, the one who possesses the build- 
 ing must frequently pay for it. Often, however, the separa- 
 tion in ownership is permanent, the house owner paying per- 
 petually an annual surn for the use of the ground. This is the 
 case in Baltimore, for example, where ground rents are an 
 important feature in the economic life of the city. In such 
 cases the two kinds of income are very clearly distinguished. 
 
 Some modern economists have extended the meaning of both 
 rent and interest, using them as two different ways of describ- 
 ing one form of income, rather than as two distinct kinds of in- 
 come. This usage is based on the obvious fact that the rent 
 which a landlord receives for an acre of land may easily be com- 
 puted as a certain rate of interest on the money value of the land, 
 just as the amount earned by a machine may be viewed either 
 as the rent of the machine or as interest on its money price, 
 
 407 
 
4o8 OUTLINES OF ECONOMICS 
 
 But we shall see later that the income from other production 
 goods, while governed in part by the same laws that control the 
 income from land, is also governed in part by very different 
 laws. Without dwelling further upon this distinction at this 
 stage of our discussion, let us remember that in the great ma- 
 jority of economic writings the term " rent " means only an 
 income derived from the ownership of land, and that it is used 
 only in this sense in the following discussion. 
 
 The Services of Land. — The first thing to be noted about 
 land is its quality. Differences of fertility are familiar to every 
 one, and depend upon what have been known as the " original 
 and indestructible properties of the soil." An effort has been 
 made by certain writers to minimize or deny the significance of 
 this factor. It has been said that " soil " is not indestructible, 
 that it may be exhausted or removed from land altogether, 
 and that it may in turn be created by means of fertilization. 
 These writers recognize in land no other indestructible property 
 than standing room. This objection arises from the use of the 
 word " soil " in a narrow sense. 
 
 If by " soil " we mean only that thin top layer containing 
 some elements necessary to plant life, it is true that this may 
 be carted on or off at pleasure, that it may be wasted or replen- 
 ished. But, granting this, there still remain many qualities 
 of land which are indestructible and unproducible, and which 
 so directly affect the productiveness of the land that we may not 
 inappropriately call them " properties of the soil." Such a 
 property is the conformation of the land. A steep, gravelly 
 hillside will by no possible effort equal a plain in fertility. The 
 north side of a mountain cannot be made to produce the same 
 as the south side. Climate is not, to be sure, a " property of 
 the soil," but it is an inseparable appurtenance of the land, 
 and upon it the productiveness of the land in large measure 
 depends. The ownership of a piece of land carries with it the 
 advantage of all the conditions which attach to that land. 
 The expression, " original and indestructible properties of the 
 soil." is inadequate and misleading; but it covers more than 
 mere '' standing room." 
 
THE RENT OF LAND 409 
 
 We will, therefore, adopt another expression to explain what 
 we mean by quality in land ; namely, the irremovable conditions 
 affecting its productiveness. Of these its extent (standing room), 
 its conformation, and its climate are essentially original and in- 
 destructible. Others, such as are connected with the " soil " in 
 the narrow sense, are not indestructible nor necessarily original, 
 but they affect rent none the less. Fertihty, even when arti- 
 ficial, becomes essentially a property of the land. From the 
 case where capital is embodied in land and entirely assimilated 
 to it in character, we pass by insensible gradations to fences, 
 barns, houses, etc., which more and more assume the character 
 of capital as distinguished from land. It would be possible 
 to restrict the term " land " to strictly natural or " original " 
 land, and apply the term " capital " to all products, including 
 the soils of old land. This would be a logical distinction, but, 
 like so many logical distinctions, would be confusing. On the 
 other hand, if we include under land all capital that has been 
 incorporated in it, we must recognize that there is no absolute 
 line of division between land and capital. Thus we are again 
 reminded that distinctions in economics, as well as in practical 
 life, are questions of convenience, and are good or bad accord- 
 ing as they are more or less useful. 
 
 The second great fact regarding land is location. On one side 
 this is closely connected with climate. But a more distinct 
 meaning of the word is situation with respect to markets. 
 Everybody knows that land a hundred miles from market is, 
 other things being equal, worth more than land a thousand miles 
 from market. This, however, is a question of accessibility rather 
 than of mere distance. Land may be far away and yet easy to 
 reach, or near and difiicult of access. Any change in the expense 
 of transportation affects rents. The rents of England have 
 been revolutionized by cheap ocean transportation, which has 
 practically brought distant land very near to her shores. To 
 this fact of location we must ascribe almost wholly the enormous 
 rents paid for city lots. Here, again, transportation facilities 
 powerfully affect rents. 
 
 One important difference in the way quality and location affect 
 
4IO OUTLINES OF ECONOMICS 
 
 rent must, however, be noted. The quality of a piece of land 
 affects the amount of its physical product; it determines how 
 many bushels of wheat or how many pounds of cotton it will 
 yield with a given amount of cultivation. The locatioii of land 
 does not, it is true, affect the amount of its physical product, 
 but it does affect the price of the product, since that varies with 
 the expense of transporting the product to market. The money 
 value of a piece of land to the user depends upon the money 
 value of its yield, which is, of course, the number of units of 
 products multiplied by the price per unit. Suppose a man 
 owns two wheat farms of equal size, one in Dakota and one in 
 Illinois. If the farm in Dakota produces thirty bushels of 
 wheat to the acre, and it costs twenty cents a bushel to get it 
 to the Chicago market, where wheat is selling at a dollar per 
 bushel, while the farm in Illinois produces twenty-five bushels 
 to the acre, and it costs four cents a bushel to get this to the 
 Chicago market, the farms are equally productive so far as 
 the owner is concerned, for in each case he will get $24 for an 
 acre's yield of wheat. If the other conditions of production 
 are the same, the farms are equally valuable to the owner. 
 From the social point of view, too, one of the farms is as good 
 as the other. For the costs of transportation, of moving things 
 to where they are wanted, have to be counted among the legiti- 
 mate and necessary costs of production. In short, we may say 
 that the two pieces of land are equally good land. When we 
 speak of good land, therefore, in connection with the subject 
 of rent, we mean land which for all purposes taken together is 
 desirable. 
 
 Rent under Assumed Conditions of Uniform Intensivity of 
 Cultivation. — The first settlers in a new country have no need to 
 pay rent. They find plenty of land, and even the best of it will 
 be a free good, like air or water. So long as any man can get land 
 of the best quality free, there is no reason why he should pay rent 
 to any one else. But this fortunate state of affairs will last only 
 so long as some of the best lands remain unoccupied. When 
 increase in the population makes the utilization of inferior lands 
 necessary, the owners of the better lands will be able to demand 
 
THE RENT OF LAND 
 
 411 
 
 and receive a rent for the use of their lands. This will be made 
 clear by reference to Figure i, which is constructed on the 
 assumption that there are six grades of land, A, B, C, D, E, 
 and F, and that for all these lands the same amount of cultiva- 
 tion per acre is necessary. The successive rectangles repre- 
 sent the selling value of the product that can be raised on one 
 
 G D 
 
 Fig. I. 
 
 E 
 
 F 
 
 acre of each of these different grades of land, by the use of a 
 fixed amount of labor and capital. The product of an acre 
 of the best land, A, will sell for Oamy dollars. Until all of this 
 best land is occupied, no rent will be paid, and the entire value 
 of the product will be available for the expense of the capital 
 and the wages of labor employed in its cultivation.^ 
 
 As soon, however, as it becomes necessary to cultivate some of 
 the B lands, the situation will be altered. The owners of the A 
 lands can now exact a rent for their use, and the tenant farmer 
 has no alternative, except to utilize land of the second grade, 
 on which the fixed amount of labor and capital will only produce 
 a product per acre selling for ahnk dollars. The rent which 
 will be paid per acre for A lands will amount to the difference 
 between the value of the products of the two grades of land 
 {hkmy in the diagram). For if the landowners attempt to charge 
 more than this difference, tenant farmers will find it more 
 
 1 The profits which the fanner may receive as entrepreneur do not affect the 
 analysis, and may accordingly be neglected. 
 
412 OUTLINES OF ECONOMICS 
 
 advantageous to use the B lands; if they charge less, the A 
 lands will be the more remunerative to the farmer, and competi- 
 tion among the farmers for the leases of A lands will force the 
 rent up. In short, rent will normally be fixed at the point 
 which will just equalize the advantages of cultivating the two kinds 
 of land. 
 
 As soon as increased population and the consequent need of 
 a larger food supply and more raw materials have forced men to 
 begin to cultivate lands of the C grade, the B lands will command 
 a rent, while the rent of the A lands will be increased by an 
 amount equal to the rent of the B lands. And as cultivation is 
 pushed down to still poorer and poorer lands, the rents which 
 these better lands command will be still further increased. 
 Thus, when some lands of grade E are in use, the value of the 
 product which can be got from this free land, by the use of the 
 fixed amount of labor and capital, will be dert dollars per acre. 
 This sum will just about pay the cost of labor and capital, for if 
 it amounts to less than these expenses of production, the E lands 
 will not be worth cultivating ; if it amounts to very much more, 
 it will pay to cultivate still poorer land. But if dert dollars 
 will just pay wages and interest on the E lands, the same 
 sum will pay wages and interest on the better lands, for we 
 have assumed that the same amount of labor and capital 
 is used on each grade of land. The expense for labor and 
 capital will, therefore, be represented on each rectangle by 
 the area below the line gt, while the area above this line will 
 represent in each case the rent per acre which the landowner 
 will receive. 
 
 Rent, under these conditions, is a differential which measures 
 accurately the superiority of the rent-bearing land over the mar- 
 ginal land — the land which just repays the expenses of cultiva- 
 tion. It is not necessary to the significance of the theory that 
 all, or even any, of the farmers should be tenant farmers. If 
 the farmer owns the land that he operates, the part of his income 
 to which may be attributed the superiority of his land over an 
 equal area of marginal land must, in any accurate analysis, 
 be counted as rent. 
 
THE RENT OF LAND 
 
 413 
 
 Rent under Actual Conditions. — The conditions assumed in 
 the foregoing analysis depart from actual conditions in one im- 
 portant particular, — the assumption that equal amounts 
 of labor and capital, that is, a uniform intensivity of cultiva- 
 tion, would be used on lands of different grades. As a matter 
 of fact, even after the A lands are all occupied, the supply of 
 agricultural products can be increased without resort to poorer 
 lands. All that is really necessary is the more intensive culti- 
 vation of the A lands. This cannot be done, however, without 
 encountering the law of diminishing productivity. Successive 
 equal amounts of labor and capital used on the same lands 
 cannot be expected to yield uniformly large increments of prod- 
 uct. It will pay, however, to make use of more intensive culti- 
 vation up to the point where the last unit of labor and capital 
 adds barely enough to the prod- 
 uct to pay for the increased 
 expense, — a point which is called 
 the intensive margin. The result 
 of this more intensive cultivation 
 is represented in Figure 2. Now 
 the first rectangle in this diagram 
 (Oamy) represents precisely the 
 same thing as is represented by 
 the first rectangle in Figure i, the 
 return (in value of product) from 
 the cultivation of an acre of land 
 of A grade by the use of a fixed 
 amount of labor and capital. The second rectangle in Figure 2, 
 however, represents the additional product resulting from the 
 use of a similar unit of labor and capital on the same acre, while 
 the third represents the increment of product due to the employ- 
 ment of yet a third unit of labor and capital on the same land. 
 Assume that this third unit, A^, adds just enough to the selling 
 value of the product to pay for itself. Then, as already ex- 
 plained in the discussion of diminishing productivity, the area 
 Ocph will represent that part of the farmer's income which will 
 be used up by the expense incurred for the three units of labor 
 
 Fig. 2. 
 
 Ai 
 
414 
 
 OUTLINES OF ECONOMICS 
 
 and capital used on this one acre of land, and the area above 
 the line hq will represent the real rent of that acre.^ If land E 
 (Figure i) just repays the expenses of cultivation when one unit 
 of labor and capital is used per acre, the value of the product 
 per acre of this land will equal the value of the increment of 
 product attributable to the third unit of labor and capital used 
 on land A. (That is, the area dert, Figure i, equals the area 
 hcpq, Figure 2.) So far, then, as the margin of cultivation is 
 concerned. Figure i represents the conditions accurately. The 
 productivity of capital and labor at the intensive and extensive 
 margins is the same. 
 
 But Figure i does not represent the complete theory of rent 
 in that (i) it does not indicate the fact that larger quantities 
 of capital and labor are used on the better lands than on the 
 
 poorer lands, and (2) it 
 does not represent the 
 larger products due to 
 this more intensive culti- 
 vation of the better lands. 
 These considerations are 
 taken account of in Fig- 
 ure 3, which also, by the 
 substitution of curves for 
 successive rectangles, 
 represents the infinite va- 
 riety of degrees of good- 
 ness of the different acres 
 making up the land sup- 
 ply of a country. In Figure 3 the line am represents the money 
 value of a product of a unit of labor and capital on the poorest 
 land in use, and the area hmi represents what rent would be 
 under conditions of uniform intensivity of cultivation. The area 
 Oamg represents the diminishing amounts of labor and capital 
 used per acre as we pass from the better to the poorer lands, 
 while the area ymg represents the rent per acre of the different 
 grades of lands. The foregoing analysis leads to the following 
 ^ Neglecting, for the present, the possible existence of profits. 
 
 Fig. 3- 
 
THE RENT OF LAND 415 
 
 statement of the theory of rent, which the reader may verify 
 for himself by referring to Figures i and 2 : 
 
 The rent of any piece of land is measured hy the difference between 
 the money value of the products obtained from it by the use of the 
 most advantageous amoimts of labor and capital and the money 
 value of the products which could be obtained by the use of the same 
 amounts of labor and capital on marginal land, or at the intensive 
 margin of cultivation. 
 
 This statement should not be understood as comparing the 
 total product raised on a given piece of land with the total prod- 
 uct which could be got from the same amount of marginal land. 
 This would be to reintroduce the assumption of uniform inten- 
 sivity of cultivation — an assumption which impaired the ade- 
 quacy of the theory of rent illustrated in Figure i above. On 
 the contrary, it is assumed in the present statement that the 
 farmer would use whatever amount of the marginal land he 
 found most profitable. If it were profitable to use twenty 
 times as much labor and capital on a certain piece of land as 
 on a similar amount of marginal land, to employ the same 
 amount of labor and capital profitably on marginal land would 
 take twenty times as much land. 
 
 Rent and the Marginal Product of Land. — In an earlier chapter it was 
 suggested that rent could be measured by the marginal product of land ; in 
 other words, that the amount which a farmer would pay per acre for the use 
 of land would depend upon the money value of so much of his product as 
 was dependent upon the possession of any one acre of land. In that dis- 
 cussion it was assumed, however, that land was of a tmiform degree of good- 
 ness. Obviously, if all land really were of a maiform degree of goodness, in 
 aU ways equally desirable, no rent would be paid imtil aU lands were utilized, 
 when rent would arise on account of the necessity of increased intensivity of 
 cultivation. 
 
 But even under the actual conditions of the existence of different grades of 
 land and of a large body of land which is below the margin of cultivation, 
 the rent of any acre of the better lands can be stated in terms of the value 
 of its product. For the rent of any acre of land is determined by the money 
 value of the amount of the product imputed to it (as distinct from the product 
 imputed to the labor and the capital employed upon it). Now the product 
 that must be imputed to any acre of land is, of course, the amount which it 
 adds to the total product, or, what amounts to the same thing, the amoimt by 
 
4l6 OUTLINES OF ECONOMICS 
 
 which the total product would be decreased if just as much labor and capital 
 were employed in agriculture, but if that particular acre of land were not 
 available. This means, however, that the labor and capital which would 
 have been employed on this land would have to be utilized either in cultivat- 
 ing more intensively the lands already utilized or in cultivating lands pre- 
 viously uncultivated; that is, at either the intensive or extensive margin. 
 Obviously the product imputed to the land in question would be the differ- 
 ence between the total product got from it and the product which would 
 result from the employment of the same amount of labor and capital at the 
 margin. Thus, by a somewhat different line of analysis, we have again 
 reached the statement of the theory of rent given in the preceding section. 
 
 The Different Uses of Land. — We have seen that the better 
 lands will repay a more intensive cultivation than the poorer 
 lands, and have found this fact to be of great significance in the 
 theory of rent. By varying degrees of intensivity of cultivation 
 we do not mean only the more thorough cultivation of the land 
 in the raising of any one crop. Land produces a great variety 
 of products, and some of these need much more intensive culti- 
 vation than others. In the business of raising cattle, as it is con- 
 ducted on a large western ranch, the total investment of capi- 
 tal and labor may be very considerable, but the investment per 
 acre of land is very small indeed ; while a small market garden, 
 located near a great city, will repay a very high degree of inten- 
 sivity of cultivation. It is only on the best lands that crops 
 necessitating a large amount of labor per acre can be raised 
 profitably. By the best lands we mean in this connection 
 not only those lands which are best fitted by soil and climate 
 for the production of particular crops, but the best lands in 
 the sense that they are nearest the market. For example, 
 cities in the eastern part of the United States get part of their 
 supply of fresh vegetables from market gardens in their own 
 environs, while another part of this supply may come from the 
 southern states and even across the continent from California. 
 The local market gardens are good lands on account of their 
 situation; the more distant lands are good lands on account 
 of special qualities of soil or climate which enable them to furnish 
 *' out of season " vegetables. 
 
 Because certain lands are adapted, on account of quality or 
 
THE RENT OF LAND 417 
 
 location, for intensive cultivation, they command high rents. 
 On the other hand, lands which command high rents for alter- 
 native uses generally have to be cultivated intensively, because 
 the entrepreneur is forced by the very fact of high rent to econo- 
 mize in his use of land as compared with his use of capital and 
 labor. The raising of flax as raw material for hnen is a profitable 
 agricultural industry in densely populated Belgium, but it 
 has never met with much success in the United States because 
 flax straw of a quality fit for the better grades of linen demands 
 a large amount of care and labor. Land is so plentiful here 
 that it pays us better to specialize in a less intensive kind of 
 agriculture — to spread our labor and capital more thinly over 
 a larger number of acres. 
 
 The poorest land that can profitably be used in the growing 
 of any one kind oj product is not necessarily marginal land. 
 Land too poor to use for market gardening may be good wheat 
 land; land too poor to devote to wheat may be good grazing 
 land. The poorest land devoted to any one purpose may 
 yield a rent, arising from its relative superiority over other 
 lands for some alternative use. It will be readily understood 
 that the marginal lands used as a basis of comparison in 
 our statement of the law of rent are the poorest lands used 
 for any purpose — grazing lands, possibly. But, as we have 
 seen, rent may also be measured from the intensive margin of 
 cultivation, and the intensive margin is found on all lands, even 
 the best. 
 
 Although all our illustrations of the theory of rent have been 
 drawn from agriculture, the principle is, in fact, perfectly gen- 
 eral. The rent of land used for industrial or commercial pur- 
 poses is determined in precisely the same way as the rent of 
 agricultural land. In fact, different kinds of manufacturing, 
 wholesale and retail trading, etc., may be looked upon as dif- 
 ferent possible uses of land, differing in the amount of labor 
 and capital they require, and all subject to the law of diminish- 
 ing productivity, and hence to the law of rent. When we pass 
 from the agricultural uses of land to its commercial and indus- 
 trial uses, the fact of quaUty becomes of practically no impor- 
 
 .yy 
 
4l8 OUTLINES OF ECONOMICS 
 
 tancc in the determination of rent, while the fact of location 
 becomes fundamental. 
 
 In addition to these dijGferent gainful uses of land, we have 
 to take account of its other uses, such as for pleasure grounds 
 and residence sites. Here the explanation of rent is simpler 
 than in the case of productive lands. For these lands yield 
 their utilities directly, and hence come under the general laws 
 of price. 
 
 The Capitalization of Rent. — To the individual who has a cer^^ 
 tain amount of money for which he is seeking the most profitable 
 use, the question whether he shall invest it in land or other forms 
 of production goods is apt to be in itself an unimportant one. 
 If he chooses to buy land, it will be because he can get a satis- 
 factory income from it, and he will very properly count the 
 income as interest on the funds he has invested in the land. If 
 the income from the land increases, the selling value of the 
 land will increase. From the point of view of our investor 
 this will, of course, be an increase in the '' capital value " of 
 the land. It is important to note, however, that the land does 
 not return an income simply because it is valuable. The process 
 is the reverse of this. The land aids annually in the production 
 of goods which command a price in the market ; a part of the 
 money value of this annual product is necessarily imputed to 
 the service of land and paid for in the form of economic rent ; 
 and the land is valued because it commands a rent. The money 
 value of the land is governed by its income-yielding power. 
 
 This fundamental fact is apt to escape our notice because in 
 the United States lands are more commonly sold than leased, so 
 that we think of the price of land as the price at which it 
 will sell, rather than as its annual price, or rent, although the 
 first kind of price depends upon the second. In England, 
 where lands are more commonly leased, the price of land is 
 usually thought of as its annual price or rent, while the selling 
 price is often expressed as " twenty (or other number of) years' 
 purchase," meaning twenty times the annual rent. The process 
 by which the capacity to yield a certain annual income is made 
 the basis for the determination of a certain selling price is termed 
 
THE RENT OF LAND 419 
 
 " capitalization." ^ In a country which is growing in popula- 
 tion and wealth, and where land rents are consequently increas- 
 ing, the selling value of land is apt to be somewhat greater 
 than a capitalization of the amount of income it is yielding at 
 the time of the sale would justify. This is because the owner- 
 ship of land carries with it the right to receive future as well as 
 present incomes, and the prospectively larger future incomes 
 are taken into account in the process of capitalization. 
 
 Rent and Social Progress. — The fact just mentioned — the 
 tendency of rents to increase as society progresses — is of very 
 great significance. It springs from the impossibility of satisfy- 
 ing the increasing wants of a society which is growing in popu- 
 lation and wealth without increasing the supply of food products 
 and raw materials by means of more extensive and more inten- 
 sive cultivation. As this means pushing downward the exten- 
 sive and intensive margins of cultivation, the necessary result 
 is a rise in rents. 
 
 During the early years of the nineteenth century the Napole- 
 onic wars on the continent, together with a high protective tariff 
 in England, kept England from importing any grain from 
 Europe. This, coupled with a considerable increase in the popu- 
 lation of England, resulted in very high prices for wheat, a 
 rapid extension of cultivation, and a remarkable rise in rents. 
 It was the effort of economists to explain these facts that led to 
 the formulation of the theory of rent in substantially its present 
 form. Bound up with this theory of rent was the law of dimin- 
 ishing returns — the name usually given to the fact that an in- 
 creasing population cannot supply itself with food and raw 
 materials except by the utilization of poorer and poorer lands, 
 and consequently at an increasing expense per unit of product. 
 (This law should not be confused with the law of diminishing 
 
 ' The nature of this process of capitalization will be discussed in the chapter 
 on Interest. It is a fact of common observation that the rate of capitalization, 
 that is, the ratio of income to selling value, is lower in the case of land than in the 
 case of most forms of capital goods. The durability of land, the variety of uses 
 to which it may be put, the social prestige attached to land ownership, as well as 
 the fact that in many cases its income-yielding power is likely to increase, are among 
 the things that account for this. 
 
420 OUTLINES OF ECONOMICS 
 
 productivity. One is a statement of a historical tendency in 
 one field of production — agriculture ; the other relates to the 
 proportions in which the factors of production are combined, 
 and holds true for all fields of production.) 
 
 This law of diminishing returns has been made the basis of 
 many gloomy prophecies regarding the possibilities of a general 
 and continued economic progress. Especially when this theory 
 was combined with the Malthusian theory of population, which 
 was based on the belief that population would tend to increase 
 as fast as the food supply would permit, it seemed to point to 
 insuperable barriers in the way of any considerable progress in 
 human welfare. 
 
 The history of the past century has belied these gloomy proph- 
 ecies. The increase in population has been greater than in 
 any previous period of the world's history, and yet, so far as 
 agricultural lands are concerned, the general level of rents has 
 not increased. In fact, the change has been in the other direc- 
 tion. That rents have not increased as population has grown, 
 does not disprove the law of diminishing returns. That law, 
 like other economic laws, is true only as a statement of a tend- 
 ency. If this tendency has not resulted in increased rents, it 
 is not because it has not been operative, but because other 
 powerful factors have counteracted its effects. Two things, 
 at least, have prevented a rise in rents. In the first place, im- 
 provements in agricultural methods have greatly increased the 
 product which can be got from a given acre of land. We must 
 include here not only improvements in methods of tillage and 
 cultivation, in fertilizers, in the varieties of plants, in breeds 
 of live stock, etc., but also organized social methods looking 
 toward a better utilization of the nation's land supply, such 
 as the irrigation of dry lands, and scientific forestry, which 
 has an important influence upon the conservation of the 
 rainfall. 
 
 Of much greater importance, however, than all these things 
 taken together, has been the revolution in ocean and land 
 transportation, which has enormously increased the available 
 amount of land. Lands in England have gone out of cultiva- 
 
THE RENT OF LAND , 42 1 
 
 tion because the railway and the steamship have brought the 
 great wheat fields of America to her very doors. Even in the 
 United States the new lands brought near to market by the rail- 
 ways have often been of better quality than the lands previously 
 cultivated, so that the margin of cultivation has gone up rather 
 than down. There were 2,250,000 acres of improved farming 
 lands in the state of New Hampshire in 1850; by 1900 this 
 acreage had shrunk to 1,075,000. In Massachusetts the im- 
 proved farm lands decreased in this period of fifty years from 
 2,135,000 acres to 1,300,000 acres. Similar figures could be 
 given for others of the older states. The diminution in the use 
 of old lands may be partly accounted for by their deterioration 
 in fertility under continual cultivation without proper rotation 
 of crops. But this is only a partial explanation, for any one 
 who is familiar with the conditions knows that even the most 
 careful tillage could not have kept millions of acres of farm land 
 which were once rent-yielding from going below the margin of 
 cultivation, for the simple reason that the margin of cultiva- 
 tion rose. The railway practice of making very much lower 
 rates per mile on long hauls than on short hauls has hastened 
 this process, by minimizing the disadvantages of lands of good 
 quality situated at a distance from the market. 
 
 The fact that since the introduction of the railway the margin 
 of cultivation has risen does not mean that it has risen continu- 
 ously, or that it will continue to rise. There are many who be- 
 lieve that we have only gained a brief and already passing respite 
 from the day when every increase in the demand for food prod- 
 ucts and raw materials will be met only with increasing diffi- 
 culty. It is as dangerous to prophesy, however, as it was a 
 hundred years ago. The fact that there still remain some 
 unutilized lands of good quality in what are now out-of-the- 
 way parts of the world may prove to be of less importance than 
 other things. It is a striking fact that in the United States 
 today only about half of the land actually in farms is culti- 
 vated. Some of these uncultivated portions of farms are very 
 poor lands, and others are given over to meadows and pastures. 
 But we venture to say that what idle acreage exists is due in 
 
422 OUTLINES OF ECONOMICS 
 
 part to a lack of correspondence between the historical condi- 
 tions that have fixed the size of farms and the economic condi- 
 tions that fix the number of acres that can be profitably utilized 
 by one farmer. This unexploited area is, to that extent at 
 least, a reserve which can be drawn upon as the demand for 
 agricultural products increases. Then, too, we are just begin- 
 ning to have some idea of the improvements which scientific 
 selection may bring about in the qualities and productiveness 
 of different kinds of plants ; methods of fertilization and tillage 
 are still the subjects of fruitful scientific inquiry ; forestry and 
 irrigation are yet in their infancy. Changes in demand, of 
 such a nature as to make possible the utilization of some lands 
 for the production of crops for which they are better fitted than 
 for their present uses, are also among the things that may resist 
 the tendency toward a general rise in rents. In fact, although 
 it is absurd to suppose that the rent of land will not increase 
 as society continues to increase in wealth and numbers, it is 
 just as absurd to make this fundamental tendency toward dimin- 
 ishing returns in agriculture a basis for pessimistic views regard- 
 ing the possibility of economic progress. 
 
 The Unearned Increment. — When we say that the margin of 
 cultivation has gone up, rather than down, since 1850, we do not 
 imply that rents have not, in many cases, increased. The new 
 lands opened up to use by new railways, for example, are at first 
 very cheap lands, often free lands. As they are taken up, they 
 command higher and higher rents. Practically all of the agri- 
 cultural lands now utilized in America have had such a history, 
 — even though in some cases the present rents are not as high 
 as their rents at some previous time. The fact that, through 
 the change in transportation methods, the marginal farming 
 lands of today are better lands than the marginal farming 
 lands of sixty years ago does not affect the fact that the sum 
 total of land rents, and consequently of land values, is immensely 
 greater today than at any previous time. The increase in 
 the value of land which accompanies the increase in its income- 
 yielding power is often called the unearned increment. This 
 phrase suggests that the increase in land values cannot be 
 
THE RENT OF LAND 423 
 
 attributed to any special effort on the part of the owners of 
 land, but is due to general social causes. 
 
 This does not mean that the land-owning farmer cannot in- 
 crease the selling value of his farm by wise investments of 
 capital; but, remembering that rent is the payment for the 
 irremovable conditions affecting the productiveness of land, 
 it is clear that it can be affected only to a comparatively small 
 degree by the efforts of any one individual landowner. Most 
 of the present money value of land has grown out of that 
 complex of things which we call general social progress, the 
 most important of which in this connection are growth in popu- 
 lation and growth in average wealth — the things that lead to 
 an increased demand for the products of the soil. We should, 
 however, be careful to distinguish the rise in the sum total of 
 rents which springs from the occupation of new and often better 
 lands, and the increase in rent per acre, which comes from forc- 
 ing downward the margin of cultivation. 
 
 Despite these facts, the phrase unearned increment is mis- 
 leading. As generally used, it implies a confusion of two very 
 different things, — physical quantities (acres) and selling val- 
 ues. From the fact that land is, in a physical sense, rarely 
 " produced " it is inferred that the selling value of land is 
 always " unearned." Other forms of wealth, it is sometimes 
 urged, are valuable (command a high price) because they are 
 produced at a cost ; land has no " expenses of production," 
 and is valuable only because there is a demand for land and for 
 its products. Now the reader should be able to see that this 
 is not an altogether accurate way of stating the case. Produced 
 goods, like land, are valuable only because people want them 
 and are willing to pay for them. Other things have to be paid 
 for because otherwise it will not be worth while for any one to 
 go to the expense of producing them ; land commands a price 
 because its supply is naturally limited, and because there are 
 competing users of land who can apportion the available supply 
 among themselves only on the basis of prices and rents corre- 
 sponding with the advantages which particular units of land 
 give to their possessors. 
 
424 OUTLINES OF ECONOMICS 
 
 And so far as the increase in land values can be foreseen, 
 it can rarely be " unearned." For the increase in the selling 
 value of the land will be taken into account and discounted. 
 This occurs in two ways. In the first place, the present 
 selling value of such land will be higher than that of other 
 property with similar annual income-yielding power. Usually 
 both the seller and the buyer of land will take into account 
 the probable increase in its selling value and will count this 
 as an additional gain or profit attached to the possession of the 
 land. In other words, the expected increment in value will be 
 translated into terms of present worth, and added to what 
 would otherwise be the present selling value of the land. The 
 increment, so far as it can be foreseen, has to be paid for. In 
 the second place, it is often incorrect to consider the expense 
 of buying and holding land as a thing apart from the other 
 expenses and gains of the business enterprise in which the land 
 is used. The man who builds a house to let takes into account, 
 (i) the expense of acquiring the land, (2) the expense of build- 
 ing the house, (3) taxes and repairs, (4) the probable ultimate 
 depreciation of the rental value of the house, (5) the probable 
 appreciation in the rental or selling value of the land. It is 
 common in such operations to assume that the fourth and fifth 
 factors roughly offset each other. Most of the " free " land 
 distributed under the Homestead Act was acquired by men who 
 would have thought their expected incomes, outside of the 
 probable increase in land values, insufficient to justify them in 
 acquiring and improving the lands. Any one who has watched 
 the settlement of western states and the growth of American 
 cities knows that an enormous amount of effort and sacrifice 
 has been put into improvements on land which would not have 
 been put forth if the anticipated increase in the value of the 
 land itself had not been counted on as part of the earned 
 reward. 
 
 There are unearned increments, — unexpected and undis- 
 counted increases in the values of land, and, for that matter, 
 in other capital values as well. But there are " unearned decre- 
 ments," too. The extent to which these really unearned incre- 
 
THE RENT OF LAND 425 
 
 ments are, in the aggregate, offset by unexpected and undis- 
 counted shrinkages in land values and other capital values is 
 a matter upon which we have, as yet, no adequate information. 
 
 An American reformer, Henry George, converted a large following to his 
 view that all taxes should be levied upon land values. This scheme, known 
 as the "single tax," proposes that economic rent shall go to the government 
 in lieu of taxes — a proceeding which would amount to the government 
 ownership of land, and is so understood by its adherents. The merits and 
 defects of the single tax as a scheme for raising public revenue will be con- 
 sidered in another place. Here we are concerned with it simply as a scheme 
 of economic reform. Henry George's main argument was based on the 
 alleged tendency of land to absorb all the value due to "improvements in the 
 productive power of labor." Among these improvements in the productive 
 power of labor he included such diverse things as "the growth of population, 
 the increase and extension of exchanges, the discoveries of science, the march 
 of invention, the spread of education, the improvement of government," etc. 
 "Land being necessary to labor, and being reduced to private ownership, 
 every increase in the productive power of labor but increases rent — the 
 price that labor must pay for the opportunity to utilize its powers, and thus 
 all the advantages gained by the march of progress go to the owner of land, 
 and wages do not increase." 
 
 In the lirst place, we may object strongly to the assumption that improve- 
 ments in methods of production necessarily mean improvements in the "pro- 
 ductive power of labor" — ^ an assumption which, like the socialists' labor 
 theory of value, really begs the whole question. It would be just as reason- 
 able to call these things improvements in the productive power of capital 
 or improvements in the productive power of land. In the second place, we 
 must enter an emphatic denial to the statement that "all the advantages 
 gained by the march of progress go to the owner of land." If the supply of 
 labor is increasing more rapidly than the supply of land, it is probable that 
 rent per acre will increase faster than wages per laborer; but this does not 
 preclude an advance in wages. 
 
 It must be remembered, too, that Henry George did not propose to abolish 
 rent — an obvious impossibility — but simply to do away with the private 
 receipt of rent. This would prevent the withholding of land from use for 
 purely speculative purposes; thus increase the available supply of land, 
 and consequently lower rents. That such would be the immediate result of 
 throwing all land open to use cannot be denied. But in the long rim it woidd 
 probably have little effect on rent, as it would simply lead to a more rapid 
 exploitation of the land. Land ownership, like any other institution, has 
 to be judged from the viewpoint of general social interests. The "pride of 
 ownership," as an incentive to accumulation and as a basis for good citizen- 
 ship, cannot be Ughtly put aside. 
 
426 OUTLINES OF ECONOMICS 
 
 Urban Lands. — In the modern city we have a tremendous 
 mass of land values resulting from the concentration of a large 
 population on a relatively small area.^ All are familiar with 
 the narrow limits set upon the wholesale districts, the shopping 
 districts, and the financial districts in American cities. The 
 residence districts to which the greatest social prestige attaches 
 are apt to be quite as narrowly restricted. Improvements in 
 rapid transit facilities enlarge the residence areas that are uti- 
 lized by people with moderate incomes, but only serve to increase 
 the congestion in the business centers. Much has been said 
 in favor of the special taxation of city land values. Movements 
 in this direction have already gained great strength in Europe. 
 If such taxes are to be justified, however, it must be primarily 
 on grounds of fiscal convenience. In urban lands, as elsewhere, 
 there are true unearned increments and true unearned decre- 
 ments, but it would be going altogether too far to name the whole 
 mass of urban land values, enormous as it, unearned increment. 
 
 QUESTIONS AND EXERCISES 
 
 1. Mai thus and Ricardo differed as to whether rent is an addition to the 
 total income of society. What is the correct view? 
 
 2. An accepted doctrine of taxation is that landowners cannot shift a tax 
 on land values to any one else (as the tax on toabcco is shifted from the 
 manufacturer to the consumer). Explain this on the basis of the theory 
 of rent. 
 
 3. "Rent does not enter into the determination of normal price." Ex- 
 plain the meaning of this statement. 
 
 REFERENCES 
 
 Carver, T. N. The Distribution of Wealth, Chap. v. 
 
 George, Henry. Progress and Poverty. 
 
 HuED, R. M. The Principles of City Land Values. 
 
 Marshall, Alfred. Principles of Economics , 6th ed., Book vi, Chaps, ix, x. 
 
 PiERSON, N. G. Principles of Economics, Vol. i, Part i, Chap. ii. 
 
 Ricardo, David. Principles of Political Economy and Taxation, Chap. ii. 
 
 Walker, F. A. Land and its Rent. 
 
 1 The assessed value of land, exclusive of improvements, in the city of New York, 
 amounted in 1907 to over three and a half billions of dollars — an amount nearly 
 twice as great as the assessed value of all the real estate, including improvements 
 in the state of New York outside of the city. 
 
CHAPTER XXI 
 THE WAGES OF LABOR 
 
 Wages constitute the price paid for the services of labor. 
 Under the head of " labor " we include all the various kinds of 
 personal services for which a payment is made. Professional 
 men and salaried employees are wage earners in the economic 
 sense, though the term is by common usage generally restricted 
 to manual laborers working for daUy or weekly payments. 
 There is, however, in society to-day, as every one recognizes, 
 a " laboring class," marked off by lines that are fairly distinct, 
 and including the great body of day laborers, factory hands, 
 agricultural laborers, men in various trades requiring various 
 degrees of intelligence and skill, employees in minor positions 
 in business and mercantile establishments, and the like. Some 
 of the most important and pressing present-day economic 
 problems — the variety of things" that make up what is often 
 called the " labor problem " — relate to the economic position 
 of this class. On this account it becomes of special importance . 
 to ascertain just what the rules are that determine its share 
 in the national dividend. In the discussion of wages, then, we 
 have in mind primarily the income of the " laboring class," 
 although most of the principles that will be developed apply 
 just as accurately to the other incomes that must be classed 
 as wages in the economic sense. 
 
 Wages as the Price of Labor. — The definition of wages 
 already given suggests at once the most important fact about 
 them : they are the prices paid for particular kinds of services, 
 and hence come under the general laws of supply and demand. 
 So far as the wages of any one kind of labor are concerned, we 
 can say, as we did of the prices of commodities, that they will 
 tend to be fixed at the point where the supply of that kind of 
 
 427 
 
428 OUTLINES OF ECONOMICS 
 
 labor and the demand for it are in equilibrium. But, as was 
 found in the discussion of the prices of commodities, this simple 
 statement does not take us very far into the analysis of the 
 problem. We want to know why the supply of labor and the 
 demand for it are what they are. We shall find, too, that the 
 factors governing the supply and demand of labor are in some 
 respects very different from those governing the supply and 
 demand of commodities. 
 
 The Demand for Labor. — The demand for labor is, in the 
 last analysis, a demand for the products of labor. Labor does 
 not command a price on its own account, but because it aids in 
 the production of things that satisfy human wants. But how 
 can we measure the product of labor ? How can we distinguish 
 it from the shares in the total product that are to be attributed 
 to land and capital ? We cannot say that the product of labor 
 is to be measured by the difference between the total product 
 produced by the cooperation of labor, land, and capital and the 
 product which would be produced by land and capital working 
 alone ; for this last would, of course, be zero. The fact is, as 
 we have seen in a previous chapter, that the proportion of the 
 product that is attributed to labor is determined by the prin- 
 ciple of specific or marginal productivity. 
 
 That is, we cannot think of the " product of labor," except 
 as the product of the individual laborers making up the supply 
 of labor, and the product of any individual laborer is actually 
 and exactly the amount which he adds to the total product 
 of land, labor, and capital ; in other words, the amount by 
 which the total product would be decreased if the labor of this 
 individual laborer were not utilized. The social demand for 
 the products of labor, which is the basis of the entrepreneur's 
 demand for labor, is not a demand for any vague abstraction 
 like the " product of labor in general," but is a demand for 
 the concrete products due to the activities of individual 
 laborers. 
 
 We must note also that in the case of labor, as in the case 
 of commodities, the word " demand " must not be taken in a 
 loose, indefinite sense. The demand for commodities means 
 
THE WAGES OF LABOR 429 
 
 the quantities that will be taken at certain definite prices. 
 The demand for labor does not mean anything unless it is 
 understood to refer to the number of laborers that will be em- 
 ployed in a particular occupation at a certain wage. In a 
 given occupation at a particular time wages might be fixed 
 at any one of a large number of different possible points. The 
 higher the wage, the smaller will be the number of laborers 
 that an entrepreneur can afford to employ; and that for two 
 reasons : In the first place, the higher wages mean higher 
 expenses of production, and consequently higher prices will have 
 to be charged for the product — a fact which will reduce the 
 quantity of the product that can be sold on the market, and 
 consequently reduce the demand for labor. In the second 
 place, higher wages for labor will induce entrepreneurs to 
 economize in the use of labor, and to use relatively more land 
 and capital, according to the principles which have been ex- 
 plained in the discussion of diminishing productivity. The 
 demand for any particular kind of labor is thus influenced 
 both by variations in the demand for the products of that 
 particular kind of labor, and in the proportion of the product 
 that can be attributed to labor rather than to land and capital. 
 In a similar way the elasticity of the demand for any kind of 
 labor — the extent to which variations in wages will affect the 
 quantity of labor utilized — is a complex function, being affected 
 not only by the elasticity of the demand for the particular 
 products produced by this kind of labor, but also by the readi- 
 ness with which more capital or more land, or both, can be 
 substituted for labor, as labor becomes higher priced. In the 
 printing industry, for example, a rise in wages would make it 
 profitable for employing printers to use more labor-saving ma- 
 chinery, such as typesetting and linotype machines, automatic 
 press feeders, and the like. The higher the wages of agricul- 
 tural laborers, the more profitable will be the more extensive, 
 as compared with the more intensive, uses of land. On the 
 other hand, the reader will at once think of many trades, such 
 as plumbing, where machinery cannot be substituted for hand 
 labor, and where, consequently, the only elastic element in the 
 
430 OUTLINES OF ECONOMICS 
 
 demand for labor lies in the elasticity of the demand for the 
 products of labor. 
 
 The Effect of Labor-saving Machinery on the Demand for Labor. In what 
 has just been said about the use of machinery as a substitute for labor, we 
 have had in mind only the effect of changes of wages on the relative amoimts 
 of labor and of capital that would be used in any one branch of production. 
 Quite another problem, and one of great social importance, relates to the way 
 in which the demand for labor is affected by new inventions and by the 
 introduction of new machine processes. The laborers themselves have often 
 looked at such innovations with hostility. When machinery first began to 
 be used extensively in the woolen industry in England, this opposition was 
 expressed in riots in which the new machines were destroyed, as well as in 
 "proposals to impose legislative restrictions on the use of machines, so as to 
 bring them to a level with hand work, and prevent them from doing the work 
 more quickly or more cheaply than it could be done by hand." ^ In many 
 instances laborers still are inclined to view the introduction of labor-saving 
 machinery as an economic injury to themselves. On the other hand, there 
 are many persons who claim that this attitude on the part of the laborers is 
 an evidence of shortsightedness, since the inevitable result of machine pro- 
 duction is to cheapen the prices of products and thus to lower the cost of 
 living, the net result being an increase in real wages, as contrasted with 
 nominal or money wages. 
 
 This view emphasizes an important truth, and yet it misses the real 
 point of the laborers' alleged grievance. It is true that while the first result 
 of the introduction of improved methods of production is often to bring 
 larger profits to those who introduce them (especially if the new methods are 
 protected by patents), their benefits are ultimately diffused throughout 
 society at large in the form of the fuller and better satisfaction of wants, and 
 the laboring class, as members of society, share in these advantages. But 
 while it is thus true that such improvements ultimately redound to the benefit 
 of laborers as a class, it is equally true that hardship to many individual 
 laborers is often an immediate result of the introduction of labor-saving ma- 
 chinery. Especially is this true in the case of skilled workmen in highly 
 specialized employments, who sometimes find themselves suddenly deprived 
 of the advantages of their skiU, — gained often by long years of apprentice- 
 ship. To expect that such men will feel that they are compensated for their 
 personal loss by the advantages ultimately accruing to laborers as a class, 
 is to ask too much of the altruistic elements in human nature. Workmen 
 have learned, however, from the experience of the past hundred years, that 
 the introduction of machinery is inevitable, and in the better-organized 
 trades they are in many cases pursuing the wiser course of trying to regulate 
 the conditions of the introduction of new kinds of labor-saving machinery 
 
 1 Cunningham and McAithur, English Irdustrial History, p. 226,. 
 
THE WAGES OF LABOR 43 1 
 
 in such a way as to dimmish the hardship inflicted on individual workingmen. 
 Thus, when the linotype machine began to displace hand compositors in the 
 printing trade, the typographical union was able to secure the retention of 
 many hand compositors as linotype operators, together with a reduction 
 in the length of the working day. 
 
 It should be noted also that the eiJect of the introduction of machinery 
 upon the demand for labor varies in different industries, the most important 
 factor in this connection being the elasticity of the demand for the products 
 of the particular trade affected. In the case of the linotype just mentioned, 
 the lessened cost of composition made it possible for newspapers greatly to 
 increase their reading matter, so that the actual reduction in the number of 
 employees was small compared with what might have been expected. The 
 introduction of machine methods into the English textile industry during the 
 period of the Industrial Revolution furnishes an instructive example. The 
 change in the methods of manufacturing cotton cloth came just as the in- 
 vention of the cotton gin had greatly increased and cheapened the supply of 
 raw material. This, coupled with the decreased cost of manufacturing, so 
 cheapened cotton cloth (which had previously been very expensive) that its 
 use was largely increased. In fact, a great many more persons were em- 
 ployed in spinning and weaving cotton soon after the Industrial Revolution 
 than immediately before it. In the woolen industry, however, there was no 
 such immediate increase in the sale of the product, so that many workers 
 were displaced, and had to seek occupations where their specialized skiU was 
 of no avail. Especially when the occupation affected is a highly specialized 
 but relatively unimportant one in a series of processes comprised in the 
 manufacture of a product the wage-earning power of the displaced laborers 
 is apt to be seriously diminished. 
 
 The Supply of Labor. — It is when we fix our attention 
 upon the nature of the supply of labor that differences be- 
 tween the way in which wages are determined and the way in 
 which the prices of commodities are determined become most 
 noticeable. 
 
 In the first place, if we view industry in general, we notice 
 that in the case of labor there cannot be much difference between 
 the actual supply and what we called, when discussing excha,nge 
 value, the " potential supply." Labor is in this particular 
 like the most perishable of commodities : the nmnber of work- 
 ing days in a man's life is limited, and those that are not sold 
 are irrevocably gone. The laborer has, it is true, some power 
 in the way of " holding out for higher wages," but even this 
 power is limited rather narrowly by the absolute necessity of 
 
432 OUTLINES OF ECONOMICS 
 
 making a livelihood. In the long run small wages are bettei 
 than none. The sale of labor is often a forced sale. 
 
 In the second place, the fact that labor is inseparable from 
 the person of the laborer has important results. When the 
 laborer enters into an agreement to work for wages, he not 
 only sells his labor, but he gives up a certain amount of control 
 over his own life ; he agrees to live and work under conditions — 
 often unpleasant ones — set for him by others ; he accepts, in 
 short, all the environment of his task, as well as the task 
 itself. 
 
 Connected to some extent with this last fact is a third differ- 
 ence — the relative immobility of labor. Commodities may 
 always be sent to the market where they will command the best 
 price, but the laborer is restrained by family ties, patriotism, 
 differences in language, customs, and religion, ignorance, and 
 the like. The result is that variations in wages as between 
 dififerent countries or as between different localities in the same 
 country are much greater than similar variations in prices. 
 
 The Relation of the Structure of the Population to the Supply 
 of Labor. — We are apt to take it for granted that the supply 
 of labor in different countries and localities depends primarily 
 on the numbers of the population. This is, of course, funda- 
 mentally true, but we must also note that the structure of the 
 population is a variable thing, and one that affects the supply 
 of labor. Over four fifths of the persons employed in gainful 
 occupations in the United States in 1910 were males — a fact 
 which suggests that the relative proportions of the sexes in 
 the population have an important effect on the supply of labor. 
 There are more males than females in the population of the 
 United States, while the reverse is true of most European coun- 
 tries, this difference being due in large part to the excess of 
 males among our European immigrants. There are important 
 differences in this respect between the individual states. Males 
 constitute nearly two thirds of the population of Montana 
 and less than one half of the population of Massachusetts. 
 The age composition of the population must also be taken into 
 account. The United States census of 1910 showed that nine 
 
THE WAGES OF LABOR 433 
 
 tenths of the persons engaged in gainful occupations were be- 
 tween 15 and 65 years of age — comprising what is sometimes 
 called the " productive age group." A larger proportion of the 
 population of the United States is between these ages than is the 
 case in most European countries — a fact which is due to the 
 large number of foreign-born adults in our population. In most 
 European countries a larger proportion of the population is of 
 " productive age " than is true for the native population of the 
 United States. In considering the effect of these natural group- 
 ings of the population upon the supply of labor, we have to also 
 take account of differences in the nature of industries, in national 
 or local customs, and in the presence or absence of legal restric- 
 tions, — all of which affect the number of women and children 
 who can be counted as part of the available supply of labor. 
 Many observers have suggested that the frequent holidays 
 found in the Latin countries of Europe form an appreciable 
 obstacle in the way of the industrial development of those 
 countries, as they materially diminish the real supply of labor. 
 The supply of labor is not, however, merely a matter of the 
 number of available laborers ; it is also conditioned by their effi- 
 ciency. The physical strength and vigor, industry, intelligence, 
 ingenuity, and moral qualities of the laboring population deter- 
 mine the amount and kinds of work they can do. These things 
 vary greatly as between different races and as between different 
 individuals of the same race. They are not entirely a matter of 
 heredity, for they can be influenced greatly by the physical and 
 social environment. So far as high wages mean more and better 
 food, and improve the other conditions of living, they tend to in- 
 crease physical and mental efficiency, and thus to increase the 
 quantity and better the quality of labor that can be got from a 
 given population. There may often be, even when we take only 
 production into account, a real economy in high wages. Public 
 education and public activity in regard to such matters as pure 
 foods, hygienic conditions in homes and in factories, and oppor- 
 tunities for wholesome recreation tend to increase the efficiency 
 of labor, and might be justified on this ground. The right view, 
 however, is that such things would be justified on their own ac- 
 
434 OUTLINES OF ECONOMICS 
 
 count, as tending to raise the level of human living, even if they 
 did not increase human efficiency. 
 
 The Relation of the Growth of the Population to the Supply of 
 Labor. — Just as the potential supply of commodities at any 
 given time is determined largely by past conditions, so the 
 potential supply of labor at any given time is to a very large 
 extent predetermined. Subject to the limitations which have 
 been mentioned in the preceding section, the supply of labor 
 is a matter of the numbers of the population, and the factors 
 affecting the growth of the population are, from the long-time 
 point of view, the most important things determining the supply 
 of labor. 
 
 Most of the discussion of these factors has centered around 
 the Malthusian theory of population — the doctrine that popu- 
 lation tends to increase faster than the food supply, and is 
 only held back by the actual pressure of famine and disease 
 (arising from an insufi&cient food supply), or by the prudential 
 motives which restrain men from undertaking the responsibility 
 of marrying and raising families upon incomes insufficient to 
 provide the necessities of life. Just what the first part of this 
 doctrine means can be made clear by referring to the conditions 
 in a country like India, where the population presses so closely 
 upon the food supply that any considerable failure in the rice 
 crop is sure to result in famine and starvation. Every increase 
 in the food supply is followed there by an increase in the birth 
 rate and a decrease in the death rate ; every diminution in the 
 food supply is followed by a decrease in the birth rate and an 
 increase in the death rate. The frequent famines in India, 
 which have been charged by some ignorant or prejudiced ob- 
 servers to neglect or incompetence on the part of the British 
 government, are, in fact, absolutely unpreventable, so long as 
 these conditions prevail. 
 
 When, however, we fix our attention upon the United States, 
 or England, or any country possessing Western civilization, 
 we notice some things that do not seem to harmonize with the 
 Malthusian theory. The population does not press so closely 
 upon the food supply that any widespread suffering follows a 
 
THE WAGES OF LABOR 435 
 
 season of poor crops. Poverty seems to have but little restric- 
 tive effect on the birth rate, which is generally higher among 
 the poorer classes than among the well-to-do. Such facts have 
 been cited by critics of the Malthusian theory, some of whom 
 have been inclined to credit it with very little economic sig- 
 nificance. Yet when we take a broader view of the facts, they 
 appear in quite a different light. 
 
 The best estimates indicate that England did not have over 
 five and a half million inhabitants in 1630, and yet overcrowding 
 at home was one of the reasons commonly given for the policy 
 of colonization which England was undertaking at that time. A 
 hundred years later, despite the growth of industry, and of 
 foreign and domestic trade, as well as some important improve- 
 ments in agricultural methods, the population had increased 
 to only about 6,200,000. In 1761, on the eve of the Industrial 
 Revolution, the population is estimated to have been about 
 6,700,000.^ By 1 83 1, when the factory system was thoroughly 
 established (although England was still trying to raise most 
 of her own food supply), the population had more than doubled, 
 amounting to about 14,000,000. Since that time England 
 has developed her manufacturing and commercial interests, 
 but has imported a larger and larger proportion of her food 
 supply and raw materials from newer countries, where land is 
 cheaper. The latest census of England (191 1) showed a popu- 
 lation of 36,000,000. There is no explanation of this remark- 
 able growth in the population of a country which was " over- 
 crowded " in 1630, other than the obvious one implied in the 
 fact that the opening up of new countries and the improvements 
 in transportation have enormously increased the world's supply 
 of food products and raw materials — a considerable portion 
 of which England has been able to get for herself through the 
 development of those commercial and manufacturing activities 
 in which her early start, her situation, her coal and iron mines, 
 and her own necessities, have given her a preeminence. 
 
 The total population of all Europe in 1760 was probably not 
 over 130,000,000. In 1915 it was about 450,000,000, some 
 1 For these estimates, see Census of Great Britain, 1850, Vol. ii. 
 
436 OUTLINES OF ECONOMICS 
 
 200,000,000 of this increase having taken place since 1820, and 
 about 150,000,000 since 1872. Account must also be taken of 
 about 125,000,000 persons of European origin or descent Uving 
 outside of Europe at the beginning of the twentieth century. 
 Moreover, wherever this European expansion has carried West- 
 ern civilization and industrial methods, the numbers of the native 
 population have more often increased than decreased.^ Such, 
 for example, is the case in Mexico, South America, the Philip- 
 pines, Java, India, and Egypt. For at least a hundred and fifty 
 years before the opening of Japan to Western civilization its 
 population had remained nearly stationary. Since 1871 it has 
 increased from 33,000,000 to approximately 53,000,000 (1915). 
 The probability that this great increase in that part of the world's 
 population which has adopted modern industrial methods 
 has come about by a decrease in the death rate rather than by 
 an increase in the birth rate does not alter the significance of 
 the fact that these improved methods of production and trans- 
 portation have operated like the release of a spring,^ allowing 
 the natural tendency toward the increase of the population 
 to work itself out more fully. 
 
 In view of these facts it is impossible to deny a large amount 
 of significance to the Malthusian theory of population. Popu- 
 lation has generally increased wherever the increase in wealth 
 has afforded it opportunity. Yet it does not follow that the 
 Malthusian theory is, in its strictest interpretation, true. Popu- 
 lation has not increased as rapidly as wealth has increased. 
 Average real incomes are very much higher than they were 
 before the Industrial Revolution — a statement that holds 
 true for average real wages as a particular form of income. 
 Interpreted in the light of the principle of diminishing produc- 
 tivity, this means that population has not increased so rapidly 
 as capital and the available supply of land have increased. If 
 there had been no increase in population during the last one 
 
 1 W. F. Willcox, "The Expansion of Europe in Population," American Economic 
 Review, Vol. v, p. 749. 
 
 2 This figure was applied to the effect of an increase in wealth upon the growth of 
 the population by Sir James Steuart, in his treatise on PoHtical Economy (1767). 
 
THE WAGES OF LABOR 437 
 
 hundred and fifty years, the marginal productivity of labor would 
 (if, nevertheless, modern methods of production had been de- 
 veloped) have 'been very much higher than it is, and wages 
 would have been correspondingly higher than they are. 
 
 The Subsistence Theory of Wages. — The doctrine that 
 wages tend, in the long run, to equal a bare subsistence, was a 
 theory advanced by English economists in the first quarter of 
 the nineteenth century as a corollary of the Malthusian law 
 of population. Said Ricardo : " The natural price of labor 
 is that price which is necessary to enable the laborers, one with 
 another, to subsist and to perpetuate their race, without either 
 increase or diminution." Granting the premises, the logic 
 was incontrovertible : If wages fall below this level of subsist- 
 ence, the result will be, in the long run, fewer laborers and there- 
 fore higher wages. If the increase in wages goes beyond the 
 level fixed by the cost of subsistence, the result will be, accord- 
 ing to the Malthusian doctrine, more laborers and therefore 
 lower wages. The cost of subsistence in this view formed the 
 " expenses of production " of labor, and the actual wages 
 determined by supply and demand were supposed to fluctu- 
 ate around these normal wages as the market prices of commodi- 
 ties fluctuate around the normal prices fixed by the expenses 
 of production. Socialists and advocates of the single tax have 
 made much of this theory of wages as proving the impossibility 
 of bettering the condition of the laboring class under existing 
 conditions. By some socialists this doctrine, in its most rigid 
 form, has been called the " iron law of wages." But socialists 
 and followers of Henry George alike have to face the difficulty 
 of accepting this theory and at the same time rejecting the theory 
 of population on which it rests — a theory which they cannot 
 accept, for its truth would obviously place insuperable obstacles 
 in the way of any lasting improvement in wages being achieved 
 through the adoption of their schemes. The subsistence theory 
 of wages, if true, would hold just as true under socialism or under 
 the national ownership of land as under existing conditions. 
 
 It should be said that the subsistence theory of wages was in 
 part a reflex of the conditions actually existing in England at the 
 
43^ OUTLINES OF ECONOMICS 
 
 time. Wages were very low, and the law required that deficien- 
 cies in wages, below the amount necessary for the maintenance 
 of the laborer and his family, should be made up out of parish 
 funds — a provision which in itself tended to keep down wages, 
 and was made still worse by the fact that the allowance for 
 maintenance to each famUy was proportioned to the size of the 
 family, thus encouraging the rapid increase of the population. 
 
 The Relation of the Standard of Life to the Supply of Labor. — 
 Whatever may have been the case in the past, the subsistence 
 theory of wages does not square with the facts of today, for the 
 amount paid in wages is obviously considerably more than is 
 " necessary to enable the laborers to subsist and to perpetuate 
 their race, without either increase or diminution." Ricardo 
 himself did not give to the " minimum of subsistence " the fixed 
 and rigid meaning which some socialists have attached to it. 
 It varied, he recognized, with the habits and customs of the 
 people. In this more elastic form the " minimum of subsist- 
 ence " shades into what is termed more accurately the " stand- 
 ard of life." The number and character of the wants which a 
 man considers more important than marriage and family constitute 
 his standard of life. Whenever wages fall below a point where 
 the standard of life can be maintained for a family, the work- 
 man will do without the family and maintain the standard of 
 life for himself alone. While the increase in the quantity of 
 goods produced that has taken place by reason of the industrial 
 revolution and the utilization of new and vast bodies of natural 
 resources has been attended with an unprecedented increase 
 in population, it has also been attended with an improvement 
 in the standard of living. Every advance in the standard of 
 life marks a step definitely gained in the economic progress of 
 the laboring class ; it affords a vantage ground for yet farther 
 progress. 
 
 This is not only because the standard of life is, by very defini- 
 tion, a fundamental factor in determining, in the long run, the 
 supply of labor, but also because experience has shown that 
 the standard of life affords an element of strength to laborers 
 in their bargains with employers. Any encroachrnents on it 
 
THE WAGES OF LABOR 439 
 
 are met with strong and determined resistance. Moreover, 
 a high standard of life is, as we have seen, one of the things that 
 make for productive efficiency on the part of the laborer, and 
 hence tend to increase his earning capacity. Many persons 
 who are deeply interested in the welfare of the laboring class 
 believe that the wisest philanthropy is embodied in the efforts 
 that are made to raise the level of living. Among such efforts 
 are included such things as the work of social settlements, 
 public and private movements to secure better conditions of 
 housing, municipal expenditures for places of public recreation, 
 for public libraries, for such things even as clean and well- 
 lighted streets ; and, above all, public education. 
 
 The extent to which the possibility of attaining a still higher standard of 
 living operates as a restraining force upon the increase of the population is 
 largely determined by the extent to which democratic ideals are realized 
 in the social organization. It is a noticeable fact, for example, that the first 
 generation of immigrants to the United States bring with them the habits and 
 ways of living of their European homes. So long as simple standards of life 
 are retained in connection with the larger incomes which they are able to 
 earn in this country, more of them are able to marry ; they are able to marry 
 earlier, and they can raise larger families. But the second generation grows 
 up in an American environment. They attend our public schools, where they 
 mingle with American children and receive an American education. The 
 possibility of taking a social and economic position higher than that of their 
 parents is opened up to them. They become saturated with the American 
 notion that each man has a chance to climb to the top of the ladder. They 
 find here no rigid barriers separating social classes from one another. "Like 
 father, like son " may have been true in Europe ; here it has no binding force. 
 Hence the birth rate among our native population of foreign parentage is 
 very much lower than the birth rate among our foreign-born population. 
 
 The Supply of Labor in Different Occupations. — Just as the 
 demand for labor on the part of entrepreneurs is not a demand 
 for " labor in general," but a demand for specific kinds of labor, 
 so the supply of labor is the supply of laborers who are able and 
 willing to do certain definite kinds of work. The supply of labor 
 in any given occupation is, at any given time, almost as rigidly 
 fixed as is the supply of labor in general. Laborers can usually 
 change from one occupation to another only at the loss of the 
 advantage of whatever specialized skill they may have acquired. 
 
44° OUTLINES OF ECONOMICS 
 
 This is, however, a matter of occupations^ not of industries. 
 There is, for example, a wide range of industries open to a skilled 
 mechanic or a stationary engineer. But in the skilled trades 
 what variability there is in the supply (at any given time) comes 
 less from any possibility of passing from one trade to another 
 than from the opportunities the more efi&cient and ambitious 
 workmen have of entering business on their own account (that 
 is, of becoming entrepreneurs) or of entering some calling where 
 general ability, rather than specialized skill, is the prime requi- 
 site. The carpenter may become a contractor ; the skilled 
 mechanic may become a traveling salesman, and this, very 
 likely, in some line where his specialized skill will still be of 
 some advantage. The options thus open to the stronger mem- 
 bers of each group should not be lost sight of in any considera- 
 tion of the forces tending to resist a downward movement in 
 the wages paid in any occupation. 
 
 Throughout the greater part of American history the most im- 
 portant option of this kind has been due to the existence of a 
 large body of free land. The mobility of labor in this country 
 has been such that it has been impossible for wages to fall much 
 below the amount which a man could make for himself by tak- 
 ing up government land on the frontier. Today, however, 
 we are confronted by a different set of conditions. The frontier 
 has completed its journey across the continent, and there 
 remains for the settler only such land as irrigation may reclaim 
 from the arid regions of the West. The wage earner will hence- 
 forth be without the strong support of the economic alternative 
 of a living got from free land. 
 
 When we take the long-period point of view, we find more elas- 
 ticity in the supply of labor in particular occupations. The 
 ranks of each trade are being continually depleted by old age, 
 death, and, to some extent, by the alternatives open to its 
 stronger members. These gaps need not be filled by an incom- 
 ing body of apprentices if the wages paid are lower than the 
 wages in other occupations demanding a similar degree of prep- 
 aration and ability. But there is a certain amount of inelastic- 
 ity even here, for a variety of reasons, among which we may 
 
THE WAGES OF LABOR 44T 
 
 note : (i) the habit of imitation, which leads a boy to enter the 
 same occupation his acquaintances have chosen ; (2) the not in- 
 frequent tendency of sons to enter their father's occupation ; 
 (3) lack of knowledge or of early appreciation of the relative 
 advantages of different employments, and (4) the fact that only 
 a small number of options may be open to the residents of a par- 
 ticular territory. These facts, in turn, have an important bear- 
 ing upon the localization of industry, for industries are apt to 
 be located in places where there is a present and prospective 
 supply of specially skilled labor. 
 
 Differences in wages, together with other factors just men- 
 tioned, are not, however, the only considerations which attract 
 laborers to different occupations. Many economic writers 
 have observed that there are differences in the wages paid in 
 different employments which are out of all proportion to any 
 differences in the training or the ability they require. Adam 
 Smith enumerated five circumstances which " make up for a 
 small pecuniary gain in some employments, and counterbalance 
 a great one in others." These are : " I. The agreeableness 
 or disagreeableness of the employments themselves ; II. The 
 easiness and cheapness, or the difficulty and expense, of learn- 
 ing them ; III. The constancy or inconstancy of employment 
 in them ; IV. The small or great trust which must be reposed 
 in those who exercise them ; and V. The probability or improb- 
 ability of success in them." These circumstances need expla- 
 nation in two particulars : First, the agreeableness or disagree- 
 ableness of an employment is very often a matter of the social 
 standing attached to it. Many men are doing clerical work 
 to whom some kind of physical exertion would be both more 
 pleasant and more profitable, but who dislike to be classed 
 among the " manual laborers." So-called " professional pur- 
 suits " attract many men to whom more lucrative opportunities, 
 requiring less special preparation, are open in other employ- 
 ments. In the second place, the significance of these circum- 
 stances is affected by the fact that the most poorly paid (because 
 the least efficient) laborers are found in the most disagreeable 
 and the most uncertain employments. 
 
442 OUTLINES OF ECONOMICS 
 
 The Wage Contract. — The wages that a laborer actually 
 receives are determined by an agreement between himself and 
 his employer. Here appear again those " gains of bargaining " 
 which were mentioned in the discussion of the prices of commodi- 
 ties. But in the case of the wage agreement, if the bargain is 
 between an employer and an individual workman, the advan- 
 tage is likely to be very largely on one side. The employer is 
 apt to know pretty accurately what he can afford to pay the 
 laborer ; he knows about how much the laborer will add to his 
 product, and his knowledge of business conditions helps him to 
 estimate the value of this added product. He knows what it 
 would cost him to get his added product in other ways, as by 
 paying some of his present employees for " overtime " work, or 
 possibly by speeding his machinery faster. Moreover, there 
 is the possibility, or even probability, of getting some other 
 laborer, in case he faUs to come to an agreement with the one 
 in question. His experience as an employer of laborers will 
 help him to gauge the minimum that the laborer will accept. 
 With the laborer the situation is very different. He can gauge 
 with less accuracy just how much his services are worth to the 
 employer. The minimum wage that he will accept will be 
 governed by his very limited power of holding out for higher 
 wages, or by his estimate of what he can get in other emplo}/- 
 ments — very few of which may be open to him. The whole 
 situation may be expressed by the statement that it is usually 
 a matter of small importance to the employer whether or not 
 he secures a particular laborer, while the securing of a particu- 
 lar emplo5Tnent is often a matter of the very greatest importance 
 to the laborer. Under these conditions wages are apt to be 
 fixed much closer to the minimum which the laborer will take 
 than to the maximum which the employer will pay. Where 
 laborers can bargain in groups rather than as individuals, their 
 disadvantages are greatly lessened. The fundamental motive 
 underlying the development of labor organizations has been to 
 secure the advantages of collective bargaining. 
 
THE WAGES OF LABOR 443 
 
 QUESTIONS AND EXERCISES 
 
 1 . How far are wages determined by the productivity of labor ? In what 
 different ways do wages affect the productivity of labor? What meaning, 
 or meanings, do you attach to the word "productivity" in the foregoing 
 questions ? 
 
 2. Why are the wages of men higher than the wages of women in the same 
 employments ? 
 
 3. Make a short outline, or table, of the factors determining the supply 
 and demand of labor. 
 
 4. Are wages paid as a reward for the irksomeness of labor? Are they 
 paid on account of the scarcity of labor ? 
 
 5. Some economists have held that "a demand for commodities is not a 
 demand for labor." Discuss this statement. 
 
 REFERENCES 
 
 Carver, T. N. The Distribution of Wealth, Chap. iv. 
 
 Clark, J. B. The Distribution of Wealth, Chaps, vii, viii. 
 
 Davidson, John. The Bargain Theory of Wages. 
 
 Fetter, F. A. Principles of Economics, Chaps, xx-xxvi. 
 
 Flux, A. W. Economic Principles, Chap. viii. 
 
 Marshall, Alfred, Principles of Econotnics, 6th ed., Book vi, Chaps, i-v. 
 
 Taussig, F. W. Wages and Capital. 
 
 Thompson, H. M. The Theory of Wages. 
 
CHAPTER XXII 
 LABOR PROBLEMS 
 
 Types of Labor Organizations. — There are at least three 
 distinct types of labor organizations : the Trade Union, repre- 
 senting a combination of wage earners in a single trade or two or 
 three closely related trades ; the Industrial Union, composed of 
 all kinds of wage earners working in a given industry ; and the 
 mixed Labor Union, made up of wage earners from many trades 
 and many industries. Thus, the Brotherhood of Locomotive 
 Engineers, strictly a trade union, makes no attempt to include 
 other workers in the railway service ; the United Mine Workers, 
 however, an industrial union, attempts to combine all persons 
 working in and around the mines ; while the Knights of Labor, 
 in the period of its strength and prosperity, fused all sorts and 
 conditions of workers in some of its district assemblies, and 
 combined these assemblies in a closely knit, highly centralized 
 national labor union. 
 
 The difference in the structure of labor organizations colors 
 their policies and gives rise to important problems. The trade 
 and industrial unions are, as we should expect, much more 
 homogeneous, and therefore much more efficient than the labor 
 unions, but they are likely to be narrower in their aims and more 
 selfish in their policies. The labor unions, on the other hand, 
 have in the past proved much less efficient, much more unwieldy 
 and much more disposed to make use of cooperation, political 
 action, and other devices which are not suited to associations of 
 wage earners, or at least not easily handled by them. 
 
 For the larger and more general objects common to wage 
 workers as a body, many of the American unions have combined 
 in a large, loosely knit confederacy, known as the American Fed- 
 eration of Labor. This organization interferes just as little as 
 
 444 
 
LABOR PROBLEMS 445 
 
 possible with the constituent unions, and confines its activity to 
 securing favorable labor laws, organizing trades in districts of the 
 country in which trade unions have heretofore failed to get a 
 start, rendering assistance to unions which are hard pushed in 
 strikes or other disputes with employers, encouraging the use of 
 union-label goods, and, in short, to furthering all those interests 
 which labor organizations have in common. The membership 
 of the American Federation of Labor in 1914 was a little over 
 two millions. 
 
 The Economic Justification of Labor Organizations. — The 
 question is often asked why labor organizations are necessary, 
 in view of the fact that wages are fixed, at least within broad 
 limits, by deep-lying economic and social forces which the labor 
 organization cannot effectively control. If wages depend upon 
 demand and supply, it is said, what excuse for the troublesome 
 and irritating trade union ? 
 
 The answer is in part that economic laws work themselves 
 out through men and through organizations — they are not self- 
 enforcing. We have had labor organizations of one kind and 
 another ever since the wage system existed, and we shall un- 
 questionably continue to have such organizations unless the 
 wage system is superseded by something more satisfactory. 
 
 Even if we grant that labor is in essentials a commodity whose 
 price is fixed by demand and supply, there is still a reason for the 
 labor organization. The supply of labor is largely controlled, 
 in the long run, as we have seen, by the standard of life ; and 
 one of the great functions of the labor organization is to 
 strengthen and advance the standard of life. If a great horde 
 of unorganized and unsympathetic wage earners are continually 
 bidding against one another in the labor market, each individual 
 endeavoring to get a little more work by offering to take a little 
 .less pay, the standard of living will be subtly undermined, "nib- 
 bled away," as a well-known writer has expressed it. The labor 
 organization, by repressing the vicious activity of this competi- 
 tion, by compelling its members to offer the same terms and abide 
 by common or standard rules, bulwarks the standard of life, and 
 gives it increased precision, increased power and durability. In 
 
446 OUTLINES OF ECONOMICS 
 
 addition, most unions endeavor to exercise a more direct and 
 positive influence upon the supply of labor, by limiting the 
 number of apprentices, helpers, and other persons entering the 
 trade. These efforts, however, are not always successful. 
 
 Current economic doctrine recognizes at least one other legiti- 
 mate function of the labor organization. In an advancing or 
 progressive state of industry there must often be some margin 
 between the price of what the laborer — under direction — 
 produces and the wages he gets for producing it. The employer 
 cannot always pay the worker the whole price of that part of the 
 product which might be imputed to the worker's efforts; if he did, 
 he would, in many cases, have only what, in another chapter, we 
 have called " minimum " profits. By stout resistance and skill- 
 ful bargaining it is often possible for the wage worker to get a 
 part of that share of the product which would otherwise go to 
 the employer as profits. Of course, that labor organization will 
 be most successful in the long run which increases the produc- 
 tivity of its members, and thus creates a larger product to be dis- 
 tributed among all the factors of production. But even if the 
 organization does not increase the productivity of its members, 
 it has a chance to improve their wages by trenching upon profits. 
 Mere bargaining, therefore, despite the operation of more 
 fundamental economic forces, is still exceedingly important. 
 And the unorganized wage workers, being poor bargainers, com- 
 bine with their fellow-workmen, not only to maintain a more 
 uniform price for their labor, but in order to procure the guidance 
 and assistance of an expert bargainer — the business agent or 
 walking delegate. The labor organization is thus a commercial 
 institution for the sale of labor in large quantities ; its primary 
 function is collective bargaining. 
 
 Labor Organizations and Monopoly. — It is plain that the 
 labor organization as a wholesale jobber of labor is essentially 
 a product of those familiar economic forces making for large-scale 
 commercial dealings ; it is brother to the trust, akin to the com- 
 bination, and thus not untainted with monopoly. One of the 
 most searching criticisms directed against the labor organization 
 is that it exhibits all the evil tendencies of monopoly. The 
 
LABOR PROBLEMS 447 
 
 charge has some elements of truth. The ultimate aim of the 
 average labor organization is to induce every worker in the 
 industry to join the union, so that by monopolizing the supply 
 of labor it may control the price. But in its principal implica- 
 tions the charge of monopoly is misleading, because the great 
 majority of unions do not attempt to limit the number of their 
 beneficiaries. They aim to increase wages, but they are willing 
 and even anxious that every member of the craft should share 
 the increase. It is rare for a labor organization to exclude from 
 its ranks a number of workers and then persecute them by refus- 
 ing to work with them or treating them as scabs. Conflicts 
 with non-union men are common, but in a very large majority 
 of cases every effort has been made to get these men into the 
 union. An organization which is constantly exhorting its com- 
 petitors to come into the combination and share its benefits 
 is at most an inclusive monopoly, and is not to be confused with 
 the exclusive monopolies found in the field of business. 
 
 Methods and Policies of Labor Organizations. — The aims of 
 labor organizations and the policies employed to achieve their 
 ends vary in accordance with the conditions of the occupation or 
 industry in which their members work. Some unions, for in- 
 stance, lay great emphasis upon apprenticeship ; and if they thus 
 secure control of the supply of labor in the trade, find it necessary 
 to place but little dependence upon strikes and boycotts. On the 
 other hand, organizations like the Brotherhood of Locomotive 
 Engineers find this question settled for them ; no one can per- 
 form the work of a locomotive engineer without preliminary 
 training, and this natural limitation of the number of trained 
 locomotive engineers makes it possible for their union to get 
 along without maintaining either-^ apprenticeship regulations or 
 the policy of the closed shop.^ And it rarely places dependence 
 upon the strike. An admirable system of mutual insurance and 
 
 ^ The familiar union rule prohibiting members of the union from working with 
 non-union men. The policy is very elastic. No objection is made to working with 
 members of an occupation not yet organized ; some unions apply the ban only to 
 non-muon men in the same trade or craft ; while others practically refuse to work 
 for an employer who hires any non-union men at all (not applying the term 
 non-union men" to laborers, porters, and other unorganized workers). 
 
448 OUTLINES OF ECONOMICS 
 
 simple collective bargaining is usually sufi&cient to keep the 
 membership loyal and obtain from employers fair rates of pay. 
 
 In the unskilled trades, on the other hand, where a period of 
 apprenticeship is wholly superfluous, some more artificial protec- 
 tion of the standard of life is employed, like the " policy of 
 the closed shop " ; and this naturally forces the union, in turn, to 
 place great dependence upon the strike and boycott. Before 
 condemning a union for employing some of these policies, there- 
 fore, or contrasting it unfavorably with highly conservative 
 unions, like the railway brotherhoods, it is necessary to inquire 
 whether or not, like the railway brotherhoods, it is protected 
 by some natural condition of the business which makes peace- 
 able collective bargaining comparatively easy. 
 
 The Problem of the Closed-Shop Policy. — It is impossible 
 to pass any general verdict upon the justice of the closed-shop 
 policy. Most Americans are inclined to condemn it offhand as 
 an attempt to deprive the non-union man of his " sacred right 
 to work." They forget that the union man enforces the closed- 
 shop policy for an exercise of his " sacred right of quitting work." 
 Except where violence is employed, the union which is attempt- 
 ing to enforce a closed-shop policy threatens to do nothing worse 
 than direct its members to quit the employment of the proprietor 
 of the open shop in question. Two equally " sacred and inalien- 
 able rights " clash in this contest, and it is plain that no decision 
 concerning the legitimacy of the closed-shop policy can be deter- 
 mined offhand by applying the touchstone of individual rights. 
 If we would know whether a strike against non-union men is jus- 
 tifiable or unjustifiable, we must inquire into all the surrounding 
 circumstances and the manner in which the strike is conducted. 
 If the strike is conducted peaceably, and if the union in question 
 is an open union, cordially inviting the " scabs " to enter and 
 share its benefits ; if the rate of wages and other conditions of 
 employment demanded by the union men are reasonable in view 
 of the cost of living and other similar conditions ; if the " scabs " 
 involved, by accepting less than a living wage or other harmful 
 conditions of employment, are working — even though of neces- 
 sity — to undermine the American standard of living ; then we 
 
LABOR PROBLEMS 449 
 
 have no hesitation in saying that the employment of the closed- 
 shop policy on the part of the union is thoroughly justifiable. 
 So far as the law is concerned the Supreme Court of the United 
 States has decided that an employer — perhaps- a large corpora- 
 tion — may discharge an employee for belonging to a union, for 
 any reason or for no reason ; and a recent act of Congress em- 
 powers combinations of workingmen to do in trade disputes 
 anything which they might lawfully do as individuals. The 
 law — or federal law at least — is apparently impartial. But 
 from the standpoint of equity and morals employers frequently 
 discharge men for indefensible reasons and unions frequently 
 attempt to enforce the closed-shop rule for purposes or by 
 methods which deserve to be condemned. 
 
 We must not confine our attention wholly to the injury done 
 to the non-union man. The non-union man frequently does a 
 real injury to his fellow-workers by accepting wages or other 
 conditions of employment that are inconsistent with the Ameri- 
 can mode of living. The price cutter in the labor market is not 
 ordinarily a social benefactor. The weakest, dullest, and least 
 enterprising laborer exerts an influence upon the general level of 
 wages out of all proportion to his importance or his deserts. 
 If this be true, the man who cuts the standard rate of wages 
 may do a grave social injury, and there is justification for those 
 who peaceably combine to prevent him from doing his destruc- 
 tive work. It must be remembered, however, that these con- 
 clusions are based upon the assumption that the union is an open 
 union and that the strike is conducted without intimidation or 
 interference with the non-union men. The moment the union 
 stoops to violence, that moment it loses all claim to the support of 
 an enlightened public opinion. 
 
 Limitation of Output. — Another policy which is generally, 
 and in many cases unjustly, condemned is the regulation of out- 
 put, systematically practiced and indorsed by most unions. 
 The output of the worker is limited in many ways. The reduc- 
 tion of the hours of labor, the limitation of wages which some 
 unions working by the piece system enforce, the prohibition or 
 penalization of overtime, all operate to check the activity or 
 
 2G 
 
4SO OUTLINES OF ECONOMICS 
 
 reduce the output of the particular workman. Here, again, 
 it is unsafe to render any general verdict upon the legitimacy of 
 the policy in question. In some industries in which the piece 
 system is employed, the rate per piece has unquestionably been 
 forced down and the workers spurred to excessive exertion by the 
 pressure and influence of pacemakers or taskmasters, paid by 
 the employers to urge the workers to the utmost speed. Where 
 such conditions prevail, no one can successfully question the 
 justice of the feeling which leads the union to object to the 
 presence of pacemakers and to prescribe a maximum wage — 
 usually above that secured by the average workman — which 
 union members are not permitted to exceed. In general, it is 
 plain that an individual laborer may underbid a competitor by 
 working more intensely, as well as by offering to work longer 
 hours or at lower pay. On this account alone, trade unions 
 are justified in defining and maintaining some regular pace or 
 standard intensity of work. Without such definition, collective 
 bargaining would be impossible. This last observation, it will 
 be noted, applies only to trades working by the day. But even 
 where the piece system is used, the workers may be justified in 
 fixing a liberal limit to the amount of piecework which the wage 
 earner shall be permitted to do in a day. For there can be no 
 question that unregulated piecework does stimulate the worker 
 to excessive exertion, and that as daily earnings under the piece 
 system tend to rise, the employer is tempted to reduce the rates. 
 Some methods of restriction, however, are wholly vicious. 
 The Journeyman Stone Cutters' Union, for instance, stoutly 
 resisted for years the application of machinery to their work, and 
 actually attempted to prevent the shipment of machine-planed 
 stone into any city where the union had succeeded in preventing 
 the introduction of planers. Such an attitude toward the intro- 
 duction of labor-saving devices deserves the severest condemna- 
 tion. Moreover, in some unions there is a tacit approval of the 
 " go-easy " system, the system of " soldiering," or " adulterat- 
 ing labor," as it has been aptly termed. Such a method of 
 restricting output not only corrupts the character of the indi- 
 vidual workman who practices it, but makes it impossible for 
 
LABOR PROBLEMS 45 1 
 
 the employer to deal with the union as a seller of honest goods, 
 and in this way tends to undermine the whole foundation of 
 trade unionism, which is, as has been said, collective bargaining. 
 On the other hand, there is no particular reason to believe that 
 union labor is especially given to " go-easy " habits of work. 
 The habit of stealthy loafing is found at its worst in certain 
 unorganized trades or occupations, so that when it appears 
 among union workmen it cannot logically be attributed to 
 organization alone. 
 
 Educational and Fraternal Activities. — Practically all unions 
 have important educational and social activities. Debate upon 
 economic topics is common in union meetings, particularly at the 
 conventions of the state and national organizations. It has even 
 been said by observers in close contact with the facts that 
 foreign-born wage earners receive their most helpful and vital 
 education in American public questions through the agency of 
 the union. This broad education, which is a most important 
 factor in elevating the standard of life, is supplemented by 
 the social activities of the labor organization. Many unions 
 maintain a so-called " Ladies' Auxiliary," in which the wives 
 of the members participate; give concerts, dances, and other 
 social entertainments, maintain charitable activities, and by 
 general social intercourse operate to unify and solidify the stand- 
 ard of life of the wage-earning group concerned. 
 
 Closely allied with these educational and social features is the 
 system of insurance benefits, which has played a very prominent 
 part in the development of labor organizations. In Great Britain 
 fully three times as much money is expended by the unions 
 upon mutual insurance of various kinds as upon administrative 
 activities, or for the support and encouragement of strikes. 
 Union insurance is helpful, not only in stimulating thrift among 
 the individual members, but in making the union more careful 
 and conservative in its policies. Moreover, it serves to keep 
 in the union a large number of members, who, if they had no 
 financial stake in continued membership, would drop out of the 
 union in times of peace, when no apparent advantage was to 
 be derived from the union. All things considered, the Cigar 
 
452 OUTLINES OF ECONOMICS 
 
 Makers' International Union has many claims to be considered 
 the most successful American labor organization ; and its suc- 
 cess is in a large degree, if not in the largest degree, attributable 
 to its wise and extensive use of mutual insurance. But on the 
 whole, the American unions make relatively little use of the 
 insurance benefit. Most of them pay strike benefits, — that is 
 part of their fighting policy, — and perhaps a majority of them 
 pay funeral benefits, while a respectable majority pay sick 
 benefits. But the employment of the superannuation, accident, 
 traveling, or " out-of-work " benefit is comparatively rare. The 
 great majority of American unions are militant in character, 
 existing primarily for the purpose of collective bargaining, and 
 placing the greatest reliance upon the policy of the closed shop 
 and the strike. 
 
 The Strike. — Probably the most important weapon of the 
 trade union is the strike. Unfortunately, also, the weapon is 
 far too frequently used. Several generations ago most trade 
 unions, while they vehemently defended their right to strike, 
 cordially indorsed arbitration and apparently looked upon the 
 strike as a weapon of last resort. Today, the average trade 
 union is at best only a lukewarm advocate of arbitration, while 
 it has come to regard striking as a permanent policy. The net 
 result has been to commercialize the strike, as it were. Instead 
 of being a more or less spontaneous outburst against conditions 
 which the workingman regarded as unrighteous and oppressive, 
 the strike has come to be a commonplace method of bettering 
 conditions of employment ; a device to be employed when con- 
 ditions are favorable, to be laid aside when conditions are 
 unfavorable, but to be used without regard to ethical considera- 
 tion when its use appears to be profitable. 
 
 The statistics of strikes published in the Twenty-first Annual Report of the 
 (United States) Commissioner of Labor, in the recurrent reports on strikes 
 and lockouts of the Massachusetts Bureau of Labor Statistics, and in similar 
 reports of other state labor bureaus, indicate that strikes are steadily increas- 
 ing in the United States. Moreover, comparison of the number of employees 
 thrown out of work with the general wage-earning population indicates, 
 although not so certainly, that the proportion of workingmen annually 
 involved in strikes has been slowly increasing. Precisely what is responsible 
 
LABOR PROBLEMS 453 
 
 for this increase in strikes is difficult to determine. The change in the 
 attitude of labor organizations toward the strike is an important factor, no 
 doubt. But the greatest reason for the increase, in aU probability, is the 
 rapid growth of organized labor. New imions are prone to strike. The 
 sudden realization of their new power, and the accumulation of strike funds, 
 tempt them to try their wings. In the long run organization probably exerts 
 a conservative and steadying influence : national machinery is created which 
 curbs the capricious impulses of the local unions; experienced men are 
 usually elected to the more important national offices, and when they are 
 called in to settle a local grievance, they arrive upon the scene of action 
 without personal resentment against the employers involved. These facts 
 create a strong hope, and, indeed, a confident belief, among many of those who 
 have studied the labor question, that when practically aU American trades 
 are organized, strikes wiU steadily decrease, as they have in England, where 
 a much larger part of the wage-earning popvdation is organized than in this 
 country. 
 
 Labor leaders maintain that strikes strengthen the solidarity of 
 the unions, and encourage the members to make personal sacri- 
 fices for the common good, while they force employers to respect 
 the strength of organized labor, and are not, in the long run, par- 
 ticularly costly. The time lost in strikes, they say, largely takes 
 the place of enforced vacations — seasonal stoppages, and other 
 kinds of unemployment with which the average wage earner is 
 normally visited during the course of the year's work. No 
 amount of such dialectic, however, can argue out of existence the 
 injury and destruction resulting from strikes. Many strikes are 
 gravely injurious to the wage earners themselves ; and almost 
 all strikes injure employers and the consuming public. From 
 the social standpoint the strike is an evil, and all justifiable 
 means should be employed to prevent its occurrence. 
 
 We must not conclude, however, that workingmen and labor 
 organizations are wholly responsible for strikes. If a body of 
 men agree not to work for a given employer unless that employer 
 complies with certain conditions, whose fault is it if the employer 
 refuses to comply and a strike follows? Very evidently the 
 fault may lie with either the master or the men, or with both. 
 The fault lies with the men if the conditions which they demand 
 are, in view of all the circumstances, unreasonable and extortion- 
 ate. The fault lies with the employer if he refuses to grant 
 
454 OUTLINES OF ECONOMICS 
 
 reasonable conditions of employment. Sometimes the fault is 
 with one, sometimes with the other ; sometimes the one gains 
 by the strike, sometimes the other ; but the public, which is 
 never at fault, stands always to lose. The greatest lesson to 
 be derived from a consideration of strikes is the necessity of their 
 suppression in the interest of the general public. 
 
 One of the greatest evils attendant upon the strike is violence emanating 
 from both sides, — from employers' associations as well as from labor unions. 
 It is frequently said that this is diminishing with the passage of years. The 
 statement is both true and untrue. A study of labor disputes in the early 
 period of the modern labor movement seems to show that the average strike 
 of that period was attended with much more violence than the average strike 
 of today. Most labor leaders have thoroughly learned the lesson that 
 violence does not pay, and they exert every effort to suppress it. But at the 
 same time the average strike of the present time is attended with some 
 violence or coercion, and the steady increase in the number of strikes makes 
 the aggregate amount of violence now greater than it was in the past. 
 
 Historically, also, a marked change has shown itself in the character of 
 the violence employed. In the past, labor lawlessness was more or less 
 sporadic; brutal, it is true, but frank and unpremeditated. The lawless- 
 ness of today, however, has taken on a far more sinister form ; it has become 
 deliberate, premeditated, in many cases official. The outrages perpetrated 
 by the officers of the International Union of Bridge and Structural Iron- 
 workers (the "dynamite conspiracy") and the whole labor history of the 
 mining industry in Colorado and Idaho make it plain that there has been a 
 certain amount of carefully planned violence perpetrated with the passive 
 consent, if not with the active encouragement, of union officials and members. 
 There can be no doubt, also, that individual employers and employers' 
 associations have stooped to equally reprehensible practices. They have 
 employed as watchmen or detectives ex-convicts, thugs, and professional 
 bad men, who unquestionably have not refrained at times from perpetrating 
 violence in order to cast discredit upon the unions. It is impossible to con- 
 clude which side is the more to blame. The lesson to be drawn is the public 
 necessity of suppressing and punishing violence or intimidation when prac- 
 ticed by either side of the controversy. 
 
 Employers' Associations. — The development of modern em- 
 ployers' associations has been briefly described in an earlier 
 chapter. Their activities give rise to a movement which may 
 be briefly described as an anti-labor movement. They are, in 
 almost every respect, the natural foil and counterpoise of the 
 labor organization. They resemble the association of laborers 
 
LABOR PROBLEMS 455 
 
 even in structure. Thus we have had employers' associations 
 recruited entirely from one industry, such as the Stove Founders' 
 National Defence Association ; associations of employers in 
 distinct but related industries, such as the national Metal Trade 
 Association ; and mixed associations in which all kinds of em- 
 ployers are united, such as the Citizens' Alliances, so common 
 a few years ago in many of the Western cities. To complete the 
 analogy, these associations frequently combined in city, state, 
 and national federations; thus forming large confederacies, 
 similar in scope and activity to the state and national federation 
 of labor. Speaking generally, employers' associations show less 
 permanence than trade unions and many of the employers' 
 associations which were active a decade ago are now moribund. 
 We find the same resemblances between employers' associa- 
 tions and labor organizations when we examine the policies and 
 aims of the former. Thus they make frequent use of the lock- 
 out. The Stove Founders' National Defense Association, for 
 example, began its interesting career with a lockout of the iron 
 molders in the employ of its members. Like the trade unions, 
 also, they have their legislative committees or lobbies, and are 
 credited, for instance, with having played an important part 
 in defeating the eight-hour and anti-injunction bills which 
 have been before Congress several times. Some of these or- 
 ganizations also maintain so-called labor bureaus, whose func- 
 tion it is to secure accurate information of the workmen in the 
 trade, so that troublesome agitators maybe refused employment ; 
 and the methods employed in this branch of the work give rise 
 to something closely akin to the " unfair list " published by 
 many national unions. Some of the more radical associations 
 have stooped at times to violence and coercion, as was illustrated 
 in 1904 by the employers' associations of the Cripple Creek 
 district which boycotted business firms, forced public officials 
 to resign by threats or violence, and filled the vacant places with 
 their own adherents. 
 
 Some of the employers' associations are conservative in tone 
 and policy, working harmoniously with the labor organizations 
 in the industry, and going no farther than to endeavor by every 
 
4S6 OUTLINES OF ECONOMICS 
 
 legitimate measure to further the interest of the affiliated em- 
 ployers. Such associations are exceedingly helpful in furthering 
 that regime of peaceable collective bargaining to which most 
 students of this subject look forward as the ultimate outcome 
 of present-day tendencies. They are thus doing in an effective 
 way the work of industrial peace. Another group, however, 
 while temperate in tone and waging no warfare on the labor 
 organization as such, nevertheless maintain certain fundamental 
 principles which are directly in conflict with the fundamental 
 tenets of trade unionism. These associations, for instance, 
 maintain that the method of wage payment — i.e. whether 
 wages shall be reckoned by the hour, the piece, or the premium 
 system — is a matter which concerns the employer alone, and 
 they refuse to submit such questions to collective bargaining or 
 arbitration. Associations in this second group do not needlessly 
 foment strifes with the unions, but they regard industrial peace 
 as a consideration secondary to the maintenance of their funda- 
 mental principles, and accordingly they have been involved in a 
 number of protracted strikes and disputes. Finally, there is a 
 third group of employers' associations, of which the average citi- 
 zens' alliance is a good example, which may be correctly described 
 as " union smashers." Such associations have little regard for 
 the establishment of sound principles of collective bargaining, 
 and they are usually violently opposed to any recognition of 
 organized labor ; their aim is to weaken and harass their enemy, 
 the labor organization, whenever possible. They represent 
 among employers something of the same feeling and attitude 
 which characterize the Industrial Workers of the World (a syn- 
 dicalist organization opposed to trade agreements, trade union- 
 ism, and even to socialism ; placing its reliance upon the strike, 
 direct action, and sabotage). The extremely radical organiza- 
 tions on both sides secure, by reason of their revolutionary ut- 
 terances and tactics, far more attention than their intrinsic 
 importance justifies. 
 
 Owing to this difference of policy among the various employers' 
 associations, it is difficult to predict how the anti-labor move- 
 ment will affect that question in which the public interest is 
 
LABOR PROBLEMS 457 
 
 greatest — the question of industrial peace. For some little 
 time, perhaps, the militant enthusiasm of the more belligerent 
 associations will probably result in multiplying strikes and 
 lockouts. In the end, however, they will probably contribute 
 effectively to the maintenance of industrial peace by checking 
 the more extortionate demands of the unions and by securing 
 that degree of organization among employers which is necessary 
 for the successful operation of collective bargaining. If wage 
 earners are to act in concert by common or standard rules, it is 
 evident that eventually they will have to deal with an organized 
 body of employers ; and the sooner such organization of em- 
 ployers is perfected, the sooner will collective bargaining be 
 established as the regular method of determining conditions of 
 employment. 
 
 The Agencies of Industrial Peace. — Although collective bar- 
 gaining does not necessarily and in every instance operate to 
 discourage strikes, its net influence is unquestionably favorable 
 to the maintenance of industrial peace. Where a powerful trade 
 union exists, and the employers resolutely refuse to deal with it, 
 strikes are frequent. Where the opposite policy is pursued, and 
 the employers frankly recognize the union, strikes are infrequent. 
 In the bituminous mining industry of the East, among steam 
 railway employees in the train service, in the needle trades of 
 New York, and in many of the industries of England, strong 
 organizations of employers and employees have shown through 
 collective bargaining the power to maintain industrial peace for 
 long periods of time. 
 
 Trade Arbitration. — In England, many, if not most, of the 
 wider systems of collective bargaining are based upon formal 
 treaties, which provide for arbitration in case the two parties 
 cannot come to an agreement concerning terms. This is fre- 
 quently referred to as trade arbitration. But in the United States 
 many of the general conferences are based upon agreements 
 which do not provide for arbitration at all. Peace is main- 
 tained, although neither side promises in any way to refrain 
 from strikes or lockouts. Mutual respect and free discussion 
 prevent actual warfare. Indeed, many authorities upon this 
 
458 OUTLINES OF ECONOMICS 
 
 subject are inclined to think that the introduction of arbitration, 
 even as a last resort, weakens the efficiency of collective bargain- 
 ing. It is almost always necessary for both sides in collective 
 bargaining to make some compromises; and this necessity 
 imposes upon the representatives of the trade unions the dis- 
 agreeable duty of reporting to their constituents that they have 
 not secured the exact terms which they were instructed in the 
 beginning to demand. Because of this fact, if a provision for 
 arbitration exists, the union representatives are disposed to throw 
 the responsibility of disappointing their followers upon the 
 shoulders of the arbitrators. 
 
 Moreover, collective bargaining is essentially inconsistent 
 with arbitration. Collective bargaining is commercial and 
 elastic ; it deals with the formulation of future terms of employ- 
 ment ; it looks to securing the best results possible ; it has no 
 rational foundation save the willingness of the parties concerned 
 to get the most possible for their labor or their money, as the 
 case may be ; whereas arbitration is judicial in essence, and its 
 successful application implies the acceptance of some established 
 principle of wage adjustment, in the justice of which both parties 
 acquiesce. It is unfortunate but true that up to the present 
 time no one has ever formulated a doctrine of wage adjustment 
 which is at once workable and acceptable to a majority of the 
 people. Arbitration is a perfectly logical device, and works 
 successfully in the interpretation of minor difficulties growing 
 out of a broad agreement which has already been accepted. 
 Or, if both sides adopt some governing principle, it is perfectly 
 possible for a disinterested arbitrator to decide what this principle 
 demands in a given situation. But as a helpful device in securing 
 the initial adoption of a fundamental agreement, mediation is 
 superior to trade arbitration, although the latter appeals to the 
 employers because it promises to prevent stoppage of work 
 pending the decision of disputes. 
 
 Voluntary Arbitration. — There are, of course, many other 
 kinds of arbitration which have proved helpful in maintaining 
 the industrial peace. Most advanced states now maintain 
 boards of conciliation and arbitration, whose business it is to 
 
LABOR PROBLEMS 459 
 
 prevent strikes if possible, and to adjust or settle them after 
 they occur. For the most part, these voluntary boards of con- 
 ciliation and arbitration have shown little ability to cope with the 
 real situation. Much more, however, could be made of voluntary 
 conciliation and arbitration than has been made in the past. 
 The short but very promising history of the Canadian Industrial 
 Disputes Investigation Act of 1907 suggests that a law which, 
 like the Canadian Act, forbade strikes and lockouts in important 
 industries until an impartial board of conciliators had had time 
 to investigate the dispute and publish their recommendations 
 and findings concerning the equities of the case, would go 
 far toward delivering us from the more injurious industrial 
 conflicts. The vital provisions of such a method of concilia- 
 tion are: (i) the prohibition of strikes and lockouts before 
 and during the investigation; (2) widespread publication of 
 the findings of the board of investigation and conciliation ; and 
 (3) full permission to strike or lockout after the publication of 
 the findings. 
 
 Compulsory Arbitration. — In New Zealand an even more 
 radical remedy — " compulsory arbitration " — has been tried. 
 Seven workingmen in any industry may organize a union and 
 lodge a demand for better conditions of employment before 
 arbitration boards, whose decisions, when ratified by the supreme 
 or central court of arbitration, are absolute and binding. Simi- 
 larly, any employer whose workmen are organized in a union may 
 take a case to the arbitration tribunals for settlement. An 
 award of the central court of arbitration may be extended by 
 the court to all competitors of the original employer in the colony. 
 In this way, compulsory arbitration brings about the intro- 
 duction of minimum wages and other conditions of employment, 
 established by the authority of the state and enforced, not only 
 by the watchful eyes of the parties concerned, but by the factory 
 inspectors themselves. In Victoria and South Australia much 
 the same results are reached through the agency of wage boards 
 — containing representatives of both the employers and their 
 employees, with a chairman selected by these representatives 
 or appointed by the government — which are empowered to pre- 
 
46o OUTLINES OF ECONOMICS 
 
 scribe minimum wages and other conditions of employment, that 
 are enforced, as in New Zealand, by the factory inspectors. 
 Strikes, however, are not prohibited under this system, although 
 they are very rare in industries in which wage boards regulate 
 wages and hours of labor. 
 
 It is impossible to enter into a detailed discussion of either the 
 New Zealand or the Victoria system at this place. Both systems 
 have been in operation since 1896, both have been extended to 
 other Australian colonies. The laws recently adopted in New 
 South Wales, South Australia, and Queensland contain the 
 principal features of both systems. The fixing of minimum 
 conditions of employment is perhaps the most important element 
 in both systems, but it is noteworthy that the compulsory 
 arbitration idea has endured and spread. Strikes are not wholly 
 prevented, particularly in industries in which the labor organiza- 
 tions are very strong ; and many employers criticize both systems 
 vehemently. With the passage of time, however, they have 
 been strengthened, not repealed ; and the consensus of qualified 
 opinion seems to be that they have succeeded. But there is 
 little probability that general compulsory arbitration will be 
 introduced into this country in the near future. It would in all 
 probability be held to conflict with state and federal constitu- 
 tions, and, moreover, a large majority of trade unionists are 
 opposed to it. 
 
 The Ultimate Solution. — In arriving at a decision concerning 
 the measures which ought to be taken to maintain industrial 
 peace, it should be remembered that strikes are much more 
 destructive and dangerous in some industries than in others, and 
 that here, as in most other economic problems, it is dangerous to 
 proceed wholly on the basis of general principles. In most 
 industries, in our opinion, the strike question may safely be left 
 to the enlightened self-interest of the parties concerned, trusting 
 to collective bargaining and the work of voluntary arbitration to 
 prevent an excessive amount of war. In small competitive 
 industries the peaceful strike is not necessarily an alarming 
 phenomenon. 
 
 Slowly and surely, however, the opinion is gathering force that 
 
LABOR PROBLEMS 461 
 
 in those industries which vitally touch the public welfare (such as 
 the anthracite coal industry, railway transportation, and the like) 
 the public should, and by an exercise of legal ingenuity might, find 
 means to preserve the peace whether the two parties immediately 
 concerned desire peace or not. Compulsory arbitration in com- 
 petitive industries would unquestionably be unconstitutional in 
 this country. But with quasi-public industries, " industries 
 affected by a public interest," the question is entirely different. 
 If, because of their monopolistic character and their intimate 
 connection with the convenience of the public, the legislature 
 may regulate the service and the rates of such industries, it 
 would seem to follow even more clearly that the legislature may 
 adopt any measure necessary to prevent the utter cessation of 
 such industries by strikes and lockouts. If, for instance, the 
 fare charged by a street railway may be regulated by the state, 
 in order to prevent monopolistic extortion, how much more 
 justifiable would be the action of the state in preventing the 
 complete interruption of the traffic of the railway by means of a 
 strike or lockout! The federal government in the Erdman 
 and Newlands Acts provides machinery for mediation and 
 arbitration in disputes affecting interstate railways. Many 
 important disputes which threatened widely to interrupt inter- 
 state commerce have been settled by mediation — and a few 
 very important disputes by arbitration — under these laws. 
 Many threatened strikes by employees in the train service have 
 been prevented ; and it is interesting to observe that with the 
 passage of time more use is made of arbitration, and that under 
 certain circumstances the arbitrators are permitted to make 
 binding awards. Compulsory arbitration or public regulation 
 of wages in the railway and other industries affected with a 
 public use is, we believe, an inevitable concomitant of the 
 public regulation of prices and profits in these fields. 
 
 Profit Sharing. — Profit sharing attempts, not to provide a 
 remedy for industrial disputes, but to anticipate and prevent 
 them by assigning to the employees a share of the profits fixed 
 in advance. It is held that this arrangement enlists the em- 
 ployees' interest in the success of the business, makes them more 
 
462 OUTLINES OF ECONOMICS 
 
 economical, and so increases their zeal and efficiency that the 
 share of profits which they receive does not reduce in the long 
 run the earnings of the employer. In other words, the em- 
 ployees create the fund from which their bonus is paid. This 
 bonus may be paid in many different ways : either in cash at the 
 end of the business year, or in shares of stock in the company in 
 question, thus making the workman partial owner of the busi- 
 ness ; or it may be amassed in a savings or insurance fund, from 
 which in his old age the workman receives a pension, or his 
 family an annuity or cash premium at the time of his death. The 
 last method of profit sharing is usually spoken of as '^ deferred 
 participation." 
 
 Neither historical study nor theoretical analysis of profit shar- 
 ing furnishes reasonable ground for the belief that this method of 
 industrial remuneration will ever play an important part in 
 solving the modern labor problem. Informal profit sharing is 
 probably very old; and the principle or theory was recognized 
 by the French economist and statesman, Turgot, as early as 
 1775. In 1842 the celebrated French firm of Leclaire inau- 
 gurated a system of profit sharing which has been permanently 
 successful. In the third quarter of the nineteenth century 
 profit sharing was widely discussed. In 1878 a hundred and 
 twenty instances were known, and the number grew steadily 
 until about 1896, since which time the relative importance of 
 profit sharing as a method of industrial remuneration seems to 
 have declined, notwithstanding the wide publicity which has 
 been given to the profit-sharing plans of the United States Steel 
 Corporation and the Ford Motor Company. 
 
 The reasons why profit sharing has not proved more successful 
 are various. In the first place, it has incurred the enmity of 
 most labor leaders, who oppose it because it has often been 
 introduced after a disastrous strike as an antidote to trade 
 unionism, and because they believe that it stimulates the men 
 to work beyond their strength, and eventually results — as 
 overspeeding always results — in reduced wages. 
 
 In the second place, it is illogical and inconsistent as explained 
 by most of its advocates. The latter assert that the workmen 
 
LABOR PROBLEMS 463 
 
 create the fund from which their dividends are paid by increased 
 care, zeal, and speed. If this be true, and the system can hardly 
 prove a permanent success unless it is true, the end which profit 
 sharing seeks would be better achieved by the piece rate or gain 
 sharing methods of wage payment. By both of these methods 
 the worker gets his premium for extra zeal and efiiciency as part 
 of his wage, not as a gift ; gets it on pay day, not at the end of the 
 year ; and feels as free to bargain and higgle about the size of the 
 premium as he does about the size of the wage. Moreover, his 
 premium cannot be dissipated by unwise management or dishon- 
 esty on the part of the employer, and it cannot be lost by reason 
 of his death, discharge, or change of employment. 
 
 Profit sharing is too often applied in an unbusinesslike way 
 that smacks of philanthropy. The average employer con- 
 sciously or unconsciously expects something in return for the 
 dividends which he distributes. And if he does expect a return, 
 it is far better that he should pay for it by a method which is 
 certain, fixed by contract or bargain in advance, and paid, not at 
 long intervals, during which it is threatened by the varying 
 fortunes of the business, but at the end of the week or month 
 when ordinary wages are paid. Of course, if in addition to fair 
 wages the employer wishes to distribute a gratuitous dividend 
 at the end of the year, for which he expects nothing in return, the 
 employee is not likely to object, and the generosity of the em- 
 ployer will probably do no harm. But such a system of profit 
 sharing cannot be expected to become prevalent throughout a 
 competitive commercial system in which most employers cannot 
 be philanthropists, even if they desire. Moreover, human na- 
 ture is so constituted that gifts of this kind create in the mind 
 of the giver an inevitable expectation of recompense. 
 
 Industrial Democracy. — The industrial organization of the 
 past was despotic. The despotic principle, the one-man power, 
 is an excellent thing in its own time and place. It gives to indus- 
 try the elasticity, celerity, and general efficiency which come 
 from singleness of aim; and in industry, despotism has con- 
 tinued longer than in the poHtical sphere. But it is merely a 
 phase of development and cannot be regarded as final. Else- 
 
464 OUTLINES OF ECONOMICS 
 
 where the despotic principle has been softened or limited, — in 
 politics, in religion, in the family, — and eventually this dis- 
 cordant element is bound to disappear or undergo serious modi- 
 fication in industry. The labor movement is primarily a 
 concerted effort to a.ch.ieve industrial democracy, which means self- 
 rule, self-control, the self-direction of the masses in their efforts 
 to gain a Hvelihood. It is principally because profit sharing 
 means a departure from, and not an approach toward, industrial 
 democracy that it has made so little progress, comparatively 
 speaking, in the last fifty years, A far more consistent method 
 of securing self-government is found in cooperation. 
 
 Cooperation is of two kinds, coercive and voluntary. Coer- 
 cive cooperation, which implies a partial or complete application 
 of socialism, is discussed in another chapter. 
 
 Voluntary cooperation takes many different forms, among 
 which we may distinguish : (i) distributive or consumers' coop- 
 eration, sometimes spoken of as cooperative buying ; (2) coopera- 
 tive borrowing or cooperative credit ; (3) cooperative marketing ; 
 and (4) producers' or pure cooperation. 
 
 Consumers' or distributive cooperation has no necessary con- 
 nection with the transportation of goods, but refers merely to a 
 method of retail or wholesale exchange. Purchasers of groceries, 
 dry goods, and the like come together to purchase what they 
 need, and thus eliminate profits. They form a stock company, 
 subscribe for shares, employ a manager and clerks, — who often 
 do not even share in the profits, — and start a business. Divi- 
 dends are sometimes paid only on shares, but the approved way 
 is to pay a moderate interest on the investment and to divide 
 profits among the customers in proportion to purchases, the divi- 
 sion being made at the end of stated intervals. Usually a larger 
 dividend is distributed to shareholders than to ordinary cus- 
 tomers ; and in some cases the employees receive as large a bonus 
 as the shareholders. Profits are thus said to be divided among 
 capital, custom, and labor. But so far as labor is concerned, the 
 most that can be said is that it receives a small share of the 
 earnings ; labor does not cooperate in the sense that it has an 
 important voice in the management of the business. The scheme 
 
LABOR PROBLEMS 465 
 
 is one of distributive cooperation plus profit sharing, not one of 
 pure cooperation. 
 
 Cooperative credit and cooperative marketing are familiar 
 phenomena in the United States: the first in the form of the 
 well-known building and loan association; the second in the 
 form of fruit growers' associations, cooperative elevator com- 
 panies, and the like, formed for the purpose of securing better 
 terms and facilities from railroads, commission houses, and 
 middlemen in general. In 191 2, for instance, there were 6300 
 building and loan associations in the United States, with a 
 membership of 2,500,000 and total assets of $1,138,000,000. 
 At the same time there were many cooperative telephone com- 
 panies, particularly in small towns and rural districts. 
 
 The good which these cooperative associations have accom- 
 plished is enormous, and there can be no doubt of their practi- 
 cability. They have not only proved commercially profitable to 
 the participators, but they have trained them to " team work " 
 and inculcated the spirit of mutual concession, the give and take 
 of concerted endeavor, which makes for social solidarity and con- 
 stitutes such an indispensable element of good citizenship in a 
 democratic state. 
 
 But they have done little and promise to do little in solving 
 the labor problem or in essentially improving the distribution of 
 wealth. They are, for the most part, composed of small capital- 
 ists, farmers, or salaried men (not wage earners), and in organiza- 
 tion differ little from democratically managed stock companies 
 of the usual type. Many, if not most, of the marketing associa- 
 tions are profit-making concerns whose employees have no more 
 voice in the selection of their bosses, and no more share in the 
 management of the business, than the employees of an ordinary 
 corporation. Even in the British cooperative societies the 
 employees have no share in the management, and though some of 
 the associations — notably the Scottish Wholesale Society — 
 indulge in a mild species of profit sharing with their employees, 
 the result is not industrial democracy, not self-government, but 
 merely joint buying plus a paternalistic scheme of profit sharing. 
 The limits of the success of the British cooperative movement 
 
466 OUTLINES OF ECONOMICS 
 
 are suggested by the fact that the employees of the cooperative 
 societies have formed themselves into a trade union for the 
 betterment of their condition of employment.^ 
 
 While consumers' cooperation and cooperative marketing — 
 both designed to abolish the profits of the middleman — are 
 important and praiseworthy forms of economic association, they 
 have little effect upon the wage-earning classes, and offer no 
 remedy for the antagonism between capital and labor in manu- 
 facturing industries. The variety of cooperation which really 
 copes with these questions and seriously attempts to regenerate 
 the wage system is producers^ cooperation. The essential fea- 
 tures of this form of cooperation are (i) that each group of 
 workers is to be associated by their own free choice ; (2) that 
 these associates shall work under a leader elected and removable 
 by themselves ; and (3) that the collective remuneration of the 
 labor performed by the group shall be divided amiong all its 
 members (including the leader) in such a manner as shall be 
 arranged, upon principles recognized as equitable by the society 
 themselves. 2 
 
 Successful cooperative experiments fulfilling the above con- 
 ditions are seldom met with. But they are not unknown. Here 
 and there a man of transcendent commercial genius and extraor- 
 dinary sympathy has succeeded in democratizing his business, 
 turning it over to his employees, and so impressing his spirit and 
 his methods upon his successors that the business continues to 
 prosper under the regime of self-government. An illustration 
 is found in the Godin Familistere of Guise^ France, which, begin- 
 ning with a scheme of profit sharing in 1877, has finally resulted 
 in the establishment not only of a cooperative manufacturing 
 enterprise, but in the successful conduct of what practically 
 amounts to a cooperative community. 
 
 But such cases are rare. Most experiments in producers' co- 
 operation have failed, and we fear they must continue to fail. 
 They apparently cannot meet the competition of businesses 
 
 1 For an account of some of the advantages of certain types of cooperative 
 marketing, see Chap, xxix {A gricuUural Problems) . 
 
 2D. F. Schloss, Methods of Industrial Remuneration, p. 228. 
 
LABOR PROBLEMS 467 
 
 organized in the ordinary way, directed by one man or set of men 
 with all the efi&ciency, mobility, and adaptability that come from 
 singleness of aim and undivided management. Industrial 
 democracy, as achieved in the cooperative form of industrial 
 organization, is too unwieldy, too slow, too mechanical. Multi- 
 tudinous management means relatively uncertain, indecisive, and 
 inefficient management. 
 
 A modified form of producers' cooperation is not unknown among the 
 manufacturing industries of this country. An approximate idea of the 
 extent of this form of industrial organization may be gathered from recent 
 census statistics. In 1909 the statistics of manufactures relating to char- 
 acter of ownership show a separate class of "miscellaneous business organiza- 
 tions" which consists almost entirely of cooperative manufacturing concerns. 
 There were in this group 4120 estabhshments (constituting 1.5 per cent of 
 all manufacturing estabhshments) employing 12,934 persons (0.2 per cent 
 of all wage earners), producing goods with an annual value of $104,766,104 
 (0.5 per cent of the aggregate product). Most of these associations are 
 cooperative creameries; and it is interesting to note that in this great 
 industry — which was cooperative in origin — the corporate form of organ- 
 ization increases in importance, measured by value of products, more rapidly 
 than the cooperative form. These figures furnish a maximum estimate of 
 producers' cooperation in the United States, and a large majority of the 
 concerns credited to cooperation in this enumeration would fail to satisfy 
 a strict definition of producers' cooperation. 
 
 The wage contract, whatever its defects, has one striking virtue 
 — certainty. The wage earner knows what to expect and gets 
 what he expects. He is safeguarded in large measure against 
 business risk, and although he may pay too high a price for his 
 safety, the safety itself is a highly desirable thing. It is one of 
 the weaknesses of producers' cooperation that the workman is 
 encouraged to invest his savings in the hazardous competitive 
 experiments in which he is engaged. He becomes part owner 
 of the enterprise, to be sure, but by doing so he assumes the risk 
 of failure, a risk which, other things being equal, it is desirable 
 to eliminate. It is very likely that the ultimate method by 
 which industrial democracy is achieved will retain that feature 
 of the present wage system by which most of the workers are 
 largely safeguarded against business losses. 
 
468 OUTLINES OF ECONOMICS 
 
 The Future of the Union. — If industrial democracy is to be 
 achieved, all present indications are that it will be through the 
 labor organization. Since the introduction of collective bar- 
 gaining, its range has constantly widened. Beginning with 
 questions of wages, hours of labor, and apprenticeship, it has 
 gradually spread, until at the present time some unions bargain 
 about the sanitary conditions of the work, the introduction of 
 safety devices, the employment of women, the use of machinery, 
 and the status of the men with whom their members work. A 
 few powerful unions insist that the foremen under whom their 
 members work shall belong to the union, demand a voice in the 
 discharge of employees, and try to force the employer, when 
 taking on new men, to select them in order from lists of unem- 
 ployed journeymen prepared by the union. These demands, of 
 course, may be harmful : in industry as in government, certain 
 functions must be entrusted almost wholly to the executive head. 
 The fact that power may be abused, however, is really beside 
 the point. The point lies in the possibility of extending the 
 range of collective bargaining until the employees shall have a 
 voice — and it is to be hoped a prevailing voice — in determining 
 the conditions of employment. Through collective bargaining 
 the control of the employees over the business may be indefi- 
 nitely expanded. Once having secured control, the majority 
 may learn, as they are slowly learning in political life, to leave 
 certain particularly difficult questions to their industrial cap- 
 tains. In the past, labor has had to seek capital and serve it. 
 In the future, capital may have to seek and serve labor. 
 
 These words are written in no spirit of advocacy, and with no 
 intention of palliating the obvious shortcomings of the trade 
 union. But the fact remains — whether we like it or not — that 
 economic theory and economic history unite in the conclusion 
 that the union has come to stay as long as the system of capi- 
 talistic production. The union must be improved, it cannot be 
 extirpated ; and the most urgent task of the present is to con- 
 vince employers and unionists that there will be no real peace 
 until employers acknowledge the inevitableness of the union, 
 and unions acknowledge — sympathetically and in practical 
 
LABOR PROBLEMS 469 
 
 ways — the social serviceableness of the employer. Trade 
 unions have been guilty of many sins — violence, monopoly, 
 political corruption. But their gravest danger at the present 
 time is a false philosophy, in accordance with which many 
 unionists have come to believe that the best way to help the 
 union is to oppose the employer. This is not true of the more 
 wisely conducted unions. The railway brotherhoods frequently 
 unite with the railway managers in securing legislation favorable 
 to the railway industry ; and the history of the National Civic 
 Federation, for example, proves that a number of the opposing 
 leaders are keenly aware that capital and labor have interests 
 in common as well as in opposition. In some way, however, 
 united labor as a whole must learn how to drive just as favorable 
 a bargain as possible with the employers in the first instance, and 
 then, the bargain having been made, to bend every effort in loyal 
 cooperation with the employer to make the business the greatest 
 possible success. This is not mere platitude. In the long run, 
 the institution that stands in the way of productive efi&ciency 
 will perish. The trade union must bring into industry something 
 besides conflict, or it will disappear. The union that so con- 
 ducts itself as to make the non-union man or the non-union shop 
 more efl&cient than the union man or the union shop, simply puts 
 a premium upon the suppression of unionism. 
 
 QUESTIONS 
 
 1. Is the industrial or the trade union the more logical form of organiza- 
 tion ? Can the two be reconciled ? Mention as many kinds of jurisdiction 
 disputes as you can. 
 
 2. Does the trade imion rest upon a sound economic basis? Is it likely 
 to endure? Is it in any large degree responsible for the conflict between 
 labor and capital? 
 
 3. Are all attempts to achieve a monopoly illegitimate? Is there more 
 justification for labor monopolies than industrial monopolies ? 
 
 4. Is the policy of the closed shop ever justifiable? Intimidation of 
 non-union men ? restriction of apprenticeship? regulation of output ? 
 
 5- The strike has been defined as a "concerted cessation of work"; is 
 this definition correct? Have men a "right" to strike whenever they wish? 
 Are employers justified in "locking out" their men at pleasure? 
 
470 OUTLINES OF ECONOMICS 
 
 6. Is the "blacklist" more justifiable than the boycott? Can either the 
 "blacklist" or the boycott be conducted in a lawful manner? 
 
 7. Distinguish between trade arbitration, voluntary arbitration, com- 
 pulsory investigation, and compulsory arbitration. What are the defects 
 of arbitration as a method of settling labor disputes? 
 
 8. What is the difference between the Victorian (wage-board) and the 
 New Zealand (compulsory arbitration) systems ? 
 
 9. Why do labor leaders oppose compulsory arbitration? Is their op- 
 position a sufficient reason for rejecting it? Why is the plea for compulsory 
 arbitration particularly strong in the case of monopolistic industries? 
 
 10. How does "gain sharing" differ from "profit sharing"? Is profit 
 sharing necessarily paternalistic? If so, is this a defect? 
 
 11. Does consumers' cooperation materially advance industrial democ- 
 racy ? Is producers' cooperation likely to grow and expand ? 
 
 REFERENCES 
 
 Adams, T. S., and Sumner, H. L. Labor Problems. 
 
 Brooks, J. G. The Social Unrest. 
 
 Carlton, F. T. The History and Problems of Organized Labor. 
 
 Cole, G. D. H. The World of Labor. 
 
 Commons, J. R. Trade Unionism and Labor Problems and Labor and 
 
 A dministration . 
 Commons, J. R. (Editor). Documentary History of American Industrial 
 
 Society (10 vols.). 
 Ely, R. T. The Labor Movement in America. 
 
 GiLMAN, N. P. Methods of Industrial Peace; A Dividend to Labor. 
 Hollander, J. H. and Barnett, G. E. (editors). Sttidies in American Trade 
 
 Unionism. 
 Industrial Commission. Report, Vols, xvii, xix. 
 Laidler, H. W. Boycotts and the Labor Struggle. 
 Le Rossignol, J. E., and Stewart, W. D. State Socialism in New Zealand, 
 
 Chaps, xiii, xiv. 
 Levasseur, E. The American Workman. 
 Marot, Helen. American Labor Unions. 
 Mitchell, John. Organized Labor. 
 PiGOU, A. C. Principles and Methods of Industrial Peace. 
 Rowntree, B. S. Poverty: A Study of Town Life. 
 ScHLOSS, D. F. Methods of Industrial Remuneration. 
 Webb, Catherine. Industrial Cooperatimi. 
 Webb, Sidney and Beatrice. History of Trade Unionism; Industrial 
 
 Democracy, 
 
CHAPTER XXIII 
 
 LABOR LEGISLATION 
 
 The conditions of employment may be fixed by individual 
 bargaining between the employer and employee, by collective 
 bargaining between the employer and groups of employees, or 
 by the State itself through legislative enactment. The last 
 method has in recent years been used not only with increasing 
 frequency, but for a variety of purposes which it is desirable to 
 differentiate. In the beginning of the nineteenth century, for 
 instance, combinations of workmen to improve their conditions 
 of employment were unlawful. There was obvious necessity 
 for labor laws, therefore, to legalize combination and make col- 
 lective bargaining legitimate. But certain classes, particularly 
 women and child wage workers, have found it nearly impossible 
 to organize for collective bargaining. In their case the state 
 has entered upon a program of positive protection, acting so 
 far as children are concerned in loco parentis. Adult men, with 
 their trade unions, have been left very largely to take care of 
 themselves; but trade unions, occupied with the absorbing 
 questions of wages and hours of labor, frequently show marked 
 indifference towards certain conditions of employment, such 
 as safety and sanitation, which from the public standpoint 
 are highly important. Of these conditions the public in its 
 own interest has been forced to take cognizance. Finally, 
 legislative enactments have been used both to foster thrift, 
 thus placing the workman in a better position to protect his 
 own interests, and to maintain uniform conditions of employ- 
 ment, so that industry shall be conducted under uniform rules. 
 To most employers, for instance, it makes very little difference 
 whether they are permitted to hire children under fourteen 
 
 471 
 
472 OUTLINES OF ECONOMICS 
 
 years of age or not ; but it is very important to them that they 
 should not be bound by more onerous restrictions than are 
 imposed upon their competitors. From this and some other 
 standpoints, the universaHty and rigidity of the labor law are 
 virtues : the stricter its enforcement and the wider the area of 
 competition to which it applies, the better. 
 
 Freedom of Combination, Conspiracy, and Injunctions. — In 
 the early part of the nineteenth century, peaceable combina- 
 tions of workmen to better the conditions of employment were 
 illegal both in England and the United States. Before the 
 middle of the nineteenth century, however, our higher courts 
 had established the doctrine that workingmen might peaceably 
 combine to secure higher wages, reduce hours, or improve shop 
 and other conditions of employment immediately affecting 
 themselves. The trade union acquired a lawful status. But 
 it must not be supposed that in the United States this freedom 
 was or is complete. Workmen might combine to secure higher 
 wages, and might enforce their demands by striking, but in 
 most jurisdictions they could not lawfully combine to secure 
 the discharge of a non-union man, nor could they threaten in 
 concert to quit dealings with a merchant unless he should refuse 
 to buy goods from some manufacturer against whom these 
 workmen or their friends were striking. Moreover, the move- 
 ment towards complete freedom was blocked or delayed in the 
 last quarter of the nineteenth century by the widespread adop- 
 tion of anti-trust laws, prohibiting combinations in restraint 
 of trade. Many of the customary activities of trade unions, 
 such as strikes to enforce the closed-shop rule, publication of 
 " unfair lists," and the like, are regarded in some jurisdictions 
 as restraints of trade. The anti-trust laws thus threw a cloud 
 upon the whole trade union movement. Finally the whole 
 situation was complicated and embittered by a doubtful use of 
 the injunction and by the uncertainty of the law itself. Statutes 
 differ, and the interpretations of similar statutes by different 
 courts are in hopeless conflict. This confusion constitutes in 
 itself a grave social problem. 
 
 We have already recorded the simple solution of this problem 
 
LABOR LEGISLATION 473 
 
 reached in England : ^ in labor disputes workmen or employers 
 may lawfully do in combination whatever any employee or 
 employer may lawfully do alone. In this country several 
 state legislatures and Congress (so far as federal law is concerned) 
 have attempted to enact the same general principles into law; 
 but the Massachusetts law on this subject has been declared 
 unconstitutional by the Supreme Court of that state, and in 
 the opinion of many authorities the federal law is likely to meet 
 a similar fate. The Massachusetts decision rests on the general 
 argument that the right to work is property, that state and 
 federal constitutions prevent any person from being deprived 
 of property without compensation or due process of law, that 
 combinations of workmen are frequently used to prevent per- 
 sons from obtaining work, and that no such combination can 
 be legitimatized by mere statute law. Whether the federal law 
 on the subject — which is contained in the Clayton Anti-trust 
 Act — will be similarly emasculated, it is impossible to say ; 
 but as this law is regarded by many labor leaders as the Magna 
 Charta of the American labor movement, and as its provisions 
 relating to the injunction, at least, are likely to be sanctioned by 
 the courts, so much of the act as relates to labor combina- 
 tions and injunctions has been briefly summarized below. Each 
 provision of the law, it may be noted, records a legislative 
 verdict upon some hotly contested point; and interpreted in 
 this light the Clayton Act becomes a valuable historical sum- 
 mary as well as a statement of the present federal law. 
 
 "The labor of a human being is not a commodity or article of commerce." 
 Labor organizations shall not be construed to be illegal combinations or 
 conspiracies in restraint of trade under federal anti-trust laws. 
 
 "No preliminary injunction shall be issued without notice to the opposite 
 party." No temporary restraining order shall be granted without similar 
 notice, unless it shall specifically show that immediate and irreparable injury 
 will result before notice can be served and a hearing had thereon : and every 
 temporary restraining order granted shall define the injury, state why it is 
 irreparable and why the order was granted without notice, shall expire in 
 not more than ten days unless extended for good cause, and shall provide for 
 a hearing (on whether a preliminary injunction shall issue) which shall take 
 
 1 P. S8. 
 
474 OUTLINES OF ECONOMICS 
 
 precedence of all matters before the court except older matters of the same 
 character. Proper bonds shall be executed to compensate for damages 
 resulting from an injunction improvidently granted; every injunction or 
 restraining order shall describe specifically and in reasonable detail the act 
 sought to be restrained ; and shall be binding only upon the parties to the 
 suit, their officers, agents, servants, employees, and attorneys, or those par- 
 ticipating with them, and who shall have received actual notice of the same. 
 In contempt proceedings for violating any injunction or order forbidding 
 an act which is also a criminal offense, the accused may demand trial by jury, 
 and penalties are limited, in the case of natural persons. Judgments of con- 
 viction may be reviewed upon writ of error as in criminal cases ; but these 
 provisions do not relate to contempts committed in the presence of the court, 
 nor to contempts committed in disobedience of any lawful order entered in 
 any suit prosecuted on behalf of the United States. 
 
 "And no such restraining order or injunction (i.e. in labor disputes) shall 
 prohibit any person or persons, whether singly or in concert, from terminat- 
 ing any relation of employment, or from ceasing to perform any work or 
 labor, or from recommending, advising, or persuading others by peaceful 
 means so to do ; or from attending at any place where any such person or 
 persons may lawfully be, for the purpose of peacefully obtaining or com- 
 municating information, or from peacefully persuading any person to work 
 or to abstain from working ; or from ceasing to patronize or to employ any 
 party to such dispute, or from recommending, advising, or persuading others 
 by peaceful and lawful means so to do ; or from paying or giving to, or with- 
 holding from, any person engaged in such dispute, any strike benefits or other 
 moneys or things of value ; or from peaceably assembling in a lawful manner, 
 and for lawful purposes ; or from doing any act or thing which might lawfully 
 be done in the absence of such dispute by any party thereto ; nor shall any of 
 the acts specified in this paragraph be considered or held to be violations of any 
 law of the United States." 
 
 The most important provisions of the Clayton Act are those 
 which we have itahcized and which apparently provide that a 
 combination of workmen may lawfully do in a labor dispute 
 anything that any party thereto might lawfully do in the 
 absence of the dispute. Whether this is wise or not time alone 
 can tell. On the surface everything seems to support the con- 
 clusion that men in concert should be permitted to do what 
 they may do singly. If the right to work is property, so also 
 is the right to quit work, and both are equally guaranteed by 
 the federal constitution. An individual not under contract 
 may quit working for an employer or dealing with a merchant 
 
LABOR LEGISLATION 475 
 
 for any reason or no reason. Why, it is confidently asked, 
 may groups of men not do the same? As a raihoad engineer 
 may quit work practicaUy when he hkes, why should not the 
 Brotherhood of Locomotive Engineers quit work as a body when 
 it pleases the organization, and thus tie up the entire railroad 
 traffic of the country, for the purpose, say, of assisting the rail- 
 road conductors of one district in refusing traffic from another 
 district in which a strike has been declared? 
 
 These questions carry in part their own answer. Many 
 acts which are either harmless or trivial when performed by an 
 individual become exceedingly injurious when swollen by 
 concert and combination. A general strike or boycott for 
 trivial or malicious ends cannot by logic-chopping be made 
 anything else, than impolitic and wrong. All this appears 
 plain when we reverse the case and pass judgment upon what 
 are practically the same acts when performed by employers. 
 A sympathetic lockout, ordered against one innocent union, 
 say of freight handlers, in order to prevent them from voting 
 funds to assist the strike of a union of railroad telegraphers, 
 for instance, would bring general criticism against the employers 
 who ordered it; but it is essentially the same in principle as 
 the sympathetic strike. The black-list — which has almost 
 no avowed friends — is in essence similar to the indirect boy- 
 cott or strike to secure the discharge of a non-union man. The 
 simple truth is that many things are dangerous when partici- 
 pated in by great numbers, which are not so when performed 
 by individuals. 
 
 The Clayton Act does not remove all the safeguards against 
 harmful combination. Most of the states still have anti- 
 trust acts and laws against unlawful combination. Moreover, 
 if we have not had general strikes and nation-wide boycotts in 
 the past, it is not because the laws or the court decisions have 
 prevented them. The inherent difficulties in the way of their 
 successful consummation, and the sense of social responsibility 
 among trade unionists and the working classes generally, furnish 
 the real protection. The real danger is that the new legisla- 
 tion will be interpreted as creating sound moral sanctions for 
 
476 OUTLINES OF ECONOMICS 
 
 things which may be inherently unfair or immoral. If trade 
 unionists and employers do not permit this legislation to blind 
 their moral judgments, and remember that the removal of a 
 legal ban from an action does not necessarily make that action 
 under all circumstances either expedient or justifiable, then it 
 is probable on the whole that the new legislation will result in 
 more good than harm. 
 
 The new law has the virtue of equalizing things. The sym- 
 pathetic lockout and the black-list cannot in practice be denied 
 to the employers. They can use them because they can use 
 them secretly ; because the president of a great corporation or a 
 small board of directors may maintain a black-list or order a 
 sympathetic lockout so quietly that it would be impossible to 
 prove their nature or for exactly what purposes they were 
 declared. The trade union, on the other hand, must act in 
 open concert, after legislative action, the nature and purpose 
 of which can with difficulty be concealed. Many of the pro- 
 ceedings must be formally recorded. The new federal law 
 puts the employer and the union on a more equal footing ; al- 
 though it ignores the vast interests of the public and removes 
 legal penalties from actions which are often morally wrong 
 and socially dangerous. In the end it will probably lead to the 
 full exercise by the state of the right to suppress any black-list, 
 lockout, strike, or boycott which becomes so extensive or 
 offensive as to shock the public sense of fair play or seriously 
 menace public welfare. 
 
 Child Labor Laws. — The class of laws which we have been 
 considering has been designed to relieve the laborer from ancient 
 disabilities, so that he may be enabled in combination with 
 his fellows to help himself. Most modern labor laws, however, 
 are of a different type. They assume that the welfare of labor 
 is of peculiar importance to society and that the state is there- 
 fore warranted in protecting the wage-earning .classes, openly 
 and frankly. Perhaps the earliest and most t3Apical legisla- 
 tion enacted in this spirit is the child labor law. 
 
 The problem of child labor is frequently misconstrued. The 
 principal reason why children work is not found in the needy 
 
LABOR LEGISLATION 477 
 
 widow, the abandoned wife, or the stony-hearted employer. 
 The principal causes of child labor are the restlessness of the 
 child ; the failure of ordinary school training to hold his atten- 
 tion and arouse his ambition ; and the ignorance or selfishness 
 of parents. And the evil consists, principally, in the fact that 
 the child who goes to work early usually gets into a " blind 
 alley " occupation, and is thus prevented from developing his 
 full potential earning power. His ability to serve both himself 
 and society is curtailed by his excessively early start. " The 
 better occupation either will not receive the young child at all, 
 or wants him with more schooling, or offers such a low initial 
 wage that both child and parent turn to the mill, with its greater 
 present wage opportunities." ^ The wage in the low-grade 
 occupation is at first relatively high, but in three or four years 
 the boy has reached his maximum earning capacity and early 
 marriage fastens him to the job. The boy who begins at six- 
 teen years or later soon catches his less fortunate brother, and 
 in a comparatively few years is earning a superior wage. As 
 a foundation for real promotion and advancement the work 
 which children between fourteen and sixteen years of age do 
 has usually little value. 
 
 It is thus plain that the problem of child labor is positive 
 and constructive, not merely negative. It avails little to pro- 
 hibit children from working at this or that; agencies must be 
 provided helpfully to guide their activities. Already the 
 most advanced states have incorporated in their laws a pro- 
 vision requiring employers of child labor to give the children 
 a specified amount of vocational training, or time to secure 
 such training, in institutions provided by the state. More 
 important still, agencies are being established to determine by 
 physical and psychological tests whether children who have com- 
 pleted the required schooling are really fitted to enter industry, 
 and what kinds of work they are best fitted to undertake.^ 
 
 ^ Susan M. Kingsbury, "The Relation of Children to the Industries," in Report 
 of Massachusetts Commission on Industrial and Technical Education, p. 44. 
 
 1 See Mental and Physical Measurements of Working Children, by Helen Thompson 
 . Wooley and Charlotte Rust Fischer. 
 
478 OUTLINES OF ECONOMICS 
 
 The beginnings are tentative and the work diflficult. But 
 the period draws to an end in which ignorant children drift 
 or are pushed by ignorant parents into the work which lies 
 nearest at hand ; and the time approaches when the most care- 
 ful thought will be given to the selection of one's life work and 
 the training for it. 
 
 Child labor laws differ greatly in the different states, and the 
 resulting inequality of burden upon competing employers so 
 complicates the problem that, in 191 6, Congress enacted a law 
 debarring from interstate commerce goods produced by very 
 young children — leaving each state to legislate as it sees fit 
 about products confined to intrastate trade. This, in our 
 opinion, should be productive of far more good than evil. But 
 the constitutionality of this new federal legislation is involved 
 in grave doubt, and the new statute is in some respects 
 unfortunately worded, so that its exact scope is not yet 
 clear. 
 
 A good state child labor law, it is now generally conceded, 
 should prohibit the employment of all children under fourteen, 
 and of all children under a higher age limit who are undersized, 
 weakly, or illiterate. " Young persons " who are deficient in 
 the fundamental requirements of an English education should 
 be compelled, where possible, to attend a continuation school. 
 Work in " immoral " or dangerous occupations, at night, or in 
 excess of eight hours per day should be forbidden for all children 
 under the higher age limit. 
 
 The successful enforcement of such laws has been found diffi- 
 cult. Birth or baptismal certificates, or other similar evidences 
 of age, have to be procured from parents ; certificates of attend- 
 ance and proficiency from school authorities; examinations 
 of health and educational requirements must be made; and 
 employers required to demand, file, and return employment 
 certificates. The community must maintain and properly 
 support factory inspectors and health and school attendance 
 officers in adequate numbers, with power to prosecute viola- 
 tions of the law and with secure tenure of office. The com- 
 munity should further provide for dependent families which 
 
LABOR LEGISLATION 479 
 
 need the earnings of their children, keep birth records, and 
 maintain schools fitted to hold the attention of the child and 
 properly train him for his life work. " The best child labor 
 law is a compulsory school law covering forty weeks in the year 
 and requiring the attendance of all children under fourteen years 
 of age." ^ 
 
 The Labor of Women. — The labor of women is not in itself 
 a problem which calls for legislation. The evil consists in work- 
 ing under conditions which undermine health and morals, or 
 for inadequate wages. It is impossible to describe here in 
 detail the various laws which have been passed relating to the 
 employment of women. Women are subject to the " factory 
 acts " relating to sanitation, safety, and occupational diseases, 
 and to general statutes regulating production in tenement 
 houses and the time, frequency, and character of wage pay- 
 ments. In the more advanced states also, the labor of women 
 in manufacturing, mechanical, and mercantile establishments 
 is likely to be safeguarded by laws limiting the hours of labor, 
 prohibiting night work and continuous employment for more 
 than six hours, for example, without an interval for meals ; provid- 
 ing and permitting the use of suitable seats ; requiring separate 
 and sanitary toilet facilities; prohibiting the employment 
 (knowingly) of women within two weeks before or four weeks 
 after childbirth ; and — in Massachusetts for example — 
 directing local authorities to furnish responsible mothers having 
 dependent children sufi&cient aid " to enable the mothers to 
 bring up their children properly in their own homes." 
 
 Until very recent years, regulations similar to the above 
 represented the extreme limit to which any American state 
 had gone in the protection of women. And even the consti- 
 tutionality of such regulation was in grave doubt, for an im- 
 portant statute limiting the hours of labor had been declared 
 unconstitutional by the highest court in Illinois, and in New 
 York a statute prohibiting night work had been similarly 
 annulled, on the general grounds that they infringed the free- 
 
 1 Cf. Florence Kelly, Some Ethical Gains Through Labor Legislation, pp. 98, 09, 
 and passim. 
 
48o OUTLINES OF ECONOMICS 
 
 dom of contract and were " unduly discriminatory between 
 citizens," the court remarking (in the New York decision) " that 
 woman is no more the ward of the state than is man." But 
 under the more hberal leadership of the Supreme Court of 
 the United States, both of the state courts in question have 
 recently reversed these decisions and have sanctioned similar 
 laws as reasonable health regulations, looking not only to the 
 protection of the individual woman but to the " welfare of the 
 race." ^ 
 
 Minimum Wage Laws for Women. — In about a fourth of 
 the states minimum wage laws have been passed, with the gen- 
 eral object of requiring that wages paid in certain occupations 
 shall be sufficient to provide for a woman's normal needs " re- 
 garded as a human being living in a civilized community." 
 Whether these statutes will be effective time alone can tell, but 
 their passage marks a revolution in the social and legislative 
 philosophy of this country. 
 
 Minimum wage laws were first adopted by the Australian 
 state of Victoria in 1896 to regulate wages and other conditions 
 of labor in the " sweated trades." Trades or industries in 
 which wages are particularly low are usually singled out by 
 legislation, though in Victoria the government may apply the 
 system to additional trades by administrative order. These 
 wage boards, as we have seen in the preceding chapter, are 
 designed to induce compulsory collective bargaining, in which 
 the state participates by compelling employers and employees 
 to fix standard conditions of employment. In England and 
 this country the legislation is as yet much more tentative 
 and restricted. " The outstanding characteristics of the Ameri- 
 can minimum wage legislation compared with that of Eng- 
 land, Australia, and New Zealand are these: The first is 
 its omission of men; the second is its reference to the 
 welfare of the people as a whole; the third, which is re- 
 sponsible for both the others, is its subordination to the courts 
 on the grounds of constitutionality, entailing the practice of 
 placing upon American states the burden of proof that they 
 1 L. D. Clark, The Law of the Employment of Labor, p. 103. 
 
LABOR LEGISLATION 481 
 
 are acting within their police powers when they create such 
 wage commissions and wage boards or conferences." ^ Some 
 of the American laws, it may be added, make no provisions for 
 joint wage boards of the Australasian type, but provide that 
 the minimum wage shall be fixed directly by a state labor or 
 industrial commission. 
 
 The general principles of minimum wage legislation are 
 simple. In many trades the majority of the workers do not 
 receive enough wages to maintain their physical efficiency. Of 
 these sub-standard wage workers a large number are partially 
 supported by other members of the family, a considerable num- 
 ber are assisted by charity, a few eke out their living by inter- 
 mittent or regular prostitution, and some " actually die of 
 under-nutrition and worry." ^ The work as a rule is simple 
 and the supply of labor excessive. Usually there is no labor 
 organization. The workers are weak and the wage is fixed 
 by individual bargaining in which the predominant force is 
 sometimes the rapacity of the employer. The tendency towards 
 a uniform or standard wage in many of these trades seems to 
 have been checked by the absence of labor organization, and 
 competing establishments in the same industry are found again 
 and again paying strikingly different wages for the same grade 
 of labor. 
 
 It is held, in short, that trades which pay less than a living 
 wage are parasitic ; that they constitute a positive drain upon 
 society at large, and that any measures necessary to place these 
 trades on a self-supporting basis are both justifiable and econom- 
 ically helpful. The establishment of a minimum wage is 
 expected to force a certain number of slow and incompetent 
 workers out of employment, although provision is usually 
 made to permit them to work under special permits. But 
 that society should be forced openly and frankly to deal with 
 and take care of its incompetent workers is regarded as an ad- 
 vantage. It is expected that such legislation in some instances 
 
 ^ Florence Kelley, in The Survey, vol. xxxiii, p. 487. 
 
 ' H. R. Seager, "The Theory of the Minimum Wage," American Labor Legislation 
 Renew, vol. iii, No. i, p. 84. 
 21 
 
482 OUTLINES OF ECONOMICS 
 
 will result in increased prices. But the consumer is expected 
 to bear his fair share in supporting those who supply his needs, 
 and both a priori analysis and experience in Australia and Eng- 
 land make it probable that the rise of wages would not be 
 accompanied by a corresponding rise in prices.^ Finally it 
 is expected that the increase in wages will compel reorganization 
 of the parasitical trades so that in the end the cost of produc- 
 tion will be decreased rather than increased. Incidentally 
 the operation of the wage boards is expected to stimulate or- 
 ganization among the wage workers concerned and to react 
 favorably upon immigration. Immigrants are less likely to 
 come, many believe, if they know in advance that they must 
 be able to earn the minimum wage or else leave the country. 
 Price cutting in the labor market will be checked; and the 
 increase in wages will focus competition upon the quality and 
 efficiency of the laborer. Most important of all, perhaps, the 
 system is expected to compel a wider and more effective use of 
 labor-saving machinery. 
 
 Minimum wage legislation slowly introduced and carefully 
 administered meets the test both of economic theory and actual 
 experience. In Victoria the legislation which was at first 
 doubtfully applied to six trades has now been made applicable 
 to 141; and 150,000 workers in a population numbering less 
 than one and one half million " have the minimum wages in 
 their trades prescribed by law." Vigorously opposed by the 
 employers on its introduction, it seems from reports of disin- 
 terested investigators to have established itself on a firm founda- 
 tion. There is yet some opposition to detaOs of the law and 
 vigorous criticism of the way in which it is administered ; but 
 from all that can be learned those who desire to do away with 
 this system of regulation constitute a very small minority. In 
 England the results seem equally favorable. Nothing revo- 
 lutionary has been accomplished, but the system has demon- 
 strated that it is practicable, even in highly complicated trades ; 
 that it can be trusted to raise wages without seriously disturb- 
 ing prices ; that it mildly stimulates organization among work- 
 
 * CJ. N. I. Stone, in The Survey, .vol. xxxiii, p. 514. 
 
LABOR LEGISLATION 483 
 
 ers who need organized effort to better themselves; that it 
 compels serious study and public investigation of trades which 
 need both ; and that it is not productive of serious evils. The 
 minimum wage has not become the maximum nor has the 
 operation of the act resulted " in wholesale dismissals of old 
 and slow workers. The predominant method of payment in 
 the scheduled trades is by piece, and where this is the case the 
 employer who has fixed piece rates yielding the equivalent of 
 the time rate to the ' ordinary worker ' runs no risk of penalty 
 if his sub-ordinary worker fails to reach that amount by reason 
 of incapacity or advanced age." ^ 
 
 So far as economic theory is concerned, there is no reason 
 to believe the minimum wage proposition unsound. The es- 
 tablishment of minimum standards of sanitation and safety in 
 Germany does not seem to have hurt industry there, and there 
 is no reason to believe that the establishment of minimum wage 
 standards would do so. Without regulation much of the com- 
 petitive fight centers about the mere money wage. A poor 
 workman may be more profitable to the employer than a skilled 
 workman provided the poor workman can be secured for a small 
 enough fraction of the wage it would be necessary to pay to 
 the skilled workman. Establish a dead line — or better, a 
 health line — and the emphasis will be placed upon efficiency 
 instead of cheapness. Wage earners will have to meet higher 
 and better standards. The competitive struggle will thus 
 operate to evoke efficient rather than low-paid workmen. 
 And the higher cost of labor will help to force the introduction 
 of better machinery and better methods of organization. 
 
 Obviously, not all the claims made for this system will bear 
 scientific scrutiny. There is, for instance, probably more 
 error than truth in the contention that every industry which 
 pays its minor workers less than a living wage is a detriment 
 rather than a help, an industrial parasite sopping the economic 
 strength of a community. Until a far better distribution of 
 the labor force has been secured, there will continue to be in 
 
 1 Constance Smith, "Working of the Trade Boards Act," Journal of Political 
 Economy, vol. xxii, p. 625. 
 
484 OUTLINES OF ECONOMICS 
 
 all probability a surplus of workers who cannot earn a living 
 wage and yet had better earn a supplementary wage than be 
 idle. There were in 1910, for instance, in this country 1,847,600 
 females between the ages of 16 and 20, inclusive, engaged in 
 gainful occupations. Young women might possibly better 
 spend these years in training for their life-work, including house- 
 keeping and the difi&cult vocation of marriage. But until 
 adequate provision for such training is made, young women of 
 this age had better be employed at wages which will tend to 
 make the family income more adequate than not to be employed 
 at all. After all, however, these are minor modifications of 
 the theory upon which the minimum wage program rests. 
 That standards should be adopted, including a wage standard, 
 which both employers and employees must meet, is on the whole 
 consistent with the best economic and social theory. 
 
 Some trade unionists oppose minimum wage laws on the 
 grounds that the minima will become maxima and that wages 
 should not be regulated by law. But the first charge has been 
 disproved by experience, and the minimum wage at its best is 
 a program for compulsory collective bargaining, not for the 
 regulation of wages by statute. It aims to introduce into un- 
 skilled vocations what are essentially trade-union methods of 
 standardization, and the criticisms which are directed against 
 it apply equally well to trade-union procedure. 
 
 Factory Acts. — Constitutional guarantees, particularly that 
 of free contract, prevent in this country the general regulation 
 of the labor of adult men, but under the police power the states 
 have the right, indeed in the language of the Supreme Court, 
 " it is among their plain duties," to regulate the physical condi- 
 tions of employment so that accidents and occupational diseases 
 may be minimized. These regulations, frequently referred to 
 as factory acts, are typified by the familiar laws requiring proper 
 fire escapes, the removal of dust or noxious vapors by fans, the 
 placing of guards about dangerous machinery, the installation 
 of mechanical belt shifters, and connection by bells or tubes 
 between rooms in which machinery is used and the engine room. 
 Such laws have now been adopted in most of the states, but 
 
LABOR LEGISLATION 485 
 
 their enforcement in many states has been very ineffective. 
 In 1913 there were fifteen states with nearly a milUon wage 
 earners in manufacturing and mechanical industries which had 
 practically no provision for factory inspectors. And even 
 where factory inspection is provided, it has too frequently been 
 half-hearted, inexpert, and emasculated by political interference. 
 In one state, " where the chief factory inspector divides his time 
 between conducting a livery stable he owns and the business of 
 caring for some 30,000 factory wage earners, I found him con- 
 tributing a remarkably concise annual report of exactly four- 
 teen words. It reads, under date of July i, as follows: *I 
 have visited the same factories as last year and find conditions 
 the same.' " ^ 
 
 While politics and administrative ineptitude have seriously 
 crippled factory regulation in this country, the truth is that 
 the problem was a new and difficult one and that there were 
 procurable few or no real experts until very recent years. Very 
 recently, however, great improvement has been made both 
 in the laws and their administration. Wisconsin, Massachu- 
 setts, New York, and other states have gone far towards solving 
 the administrative problem by placing appointments on the 
 civil service basis and consolidating powers previously lodged 
 with police, factory inspectors, and health commissioners into 
 one industrial or labor commission, with general power to enforce 
 the rules necessary to provide reasonable sanitation and safety. 
 In this way the necessary elasticity of rule and standard has 
 been secured ; and in adopting rules or standards the coopera- 
 tion of employers and labor organizations has been secured, 
 thus insuring more practical rules and the good will of those to 
 whom these rules apply. Regulation by the state can never 
 become effective until responsibility and power are centralized 
 and the responsible administrative head given sufficient dis- 
 cretion nicely to adapt regulations to the subtle complexities 
 of modern industry. With employers, employees, and factory 
 inspectors working together under practicable regulations in 
 
 ^ E. F. Brown, "The Efficiency of Present Factory Inspection Machinery in 
 the United States," American Labor Legislation Review, vol. iii, No. i, pp. 27-28. 
 
486 OUTLINES OF ECONOMICS 
 
 whose formulation all three have cooperated, rapid progress 
 has recently been made in the prevention of accidents and 
 equally gratifying improvement has been made in the methods 
 of compensating for accidents. 
 
 Employers' Liability. — Under the common law of employ- 
 ers' liability, the employer is under obligation to provide his 
 workmen, with a reasonably safe place in which to work, with 
 reasonably safe machinery, and with reasonably prudent and 
 competent fellow workmen; and the employer is liable in 
 damages for any accident to his workmen resulting from failure 
 to display this ordinary prudence and care, as well as from the 
 similar failure or negligence of any superintendent, overseer, 
 or vice-principal authorized to issue orders in his name. When 
 the employer has observed the ordinary precautions of a reason- 
 ably prudent man, however, the employee assumes all the haz- 
 ards incident to the employment or arising from the negligence 
 of fellow servants ; and even though the employer is negligent, 
 the employee cannot recover damages for an accident, if the 
 employee was aware of the employer's negligence and volun- 
 tarily accepted the risk, or if the employee has been guilty of 
 additional or contributory negligence. 
 
 This, in bare outline, is the common-law foundation of the 
 doctrine of employers' liability. It has been modified inces- 
 santly by statute law and by changing interpretation of the 
 courts ; it is vague, uncertain, and legalistic in the worst sense. 
 Under it not more than ten per cent of the victims of indus- 
 trial accidents received any compensation, and of the damages 
 paid by employers the victims received on the average probably 
 less than 50 per cent. The rest went for court costs and lawyers' 
 fees. A class of professional accident attorneys, " ambulance 
 chasers," who exploited industrial accidents for their own rather 
 than the victims' benefit, appeared in most industrial centers ; 
 ignorant juries decided on the difficult facts in the most capri- 
 cious ways, now refusing relief in deserving cases, again voting 
 excessive damages for trivial or perhaps simulated injuries; 
 the cases filled the courts ; decisions turned upon hair-splitting 
 distinctions and metaphysical niceties ; the humane employer, 
 
LABOR LEGISLATION 487 
 
 the conscientious lawyer, the far-sighted judge, workingmen, 
 and the general public became, it is hardly too much to say, 
 disgusted with the inapplicability and bungling unsuitability 
 of the doctrine of employers' liability properly to deal with the 
 grave social problem arising from industrial accidents. 
 
 Attempts to solve this problem, as stated above, first took 
 the form of incessant amendment of the old law. The fellow- 
 servant doctrine (that the employer was not responsible for 
 accidents arising from the negligence of co-employees as distin- 
 guished from vice-principals) was curtailed in some states by 
 confining " fellow servants " to those employed in coordinate 
 occupations immediately associated with the victim, and the 
 employer's defenses of " assumption of risk " and " contributory 
 negligence " were limited and in some jurisdictions almost 
 abolished. But the truth is that the whole social philosophy 
 underlying the law of employers' liability was mistaken, " not 
 so much unjust as wholly inapplicable." It misconceived 
 the nature of the social problem involved and offered remedies 
 that were wholly ineffectual. It attempted — so far as one 
 can discover behind it any real rational philosophy — to single 
 out those accidents for which the employer was to blame and 
 to compensate workmen in accordance with the damage resulting 
 from the employer's negligence. Investigation shows, however, 
 that the employer is responsible for only a minority of the 
 accidents which occur. The victim himself, his fellow workers, 
 and, most important of all, the occupational risk itself are re- 
 sponsible for the great majority of accidents. But the victim's 
 need and that of his family are just as great when the accident 
 results from the victim's negligence as when it results from the 
 employer's negligence. It is not a question of individual fault 
 and punishment for that fault; it is a question of industrial 
 or social loss and insurance against that loss. The government 
 should of course compel both employers and employees to take 
 every reasonable precaution against accident, by unequivocal 
 law or administrative order; and every infraction of the law 
 should lead to criminal indictment, not civil action. But even 
 if this were accomplished, there would still remain a large 
 
488 OUTLINES OF ECONOMICS 
 
 number of industrial accidents which if not compensated for 
 would lead to poverty, unemployment, and the suffering of 
 innocent women and children. 
 
 That the burden of industrial accidents should be borne by 
 the industry itself or the consumer and not by the laborer or 
 his family is very generally recognized ; and most foreign coun- 
 tries, together with the federal government and more than half 
 of the states, have replaced or supplemented the old law of 
 employers' liability with workmen's compensation acts. The 
 laws are described and discussed in a later chapter, on Insur- 
 ance. They have worked well : not perfectly, but with much 
 more certainty and with far less cost than the old laws. Defects 
 naturally exist in the new system which should be remedied 
 in the future. The usual compensation is too low to indemnify 
 the victim and his family adequately for the loss resulting from 
 the accident, and the limitation of payments for permanent 
 disability to four or six years or less is illogical and will cause 
 hardship. But the new system is so much superior to the old 
 that, despite these defects, its adoption must be regarded as 
 a noteworthy step in social progress achieved through legis- 
 lation. As a concrete contrast with the awkward, expensive, 
 capricious working of the old liability law, the results of the 
 operation of the Wisconsin compensation act during the year 
 ended June 30, 191 5, are suggestive of the improvement effected 
 by the change. Of all the industrial accidents occurring that 
 year, 93 per cent were settled between the employers and work- 
 men with no outside interference beyond a simple " approval " 
 by the state Industrial Commission ; 3 per cent of the cases 
 were carried to the industrial commission for adjustment ; 
 and only one fifth of i per cent was carried to the courts. The 
 injured workmen received for indemnity and medical expense 
 $1,350,000, while the administrative cost to the state was only 
 
 $13,771- 
 
 Philosophy of Labor Legislation. — In the preceding sketch 
 it has been possible only in the most superficial way to call 
 attention to a few of the more important modern labor laws. 
 It is equally impossible to discuss adequately the general aspects 
 
LABOR LEGISLATION 489 
 
 of the labor movement as it expresses itself in legislative action. 
 In conclusion, however, it may be suggestive in a rather dog- 
 matic way to pass in review some of the broader aspects of this 
 movement : 
 
 Mercantilism and its alleged failure, or the breakdown of 
 old labor legislation in the seventeenth and eighteenth cen- 
 turies, furnish no adequate reason for concluding that the new 
 legislation will fail. The old laws were enacted by a ruling 
 minority in behalf of that minority. They had to contend 
 with the persistent and growing opposition of a large ma- 
 jority of the people. They lay athwart the path of democracy. 
 The new laws have a much greater chance of success because 
 they cannot be passed until they have the support of a ma- 
 jority, and we may now reasonably look for an administration 
 thoroughly in sympathy with their purposes. 
 
 Administratively, an improved mechanism has been developed 
 in the industrial, labor, or welfare commission. From the stand- 
 point of labor legislation the tripartite division of American 
 government has been deeply unfortunate. Legislatures have 
 enacted laws, courts have passed upon them, and executives 
 have administered them who did not understand the conditions 
 and technical facts with which they dealt. More legislative 
 power and more judicial power must be lodged in labor com- 
 missions, manned by real experts (whom we are just beginning 
 to train) and empowered to deal with complex labor problems 
 by administrative orders or, more properly perhaps, legislative 
 and executive orders. The original formulation of general 
 social policy must be left to the legislature ; ultimate constitu- 
 tional and judicial questions must remain with the courts ; but 
 all special questions, legislative, judicial, and administrative, 
 should be left as fully as possible to a body supplied with means 
 and time to learn the technical facts and to enlist both employers 
 and employees in formulating and then observing the details 
 of the law. 
 
 So far as constitutional questions are concerned, the main 
 battle in the courts has, we believe, been won. Individualism 
 and freedom of contract have constituted in the past a chronic 
 
490 OUTLINES OF ECONOMICS 
 
 American disease ; but an adequate antitoxin has been developed 
 in the police power. The doctrine of the pohce power raises 
 essentially a question of fact : does the condition in question gen- 
 uinely menace the health or morals or safety of the community ? 
 Because this is primarily a question of fact, it is vitally im- 
 portant that we should have commissions or officials empowered 
 to get the facts in an impartial and authoritative way. When 
 we have the facts we shall recognize fully that " liberty " is a 
 composite and mutually contradictory term; that there are 
 liberties rather than one single liberty; that to preserve a 
 deeper and more genuine liberty we must frequently sacrifice 
 liberties of a smaller and more superficial character, and to 
 preserve the liberty of the many it is sometimes necessary to 
 restrain the liberty of the few. If there is an inalienable right 
 of free contract, may an individual in the exercise of that right 
 bind himself to slavery for life ? 
 
 Finally it is being found that this protective legislation — • 
 protective against poverty and exploitation either by persons 
 or circumstances (the last is far the more important) — does 
 not pauperize or weaken human fiber, or check the competitive 
 struggle for existence upon which so much is believed to depend. 
 Underfeeding, undereducation, underthinking, all the hand- 
 to-mouth vicissitudes that accompany abject poverty, under- 
 mine human fiber and pauperize far more effectually than state 
 regulation or assistance can ever do. Moreover, the modern 
 labor law is the antithesis of paternalism. It is the collective 
 way by which the wage-earning masses help themselves ; and 
 it is political because the evil which it seeks to remedy is political 
 as well as individual. " Of all national resources labor is by 
 far the most important. So important is it that one may 
 almost say that all else depends upon it. Not until a nation 
 has secured a body of sturdy, skillful and contented workers 
 can it be said to have met the first requisite to national efficiency. 
 ... As in the past the nation that would succeed had to 
 apply itself to the training of its soldiers, so now it must apply 
 itself to the training of its industrial workers. We are appalled 
 at the suffering, loss of life, and destruction of wealth entailed 
 
LABOR LEGISLATION 491 
 
 by war and preparation for war. They are as nothing compared 
 with the misery, sickness, and death now due to the failure of 
 society properly to control the conditions under which industrial 
 work shall be performed. No one can calculate the loss daily 
 taking place as the result of the use of feeble, untrained, dis- 
 contented workers." ^ Labor legislation represents above all 
 else an organized effort to achieve national and social efficiency. 
 
 QUESTIONS 
 
 1. Under what circumstances is the labor law used to determine condi- 
 tions of employment? What are its characteristics in this connection? 
 What differences are found in the determination of conditions of employ- 
 ment by law and by a strong trade union? 
 
 2. What is the difference between a primary and an indirect or compound 
 boycott? Is the latter lawful in the jurisdiction in which you live? Is a 
 strike to prevent the employment of non-union men lawful? 
 
 3. Does the anti-trust act of your state apply to labor organizations? 
 What is a conspiracy ? and what are the peculiar characteristics of the law 
 of conspiracy? 
 
 4. Against what aspects or characteristics of the injunction do trade 
 unionists protest ? 
 
 5. Summarize the child labor laws of your state and those relating to 
 industrial education, continuation schools, and mothers' pensions. What 
 arguments have been advanced against mothers' pensions ? 
 
 6. Do minimum wage laws operate to reduce all wages to the legal min- 
 imum? Summarize evidence on this point from the Frankfvirter-Goldmark 
 brief and other sources. 
 
 7. What bearing has the minimum wage on the immigration problem ? 
 Is it socially expedient that minors living in families with adequate incomes 
 should be prohibited from working for less than the living wage ? 
 
 8. Does compulsory insurance against sickness and old age tend to under- 
 mine or strengthen individual thrift ? Give reasons. 
 
 9. Briefly summarize the law on employers' liability in your state; or 
 if it has a workmen's compensation act, summarize the results of that law 
 as given in the latest published statistics. 
 
 REFERENCES 
 
 (See also references for Chapter XXII.) 
 
 American Labor Legislation Review (quarterly). 
 
 Andrews, Irene. Minimum Wage Legislation (with select bibliography on 
 the minimum wage). 
 
 * W. F. Willoughby, in American Labor Legislation Review, vol. iv, p. 44. 
 
492 OUTLINES OF ECONOMICS 
 
 AvES, Ernest. Report to the Secretary of State for the Home Department on 
 Wages Boards and Industrial Conciliation and Arbitration Acts of Aus- 
 tralia and New Zealand. 
 
 Beveridge, W. H. Unemployment. A Problem of Industry. 
 
 Clark, L. D. The Law of the Employment of Labor. 
 
 Clark, V. S. The Labor Movement in Australasia. 
 
 Commons, J. R., and Andrews, J. B. Principles of Labor Legislation. 
 
 Dicey, A. V. Relation Between Law and Public Opinion in England in the 
 Nineteenth Century. 
 
 Frankfurter, Fellx, and Goldmark, Josephine. The Case for the 
 Shorter Work Day (2 vols.). (Brief in the Oregon ten-hour-law case.) 
 
 Goldmark, Josephine. Fatigue. 
 
 HUTCHINS, B. L., and Harrison, A. A History of Factory Legislation. 
 
 RuBiNOW, I. M. Social Insurance. 
 
 Stimson, F. J. Popular Law Making; Handbook to the Labor Law of 
 the United States. 
 
 United States Bureau of Labor Statistics. Bulletin (Separate series upon 
 (fl) Labor Laws of the United States (including decisions of courts 
 relating to labor), {b) Foreign Labor Laws, (c) Workmen's Insurance 
 and Compensation) ; Report on Condition of Woman and Child Wage 
 Earners in the United States (19 volumes). 
 
 Webb, Sidney and Beatrice. The Prevention of Destitution. 
 
CHAPTER XXIV 
 
 INTEREST 
 
 Interest is the price paid for the services of capital. It appears 
 in two forms : loan interest, the amount paid by one man to an- 
 other for the use of money or goods owned by the latter, and 
 imputed interest, that portion of the value of the products of 
 industry which is attributed or imputed to the services of capital, 
 as distinct from the services of land and labor. Interest is usu- 
 ally measured as a percentage of the money value of capital, and 
 this, coupled with the fact that capital is often lent in the form 
 of money, has led to the prevalence of the idea that interest is a 
 payment for the use of money. This is only a partial descrip- 
 tion of interest, however, for it does not include imputed interest 
 nor the loan interest paid in the form of rentals for the use of 
 many forms of capital — buildings, for example. 
 
 Objections to Interest Taking. — • It is only in modern times that interest 
 has been generally considered a legitimate and necessary form of income. 
 The strong denunciations of usury contained in both the Old and New Testa- 
 ments are denunciations of interest taking, for the word "usury" formerly 
 meant any kind of interest, and not merely excessive interest, as at present. 
 The opinion of many classical writers is illustrated by Aristotle's dictum that 
 "money was intended to be used in exchange, but not to increase at interest." 
 During the greater part of the middle ages the authority and teaching of the 
 church was set definitely against the taking of interest in any form. In the 
 middle of the fourteenth century the prohibition of usury was incorporated 
 in the civil law. These objections, however, had reference chiefly to loan 
 interest, and interest on money lent for personal use at that ; for capital was 
 not thought of as one of the factors in production until comparatively modern 
 times. In fact, by the fifteenth century, when opportunities for the profitable 
 use of money had appeared in such forms as the purchase of rights to receive 
 land rents, or partnership ventures in trade (where interest was held to be 
 justified by the risk incurred), the canonists (the writers on church law) 
 admitted the legitimacy not only of such gainful employments of money, 
 
 493 
 
494 OUTLINES OF ECONOMICS 
 
 but also, in many cases, of interest on loans. The justification of loan inter- 
 est took on at first many curious forms. It was regarded in some cases as 
 a fine for delay in the repayment of the loan, so that lenders often resorted 
 to the subterfuge of lending money gratuitously for a nominal period, the 
 real agreement being that they were to get back their money principal, with 
 a fine for the delay added, at a later date. In other cases loan interest was 
 justified as a payment for the loss of the possible gains which the lender 
 might have got by using his money himself. Usury, which at first meant any 
 kind of loan interest, came to mean interest on money loans to reheve per- 
 sonal needs, rather than for gainful employment, then interest on loans in 
 which the element of risk was lacking, and finally, excessively high interest. 
 Today the use of capital is so prominent a feature of our productive meth- 
 ods that the legitimacy of interest is not generally questioned. Socialistic 
 writers, however, insist that interest is only a result of the system of the pri- 
 vate ownership of capital, and that with the abolition of private property in 
 production goods what is now counted as interest would become part of the 
 wages of labor. It is accordingly important that we should understand 
 clearly why interest has to be paid, as well as that we should study the factors 
 determining the rate of interest. We shall find, however, that the explana- 
 tion of the necessity of interest is really a part of the explanation of the rate 
 of interest. 
 
 Inadequate Explanations of Interest. — An idea that naturally 
 suggests itself is that interest has to be paid for the use of money 
 because " money can be profitably employed in business." But 
 this is only an attempt to explain loan interest by assuming the 
 existence of imputed interest. What we want to know is why 
 " money can be profitably employed in business." 
 
 A similar, but somewhat more definite, attempt at an explana- 
 tion is contained in the statement that interest is paid because 
 capital is productive. It is pointed out that by the use of capital 
 goods the product of industry is greatly increased over what 
 could be produced by labor and land alone. This is, of course, 
 true, but taken alone it does not explain interest. The problem 
 of interest relates to the value of the product, not to the amount 
 of the product. There is nothing in the mere quantity of the 
 product, taken by itself, that gives value to it. Farmers have 
 found more than once that a large wheat crop has sold for less 
 in the aggregate than a small one. The real problem of in- 
 terest is this : How can an entrepreneur, by the use of capital, 
 increase the selling value of his product enough to not only pay 
 
INTEREST 495 
 
 for the capital actually used up in production, but also to pay in 
 addition a surplus in the form of interest upon the capital em- 
 ployed? Nor can we say that "capital produces interest." 
 It cannot be too strongly emphasized that neither land, nor labor, 
 nor capital produces value. They are simply the instruments 
 used in the production of things that command a price in the 
 market because they satisfy human wants and will not be fur- 
 nished except at a price. Part of the value of the product is 
 imputed or attributed to capital in the form of interest, and it 
 is because of its capacity to earn interest that capital is valued. 
 To say that capital produces value is to reverse the true process. 
 Capital goods produce (or aid in the production of) other goods, 
 and the selling value of these produced goods is the cause of 
 capital value. 
 
 Why Interest can be Paid. — We shall find the analysis of our 
 problem somewhat simpler if we divide it into two parts : first, 
 why interest is possible; and second, why interest must be paid. 
 In discussing why interest can be paid, we shall assume that in- 
 terest must be paid if capital is to be used in production, reserv- 
 ing the discussion of the legitimacy of this assumption for the 
 following section. 
 
 It is the physical productivity of capital — the fact that 
 capital can be used in cooperation with land and labor in the 
 production of goods — that makes it possible for the entre- 
 preneur to look upon part of his total money income as interest 
 on his investment of capital. Now, as we have seen, the mere 
 fact that capital is productive in the physical sense does not 
 explain interest, but the fact that capital is used under the guid- 
 ance of entrepreneurs in the production of goods does explain the 
 possibility of interest. The mere physical productivity of land 
 does not explain rent — land will grow weeds as well as wheat ; 
 nor does the mere physical productivity of labor explain wages 
 — some men have put years into the construction of perpetual- 
 motion machines that are absolutely worthless. But it is the 
 business of the entrepreneur to see that land and labor are used 
 wisely ; and from his point of view they are used wisely if they 
 are used in the production of things that consumers want, and 
 
496 OUTLINES OF ECONOMICS 
 
 want intensely enough to pay such prices as will enable the 
 entrepreneur to pay the rent of the land and the wages of the 
 labor employed. Similarly, an entrepreneur will not employ 
 capital in any kind of production unless the prices he expects to 
 get for his products are such as to cover the expenses incurred 
 in the use of capital. Nor will he knowingly use so much capital 
 that his product will sell for less than a smaller product would 
 have sold for, any more than he will knowingly produce an un- 
 profitably large quantity of goods by the use of too much labor 
 or too much land. 
 
 On the one hand, the entrepreneur has to estimate the prices he 
 will get for his products ; on the other hand, he has to estimate 
 the productivity and the expense of land, labor, and capital. 
 The expense of capital includes, first, the cost of the capital 
 actually used up in production ; and second, interest on all of 
 the capital used, whether " used up "or not (assuming, as previ- 
 ously explained, the necessity of interest). The principles that 
 will guide the entrepreneur as to the relative proportions of labor, 
 land, and capital he will use have already been discussed in 
 connection with the general subject of diminishing productivity. 
 We may, however, emphasize again the fact that productivity 
 must be attributed, not to " capital in general," but to specific 
 units of specific kinds of capital, used in connection with definite 
 amounts of land and labor; the productivity imputed to any 
 particular unit of capital being the precise amount of product 
 actually dependent upon the use of that particular unit — the 
 amount by which the total product would be decreased if the 
 unit in question were not used. An entrepreneur will increase 
 his use of capital rather than of labor or land, when a given 
 expense for any kind of capital will add more to his product 
 than would a similar expense for labor or land. 
 
 The Necessity of Interest. — Free goods, such as air or the 
 force of gravitation, are productive in the physical sense, in 
 that they are absolutely necessary to most forms of production. 
 The surface of Lake Michigan is used in producing the service 
 of transportation in essentially the same way as is capital in the 
 form of a railway roadbed and track. But we cannot impute 
 
INTEREST 497 
 
 productivity to specific units of free goods, for the simple reason 
 that the amount of the product is not dependent on the utiliza- 
 tion of any one unit of them. Any one cubic foot of air could be 
 dispensed with ; we cannot even conceive of the force of gravita- 
 tion as limited in quantity ; the Great Lakes furnish pathways 
 that are more than sufficient for all the vessels that traverse 
 them. We do impute productivity to the better lands that are 
 used in production, because any one acre of them could not be 
 withdrawn from use without a diminution in the product. 
 The controlling reason for this difference is that the spontaneous 
 supply of free goods is in excess of the use that is made of them ; 
 while the supply of the better lands is limited as compared with 
 the demand for them. This suggests at once why productivity 
 has to be imputed to specific units of capital, and that is, that 
 the supply of capital is limited. 
 
 Why is the supply of capital limited ? This question leads us 
 to examine the nature of the supply of capital. Imagine a 
 society without capital carrying on its productive processes by 
 the use of labor and land only. So long as the members of this 
 community produce only what they consume directly, or (if, 
 despite the absence of capital, money economy and a system of 
 exchange may be imagined to prevail) so long as they spend all 
 their money incomes for things used up immediately in the satis- 
 faction of their wants, there will be no accumulation of capital. 
 In order that capital shall be furnished, it is necessary that some 
 members of the community turn aside from the production of 
 things that are used in the immediate satisfaction of their wants 
 and devote their time to the production of goods that will be 
 used in further production. Whether they do this on their own 
 account, or whether they are paid for their work while they are 
 doing it by others, some postponement of the satisfaction of 
 wants is necessary. In the one case those who produce the 
 capital goods give up temporarily the satisfactions which they 
 would have derived from the consumption goods they might 
 have produced. In the other case, those who are devoting part 
 of their money incomes to the payment of those who are pro- 
 ducing capital goods are giving up the immediate satisfactions 
 
498 OUTLINES OF ECONOMICS 
 
 which they might have secured with the money. In either case 
 the production of capital involves the sacrifice of waiting on the 
 part of some members of the community. 
 
 But why should waiting be called a sacrifice? Do not those 
 who give up present satisfactions in order that capital goods 
 may be produced get a full repayment if they get back in the 
 form of the products of their capital goods as much as they, for 
 the time being, give up? In other words, why should capital 
 not be furnished for productive purposes if those who furnish the 
 capital get back an exact equivalent (in price) for the amount of 
 capital they have supplied ? Why should an extra payment, in 
 the form of interest, be necessary to induce saving? 
 
 The answer to these questions is found in the difference between 
 our present appraisals of things to be had now and things to be 
 had in the future. We visualize the present more vividly than 
 we do the future ; we yield sometimes to the temptation of satis- 
 fying the more trivial wants of the present, even when we know 
 that we are thereby rendering uncertain the satisfaction of more 
 important wants in the future ; and when we take considerable 
 periods of time into account, we may reasonably say that the 
 uncertainty of life itself gives us some ground for preferring 
 present to possible future satisfactions. Notwithstanding the 
 vast difference between civilized men and savages in this respect 
 — for many of the latter seem to have absolutely no regard for 
 future needs — the fact still rem^ains that waiting is a sacrifice, 
 and in order to induce the saving that is a prerequisite to the 
 use of capital in industry, a premium or reward for waiting has 
 to be paid in the form of interest. This fact is the most funda- 
 mental thing in the explanation of interest. 
 
 It must not be inferred that, in the actual economic life of to- 
 day, no capital would be supplied if interest were not paid. 
 There are other motives that induce men to save parts of their 
 incomes. The desire to provide for old age and for such con- 
 tingencies as sickness and accident, or to make provision for 
 one's family in case of death, would result in a considerable 
 amount of saving. The mere pride of accumulation, and the 
 fact that the satisfaction of many important wants, such as the 
 
INTEREST 499 
 
 desire to own a house, or the desire for foreign travel, necessitate 
 the gradual accumulation of what is to most persons a consider- 
 able sum of money, must also be given due weight. Moreover, 
 none of these motives would in itself induce men to invest or 
 lend their saved funds in productive undertakings if no interest 
 at all were paid. In fact, this would be a matter of indifference, 
 for savings might just as well be hoarded. But a very low 
 interest premium would suffice to overcome this indifference and 
 to bring about their investment in productive undertakings. 
 Even this low interest rate, however, would be sufficient to 
 balance, in some additional cases, the difference between the 
 intensity of present wants and the intensity of future wants, 
 so that in these cases, in turn, spending or saving would be a 
 matter of indifference — an indifference that would in its turn 
 be overcome by a slight increase in the interest rate. In a 
 similar way every increase in the interest rate would induce 
 more persons to save and would induce many of those who were 
 already saving a part of their incomes to save a larger propor- 
 tion of them. 
 
 At any given time, accordingly, the interest rate is consider- 
 ably higher than is necessary to secure a large part of the waiting 
 that devolves upon those who furnish capital funds for pro- 
 ductive purposes. It is just high enough, however, to be a 
 recompense for marginal waiting, which is the waiting that 
 would not take place if the interest rate were any lower. If 
 the interest rate is 5 per cent, a dollar today is worth a dollar 
 and five cents a year from today, not to all savers, but to the 
 marginal savers. 
 
 Investment. — We have seen that the supply of capital 
 originates in the fact that some people save part of their money 
 incomes, and that interest has to be paid in order to induce this 
 saving. Such persons are said to get an " income from their 
 capital." Strictly speaking, their savings are not productive 
 capital at all, in the sense in which the word " productive " is 
 used in this book. Productive capital consists of the concrete 
 material instruments of production, such as factory buildings, 
 machines, raw materials, merchants' stocks of finished products, 
 
500 OUTLINES OF ECONOMICS 
 
 and the like. Savings are not productive capital in this sense, 
 but the process by which they are transmuted into productive 
 capital is a simple and familiar one. The simplest case is where 
 the entrepreneur saves part of his own money income and uses 
 his savings in the purchase of additional capital goods, the selling 
 value of the products of which he estimates will be large enough 
 to repay him for his waiting, as well as to replace his capital as it 
 is used up, that is, to earn interest for him as well as repay the 
 principal. Or, the entrepreneur may borrow money directly 
 from others who have saved it, agreeing to pay annual interest, 
 and in addition to repay the amount of the loan — the principal 
 — at some specified time. In the complex economy of the pres- 
 ent, however, it very often happens that the entrepreneur who 
 can use money profitably and the man who has surplus funds to 
 invest do not arrange the transaction directly. Savings are 
 " placed at interest " in savings banks, insurance companies, or 
 other financial institutions, and it is to such institutions that the 
 entrepreneur who thinks that he can use more capital profit- 
 ably applies for loans. 
 
 Very often the entrepreneur is a corporation rather than an 
 individual, but the same three methods of obtaining capital are 
 open to it. The corporation may choose to reinvest some of its 
 net earnings in productive forms of capital rather than to pay 
 them all out in dividends to its stockholders. When in need of 
 money to meet a temporary emergency, the corporation may 
 borrow from banks just as the individual entrepreneur does. 
 When in need of money for more permanent investment in the 
 durable forms of capital goods, the corporation usually issues its 
 own interest-bearing obligations in the form of bonds, which it 
 sells to banks, insurance companies, and other financial institu- 
 tions, as well as to individuals. Bond issues are merely one way 
 of borrowing money. But whether the money funds are fur- 
 nished by the entrepreneur or by others, the formation of capital 
 necessitates, first, the saving of parts of money incomes, and 
 second, the use of the funds thus secured in the purchase of 
 capital goods. The expression " investment of money " is used 
 as a short way of describing this twofold process. 
 
INTEREST 501 
 
 The Replacement of Capital. — It is clear, then, that saving 
 which necessitates waiting, is a prerequisite to the formation of 
 new capital, that is, to an increase of the supply of capital already 
 in existence. But at any given time the capital already in exist- 
 ence forms a very large proportion of the total supply of capital, 
 and it may be thought that the present interest rate does not 
 affect this portion of the supply. We must, however, take into 
 consideration the fact that almost all kinds of capital are being 
 continually used up in production. This using up may be a 
 matter of a single use, as in the case of fuel or raw materials, or it 
 may be a gradual wearing out, as in the case of a machine, but 
 such differences are differences in degree of durability rather 
 than differences in kind. 
 
 As we have seen, the entrepreneur will normally not employ 
 any given additional unit of capital unless he expects to get 
 enough from the selling value of the added product to replace 
 the capital actually used up in production as well as to pay 
 interest. This means that if the entrepreneur's estimates prove 
 correct, part of the money income he gets for his product may 
 be regarded as a replacement fund, sufficient in amount to replace 
 the capital used up in production. 
 
 We must not, however, make the error of thinking of the 
 replacement fund as definite in quantity. Whether or not any 
 unit of capital produces enough to furnish a replacement fund, 
 depends on whether the entrepreneur's estimate is a correct one. 
 There is no reason why unproductive forms of capital should be 
 kept intact in amount. He would be a foolish business man, for 
 instance, who would keep reinvesting a certain amount of money 
 in raw materials in the face of a diminishing demand for the fin- 
 ished product. Even if enough income is earned to form a re- 
 placement fund, the capital used up need not be replaced unless 
 the entrepreneur so chooses. A farmer may have saved for 
 years in order to buy a reaper. The reaper will enable him to 
 raise more wheat, or, possibly, to produce the same amount of 
 wheat at less expense. In either case it will mean an increase 
 in his net money income. He may, if he chooses, set aside enough 
 of this added income so that, when the first reaper wears out, his 
 
502 OUTLINES OF ECONOMICS 
 
 accumulated funds will replace it. From one point of view we 
 may say that in this way the reaper " replaces itself." But the 
 farmer may, if he prefers, use all of his increased income in the 
 purchase of additional comforts and luxuries for himself and his 
 family. In deciding whether he will replace his capital or in- 
 crease his present consumption, he will be guided by the same 
 kind of an estimate of the relative importance of present and 
 future wants on the one hand, and of the amount which the 
 capital will add to his income, on the other hand, that guided 
 him in the original saving which led to the purchase of the first 
 reaper. 
 
 Similar illustrations can be found in other kinds of undertak- 
 ings. Many business enterprises have failed because business 
 men have " lived beyond their incomes " — which often means 
 simply that they have not replaced their capital so rapidly as 
 they have used it up. Many American railways have main- 
 tained a specious prosperity for many years by paying " un- 
 earned dividends " ; that is, by letting their capital (roadbed, 
 rolling stock, buildings, etc.) deteriorate through not expending 
 enough of their gross income in the maintenance of their way 
 and equipment. 
 
 The stock of capital in existence at any one time is the result of 
 past sa\dng. But this stock of capital cannot he maintained intact 
 without more sa-uing. From this point of view we may say that 
 the sacrifice of present satisfactions for future satisfactions 
 which society undergoes in order to reap the advantages of 
 capitalistic production is not something that is done " once for 
 all," but is a continuous sacrifice. 
 
 The Shifting of Investment. — As a matter of fact, a large 
 amount of the capital that is used up in production is not re- 
 placed, for the simple reason that entrepreneurs find that some 
 particular kinds of capital are not profitable; that is, they do 
 not add enough to the selling value of the entrepreneur's total 
 product to repay them for their cost (including interest and 
 repayment of principal). It may happen that the entrepreneur 
 has been mistaken as to the technical efiiciency (or productivity) 
 of his capital, or that he has overestimated the demand for his 
 
INTEREST 503 
 
 products. New inventions or new methods of production may 
 lessen the income-yielding power of part of the existing stock of 
 capital, or capricious changes in demand may have a similar 
 effect. At the same time, these new methods of production and 
 these changes in demand are making new forms of capital prof- 
 itable. Even if the " replacement fund " were a definite and 
 rigid annual sum, it would not be entirely devoted to replacing 
 the particular kinds of capital that had been used up in produc- 
 tion. There would be a continual shifting from the less prof- 
 itable to the more profitable forms of capital. 
 
 We often hear it said that capital is transferred from one indus- 
 try to another, or from one locality to another, or from one 
 country to another. Such expressions are misleading. Capital 
 goods are not usually transferred in this fashion, although in 
 exceptional cases it may happen.^ These statements often 
 mean that the ownership of capital changes, as when a capitalist 
 sells his holdings in one industry to another capitalist and invests 
 his own funds in another undertaking. The most important 
 way in which " capital is transferred " is through that gradual 
 process of shifting in the forms of investment which has just 
 been described. 
 
 The Relation of the Durability of Capital Goods to Invest- 
 ment. — The ease with which investments may be shifted 
 varies for different forms of capital. Especially important in this 
 connection is the durability of capital. As has been already 
 suggested, some forms of capital are destroyed as capital by a 
 single use. The fuel and raw materials used in a manufacturing 
 establishment and the merchant's stock in trade belong to this 
 category. The merchant's stock in trade becomes consump- 
 tion goods in the hands of consumers ; raw materials reappear 
 in the finished product, as do other forms of capital for that 
 matter, although in a less obvious sense. But the fact remains 
 that these particular forms of capital investments yield their 
 services only once, and when they are once used by the entre- 
 
 ^ For example, some generally used kinds of machinery (such as lathes, milling 
 or planing machines, engines, or motors) may be transferred from one establishment 
 in one industry to an establishment in another industry. 
 
504 OUTLINES OF ECONOMICS 
 
 preneur for the purpose for which they were intended, they 
 cease to be capital, even though they may have successors in 
 new forms of capital. 
 
 From such transient forms of capital we may pass by insensible 
 gradations to capital goods which yield a long succession of serv- 
 ices, the series culminating in such durable forms of capital as 
 buildings used for productive purposes, or railway roadbeds. If 
 a particular form of capital lasts for exactly a year — the period 
 of time usually taken as a unit in the computation of the rate 
 of interest — estimating the expense of employing such capital 
 is a very simple matter. If, for example, the rate of interest 
 which an entrepreneur sets as his minimum is 6 per cent, he will 
 not invest $1000 in such capital unless he estimates that it will 
 increase his product by an amount that will sell for at least 
 
 In the case of the more transient forms of capital, however, the 
 computation is usually made by taking into account the " rate 
 of turnover." A manufacturer may be constantly buying raw 
 materials and making them into finished products. If the raw 
 materials purchased during a year cost $3000, but if, on the 
 average, only $1000 is invested in raw materials at any one 
 time, the capital is said to be " turned over " three times during 
 the course of the year. The interest rate is computed only on 
 the average amount of capital " tied up," so that interest of 2 
 per cent on each turnover would amount to 6 per cent on the 
 actual investment of money. 
 
 In the case of the more durable forms of capital the computa- 
 tion is more complicated. Here the entrepreneur has to take 
 into account not only the original expense of the capital good and 
 the amounts which it will add to his annual product, but also its 
 durability, and the fact that a large part of the income which it 
 will earn for him is future income. This future income, as we 
 have seen, will not be appraised so highly as the same amount of 
 present income would be. 
 
 The Expense and Price of Capital. — When we speak of the 
 cost or expense of capital, we may have in mind either one of 
 two distinct things. We may mean (i) the price paid by the 
 
INTEREST 505 
 
 entrepreneur for the loan of the money funds which he invests 
 in specific kinds of capital goods, or we may mean (2) the prices 
 paid for the capital goods themselves. The first thing is, of 
 coarse, loan interest; the second is simply a matter of the 
 market prices of commodities. It is this second thing — the 
 market price of capital goods — that we wish to consider at 
 this point. As commodities, these capital goods come under 
 the general laws of value and price, and most of what has 
 been said in earlier chapters about the valuation of consump- 
 tion goods holds just as true in respect to the valuation of 
 these production goods. Their price at any given time is 
 apt to be fixed rather close to the point where demand and 
 supply would be in equilibrium. In the long run their values — 
 if they are not patented products, but are competitively pro- 
 duced — cannot get very far away from the expenses of produc- 
 ing them. 
 
 But there is one fundamental difference which has been sug- 
 gested in other connections. Consumption goods are valued 
 because they satisfy human wants, and the intensity of the 
 wants which particular units of goods satisfy have, through 
 the principle of marginal utility, a very direct relation to their 
 market values. Capital goods do not satisfy human wants 
 directly ; they command a price simply because they aid in 
 the production of goods that do satisfy human wants directly. 
 The demand for them, as we have seen, is the entrepreneur's 
 interpretation of the demand for their products. The law of 
 diminishing productivity bears about the same relation to the 
 determination of their values that the law of diminishing 
 utility does to the determination of the values of consumption 
 goods. 
 
 As in the case of the demand for labor, the elasticity of the 
 demand for a particular sort of capital goods is affected not 
 only (i) by the fact that the higher the price of the capital, 
 the higher will have to be the price of the product, and, conse- 
 quently, the smaller will be the quantity of the product that 
 can be sold, but also (2) by the fact that when the price of any 
 variety of capital goods is relatively high, the entrepreneurs 
 
5o6 OUTLINES OF ECONOMICS 
 
 will economize in the use of that particular kind of capital and 
 will use relatively more labor, relatively more land, and rela- 
 tively more of the other forms of capital. The first of these 
 facts is a corollary of the law of diminishing utility ; the second, 
 a corollary of the law of diminishing productivity. 
 
 This analysis of the price of capital goods relates, however, 
 only to the supply of new capital goods. After capital goods 
 are once definitely installed in industrial uses, its selling value 
 is determined solely by its ability to earn an income for its 
 owner. If the entrepreneur has overestimated the technical 
 efficiency of a machine or the salability of its products, that is, 
 if he has overestimated its income-yielding power, he may find 
 that its money value to him is less than the price he paid for it. 
 Here, however, we have to note an important distinction be- 
 tween /ree capital and specialized capital. 
 
 Free and Specialized Capital. — By free capital we mean 
 capital that has a number of different possible uses, or that can 
 be transferred from one industry or one establishment to an- 
 other. Specialized capital is capital that can be used for only 
 one purpose, and that cannot be transferred from one estab- 
 lishment or industry to another. The capital invested in the 
 construction of a railway roadbed, or in the digging of an irri- 
 gation ditch, is absolutely specialized. The roadbed and the 
 irrigation ditch are of use only in connection with the particular 
 transportation or agricultural undertakings for which they were 
 constructed. If the undertakings should fail, the value of these 
 specialized forms of capital would be absolutely wiped out. A 
 manufacturing firm may invest a large amount of money in 
 new models of specially designed machinery. If the new 
 machines prove unsuccessful, their value may sink to what they 
 wUl sell for as scrap iron. 
 
 Free capital is found in such forms as tools, machines of the 
 standard models that are used in different establishments in 
 the same industry, or even in different industries ; raw materials 
 that can be made up into different kinds of finished products 
 and the like. A farmer who stocks his farm with dairy cattle, 
 but finds his land unsuited for a dairy farm, does not incur a 
 
INTEREST 507 
 
 total loss on his investment, for he can sell his cattle to some 
 farmer who can make profitable use of them. 
 
 The distinction here emphasized is only one of degree. We 
 have capital in a considerable variety of forms that are partly 
 free and partly specialized. Such capital is capital that is best 
 adapted to one specific purpose, but which may also be put to 
 other uses. One frequently sees buildings, originally erected for 
 office purposes on a badly chosen site, that have been give over 
 to small manufacturing concerns. A building intended for a 
 factory may serve fairly well as a warehouse. 
 
 The importance of these distinctions lies in the fact that the 
 possibility of alternative uses forms a barrier to the deprecia- 
 tion of the selling value of such free capital as is found to yield 
 less income in some particular use than was expected by the 
 entrepreneur. If such goods can yield a larger income in some 
 other use, they can be transferred (through a change in the 
 nature of the entrepreneur's business or through sale or lease to 
 other entrepreneurs) to this more profitable use. Such trans- 
 fers are continually taking place in actual business. 
 
 Capital and Land. — The analysis of the process by which 
 capital goods are priced opens the way for a consideration of a 
 problem that has been suggested in earlier pages, — the rea- 
 son for the economic distinction between capital and land. 
 Some points of similarity are obvious : land and capital are 
 both valued according to their income-yielding power. The 
 selling value of land, like the selling value of capital, is based in 
 large measure on the capitalization of the prospective income 
 to be derived from it. From the point of view of the individ- 
 ual investor, the purchase of land for productive purposes is an 
 investment of money just as truly as is the purchase of capital 
 goods. 
 
 Yet there are equally obvious differences : land is given by 
 nature; capital is "man-made." The amount of land is 
 limited — a statement that holds true whether we have in 
 mind the land actually available for productive uses under 
 existing conditions, or whether we have in mind the whole 
 surface of the earth. The supply of capital, on the other hand, 
 
5o8 OUTLINES OF ECONOMICS 
 
 is capable of indefinite extension. It may be said, of course, 
 that an extension of transport facilities, by which the available 
 supply of land is increased, is a " production of land." This 
 is, however, only a figurative use of the word " production." 
 In this figurative sense the growth of a city, by which barren 
 areas become desirable building lots or factory sites, is like- 
 wise a " production of land." The recent opening up of the 
 Canadian Northwest has been due to the production of capital 
 in the form of railways. The land was already there, but the 
 necessary form of capital was lacking. Another distinction 
 is found in the fact that land, in its most essential qualities, is 
 a permanent thing, while capital is of all possible degrees of 
 durability. 
 
 These obvious physical differences between land and capital 
 would hardly justify us in drawing a line between them in a 
 discussion of the distribution of wealth unless these physical 
 differences were the causes of differences in the ways in which 
 the incomes from land and capital are determined — differ- 
 ences, that is, between rent and interest. Here, again, we find 
 points of similarity and points of difference. The points of 
 likeness become prominent when we view the mechanism of 
 wealth production as it exists at any given time, but become less 
 significant as we shift our view to the forces at work through a 
 considerable period of time. 
 
 If, for example, we could take something like an instantaneous 
 photograph of the processes of the production and distribution 
 of wealth, we would see no important differences between the 
 capital and the land used in production. We would see that 
 society is equipped with a stock of capital goods, in all stages 
 of wear, of all possible degrees of technical efficiency, and vary- 
 ing greatly in fitness or adaptability to the work of producing 
 the particular products that consumers are demanding. Not 
 all of these capital goods are yielding an income that is suffi- 
 cient to provide for their replacement as they wear out, and in 
 addition to pay a surplus, or premium, in the form of interest. 
 Some, it is true, may be yielding even more than the amount 
 necessary for these purposes. Machinery of new and excep- 
 
INTEREST 509 
 
 tionally efficient sorts, but not as yet of widespread or general 
 use ; raw materials or dealers' stocks of goods that, by reason of 
 a sudden increase in demand, are selling at an exceptionally 
 high price, — such capital goods may be earning considerably 
 more than interest and replacement. 
 
 On the other hand, we would see a large amount of capital in 
 such forms as obsolete kinds of machines, ill-planned factory 
 buildings, raw materials or dealers' stocks in trade that were 
 bought in expectation of a demand that did not materialize. 
 Such capital goods may earn considerably less than interest and 
 replacement. When capital is once fixed in definite forms, the 
 question of the original money cost of the capital does not enter 
 into the question of the profitableness of using it. An entre- 
 preneur who borrows money to invest in capital goods has to 
 repay the interest and ultimately the principal of the loan, 
 whether this particular investment of capital proves sufficiently 
 remunerative or not. In accounting practice such expenses 
 are called " fixed charges," because they go on whether the cap- 
 ital is used profitably or not. In fact, the entrepreneur will 
 find it to his advantage to use the capital, rather than to let it 
 lie idle, so long as its use adds anything to his total net income. 
 A machine may thus be worth using, even if not worth replac- 
 ing; dealers can better afford to sell their goods for less than 
 they paid for them than not to sell them at all ; a landlord will 
 prefer to rent a building at a very low rate, rather than to let it 
 remain vacant. Capital goods that are just barely worth us- 
 ing may be called " marginal capital goods," and are, from our 
 present viewpoint, analogous to marginal land. At any given 
 time, then, the existing capital goods which it does not pay to 
 use may be thought of as " below the margin," while the income 
 yielded by the better capital goods may be thought of as a 
 rent of capital, analogous in many ways to the rent of land. 
 For this reason Professor Marshall has called the income from 
 capital goods, when the point of view takes into account only 
 a short period of time, quasi-rent. 
 
 When, however, we shift our point of view so as to take into 
 .account a longer period of time, we see an important difference 
 
5IO OUTLINES OF ECONOMICS 
 
 between the income from land and the income from capital. 
 We see, then, that society's stock of capital is a shifting thing. 
 On the one hand, it is being continually depleted on account of 
 the fact that, in the process of production, capital goods are 
 being used up or worn out, or because they are in some cases 
 passing for other reasons below the margin of profitable use. 
 On the other hand, the stock of capital is continually being 
 replenished by the investment of savings in new forms of 
 capital goods. Most of these investments merely replace capi- 
 tal that has been worn out or used up, but some, and in a pro- 
 gressive society, a considerable proportion, represent the crea- 
 tion of new forms of capital. 
 
 Now, as we have seen, the investment of savings in capital 
 goods is guided by the estimates that entrepreneurs make of the 
 profitableness of these investments, the criterion of the profit- 
 ableness of any possible investment being its ability at least to 
 replace the principal and provide for the interest on the money 
 invested. When experience has shown that particular forms 
 of capital will not measure up to this standard of profitableness, 
 these forms will not be replaced as they wear out. When 
 certain forms of capital enable entrepreneurs to get any con- 
 siderable surplus over and above interest and replacement, the 
 tendency will be, so far as competition rules (that is, so far as 
 monopoly, as in the case of patented machinery, does not pre- 
 vent) , to increase the investments in these forms of capital, and 
 in this way to force the earnings of these specially advantageous 
 forms of capital down to the common level of interest and 
 replacement. Just as the expense of producing consumption 
 goods forms a " normal price," to which their actual prices 
 (under competitive condition) continually tend to approxi- 
 mate, so the expenses incurred in investments in capital form 
 a '^normal remuneration of capital" toward which its actual 
 earnings continually tend. Similarly, the price of capital, 
 although actually determined at any one time, like the price 
 of land, by its ability to earn an income for its possessor, tends 
 in the long run to approximate the expense of producing capi- 
 tal. This expense includes, it must be remembered, both the 
 
INTEREST 511 
 
 actual money cost of new capital goods and the expense of in- 
 terest on this money cost. Normal interest is the interest on 
 absolutely free capital in the form of loanable funds. 
 
 Land, of course, has no normal price, because it has no ex- 
 pense, of production. This difference is not of mere theoretical 
 importance, but has an important bearing upon many social 
 problems. For example, when we take a long period of time 
 into account, no such thing as an '' unearned increment " ap- 
 pears in the value of capital. Productivity has to be imputed 
 to capital because its supply is limited by reason of its expenses 
 of production and by reason of the sacrifices involved in wait- 
 ing, while productivity is imputed to the better lands simply 
 because the supply of them is limited by nature. When we 
 measure rent as a return per acre (or other unit) of land, and 
 interest as a percentage on the money invested, we recognize 
 this fundamental distinction between rent and interest. That 
 rent may be viewed for some purposes as interest on the money 
 value of the land, and that interest may similarly be viewed 
 (at any given time) as a " quasi-rent " of capital goods, does 
 not alter the fundamental nature of the distinction. 
 
 We have seen that the shifting of investment by which the 
 earnings of capital are made to tend toward a normal standard 
 is easier in the case of the more transient forms of capital 
 than in the case of the more durable forms. The more durable 
 a capital good, the more nearly is the income derived from it 
 analogous to the rent of land. As was suggested in the discus- 
 sion of rent, it is not necessary or advisable to draw a hard and 
 fast line between capital and land. Permanent investments 
 of capital in the form of improvements to land may very 
 properly be regarded as land. The farmer who is contemplating 
 installing a drainage system or an irrigation system for his 
 land views such an investment, at the time, as an investment 
 of capital. But when the capital is definitely incorporated 
 with the land in these permanent forms, there is no reason why 
 it should be called capital rather than land. The total income 
 yielded by the improved acres will, in all essential particulars, 
 be land rent. 
 
SI 2 OUTLINES OF ECONOMICS 
 
 The distinction which we have drawn between capital and 
 land is not a mere matter of names. It makes Uttle difference 
 whether we call one group of productive agents " capital " 
 and another group " land " or whether we class all of these 
 productive agents together (as many economists do) under the 
 name of " capital." The important thing is that we should 
 see clearly that there is one group of productive agents whose 
 " rents " are determined — ■ in the long run — by the rate of 
 interest on loanable funds, and that there is another group of 
 productive agents whose earnings are not so determined. 
 
 Capital and Consumption Goods. — There are also some 
 points of likeness between capital and the more durable forms 
 of consumption goods. The person who buys a piano is not 
 only satisfying his present wants, but expects to get from it a 
 long period of use, extending into the future. The purchase of 
 any durable consumption good is in this way one form of sav- 
 ing for the future. Moreover, such provisions for future wants 
 will not be made unless we feel that present provision for these 
 future wants is important enough to justify us in giving up 
 some possible present satisfaction. 
 
 These facts must be taken into account in any full analysis 
 of the valuation of consumption goods, but they do not justify 
 us in obliterating the line between capital and consumption 
 goods. Consumption goods yield directly an income of satis- 
 factions ; capital yields a money income. A merchant's stock 
 in trade is capital because it will yield a money income to its 
 possessor; when sold to consumers, the same goods become 
 consumption goods because they yield an income of satisfac- 
 tions. In short, the distinction between capital and consump- 
 tion goods is based upon one of the most fundamental things 
 in the existing economic system — the fact that the incomes 
 which men receive for the productive services of their capital 
 are money incomes. 
 
 Capital and "Wages. — In most undertakings wages are 
 advanced to workmen engaged in the production of goods before 
 the goods are sold. A farmer, for example, has to pay his 
 harvest hands and other workmen before he receives any money 
 
INTEREST 513 
 
 from the sale of his wheat. Whether he borrows the amount 
 needed for wages, or whether he pays them out of his own sav- 
 ings, interest on the amount advanced has to be counted among 
 the expenses of production, and the wages advanced are, for 
 the time being, an investment of capital. In most manufactur- 
 ing establishments a more or less lengthy average period of 
 time elapses between the work actually done by the workmen and 
 the sale of the products of their work. In such establishments 
 a considerable amount of capital is invested in wage advances. 
 This does not mean that we are to consider the laborers as being 
 in any sense capital. For the gradual process by which the 
 raw material becomes the finished product is itself a continuous 
 investment of capital. All of the various expenses of production 
 are really different ways of investing money in capital goods. 
 Add to the cost of the raw material all of the expenses (including 
 wages and payments of rent and interest as well) incurred in 
 order to produce the finished product of the establishment, 
 and you have simply the total investment in capital goods in 
 the form of the finished product. A complete inventory of 
 capital goods would include then (in addition to buildings, 
 machinery, etc.) not only raw materials and the finished prod- 
 ucts that are ready for sale to consumers, but also the prod- 
 ucts on hand at any one time in a partly finished state. Thus, 
 though the payment of wages is often an investment of capital, 
 it must be remembered that the payment of wages is only one 
 of the ways in which money is invested in concrete, definite, 
 capital goods. 
 
 Competitive Investment. — Thus far our discussion has run 
 in terms of the investment of money in what we have just called 
 " concrete, definite, capital goods," to be used in the produc- 
 tion of other goods. We have pictured entrepreneurs and 
 capitalists as servants of society, — as investing money in 
 producing the things people want and are willing to pay for. 
 But in order to portray some of the essential facts of modern 
 business enterprise this picture has to be modified. Business 
 men are primarily interested in acquisition rather than in pro- 
 duction, in making money rather than in making goods. From 
 
514 OUTLINES OF ECONOMICS 
 
 the point of view of both the entrepreneur and the capitalist, 
 money is invested to yield an income rather than to increase the 
 aggregate output of consumable goods. 
 
 In part, and in very large part, it is true, investments yield an 
 income because they further the production of things that 
 satisfy human wants. Such is the case in general with (income- 
 yielding) investments in agriculture and in other industries 
 where the products of competing establishments cannot be 
 distinguished, one from another, and are sold in a general 
 market where prices are fixed very accurately by general com- 
 petitive conditions. But there is left a very important field of 
 enterprise in which the entrepreneur may find it worth while 
 to invest large amounts of money in " selling expenses." Put 
 in a very general but roughly accurate way, these expenses are 
 incurred, not in producing things people want, but in inducing 
 people to want the particular things the entrepreneur has for 
 sale. Advertising expenditures are the most obvious form of 
 such investments. Part of the salaries paid to traveling sales- 
 men must also be placed under this head. Sometimes a new 
 establishment will be created, with full knowledge of the fact 
 that it must run at a loss until a demand for its products is 
 developed. Such losses are investments of this type. Two 
 thirds or more of the aggregate expenses of many establishments 
 making patent medicines are selling expenses. And in the manu- 
 facture and sale of other products enormous investments are 
 made with the purpose of creating and holding a market for 
 goods marked by particular brands and trade-marks. A note- 
 worthy feature of modern business is the attempt on the part of 
 manufacturers and wholesalers to influence the demand of ulti- 
 mate consumers through advertising. 
 
 From the point of view of the individual competitor such 
 expenses and the expenses of buying or making capital goods 
 are alike " investments." But they are competitive, acquisi- 
 tive, investments rather than socially productive investments. 
 Their purpose is not to satisfy an existing demand but to shift 
 demand from other channels. So far as such expenditures 
 succeed in gaining trade, the capitalized income-yielding power 
 
INTEREST 515 
 
 of a business undertaking will be greater than the " capital 
 values " that can be imputed to the stock of capital goods on 
 hand. These surplus capital values, embodied only in the 
 preferences of consumers for particular products, may be 
 recorded, like other values, in the actual price paid when the 
 business is sold. 
 
 This is not to say that all selling expenses are from the social 
 point of view wasteful. Some of the things for which a mar- 
 ket is thus created may be better things, judged by rational 
 standards, than the things which they displace. Moreover, 
 scrupulously truthful advertising is frequently a real help to 
 the consumer, perplexed by the range of alternative choices 
 open to him, and often without knowledge of the qualities of 
 competing goods or of their fitness to serve his purposes. But 
 this is only an incidental and by no means a necessary result of 
 these competitive investments. They may sometimes lead to 
 the education of the consumer, but they may also lead to the 
 exploitation of weakness and ignorance. And in either case they 
 are no part of the social process of the " production of goods." 
 
 The Flow of Money Income. — We now come to the heart of 
 our problem, — the analysis of the general forces determining 
 the rate of interest. For this purpose we shall find it conven- 
 ient to examine the general process of the flow of money ' 
 income. There is a continuous flow of money income through 
 the hands of entrepreneurs, appearing first in the form of the 
 prices that are paid them for their goods, then (neglecting 
 profits) in their own payments for labor, land, and capital, 
 then reappearing in the prices which those who furnish these 
 agents in production pay for other goods, and so on in a con- 
 tinually recurring cycle of income and outgo. 
 
 This process is made more complicated, however, by the fact 
 that not all of the entrepreneur's expenses appear directly as 
 rent, wages, or interest. A considerable part, and in many 
 cases (as in mercantile establishments), the largest part of such 
 expenditures is for various concrete forms of capital, — raw 
 
 * Using the word money in its broadest sense, including such transferable credit 
 instruments as are used in making payments. 
 
5l6 OUTLINES OF ECONOMICS 
 
 materials, dealer's stocks of goods, machines, etc., — and for 
 advertising as well. Here a part of the money income received 
 by the entrepreneur in the form of the prices paid for his own 
 goods emerges in the prices which he pays for the goods sold by 
 other entrepreneurs, and which, in turn, make up a part of their 
 money incomes. But this other class of entrepreneurs — who 
 supply capital goods rather than consumption goods — are 
 subject to the same necessity of expending their money incomes 
 in the payment of wages, rent, and interest, and in the purchase 
 of different kinds of capital goods. To push the analysis still 
 further would obviously lead us only into needless repetition. 
 One important fact, however, appears clearly: If we could 
 trace the expense of producing any consumption good back 
 through all the long series of services and of production goods 
 that have contributed to its making we would find that this 
 expense reduces itself, ultimately, to rent, wages, and interest, not 
 counting what remains in the entrepreneur's hands as profits. 
 Part of the flow of money income passes through the hands of a 
 chain of entrepreneurs, but it nevertheless originates in the 
 prices that consumers pay for the things that satisfy their 
 wants and emerges in the form of the payments made for the 
 productive services of land, labor, and capital. 
 
 Yet another correction must be made, however, to fit this 
 picture of part of the economic process more closely to the facts. 
 The money which consumers pay for particular commodities 
 does not usually constitute the actual fund with which the 
 entrepreneur pays for the labor, the land, and the capital goods 
 used in the production of those particular commodities. Still 
 less does it constitute the actual fund from which the entre- 
 preneurs who supply the necessary capital goods pay their 
 expenses, or from which the expenses of still more remote stages 
 in the process of production are paid. The roundabout, in- 
 direct methods which characterize modern production, and 
 which involve the division of the productive process among 
 countless different undertakings, take time. The goods which 
 consumers buy today are the result of a long series of produc- 
 tive efforts extending back indefinitely into the past. Simi- 
 
INTEREST 517 
 
 larly the productive efforts of today avail but relatively little 
 toward the satisfaction of present wants, for they are in large 
 part directed to forwarding, often in the most indirect ways, 
 the production of things that will come to a final fruition in the 
 satisfaction of human wants only in the more or less remote 
 future. 
 
 The Annual Product and the Social Dividend. — Viewed in 
 this way the annual product of society is something very differ- 
 ent from the social dividend. The year's work is begun with an 
 equipment of economic goods of all kinds, — finished goods in 
 the hands of dealers and manufacturers, goods in all stages of 
 completion, growing crops, factory and mercantile buildings, 
 machines, and all the auxiliary apparatus of production in a 
 finished or unfinished state. The annual product includes all 
 the additions made to this stock of goods, and all that is accom- 
 plished in forwarding such goods as are destined for human 
 consumption towards the form, place, and time in which and 
 at which they are wanted. It includes all that is done in a 
 similar way to forward, replenish, and increase the stock of 
 production goods. It includes also all the personal services 
 that command a money payment which are not embodied in 
 concrete goods, but which confer their benefits in the very in- 
 stance of their performance. 
 
 But while the productive efforts of society are thus constantly 
 building up and modifying the stock of economic goods, this 
 stock is continually being depleted in various ways. The 
 instruments of production are constantly wearing out, or are 
 being cast aside on account of the introduction of either more 
 efficient appliances or more efficient methods which utilize 
 other kinds of appliances. Then, too, as the final outcome of 
 this productive process there is a constant stream of finished 
 consumption goods passing into the hands of consumers. The 
 social dividend consists of this flow of consumption goods, to- 
 gether with those direct personal services which do not have to 
 do directly or indirectly with the fitting of goods for human 
 consumption, but which nevertheless satisfy wants and com- 
 mand a money payment. While the social dividend is to a 
 
5l8 OUTLINES OF ECONOMICS 
 
 large extent the outcome of past work and effort, the annual 
 product is very largely a provision for future wants. 
 
 What is the effect of all these considerations upon our analysis 
 of the flow of money income? It still remains true that the 
 money which consumers pay to entrepreneurs is in turn used 
 by them in the payment of their expenses of production, and 
 that the money which they in turn pay to other entrepreneurs 
 for various forms of capital goods is used in the payment of 
 expenses of production. But the prices consumers are paying 
 are for goods, the expenses of producing which have (at least in 
 greater part) already been paid. If we should trace back the 
 expenses of producing the capital goods used in producing these 
 consumption goods our search would lead us into the more 
 remote past, while still further analysis of the expenses of pro- 
 duction would discover an increasing number of ramifications 
 running back into the still more distant past. The present 
 flow of money income, originating in the prices paid by con- 
 sumers, passes, as we have seen, through the hands of a chain 
 of entrepreneurs and in this process gets ultimately into the 
 hands of laborers, capitalists, and landlords. But most of the 
 productive services which are thus remunerated are services 
 which will avail toward the satisfaction of future rather than of 
 present wants. In other words, the prices paid for consumers' 
 shares in the social dividend constitute (save for an important 
 exception to be noted presently) the fund which pays for the 
 annual product. The productive eforts of the past, which satisfy 
 the wants of today, were padd for out of past income, while the 
 present work of producing goods that will be ripe for consumption 
 only in the future is paid for out of present income. In this fact 
 lies the kernel of the interest problem. 
 
 Investment a Cumulative Process. — Not only, as we have 
 seen, does the entrepreneur invest in such things as machines 
 and buildings, but his purchases of raw materials, his advances 
 of wages to laborers, the interest which he pays on borrowed 
 capital, the rent or the purchase price which he pays for 
 land, and his various competitive selling expenses are also in- 
 vestments. No such investments can be regarded as remu- 
 
INTEREST 519 
 
 nerative unless the entrepreneur gets in the selHng prices of his 
 products enough to provide interest upon such outlays as well as 
 to cover the outlays themselves. These facts have already 
 been noted, but at first, for simplicity's sake, we confined our 
 analysis to the capital expenditures of the individual entre- 
 preneur. The full significance of the role which capital plays in 
 production does not appear until we view the activities of the 
 individual entrepeneur as only a link in the continuous chain of 
 activities that make up the productive process. 
 
 The point of special significance in this connection is the fact 
 that the finished products sold by some entrepreneurs constitute 
 the capital goods (raw materials, productive appliances, adver- 
 tising media, etc.) bought by other entrepreneurs. When one 
 entrepreneur sells his products to another entrepreneur his 
 period of " waiting " is completed, so far as his advances of 
 money funds in the production of these particular units of goods 
 are concerned. But the " waiting " is only transferred to the 
 other entrepreneur, who adds further expenditures of money 
 and, in turn, gets his remuneration from the sale of his product. 
 The important conclusion to which this analysis leads is that 
 (so far as the entrepreneurs have been accurate in their esti- 
 mates) the prices which consumers are paying today for finished 
 goods cover not only all the actual money expenditures which 
 have been made in the past in the production of these goods, 
 but also the interest on all such expenditures from the time 
 they were made up to the time of the sale of the finished goods 
 to the ultimate consumer. 
 
 Similarly the expenditures made by entrepreneurs today in 
 the production of goods that will directly or indirectly satisfy ' 
 future wants must (so far as these entrepreneurs and those who 
 will control the remaining steps in the productive process are 
 accurate in their estimates) be covered, together with accrued 
 interest, by the prices which consumers will pay in the future. 
 Present wants are satisfied by means of the productive efforts of 
 the past. These productive efforts were paid for out of past 
 income, but the outlays were made in the expectation that pres- 
 ent prices would sufl&ce to repay them, with interest. A par- 
 
520 OUTLINES OF ECONOMICS 
 
 ticular entrepreneur may be interested only in disposing of his 
 products at remunerative prices to the entrepreneurs who stand 
 next to him in the productive series, but this does not alter the 
 essential nature of investment, which, from the social point of 
 view, is a cumulative process. 
 
 The Sources of Investment Funds. — The gross money in- 
 come of entrepreneurs furnishes by far the most important part 
 of the current supply of investment funds, and the most im- 
 portant form of investment is found in the entrepreneur's 
 customary practice of " putting money back into the business." 
 That this way of investing money is customary, even habitual, 
 does not mean that the amount as well as the particular forms 
 of such investments is not a matter subject to the discretion 
 of the entrepreneur. So far as the entrepreneur is not hampered 
 by contracts (with customers, other entrepreneurs, money 
 lenders, landlords, or laborers) he is free to do as he pleases 
 with his income. As a matter of fact he is likely to devote a 
 fairly constant proportion of it to the replacement of the capital 
 goods that are being used up or worn out and to the other 
 necessary expenses of continued production. 
 
 It rarely happens, however, in any undertaking, that income 
 and expenditure are so nicely adjusted and so evenly distributed 
 through the year that the one always suffices to provide for the 
 other. A temporary surplus may be followed by a temporary 
 deficit. Transfers of goods on credit, helped out by the institu- 
 tion of banking, smooth over some of these irregularities. More- 
 over, while the entrepreneur need not continue to renew his 
 capital investments unless he chooses, he is at liberty to do even 
 more than this if he deems it advisable. That is, his profits — 
 the excess of his gross income over and above his current and 
 normal capital expenditures — may be used for additional capital 
 expenditures. 
 
 Still another source of capital funds is found in the rent, wages, 
 and interest into which, as we have seen, the expenses of produc- 
 tion ultimately resolve themselves. For so far as these forms of 
 income are saved by their recipients, rather than expended im- 
 mediately for consumption goods, they may be lent directly or 
 
INTEREST 521 
 
 through savings institutions to entrepreneurs. This is the 
 important exception, previously mentioned, to the statement 
 that " the prices paid for consumers' shares in the social dividend 
 constitute the fund which pays for the annual product." The 
 truth is that as the flow of money income passes from entre- 
 preneur to entrepreneur, a part only, although the larger part, is 
 put into expenditures for gain. The residuum is used by entre- 
 preneurs in paying for their own shares in the social dividend. 
 In much the same way the money income received by those who 
 furnish labor, land, or capital is only in part paid back to entre- 
 preneurs in return for consumption goods, the residuum being 
 put (through loans to entrepreneurs) into expenditures for gain. 
 The Interest Rate. — It will be seen, then, that as the flow 
 of money income passes through the hands of entrepreneurs, 
 laborers, capitalists, and landowners, it is divided into two 
 streams, one of which goes to pay for the present goods that have 
 been produced in the past, while the other goes to pay for the 
 present expenses of forwarding the production of goods for future 
 consumption. This division represents a kind of social balanc- 
 ing of possible present satisfactions over against the larger future 
 satisfactions which the productive use of capital makes possible. 
 On the one hand we have the entrepreneurs' estimates of how 
 much specific amounts of capital funds are worth to them, — 
 estimates which involve judgments as to the amount of salable 
 product dependent upon the use of these specific amounts of 
 capital funds, the prices that can be got for such products, and 
 the period of time that will elapse before they will be remuner- 
 ated for such investments. On the other hand we have the 
 judgments of those who supply capital funds as to the relative 
 importance of future and present satisfactions. The interest 
 rate will normally be fixed, of course, at a point where the supply 
 and demand of money funds for investment will be in equi- 
 librium.^ 
 
 * Short-time fluctuations in the interest rate are dependent very largely on the 
 condition of bank reserves. This relation has been explained in the chapters on 
 money and banking. In the long run, however, it is the "supply of waiting" that 
 ■is the important thing. 
 
522 OUTLINES OF ECONOMICS 
 
 The process of production involves the expenditure of rent, 
 wages, and interest for returns of all possible degrees of futurity, 
 and a consequent comparison and balancing of the productivity 
 of investments for shorter and longer periods of time. That is, 
 social estimates ^ of productivity are estimates of the relative 
 importance of the ultimate products, realizable at different 
 periods of time in the future, that are dependent upon specific 
 present expenditures in the form of rent, wages, or interest. 
 Or, in other words, there is a continuous effort to make the most 
 advantageous of all the various possible combinations of land, labor, 
 and waiting. For just as rent, wages, and interest are the 
 ultimate expenses of production, so the ultimate factors in 
 production may be said to be land, labor, and waiting. 
 
 The entrepreneur bases his demand for investment funds 
 upon his estimate of the demand for his products, together with 
 his estimate of the relative economy of the use of methods call- 
 ing for greater or less degrees of " roundaboutness," involving 
 different amounts of waiting on the part of himself and of 
 others who supply him with investment funds. This means 
 that the interest rate is itself one of the factors determining 
 the demand for waiting. The higher the rate of interest, the 
 greater will be the expense of using roundabout methods, in- 
 volving much waiting. 
 
 The supply of waiting varies with the interest rate. Other 
 things being equal, the higher the interest rate, the larger will be 
 the parts of money incomes that will be saved rather than spent 
 immediately in the satisfaction of wants. It has sometimes been 
 said that saving increases as wealth increases. If this is taken to 
 mean that the larger the income of the individual, the larger, 
 other things being equal, will be the amount he will save, the 
 statement probably expresses a general truth. The larger the 
 income, the less important are the immediate wants dependent 
 for their satisfaction on a given amount of money. It does not 
 follow that the proportion of the income that is saved is apt to be 
 
 1 By "social estimates" of productivity we mean only the net outcome of the indi- 
 vidual estimates of all the different individual buyers and sellers, lenders and 
 borrowers. 
 
INTEREST 523 
 
 any larger in the case of a large income than a small income. 
 If, on the other hand, the statement is taken to refer to the in- 
 crease of wealth in society at large, we have to take account of 
 the fact that as wealth increases new wants develop, and the net 
 effect on saving is apt to depend on the character of the new 
 wants, — ■ whether they call for increased current expenditures or 
 whether they involve the accumulation of considerable sums. 
 Convenient opportunities for saving, such as those afforded by 
 savings banks, insurance companies, and the supply of con- 
 venient forms of investment securities have (apart from the rate 
 of interest they offer) an important effect upon the amount of 
 saving. 
 
 Gross Interest and Net Interest. — Net interest is pure inter- 
 est — the amount actually necessary to recompense marginal 
 waiting. Gross interest — the interest actually paid on loans 
 — includes payments for other things. In the first place, 
 actual interest often includes some payment for the supervision 
 which the capitalist has to maintain over his investment. Even 
 the man who " lives on his income " usually has to devote a 
 certain amount of time to the investigation of the safety of 
 different possible investments, to the collection of interest and 
 principal and similar things. The net earnings of savings 
 banks — the difference between the interest they get on their 
 investments and the interest they pay their depositors — are 
 partly a payment for this element of supervision. 
 
 A second element in gross interest is the payment for the risk 
 the lender undergoes of losing all or part of his expected return 
 (including principal and interest). This does not mean, as some 
 writers have said, that the interest rate contains an element of 
 insurance, for insurance means the elimination of individual risk 
 through the combination of risks. The fact is simply that, as 
 every one knows, lenders will not take greater risks without the 
 prospect of greater gains. There is some element of speculation 
 in all loans but the very safest, and the extra income received on 
 the more legitimate loans is profit rather than insurance. 
 
 Usury Laws. — Interest is one form of price in regard to which 
 society stiU expresses some distrust of the operation of un- 
 
524 OUTLINES OF ECONOMICS 
 
 hindered competitive forces. Only nine American states do not 
 provide a legal maximum above which the interest rate cannot 
 legally be fixed. Such laws are based on the justifiable assump- 
 tion that the borrower is in many cases the weaker bargainer, 
 pressed often by that necessity which " never drove a good 
 bargain." In many places the laws are not enforced, but else- 
 where they have an important effect on some kinds of loans, 
 especially bank loans in the rural districts, — farm mortgages 
 and overdue book credits. It is to be feared, however, that their 
 result is often not so much to lower the rate of interest as to cut 
 off many loans which lenders would not be justified in making 
 except at high rates of interest. In the case of many loans on 
 fairly good security, however, usury laws have probably operated 
 to the advantage of the borrowers. 
 
 QUESTIONS 
 
 1. Could a socialist state dispense with interest ? with waiting? 
 
 2. How has the rate of interest been affected by the opening up of new 
 and fertile lands? 
 
 3. Use supply and demand curves to illustrate the determination of the 
 rate of interest. 
 
 4. Is a rented house capital or a consumption good ? 
 
 5. Analyze the effect of an increase of expenditures for present goods 
 upon present and future social dividends. 
 
 6. If money wages could be suddenly increased by 10 per cent would 
 there be a corresponding increase in real wages ? 
 
 7. Are the roulette tables at Monte Carlo capital ? Is a burglar's jimmy 
 capital ? Is a battleship capital ? 
 
 REFERENCES 
 
 Bohm-Bawerk, E. von. Capital and Interest; Positive Theory of Capital, 
 
 Books v-vii. 
 Carver, T. N. The Distribution of Wealth, Chap. vi. 
 Cassell, G. The Nature and Necessity of Interest. 
 Davenport, H. J. Economics of Enterprise, Chaps, xviii-xxi. 
 Fisher, Irving. Capital and Income; The Rate of Interest. 
 Gonner, E. C. K. Interest and Saving. 
 Marshall, Alfred. Principles of Economics, 6th ed., Vol. i. Book ii, 
 
 Chap, iv; Book iv, Chap, vii; Book vi. Chap. vi. 
 Taussig, F. W. Principles of Economics, Vol. ii, Chaps, xxxviii-xl. 
 
CHAPTER XXV 
 PROFITS 
 
 The difference between the total money income which an 
 entrepreneur receives and his expenses of production consti- 
 tutes his profits. Profits, then, are a surplus over and above 
 the expenses of production. There are two ways of measuring 
 profits: first, with reference to some unit of time, such as a 
 year ; and, second, with reference to particular units of product. 
 Thus, when a manufacturer speaks of his profits during a year, 
 he has in mind the difference between his total expenditures and 
 total receipts for that year. But when he speaks of his profits 
 on a particular sale, he has in mind the difference between the 
 expense of producing and selling the particular goods sold and 
 the prices received for them. The two ways of measuring 
 profits are not alike, because a large part of the expenses in- 
 curred by an entrepreneur in any given year may be payments 
 for work done in connection with the production of goods that 
 will not be marketed until some time later. In the long run, 
 however, the amount of annual profits will be determined by 
 the profits on particular transactions or on particular products, 
 so that for present purposes it is not necessary to press the dis- 
 tinction any farther. It is sometimes more convenient to use 
 the word " profits " in one sense, and sometimes in the other 
 sense. 
 
 Profits, being a surplus, do not constitute a homogeneous 
 income determined by any one principle or set of principles. 
 They are the resultant of all the forces that tend to bring about 
 inequalities between the prices paid for things and the expenses 
 of producing them. It is not possible in a brief analysis even 
 to attempt to break up this mixed form of income into all of 
 
 S2S 
 
526 OUTLINES OF ECONOMICS 
 
 its constituent parts. But we must distinguish between two 
 different elements in what are commonly called profits, namely 
 entrepreneur's wage and pure profits. 
 
 Entrepreneur's Wage. — This element in profits is sometimes 
 called the " wages of management," and constitutes the pay- 
 ment received by the entrepreneur for his services as manager 
 or supervisor of his business. It is not easy to draw a line be- 
 tween this element in profits and wages. In fact, " entrepre- 
 neur's wage " could be discussed just as appropriately under 
 the general head of wages as in connection with the general 
 subject of profits. The only distinguishing things about this 
 particular kind of wages are that, unless the entrepreneur 
 adopts the bookkeeping form of paying wages to himself, they 
 come out of the general surplus or residuum commonly called 
 profits in actual business, and that they are the wages paid for 
 a particular kind of labor. 
 
 The average American farmer usually does a certain amount 
 of work himself that might be done by hired laborers, and so 
 far as his income represents the amount he saves by doing such 
 work himself, it is to be regarded as ordinary wages. But in 
 addition, he does other work of a more purely managerial 
 quality, including the general direction of the time and methods 
 of tillage and harvesting, the organization of the working force ; 
 in fact, the determination of what may be succinctly described 
 as the general coordination of labor, capital, and land. The 
 reader may ask: Could not this part of the work be turned 
 over to a salaried foreman? Certainly, and in some cases, 
 as on the estates of so-called " gentlemen farmers," all of it. 
 In fact, the amount of the managerial work actually done by 
 the entrepreneur himself in any kind of undertaking is a variable 
 quantity, depending upon the extent to which managerial 
 authority is delegated to foremen, superintendents, and salaried 
 managers. In the case of corporations practically all of the 
 actual work of management is intrusted to ofiicials and em- 
 ployees whose salaries are counted among the expenses of 
 operation. In any case the " wages of management " exist, 
 although they do not always exist as " entrepreneur's wage," 
 
PROFITS 527 
 
 nor do they always constitute a part of what is called profits 
 in the accounting of the enterprise. 
 
 Even in cases where the entrepreneur is in all respects his own 
 manager (which is, after all, the most frequent case in a host of 
 small business undertakings), the entrepreneur's wage con- 
 stitutes a kind of minimum profits, and is in reality a part of 
 the expenses of production. Minimum profits are necessary 
 profits, the money price needed to induce the entrepreneur to 
 engage in and continue his work. They can be measured 
 roughly by the salary which the entrepreneur could get by 
 working for some one else. Some men would prefer to be 
 their own masters even at a smaller income, while others would 
 shrink from the responsibilities of independent business life, 
 even if a larger income were attached to it, so this method of 
 measuring minimum profits is only approximate. 
 
 Minimum profits will vary with managerial efficiency. The 
 more efiicient farmer will get a larger product with a given 
 equipment of land, labor, and capital than will the less eflficient 
 farmer. So will the more efiicient manufacturer. Differences 
 in managerial efficiency will cause corresponding differences 
 in minimum profits. 
 
 Pure Profits Impossible under Certain Conditions. — It will 
 help us to get a notion of the meaning of pure profits and of the 
 sources from which they are obtained if we pause to consider 
 the conditions under which they could not exist. Under what 
 conditions would the selling prices of goods always be just 
 about equal to the expenses of producing them (including the 
 wages of management) ? Under what conditions, in other 
 words, would market prices always be kept approximately 
 equal to normal prices? 
 
 The first prerequisite, it is clear, is a very complete and 
 perfect state of competition. Capital and labor would have 
 to be so fluid that they could be shifted from one employment 
 to another to take advantage of the slightest possible differences 
 in gains. In the second place, it is not suflicient that business 
 men, capitalists, and laborers should be quick to take advan- 
 tage of their opportunities; they would have to know their 
 
528 OUTLINES OF ECONOMICS 
 
 opportunities. Full knowledge of the relative advantages of 
 different occupations, of different employments, of different 
 investment opportunities, of different fields for business enter- 
 prise, would always have to exist. Consumers, too, would have 
 to be always alert to take advantage of any slight differences 
 in the prices of competing producers, or in the quality of their 
 goods and services. Moreover, their tastes and preferences 
 with regard to the things they consume would have to be 
 constant, or at most could change but slowly. Similarly, the 
 introduction of new inventions and other new ways of produc- 
 ing things must be ruled out. 
 
 In short, if economic activity were sheer routine; if each 
 business man, hard pressed by an alert and well-informed 
 competition, had no opportunity before him except to produce 
 standardized products for a dependable market, pure profits 
 would be quite impossible. The able business man could get a 
 larger income than his fellows only by getting a larger product 
 for a given expense for labor, capital, and land. Paying the 
 same prices for these productive agents as his competitors, 
 selling the same kinds of products at prices identical with theirs, 
 only as he gets a larger product for a given expense, only, that 
 is, as he is a more efficient manager, can his gains be larger than 
 theirs. His profits are limited to his wages of management. 
 So smoothly and perfectly would the routine of the economic 
 process operate that there would be no field for what is, in 
 reality, merely another name for profit seeking, — business 
 enterprise. 
 
 The Sources of Pure Profits. — Pure profits exist because 
 competition does not work perfectly; because people do not 
 always know and are not always alert to seize the most ad- 
 vantageous course open to them either as producers or as con- 
 sumers ; because there are such things as fads and fashions and 
 changes in the quantity and quality of wants; because the 
 system of competitive prices is not a thoroughly consistent 
 structure ; because, in short, room is left for business enterprise. 
 
 Take, for example, a very simple case. A owns a house, 
 which he is willing to sell for $5000. B is willing to pay $6000 
 
PROFITS 529 
 
 for just such a house, but neither A nor B knows the other or 
 the other's position as a buyer or seller. C, knowing the situa- 
 tion, buys from A for $5000 and sells to B for $6000, gaining a 
 profit of $1000 for himself. This profit, it is obvious, is made 
 possible only by the lack of complete knowledge of the situation 
 on the part of A and B. The transaction is without risk to C, 
 who merely takes advantage of this specific instance of the 
 general fact that for many classes of goods competition fails to 
 set a definite market price. 
 
 Next, assume that the purchaser, B, has bought the house 
 merely for the sake of selling it again, if possible, at a profit. 
 He may have reason to believe that there will be an increase in 
 the demand for houses or in the expense of building them, so 
 that he counts on finding a buyer who will pay more than 
 $6000 for the house. If he succeeds, it will be because the 
 general market situation, so far as houses are concerned, will 
 have changed in accordance with his own forecasts. He takes 
 the risk of loss, but this does not mean that he is blindly " tak- 
 ing a chance," On the basis of present facts he reaches certain 
 conclusions or judgments with respect to future probabilities. 
 He cannot eliminate risk, but can select what seems to him to 
 be a favorable opportunity. His profits — if he gets them — 
 are to him the result of successful risk-taking. 
 
 These two methods of getting profits, employed by C and B, 
 respectively, indicate the two general sources of profits : (i) in- 
 consistencies, incomplete adjustments, in the general price 
 situation as it exists at any one time ; (2) changes in the general 
 price situation. But (3) in most business operations these two 
 sources of profits are blended. And yet there are many trans- 
 actions which are like those suggested in our illustration in that 
 profits are derived entirely from one source or from the other, 
 
 I. We shall consider first those transactions in which buying 
 at one price and selling at another are for the profit-seeker 
 practically simultaneous operations. Risk, on the individual 
 transaction, is eliminated. But there remains the risk that, if 
 one makes this type of profit-seeking one's vocation, one's 
 aggregate gains may not amount to enough to compensate 
 
530 OUTLINES OF ECONOMICS 
 
 one for one's incidental expenses and for the use of one's 
 time. 
 
 Profits of this kind are found in many real estate operations, 
 in some transactions conducted by brokers in different fields, 
 in arbitrage transactions in foreign exchange or securities or 
 produce, and, naturally, in a large variety of miscellaneous 
 isolated transactions. There is no reason to believe that the 
 aggregate amount of pure profits of this sort is large. Where 
 large margins may exist between buying and selling prices 
 (as in the case of land, works of art, and other non-reproducible 
 goods) or where the aggregate volume of transactions is so 
 great as to make even small differences in prices significant, 
 intermediaries and go-betweens multiply, and competition 
 tends to pull their (annual) profits down to an entrepreneur's 
 wage, or less. 
 
 2. More important as an independent source of profits is the 
 difference between the price situation at any one time and the 
 price situation at some later time. A very common profit- 
 seeking operation consists of buying things now in the hope of 
 selling them at a higher price in the future, or of selling things 
 now (for future delivery) with the expectation of securing them 
 at a lower price in the future. The larger part of '' specula- 
 tion " in real estate, in produce, and in securities, is profit- 
 seeking of precisely this t5rpe. 
 
 Risk always attends such operations. The speculator may 
 prove to have been mistaken in his analysis of the general 
 situation, or new and unforeseen factors may enter. Prices 
 may move in a direction opposite to that on which the speculator 
 had counted, and losses rather than profits may result. This 
 may, for example, be caused by competition in profit-seeking. 
 Other speculators will in most cases have seen the same op- 
 portunity for profits. By buying now in large quantities for 
 speculative purposes they are sure to increase present prices. 
 Similarly, by selling at a later date they are equally certain to 
 make prices then lower than they otherwise would have been. 
 The chief economic service of speculation, in fact, lies in its 
 tendency to lessen fluctuations in prices. But the thing may 
 
PROFITS 531 
 
 be overdone : future prices may be forced down to a point 
 where the expected profits are turned into losses. And, mutatis 
 mutandis, the same considerations hold true of " bear " opera- 
 tions, on the other side of the market. The possibility of being 
 caught in a price movement of this sort, resulting from over- 
 speculation, is one of the ordinary risks of this kind of profit- 
 seeking. 
 
 3. In most cases, as we have said, the two general sources of 
 profits are blended. The great mass of business transactions 
 are not so simple as those we have just considered. Profits 
 are sought, not merely by buying one thing and then selling 
 it, either immediately or at some other time, but also, and 
 more generally, by buying certain things and then using them, 
 combining them, in such a way as to get a new salable product, 
 or at least a product to which new qualities have been added. 
 Returning to the illustration of the house, we may assume that 
 it may have been built to sell, and the things bought were, in 
 the first instance, labor, building materials, and advances of 
 funds with which to make payments. Or the house might have 
 been built by a contractor, who first sold the house (for " future 
 dehvery ") and then bought the labor and material and advances 
 necessary for its construction. And so in agriculture, manu- 
 factures, and commerce generally : the entrepreneur buys some 
 things — labor, land or its use, capital goods in various forms, 
 advances of loanable funds — and sells other things — the 
 commodities or services that are his " products." 
 
 The inconsistencies and maladjustments in the general price 
 situation of which he tries to take advantage are, in short, the 
 differences between the prices he has to pay for the things he 
 uses in making and selling his products and the prices he gets 
 for his products. If competition worked with absolute prompt- 
 ness, smoothness, and efficiency, things would sell at prices 
 equal to their expenses of production, and the most the entre- 
 preneur could get would be, as we have seen, his entrepreneur's 
 wage. 
 
 The time element, involving the possibility of gains (or losses) 
 ,from price changes, also enters in, because most of the expenses 
 
532 OUTLINES OF ECONOMICS 
 
 of production are incurred either before or (in the case of con- 
 tracts for future delivery) after the price which can be got for 
 the product is finally determined.^ 
 
 Marginal Productivity and Profits. — In our discussion of the 
 law of diminishing productivity ^ we took no account of pure 
 profits. We saw that in any undertaking a definite part of 
 the product had to be imputed or attributed to each productive 
 agent, and further, that the amount of product so attributed to 
 any unit of a productive agent was the amount dependent upon 
 the use of that particular unit. But this does not mean that in 
 any undertaking the sum of those parts of the product which 
 have to be imputed to particular productive agents will exhaust 
 the whole product. Moreover, it is not wholly correct to 
 think of the product as being created by the " application " of 
 labor and capital to land or of land and capital to labor. 
 
 In any business undertaking, the one thing always given or 
 fixed (at any one time) is the general object of the undertaking, 
 the business scheme, the productive or acquisitive plan of the 
 entrepreneur. In carrying out his plans, in securing a product 
 and a market for it, the entrepreneur has to utilize productive 
 agents. In combining them, in applying them to his general 
 profit-seeking plan, he encounters the law of diminishing produc- 
 tivity, and, normally, pushes each particular kind of expenditure 
 up to the marginal point. If he is successful there will be a 
 surplus over and above his aggregate expenses. That is, his 
 total product will more than cover the " specific products " 
 that have to be imputed to the various productive agents he 
 utilizes. This surplus, of course, is his profits.^ 
 
 1 Entrepreneurs are often able to eliminate or shift part of this price-fluctuation 
 element in profits (with its accompanying chance of loss). The building contractor 
 may, for example, contract for his materials when he enters into a contract to build 
 a house. Manufacturers of flour and of cotton goods, as well as grain and cotton 
 buyers, are able largely to shift the risk of price fluctuations to professional specula- 
 tors by means of the process known as "hedging," which will be described in Chapter 
 xxix. 
 
 * See Chapter xix. 
 
 ' Although the present chapter is concerned only with profits in competitive 
 undertakings, this analysis of the relation of profits to the law of marginal produc- 
 tivity holds true also of monopoly profits. 
 
PROFITS 533 
 
 Profits for the Industry and Profits for the Establishment. — 
 We must note at this point an important difference between 
 the production of standardized goods — where one estabhsh- 
 ment's product is like another's — and the production of goods 
 or services which are marked off or distinguished as the output 
 of particular establishments. 
 
 In agriculture, for example, standardized products are pro- 
 duced for a general market. If certain farmers make larger 
 incomes than their neighbors it is generally because they are 
 more efficient farmers and earn a larger entrepreneur's wage. 
 This may show itself in two ways. First, a good farmer will 
 get a larger product with a given expenditure. He will appor- 
 tion and use his productive agents to better advantage. Sec- 
 ond, because he gets a larger product by means of a given 
 expenditure, he will be able to push his expenditures further 
 before coming to the margin beyond which it will not pay him 
 to go. That is, he can advantageously " farm on a larger 
 scale " than his less efficient neighbors. But while these ad- 
 vantages increase his entrepreneur's wage, they do not, in 
 themselves, create pure profits. 
 
 If the farmer gets pure profits it is because he has successfully 
 tried some new crops or some new methods, or because he has 
 been individually fortunate in some other way, or because 
 he and other farmers have been able to sell their crops at 
 profitable prices. This last point is the important one. In 
 agriculture and other industries producing standardized prod- 
 ucts for a general market, by far the most important profits 
 (and losses) are those which come to the industry as a whole. 
 Except for the effect of such things as local droughts or frosts 
 or blights, when the wheat growers of the country prosper they 
 prosper together, and when they lose they lose together, — 
 and so with the corn growers and the tobacco growers and the 
 cotton growers. Wars, tariffs, crop failures abroad, — these 
 and other things like these will affect the demand for their 
 products. The supply will depend in part upon weather con- 
 ditions, but more largely upon the amount of these crops that 
 farmers as a group have thought it worth while to plan to grow. 
 
534 OUTLINES OF ECONOMICS 
 
 These conditions of supply and demand are absolutely beyond the 
 control of any one individual producer. A succession of profit- 
 able years is sure to result in an increased output, with lower 
 prices and lower profits. In agriculture, as everywhere, there 
 are rewards for the efficient and energetic producer, but, with 
 minor exceptions, his chances of getting pure profits are de- 
 pendent upon the fortunes of the industry as a whole. 
 
 In the fields in which each entrepreneur can mark off his 
 product or his establishment as his own, we find a very different 
 situation. The manufacturer or jobber v/ho can in some way 
 identify his products by special brands, and the retailer, deal- 
 ing directly with the consumer, are able to secure pure profits 
 (and to run the risk of corresponding losses) on their individual 
 undertakings, over and beyond such profits and losses as may 
 come from general business fluctuations. 
 
 Here also the entrepreneur is hmited by the law of diminish- 
 ing productivity, and here also he normally pushes his expen- 
 ditures of all kinds up to the margin. And (if he is his own 
 manager) he will get a larger or smaller entrepreneur's wage 
 according as he can get a larger or smaller product per unit of 
 expense. But many of his expenses will be what we have 
 called " competitive investments," that is, they will be devoted 
 to creating a market for his products rather than to creating 
 the products. The quantities that he can profitably produce 
 and, within limits, the prices he can charge, will be determined 
 very largely by his success .in inducing purchasers to prefer 
 his goods or his store to others. The profits of cotton growers 
 are directly conditioned, as we have seen, by the aggregate 
 demand for cotton and the aggregate supply of cotton. But 
 with the retail dealer and with the manufacturer of breakfast 
 foods or canned fruits or clothes or soap or motor cars or foun- 
 tain pens or almost any other kind of branded merchandise, 
 profits depend very largely upon the preference of consumers 
 for one store or for one make of goods. The getting of profits 
 is not merely a matter of indirect competition among indus- 
 tries; it is a matter of direct competition among individual 
 establishments. One competitor may gain while others in the 
 
PROFITS 535 
 
 same field are losing, and may gain even in the face of a gener- 
 ally unprosperous condition of business. 
 
 Good-will. — It very often happens that the entrepreneur 
 who has developed his business to a profitable point is able to 
 attach some degree of permanency to his profits. A merchant 
 often relies to a very considerable extent upon the patronage 
 of an established clientele of customers, and he in turn may 
 prefer, other things being equal, to purchase his goods from 
 particular wholesale houses. Manufacturers and wholesalers, 
 too, try to build up a habitual preferential demand for their 
 products. When a business undertaking is sold as a whole, 
 its established connections of this sort enter into the price paid 
 for it, under the head of " good-will." This good-will element 
 is generally measured by the difference between the selling value 
 of the business as a whole and the selling value imputed or 
 ascribed to its specific assets in the form of capital goods and 
 accounts receivable (minus its specific liabilities). In the sale 
 of a newspaper it often happens that its good-will (its established 
 advertising and subscription patronage) is the only thing ac- 
 tually transferred. This does not mean, however, that the 
 selling price of the good-will of an establishment necessarily 
 corresponds to a capitalization of its pure profits. The good- 
 will may be, in individual cases, very much less than the aggre- 
 gate amount of the expenses incurred in the past in the effort 
 to build it up. And when once sold at a fair price, the purchaser 
 acquires no pecuKar power of getting unusual profits. For him 
 the price paid for good-will is an investment, and he has to 
 deduct interest on the investment before he can count his in- 
 come as profits. In short, he has to start afresh, with no 
 differential advantage. 
 
 Good- will is to be attributed, in large measure, to the economic 
 inertia and friction which result from the fact that buyers are 
 guided to a very large extent by custom and habit rather than by 
 conscious choice. However, in many small transactions, for 
 customers to attempt to buy always at the lowest price would 
 result in a waste of time and energy disproportionate to the gain. 
 , Hence, aside from the influence of custom and habit, there may 
 
536 OUTLINES OF ECONOMICS 
 
 often be rational ground for the continued patronage of particular 
 establishments and the continued purchase of particular goods 
 which customers have found to be trustworthy. 
 
 The Relation of Risks to Profits. — Profits differ from other 
 forms of income in the degree to which they are contingent 
 upon successful risk taking. But risk taking, in this sense, as 
 we have seen, does not mean a blind dependence on chance. 
 Chance is, of course, an element in profits. Capricious changes 
 in fashion often bring temporarily high profits to dealers who 
 happen to have the right kinds of goods in stock, or to manu- 
 facturers who happen to have the equipment needed to produce 
 the right kinds of goods. And other examples will suggest them- 
 selves to the reader. But there are chance losses as well as 
 chance gains, and there is no reason to believe that they are 
 not quite as numerous and important. Chance gains, therefore, 
 do not constitute any important part of the income going to 
 entrepreneurs as a class, but they may often be a considerable 
 element in the profits of a particular entrepreneur. 
 
 Risk taking is nearly synonymous with business enterprise. 
 It involves careful estimates of the amounts of product that can 
 be got from different combinations of labor, capital, and land, 
 and equally careful estimates of the salabiHty of such products. 
 It is in this latter field, which involves the diagnosis of market 
 conditions with a view to ascertaining their probable trend, as 
 well as the possibility of affecting them to his advantage, that 
 an entrepreneur's skill finds its chief opportunity. Yet, though 
 he may deal with probabilities rather than with possibilities, he 
 is nevertheless a risk taker. His estimates have to do with mar- 
 ket conditions that are often entirely beyond his personal 
 control, and which, at best, he can influence only by efforts 
 directed to that end, — by expenditures that may prove to have 
 been wasted. 
 
 To anticipate consumers' demands correctly is not in itself a 
 guarantee of profits to any entrepreneur. If other entrepreneurs 
 have counted on the same demand, it may easily happen that the 
 total product cannot be sold at a profitable price. In fact, the 
 " market conditions " which the entrepreneur has to forecast 
 
PROFITS 537 
 
 include the conditions of supply as well as of demand. But even 
 in case a given entrepreneur has succeeded in producing the 
 precise things that consumers are demanding and other entre- 
 preneurs are not producing, and has thus been able to get large 
 profits, he cannot count on their permanence. Demand may 
 change, but even if demand remains constant or increases, his 
 large profits will be a standing invitation to other entrepreneurs 
 to enter the same field, — a condition which will continue until 
 competition forces the profits of this particular kind of business 
 down to where they just suffice to pay the wages of management. 
 If the product can be marked off, or distinguished in some way, 
 good-will may be built up, as we have seen, so as to give some 
 degree of permanency to profits. But even here the entre- 
 preneur has to guard against the inroads of other business men, 
 seeking to win trade for their own products. In some few cases 
 profits are secured without risk ; some (not all) kinds of risks 
 can be eliminated by insurance or shifted to some other risk 
 taker ; but, in general, profit seeking and risk taking go hand 
 in hand. 
 
 The Entrepreneur. — We have, for convenience, spoken of 
 " the entrepreneur " of an enterprise. We have also assumed 
 that general managership and supervision of the undertaking 
 is in the entrepreneur's hands. But the reader has been warned 
 that all managerial duties may be, and often are, delegated to 
 salaried employees, and that the entrepreneur may also be 
 capitalist, landlord, and laborer. Most American farmers are 
 all three. And most entrepreneurs in other fields supply a part 
 of their own investment funds. But who, in a particular 
 enterprise, is '' if ^e entrepreneur"? 
 
 The entrepreneur is the " business man," as distinguished 
 from the capitalist, the laborer, or the landowner. He is, more 
 specifically, the one who profits if a business undertaking suc- 
 ceeds and who loses if it fails. Now it is clear that more than one 
 person may lose if a business undertaking fails, — or others than 
 the common stockholders, often regarded as " corporate entre- 
 preneurs," if the business is incorporated. Bondholders, other 
 creditors, laborers even, may also lose. The fact that the bond- 
 
538 OUTLINES OF ECONOMICS 
 
 holders are preferred creditors may limit their losses, but does not 
 necessarily safeguard them from losing. The fact is that every 
 one who has risked something on the success or failure of a par- 
 ticular business undertaking is, in that degree, entrepreneur. 
 The capitalist who buys 5^ per cent bonds instead of virtually 
 riskless 3^ per cent bonds, or who buys 7 per cent preferred stock 
 at par, the money lender who has no security other than the pro- 
 spective earnings of the business, the laborer who chooses a well- 
 paid but uncertain employment to a surer but lower-paid one, 
 are all profit-seekers. If the business undertakings in which 
 they thus cooperate succeed, they share in the profits, up to 
 a stated amount; if these undertakings fail, these various co- 
 operators lose, in larger or smaller amount. Their profits, if 
 they get them, are surpluses over costs, the costs being meas- 
 ured by the interest and wages that they could have obtained 
 in virtually safe alternative employments. Wherever in eco- 
 nomic life one finds successful risk taking, there one finds profits. 
 The " individual entrepreneur " and the holder of common 
 stock merely assume a relatively larger burden of risk; have 
 the opportunity of reaping, in case of success, correspond- 
 ingly larger profits; and usually exercise a correspondingly 
 larger measure of responsible direction of the policies of the 
 undertaking. 
 
 Profits and the Justification of the Competitive System. — 
 It is the desire to get money profits that leads entrepreneurs to 
 produce particular things and to produce them in particular 
 ways. It is for this reason that old channels of productive 
 efifort are continually being abandoned, and that the use of 
 labor, capital, and land is continually being guided into new 
 channels. The shifting of productive effort which the pursuit 
 of money profits involves consists, for the most part, of efforts 
 on the part of entrepreneurs to meet the shifting wants of 
 consumers. 
 
 One of the strongest arguments for the superiority of the com- 
 petitive system over any possible substitute for it lies in the claim 
 that, under competition, the guiding of production into the 
 channels indicated by the search for money profits will result in 
 
PROFITS 539 
 
 the maximum satisfaction of human wants. This seems to 
 follow from the fact that the prices people are willing to pay for 
 certain commodities measure the importance which they attach 
 to the possession of those commodities. The shifting of labor 
 and capital from less profitable to more profitable uses means, in 
 general, that more intense wants will be satisfied with the same 
 expenditure of productive energy. All this is implied in the 
 statement made above that the shifting of productive effort 
 is mainly in response to the changing wants of consumers. This 
 argument, that under free competition the pursuit of money 
 profits leads to the best adaptation of productive efforts to the 
 satisfaction of the wants of consumers, is one that has rarely 
 been squarely met by those who attack the competitive system. 
 There are, however, several important considerations that lessen 
 to some extent its force. 
 
 In the first place, the extent to which the wants of any indi- 
 vidual affect the ordering of the productive process depends 
 upon his purchasing power, that is, primarily, upon his income. 
 It is manifestly absurd to say that the shifting of labor and capi- 
 tal from the production of necessities for the poor to the produc- 
 tion of luxuries for the rich, simply because it may be more 
 profitable, necessarily means a better satisfaction of human 
 wants. The extent to which wants are satisfied depends on the 
 way wealth is distributed, as well as upon the amount and 
 kinds of things produced. 
 
 Moreover, even granting that the stimulus of money profits 
 leads to the best practicable satisfaction of the wants of present 
 consumers, this may sometimes be achieved by imposing added 
 difficulties in want-satisfaction on future generations. The 
 lines of procedure that will bring maximum profits to entre- 
 preneurs sometimes run counter to the more permanent in- 
 terests of society. We all recognize, for example, that there 
 may be such a thing as a too rapid exploitation of natural 
 resources. The history of timber lands in America furnishes an 
 instructive example. 
 
 A still more important qualification of the statement that com- 
 petitive profit seeking works for the best interests of society, 
 
540 OUTLINES OF ECONOMICS 
 
 viewed as a body of consumers, is found in the fact that when we 
 begin to speak of the interests of society, we introduce, of neces- 
 sity, the ethical point of view. This means that we must con- 
 sider not only the quantity but also the quality of want-satisfac- 
 tions. For purposes of the economic analysis of market forces, 
 we make no distinction between different kinds of wants, but 
 it is impossible to discuss social well-being without taking into 
 account the fact that from the point of view of the interests of 
 society some kinds of want-satisfactions are good and some are 
 bad, and that even the better kinds of want-satisfactions vary 
 greatly in their importance, when measured by any rational 
 criterion of social welfare. The production of socially undesir- 
 able things, such as intoxicating liquors, adulterated foods, 
 ill- ventilated tenements, etc., is often prohibited, while, on the 
 other hand, society has found that certain socially-desirable 
 things, such as schools, parks, libraries, clean streets, etc., will 
 not be supplied at all, or will not be supplied in sufficient 
 quantities by private business enterprise. All indications point 
 to a very considerable extension of organized social activity at 
 precisely those points where the private pursuit of money profits 
 has proven itself inadequate. 
 
 QUESTIONS 
 
 1. Are profits as defined in accounting identical with profits as defined in 
 economics ? 
 
 2. Is there a sense in which pure profits can be said to be a reward for 
 productive services? If so, should they be counted among the expenses of 
 production ? 
 
 3. In what way are the profits of a retailer attributable to "incon- 
 sistencies and maladjustments in the price situation"? 
 
 4. Does a monopolist push his expenditures of aU kinds up to the marginal 
 point ? 
 
 5. What industries, aside from agriculture, produce "standardized prod- 
 ucts for a general market " ? 
 
 6. Some economists speak of the "profits on capital." Others speak of 
 profits as income secured by personal exertions. Which form of statement is 
 correct? Are the two necessarily inconsistent? 
 
 7. Is good-will capital ? 
 
 8. If there were no economic risks, woiold profits be possible? 
 
PROFITS 541 
 
 REFERENCES 
 
 Carver, T. N. Distribution of Wealth, Chap. vii. 
 
 Clark, J. B. Distribution of Wealth, Chap. vi. 
 
 Hawley, F. B. Enterprise and the Productive Process. 
 
 Haynes, John. "Risk as an Economic Factor." Quarterly Journal of 
 
 Economics, Vol. ix, pp. 409-449. 
 Marshall, Alfred. Principles of Economics, 6th ed., Book vi. Chaps. 
 
 vii, viii. 
 Veblen, Thorstein. Theory of Business Enterprise, Chap. iii. 
 
CHAPTER XXVI 
 THE PERSONAL DISTRIBUTION OF WEALTH 
 
 In the present chapter we shall study the distribution of 
 wealth and income among individuals simply as individuals, 
 and not as agents of production or owners of productive agents. 
 What is the cause of large fortunes? Is the middle class dis- 
 appearing? Can we abolish poverty? To begjn with, certain 
 distinctions must be clearly drawn. 
 
 Wealth and Income. — The distribution of wealth and in- 
 come should first be distinguished from the distribution of final 
 consumption. We may ha,ve in mind simply the enjoyment 
 of material things and services. A man of vast possessions 
 may be very frugal in his consumption, acting with respect to 
 most of his property simply as a trustee for society. But when 
 we are interested in social classes, industrial democracy, and 
 personal power and independence, the distribution of wealth or 
 income is important, no matter how frugal the owners of large 
 wealth may be. 
 
 Absolute and Relative Well-being. — Two entirely independ- 
 ent inquiries are very frequently confused, (i) We may wish 
 to know whether the condition of the mass of the people is get- 
 ting better or worse. Do they have more or less of the good 
 things of life than their ancestors had? But we may also ask, 
 (2) What share of the total product of industry is received by 
 each section of the community ? Which section is gaining upon 
 the others? If A and B divide a catch of ten fish equally to- 
 day, and if to-morrow A gets ten out of a total catch of thirty, 
 then absolutely his income has increased, but relatively it has 
 declined. 
 
 Concentration of Wealth and Large-scale Production. — It is 
 perhaps worth while to warn the reader against confusing the 
 
 542 
 
THE PERSONAL DISTRIBUTION OF WEALTH 
 
 543 
 
 question of large and small fortunes with the question of large 
 and small scale production. However improbable, it is at least 
 conceivable that there might be an equahty of property with 
 production carried on largely as it is today, for we have but to 
 imagine an equal distribution of holdings of stocks and other 
 equities in business enterprise. 
 
 Methods of Measuring Concentration of Wealth and Income. 
 — How shall we tell whether the middle class is tending to dis- 
 appear ? A common method is to make a classification of wealth 
 and income, and then to compare the number of persons in 
 each class at different dates. The unreliability of the conclu- 
 sions based on such a procedure is made clear by the following 
 hj^othetical illustration : Let $ioo be distributed among ten 
 persons as foUows: $i, $3, $5, $7, $9, $11, $13, $15, $17, $19. 
 Then suppose each individual's holding is doubled, thus : $2, 
 $6, $10, $14, $18, $22, $26, $30, $34, $38. Relatively to each 
 other they are all in the same position as before, but by the 
 erroneous method of comparison referred to, there appears to 
 have been a concentration because the number in the highest 
 class has increased most rapidly : 
 
 TABLE I 
 
 Class 
 
 Ntjmber 
 
 Dollars 
 
 First Case 
 
 Second Case 
 
 and less than 5 
 
 2 
 
 3 
 2 
 
 3 
 
 I 
 I 
 
 10 and less than 15 
 
 IK and over . 
 
 2 
 
 6 
 
 
 
 A satisfactory method of comparing the distribution of wealth 
 at different epochs must take account of the changing significance 
 of fi.xed classifications when there has been a change in the per 
 capita wealth. This can be done by observing what proportion 
 of the wealth is owned by certain sections of the population, 
 such as the poorest third, the middle third, or the upper third 
 
544 OUTLINES OF ECONOMICS 
 
 If a larger proportion of the total wealth falls into the hands of 
 the upper third, we may say there is evidence of a growing con- 
 centration of wealth. It is clear that no definite movement is 
 necessarily discernible even when changes are taking place, for 
 these changes may tend toward concentration in one part of 
 society and toward diffusion in another. 
 
 Statistics of Distribution. — There are many investigations 
 showing the earnings of particular classes of workers, but in the 
 United States there is no reliable statement of the division of the 
 national wealth or income among all classes of society. We can- 
 not use the property tax assessments for this purpose because of 
 their inaccuracy, and because of the fact that one individual 
 may be taxed in various jurisdictions. The returns of the pro- 
 bate courts have been used as a basis for a statement of wealth 
 distribution in the United States on the assumption that the dis- 
 tribution of wealth among persons who die in any year is an 
 index of the distribution of wealth among those who are living. 
 But the incompleteness of our probate returns makes this method 
 also a hazardous one. The federal income tax returns will 
 yield some valuable data regarding the number of higher in- 
 comes when the material is properly tabulated for that purpose. 
 
 Out of very inadequate material, however. Professor W. I. 
 King has constructed the estimates shown in Table II. His 
 figures indicate, further, that the richest 2 per cent of the 
 families in the United States get about one fifth of the aggre- 
 gate income, while the poorest two thirds of the families get 
 about 39 per cent of the aggregate income. These estimates 
 cannot be supposed to be entirely accurate, but the impression 
 they give is undoubtedly correct in its general outlines. 
 
 The growth of the number of millionaires has been used as an 
 evidence of growing wealth concentration, but it should be 
 noted that a growth of population and wealth in a community 
 would cause an increase in the number of millionaires, even if 
 the relation between the various classes remained the same. 
 Suppose that in 1850 there had been in the United States but 
 fifty millionaires, that three hundred and fifty persons had from 
 $750,000 to $1,000,000, and that six hundred persons had from 
 
THE PERSONAL DISTRIBUTION OF WEALTH 
 
 545 
 
 $500,000 to $750,000. If the population had remained the 
 same and every one's wealth had been doubled, in 1900 there 
 would have been one thousand millionaires, and if the popula- 
 tion at the same time increased fourfold, with the relations 
 among the new population the same as in the old, we should 
 then have four thousand millionaires without any tendency 
 toward concentration. Nevertheless, the increase of large for- 
 tunes has been so startling that in spite of these considerations 
 one may perhaps regard them as an indication of a growing con- 
 centration of wealth. The lists of very rich men published in 
 the United States from time to time are instructive on this point. 
 In 1820 men with a personal property of $20,000 were included ; 
 in 1846 a total property of $50,000 was considered very large ; 
 in 1855 this was doubled ; in 1892 a man had to be a million- 
 aire to be considered very rich, and at present one may speak 
 of even a billionaire. 
 
 TABLE II 
 
 Distribution of Incomes in the United States: igio^ 
 
 Incomes 
 jN Dollars 
 
 Per Cent of Families 
 
 Incomes 
 IN Dollars 
 
 Per Cent of Families 
 
 RECEIVING Less than 
 Stated Incomes 
 
 RECEIVING Less than 
 Stated Incomes 
 
 200 
 
 .07 
 
 1500 
 
 90.31 
 
 300 
 
 1.04 
 
 1800 
 
 93-67 
 
 400 
 
 7.17 
 
 2000 
 
 94.86 
 
 500 
 
 16.70 
 
 2400 
 
 96.18 
 
 700 
 
 38.92 
 
 3000 
 
 97.42 
 
 ICX)0 
 
 6943 
 
 3600 
 
 98.10 
 
 I2CX3 
 
 81.69 
 
 4000 
 
 98.39 
 
 More satisfactory statements can be made for those countries 
 which collect an income tax. The following figures for 1892 
 and 1902 are from a table prepared by Professor Wagner, in a 
 study of the income-tax returns of Prussia, and the correspond- 
 ing figures for 19 1 3 have been added : 
 
 1 From W. I. King, Wealth and Income of the People of the United States, p. 228. 
 2N 
 
546 
 
 OUTLINES OF ECONOMICS 
 
 TABLE III 
 
 Incomes in Prussia: 1892, 1902, and 1913^ 
 
 Incomes in 
 Dollars 
 
 Per Cent of Persons 
 (Heads of Families or Self- 
 Supporting Individuals) 
 
 Per Cent of Income 
 (That below $214 is estimated) 
 
 
 1892 
 
 1902 
 
 1913 
 
 1892 
 
 1902 
 
 1913 
 
 Below 214 . . , 
 214-714 . . . 
 714-2261 . . 
 2261-7259 . 
 7259-23800. 
 Over 23800. 
 
 78.18 
 18.98 
 2.33 
 0.41 
 0.08 
 0.01 
 
 70.66 
 
 25-83 
 
 2.88 
 
 0.51 
 
 O.IO 
 
 0.02 
 
 52.49 
 
 42.12 
 
 4-53 
 
 .68 
 
 .14 
 
 .04 
 
 41.21 
 
 30.01 
 
 12.83 
 
 7.37 
 
 4-6s 
 
 3.93 
 
 32.97 
 34-92 
 13-73 
 
 7.84 • 
 
 5-13 
 
 5-40 
 
 18.28 
 
 46.25 
 
 15-84 
 
 8.12 
 
 5.62 
 
 5.89 
 
 Absolute 
 amounts 
 (Total) .... 
 
 Number 
 11,162,000 
 
 Number 
 12,813,000 
 
 Number 
 15,404,855 
 
 Dollars 
 2,309,076,000 
 
 Dollars 
 3,039,498,000 
 
 DoUars 
 4,736,000,000 
 
 The great mass of the people even in 19 13 were too poor to pay 
 any income tax at all, the minimum income taxed being $214. 
 About 5 per cent of the population at the top received about one 
 third the total income in 1913, but in connection with such a 
 statement it should be said that even if incomes should be 
 equally distributed, the average income per family, or single 
 adults, would be very small. In 1902 the average money 
 income was $237 and in 1913 it had risen to $307. This 
 absolute increase in money incomes among the poorest class 
 of the people is shown in the table in the much smaller propor- 
 tion of the population found in the class with incomes below 
 $214 in 1913 than in 1902. This increase in money income 
 does not necessarily mean greater well-being or greater equal- 
 ity, but the table as a whole shows no marked tendency 
 toward a concentration of incomes in the hands of the upper 
 classes. 
 
 When we turn from, the question of relative well-being to that 
 of the actual condition of each class taken by itself, we find two 
 facts standing out prominently: (i) the fruits of economic 
 
 1 From Zeitschrift des Preussicken Statistischen Bureaus, 1904, p. 231, and Statis' 
 tisches Jahrbuchfilr den Preussischen Staat, 19 13. 
 
THE PERSONAL DISTRIBUTION OF WEALTH 547 
 
 progress have not been confined to a small class, but have been 
 shared by the masses, and (2) a surprisingly large section of the 
 population is still in poverty. 
 
 With respect to the first fact, we may say that in material 
 comforts the people of this generation are better off than they 
 have ever been before. The work of settlement in which so 
 many of our forefathers engaged was laborious and exhausting. 
 Food was often scarce, disease was rife in many settlements, 
 and the women and children in particular suffered greatly. 
 After the wilderness was cleared, there ensued a period of 
 " rude plenty." Food was abundant, but it was coarse in 
 quality and restricted in variety, whilst everything that 
 had to be brought from a distance was very expensive. 
 Education was difficult to secure, books scarce, and the 
 lives of most people were, in the main, monotonous and 
 uneventful. 
 
 The course of wages from the middle of the eighteenth cen- 
 tury to the year 1905, and the movement of prices from i860 
 to the latter date, are given in Table IV following. The figures 
 are not altogether comparable, nor so trustworthy as could be 
 wished, but the general impression which they give is correct 
 for the period covered. Speaking generally, money wages 
 have steadily risen, and the hours of labor have declined, with 
 minor interruptions, since the colonial period, while prices have 
 fluctuated irregularly. This table cannot be given in the same 
 form for later years, but a recent study covering the period 
 from 1890 to 191 2 shows that the purchasing power of hourly 
 wages, although increasing from 1890 to 1905, fell rapidly 
 after that date owing to the rapid increase in prices, so that 
 an hour's wages purchased less in 191 2 than in any previous 
 year of the period. As the number of hours per week de- 
 creased steadily from 1890 to 191 2, the purchasing power of 
 a week's wages was only about 85 per cent of what it had 
 been in 1890. Purchasing power here is measured by retail 
 prices of food.^ 
 
 ^ I. M. Rubinow, "The Recent Trend of Real Wages," American Economic 
 Review, Vol. iv, p. 811. CJ. the table on p. 341, above. 
 
548 
 
 OUTLINES OF ECONOMICS 
 TABLE IV 
 
 Wages, 
 
 Prices, and Hours of Labor 
 CN i860 taken as 100 
 
 Wages, Prices, and 
 OF Labor in 1890 
 as 100 
 
 Hours 
 
 TAKEN 
 
 Day Laborers in 
 Massachusetts i 
 
 Employees in Manufacturing 
 Industries — Eastern States 
 
 General Industry, excusing 
 
 Agriculture, Mining, and 
 
 Transportation 
 
 
 Rela- 
 tive 
 
 Year 
 
 Relative 
 
 Year 
 
 Relative 
 
 Period 
 
 
 Cost 
 
 Hours 
 
 
 
 Hours 
 
 
 Wages 
 
 
 Wages' 
 
 of 
 Living' 
 
 of 
 Labor' 
 
 
 Wages < 
 
 Prices 6 
 
 of 
 Labor* 
 
 1752-60 
 
 .29 
 
 i860 
 
 100 
 
 100 
 
 100 
 
 1881 
 
 95-3 
 
 II4-5 
 
 103 
 
 1761-70 
 
 •325 
 
 1861 
 
 100 
 
 III 
 
 99.1 
 
 1882 
 
 96.9 
 
 ^^7-5 
 
 103 
 
 1771-80 
 
 •376 
 
 1862 
 
 100 
 
 123 
 
 98.2 
 
 1883 
 
 97-7 
 
 114.8 
 
 103 
 
 1781-90 
 
 .428 
 
 1863 
 
 109 
 
 137 
 
 98.2 
 
 1884 
 
 98.5 
 
 107.7 
 
 103 
 
 1791-00 
 
 .623 
 
 1864 
 
 120 
 
 163 
 
 98.2 
 
 1885 
 
 97.8 
 
 100.8 
 
 103 
 
 1801-10 
 
 .817 
 
 1865 
 
 141 
 
 ^75 
 
 97-3 
 
 1886 
 
 97.8 
 
 99.6 
 
 102 
 
 1811-20 
 
 .910 
 
 1866 
 
 153 
 
 172 
 
 98.2 
 
 1887 
 
 98.6 
 
 100.3 
 
 100 
 
 1821-30 
 
 .796 
 
 1867 
 
 172 
 
 164 
 
 98.2 
 
 1888 
 
 99.2 
 
 102. 1 
 
 100 
 
 1831-40 
 
 .872 
 
 1868 
 
 167 
 
 165 
 
 96.4 
 
 1889 
 
 99.6 
 
 102. 1 
 
 100 
 
 1841-50 
 
 .852 
 
 1869 
 
 174 
 
 163 
 
 96.4 
 
 1890 
 
 100. 
 
 lOO.O 
 
 100 
 
 1851-60 
 
 •975 
 
 1870 
 
 175 
 
 157 
 
 95-5 
 
 1891 
 
 99-7 
 
 IOI.4 
 
 99.8 
 
 
 
 1871 
 
 178 
 
 148 
 
 95-5 
 
 1892 
 
 100.3 
 
 99-5 
 
 99.8 
 
 
 
 1872 
 
 174 
 
 147 
 
 95-5 
 
 1893 
 
 100.2 
 
 102.0 
 
 99.6 
 
 
 
 1873 
 
 175 
 
 149 
 
 95-5 
 
 1894 
 
 96.7 
 
 97-4 
 
 99.1 
 
 
 
 1874 
 
 170 
 
 145 
 
 95-5 
 
 1895 
 
 97-4 
 
 95-5 
 
 99.4 
 
 
 
 1875 
 
 161 
 
 141 
 
 93-6 
 
 1896 
 
 98.S 
 
 93-3 
 
 99.1 
 
 
 
 1876 
 
 156 
 
 134 
 
 93-6 
 
 1897 
 
 98.2 
 
 94.0 
 
 98.9 
 
 
 
 1877 
 
 146 
 
 131 
 
 93-6 
 
 1898 
 
 99.0 
 
 96.4 
 
 99.0 
 
 
 
 1878 
 
 142 
 
 126 
 
 93-6 
 
 1899 
 
 100.2 
 
 97.2 
 
 98.5 
 
 
 
 1879 
 
 140 
 
 123 
 
 93-6 
 
 1900 
 
 103. 1 
 
 98.7 
 
 98.0 
 
 
 
 1880 
 
 137 
 
 125 
 
 93-6 
 
 1901 
 1902 
 1903 
 1904 
 1905 
 
 104.8 
 108.2 
 III. 2 
 III. I 
 112.8 
 
 102.7 
 108.3 
 107.7 
 109. 1 
 109.8 
 
 97-4 
 96.6 
 95-9 
 95-2 
 95-2 
 
 1 Data from Report of Massachusetts Bureau of Statistics of Labor for 1885, 
 P- 455- 
 
 2 Data from Mitchell, Gold, Prices, and Wages under the Greenback Standard, 
 pp. 242-244. The cost of living here is based upon retail prices and covers rent as 
 well as food, etc. 
 
THE PERSONAL DISTRIBUTION OF WEALTH 549 
 
 Regarding the second fact, we may say that certain English 
 investigations show that more than one fourth of the population 
 of the cities of London and York are below the poverty Hne. 
 To be sure, it is not easy to determine definitely how poor a 
 person must be in order to be " in poverty," but the statement 
 just made is based upon standards that are undeniably con- 
 servative. But a number of those actually in poverty have 
 enough income to purchase the minimum physical requirements 
 if they knew how to spend their money wisely. In the city of 
 York 9.91 per cent of the population had insufiScient earnings 
 for minimum requirements estimated at $5.25 per week for a 
 family of five. This minimum is very low, and it is easily 
 within the mark to say that at least a fifth of the population of 
 York did not have in 1899 a sufficient income for a decent 
 existence. In the United States the proportion of the urban 
 population below the poverty line is probably somewhat less, 
 but reliable statistics cannot be quoted. 
 
 An American writer has estimated that ten million persons in 
 the United States are in poverty, not all in distress, but " much 
 of the time underfed, poorly clothed, and improperly housed." 
 The estimate is based on statistics of unemployment, returns of 
 boards of charity, court records of evictions, and pauper burials. 
 Whatever the actual figures may be, they would doubtless be 
 startling in comparison with statistics of our industrial progress. 
 
 Causes of Poverty and Riches. — The explanations of poverty 
 and riches may be divided into two classes : (i) those that em- 
 phasize individual responsibility, and (2) those that emphasize 
 
 ' Based upon statistics covering 21 industries given in the Aldrich Report on 
 Wholesale Prices, Wages, and Transportation. 
 
 * Statistics for 1881-1889 cover 25 city occupations, and are based upon data 
 given in Bulletin of the Bureau of Labor, No. 18, p. 669. Statistics for 1890-1905 
 cover 349 occupations, and are based, upon data given in Bulletin of the Bureau of 
 Labor, No. 65, p. 20. 
 
 ' Wholesale prices from 1881 to 1889, based upon data given in the Aldrich Report 
 on Wholesale Wages, Prices, and Transportation, Part i, p. 99. Retail prices of food 
 from 1890 to 190S, from the Bulletin last cited. 
 
 • From the Aldrich Report and Bulletin cited above. After 1890, statistics are 
 based on hours of labor per week. 
 
550 OUTLINES OF ECONOMICS 
 
 social responsibility. According to the first, a comfortable for- 
 tune is the reward of efificiency, and poverty the penalty of in- 
 efficiency. To find fault with existing wealth distribution, it 
 is alleged, is to find fault with nature for making individual 
 differences in ability so enormous. That there are idle and 
 worthless persons among the rich is not to be denied, but they, 
 it is said, are to be regarded as the exceptions. As a class, 
 according to this view, the rich add more to the wealth of society 
 than they consume, and they do not in reality deduct any- 
 thing from the income of the lower classes. 
 
 Those who emphasize the second explanation, on the other 
 hand, point to the existence of all sorts of special privileges 
 which enable the few to levy toll on the production of the nation. 
 They assert that the fortunes of most millionaires originated 
 under the shelter of some monopolistic enterprise. As to the 
 poor, they call attention to the fact that inefficiency may be 
 the result of poverty as well as the cause of it. Society must, 
 therefore, take active measures to better the environment of 
 the poor. They must be taught to live wisely, and their chil- 
 dren must be given a fair chance in life. Children who do not 
 get enough to eat when young cannot be expected to take care 
 of themselves when they are men and women. 
 
 "The prime importance of monopoly privileges in the distribution of 
 wealth is shown by the results of the investigation of the New York Tribune 
 (1892) in its efforts to ascertain the sources of the fortunes of the millionaires 
 of the United States. That investigation was undertaken to show that the 
 system of protection has not been the main cause for monopolies and great 
 fortunes. The investigation amply demonstrated this proposition. Of 
 the 4047 millionaires reported, only 11 25, or 28 per cent, obtained their 
 fortunes in protected industries. The following partly estimated summaries 
 are based on the Tribune report. They show that about 78 per cent of the 
 fortunes were derived from permanent monopoly privileges and only 21.4 
 per cent from competitive industries unaided by natural and artiiicial mo- 
 nopolies. Yet there can be no question that if these 21.4 per cent were fully 
 analyzed, it would appear that they were not due solely to personal abilities 
 unaided by these permanent monopoly privileges. They were mostly 
 obtained from manufactures, and five sixths of the manufactures of the 
 country are based on patents. Besides, fortunate investments in real estate, 
 stocks, etc., have often contributed to fortunes where they do not appear 
 
THE PERSONAL DISTRIBUTION OF WEALTH 551 
 
 prominently. Furthermore, if the size of the fortunes is taken into account, 
 it will be found that perhaps 95 per cent of the total values represented 
 by these millionaire fortunes is due to those investments classed as land 
 values and natural monopolies and to competitive industries aided by such 
 monopolies." ^ 
 
 Those who take this second view do not deny that individual 
 differences in ability exist and are a cause for a difference in for- 
 tune. But they think that conditions are such that differences 
 in reward are quite out of proportion to the difference in ability. 
 A Uttle shrewdness may accumulate a fortune just as the touch 
 of a child's hand may start a bowlder down the mountain side. 
 
 The controversy as to the ultimate responsibility for poverty 
 cannot be settled by an appeal to the results of the investigations 
 that have been made as to the immediate causes of poverty. 
 The investigation in the city of York, before referred to, gives 
 the following as the immediate causes of primary poverty, that 
 is, of incomes insufficient to provide the minimum requirements 
 for physical efficiency even if wisely spent : 
 
 TABLE V 
 
 Immediate Causes or "Primary" Poverty ^ 
 
 Per Cent of Poptjlation 
 IN Poverty 
 
 Death of chief wage earner 
 
 lUness or old age of chief wage earner . . 
 
 Chief wage earner out of work 
 
 Irregularity of work 
 
 Size of family, i.e. more than four children . 
 In regular work but at low wages .... 
 
 15-63 
 
 2.31 
 
 2.83 
 
 22.16 
 
 51.96 
 
 Is Greater Diffusion Possible ? — Most people agree that a 
 greater equality of possessions would be desirable if it could be 
 brought about without any confiscation of the real earnings of 
 the more efficient members of society. The idea of a leisure 
 
 1 J. R. Commons, The Distribution of Wealth, p. 252. 
 '^ B. S. Rowntree, Poverty, p. 120. 
 
552 OUTLINES OF ECONOMICS 
 
 class whose mission it is to further culture without substantial 
 contributions to the production of what it consumes, does not 
 find much favor in this democratic age. The disadvantages of 
 wide extremes in wealth have been so often pointed out by 
 social philosophers that they need not be emphasized here. 
 But those who believe that the competitive system roughly 
 apportions rewards according to individual production will say 
 that nothing can be done directly to diffuse wealth. That 
 each individual should bear the consequences of his own con- 
 duct, they think, is necessary as a discipline for the race. " Give 
 the children of the shiftless, by thoughtless charity or various 
 systems of poor relief, the right to eat the substance of the effi- 
 cient and the prudent, and you will soon lose both the capital 
 and the morality under which that capital has been created," ^ 
 says one able writer. 
 
 Those, on the other hand, who think that something can and 
 should be done, question the possibility of discovering the real 
 contributions of individual workers under modern complex in- 
 dustrial conditions with any degree of exactness, and think there 
 is little danger of discouraging industry and thrift. If the 
 highest incomes were $100,000 per year, men would struggle just 
 as hard as they do now to get into the highest class. 
 
 If we take the view that something can be done to lessen the 
 extreme inequality in wealth distribution that exists at the 
 present time, it is necessary to formulate some program of 
 social reform. In framing such a program it must be re- 
 membered, on the one hand, that the right of private property 
 is not an absolute right. No one has a vested interest in that 
 institution, and we are at liberty to make such modification in 
 the institution as will contribute to the social welfare. For the 
 present the measures here advocated are not in the slightest 
 danger of being carried so far as to discourage that wealth- 
 getting ambition which is considered by many to be essential 
 to progress. On the other hand, there is danger of injuring by 
 wrong methods the very persons whom it is desirable to elevate. 
 Indiscriminate charity may convert poverty to pauperism. 
 1 A. T. Hadley, Economics, p. 49. 
 
THE PERSONAL DISTRIBUTION OF WEALTH 553 
 
 "This distinction between the poor and the paupers may be seen every- 
 where. There are, in all large cities in America and abroad, streets and 
 courts and alleys where a class of people live who have lost all self-respect and 
 ambition, and who rarely if ever work, who are aimless and drifting, who like 
 drink and who have no thought for their children, and who live aimless and 
 contentedly on rubbish and alms. ... In our American cities,Negroes, 
 Whites, Chinese, Mexicans, Half-breeds, Americans, Irish, and others are 
 indiscriminately housed together in the same tenements and often in the 
 same rooms. The blind, the crippled, the consumptive, the aged, — the 
 ragged ends of life; the babies, the children, the half-starved, underclad 
 beginnings in life, all huddled together, waiting, drifting. This is pauper- 
 ism. There is no mental agony here; they do not work sore; there is no 
 dread; they live miserably, but they do not care. 
 
 " In these same cities, and indeed everywhere, there are great districts of 
 people who are up at dawn, who wash and dress, and eat breakfast, kiss 
 wives and children, and hurry away to work or to seek work. The world 
 rests upon their shoulders ; it moves by their muscle ; everything would stop 
 if for any reason they should decide not to go into the fields and factories and 
 mines. But the world is so organized that they gain enough to live upon 
 only when they work ; should they cease, they are in destitution and hunger. 
 The more fortunate of the laborers are but a few weeks from actual distress 
 when the machines are stopped. Upon the unskilled masses want is con- 
 stantly pressing. As soon as employment ceases, suffering stares them in 
 the face. They are the actual producers of wealth, but they have no home 
 nor any bit of soil which they can call their own. They are the millions who 
 possess no tools and can work only by permission of another. In the main 
 they live miserably, they know not why. They work sore, and yet gain noth- 
 ing. They know the meaning of hunger and the fear of want. They love 
 their wives and children. They try to retain their self-respect. They have 
 some ambition. They give to neighbors in need, yet they are themselves the 
 actual children of poverty." ^ 
 
 We shall not discuss here the methods of alleviating the suf- 
 fering that comes from poverty. The best methods of charit- 
 able relief are necessary as palliatives, but they cannot cure the 
 evils of poverty. Two classes of reform measures should be 
 distinguished : (i) those that aim to alter the methods of wealth 
 acquisition in the future, and (2) those that aim to diffuse the 
 excessive accumulations of the past. 
 
 Modifying the Methods of "Wealth Acquisition. — These 
 measures again fall into two classes : (a) prevention of improper 
 
 1 R. Hunter, Poverty, pp. 3-5. 
 
554 OUTLINES OF ECONOMICS 
 
 methods of wealth accumulation ; (b) eliminating or strengthen- 
 ing the inefficient members of society. Under the first of these 
 falls the problem of reducing to lower terms such incomes as 
 are individually unearned. There must be such control of 
 monopolistic privileges as to keep them from being the means 
 of exploiting the public. Fraud and favoritism must be elim- 
 inated so that income shall not be wholly out of proportion 
 to service or needs. 
 
 The second class includes a large variety of methods, (i) It 
 is possible to do something to prevent defective human beings 
 from being born. There is a growing sentiment in favor of 
 preventing the marriage of persons who are not fit for marriage. 
 No individual would be deprived of any important right if a 
 medical certificate of good health were made a condition pre- 
 cedent to the granting of a marriage Hcense, although here 
 education may prove the more effective remedy. (2) Education 
 should be made compulsory, with the endeavor of making the 
 rising generation not only efficient producers, but also wise 
 spenders of what they receive. (3) It is possible to provide 
 against the misfortunes of Ufe by insurance of various kinds. 
 If men will not voluntarily make provision for themselves and 
 for those dependent upon them in cases of sickness, accident, 
 old age, and premature death, they should be helped to do so 
 indirectly by some comprehensive system of workingmen's 
 insurance and old age pensions. (4) The solution of the prob- 
 lem of unemployment depends in part upon indirect measures, 
 such as monetary and banking reform, which steady the prog- 
 ress of industry, although more efficient labor exchanges and 
 unemployment insurance are direct measures which are of some 
 help. If business men and political leaders ever become as 
 much interested in the problems of unemployment as in tariff 
 reform, we may expect that productive use will be found for 
 the unemployed so far as they are employable, and if this proves 
 impracticable, we shaU recognize that if society cannot offer 
 a wiUing and able man an opportunity to work, it must give 
 him a vacation with pay. (5) Opportunities for saving should 
 be multiplied. The establishment of our postal-savings system 
 
THE PERSONAL DISTRIBUTION OF WEALTH 555 
 
 is a small step in this direction. (6) The health and vigor of 
 the people should be improved by more efficient use of " pre- 
 ventive medicine " and public hygiene in all its various phases, 
 and by improvement in the conditions of work. 
 
 The Diffusion of Wealth. — To some extent large fortunes dis- 
 appear without governmental interference, but it takes com- 
 paratively slight ability to maintain an inherited estate. It 
 does not seem practicable or desirable to limit directly the total 
 amount of wealth which a man may own, but there is no reason 
 why the government should refrain from consciously encourag- 
 ing the diffusion of wealth. The regulation and taxation of 
 inheritances seems to be the proper remedy in this connection, 
 even if its action is somewhat slow. 
 
 QUESTIONS AND EXERCISES 
 
 1. Can anything be said in favor of a leisure class ? 
 
 2. Would Mr. Carnegie's plan of levying an inheritance tax of 50 per cent 
 destroy the incentive to work ? 
 
 -3. Explain the various systems of poor relief. 
 
 4. Describe the work of some public employment office. 
 
 5: Describe the growth of postal savings. 
 
 6. What were the causes of the development of the fortune of John Jacob 
 Astor? 
 
 7. Discuss the following statement: "We have, then, little reason for 
 expecting that the prevailing insecurity in the lot of the modern workman 
 will ever be removed by the development of individual thrift." — A. S. John- 
 son, Political Science Quarterly, Vol. xxii, p. 244. 
 
 REFERENCES 
 
 Adams, T. S., and Sumner, H. L. Labor Problems, Chap. v. 
 
 Brooks, J. G. The Social Unrest, Chap. vii. 
 
 Booth. Life and Labour of the People in London, final volume. 
 
 Commons, J. R. Distribution of Wealth, pp. 252 seq. 
 
 Devine, E. T. Principles of Relief. 
 
 Ely, R. T. Property and Contract, Vol. i. Chap. xiii. 
 
 Falkner, R. p., "Income Tax Statistics," Quarterly Publications of the 
 
 American Statistical Association, Vol. xiv, p. 521. 
 Hadley, a. T. Economics, pp. 39-63, 330-335. 
 Hollander, J. H. The Abolition of Poverty, Chaps, ii, viii. 
 Hunter, Robert. Poverty. 
 
5S6 OUTLINES OF ECONOMICS 
 
 HoBSON, J. A. The Social Problem, Chap, iv; Problems of Poverty, Chap. ix. 
 
 Henderson, C. R. Modern Methods of Charity. 
 
 Johnson, A. S. "Influences affecting the Development of Thrift," Political 
 
 Science Quarterly, Vol. xxii. 
 King, W. I. The Wealth and Income of the People of the United States. 
 RowNTREE. Poverty: A Study in Town Life. 
 Streighthoff, F. H. "The Distribution of Incomes," Columbia University 
 
 Studies in History, Economics, and Public Law, Vol. iii, No. 2. 
 Taussig, F. W. Principles of Economics, Vol. ii. Chap. liv. 
 Warner, A. G. American Charities. 
 Watkins, G. p. "The Growth of Large Fortunes," Publications of the 
 
 American Economic Association, Third Series, Vol. vii. No. 2. 
 YouNGMAN, Anna. Economic Causes of Great Fortunes. 
 
PART IV 
 SELECTED ECONOMIC PROBLEMS 
 
 CHAPTER XXVII 
 TRANSPORTATION ECONOMICS 
 
 Transportation Economics Defined. — Transportation may 
 be studied from various points of view. It presents its peculiar 
 problems to the engineer, to the lawyer, to the financier, to the 
 accountant, to the operating official, and finally to the economist. 
 The economist studies the relations of transportation to other 
 industries and to the public welfare. Leaving to the engineer 
 the building of bridges, to the accountant the recording of the 
 condition of the business, and to the general manager the 
 securing of efi&cient operation, we turn our attention primarily 
 to the principles that govern the determination of rates and 
 fares, although there are many other problems to be considered 
 in transportation economics, some of them peculiar to this 
 field and some but special illustrations of principles underlying 
 all industry. We make use of the technical knowledge of the 
 engineer and of the other specialists that have been mentioned, 
 and yet our point of view is distinct. 
 
 Scope of the Term Transportation. — A complete treatment 
 of the subject of this chapter would involve a consideration of 
 steam railways, interurban and city railways, the common 
 roads, water transportation, as well as the post ofBce, the tele- 
 graph and the telephone. Aerial transportation may bring new 
 economic problems in the future. But it will be necessary in 
 this chapter to confine the discussion to some of the leading 
 principles in the economics of railroad transportation. As 
 
 557 
 
558 OUTLINES OF ECONOMICS 
 
 explained in Chapter VI, the early turnpike era was followed by 
 one of canal building, and this in turn by the railroad era. We 
 are now realizing that we must enter upon a new era of road 
 building and of the improvement of waterways. Canal and 
 river improvement, however, should be urged, not on the general 
 ground that water transportation is cheap, but only in specific 
 instances where it can be shown to be as advantageous as rail 
 transportation when all of the elements of expense are taken into 
 consideration. It is a matter of debate, for example, whether 
 the recent construction of the New York barge canal was 
 economically justified. The improvement of our common 
 roads is now being vigorously forwarded by state and local 
 activity. In 191 6 the federal government made an appropria- 
 tion to aid the states in carrying on this work. 
 
 Nature of the Railway Industry. — Hardly anything can be 
 produced without the participation of some transport agency. 
 Modern industrial civilization would be impossible without an 
 efficient system of commercial intercourse. The dependence is 
 mutual, for present methods of transportation clearly would be 
 uneconomical without a large trafi&c. The influence of cheap 
 transportation is especially important in the fact that it promotes 
 an extensive division of labor by widening the market. It per- 
 mits each region to devote itself to that line of production for 
 which it is best adapted. 
 
 The number of persons employed by railways in the United 
 States in 1910 was about 1.7 millions, which was 4.45 per cent 
 of the number of gainful workers reported by the census of that 
 year. This percentage probably understates the relative impor- 
 tance of transportation as compared with other economic ac- 
 tivities, because the capital per employee is larger in the railway 
 industry than in other lines of work. An attempt has sometimes 
 been made to minimize the importance of the question of rail- 
 road rates by comparing the transportation charge on such an 
 article as a pair of shoes with the cost of the shoes and showing 
 that it is too small appreciably to affect the retail price. This 
 overlooks the fact that freight charges enter into the cost of the 
 materials and of the machinery required to produce the shoes. 
 
TRANSPORTATION ECONOMICS 559 
 
 The freight charge constitutes a large percentage of the cost of 
 such an article as coal. But, on the other hand, the importance 
 of changes in freight rates is sometimes overemphasized by com- 
 paring the total annual freight revenue per family with the 
 estimated income of the average family. Thus in the 5^ear 
 ending June 30, 19 10, the freight revenue of railways in the 
 United States was $1,925,553,036, and the number of families 
 as reported by the census of 1910 was 20,255,555, making 
 an average of ninety-five dollars per family. It should be 
 obvious that this figure cannot be compared with the amount 
 which the average family spends for food, clothing, and other 
 items of final consumption. If the comparison is made at 
 all, it must be with the total annual production of the nation 
 per family, for freight charges enter into the cost of such 
 items as the factories, war-ships, and railway bridges con- 
 structed each year as well as of the articles produced for final 
 consumption. 
 
 Railways differ from manufacturing industries in that they 
 produce place utility and not form utility, and in the further 
 fact that it is customary for manufacturers to own the materials 
 which they change in form while railways as a rule do not own 
 the materials which they transport. In other words, railways 
 sell services simply, while manufacturers sell articles in which 
 they have embodied certain services. The freight charges paid 
 by the shipper may be compared with the toll which the farmer 
 used to pay for having his corn ground at the mill. The fact 
 that railways do not buy and sell the commodities to which they 
 add utility as manufacturers do, makes the amount of their 
 yearly income and outgo much smaller in comparison with the 
 amount of capital employed than is the case with manufacturers. 
 Roughly speaking, it takes railways five years to " turn over " 
 their capital, the total operating revenues of the railways in the 
 United States being about three billions of dollars a year, while 
 their capitalization is about fifteen billions (excluding intercor- 
 porate duplications). For the year 1909, the Bureau of the 
 Census reports manufacturing establishments as having a capital 
 of 18.4 billions of dollars and an annual value of products of 
 
560 OUTLINES OF ECONOMICS 
 
 20.7 billions. The value of products less cost of materials pur- 
 chased, that is, the value added by the manufacturing process, 
 was 8.5 billions. While no accurate comparisons are possible 
 from these data, they warrant the conclusion that capital is 
 relatively much more important as a factor of production in the 
 railway industry than in manufacturing enterprises taken as a 
 whole. The fact that railway services are rendered in con- 
 nection with a large fixed capital explains much in our railway 
 history, especially with respect to matters relating to competi- 
 tion, monopoly, and rate making. 
 
 Railway Competition. — The early roads were short, independ- 
 ent lines, largely for local traffic or to serve as feeders to canals. 
 The first movement toward the efficiency of the present system 
 was the welding together of separate links into through lines. 
 The New York Central, for example, was formed in 1853 out of 
 ten or eleven previously independent lines between Albany and 
 Buffalo. The development of parallel through lines introduced 
 an era of sharp competition. In the seventies the lines connect- 
 ing Chicago and the Atlantic seaboard engaged in a series of rate 
 wars. The experience of this decade showed clearly the tempo- 
 rary and unstable character of competition among parallel lines. 
 The rule seemed to be that a railway war must be followed by a 
 rate agreement of some sort, so that instead of the maintenance 
 of a supposedly fair level of rates by the steady pressure of com- 
 petition, we find there was an alternation of high and low rates. 
 The inevitable annihilation of direct competition in rates be- 
 tween railways is clearly portrayed in a congressional report in 
 1874, where the following prediction was made : " But when the 
 natural tendencies of corporate power have wrought out their in- 
 evitable conclusions, the magnitude of our combinations will 
 probably be in proportion to the extent of the field in which they 
 operate." But so strongly was it felt at that time that competi- 
 tion is the life of trade, that the committee which made this 
 report recommended that the government build a line of its 
 own, merely to maintain competition with the private roads, for 
 it was thought that the government could resist the temptation 
 to enter into a combination. 
 
TRANSPORTATION ECONOMICS 561 
 
 The history of Belgium affords an instructive illustration of the effect of 
 a mixed system of public and private ownership. Belgium began in 1837 
 with a carefully planned system of public railways. Ten years later it 
 was decided to grant charters to private companies. A large number of 
 private roads was organized, some with the purpose of competing with the 
 state system. It was thought that competition between the state and private 
 roads would be beneficial. The Massachusetts Railroad Commission, in its 
 report of 1871, recommended a trial of this plan in Massachusetts. But in 
 Belgium the private lines were soon merged into four systems, which com- 
 peted so vigorously with the state roads that the government adopted the 
 policy of purchasing them. 
 
 Pooling and Consolidation. — As a result of the intense struggle 
 for business among the roads, there was a widespread resort to 
 the practice of pooling, that is, a division of the earnings or ton- 
 nage of the aggregate business. This form of combination, 
 however, was at least nominally abandoned after it was declared 
 illegal by the Interstate Commerce Act of 1887, but organiza- 
 tions for the purpose of making rates continued to exist. In 
 1897 these were also declared illegal by the Supreme Court of the 
 United States on the ground that they were in violation of the 
 Anti-trust Act of 1890.^ The decision, however, did not clearly 
 prohibit the enlargement of the various systems by the purchase 
 and lease of other lines, or by securing indirect control by the 
 purchase of the majority of their stock. But in 1904 the Su- 
 preme Court again applied the Anti-trust Act of 1890 in a case 
 against the Northern Securities Company, a corporation formed, 
 not for the purpose of directly engaging in the railway business, 
 but for the purpose of holding the capital stock of the Great 
 Northern, Northern Pacific, and Burlington systems, two of 
 which were competing systems. In 191 2 it was decided that for 
 the Union Pacific Railroad Company to hold indirectly 46 per 
 cent of the stock of the Southern Pacific Company was illegal, 
 although only a small percentage of the total traffic of these 
 roads could be regarded as competitive. The Northern Securi- 
 ties decision did not prevent the systems involved from con- 
 tinuing to be controlled by the same financial interests, but the 
 Union Pacific case has apparently resulted in severing the finan- 
 
 1 See p. 237, above. 
 20 
 
562 OUTLINES OF ECONOMICS 
 
 cial control of the Union Pacific from that of the Southern 
 Pacific. 
 
 The present organization of any one of our large systems, like 
 a geological record, reveals the nature of the changes that have 
 been going on. The consolidated company controls a number of 
 large lines, perhaps by stock ownership, and each one of these is 
 made up of a number of subsidiary roads united as a result of 
 purchase, partial stock ownership, or lease. 
 
 Thus the Baltimore and Ohio in 191 2 operated 4455 miles of 
 line, of which it owned 545 miles, while 3897 miles were con- 
 trolled through partial or complete stock ownership, the re- 
 mainder being operated under lease or trackage rights. It also 
 controlled the Cincinnati, Hamilton, and Dayton, an independent 
 operating company. There are numerous illustrations of the 
 control of one large operating company by one or more other 
 operating companies. Thus the Northern Pacific and Great 
 Northern Companies jointly control the Burlington. Again, 
 several operating companies may be controlled by a holding com- 
 pany which does not itself operate any mileage. This is the case 
 with the Louisville and Nashville and the Atlantic Coast Line 
 Railroads, both of which are subsidiary to the Atlantic Coast 
 Line Company. Again, two or more railroads, apparently quite 
 independent of each other in the matter of stock ownership, may 
 nevertheless be dominated by the same financial interests. Thus 
 the Morgan interests control the Erie and the Southern as well 
 as other railroads. It is safe to say that ten groups of capital- 
 ists control over three fourths of the railway mileage of the 
 United States. 
 
 In spite of the progress of consolidation, competition has not 
 entirely disappeared. Even where there is no active cutting 
 of rates by parallel lines, there may be rivalry in service; but 
 this form of competition has also proven to be unstable and 
 unsatisfactory, as is seen in problems arising in connection with 
 terminal freight services. Again, alternative routes may lead 
 to competition among railways that are not parallel. Thus 
 the roads serving the north Atlantic ports compete in the 
 carriage of grain with those extending to Galveston and New 
 
TRANSPORTATION ECONOMICS 563 
 
 Orleans. The influence of water competition on railway rates 
 has been recognized by the Interstate Commerce Commission in 
 the adjustment of transcontinental rates and in the numerous 
 exceptions it permits in the southern states to the rule that the 
 charge for the shorter haul shall not exceed that for the longer. 
 The activities of the traffic departments of railways indicates 
 the existence of competition for business at many points. 
 The Panama Canal will be a factor in railway competition. 
 
 Much has recently been said about the influence of market 
 competition as a force affecting rates, even when the roads have 
 been consolidated. To illustrate, the farmers and railways of 
 North Dakota are joint producers of wheat, and they are both 
 desirous that it shall be sold in competition with other wheat in 
 the London market. It would be ruinous to the roads to make 
 such high rates that the farmers could not afford to sell their 
 grain. The railways cannot be prosperous if the farmers, mer- 
 chants, and manufacturers along their lines are not prosperous. 
 This partnership, however, has its limits, for a rate which would 
 enable the producer to continue in business might still be un- 
 reasonably high. 
 
 The Movement of Rates. — The average revenue per ton mile 
 of traffic in the United States fell from i.ooi cents in 1888 to 
 .729 cents in 1900, rising to .780 in 1904, and falling again to 
 .729 in 1913. Average ton-mile receipts, however, are not an 
 accurate index of changes in rates, for this average is affected 
 by the changes in the nature of the traffic as well as by changes 
 in rates charged. The average ton-mile revenue is really a 
 weighted index num.ber with changing weights at different peri- 
 ods. If the proportion of low-grade freight increases, or if the 
 length of haul increases, there will be a fall in ton-mile receipts 
 without any change in rates. But if we also take into consider- 
 ation rates on specific commodities, such as wheat, or stoves, 
 between specffic points, no doubt remains but that a large de- 
 crease in freight rates took place up to the year 1900. Since 
 that time there have been many increases in published rates, 
 but also many decreases have been made by order of various 
 regulating bodies. It may be that the net effect of these changes 
 
564 OUTLINES OF ECONOMICS 
 
 is fairly well represented by the ton-mile revenue, which has 
 shown little change since 1900, although there has been some 
 increase in the proportion of low-grade tonnage and in the aver- 
 age length of haul between 1900 and 19 13, which would seem 
 to indicate some increase in rates since 1900. 
 
 In 1910 the railway companies, both in the East and in the 
 West, asked the Interstate Commerce Commission to sanction 
 a general increase in freight rates. This it refused to do. In 
 1914, a renewed request for permission to increase rates on the 
 part of Eastern carriers was at first denied but later granted. 
 In 19 1 5 an advance in rates on a long list of commodities was 
 proposed by carriers in the Middle West. The commission 
 permitted certain of the advances proposed and denied others. 
 Railway representatives assert that rates should increase when 
 prices generally are increasing, but they have failed to demon- 
 strate any general increase in their own "cost of living" except 
 in the higher rates of wages paid and the higher rates of interest 
 recently prevailing. In the years following 1908, passenger 
 rates were radically reduced in many states by two-cent fare 
 laws. The average revenue per passenger per mile had shown 
 little change prior to that time since the early nineties, when 
 it was somewhat higher. Recently Eastern railways have 
 also made general increases in passenger rates. A joint com- 
 mittee of Congress recommended in 19 14 that the payments 
 to railroads for carrying the mails be increased. 
 
 These general changes or proposed changes in rates and fares 
 give renewed interest to the question of how a reasonable rate 
 may be determined.^ 
 
 1 It is left as an exercise for the student to draw charts of the movement of rev- 
 enues per ton per mile and per passenger per mile from the Statistics of Railways 
 published by the Interstate Commerce Commission, and to compare at different 
 dates the average length of haul and the proportions of various kinds of commodities 
 carried. But it must be remembered that the average revenue per ton per mile 
 is a single figure representing the result of applying an almost infinite variety of 
 specific rates under varying traffic conditions. This is at once the advantage and 
 defect of an average. To emphasize this point the average receipts per ton per 
 mile are given in the following table for eight selected commodities by geographical 
 districts. The average length of haul as given in this table is obtained by dividing 
 the tons per mile by the number of tons carried, as reported by each railroad, in- 
 
TRANSPORTATION ECONOMICS 
 
 565 
 
 The Level of Rates. — If, owing to the monopolistic nature of 
 the railway business, the determination of rates can no longer be 
 left to the automatic working of competitive forces, they must 
 be consciously determined according to fundamental principles. 
 Competition was supposed to do justice by limiting the aggregate 
 earnings of an establishment approximately to the expenses of 
 
 eluding both the tons originating on the line of the carrier and the tons received 
 from connecting carriers. The average haul, therefore, is the average haul on one 
 railroad and not the average haul for the railroads regarded as one system. 
 For all commodities taken together in 19,13 the average haul of a ton on one rail- 
 road was 147 miles as against 260 miles for all the railroads regarded as a system. 
 This last figure is obtained by dividing the ton-miles by the number of tons re- 
 ported as originating on carriers' lines, excluding the tonnage received from con- 
 necting carriers. The same correction cannot be made for the individual com- 
 modities. The following table, it may also be noted, does not cover all of 
 the mileage of the country, as many railroads do not compile trafi&c statistics in 
 this form. 
 
 Average Receipts per Ton per Mile and Average Length of Haul for 
 Selected Commodities in Carload Lots for Year Ending June 30, 1913, 
 Covering 151,941 Miles of Road 
 
 (From Statistics of Railways in the United Stales, 1913, p. 44.) 
 
 
 
 
 
 
 
 Id 
 
 "& 
 
 
 District and Item 
 Covered 
 
 
 
 1 
 
 
 u 
 
 > 
 
 /3 
 
 1^ 
 
 H 
 1" 
 
 h 
 
 E 
 
 i 
 
 PQ 
 
 Eastern District 
 
 
 
 
 
 
 
 
 
 Receipts per ton-mile 
 
 — cents 
 Length of haul — miles 
 
 0.37S 
 262 
 
 0.851 
 158 
 
 0.538 
 252 
 
 0.842 
 228 
 
 0.893 
 327 
 
 0.571 
 170 
 
 o'4i7 
 126 
 
 0.623 
 148 
 
 Southern District 
 
 
 
 
 
 
 
 
 
 Receipts per ton-mile 
 
 — cents 
 Length of haul — miles 
 
 0.620 
 250 
 
 0.938 
 193 
 
 1.927 
 179 
 
 1.723 
 138 
 
 1 .043 
 
 2SS 
 
 o.SSS 
 119 
 
 0.403 
 180 
 
 0.734 
 161 
 
 Western District 
 
 
 
 
 
 
 
 
 
 Receipts per ton-mile 
 — cents 
 Length of haul — miles 
 
 0.740 
 236 
 
 I-I5S 
 162 
 
 1.792 
 230 
 
 1-397 
 209 
 
 1. 106 
 
 327 
 
 0.630 
 173 
 
 0.676 
 117 
 
 0.713 
 
 200 
 
 Total — All Districts 
 
 
 
 
 
 
 
 
 
 Receipts per ton-mile 
 
 — cents 
 Length of haul — miles 
 
 0.581 
 248 
 
 1.005 
 166 
 
 1.693 
 214 
 
 1.258 
 209 
 
 0.965 
 323 
 
 0.578 
 170 
 
 0.447 
 135 
 
 0.701 
 
 176 
 
566 OUTLINES OF ECONOMICS 
 
 doing the business, and it seems most natural that we should ap- 
 ply the same standard in our railway rate making. There can be 
 no doubt but that expense is a safe guide so far as it can be ac- 
 curately determined. It needs but a slight analysis of railway 
 expenditure, however, to reveal the difficulty of using expense as 
 a criterion of a fair rate. In 1913 the railways reported to the In- 
 terstate Commerce Commission operating revenues and other in- 
 come amounting to 3297 millions of dollars, and in this same year 
 the interest on funded debt and dividends amounted to 666 mil- 
 lions, or 20. 2 per cent of the revenues and other income. This rep- 
 resents the amount accruing to the stock and bondholders as joint 
 owners of the business, not counting the increase in surplus. Is 
 this a proper payment to such owners ? That some compensa- 
 tion of this sort is necessary under the regime of private capi- 
 talism is clear, for if none were made, new roads would not be 
 built nor would old ones be maintained. A common answer is 
 that the owners should be allowed a fair return upon their 
 investment, but it is difficult to say what is a fair return and what 
 is the actual investment. The rate of interest to be allowed 
 must be determined from a study of the investment market and 
 from a consideration of what is necessary to provide a surplus 
 for the lean years and for unproductive improvements. 
 
 A more perplexing question is to decide upon a fair valua- 
 tion upon which the return is to be calculated. Neither the 
 amount of stocks and bonds nor the ledger value of the prop- 
 erty is a safe guide. In some cases the actual investment may 
 be traced historically where the records have not been destroyed, 
 but this raises a series of difficulties. Was the investment 
 wisely made, or does it contain a large profit paid to some con- 
 struction company? Should investments made out of income 
 or surplus be distinguished from the original investment or from 
 proceeds of the sale of stock and bonds? The difficulty of as- 
 certaining the full history of the investment has led to estimates 
 of the cost of the production or reproduction of an enterprise 
 by means of an engineering survey of the road and equipment. 
 The Interstate Commerce Commission, through its Division of 
 Valuation, has been engaged on the gigantic task of making 
 
TRANSPORTATION ECONOMICS 567 
 
 a valuation of the entire railway system of the United States. 
 Expensive as this undertaking is, it seems to be the only hope 
 of reaching an equitable determination of what is to be regarded 
 as a fair valuation upon which to base rates. Should the people 
 of the United States ever reach the conclusion that it is wise 
 for them to own the railways, a valuation of this kind, kept 
 up to date by appropriate accounting, will be of the greatest 
 benefit. But the " physical " or engineering valuation itself 
 will not answer the question of what is a fair value. Shall the 
 "cost new" or the "depreciated value" be taken? To what 
 extent shall an intangible or " going " value be recognized? 
 
 No answer of universal application can be given to these ques- 
 tions, but it may safely be said that when a depreciation fund 
 has been accrued through annual charges to operating expenses, 
 the amount of such depreciation must be deducted from the 
 cost new. It is sometimes said that if we deduct depreciation 
 we must also add appreciation, but this is taken into account in 
 the method by which valuations are usually made, that is, where 
 real estate is valued according to the selling price of neighboring 
 lands. It is extremely doubtful whether any going or intangible 
 value should be recognized. To do this might amount to re- 
 warding a railroad for becoming a monopoly. The case is some- 
 what different from that of a manufacturing establishment where 
 its " good- will " may frequently be developed by superior skill 
 in the face of competition. 
 
 Relative Rates. — When the general level of rates has been 
 determined we are confronted by the question of what should be 
 charged for each particular shipment, and here we find the appli- 
 cation of the principle of expense of still greater difficulty and un- 
 certainty. In attempting to say what it costs to carry a ton of 
 coal a mile, we find that a large part of the expenditure is incurred, 
 not for one specific kind of commodity, but jointly for many 
 kinds. The roadbed, ties, and rails are maintained, not for 
 coal cars alone, but for passenger trains as well. Even with the 
 most careful bookkeeping it is possible to trace a direct causal 
 connection between only a part of the expenses and specific 
 portions of the traffic. It is possible to say that a certain traffic 
 
568 OUTLINES OF ECONOMICS 
 
 requires a certain amount of extra labor and fuel, and causes a 
 certain amount of wear and tear, and clearly such trafl&c should 
 normally pay enough to meet these expenses at least, if we wish 
 to prevent waste. But what shall be done with such joint ex- 
 penditures as fall under the head of maintenance of way ? Shall 
 they be charged to the freight or to the passenger services ? The 
 prevailing opinion has been that the cost of carrying a specific 
 shipment cannot be determined with sufficient accuracy for any 
 useful purpose because the element of ''joint expense " is said to 
 be a prominent characteristic of the production of railway serv- 
 ices. In 1894 the National Association of Railroad Commis- 
 sioners and the Interstate Commerce Commission indorsed the 
 view that railroads should not be required to separate the 
 operating expenses of their freight and passenger services. Since 
 that time there has been a great development among manufac- 
 turing enterprises of what is known as cost accounting, which is 
 concerned with the apportionment of the total expenses of a 
 factory among its several products. This has been found use- 
 ful both in matters connected with the fixing of prices and in 
 determining the efficiency of the various departments of an 
 enterprise. Statistics of this kind were also developed by some 
 railway managements, but little use was made of them in de- 
 termining rates. In 1907 the railroad commission of Wiscon- 
 sin gave an impetus to railway cost accounting by its opinion 
 in the case of Buel vs. C. M. and St. P. Railway, where the 
 reasonableness of a passenger rate of three cents a mile had been 
 questioned. A complete apportionment was made of the 
 expenditures of this railroad between its freight and passenger 
 services. In 1914 the Interstate Commerce Commission recon- 
 sidered the whole matter, and after a public hearing decided that 
 in the future railways must report their operating expenses sepa- 
 rately for freight and passenger services according to bases to 
 be prescribed by the commission. ^ 
 
 Is there a sound theoretical basis for this newer development ? 
 This is a controverted point in economic theory and a full dis- 
 cussion cannot be given here. What has been said in Chapter 
 
 ^ In the Matter of the Separation of Operating Expenses (30 1. C. C. Reports, 676). 
 
TRANSPORTATION ECONOMICS 569 
 
 XI regarding constant and variable expenses and joint expenses 
 of production should be reviewed in this connection. Within 
 certain limits an increase in the volume of railway traffic results 
 in a lower average outgo per unit of product because certain 
 items, such as maintenance of way and the interest on the in- 
 vestment in the roadway, do not grow as rapidly as the traj0&c, 
 not to mention other economies. As railways can classify their 
 traffic by commodities and points of origin and destination, it 
 will pay to make low rates on traffic which would not otherwise 
 be secured. But it is superficial to stop with the analysis at this 
 point. As traffic increases the tracks and bridges are strength- 
 ened and additional tracks are added. In the long run the 
 amount of the investment is markedly affected by the volume of 
 traffic; that is, in the long run there is a causal connection be- 
 tween growth in volume of traffic and growth in maintenance 
 and interest charges, and this is the theoretical basis for attempt- 
 ing to distribute transportation and equipment expenses and at 
 least a part of the maintenance and interest charges to specific 
 services. As a matter of fact, over 70 per cent of all of the 
 operating expenses can be directly assigned to freight service 
 or to passenger service without arbitrary apportionments, when 
 the accounting is arranged for that purpose, and a considerable 
 part of the investment can also be directly assigned to one serv- 
 ice or to the other. The kind of expenses which can be dis- 
 tinguished as between freight trains and passenger trains can also 
 logically be distinguished as between different classes of freight 
 trains, so that the cost of hauling a trainload, a carload, or even 
 a ton of freight a mile can be approximated. If any class of 
 freight traffic or passenger traffic cannot bear the operating 
 expenses and interest charges attributable to that class of traffic, 
 it is not profitable traffic. 
 
 It is worth noting that the variety of railway services is not 
 nearly so great as might be imagined from the multiplicity of 
 rates in existence. Freight transportation consists in moving 
 a mass of material in freight cars, and from the cost standpoint 
 it makes little difference whether we call the material sand, 
 cement, or iron ore. The fact that commodities vary in bulk 
 
570 OUTLINES OF ECONOMICS 
 
 as compared with their weight is not an insuperable difficulty in 
 comparing their costs of transportation. Forty tons of coal 
 can be loaded in one car while forty tons of bird cages might re- 
 quire forty cars, but the train resistance caused by a car and 
 contents in each case can be measured approximately. 
 
 While greater emphasis may in the future be laid on the cost 
 principle, rates will doubtless continue to be based to a very 
 large degree on the principle of " charging what the traffic will 
 bear." Whether because of past commercial developments or 
 for reasons of public policy, some traffic will be carried at rates 
 less than those indicated by cost considerations, and this means 
 that other traffic will have to bear rates higher than those 
 indicated by considerations of cost. Some of the expenses of 
 every railroad, varying in some degree with its stage of develop- 
 ment, may even in the long run be regarded as independent of 
 the traffic, and such expenses should be distributed over such 
 traffic as can best bear them. In the construction of freight 
 classifications, the value of a commodity itself is given con- 
 sideration as a measure of what the traffic can bear or of the 
 " value of the service," but it is clear that this is not an exact 
 measure. 
 
 Distance. — A most perplexing factor in rate making is that 
 of distance. In actual practice, distance has been to a very large 
 degree ignored. For example, in group rates, the same charge 
 is made to a common market from any point within a certain area, 
 irrespective of the length of the haul. In the hasing-point system, 
 the rates to small towns in a certain region will not vary accord- 
 ing to the distance from the point of shipment, but are found 
 by adding together the rate to a railway center, called a basing 
 point, and the local rate from this basing point to the small town, 
 even though the town be nearer than the basing point to the 
 original point of shipment. Again, goods brought from a for- 
 eign country to a point in the interior may be given a rate lower 
 than the domestic rate from the point of entry to the same point 
 in the interior. Again, goods intended for export sent from Chi- 
 cago to New York may pay less than those intended for use in 
 New York. Goods are sent to San Francisco from New York 
 
TRANSPORTATION ECONOMICS 57 1 
 
 for less than the rate from many points west of the Mississippi 
 River to San Francisco.^ These conditions have largely grown 
 out of the competition of railways among themselves and with 
 waterways. 
 
 The fact that distance is one element in the expense of carriage 
 suggests that it should be taken account of in making rates, 
 although there are many circumstances which necessitate a de- 
 parture from the rule of a strict mileage rate. The fact that 
 terminal charges, for example, are the same for a long as for a 
 short haul justifies a decrease in the total charge per ton mile as 
 distance grows. The great advantage of following a schedule of 
 rates based on distance is that it affords some basis, although not 
 an absolute guide, for settling sectional disputes concerning 
 relative railway charges. 
 
 Government Ownership or Government Regulation? — With 
 the decline of competition in the railway business, the alternative 
 lies between private operation with government supervision on 
 the one hand, and government ownership and operation on the 
 other. There cannot be said to be any well-defined movement 
 for government ownership in the United States. Socialists favor 
 it as a step in the direction of their ideals, but conservative 
 persons also have recognized that the difficulty of regulating 
 railroads with sufficient stringency to prevent abuses and at the 
 same time with siiificient freedom given to railway managements 
 to develop their properties in the most efficient manner may 
 make government ownership inevitable. 
 
 No convincing argument for either side of this question can 
 be made by comparing the quality of railroad service and the 
 rates charged in countries that have government ownership with 
 the service and rates of railways privately owned and managed. 
 There is little question that government ownership is feasible 
 in this country and that good service might be expected. Greater 
 pains might be taken to consider public convenience, and labor 
 conditions might be improved for the lower classes of employees. 
 
 * See City of Spokane v. Northern Pacific Railway Co., 21 I. C. C. 400 and 23 
 I. C. C. 454; United States v. Union Pacific Railroad Co., 234 U. S. 4gs ; Commod- 
 ity Rates to Pacific Coast Terminals and Intermediate Points, 32 I. C. C. 611. 
 
572 OUTLINES OF ECONOMICS 
 
 Personal discrimination might be expected to cease altogether. 
 It has been suggested that rates could be reduced because, owing 
 to the superior credit of the United States government, capital 
 could be secured at a lower rate of interest. But it is difl&cult 
 to tell to what extent the credit of the government might be 
 adversely affected by the issue of sufficient bonds to purchase 
 the railways of this country. There might be economies in the 
 elimination of some of the expenses due to the efforts of railways 
 to get traffic away from each other, to roundabout hauls, and to 
 useless duplication of facilities. 
 
 The political consequences might be unfavorable. It would 
 be unfortunate to have sectional disputes as to rates thrown 
 into politics. Railroad extensions might become " pork," like 
 our river and harbor improvements. The voting power of 
 railway employees might be sought by politicians by promises 
 of improved conditions of work. 
 
 A most serious consideration is the question of efficiency of 
 management. A private and a public monopoly alike may be- 
 come unprogressive. It may be that our system of regulation 
 can be so developed that it will serve at once as a check upon abuses 
 and as a stimulus to efficiency. It is not always best to decide 
 today what can as well be decided tomorrow. Whether or not 
 government ownership is coming, the perfection of the govern- 
 ment control of our private railways would seem to be the wisest 
 next step. Government regulation has already accomplished 
 much in the United States. It has nearly eliminated rebates 
 and personal discrimination ; it has given stability to rates ; it 
 has strengthened railway credit ; it has promoted uniformity in 
 accounting ; it has shown that it can raise rates as well as lower 
 them and that it can settle sectional disputes as to rates in a com- 
 prehensive way. There still remains the task of determining the 
 amount of railway investment entitled to a return, of devising 
 a proper control over capitalization, of perfecting the rate 
 system, and of working out comparative standards of effi- 
 ciency. We may well hope that government ownership will at 
 least be deferred until more has been accomplished along these 
 lines. 
 
TRANSPORTATION ECONOMICS 573 
 
 Government Regulation of Railways in the United States. — 
 
 Railway corporations in the United States are almost all organ- 
 ized under the laws of the separate states. Formerly special 
 laws were passed when a railway company was to be formed, but 
 at the present time there are general laws specifying what con- 
 ditions must be complied with in order that a number of persons 
 may organize a railway corporation. The separate states have 
 imposed a number of regulations and restrictions not only on the 
 companies which they have chartered but also on others doing 
 business within their borders. These relate to the safety and 
 the comfort of passengers, train service, consolidations, pooling, 
 ticket-scalping, discriminations between shippers and places, 
 the issue of securities, and reasonableness of charges. Railway 
 or public service commissions are found in all but a few states. 
 
 That a railway corporation is subject to government regulation 
 in the interest of the public welfare has been clearly established 
 by a long line of judicial decisions beginning with the leading 
 " Granger " case of Munn vs. Illinois} But the authority of 
 the state governments has been greatly limited by two provisions 
 in the federal Constitution. Congress having been given control 
 over interstate commerce, the states must confine themselves in 
 their regulations to commerce wholly within the state. And 
 the Fourteenth Amendment declares that no state shall deprive 
 any person of life, liberty, or property without due process of law 
 or deny to any person within its jurisdiction the equal protec- 
 tion of the law. The courts have interpreted this provision to 
 mean that neither a state legislature nor a commission created 
 by it can fix rates even on m/rastate traffic without a review by 
 the courts. The courts have often declared rate legislation by 
 states void on the ground that it confiscated the property of the 
 stockholders.^ 
 
 Federal regulation of railways is based on the Interstate 
 Commerce Act of 1887, which has been repeatedly amended, 
 most extensively in 1906 and 19 10. The following is a summary 
 of the amended act, as in force in 1916 : 
 
 1 94 U.S. 113(1876). 
 
 * The Fifth Amendment imposes similar limitations upon the federal government. 
 
574 OUTLINES OF ECONOMICS 
 
 The Interstate Commerce Commission consists of seven mem- 
 bers appointed by the President with the " advice and consent " 
 of the Senate, with terms of seven years, not more than four of 
 the commissioners being from the same political party. The 
 jurisdiction of the commission extends not only over steam rail- 
 ways but also over electric railways, telegraph, telephone, and 
 cable companies, pipe lines, express and sleeping car companies, 
 and to some extent over water carriers. The control in these 
 cases extends to interstate traffic merely. 
 
 All charges and practices must be reasonable, but no general 
 standards of reasonableness have been prescribed by Congress. 
 Certain specific things are prohibited. There can be no dis- 
 crimination between persons or places and no free passes or free 
 transportation except to classes of persons specified in the act. 
 The giving of rebates renders both shipper and carrier liable 
 to punishment. Pooling is prohibited, and no railway may 
 have any interest in any competing water carrier. When rates 
 have been reduced to meet water competition they may not 
 be raised again without permission. No common carrier may 
 make any greater charge for a shorter than for a longer dis- 
 tp,nce in the same direction, the shorter being included within 
 the longer, unless authorized to do so by the commission. 
 Carriers must file with the commission copies of all their rates 
 and fares, and no carrier may make charges different from these 
 published rates. Changes in rates require thirty days' notice 
 unless a shorter time is permitted by the commission. The 
 commission may suspend rates for a period of 120 days and a 
 further period of six months. 
 
 Any person may make a complaint regarding rates or prac- 
 tices and the commission may institute inquiries on its own mo- 
 tion. It has power to fix maximum rates for a period of two 
 years and may award reparation to shippers who have been 
 overcharged. The orders of the commission may be reviewed 
 by the courts as to questions of law but not as to findings of fact. 
 A Commerce Court was created in 19 10 to hear appeals from the 
 commission's orders but this court was abolished in 19 13, its 
 jurisdiction being vested in the several district courts. 
 
TRANSPORTATION ECONOMICS 575 
 
 Section 20 of the act empowers the commission to require 
 annual and special reports from transportation companies and 
 to prescribe the form of the accounts which may be kept. Under 
 this provision uniform classifications of accounts have been 
 worked out in cooperation with railway accountants. 
 
 In 1913 Congress directed the commission to ascertain the 
 value of all the property of every common carrier subject to the 
 act. As to every piece of property there is to be ascertained 
 the original cost to date, the cost of reproduction new, the cost 
 of reproduction less depreciation, and other values, if any. In 
 19 14 the commission was given authority to enforce the Clayton 
 Anti-trust Act so far as it applies to common carriers. The 
 main purpose of this part of the act is to prevent those inter- 
 corporate relationships which tend to lessen competition. 
 
 The commission is also charged with the enforcements of 
 safety appliance and boiler inspection provisions and with 
 matters relating to hours of service of employees and to railway 
 accidents. 
 
 The Interstate Commerce Commission regularly employs about 700 
 persons, but the work of valuation has temporarily greatly increased this 
 number. A general survey of its work each year is given in its Annual Report 
 to Congress. Its 30 or more volumes of decisions, published as the Inter- 
 state Commerce Commission Reports, contain a vast amount of descriptive 
 material concerning the rate structures and the practices of railways in the 
 United States. Information concerning the mileage, capitalization, reve- 
 nues, expenses, and trafi&c of railways will be found in its annual volume called 
 Statistics of Railways in the United States. 
 
 QUESTIONS AND EXERCISES 
 
 1. Write a description of some railway system, giving its organization, 
 capitalization, earnings, dividends, nature of traihc, territory covered, etc. 
 
 2. Make a digest of the opinions in the Northern Securities Case, 193 
 U. S. 197, and the United States vs. The Union Pacific Railroad Company, 
 226 U. S. 61. 
 
 3. If you have paid $200 for a share of stock in a monopolistic enter- 
 prise, have you a right to complain if government regulation so affects its 
 earnings that the price of the share falls to $100? 
 
 4. Discuss the conflict of authority between state and federal commis' 
 sions {Shreveport Cases, 234 U. S. 342). 
 
576 OUTLINES OF ECONOMICS 
 
 5. Can one ascertain what it costs the railways to carry United States 
 mails? 
 
 6. Can the passenger service be said to be a by-product of the freight 
 service? 
 
 7. Compare some of the leading railways from the standpoint of density 
 of trafl&c. 
 
 8. What would be the economic effects of a "postage-stamp " railway rate 
 system, in which rates vary with the weight and nature of the shipment, 
 but not with distance ? 
 
 REFERENCES 
 
 AcwoRTH, W. M. Elements of Railway Economics. 
 
 Bureau of Corporations. Report on Transportation by Water, 1909, 1910. 
 
 Hammond, M. B. Railway Rate Theories of the Interstate Commerce Commis- 
 sion. 
 
 Interstate Commerce Commission. Annual Reports; I. C. C. Reports; 
 Statistics of Railways in the United States. 
 
 Johnson, E. R. American Railway Transportation; Ocean and Inland 
 Water Transportation: Report on Panama Canal Traffic and Tolls. 
 
 Johnson, E. R., and Huebner, G. G. Railroad Traffic and Rates (2 vols.). 
 
 Joint Committee on Federal Aid in the Construction of Post Roads. Re- 
 port (1914). 
 
 McPherson, L. G. Railroad Freight Rates in Relation to Industry and 
 Commerce. 
 
 Meyer, B. H. Railway Legislation in the United States, Part ii. 
 
 Morris, Ray. Railroad Administration. 
 
 MouLTON, H. G. Waterways versus Railways. 
 
 National Waterways Commission. Report (1909). 
 
 PiGOU, A. C. Wealth and Welfare, Chap. xiii. 
 
 Ripley, W. Z. Railroads: Rates and Regulation; and (editor) Railway 
 Problems. 
 
 Sakolski, a. M. American Railroad Economics. Chap. iii. 
 
 Smith, J. R. The Ocean Carrier. 
 
 Vrooman, C. S. American Railway Problems. 
 
 Webb, W. L. Economics of Railroad Construction, Part i. 
 
CHAPTER XXVIII 
 INSURANCE 
 
 Nature of Insurance. — The essential idea of the modern in- 
 stitution of insurance is cooperation in the bearing of losses which 
 are likely to happen to any one of a large group of persons but 
 which will actually fall upon but few members of the group. It 
 is thus directly opposed to gambling, although wagers have fre- 
 quently been made in the form of the insurance contract. It 
 may appear at first that the man who insures his house is 
 making a wager with the insurance company that his house will 
 burn, but this is in fact like betting on both sides of an event. 
 If the man does not insure, he may be regarded as betting that 
 his house will not burn, and by wagering with the insurance com- 
 pany that it will burn, he relieves himself of risk. For this relief 
 he is willing to incur the certain loss of his premium. Insurance 
 does not free the policy holders from loss, but it means many 
 small losses in place of a few unbearable ones. In well-devel- 
 oped forms of insurance there is also no risk for the insurance 
 company, because the amount of loss is approximately known in 
 advance, as will be explained presently. 
 
 The question is sometimes asked whether insurance is pro- 
 ductive in the sense that other economic activities are productive. 
 The answer is decidedly in the affirmative, for the feeling of 
 security that it makes possible is a real satisfaction which we are 
 willing to purchase. Then too, there is a very important eco- 
 nomic gain in distributing among many persons the burden of 
 losses which would otherwise fall heavily upon a few. Further- 
 more, the relief of distress among the unfortunate without com- 
 pelling them to accept charity is a distinct social gain, and 
 finally, many of our business operations are facilitated by the 
 iP 577 
 
578 OUTLINES OF ECONOMICS 
 
 existence of a system of insurance. Prevention of loss is not 
 properly a part of the idea of insurance, but nevertheless insur- 
 ance as it exists today does have many tendencies in that 
 direction, especially in such forms as fire and steam-boiler in- 
 surance. On the other hand, insurance causes a certain amount 
 of loss by provoking to some extent incendiarism, self -mutilation, 
 or suicide, and even normal persons are likely to be less careful 
 when they know they are insured. On the whole, however, we 
 can scarcely overestimate the importance to society of an in- 
 stitution which equalizes economic shocks and multiplies the 
 incentives to thrift. 
 
 The Law of Probabilities. — A special profession (that of the 
 actuary) and a special branch of mathematics have grown up as 
 a basis of the institution of insurance. It is a knowledge of the 
 law of large numbers that changes insurance from a wager to a 
 business of a routine-like nature. If a coin is tossed a large num- 
 ber of times, heads will appear about as often as tails. This may 
 be counted upon as practically certain, but with respect to any 
 particular throw taken by itself, there is no way of telling in ad- 
 vance whether heads or tails will appear. This truth has been 
 worked out and applied most definitely to life insurance, but in 
 other business callings also an effort is made to gather data that 
 will m.ake possible the formulation of statistical laws as guides 
 in making business plans. 
 
 Origin and Development. — Arrangements embodying the 
 idea of insurance are found among the ancients, but the modern 
 institution of insurance, although its origin is obscure, first be- 
 comes prominent in the loans on bottomry which became com- 
 mon during the thirteenth and fourteenth centuries. A loan on 
 bottomry meant that money was borrowed by the owner of a ship 
 and was to be repaid with interest at the termination of his 
 voyage, but the principal and interest were not to be repaid if 
 the ship was lost. Sometimes this took the form of insuring 
 the captain's life, but no scientific system of life insurance ap- 
 peared until the compilation of life tables. 
 
 Fire insurance received an impetus from the Great Fire of 
 London in 1666, the first company organized upon strict mer- 
 
INSURANCE 579 
 
 cantile principles being the " Fire OflSce," organized in 1680. It 
 had a brigade of its own to prevent and extinguish fires. In 
 1693 Edmund Halley made a report to the Royal Society regard- 
 ing the mortality at various ages upon the basis of tables of 
 births and funerals at the city of Breslau ; but, practically, life 
 insurance as a business dates from th-e organization of the " Old 
 Equitable " in 1762. 
 
 Before this, however, there were many associations for conducting in- 
 surance upon a speculative basis, which entered into wagers of every con- 
 ceivable description. "Even the morality of the newspapers of that day 
 was shocked by such proceedings; we find the London Chronicle of 1768 
 thus declaiming, 'The introduction and amazing progress of illicit gaming 
 at Lloyd's Coffee-house, is among others, a powerful and very melancholy 
 proof of the degeneracy of the time. Though gaming in any degree is per- 
 verting the original and useful design of that Coffee-house, it may in some 
 measure he excusable to speculate on the following subjects : — Mr. Wilkes 
 being elected member for London ; which was done from 5 to 50 guineas 
 per cent.; — Mr. Wilkes being elected member for Middlesex, from 20 to 
 70 guineas per cent ; — Alderman Bond's life /or one year, now doing at 7 per 
 cent; — On Sir J. H. [mark the modesty] being turned out in one year, now 
 doing at 12 guineas per cent; — On John Wilkes' life for one year, now 
 doing at five per cent. N.B. — Warranted to remain in prison during that 
 period; — On a declaration of war with France or Spain in one year, 8 
 guineas per cent. But,' continues the sensitive Journalist, 'when policies 
 come to be opened on two of the first peers in Britain losing their heads 
 at los. 6d. per cent, or on the dissolution of the present parliament within 
 one year at 5 guineas per cent., which are now actually doing, and under- 
 written chiefly by Scotsmen, at the above Coffee-house, it is surely high time 
 to interfere.'" ^ 
 
 In the United States, fire insurance was fairly well begun 
 even in pre-revolutionary days. In 1830 the New York Life 
 and Trust Company was organized, and twelve years later ap- 
 peared the Mutual Life Insurance Company of New York, 
 which is the oldest of the existing American life insurance com- 
 panies which insure more than a restricted class of individuals. 
 In the seventies numerous failures brought the " old line " life 
 insurance companies into discredit, and in the following years 
 this fact, together with the desire for cheap insurance, caused 
 
 ^ Walforci, The Insurance Guide and Handbook, 4th ed., p. 27. 
 
58o OUTLINES OF ECONOMICS 
 
 a marked development of assessment insurance, against which 
 there has in turn been a reaction because of its unscientific basis. 
 Subsequently the " old line " companies again suffered a loss of 
 prestige on account of the scandalous extravagance and corrup- 
 tion revealed by official investigations. The evil practices had 
 to do chiefly with the management of the surplus, which was not 
 under legal control as was the reserve. (These terms will be ex- 
 plained presently.) The accompanying table shows the growth 
 in American life insurance since 1850. The check in 1880 may 
 be noted. Between 1890 and 1910 the total amount of life in- 
 surance in force in ordinary and industrial companies increased 
 fourfold. The average amount in force per family was $319 
 in 1890 and $801 in 19 10. It is perhaps needless to state that 
 the average amount per policy is much larger than this in 
 ordinary though not in industrial insurance. The foregoing 
 does not include the insurance fraternal orders, which had 
 10,122,169 certificates and $9,839,909,282 of insurance in force 
 in 1911. 
 
 Forms of Insurance Organization. — Fire insurance may be 
 written by stock companies, by mutual companies, or by associa- 
 tions of individual insurers, known as underwriters and Lloyds. 
 Mutual companies, again, may be either local (county or town) 
 mutuals, state or general mutuals, or the manufacturers' mutuals. 
 The local town mutuals have the advantage that they can be 
 conducted with a very low cost of administration, but the stock 
 companies seem best adapted to the business of fire insurance, 
 since it is desirable that the risk of a conflagration should be 
 spread over a very wide territory. 
 
 Life companies are also found both in the stock and mutual 
 form. Theoretically the management of the latter is in the 
 hands of the policy holders themselves, but in actual practice 
 they must be managed by a small group of financiers. Life in- 
 surance companies are also classified according to the plans of 
 premium payments : (i) " old line " level premium, (2) assess- 
 ment, and (3) stipulated premium. 
 
 Where risk enters in modern life, companies are often organized 
 to offer an escape from it through insurance even before enough 
 
INSURANCE 
 
 581 
 
 data have been collected to make possible the accurate predic- 
 tion of the amount of loss. In addition to life insurance we have 
 indemnity in case of sickness, accident, destruction by fire, 
 wind, hail, or explosions of boilers or fly wheels, broken windows, 
 
 NtJMBER OF Policies and Amount of Life Insiirance in Force in 
 Ordinary and Industrial Companies, 1850 to 191 2 ^ 
 
 Ordinary 
 
 Industrial 
 
 Calendar 
 Year 
 
 Number of 
 Policies 
 
 Amount (Dollars) 
 
 Number of 
 Policies 
 
 Amount (Dollars) 
 
 1850 
 i860 
 1870 
 1880 
 1890 
 1895 
 1900 
 
 190S 
 19 10 
 1912 
 
 29,407 
 
 60,000 
 
 839,226 
 
 685,531 
 1,319,561 
 1,940,945 
 3,176,051 
 5,621,417 
 
 6,954,119 
 8,159,103 
 
 68,614,189 
 
 180,000,000 
 
 2,262,847,000 
 
 1,581,841,706 
 
 3,620,057,439 
 
 4,917,694,131 
 
 7,093,152,380 
 
 11,054,255,524 
 
 13,227,213,168 
 
 15,555,901,171 
 
 236,674 
 3,882,914 
 
 6,952,794 
 11,219,296 
 16,872,583 
 23,044,162 
 26,521,655 
 
 20,533,469 
 
 428,789,342 
 
 820,746,562 
 
 1,468,928,342 
 
 2,309,754,235 
 3,179,489,541 
 3,684,054,893 
 
 and loss from burglary or the unfaithfulness of employees. Li- 
 ability insurance in over a dozen different forms guards against 
 loss from damage suits. It is impossible to take up the problems 
 that are peculiar to each one of these branches, and attention will 
 be confined to some of the leading features of life insurance and 
 of what is called social insurance. 
 
 Life Insurance 
 
 Life Tables. — A life table or mortality table shows how many 
 of a large group of persons of the same age will survive to each 
 higher age. A number of these tables have been calculated, 
 but the one generally used in this country is the American Ex- 
 perience table, a portion of which is here reproduced : 
 
 ^ Statistics from the Insurance Year Book. 
 
582 
 
 OUTLINES OF ECONOMICS 
 
 Age 
 
 Living at Beginning of Year 
 
 Dying during the Year 
 
 lO 
 
 100,000 
 
 749 
 
 II 
 
 99,251 
 
 746 
 
 12 
 
 98,505 
 
 743 
 
 13 
 
 97,762 
 
 740 
 
 14 
 
 97,022 
 
 737 
 
 IS 
 
 96,285 
 
 735 
 
 16 
 
 95,550 
 
 732 
 
 17 
 
 94,818 
 
 729 
 
 18 
 
 94,089 
 
 727 
 
 19 
 
 93,362 
 
 725 
 
 * 
 
 * 
 
 * 
 
 90 
 
 847 
 
 385 
 
 91 
 
 462 
 
 246 
 
 92 
 
 216 
 
 137 
 
 93 
 
 79 
 
 58 
 
 94 
 
 21 
 
 18 
 
 95 
 
 3 
 
 3 
 
 With such data and with an assumed rate of interest and ex- 
 pense, it is possible to say with considerable certainty how much 
 money must annually be collected from the policy holders in 
 order to pay each one $1000 or other specified sum at death. 
 
 Premium Plans. — It would be possible to collect from those 
 surviving at each age enough money to pay for the deaths that 
 would happen during the ensuing year. This step rate or natural 
 premium plan necessitates a larger and larger assessment with 
 advancing age ; that is, as the earning power of the insured is 
 declining. This induces many persons who continue in good 
 health to discontinue their insurance, thus leaving only an " ad- 
 verse selections of risks " for the insurance company or associ- 
 ation. It has become customary to arrange the payments on 
 what is known as the level premium plan, the same annual pay- 
 ment being made throughout the life of the policy. This pay- 
 ment may be on the ordinary life plan, that is, the payments 
 continue throughout life ; or ten, fifteen, or twenty limited pay- 
 ments may be made, the policy continuing in force for life; 
 
INSURANCE 583 
 
 or the insurance may be for only a term of years during which 
 the premiums are paid, the insurance ceasing entirely at the 
 end of the term. This is the cheapest kind of insurance, for 
 the insurance company knows that many of the insured will 
 survive beyond the term, and to them no payment need be 
 made, but when the insurance continues for life, the payment 
 becomes a certainty in every case. 
 
 The Reserve. — If a level premium is charged, the income of 
 the company in the earlier years of a policy exceeds the expense 
 of carrying the risk, as measured by the losses on account of the 
 deaths among the policy holders of like age. The portions of the 
 premium not currently used must be held for the credit of the 
 policy holder until the later years, a certain rate of interest being 
 allowed. This accumulating fund is known as the reserve. In 
 the later years of the life of a policy, the reserve is gradually 
 drawn upon to meet the deficit arising from the fact that in 
 these years the level premium payments will be insufficient to 
 meet the cost of carrying the risk, — smaller, that is, than they 
 would have been under the step rate or natural premium plan. 
 
 Surplus. — If the insured live longer than was assumed by 
 the company in calculating its premiums, more money will be 
 collected than is necessary to meet the obligations of the insur- 
 ance contracts. This is one source of surplus. Again, the 
 funds held in trust by the company may be invested at a higher 
 rate of interest than was assumed in the calculations, and this is 
 a second source of surplus. A third source of surplus is in keep- 
 ing expenses below what was assumed in the calculations. (The 
 addition which is made to the net premium to cover expenses is 
 called "loading," and is commonly not far from a fourth of the 
 gross premium.) The amounts paid in by those who subse- 
 quently lapse or surrender their policies do not all go to the 
 surplus, for it is customary now to allow " surrender values " 
 and " paid-up insurance " ; but as these allowances are subject 
 to a surrender charge, there is some addition to the surplus 
 from the surrendered or lapsed policies. Out of the surplus are 
 paid the dividends on the capital stock, if there be any, and 
 the dividends to each policy holder, which in some cases are 
 
584 OUTLINES OF ECONOMICS 
 
 credited or paid annually to each policy holder, but in other 
 cases not untU the expiration of a period of years. 
 
 Endowments. — What is ordinarily called an endowment 
 policy is a combination of two distinct forms of contract. A 
 simple life insurance contract promises to pay a certain sum 
 upon the death of the insured ; a pure endowment contract would 
 pay a certain sum if the holder of the policy survives after a 
 period of years. A twenty-year endowment insurance policy 
 combining these two features means that payment would be 
 made at death if that occurred within the twenty years, or at the 
 expiration of twenty years if the policy holder survives. 
 
 This form of policy has been declining in popularity because 
 in its ordinary form it is disadvantageous to the policy holder, 
 unless he be so thriftless that he cannot be induced to save in any 
 other way. If insurance could not be obtained in any other 
 way, it might be wise to purchase such a policy, but the objects 
 of saving and insuring can be more cheaply accomplished by 
 separating the two features. If, instead of paying $50 for an 
 endowment policy, the holder paid part of this for term insurance 
 and put the remainder in a savings bank at three or four per cent 
 compound interest, there might be more to his credit whether 
 he lived or died. But when the loading is properly arranged, 
 and with an annual distribution of surplus, the endowment policy 
 performs a useful function as an encouragement of thrift. In 
 fact, a very long-term endowment maturing at, say, age sixty- 
 five, would best meet the needs of a great many persons. Many 
 others, feeling that they lack the necessary determination to save 
 regularly a portion of their incomes in the ordinary way, find 
 the endowment policy a useful form of " compulsory saving." 
 
 These points will be made clearer by the following illustration 
 of what becomes of the premium in the case of a ten-year endow- 
 ment policy at age thirty-five with a premium of $107.70, when 
 it is assumed that the mortality will be in accordance with the 
 American Experience Table, that the company will earn three 
 per cent on its funds, and that the expense charged each year to 
 this policy will be as given in the table.^ 
 
 * Report of the Wisconsin Joint Legislative Investigating Committee, igo6, p. 153. 
 
INSURANCE 
 
 58s 
 
 Policy Year 
 
 Expense Charge 
 
 Mortality Charge 
 
 Deposit 
 
 I 
 
 $ 18.40 
 
 $7-96 
 
 $ 81.34 
 
 2 
 
 18.40 
 
 7-31 
 
 165.77 
 
 3 
 
 18.40 
 
 6.62 
 
 25342 
 
 4 
 
 18.40 
 
 5-89 
 
 344-43 
 
 5 
 
 18.40 
 
 5.10 
 
 438.96 
 
 6 
 
 18.40 
 
 4.26 
 
 537-17 
 
 7 
 
 18.40 
 
 3-32 
 
 639.27 
 
 8 
 
 18.40 
 
 2.32 
 
 745-43 
 
 9 
 
 18.40 
 
 1. 21 
 
 855-89 
 
 10 
 
 18.40 
 
 — 
 
 970.87 
 
 Totals 
 
 $ 184.00 
 
 $43-99 
 
 
 Industrial Insurance. — The business of insuring the lives of 
 workingmen in this country is characterized by the small size 
 of the average policy, the large number of lapses, and the heavy 
 expense of solicitation. The companies say that the working- 
 man is so thriftless that it is necessary to collect the premiums 
 through a house-to-house canvass by agents. The hesitancy 
 shown by workingmen to insure in these companies is considered 
 by some persons, however, as an evidence of their thrift. Which 
 is the correct view may be shown by the results of an experiment 
 which is now being tried in the state of Massachusetts. Savings 
 banks have been authorized to organize insurance departments 
 and to sell life insurance, but without employing paid agents or 
 solicitors. The state bears the actuarial, medical, and certain 
 other expenses. The workingman is expected to go of his own 
 accord to the bank or to one of the agencies at convenient places. 
 The whole system is supervised by a state actuary and a state 
 medical director, and the safety of the plan is assured by a guar- 
 antee fund. Three forms of policies, limited to $500 each, are 
 provided for : ordinary life insurance, endowment, and a com- 
 bination of life insurance and old-age annuity. The plan has 
 met with some success, but is still in an experimental stage. 
 
 State Insurance. — Insurance is well adapted to direct man- 
 agement by the State because the actual conduct of the business 
 
586 OUTLINES OF ECONOMICS 
 
 is of a relatively simple and routine character and because the 
 State can offer greater security and can command greater confi- 
 dence than is possible in the case of a private corporation. Com- 
 petition has had the effect of causing rival companies to invent 
 many outwardly attractive combinations of policy conditions, 
 but on the whole it has increased rather than decreased the ex- 
 pense of doing the business. When the State enters the field 
 simply as an additional competitor, as in New Zealand, its full 
 advantage is not apparent ; but if it has a monopoly of the busi- 
 ness and compels every one to insure, it can perhaps, without 
 any selection of risks, effect the insurance at a lower price than 
 is asked by any existing private company.^ In 19 13 the state 
 of Wisconsin began the sale of life insurance. The main object 
 of the law is the reduction in the cost of insurance by reducing 
 the expense of solicitation and administration. The credit of 
 the state is involved only to the extent of the life fund created by 
 the insurance act. In Italy life insurance is a state monopoly. 
 
 State Regulation. — Following the example of Massachusetts 
 in 1858, other states have appointed insurance commissioners 
 for the supervision of this business, and the insurance laws of 
 a single one of these states are now sufficient to make a good- 
 sized volume. Insurance companies have found this variety of 
 control irksome and have generally advocated federal control of 
 insurance. Although something would be gained, it cannot be 
 said that there is any great need of federal control of life insur- 
 ance, not to mention the constitutional difficulties, because it is 
 not absolutely necessary, as in transport or fire insurance, that 
 one life company do business in many states, and the people of 
 each state should have the power to say what kind of insurance 
 institutions they desire to have. 
 
 An enumeration of the requirements in the state of New York 
 will illustrate the nature of state regulation : A certificate of 
 authorization must be obtained from the Superintendent of In- 
 surance and a deposit of securities must be made. A minimum 
 capital stock is prescribed and regulations are made concerning 
 
 1 Consult the article by M. M. Dawson in Bliss, Encyclopedia of Social Reform, 
 new ed., p. 637. 
 
INSURANCE 587 
 
 the investment of stock and surplus. There are also provisions 
 relating to standards of solvency, reinsurance, limitation of risks, 
 admission of foreign companies, examination of accounts, and 
 annual reports. The policy must contain the entire contract, 
 and the statements are to be taken as representations and not 
 warranties. No misleading estimates and deceptive statements 
 are to be issued for the purpose of getting business. Life insur- 
 ance companies are to do either a participating or non-partici- 
 pating business, and in the former case the surplus must be an- 
 nually apportioned and paid to each policy. There are further 
 provisions regarding the valuation of policies, surrender values, 
 discrimination, election of directors, limitation of the amount of 
 new business each year, limitations as to expenses and salaries of 
 oflScers, and standard forms of policies are prescribed for both life 
 and fire insurance. 
 
 Social Insurance 
 
 Social Insurance Defined. — Social insurance refers to those 
 insurance or quasi-insurance institutions which are organized 
 by the state to alleviate the distress which is likely to fall upon 
 the poorer classes as a result of accident, sickness, invalidity, 
 old age, unemployment, and the premature death of the chief 
 wage earner of the family. All insurance is obviously social 
 in the sense that it implies cooperation on the part of many 
 persons and is subject to extensive state regulation, but what 
 is called social insurance implies the activity of the state far be- 
 yond mere regulation. It is true that private activity has done 
 much in the direction of workingmen's insurance, but it is be- 
 cause these efforts have proved inadequate that the movement 
 for social insurance has gathered force. It is to be distinguished 
 from poor relief in that it recognizes that the normally thrifty 
 wage earner cannot purchase adequate life and accident insur- 
 ance from private commercial companies and that the respon- 
 sibility rests on society to provide that which it is impossible for 
 the individual to provide. It endeavors by insurance methods 
 to provide in advance for the coming of the evil day, so that the 
 
588 OUTLINES OF ECONOMICS 
 
 benefits paid will be received, not as a matter of charity, but 
 as a matter of right. 
 
 Compensation for Industrial Accidents. — In the United 
 States social insurance has begun its development in connection 
 with the problem of industrial accidents. Under the common 
 law, the employer is not responsible to an employee injured 
 while at work if a reasonably safe place to work has been fur- 
 nished. Even if the employer is at fault, there is no redress if 
 there has been contributory negligence on the part of the em- 
 ployee or one of his fellow servants or if the accident happens 
 without negligence that can be traced to any particular person. 
 This law of negligence has generally been modified by legis- 
 lation designed to increase the responsibility of the employer, as, 
 for example, by the restriction or elimination of the fellow ser- 
 vant doctrine."^ While employees have sometimes been able to 
 secure damages amounting to small fortunes, the general result 
 of this legal system is that in the vast majority of cases only 
 small damages or none at all are secured, or, if secured, they are 
 in large part offset by the cost of litigation. The liability 
 of the employer, however, is a serious matter to him, and an ex- 
 pensive system of employers' liability insurance has grown up. 
 The more severe the modifications in the law of negligence be- 
 come, the higher are the rates imposed by the liability com- 
 panies. Such is the expense of conducting this business that 
 it is safe to say that less than one half of the money paid for em- 
 ployers' liability insurance premiums ever reaches the injured 
 employees in damages. While labor leaders were drafting bills 
 designed to increase still further the liability of employers, 
 attention was turned to European practice, where the view 
 had come to prevail that it is useless to try to locate the 
 responsibility for accidents, except for purposes of preventing 
 them in the future, and that if a workman is injured in the 
 course of his employment, he should be promptly assisted, even 
 if he had been negligent. Accidents were looked upon as a 
 trade risk against which the workingman should be adequately 
 insured. 
 
 ^ See Chapter xxiii. 
 
INSURANCE 589 
 
 The result was that in the years following 1910a wave of work- 
 men's compensation legislation swept over our northern and 
 western states. By the end of 1914 over one half of our states 
 had enacted compensation for accident laws. The federal 
 government had in 1908 established a system of compensation 
 for industrial accidents for the majority of its industrial em- 
 ployees. During the first five years of its operation $1,804,000 
 was paid out as compensation, nearly one half of which was paid 
 to employees of the Isthmian Canal Commission. The law 
 did not abolish the criterion of negligence, as according to its 
 terms accidents resulting from the misconduct or negligence 
 of the injured person are not compensated. The amount of 
 compensation is the injured workman's wages during disability, 
 not exceeding one year, or in fatal cases, an amount equal to one 
 year's wages. In other respects also the law does not conform 
 to an ideal compensation law and efforts have been made to 
 amend it.^ 
 
 The provisions of the various state laws differ greatly in de- 
 tail, but it may be said that in general they provide for definite 
 payments to injured workmen in hazardous employments, prac- 
 tically regardless of negligence and almost universally at the 
 expense of the employer. In some states the law is compul- 
 sory, that is, the employer engaged in the industries covered 
 must pay the compensation specified and must insure himself 
 against the liability. In other states the law is nominally op- 
 tional, the employer and employee being free to remain under 
 the old law of negligence, but an inducement is given to them to 
 choose the new compensation method by providing that if either 
 does not accept it, he is put to certain disadvantages under the 
 law of negligence. The purpose of this roundabout method (not 
 always successful) of securing compliance is to overcome the 
 difficulty that under our constitutional guarantees of freedom 
 a direct compulsion might not be sanctioned by our courts, 
 while the modification of the law of negligence is well established 
 by precedent. 
 
 The following are the standards (abridged) recommended by 
 
 * Bulletin of the Bureau of Labor Statistics, No. 155, p. 77. 
 
590 OUTLINES OF ECONOMICS 
 
 American Association for Labor Legislation for workmen's 
 compensation laws : ^ 
 
 1 . As to the scale of compensation : Medical attendance 
 should be furnished. No compensation should be paid for a 
 definite period at the beginning of disability, the period being 
 not less than three nor more than seven days. The disabled 
 workman should receive during total disability 66f per cent 
 of wages, not to exceed $20.00 a week and not less than $5.00= 
 In case of partial disability the compensation is based on loss 
 of earning power. In case of death, the employer should be 
 required to pay funeral expenses, and the widow, if living with 
 the decedent at the time of his death, or if dependent, should be 
 granted 35 per cent of his wages until her death or re-marriage, 
 with a lump sum on re-marriage equal to two years' compensa- 
 tion. Compensation may also be given to other dependents. 
 
 2. The general argument for compensation applies to all 
 employments, but practical considerations may justify the tem- 
 porary exclusion of farm labor, domestic servants (except in 
 connection with hotels and restaurants) and casual employ- 
 ment not carried on for the profit of the employer. 
 
 3. Compensation should be provided for all personal injuries 
 in the course of employment, and death resulting therefrom in 
 six years, but no compensation should be allowed where the 
 injury is occasioned by the wilful intention of the employee 
 to bring about the injury or death of himself or another. The 
 act should embrace occupational diseases which, when con- 
 tracted in the course of employment, should be considered 
 personal injuries for which compensation shall be payable. 
 
 4. Compensation should be the exclusive remedy; that is, 
 the workman should not be given the option of bringing suit 
 under the law of negligence. 
 
 5. Employers should be required to insure their compensation 
 liability. Employers may maintain their own insurance fund 
 under certain conditions, insure in a mutual association, in a state 
 insurance fund, or in a private stock company. 
 
 6. An accident board should be maintained by the state, 
 
 ^American Labor Legislation Review, vol. iv, p. 585. 
 
INSURANCE 591 
 
 the members of which should devote their entire time to the 
 administration of the compensation law. 
 
 7. Provision should be made for the settlement of compen- 
 sation claims either by agreement subject to the approval of the 
 accident board, or if no agreement is reached, by arbitration, 
 with an appeal to the accident board. Appeals from the decrees 
 of the accident board should be allowed only on questions of law. 
 
 8. Provision should be made for full and accurate reports of 
 all industrial accidents. 
 
 Occupational diseases are not included by the compensation 
 laws of the several states, although the Supreme Court of Massa- 
 chusetts has construed such diseases to be injuries entitling the 
 employee to compensation. In Michigan, however, the con- 
 trary view has been taken. 
 
 Sickness Insurance. — Compulsory sickness insurance has 
 been introduced in about one half of the large countries of 
 Europe and voluntary subsidized sickness insurance in others, 
 but we have so far left practically everything in this direction 
 to private effort, although there are state miners' hospitals in 
 five states and the federal government conducts a hospital 
 service for seamen. Many students of the subject believe that 
 sickness insurance will never be made effective unless it is made 
 compulsory. It is significant that Great Britain, where the tradi- 
 tions, as in the United States, are against compulsion, made 
 sickness insurance compulsory by the act of 191 1. The major- 
 ity of workers, by virtue of being employed, are assured certain 
 benefits in case of illness, the cost of the insurance being met 
 partly by the government, partly by the employer, and partly by 
 deduction from the employees' wages. In Germany, where a 
 system of compulsory sickness insurance was established as early 
 as 1883, one third of the cost is borne by the employers and two 
 thirds by the employees. The sickness insurance benefits in 
 that country cover also the care in whole or in part for the first 
 thirteen weeks of those injured as the result of industrial acci- 
 dents, after which time the accident benefits are paid wholly from 
 accident insurance funds, and include maternity benefits, fu- 
 neral benefits, and sometimes sick benefits for the members of the 
 
592 OUTLINES OF ECONOMICS 
 
 family other than the insured. Maternity benefits were added 
 in England by an amendment in 19 13. We have need for simi- 
 lar laws in this country and the framing of such laws may be 
 looked upon as the next step in social insurance here. 
 
 Old Age Insurance. — We are familiar in the United States 
 with a pension system growing out of past wars and with local 
 pensions for firemen and policemen. Other countries have 
 provided in a much more general way by pensions, subsidized 
 voluntary insurance, or by compulsory insurance for the relief of 
 persons incapacitated by old age. Invalidity and old age insur- 
 ance is one of the three great branches of the German insurance 
 system. It covers the great majority of the wage earners of 
 both sexes. There are contributions in equal amounts by the 
 insured workmen and their employers and a yearly addition is 
 made to each pension by the government. The English law of 
 1908, on the other hand, provides for a straight pension to per- 
 sons 70 years of age or over whose incomes are below $153 a 
 year and who have not certain disqualifications mentioned in the 
 act. The amount paid varies from 24 cents to $1.20 aweek. 
 The British system resembles poor relief more closely than insur- 
 ance. For years an attempt has been made to induce the United 
 States government to adopt an old age pensions system for its 
 employees, but there has been radical difference of opinion as to 
 whether such a system should be with or without contributions 
 by employees. In this, as in the more general problem, a non- 
 contributory pension may be the more advisable at the start, 
 but a contributory old age insurance system is doubtless more 
 desirable as permitting of more liberal incomes and as en- 
 couraging thrift. 
 
 Unemployment Insurance. — The solution of the problem 
 of unemployment involves much more than insurance. The 
 progress of industry should be made less irregular and men and 
 opportunities for work should be brought together more readily. 
 Attention is being turned at present in the United States to the 
 establishment of a national system of labor exchanges. It is 
 not to be expected, however, that unemployment can be elimi- 
 nated. It is a misfortune which should be provided against by 
 
INSURANCE 593 
 
 insurance. Many European cities have made experiments in 
 this field which have left much doubt as to the practicability 
 of insurance as a general remedy for the evil of unemployment. 
 But the British National Insurance Act of 191 1 has instituted a 
 great experiment which is tending to remove this doubt. By 
 that act persons engaged in building, construction of railroads, 
 docks, or canals, shipbuilding, iron-founding, construction of 
 vehicles, and saw-milling are entitled to receive unemployment 
 benefits. About a quarter of a million of persons are covered 
 by the act. The cost of this insurance is met by contributions 
 from employers and employees and partly from appropriations 
 by Parliament. 
 
 Life Insurance for Workingmen. — Our private life insurance 
 companies are selling a good many policies which are pay- 
 able, not as lump sums, but in installments or annuities, to the 
 survivors of the insured. Wage earners cannot often afford to 
 purchase such policies, but the same object is to some extent 
 attained by widows' and orphans' pensions. Beginning with 
 1 91 2 such pensions have been made a part of the German in- 
 surance system. In the United States many state laws have 
 recently been enacted providing for pensions to mothers in need 
 of relief. While these American acts are to be viewed as a form 
 of poor relief, they are significant as possible forerunners of a 
 comprehensive system of workingmen's life insurance. 
 
 Objections to Social Insurance. — Aside from questions of 
 constitutional law, social insurance is met with the following 
 difficulties : (i) It implies a considerable addition to the wages 
 bill and it has been urged that it is unfair to place this burden 
 on the employers of one state unless similar burdens are placed 
 on employers of other states. (2) It is contrary to the eco- 
 nomic philosophy of those who wish to see state activity reduced 
 to a minimum. (3) It has been charged that social insurance 
 discourages thrift and that it leads to demoralization because it 
 encourages malingering and staying at home for trivial ailments. 
 Cases are cited in which a maternity benefit was spent on liquor 
 by the husband, and one man is said to have spent the maternity 
 benefit in the purchase of a graphophone. It should be noted, 
 
 2Q 
 
594 OUTLINES OF ECONOMICS 
 
 however, that all insurance is subject to abuse. Who would 
 question the beneficence of fire insurance because it leads in 
 some cases to incendiarism? Fire insurance companies do a 
 good deal in the way of fire prevention. Similarly, not the 
 least important aspect of social insurance is its relation to the 
 conservation of the national health. The employers' associa- 
 tions in Germany organized for accident compensation have 
 done much for accident prevention, and a system of sickness 
 insurance gives timely medical and adequate care to many who 
 now waste their money on patent medicines. 
 
 QUESTIONS 
 
 1. Define insurance. 
 
 2. What is a mortality table? 
 
 3. How woiild you find the premium for insuring a group of persons for 
 one year for $1000 each? 
 
 4. Distinguish between reserve and surplus. 
 
 5. What is a "pure" endowment pohcy? 
 
 6. What are the advantages and disadvantages of assessment insurance ? 
 
 7. What has been New Zealand's experience with State insurance? 
 
 8. What is meant by the "moral hazard"? 
 
 9. What are tontine policies ? 
 
 10. Why is the "fellow-servant doctrine" not suited to modern con- 
 ditions ? 
 
 11. Discuss the possible effects of social insurance on wages. 
 
 12. Are old-age pensions a form of insurance? 
 
 REFERENCES 
 
 Alexander, William. The Life Insurance Company. 
 
 American Labor Legislation Review: "Social Insurance," June, 1913; 
 " Sickness Insurance," March, 1914; "Unemployment," May, 1914. 
 
 Annals oj the American Academy of Political and Social Science, Vol. xxvi. 
 
 Dawson, M. M. The Elements of Life Insurance; The Business of Life 
 Insurance. 
 
 Dawson, W. H. Social Insurance in Germany. 
 
 FoERSTER, R. F. "The British National Insurance Act," Quarterly Jour- 
 nal of Economics, Vol. xxvi, p. 275. 
 
 Feankel, L. K. and Dawson, M. M. Social Insurance in Germany. 
 
 Fricke, W. A. (compiler). Insurance — A Text-hook. 
 
 Gephart, W. F. Insurance and the State; Principles of Insurance {Life). 
 
 Gibbon, I. G. Unemployment Insurance, Chap. viii. 
 
INSURANCE 595 
 
 Gow, William. Marine Insurance. 
 
 HuEBNER, Solomon. Property Insurance; Life Insurance. 
 
 Jack, A. F. An Introduction to the History of Life Assurance. 
 
 Kitchen, F. H. The Principles and Finance of Fire Insurance. 
 
 Massachusetts Commission on Old Age Pensions, Annuities, and Insurance. 
 
 Report, 1910. 
 Mom, Henry. Life Assurance Primer. 
 
 New York Insurance Investigating Committee. Report, 1905 (6 vols.). 
 RuBiNOW, I. M. Social Insurance. 
 Seager, H. R. Social Insurance. 
 The Insurance Year Book, Annual (2 vols.) 
 United States Bureau of Labor Statistics. Bulletin, Nos. loi, 102, 103, 107; 
 
 109, 126, and 155. 
 United States Commissioner of Labor. Twenty-fourth Annual Report. 
 Walford, Cornelius. The Insurance Guide and Handbook. 
 Wisconsin Insurance Investigating Committee. Report, 1906. 
 Yale Readings on Insurance (2 vols.) 
 Zartman, L. W. The Investments of Life Insurance Companies. 
 
CHAPTER XXIX 
 AGRICULTURAL PROBLEMS 
 
 The socialistic ideal of a highly centralized and delicately 
 coordinated industrial system, discussed in the following chap- 
 ter, is confronted with a sharp contrast in the agricultural in- 
 dustry as it exists to-day. Even in the most advanced coun- 
 tries, agriculture is still strikingly decentralized, and furnishes 
 at once the best illustration and the most fertUe source of 
 economic individualism. Even in this country, where the 
 movement of industrial consolidation has proceeded with un- 
 usual rapidity, agriculture has never been, and shows little 
 tendency to become, a large-scale industry. The principal 
 statistical evidence bearing upon this aspect of American agri- 
 culture is presented in Table I, on the following page. 
 
 Size of Farms. — So magnificent was the public domain of 
 the United States that for many generations the number of 
 farms increased more rapidly than the population and much 
 more rapidly than the rural population. Between 1850 and 
 1910, for instance, the number of farms increased more rapidly 
 than the population in four of the six decades. But such a 
 movement could not continue indefinitely, and in recent years 
 the relative number of farms has slightly fallen off. Even to- 
 day, however, as shown in the last column of Table I, there is a 
 larger acreage of improved farm land per capita than there was 
 in 1850, and despite the rapid increase of population between 
 1900 and 1 9 10, the increase in the amount of improved farm 
 land almost kept pace. 
 
 This steady increase in the number of farms and farmers could 
 only have been maintained by a general diminution in the aver- 
 age size of the farm. From 1850 to 19 10 the average number 
 of acres per farm decreased from 203 to 138, while the acreage 
 
 596 
 
AGRICULTURAL PROBLEMS 
 
 597 
 
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598 OUTLINES OF ECONOMICS 
 
 of improved land per farm has remained nearly constant. 
 Since 1880 we have had detailed statistics for farms of different 
 sizes. Farms of all sizes have been increasing, but the in- 
 crease has been greatest for farms under 50 acres in size, the 
 relative importance of which has increased steadily since 1880. 
 The relative importance of farms over 50 acres in size has 
 decreased. 
 
 Broad statements of this kind cover a multitude of different 
 movements and tendencies. Between 1900 and 1910, for in- 
 stance, farms under 50 acres and from 175 to 1000 acres increased 
 more rapidly than the total; whereas farms from 50 to 175 
 acres, and those over 1000 acres in extent, increased less rapidly 
 than the total. In the North, between 1900 and 1910, farms 
 between 20 and 100 acres in size decreased both absolutely and 
 relatively; all others, including farms over 1000 acres, gained 
 in relative importance. 
 
 In the South, farms smaller than 100 acres increased while 
 those over 100 acres in size diminished in relative importance. 
 In the West the movement was substantially the same as in the 
 South : farms under 100 acres in size increased while all those 
 over 100 acres in size lost ground, comparatively speaking, 
 except the class of farms containing from 175 to 449 acres, 
 which showed a small relative gain. In the North, particu- 
 larly in New England, there seems to be a real increase in the 
 number and importance of the large farms, those which in cer- 
 tain sections would be called " gentlemen's farms " ; but this 
 is more than counterbalanced by the partition of plantations of 
 the South and of the cattle ranges and bonanza farms in the 
 West. 
 
 Although the average farm decreased in size between 1900 
 and 1910, there was a striking increase in the value of the aver- 
 age farm and its equipment. In the last half of the nineteenth 
 century no tendency towards the increase in capital value of 
 the farm unit had appeared. The value of the total property 
 and equipment of the average farm was actually lower in 1900 
 than in i860 ; and the increase in the items of implements and 
 machinery was quite in keeping with the rapid growth in wealth 
 
AGRICULTURAL PROBLEMS 599 
 
 and income in the United States, particularly among agricul- 
 tural laborers and farm population. But between 1900 and 
 1910 the situation was, in appearance at least, transformed. 
 As one commentator has aptly said, the selling price of farm 
 property increased by a larger amount in the first decade of the 
 twentieth century than it did in the entire period between the 
 landing of Columbus and the close of the nineteenth century. 
 The average value of all farm property per farm, as shown by 
 Table I, rose from $3563 in 1900 to $6444 in 1910. The in- 
 crease was greatest in the value of the land itself. In this 
 decade the average value per farm of all farm property in- 
 creased 80,9 per cent ; that of land alone, 96.7 per cent ; farm 
 buildings, 60.3 per cent; implements and machinery, 51.9 per 
 cent ; farm animals, including poultry and bees, 44.4 per cent. 
 
 The full significance of this striking change is difficult to 
 ascertain. In many respects is it more apparent than real and 
 reflects merely the depreciation in the general purchasing power 
 of the monetary unit. Thus, the average value of farm equip- 
 ment per farm increased in a decade from $667 to $973, only 
 45.9 per cent, hardly more than the general increase in prices 
 throughout the country and probably no more than the aver- 
 age income or ability of the typical farmer. So far as equip- 
 ment is concerned it is probably no more difficult for the aver- 
 age farmer to secure the required amount of equipment today 
 than it was twenty years ago. But the total value of farm 
 land has increased more than 100 per cent, and the value of the 
 land in the average farm has increased nearly 100 per cent. 
 The movement is real and exceedingly significant so far as 
 land values are concerned. Prices of farm products have in- 
 creased more rapidly than most other prices. This has re- 
 flected itself in a rise in the value of farm land which is far 
 greater than the rise in the general price level. It has become 
 in many sections far more difficult than it used to be for the 
 yoimg farmer to secure a farm of his own, and in those districts 
 tenancy has increased rapidly, while in many of them the popu- 
 lation has actually dechned. 
 
 Technically speaking, therefore, there appears no significant 
 
6oo OUTLINES OF ECONOMICS 
 
 increase in the size of the unit of agricultural industry. The 
 farm unit is not growing in the physical or material sense in 
 which the factory may be said to be growing. There is no 
 consolidation or concentration such as we find in the manufac- 
 turing industries. But the amount of capital represented by the 
 farm unit has increased strikingly in the last few years and 
 probably much more rapidly than the average wealth or in- 
 come of the farm population.^ 
 
 So much for the size of the farm as it is ; the next question 
 concerns the size of the farm as it should be. Would the pros- 
 perity of the agricultural classes and the general welfare be in- 
 creased by expanding or reducing the farm unit, by more or less 
 intensive farming? 
 
 Obviously no simple answer can be given to this question. 
 The value of the land or the rent it will bring is perhaps the 
 most important factor : high rental value indicates that the 
 margin of cultivation has been forced to a comparatively low 
 point, and makes it both necessary and profitable to work the 
 land intensively, for the same reason that the owner of a very 
 valuable manufacturing plant is inclined to run it night and 
 day, if possible, in order to reduce that part of the cost of pro- 
 duction which represents fixed charges or interest on the capital 
 that is sunk in the enterprise. In addition to the factor of rent, 
 the amount of capital that he can command, the kind of farm- 
 ing in which he is most skilled, the character of the labor he can 
 secure, the proximity of markets, and the adequacy of trans- 
 portation facilities, all must be taken into account by the in- 
 dividual farmer in determining how large a farm he will attempt 
 to manage and how intensively he will farm it. 
 
 Speaking generally, however, two powerful but counteracting 
 forces can be detected in the agricultural industry, which pre- 
 vent the industry from becoming either predominantly iaten- 
 sive or predominantly extensive. On the one hand, machinery 
 can be employed most advantageously on a comparatively large 
 
 1 "In recent years the value of farm lands has been increasing at the rate of about 
 5 per cent a year, or approximately $2 per acre per year." Monthly Crop Report, 
 vol. ii, No. 4 (April 15, 1916). 
 
AGRICULTURAL PROBLEMS 6oi 
 
 farm, and, other things being equal, the use of labor-saving 
 machinery is desirable. On the other hand, the importance of 
 labor is greater, and the importance of the manager or entre- 
 preneur is less, in agriculture than in manufactures ; and on 
 this account the stimulus given to the individual laborer by the 
 sense of proprietorship is a far more potent factor in agriculture 
 than in other industries. Large factories controlled by one 
 entrepreneur employing hundreds of dependent workmen have 
 proved economically superior in the manufacturing industry, 
 because of the possibility of supervising the labor, checking and 
 measuring its efficiency automatically. In agriculture, how- 
 ever, technical skill remains far more important relatively to 
 those commercial or financial talents which distinguish the 
 successful employer than in any other great division of pro- 
 duction. 
 
 This question is primarily one of private profit, which the in- 
 dividual must decide for himself, but the legislator and the 
 scientific student can assist the farmer by helping him to develop 
 and use a system of sound farm accounting, and in keeping 
 him awake to those changes in prices, wages, and transportation 
 charges to which the farm organization must adjust itself. On 
 the whole, however, the emphasis is wisely placed by the aver- 
 age educator, at the present time, upon the possibilities and 
 opportunities of more intensive farming. In the past, exten- 
 sive farming has been, and justifiably so, the rule in this coun- 
 try, and the force of inertia is all directed that way. But the 
 demands of the future will be in the opposite direction. As 
 cities multiply and the market approaches the farm, intensive 
 farming will be forced upon the people, and the readier we are 
 to adapt ourselves to this change, the less will be the friction 
 and loss. Moreover, the ability to earn a living by intensive 
 farming makes it easier to acquire a farm ; and we are strongly 
 of the opinion, as will appear hereafter, that widely diffused 
 ownership is better than a general system of tenancy, even 
 where land values are high. 
 
 Finally, it may be noted that practically every European coun- 
 try attempts by legislation to increase the number of small 
 
6o2 OUTLINES OF ECONOMICS 
 
 holdings; and in a mixed problem of this kind, which is as 
 much psychological and social as strictly economic, the instincts 
 of the majority are likely to have a sound social basis. Even 
 in England, where comparatively large farming has had the 
 greatest opportunity and the most favorable environment, the 
 consensus of opinion seems to favor the' encouragement of small 
 holdings. English authorities maintain, as a rule, that a mixed 
 system of large and small farms is the ideal condition, but that 
 at present the emphasis should be placed on intensive farming. 
 In 1889 a (British) select committee on the subject recom- 
 mended unanimously that " the extension of a system of small 
 holdings is a matter of national importance " ; and in 1892 Par- 
 liament passed the Small Holdings Act which empowers county 
 councils to purchase land and sell or lease it in small holdings. 
 Purchasers were required to pay one fifth of the price on taking 
 possession, and the remainder in fifty years. In the beginning 
 the act does not appear to have been a glowing success, and by 
 1903 only 62 small holdings, covering 248 acres, had been sold, 
 and 166 buildings, covering 373 acres, let. In 1907, however, 
 a new Small Holdings and Allotments Act was passed, special 
 commissioners were authorized to ascertain the demand for 
 small holdings in the various counties, and county councils 
 were authorized to acquire land compulsorily. Between the 
 passages of this act and the end of 191 2 various county councils 
 acquired 155,000 acres of land, all of which, except two per cent, 
 was leased to small holders. In 191 2 there were 292,720 small 
 holdings (one to fifty acres) in England and Wales, of which 
 9937, or about 3 per cent, had been provided by county councils. 
 While there is a marked difference of opinion in Great Britain 
 on the subject, the weight of testimony and balance of opinion 
 plainly incline towards the conclusions : (i) that an extension of 
 small holdings is desirable not only from the standpoint of 
 national well-being but from that of the agricultural laborer as 
 well ; (2) that agricultural laborers who employ farming methods 
 suited to small holdings can make a decent living without an 
 excessive amount of toil, in proof of which there seems to be a 
 large unsatisfied demand for these small holdings ; (3) that small 
 
AGRICULTURAL PROBLEMS 603 
 
 holdings under private land owners are likely to decline rather 
 than increase in numbers, owing to insecurity of tenure and high 
 rents ; (4) and that in consequence the intelligent assistance of 
 the government is needed to achieve the desired results.^ 
 
 We would not be misunderstood. A universal system of small 
 holdings would be good for no country, as a certain number of 
 large farmers, assisted by abundant capital, are needed to set 
 the pace in the improvement of agricultural methods. And in 
 the United States, it is hoped, small holdings on the British 
 scale will not have to be considered for many generations. But 
 this country as well as England needs to cultivate that spirit 
 which has made Danish agriculture, in spite of great obstacles, 
 such a marvelous success ; and it is imperative to avoid, if we 
 can, the growth of those conditions which have drawn so much 
 of the best blood of rural England to the cities. Both of these 
 objects, we believe, will be measurably advanced by the encour- 
 agement of intensive farming. 
 
 Ownership and Tenancy. — The essential facts bearing upon 
 the subject of farm ownership and tenure are summarized in 
 Table II, printed on the following page. 
 
 Section A of the table shows that share tenancy is increasing 
 in the United States, and that the proportion of farms operated 
 by their owners was smaller in 19 10 than in any earlier census 
 year. Two interpretations of this phenomenon have been ad- 
 vanced. According to the first, which is based partially upon 
 the statistics cited in Section B of the table, the growth of 
 tenancy is due primarily to the increasingly rapid rise of farm 
 laborers from the position of wage earner to that of tenant. 
 In this view, accordingly, the increase of tenancy is encourag- 
 ing. According to the second interpretation, based partially 
 upon the facts presented in Sections C and E, the growth of 
 tenancy is not an encouraging sign, and indicates that it is 
 becoming more and more difi&cult to acquire ownership of land 
 in this country. The statistics of ownership under C prove 
 that there is a steady movement from tenancy to ownership as 
 farmers grow older. More than 70 per cent of the farmers 
 
 ^ Cf. The Report of the Land Enquiry Committee, vol. i, Part ii, Chap. iii. 
 
6o4 
 
 OUTLINES OF ECONOMICS 
 
 TABLE II 
 
 Statistics of Farm Ownership and Farm Tenure nsr the United 
 States: 1880-1910 
 
 1910 
 
 1900 
 
 1890 
 
 B< 
 
 C < 
 
 D< 
 
 E 
 
 Per cent of farms operated by owners . . 
 Per cent of farms operated by cash tenants 
 Per cent of farms operated by share tenants 
 
 Per cent of males employed in agriculture : 
 
 Who are owners 
 
 Who are tenants 
 
 Who are laborers and others .... 
 
 Per cent of persons owning farm homes : 
 
 All ages 
 
 Under 25 years 
 
 25 to 34 years 
 
 35 to 44 years 
 
 45 to 54 years 
 
 55 years and over 
 
 63.0 
 13.0 
 24.0 
 
 Per cent of owners of rented farms who own : 
 
 1 farm 
 
 2 farms 
 
 3 and under 5 farms 
 
 5 and under 10 farms 
 
 10 and under 20 farms 
 
 20 farms and over 
 
 Per cent of farm homes owned : 
 
 Free 
 
 Encumbered 
 
 Encumbered, all ages . . 
 Encumbered, under 25 years 
 Encumbered, 25 to 34 years 
 Encumbered, 35 to 44 years 
 Encumbered, 45 to 54 years 
 Encumbered, 55 years and over 
 
 66.4 
 33-6 
 
 64.7 
 
 I3-I 
 22.2 
 
 71.6 
 
 lO.O 
 
 18.4 
 
 42.3 
 
 42.0 
 
 23.1 
 
 16.6 
 
 34-6 
 
 41.4 
 
 64.4 
 
 65-9 
 
 27.8 
 
 32.6 
 
 45-3 
 
 49.8 
 
 64.4 
 
 64.0 
 
 70.7 
 
 72-3 
 
 81.4 
 
 82.2 
 
 80.0 
 
 — 
 
 11.4 
 
 — 
 
 S-4 
 
 — 
 
 2-3 
 
 — 
 
 0.7 
 
 — 
 
 0.2 
 
 — 
 
 69.0 
 
 71.8 
 
 31.0 
 
 28.2 
 
 31-0 
 
 28.2 
 
 29-3 
 
 21.9 
 
 35-5 
 
 31-9 
 
 36.6 
 
 31-8 
 
 31.8 
 
 30.2 
 
 24.6 
 
 22.6 
 
 The statistics opposite B are in the nature of estimates, a small number of 
 female owners and tenants being included mider "laborers and others." The aggre- 
 gate percentages opposite A differ from those opposite C, owing to the fact that they 
 were collected by different departments of the census, and apply to slightly different 
 areas. The agricultural statistics published in the reports of the Thirteenth Census 
 are not so detailed as those published in the reports of the Twelfth Census. 
 
AGRICULTURAL PROBLEMS 605 
 
 between 45 and 54 years of age, but only 45.3 per cent of those 
 between 25 and 34 years of age, owned the farms which they 
 operated in 1900. This steady advance is encouraging; but 
 the comparison of the figures for 1900 and 1890 indicates that 
 the rate of advance is declining. Moreover, the statistics pre- 
 sented in Section E show that the proportion of owned farms 
 which were burdened with indebtedness was, for every age group, 
 larger in 1900 than in 1890, and, in the aggregate, larger in 19 10 
 than in 1890. 
 
 The statistics presented in Table II and the two interpretations 
 of their meaning are not, in reality, inconsistent. Tenancy is 
 more frequent in the South Central and South Atlantic states 
 than in other sections of the country, and more prevalent among 
 colored farmers than any other class. Here, evidently, tenancy 
 does represent an advance. The negroes who are tenants today 
 were farm laborers a few years ago and slaves a half century 
 back. On the other hand, tenancy is also prevalent and grow- 
 ing in the richest farming district of the country, a district in 
 which farm values are high and advancing very rapidly ; and 
 in this district — the North Central states — there is evidence 
 of a close though not perfect correlation between farm values 
 and tenancy.^ 
 
 There is no cause for grave alarm concerning farm tenancy in 
 this country. Although the census of 1900 revealed one land- 
 lord who owned 704 farms worth $4,545,230, Section D of Table 
 II shows that 80 per cent of the landlords owned only i rented 
 farm, and 96.8 per cent less than 5 rented farms; while the 
 additional fact that 78.8 per cent of the landlords lived in the 
 same county in which their farms were located proves that 
 absentee landlordism has not developed to any extent in this 
 country. But we cannot regard present tendencies with all the 
 complacency exhibited by some writers.^ For not only has it 
 been shown that the increase of tenancy in the North Central 
 states is probably due to the increasing difiiculty of acquiring 
 
 ^ See H. C. Taylor, Agricultural Economics, pp. 224-250. 
 
 2 See Twelfth Census, Agriculture, Part I, pp. Ixxvii-lxxxi ; and E. L. Bogart in 
 tht Journal of Political Economy, vol. xvi, pp. 201-211. 
 
6o6 OUTLINES OF ECONOMICS 
 
 land consequent upon advancing land values; but tenancy is 
 almost certain to increase as land values advance, unless the 
 American farmer learns how to get a living from smaller hold- 
 ings. And land values are increasing with almost startling 
 rapidity. In the four years 1911-1915 the value of improved 
 farm land in this country increased over 25 per cent. When 
 land goes to $200 an acre, the average young farmer can neither 
 save enough nor command enough credit to buy a farm of 160 
 acres and equip it properly. We shall have either more tenancy 
 in the older sections of the country, as time passes, or smaller 
 farms and a different type of agriculture. As stated above, the 
 latter change would probably do more good than harm in the 
 end. Our only fear is that the American farmer may not adjust 
 himself to it rapidly enough. 
 
 And it is doubtful whether we ought to derive comfort from an increase 
 in the proportion of owners — as shown in Section B of Table II — when 
 this increase restilts from an exodus of the agricultural population to the 
 cities, which must itself be regarded with grave apprehension. Some 
 writers explain away the increase of tenancy by dividing the agricultural 
 class into three reservoirs, — owners, tenants, and others (presumably 
 laborers) , — and assure us that the swelling volume of the middle reservoir 
 is due to an increasingly rapid flow from the labor reservoir to the tenant 
 reservoir, rather than a decreasingly rapid flow from the tenant reservoir to 
 the reservoir of owners. But what about the flow from the labor reservoir 
 to non-agricultural occupations? And how much of the diminution of 
 ownership in trade and manufactures should be charged to the same move- 
 ment of population from the country to the city? It is a condition^ not a 
 theory, confronting us, and when we start to explain this condition, it is 
 not permissible to halt midway in the explanation. 
 
 Farm Labor and Earnings. — It is not difi&cult to understand 
 the " exodus from the farm " when we consider the demands 
 which farming makes on the industry and managerial skUl of the 
 farmer, the lure of city life, and the relatively small amount of 
 cash which the farmer has at his command. The labor and 
 drudgery of farm life are steadily being lightened, the income 
 of the farmer has risen rapidly in late years, and as a recent 
 writer tells us, " it is probably true that the farming population 
 of the United States, consisting as it does of more than thirty 
 
AGRICULTURAL PROBLEMS 607 
 
 million people, has a larger average income per family than any 
 other equally homogeneous group of individuals of anything 
 like the same size anywhere in the world." But when taxes 
 and interest on indebtedness are paid the average farm family 
 has little actual cash to spend on amusements, and a careful 
 estimate made by the same writer for the year 1909 " shows 
 that after all the expenses are paid the average family has $724 
 of net earnings, of which $322 was earned by the capital in- 
 vested in the farm, and $402 by the labor of the farmer and his 
 family. These $724 of net earnings were received by the family 
 in the following manner : $303 in cash, $35 as fuel, $125 as rent, 
 and $261 as food furnished by the farm." ^ 
 
 There can be no doubt, however, about the improvement in 
 the conditions and wages of farm labor. The movement of 
 farm wages since the Civil War is described statistically in 
 Table III, following. From this it appears that farm wages 
 were higher in the last year for which statistics are available 
 than ever before, if we properly discount the inflated currency 
 in which wages were paid in 1866, 1869, and 1875. Moreover, 
 the testimony is practically unanimous to the effect that the 
 increased use of farm machinery has not only reduced the hours 
 of labor, but has diversified and lightened the toil of the farm 
 hand. Added to these evidences of increasing material comfort 
 is the reassuring fact that the farm hand retains, in a large 
 degree, his superior social position. The native white farm 
 laborer usually eats at the same table with his employer, shares 
 his social diversions, and in general mixes in the same social 
 class on terms of approximate equality. 
 
 There is room, however, for much improvement. The hours 
 of labor are long in the country, — 10 in winter, 12 in summer, 
 13 in harvest season, according to our latest information, — 
 and, except on a very small number of farms, there are two or 
 three months in the year when the laborer cannot secure full 
 work. " The able-bodied, industrious man desirous of employ- 
 ing his full vigor continuously finds a limitation in the average 
 
 ' E. A. Goldenweiser, "The Farmer's Income," The American Economic Review, 
 vol. vi, pp. 46, 48. 
 
6o8 
 
 OUTLINES OF ECONOMICS 
 
 TABLE III 
 
 Wages of Farm Labor in the United States for Specified Years. 
 
 1866-1915 
 
 (Wages expressed in paper currency for the years 1866, 1869, 1875) 
 
 
 Per Month 
 
 Per Day 
 
 AT Harvest 
 
 Per Day Other 
 Than Harvest 
 
 Year 
 
 
 
 
 
 
 Without 
 board 
 
 With board 
 
 Without 
 board 
 
 With board 
 
 Without 
 board 
 
 With board 
 
 191S 
 
 $30.15 
 
 $21.26 
 
 $1.92 
 
 $1.56 
 
 $1.47 
 
 $1.13 
 
 1914 
 
 29.88 
 
 21.05 
 
 1.91 
 
 -55 
 
 1-45 
 
 I-I3 
 
 1911 
 
 28.77 
 
 20.18 
 
 1.85 
 
 1.49 
 
 1.42 
 
 1.09 
 
 1910 
 
 27.50 
 
 19.21 
 
 1.82 
 
 1-45 
 
 1.38 
 
 1.06 
 
 1902 
 
 22.14 
 
 16.40 
 
 1-53 
 
 1-34 
 
 I-I3 
 
 .89 
 
 1899 
 
 20.23 
 
 14.07 
 
 ^■37 
 
 1. 12 
 
 I.OI 
 
 •77 
 
 1898 
 
 19.38 
 
 13-43 
 
 1.30 
 
 1.05 
 
 .96 
 
 .72 
 
 189s 
 
 17.69 
 
 12.02 
 
 1. 14 
 
 .92 
 
 .81 
 
 .62 
 
 1894 
 
 17-74 
 
 12.16 
 
 1-13 
 
 ■93 
 
 .81 
 
 .63 
 
 1893 
 
 19.10 
 
 13.29 
 
 1.24 
 
 1.03 
 
 .89 
 
 .69 
 
 1892 
 
 18.60 
 
 12.54 
 
 1.30 
 
 1.02 
 
 .92 
 
 .67 
 
 1890 
 
 18.33 
 
 12.45 
 
 1.30 
 
 1.02 
 
 .92 
 
 .68 
 
 1888 
 
 18.24 
 
 12.36 
 
 1-31 
 
 1.02 
 
 .92 
 
 .67 
 
 1885 
 
 17.97 
 
 12.34 
 
 1.40 
 
 1. 10 
 
 .91 
 
 .67 
 
 1882 
 
 18.94 
 
 12.41 
 
 1.48 
 
 I.I5 
 
 •93 
 
 .67 
 
 1879 
 
 16.42 
 
 10.43 
 
 1.30 
 
 1. 00 
 
 .81 
 
 •59 
 
 187s 
 
 19.87 
 
 12.72 
 
 1.70 
 
 1-35 
 
 1.08 
 
 .78 
 
 1869 
 
 25.92 
 
 16.55 
 
 2.20 
 
 1.74 
 
 1.41 
 
 1.02 
 
 1866 
 
 26.87 
 
 17.45 
 
 2.20 
 
 1.74 
 
 1.49 
 
 1.08 
 
 condition of farming. Seed time and harvest make busy their 
 respective periods, but whenever the frost of winter or the 
 drought of summer suspend the activity of vegetation, there 
 will be an interval in the work of the cultivator." ^ 
 
 ^ See Crop Reporter, vol. xiv, No. 3, and Monthly Crop Report, vol. ii, No. 3. 
 Broad averages are particularly unsatisfactory in dealing with the wages of farm 
 labor, and the reader should regard this table not as an exact exhibit of money 
 wages, but as a compendious method of describing a movement the details of which 
 are beyond the scope of this treatise. For more adequate discussions, see Bulletin, 
 No. 26, Miscellaneous Series, and Bureau of Statistics, Bulletin 99, U. S. Depart- 
 ment of Agriculture. 
 
 2 J. H. Blodgett, " Wages of Farm Labor in the United States," p. 25. Bulletin, 
 No. 26, Miscellaneous Series, U. S. Department of Agriculture, p. 25. 
 
AGRICULTURAL PROBLEMS 609 
 
 Furthermore, the best evidence obtainable supports the con- 
 clusion that while " skilled labor, owing to its contact with ma- 
 chinery and the influence of education, has attained increased 
 efficiency," " unskilled and irregular labor has lost much of its 
 former adaptability and value to the farm." ^ Worst of all, 
 there is rapidly developing a class of migratory or casual agri- 
 cultural laborers who drift from city to country and back again, 
 who have no ambition to establish themselves permanently 
 upon the land, and yet teach the farmer to rely upon their 
 assistance, and debase the real standard of living of the laborer 
 who adopts farming as a serious occupation, and looks forward 
 to the acquisition some day of a farm of his own. 
 
 Farm Indebtedness and Agricultural Credit. — The favorite 
 instrument by which land ownership is achieved in this coun- 
 try is the farm mortgage. As shown above, 33.6 per cent of the 
 farms in this country were mortgaged in 1910, and this propor- 
 tion had increased from 28.2 per cent in 1890. But this is not 
 in itself alarming. The ratio of mortgage debt to farm value 
 was only 27.3 per cent in 19 10 as against 35.5 per cent in 1890, 
 and the owner's average unencumbered equity per farm in- 
 creased from $2200 in 1890 to $4574 in 1910. Moreover, the 
 proportion of mortgaged farms in the latter year was higher 
 in Iowa and Wisconsin than in any other states, although agri- 
 cvdture is particularly flourishing in these states. Statistics 
 collected in 1890 indicate that nearly 65 per cent of mortgage 
 indebtedness of farms is contracted for the purpose of buying 
 the farms, from 15 to 20 per cent for stocking, equipping, drain- 
 ing, and improving farms, while probably not more than 5 or 6 
 per cent represents losses, household expenses, and " unproduc- 
 tive consumption." The farm mortgage accordingly is not 
 necessarily a bad thing. It is " a mere business venture " and 
 in this country has proved a successful venture in a surprisingly 
 large proportion of cases. 
 
 If farms are operated more efficiently by their owners than 
 by tenants or hired managers, it is obviously desirable to get the 
 title to the farm into the hands of the farm operator as soon as 
 
 ^ Final Report of the Industrial Commission, p. q2. 
 
6lO OUTLINES OF ECONOMICS 
 
 possible. For this purpose some use of credit is usually neces- 
 sary. Credit also must usually be used to secure the proper 
 amount of farm machinery, stock, and other equipment. Agri- 
 culture today has become a highly capitalized industry, employ- 
 ing in this country, it is estimated, about twice as much capital 
 as the manufacturing or factory industries. And the indications 
 are that the average farmer at present cannot secure, or at least 
 does not employ, enough circulating capital. Studies have been 
 made of the earnings of farmers classified according to the amount 
 of capital employed on each farm ; and these indicate that, after 
 due deduction for interest upon all capital employed, the re- 
 maining net income varies directly with the amount of capital 
 employed, until the latter reaches $25,000 or $30,000. The 
 New York studies indicate that farmers working with less than 
 $5000 capital earn less than the ordinary farm hand in the same 
 vicinity ; and that in the districts covered, the average farmer 
 cannot earn a fair return for his labor unless he has the use of 
 from $10,000 to $20,000 worth of capital. The figures in ques- 
 tion are possibly affected by the probable fact that it is the 
 better class of farmers who are enabled to obtain the larger 
 amount of loan capital. But whether this be the fact or not, 
 it is obviously desirable that the farmer should be able to secure 
 whatever amount of capital is necessary, at the lowest practi- 
 cable cost. 
 
 At the present time credit facilities are not adequate in many 
 rural districts. Recent statistics collected by the federal De- 
 partment of Agriculture, for instance, show that the average 
 rate for interest and commissions on farm mortgage loans ex- 
 ceeds 7 per cent in twenty-five states, and rises as high as 10 
 per cent in New Mexico, Montana, and Wyoming. This is the 
 average rate, and there are presumably many instances of very 
 much higher rates. The average commission which it is neces- 
 sary to pay to the middleman or intermediary exceeds 2 per 
 cent a year in certain districts of North Dakota, Oklahoma, 
 and North Carolina. The average rate for interest and other 
 costs on loans to farmers on personal security exceeds 10 per 
 cent in twenty states and rises to 15.6 per cent in Oklahoma, 
 
AGRICULTURAL PROBLEMS 6ll 
 
 13.8 per cent in New Mexico, and to 12.4 per cent in Alabama. 
 The average rate exceeds 12 per cent on 57.3 per cent of the 
 loans reported in North Dakota, on 55.3 per cent in New Mex- 
 ico, 25.5 per cent in Alabama, and 34.7 per cent in Colorado. 
 Even in the state of Michigan 5 per cent of the loans on 
 personal security cost the borrower more than 12 per cent a 
 year. Recent investigations made by the Comptroller of the 
 Currency also make it plain that in some sections of the coun- 
 try extortionate rates of interest are being charged by banks 
 on farm loans ; and that in some districts the farmers are really 
 being exploited by rural " loan sharks." 
 
 American farmers not only pay an unnecessarily high price 
 for the credit which they receive, but it is not supplied in the 
 most convenient and suitable forms. The farmer who borrows 
 to buy a farm or to construct a barn wants a loan for more than 
 four or five years in order to avoid the trouble of expense and 
 renewal, with the periodic danger of foreclosure. The loan 
 should run in many cases for twenty -five years or more ; the 
 payment should be arranged so that the principal may be 
 gradually extinguished as the interest is paid, and the farmer 
 should retain the right to extinguish the entire principal when- 
 ever it became convenient or practicable for him to do so. In 
 the case of short-time loans on personal security, similarly, the 
 farmer does not want a sixty-day or ninety-day loan, the kind 
 of accommodation which commercial banks prefer to give, but 
 needs usually a loan running from six months to a year, in 
 order to cover the waiting period between planting and harvest 
 time. Moreover, the banks in some sections of the country at 
 present force farmers who borrow from them to specialize in 
 one crop — a money crop — in order to keep the security in 
 some easily realizable form. American banks have in this way 
 helped to prevent the adoption of diversified farming. 
 
 In Europe, agricultural credit is furnished at low cost and con- 
 venient terms by a series of mortgage land banks and farmers' 
 loan societies or credit unions, which vary greatly in detail and 
 structure but rest upon certain common fundamental principles. 
 Long-time credit is provided by mortgage land banks, the oldest 
 
6l2 OUTLINES OF ECONOMICS 
 
 form of which is perhaps the Prussian Landschajt. These 
 banks lend to their members on real estate mortgage, and then 
 issue bonds secured by the entire body of mortgages in such a 
 way as to replace or reenforce each individual's credit with the 
 credit or security of the whole group. In some of these associa- 
 tions all the property of the members is pledged for the support 
 of the bonds, but experience makes it plain that this is unneces- 
 sary and that the mortgages themselves, under proper manage- 
 ment, afford sufficient security to insure ready sale for the bonds. 
 The associations or banks which provide short-time credit differ 
 greatly in form. Some are stock companies, receive savings de- 
 posits, and obtain a considerable part of the money funds which 
 they lend from stock subscriptions and deposits. In others a 
 group of men simply pool their credit, borrow from outside 
 sources on their unlimited liability, and lend the proceeds of 
 these loans to the members of the union. Machinery, organi- 
 zation, and rules differ, but the fundamental principles and re- 
 quirements are as follows : 
 
 1. A pooling of credit and securities so that the debt of 
 each member is backed by the collective credit or good-will of 
 the association. 
 
 2. Rigid scrutiny of the loan and the security by appraisers 
 (usually neighbors of the borrower) who have every opportunity 
 of knowing the circumstances of the borrower and the value of 
 the security offered. 
 
 3. Limitation of credit to loans for productive purposes. 
 The grant of credit for speculative purposes is strictly forbidden, 
 and many societies provide that loans may be called if the 
 money is not properly used. 
 
 4. Management in behalf of the borrower. This represents 
 the most essential difference between the cooperative credit 
 associations of Europe and the credit institutions of this coun- 
 try. Where stock is issued, each stockholder usually has only 
 one vote, and dividends are limited, usually to the rate paid 
 upon borrowed money. Additional earnings, if any, are turned 
 into a surplus fund which, if the union is dissolved, goes to charity 
 or some public purpose. 
 
AGRICULTURAL PROBLEMS 613 
 
 5. Adaptation of the period and terms of the loan to the 
 needs of the creditor, with provision for amortization and per- 
 mission to pay off the loan whenever the debtor finds it possible. 
 
 Cooperative credit associations or rural banks have multi- 
 plied rapidly all over Europe. They have greatly reduced 
 rates of interest to farmers, and do an enormous amount of 
 business at low cost and with very little loss. Large central or 
 district associations have been established which bring the rural 
 societies in touch with city money markets, help to procure 
 funds for the local associations, and guide their activities by 
 constant inspection and audit. As a natural corollary, co- 
 operative supply associations have been developed in many 
 places, which furnish fertilizers, farm machinery, seed, and other 
 supplies to members at the lowest possible prices. In New 
 Zealand and Australia the State itself has, apparently with 
 entire success, undertaken the function of lending money to 
 farmers for the improvement and development of agricultural 
 land. In this country a few states have adopted laws facili- 
 tating the formation of rural credit associations, and in July, 
 1916, the President approved an act of Congress the purpose 
 of which is well indicated by its longer title : " An act 
 to provide capital for agricultural development, to create 
 standard forms of investment based upon farm mortgage, to 
 equalize rates of interest upon farm loans, to furnish a mar- 
 ket for United States bonds, to create government depositaries 
 and financial agents for the United States, and for other 
 purposes." 
 
 This law represents an earnest attempt to give expression to 
 the principles set forth on the preceding page. The machinery is 
 perhaps necessarily, but unfortunately, cumbersome. The law 
 creates a hierarchy of land banks, the control of which is cen- 
 tralized in a Federal Farm Loan Board composed of the Secre- 
 tary of the Treasury and four members appointed by the Presi- 
 dent, to serve for terms of eight years. This board is to be 
 assisted by farm loan registrars to supervise the issues of farm 
 loan bonds and to have custody of the mortgages and securities 
 upon which they are based ; by land bank appraisers to deter- 
 
6l4 OUTLINES OF ECONOMICS 
 
 mine the value of properties offered as securities ; by " as 
 many land bank examiners as it shall deem necessary " ; and 
 by such attorneys, experts, and other employees as are required 
 to conduct the business of the board. The country is to be 
 divided into twelve districts, in each of which there shall be a 
 Federal Land Bank with capital stock of not less than $750,000. 
 The government is to supply this capital unless it is forthcoming 
 from other sources, thus involving the government in a maximum 
 stock subscription of $9,000,000. Government shares are to 
 draw no dividends. It is obviously intended and hoped that 
 these land banks shall operate through small National Farm 
 Loan Associations composed of persons desiring to borrow 
 money under the act ; but in case such loan associations are not 
 created rapidly or widely enough, provision is also made for 
 joint-stock land banks, with a capital of not less than $250,000, 
 only half of which need be paid in cash before operations are 
 begun. The larger federal land banks are also authorized to 
 create branches and if necessary to lend money through agents 
 scattered throughout the country. 
 
 No provision is made for loans on personal property or per- 
 sonal security. Loans must be secured by first mortgages not 
 exceeding in amount 50 per cent of the value of the land 
 and 20 per cent of the value of the improvements thereon 
 pledged as security. Interest rates are limited to 6 per cent ; 
 proper provision is made for the amortization of the principal 
 while the interest is being paid ; the loan may run from five to 
 forty years and may be issued only to a person who is "at the 
 time, or shortly to become, engaged in the cultivation of the 
 farm mortgaged." Such loans may be made only for the pur- 
 pose of purchasing land for agricultural uses ; to provide for 
 the purchase of equipment, fertilizers, and live stock ; to pro- 
 vide for buildings and the improvement of farm lands ; or to 
 liquidate the indebtedness of the owner of the land mortgaged. 
 
 The greatest danger of such legislation, perhaps, is that the 
 extension and multiplication of credit will increase the demand 
 for land, raise its price, and so injure the very classes which it 
 is designed to aid, namely, young farmers and tenants who are 
 
AGRICULTURAL PROBLEMS 6lS 
 
 working hard to acquire title to the farms which they operate. 
 Moreover, there is an important connection between the interest 
 rate and the price of land which must be considered in this 
 connection. Land value is frequently expressed as "so many 
 years' purchase," i.e. so many times the annual rent or net yield, 
 the number of years' purchase depending upon the interest rate. 
 Roughly speaking, " twenty-five years' purchase " corresponds to 
 a four per cent interest rate, " twenty years' purchase " to a 
 five per cent interest rate. If we reduce the interest rate, will 
 we not automatically increase the price of land? 
 
 While there is a real connection between land values and the 
 interest rate, it does not follow that a reduction of, say one fifth, 
 in the interest rate will be followed by an increase of one fifth 
 in the value of land. The interest rate which largely controls 
 in this connection is the rate on purchase-money mortgages, 
 which do not include so large an allowance to cover risk and 
 similar costs as do the other and smaller farm loans, interest 
 on which it is the primary purpose of this legislation to reduce. 
 In consequence, whUe it is probable that improved credit will 
 tend to raise the price of land, it is almost certain that the in- 
 crease will not be commensurate with the relief to the farmer 
 afforded by the reduced cost of loans. 
 
 Tenancy versus Encumbered Ownership. — At this point it 
 is necessary to discuss briefly the question when and where — 
 if ever — tenancy is to be preferred to land ownership. For 
 though it may come as a surprise to some American readers, 
 many foreign authorities of the highest rank strongly advocate 
 tenancy in preference to ownership when land has become very 
 valuable. In the expert evidence given before the British com- 
 mittee of 1906 on small holdings, for instance, the balance of 
 opinion seems to have inclined toward tenancy rather than 
 ownership. 
 
 Here again we meet one of those mixed economic and psycho- 
 logical questions to which no simple answer can be given. In a 
 frontier or newly settled commimity, there is, of course, little 
 reason for tenancy from any standpoint. But in an old com- 
 munity, where land values are high and are as likely to fluctuate 
 
6l6 OUTLINES OF ECONOMICS 
 
 downwards as upwards in the next score of years or so, the eco- 
 nomic arguments in favor of tenancy are exceedingly strong if 
 not altogether convincing, (i) Under such circumstances the 
 farmer who insists upon holding the title to the land which he 
 tills must either go deeply into debt, or understock his farm, or 
 both. To underequip the farm means poor agriculture ; and 
 a heavy debt hangs like a millstone around the neck of a farmer 
 when land values are not on the increase. The tenant farmers 
 of England have had a far more pleasant time since 1873 than 
 the small landowning farmers whose holdings were encumbered 
 with debt at that time. (2) The ownership of land throws upon 
 the farmer all the responsibilities of the speculative entrepreneur, 
 and other things being equal — if they can ever he regarded as 
 equal — it is desirable for the man of small means to avoid 
 these responsibilities. The tenant system offers a means of 
 insurance against some of these risks. (3) Such insurance be- 
 comes all the more advantageous and encumbered ownership 
 all the more disadvantageous because of the well-known fact 
 that land yields a net return, year by year, lower than almost 
 any other form of property. Part of this is due to the social 
 prestige of landownership and part to the fact that over very 
 long periods the small annual profit on land is likely to be com- 
 pensated for by an increase in the selling value of the land. 
 Under such circumstances landownership is partly a luxury and 
 partly a method of saving, usually for the descendants and heirs 
 of the saver. Both factors conspire to make land a poor invest- 
 ment for the man of small means. He cannot afford luxuries, 
 on the one hand, and he must find a business calling, on the 
 other hand, that yields him a quick return. (4) And finally, it 
 must be noted that the question of tenancy is not like the labor 
 problem which has developed in the factory industries. The 
 tenant is not a wage earner. He may be as independent as the 
 manufacturer who hires the land, buildings, and possibly the 
 machinery with which he works. The problem of tenancy, 
 therefore, has no necessary relationship to the problem created 
 by the existence of a class of permanent wage earners. The 
 small entrepreneur still holds the field in agriculture, all over 
 
AGRICULTURAL PROBLEMS 617 
 
 the world. The question is simply whether he shall hire his 
 plant or own it. 
 
 Notwithstanding the fact that tenant farming may go hand in 
 hand, as it does in England, with good farming, and notwith- 
 standing the desirability of reducing the speculative risks of an 
 industry which is at best much too uncertain, the problem can 
 never be settled on economic grounds alone ; and if we add to 
 the economic virtues of ownership its social and moral advan- 
 tages, the final verdict must be rendered against tenancy. 
 Ownership not only spurs the zeal of the farmer, dignifies his 
 occupation, and inculcates a love of the soil which nothing else 
 inspires in so great a degree, but it gives the farmer a stake in 
 the political game, steadies him, and thus improves his citizen- 
 ship. It is perfectly plain that ownership cannot be enforced 
 upon a people that are not prepared for it. And it is equally 
 obvious that the virtues which go with ownership may and often 
 do degenerate into vices : the peasant proprietor's love of the 
 soil occasionally becomes land worship, his thrift avarice, his 
 conservatism blind fear, and his industry cruel, — he drives 
 himself and wife and children at a pace that would put the 
 sweater to shame. 
 
 But we are not advocating the extension of landownership 
 through state aid. We simply call attention to the desirability 
 of fostering those qualities which lead to the diffusion of owner- 
 ship and are in turn strengthened by ownership ; and we main- 
 tain that the American people at present are in no danger of 
 excessive thrift or of the sordid materialism of peasant proprie- 
 torship at its worst. The tendencies and the dangers are almost 
 all in the opposite direction. If, in the next fifty years, the 
 farmers of the Middle West become predominantly tenants, it 
 will not be because tenancy is economically and socially superior 
 to ownership, but because the farmers of that district have not 
 had the thrift to save and the ability to adapt themselves to 
 more intensive agriculture. And the step will be backward, not 
 forward. The popular instinct which in this country causes an 
 increase of tenancy to be regarded with distrust is a sound 
 instinct. 
 
6l8 OUTLINES OF ECONOMICS 
 
 A minor disadvantage of tenancy is found in the fact that tenancy, when 
 it becomes predominant, raises difficulties that can only be met by constant 
 State interference. Short leases, with no indemnification to the tenant for 
 the improvements which he has made, lead to rack-renting, exhaustion of 
 the soil, and class hatred between landlords and tenants. Long leases, on 
 the other hand, afford insufficient protection to the landlord ; because when 
 prices are high the tenant thrives and pays his rent promptly, but when 
 prices faU rents go unpaid and the landlord has no real redress. In Eng- 
 land the situation has been met by a system of short-time leases together 
 with compensation to the tenant — a legal obligation which the landlord 
 cannot escape by "contracting out" — for any improvement made by the 
 tenant whose value he has not exhausted. Neither party can abrogate a 
 lease without a year's notice, although by mutual consent this may be re- 
 duced to six months. This system permits rentals to be adjusted frequently 
 as prices change, rules out excessive competition, protects the landlord, and 
 warrants the tenant in making any improvement required by good farming, 
 since he knows that, if the landlord orders him out, he can collect on his de- 
 parture the actual value of improvements made by him, whose benefits he 
 has not had time to reap. In practice, the incoming tenant usually pays for 
 the unexhausted improvements, and disputes are settled by arbitration. 
 Under this system, "the relation between landlord and tenant is very satis- 
 factorily arranged, the farmers are, as a rule, contented with the present 
 system, and the fields of England prove that landownership on the part of 
 farmers is not essential to good agriculture." ^ 
 
 Marketing of Farm Products. — The work of the farmer is 
 not finished until he has successfully sold his produce. Com- 
 paring the price received by the farmer with the retail price of 
 the same produce, many critics have complained that the inter- 
 mediate distributive ^ process is wasteful and expensive. But 
 careful investigation of the necessary costs of marketing does 
 not indicate, on the whole, that our distributive system is so 
 ineificient as to call for complete replacement. Improvement of 
 present methods, and not revolution, seems to be the proper 
 solution. 
 
 On the other hand, the marketing system is manifestly defec- 
 tive at many points. The farmer himself is responsible for some 
 of the most costly defects. He frequently does not show suffi- 
 cient care in producing the exact varieties of products most in 
 
 ' H. C. Taylor, The Decline of Landowning Farmers in England, p. 6i. 
 2 The word "distributive" is used in the popular sense in this chapter. 
 
AGRICULTURAL PROBLEMS 619 
 
 demand, or in sorting and crating them for market after they 
 have been produced. Goods are carelessly and dishonestly 
 packed ; there is sometimes a dearth of buyers and sometimes 
 a monopolistic agreement among buyers at country points. 
 
 There is also room for improvement in the transport of such 
 goods from the coimtry buying point to the wholesale markets. 
 Many railroads do not have a sufficient supply of refrigerator 
 cars and lack facilities for handling perishable goods. A suffi- 
 cient number of cars is frequently not provided just when they 
 are most needed, there are many avoidable delays in transit, and 
 frequently great difficulties in adjusting and paying claims for 
 damages. Generally speaking also, railway tariffs favor through 
 traffic at the expense of local traffic and are thus partly respon- 
 sible for the concentration of manufactures and population in the 
 large cities, preventing that diffusion of people throughout the 
 country which would furnish a large number of small local 
 markets. 
 
 Among the wholesale dealers, particularly the commission 
 houses, there is also room for improvement. Fraud and sharp 
 practices have been common in the past. Well-organized and 
 convenient markets have not been provided, there has not been 
 enough inspection or publicity, and where the goods are dis- 
 posed of at auction collusive agreements have frequently existed 
 between particular traders and the auction company itself. 
 
 There is no simple or general remedy for these conditions. 
 In order to secure good country markets, cooperation among 
 farmers has proved successful and probably offers the logical 
 and best way of disposing of farm products at country points. 
 Cooperation has also been used successfully in the market- 
 ing of perishable goods, and here the commission system has 
 been partly replaced by associations of farmers or growers such 
 as the California Fruit Growers and Shippers Association, which 
 maintains auction rooms in eastern cities and sells its own 
 products directly. The Southern California Fruit Exchange in a 
 few years reduced the cost of marketing California fruits from 
 10 per cent to 3 per cent of the selling value. 
 
 The cooperative marketing association and the intermediate 
 
620 OUTLINES OF ECONOMICS 
 
 trader who buys from the grower and sells to the retailer have 
 in common two points of superiority over the commission sys- 
 tem. They replace the lukewarm interest of an agent by the 
 care and solicitude of an owner, and by shipping in large quan- 
 tities they are in position to obtain much better rates from the 
 railways, to say nothing of the other economies effected by 
 handling goods on a large scale. The cooperative marketing 
 associations have also effected great economies by carefully 
 studying prices in the various markets and distributing their con- 
 signments so as to get the highest prices prevailing at the time. 
 The independent trader, however, can select the most avail- 
 able market even more successfully than the cooperative asso- 
 ciation, and speaking generally we do not expect to see the 
 commission house displaced by a cooperative machinery which 
 transfers products direct from the farmer to the retailer. An 
 intermediate mechanism is probably necessary. It is a logical 
 and probably an economical manifestation of the division of 
 labor. The actual purchaser or trader, however, will probably 
 slowly displace the commission man; and there can be little 
 doubt that the farmer has gained enormously by the substitu- 
 tion of the trader for the commission house in the marketing 
 of the great staple products. The trader comes almost to the 
 door of the farmer with constant bids for his grain. He is an 
 expert in railway rates, is in constant telegraphic communica- 
 tion with the great markets of the world, and handles products 
 in such large quantities as to reduce intermediate expenses to a 
 minimum. Occasionally, as has sometimes been the case with 
 the great line-elevator companies, he works in conjunction or in 
 collusion with the railways, overbidding the small grain dealer, 
 and forcing the railways to grant rebates on the large shipments 
 which he commands. Even in this case, the farmer gains by the 
 size and efl&ciency of the middleman (though the small dealer 
 may suffer) because part of the economies effected — even those 
 effected by discriminative railway rates — will come to him in 
 the long run. Cases of monopolistic oppression are theoretically 
 possible when there is only one buyer and one railway who are 
 in collusion, and the farmer is deprived — because of high rail- 
 
AGRICULTURAL PROBLEMS 621 
 
 way rates — from shipping his products elsewhere. But the 
 loss to the farmer through extortion of this kind has in general 
 been much more than counterbalanced by the striking economies 
 effected by the great trading companies ; though this, of course, 
 affords no justification either for monopoly or railway dis- 
 crimination. Both should be suppressed, but in such a way as 
 to save for the farmer the distributive economies effected by 
 large-scale handling. 
 
 Finally, the government can be of great assistance, provided 
 the laws under which it works are passed after careful investi- 
 gation and designed to improve rather than revolutionize exist- 
 ing marketing machinery. Laws have been passed governing 
 the grain trade, cold-storage warehouses, future trading in 
 cotton, and the size and character of standard packages. More 
 important still are the state laws providing for the regulation of 
 commission merchants and the creation of marketing com- 
 missions. 
 
 Space does not permit a discussion of the laws regulating com- 
 mission merchants passed by Minnesota (1899), New York 
 (1913), and other states. Speaking generally, commission dealers 
 under these laws must obtain a license from some state com- 
 mission or official and post a bond for the benefit of consignors 
 conditioned upon faithful observance of the law. The laws 
 usually require licensees to keep an exact record of the circum- 
 stances of each sale and to make returns to shippers within a 
 very short period after each sale. Either by the statute itself 
 or by administrative ruling it is quite common to prohibit the 
 commission dealer from buying consigned products for himself 
 or from selling them to any other corporation or firm in which 
 he has an interest. Licenses may be revoked for malpractice 
 of the following kinds : making false charges for cartage, 
 handling, insurance, or other services not actually rendered; 
 failure to make prompt settlements with consignors ; rendering 
 false statements as to the sale or condition of the goods on 
 receipt; sending out false information concerning prices or 
 other market conditions; maintaining combinations to fix 
 prices ; violating or neglecting other features of the law. Not 
 
622 OUTLINES OF ECONOMICS 
 
 a great many complaints have been registered under the Minne- 
 sota law, '' due partly perhaps to ignorance of the law's exist- 
 ence, and partly to a feeling that it is hardly worth while to 
 proceed under it. It may also be an indication that there has 
 not been so much dissatisfaction among shippers as most people 
 imagine." ^ According to most competent observers these 
 laws have exercised on the whole a salutary effect and promise 
 greatly to improve what has hitherto been one of the weakest 
 links in the distributive chain, the ineffective commission mer- 
 chant. 
 
 In a number of states commissions or departments have been 
 organized for the purpose of improving marketing methods. 
 For the most part these commissions have not accomplished 
 any very concrete results up to the present time. What is most 
 needed now is study and investigation rather than an attempt 
 to introduce on a magnificent scale costly cooperative or other 
 schemes whose practical efficiency has not been demonstrated 
 either by practice or the most thorough advance study. Much 
 more helpful and promising is the federal Office of Markets and 
 Rural Organization, which by its careful investigations is 
 gradually laying the basis for a scientific correction of the, ireal 
 defects and abuses which exist. 
 
 Speculation. — The modern marketing or distributive mecha- 
 nism not only relieves the producer of a large part of the specula- 
 tive risk which attends the transmission of raw material from 
 the farm to the consumer, and calls public attention to this specu- 
 lative element by collecting or concentrating it, but it is respon- 
 sible also for a large amount of unnecessary speculation which 
 many persons believe to be particularly injurious to the farmer. 
 We are not here concerned with the general evils of speculation 
 but with the prevalent belief that speculative dealing in futures 
 tends to reduce prices. " What is generally urged is that the 
 professional short seller, by his sales of fictitious wheat or cotton, 
 creates a fictitious oversupply in the market, which is just as 
 instrumental in depressing prices as would be an abnormally 
 
 ^ L. D. H. Weld, The Marketing of Farm Products, p. 453. The discussion at 
 this point is largely based upon Professor Weld's admirable book. 
 
AGRICULTURAL PROBLEMS 623 
 
 large supply of actual wheat thrown on the market by the 
 farmer." ^ This charge is frequently supplemented by the 
 assertion that it requires less money in margins to " sell short " 
 — or gamble on a fall in prices — than to " sell long " in antic- 
 ipation of a rise, and that, in consequence, the weight of the 
 speculative dealing in farm products is exerted in the direction 
 of lower prices. 
 
 This particular charge against speculation is confirmed neither 
 by a priori reasoning nor by inductive analysis. Every " ficti- 
 tious " sale of wheat, to use that as an illustration, must be 
 balanced by an equivalent " fictitious " purchase. The " bear " 
 who sells October wheat in July, even though he may hope to 
 depress the price of October '' futures," exercises no harmful in- 
 fluence upon the actual July or " spot " price, which is con- 
 trolled by the demand for and supply of actual wheat; and 
 when October comes, " the short seller of July appears now as a 
 buyer in order to cover his contracts, and if his trading has any 
 effect on the market at all, it is to increase the demand, not the 
 supply." 
 
 It is very plain that the fictitious market may be artificially 
 influenced by speculative deals, but as a general thing the ficti- 
 tious market is ruled by the actual market, not vice versa; and 
 the only influence exerted by gambling in futures upon " spot " 
 prices (with which alone the farmer is concerned) is a good in- 
 fluence. This influence arises out of the effect of future trans- 
 actions in lessening price fluctuations and in modifying present 
 use by anticipating future necessity. And the complaint that it 
 requires less capital to " bear " the market than to " bull " it, 
 as well as a great number of ingenious criticisms of a similar 
 kind, would all be negatived — ff they were true — by the in- 
 evitable consequence that any permanent factor of this kind 
 would be quickly appreciated by speculators and fully discounted. 
 In no market are influences of this kind more accurately detected 
 or more quickly dissipated by competitive forces than on the 
 produce and cotton exchanges. 
 
 * N. I. Stone in the Report of the Industrial Commission, vol. vi, p. 189 ff., from 
 which other quotations cited in this section are also taken. 
 
624 OUTLINES OF ECONOMICS 
 
 Actual investigations of prices confirm the theoretical argu- 
 ment made above. The average prices of spot wheat in Sep- 
 tember, October, and November — just after harvest, when the 
 ordinary farmer is compelled to sell — have been nearer the 
 average price for the entire year, since the speculative wheat 
 market has become highly organized, than in the forties and fifties 
 when wheat was sold like any other farm product. And there 
 are reasons for the belief that speculation has not only equalized 
 yearly fluctuations, but that the leveling has been up, not down, 
 in the interest of the farmer who is compelled to sell after 
 harvest, as opposed to the wealthier miller or trader who in the 
 past carried over a supply for the lean months. " It is not un- 
 commonly stated that in the last few years futures in the wheat 
 market have not, in the long run, stood enough above ' spots ' 
 to cover all the expenses of carrying. Some suggested reasons 
 for this are : cut charges for storage ; the failure of outside 
 speculation to maintain the market against hedging sales ; the 
 fact that the great elevators will buy wheat and carry it for 
 what they can get, and perform the functions of both carrier 
 and trader for the commission of one. In any case, the tendency 
 is to bring all prices together." ^ 
 
 Not only does " speculation " tend to equalize price fluctua- 
 tions between different points of time and between different 
 markets, but it serves the exceedingly useful purpose of provid- 
 ing a " body of professional risk takers " whose function is to 
 protect the actual merchandiser from many of the speculative 
 risks inherent in modern business. This protection against 
 risk is secured for the most part through " hedging," which 
 has been defined " as a purchase or sale for future delivery in- 
 tended to offset and thereby to protect an actual transaction 
 in merchandise." The terminal grain elevator which has accu- 
 mulated a large amount of grain sells a corresponding amount 
 for future delivery and thereby eliminates nearly all of the specu- 
 lative risks involved in its business. The miller who has taken 
 a contract to deliver flour at some time in the future hedges by 
 
 1 H. C. Emery, Specidation on the Stock and Produce Exchanges of the United 
 States, p. 131. 
 
AGRICULTURAL PROBLEMS 625 
 
 buying future wheat sufficient to produce the flour called for in 
 his contract. The country grain buyer who knows that an inter- 
 val of time must elapse between the purchase of grain and its 
 sale at the point of destination finds similar protection in a 
 " future " which permits him to specialize in the distributive 
 function of getting grain from the producer to the ultimate con- 
 sumer with a minimum of speculative danger. There are simi- 
 lar operations in the cotton market. 
 
 Speculation in the narrow sense, and even more truly the 
 highly-organized market which we associate it with, are respon- 
 sible for a certain amount of harmful gambling which should be 
 suppressed ; but in their ultimate economic effects they are 
 highly useful institutions designed to concentrate the uncer- 
 tainties and risks inherent in the very nature of production for a 
 future market. And it is important to note that hedging, the 
 transaction by which risks are eliminated for those who prefer 
 to specialize in the less dangerous types of profit-seeking, would 
 be impossible without the more speculative traders who prac- 
 tically bet on future fluctuations of prices. To steady and 
 reduce these fluctuations, provide a certain market, and elimi- 
 nate the exploitation of the ignorant by the expert traders, 
 speculation and the market mechanism which it requires seem 
 to be necessary and inevitable. 
 
 QUESTIONS 
 
 1. Make a list of the economic factors which regulate the size of farms. 
 Is the average farm likely to grow larger or smaller with the passage of time ? 
 Is the narrow economic conclusion concerning the size of the farm, based 
 upon maximum net profit to the individual farmer, subject to modification 
 by reason of social or moral considerations? 
 
 2. Has the net effect of the rural exodus been favorable or unfavorable 
 to agriculture and the agricultural classes? to society generally? 
 
 3. Does the increase of tenancy in the Southern states represent progress 
 or retrogression? in the North Central states? 
 
 4. Under what conditions is the cash rental superior to share tenancy? 
 Would the "corn rent" — a sHding rental varjang with the price of farm 
 products — be superior to both ? Are short leases better than long leases 
 for the landlord ? 
 
 5. Do the farmers in your locality suffer from the lack of credit facilities? 
 
 2S 
 
626 OUTLINES OF ECONOMICS 
 
 Have they any difficulty in finding safe and convenient investments for their 
 savings ? 
 
 6. What is the advantage of specialized farming over diversified farming? 
 Do we imply, when we advocate diversified farming, that the farmer should 
 "buy nothing that he can raise or make for himself"? 
 
 7. Is speculation a "necessary" or an "unnecessary evil"? Is it an 
 evil? 
 
 REFERENCES 
 
 Brace, H. H. The Value of Organized Speculation. 
 
 Commissioner of Corporations. Report on Cotton Exchanges, Part v. 
 
 BuTTERFiELD, K. L. Chapters in Rural Progress. 
 
 Carver, T. N. Principles of Rural Economics. 
 
 Eleventh Census. Real Estate Mortgages; Farms and Homes; Proprietor- 
 ship and Indebtedness. 
 
 Twelfth Census. Vol. v, Agriculture; Supplementary Analysis, "The 
 Negro Farmer," pp. 511-579. 
 
 Thirteenth Census. Vol. v, Agriculture. 
 
 Coulter, J. L. Cooperation among Farmers. 
 
 Emery, H. C. Speculation on the Stock and Produce Exchanges of the United 
 States. 
 
 Haggard, H. R. Rtiral England. 
 
 Herrick, M. T., and Ingalls, R. Rural Credits: Land and Codperative. 
 
 Jebb, L. The Small Holdings of England. 
 
 Marshall, Alfred. Principles of Economics, 6th ed.. Book vi. Chap. x. 
 
 Mill, J. S. Principles of Political Economy, Book ii. Chaps, vi-x. 
 
 MoRMAN, J. B. Principles of Rural Credits (with bibliography). 
 
 Prothero, R. E. English Farming, Past and Present. 
 
 U. S. Department of Agriculture. Year Book; The Crop Reporter. 
 
 Industrial Commission. Report, Vols, vi, x, xi, xix. 
 
 Rogers, A. S. L. The Business Side of Agriculture. 
 
 RowNTREE, B. S. Land and Labour: Lessons from Belgium. 
 
 Taylor, H. C. Agricultural Economics; and "The Decline of Landowning 
 Farmers in England," Bulletin of the University of Wisconsin, No. 96. 
 
 Warren, G. F. Farm Management. 
 
 Weld, L. D. H. The Marketing of Farm Products. 
 
CHAPTER XXX 
 SOCIALISM 
 
 Socialism Defined. — Socialists seek the establishment of in- 
 dustrial democracy through the instrumentality of the State. 
 Our political organization is to become also an economic indus- 
 trial organization. Socialism contemplates an expansion of the 
 business functions of government until the more important 
 businesses are absorbed. • Private property in income-yielding 
 capital and land is to be abolished. Socialists make no war 
 upon capital ; what they object to is the private capitalist. 
 They desire to socialize capital and to abolish capitalists as a 
 distinct class. Their ideal, then, is not, as is supposed by the 
 uninformed, an equal division of existing wealth, but a change 
 in the fundamental conditions governing the acquisition of 
 incomes. 
 
 Socialists usually say that labor creates all wealth. Land 
 and capital, they hold, are merely passive factors of production, 
 and their owners ought not to receive a share of the product 
 unless they personally are useful members of the community. 
 Labor is the active factor, and all production is carried on for 
 the sake of man. Land and capital are simply the tools of 
 man. Socialists admit that the owners of these tools must 
 receive a return for them when industry is organized as it is 
 now ; hence they desire that these tools should become public 
 property. They wish to make of universal application the 
 command of the Apostle Paul, " If a man will not work, neither 
 let him eat." 
 
 Distributive Justice. — Socialists, in common with a great 
 many other people who do not accept their attitude toward the 
 organization of industry, desire distributive justice. As to what 
 constitutes justice they are not wholly agreed, but there is 
 
 627 
 
628 OUTLINES OF ECONOMICS 
 
 among them a tendency to accept equality of needs rather than 
 productivity as a basis. Some, it is true, have advocated an 
 almost mechanical equality, but most socialists today would 
 regard the question of a precise standard for the distribution of 
 income as not of present importance. They are simply agreed 
 in this, that the distribution of the present day is wholly unjust. 
 They think that men today do not have equal chances in life 
 and that there is too much special privilege. The rewards, they 
 think, today go to those who are shrewd and cunning, who are 
 skillful in manipulating stocks and bonds, or who are favored 
 by inheritance with a good start, rather than to those who 
 render great social service. The inventors, poets, authors, 
 scientists, skilled mechanics, and factory managers, they allege, 
 are the large producers, but they do not get the big prizes. 
 
 Varieties of Socialism. — The foregoing characterization ap- 
 plies to most persons who have been called socialists, but the 
 genus contains a number of species which should be distinguished. 
 
 I. One group has been called " Utopian." This j5rst group 
 contains those who have become impressed with the evils of the 
 present competitive system and propose the collective owner- 
 ship of the means of production as a remedy, in much the same 
 spirit with which a physician writes a prescription to cure his 
 patient. There have been many attempts to picture to us how 
 smoothly things would proceed if men could only be persuaded 
 to adopt the collective ownership of land and capital. As a type 
 of this class we may take Robert Owen. His life was contem- 
 poraneous with the Industrial Revolution in England, he him- 
 self being a successful manufacturer. He saw with his own eyes 
 the evils of unrestricted competition, and was filled with an 
 earnest desire to better the condition of the working classes. 
 He is remembered as a factory reformer and promoter of volun- 
 tary cooperation, but yet he regarded these efforts as not suffi- 
 ciently radical. He thought human nature must be reformed 
 by careful training from childhood in an atmosphere of associa- 
 tion, instead of in the self-seeking, commercial atmosphere 
 which surrounded him. He spent his large fortune in an at- 
 tempt to carry out his ideas regarding the reconstruction of 
 
SOCIALISM 629 
 
 society. Among his projects was the founding of a colony at 
 New Harmony, Indiana, where no private property or com- 
 petition should exist. After a struggle of two years, the 
 experiment ended, as most other similar enterprises have, a 
 complete failure. In this group would also be placed Saint- 
 Simon, Fourier, Cabet, Blanc,^ and Bellamy. 
 
 2. The " Marxian " socialists call themselves " scientific," 
 as distinguished from the idealistic writers just mentioned. 
 They insist that they have no cure-all for the ills of society. 
 Socialism in their eyes is, in the main, only an explanation of 
 what is happening. The private capitalistic system is breaking 
 down, they say, and the logical result must be the collective 
 ownership of the means of production as the next stage in social 
 evolution. They say that setting aside all question of " ought " 
 or " desirability," collective ownership is coming, and we might 
 as well adjust ourselves to it. The four leading features of the 
 Marxian philosophy are : (i) the view of society as an evolu- 
 tionary product ; (2) the economic interpretation of history, 
 according to which our whole social life, including our ideas con- 
 cerning religion, art, marriage, etc., are but a reflex of past and 
 present economic conditions ; (3) the doctrine of surplus value, 
 according to which the income of the capitalist class does not 
 represent a return for the sacrifice of " abstinence " or " wait- 
 ing," but results from the fact that through the ownership of 
 the means of production its members can compel the laboring 
 class to work a longer number of hours than is necessary to pro- 
 duce the wages which the laborers receive, what is produced 
 in this additional number of hours being the source of capitalist 
 income ; and (4) the doctrine of the class struggle, which finds 
 a deep antagonism between the capitalist class and the laboring 
 class, that can only result in the overthrow of the former. 
 Most socialists now believe that this victory will be won with- 
 out bloodshed, as a result of a gradual increase in the strength 
 of the socialist party as a political organization. 
 
 3. The Fabian Socialists, of whom the members of the 
 
 * Louis Blanc was less " Utopian" than the others. He was transitional and in 
 reality paved the way for the German and later "scientific" movement. 
 
630 OUTLINES OF ECONOMICS 
 
 Fabian Society of England are t3;^es, have disapproved both of 
 the founding of Utopian settlements and of the philosophy of 
 Marx. The aim of this society has been to spread socialistic 
 ideas by the dissemination of knowledge on the subject, rather 
 than by an organized political movement, advocating this or 
 that reform as opportunity indicated. The membership has 
 come largely from the educated middle class, and has never 
 been very large, although the society has exercised a very great 
 influence. Practically, the views of the more conservative 
 socialists in France and Germany do not differ greatly from 
 those of the Fabians. 
 
 The following words of the late Jean Jaures on the method of 
 realizing the socialist ideal are of interest in this connection : 
 
 "All Socialists, indeed, some openly, others with infinite precautions, 
 some with a mischievous Viennese good-nature, declare it to be untrue that, 
 taken as a whole, the economic material condition of the proletariat is get- 
 ting worse and worse. It must be conceded, after taking account of the 
 tendency to sink and the tendency to rise, that in the immediate reality of 
 life, the tendency to sink is not the stronger. Once this has been granted, 
 it is no longer possible to repeat after Marx and Engels that the capitalist 
 system will perish because it does not insure to those whom it exploits the 
 minimum necessities of life. It follows from the same admission that it has 
 also become puerile to expect that an economic cataclysm, menacing the 
 proletariat in its very existence, will bring about, by the revolt of the instinct 
 of self-preservation, the 'violent overthrow of the bourgeoisie.' 
 
 "It is not by an unexpected counter-stroke of political agitation that the 
 proletariat will gain supreme power, but by the methodical and legal organi- 
 zation of its own forces under the law of the democracy and universal suf- 
 frage. It is not by the collapse of the capitalistic bourgeoisie, but by the 
 growth of the proletariat, that the Communist order will gradually install 
 itself in our society." ^ 
 
 4. The Christian socialists. About the middle of the nine- 
 teenth century, such men as Kingsley, Maurice, and Hughes in 
 England were much impressed by the misery of the poor, and 
 they attacked the competitive system as being responsible for 
 the evils which they saw. Voluntary cooperation and the ele- 
 vation of the workingman's character seemed to them the proper 
 
 1 Studies in Socialism (trans, by M. Minturn), pp. 167-169. 
 
SOCIALISM 631 
 
 remedies. Thus their theories do not fall under the head of 
 socialism as we have defined the term. There is another group 
 who believe that the ideals of Christianity can only be realized 
 through the abolition of private capitalism. In Germany and 
 in France socialist movements have been organized by adherents 
 of both Protestant and Catholic churches. In the United States 
 there has been no similar movement, although we find the term 
 Christian socialist occasionally employed. 
 
 5. State socialism is a term frequently used in German dis- 
 cussion to designate the views of those who favor an extension 
 of the economic functions of government without any great 
 change in existing class relations. 
 
 6. " Socialism of the chair " (Kathedersozialismus) refers to 
 the views of university professors, particularly in Germany, who 
 have advocated State interference with property rights to any 
 extent demanded by public welfare, and have opposed the 
 laissez-faire doctrines of the older economists. These men are 
 not to be classed as socialists, the term being used as a reproach 
 by their conservative opponents, and the designation has now 
 chiefly historical significance. 
 
 7. Syndicalism may be mentioned here, although it is more 
 akin to anarchism than to socialism, and is to be viewed as a 
 form of labor organization. The term is derived from the 
 French word for labor union. The syndicalists believe that 
 the emancipation of the working classes is to be achieved, not 
 through control of present government, but by means of the 
 control of, first, industry and, second, government by labor 
 imions. They advocate the use of general strikes and of other 
 destructive tactics, such as sabotage. They are extremely 
 pessimistic with respect to the outlook for the laboring classes. 
 This doctrine had its highest development in France about 
 1908 and has had some following in England and America. 
 The tactics of Syndicalism are condemned by the American 
 Socialist Party. 
 
 Communism. — Communism was the term employed by Karl 
 Marx to distinguish his own philosophy from the " Utopian " 
 schemes of such men as Owen, which he termed socialistic. But 
 
632 OUTLINES OF ECONOMICS 
 
 today the reverse has become the common usage. Communism 
 now very generally signifies the abolition of private property 
 not only in production goods, but also in consumption goods, 
 whereas socialists contemplate the retention of private property 
 in income. In this case there would be provision of private 
 property for every one, and in this one respect socialists: em- 
 phasize and extend the idea of private property. 
 
 Socialism an Extension of Existing Institutions. — Our govern- 
 ment owns the post ofiS.ce; most governments the telegraph. 
 Nearly all own the wagon roads. Some own the canals and rail- 
 ways. Many governments own factories. Probably every 
 national government does at least a little manufacturing. Most 
 governments cultivate forests, and some cultivate arable land. 
 We have only to imagine an extension of what already exists 
 until government enterprise dominates in manufactures, mining, 
 transportation, commerce, and carries on, in short, most pro- 
 ductive enterprises, and we have socialism. 
 
 But saying that socialism is an extension of existing institu- 
 tions may lead to a misconception. The elimination of private 
 capitalism, it is supposed, would work a most radical change in 
 many branches of our social life. The commercial spirit, social- 
 ists think, would be abolished, and with it all that is dependent 
 upon it. We are trained today from childhood up, it is alleged, 
 to try to " make money," and this accentuates the selfish 
 elements in our nature ; and it is therefore maintained that our 
 present system does nothing to promote, and does much to 
 hinder, the development of the brotherly spirit. 
 
 The Strength of Socialism. — Socialism makes perhaps its 
 strongest claim in its plea, first, for a scientific organization of 
 the productive forces of society, and second, for a just distribu- 
 tion of the annual social income. It is said that the present 
 production of economic goods is small in proportion to popula- 
 tion, but the socialist replies : " Naturally enough. Competition 
 is wasteful. Two railways are built where one would suffice. 
 Two trains run parallel between two cities where one would 
 serve the public equally well. Three times as many milk 
 wagons, horses, and drivers are required to serve the people 
 
SOCIALISM 633 
 
 with milk as would suffice if the milk business were organized 
 like the mail distribution in cities. Look at the shops, whole- 
 sale and retail, and see the waste of human force. Without 
 competition, the dry goods business and the grocery business 
 could be carried on with a third of the present expenditure 
 of energy. Reflect on all the idle classes in modern society. 
 Socialism would set everybody to work, and, making each one 
 dependent on his own exertions for success, would stimulate all 
 energies." The argument is a telling one, but it does not prove 
 its point unless we grant that the present waste and idleness 
 cannot be suppressed or greatly diminished without a departure 
 from the fundamental principles of our present industrial order, 
 or that the waste and idleness are not counterbalanced by 
 advantages. 
 
 Justice is a strong plea in the socialist philosophy. It cannot 
 be for one moment claimed that each one's income is at present 
 in proportion to his services to humanity. Income in proportion 
 to industrial merit is attractive to an ethical sentiment. But 
 cannot we approximate justice in distribution on the basis of 
 the existing order? There is nothing distinctively socialistic 
 about the desire for distributive justice. It is a feeling that 
 actuates those who work for the control of monopolies, for tax 
 reform, for regulation of inheritances, and for labor legislation. 
 The socialist simply differs from these people in his method of 
 attaining his ideal. 
 
 The socialist criticism of the present regime is especially severe 
 in the matter of unemployment. There are always some men 
 able and willing to work who are seeking employment, and 
 periodically, with the coming of crises and depressions, the lack 
 of employment becomes widespread. Again, it is urged that 
 today goods are made for sale, not for use, as they would be 
 under the socialistic regime. Adulteration, deception, and 
 " cheap and nasty " goods are the direct outcome of a system 
 of private capitalism. In the socialistic state we are told the 
 business of the shopkeeper is to help you find what you really 
 need ; at the present time it is to his interest to persuade you 
 to buy what you do not need or what will give him the greatest 
 
634 OUTLINES OF ECONOMICS 
 
 profit. The spirit of competition is to the socialist simply war- 
 fare. In every business establishment a good part of the most 
 highly paid labor is devoted, not to the production of goods, but 
 to finding a market. Ability to fight one's competitor is quite 
 as essential in business as is the ability to turn out good products. 
 
 The Weakness of Socialism. — i. Strong as may be the fore- 
 going indictment of the existing industrial system, it is not suffi- 
 cient to indicate that socialism is to be the necessary or the desir- 
 able outcome. The modern machine age is little more than a 
 century old, and some of its most important phases are very 
 recent. The dire predictions made by Karl Marx and his fol- 
 lowers on the strength of some of the earliest phenomena of the 
 factory system have not been borne out, and similarly the evils 
 of today may possibly be very largely eliminated without de- 
 parting from our fundamental institutions. In short, the first 
 weak point in the socialist's position is that he attempts to pre- 
 dict the course of economic evolution too far in advance. That 
 we shall have a juster distribution of wealth in the future, and 
 that we shall eliminate many of the present wastes of production 
 seems probable, but whether this will be accomplished by a 
 socialistic organization it would be very hazardous to predict. 
 It is desirable to have ideals to work toward, but we should not 
 pin our faith now to a future method for attaining them, for no 
 one can say that the collective ownership of all of the important 
 means of production presents a question that needs to be 
 decided now. 
 
 2. The socialist underestimates the efficiency of the present 
 system. In particular he fails to see the significance of the great 
 and (in many respects) smoothly-working system of economic 
 cooperation that has resulted from giving opportunity to free 
 individual enterprise. To-day there is a premium on energy 
 and thrift. Much may be wasted, but much is also produced. 
 That socialism would result in a larger sum total of goods for 
 consumption has never been proved. But, on the other hand, 
 we can say that the present regime is continually offering more 
 and more to the mass of the people. Their standard of life is 
 continually rising. Our economic world is a bettering world. 
 
SOCIALISM 63s 
 
 3. The socialist is also in other respects too pessimistic with 
 respect to the present. He sees all of the starvation, misery, 
 luxury, and extravagance, but he passes by the millions of happy 
 homes scattered throughout the land. He does not see that the 
 world is full of opportunity for the rising generation, that even 
 if the chance for the ownership of an independent business for the 
 ordinary man is smaller, the things which he can enjoy, if he is 
 of average intelligence and energy, are much greater than ever 
 before in the world's history. 
 
 4. The socialist underestimates the importance of individual 
 responsibility. Today a man is confronted by the stern neces- 
 sity of making his own way, and this must have some good effect 
 upon character. On the whole, the lazy and incompetent are 
 sifted out. Bad heredity and a lack of proper training are the 
 cause of a good part of economic misfortune. It is well to dis- 
 tinguish the criticism here made from the common error of 
 supposing that socialism would necessarily crush individuality 
 and that all would be compelled to dress and eat alike. 
 
 5. The socialist underestimates the importance of free enter- 
 prise in industry. If a man now believes that he can develop 
 a certain industry that will satisfy important wants of the people 
 in the future, he does not need to secure the consent of some 
 government official to make the experiment. The possibilities 
 of a free and spontaneous development should be safeguarded 
 from governmental routine to every possible extent. 
 
 6. Perhaps the most frequently mentioned objection to social- 
 ism is the danger to liberty. Under socialism there would be 
 simply the public sphere of employment, and there is reason to 
 fear that the inability to escape from the public sphere would 
 compel the submission to onerous and tyrannical conditions 
 imposed by the administrative heads of the business in which 
 one might be engaged. The socialists, it is true, have a re- 
 joinder in the fact that this objection refers to liberty in the 
 negative sense of freedom from interference rather than in the 
 positive sense of the power to have and to enjoy goods, and yet 
 there are many persons who fear the tyranny of the majority. 
 Those in whose hands political and economic control centered 
 
636 OUTLINES OF ECONOMICS 
 
 would have tremendous power, however they might be selected 
 or appointed. As in the religious sphere in the past, so in the 
 economic sphere in the future, we may find that compulsory 
 cooperation is incompatible with human nature. 
 
 7. The Marxian socialists may be criticized for the impor- 
 tance which they attach to the economic interpretation of his- 
 tory, for the validity of that proposition does not establish the 
 validity of the socialist contention. Even if it be true that our 
 social life is a reflex of our economic activity, it still does not 
 necessarily follow that our economic development is going to be 
 such as will land us in socialism. Their doctrine of the class 
 struggle also does not give an accurate account of existing con- 
 ditions. We have a laboring class and a capitalist class, it is 
 true, but there is also a considerable class, perhaps large enough 
 to hold the balance of power between the other two, which does 
 not sympathize exclusively with either laborers or capitalists. 
 Moreover, we have yet other social classes, divided from one 
 another by lines that cut across those separating the capitalists 
 and the laborers. Race is, for example, the basis of a social 
 classification that lessens the unity and cohesiveness of the 
 laboring class. 
 
 Social Reform. — There are those who recognize the strength 
 of the socialist's criticism of the existing economic and social 
 order, but who believe it wise to attack the various problems 
 confronting us one at a time. Social reform seems likely to 
 accomplish more valuable results than socialism. We have a 
 monopoly problem before us now. Its solution may involve a 
 considerable extension of government enterprise. Why not con- 
 centrate our efforts upon that problem instead of making up 
 our minds now whether some day the greater proportion of the 
 industrial field must be collectively owned and managed? 
 
 The Socialist Movement. — In every country of importance 
 at the present time there is an organized socialist movement. 
 In Germany the Social-democratic party is the largest political 
 party of the empire, having polled over one third of the total 
 votes cast in 181 2, although it has less than 28 per cent of the 
 seats in the Reichstag. The growth in votes and representation 
 is shown in the following table : 
 
SOCIALISM 
 
 637 
 
 Year 
 
 Socialist Vote in Germany 
 
 Representatives 
 IN Reichstag 1 
 
 1878 
 
 437,100 
 
 9 
 
 1881 
 
 312,000 
 
 12 
 
 1884 
 
 550,000 
 
 24 
 
 1887 
 
 763,100 
 
 II 
 
 1890 
 
 1,427,300 
 
 35 
 
 1893 
 
 1,786,700 
 
 44 
 
 1898 
 
 2,107,100 
 
 56 
 
 1903 
 
 3,010,800 
 
 81 
 
 1907 
 
 3,259,000 
 
 43 
 
 1912 
 
 4,250,400 
 
 no 
 
 Although the oflScial platform of the party adheres strictly to 
 the orthodox Marxian faith, the party itself has worked for 
 many reforms tending to favor the lower classes, and a large 
 element of the party (the " revisionist " wing) is in favor of 
 putting the doctrine of the class struggle and complete collec- 
 tivism in the background, and laying main emphasis for the 
 present upon social reform. In France there are a number of 
 socialist factions of various degrees of radicalism, nominally 
 united in one party, the factional strife being one of the promi- 
 nent characteristics of the movement in that country. Their 
 combined representation in the Chamber of Deputies is about 
 one sixth of the total membership. A member of the moderate 
 group, Millerand, was made Minister of Commerce (1899) in 
 the Waldeck-Rousseau cabinet. Since that time other social- 
 ists have accepted cabinet portfolios, but as individuals and not 
 as representatives of the socialist party. In a number of French 
 municipalities the government is almost completely socialistic 
 in personnel. The result in these cases has been an increased 
 public activity in behalf of workingmen, the poor, and the un- 
 fortunate. 
 
 In Belgium the success of the socialist party in promoting the 
 cooperative movement has been striking. In England no one 
 socialist party has attained the prominence of those in Germany 
 
 ^The total number of seats in the Reichstag is 397. 
 
638 OUTLINES OF ECONOMICS 
 
 and France. Some of the socialist organizations have joined 
 with the trade unions in forming a Labor Party, which in 1914 
 had 39 representatives in Parliament. In the United States 
 there are two rival parties, the Socialist party and the Socialist 
 Labor party (of minor importance), both having platforms based 
 upon the Marxian philosophy. The list of socialist officials in 
 the United States in 1913 included 21 members of State legisla- 
 tures, 34 mayors, and 612 municipal, county, and school officers. 
 In 191 2 a socialist was elected to Congress from Wisconsin. 
 The elections of 19 14 also resulted in the choice of one socialist 
 member of Congress (from New York). In 19 12 the presidential 
 candidates of the two socialist parties polled 6.3 per cent of the 
 total vote, the total socialist vote at four recent presidential 
 elections being : 1900,130,336; 1904,441,776; 1908,438,509; 
 1912, 931,406. 
 
 Socialists have rendered good service by calling attention to 
 social problems, by forcing us to reflect on the condition of the 
 less fortunate classes, by quickening our consciences ; also by 
 helping us to form the habit, acquired by few as yet, of looking 
 at all questions from the standpoint of the public welfare and 
 not merely of individual gain ; finally, by calling our attention 
 to the nature of the industrial functions of government and 
 helping us to separate rationally the private industrial sphere 
 from the public industrial sphere. A number of questions hav- 
 ing no connection with socialism have been, even by socialists, 
 not infrequently associated with it. Atheism and free love may 
 be mentioned. Socialists generally, however, regard religion 
 and marriage as changing institutions. 
 
 Anarchism. — In contrast with the socialist, the anarchist 
 holds that the ideal social arrangement is that men should freely 
 and spontaneously form cooperative groups. The anarchists 
 attack government and deny the right of one man to exercise 
 authority over another. Freedom, independence, self-reliance, 
 non-compulsion, are what appeal to them. Such an ideal con- 
 tains nothing reprehensible, but its complete attainment is im- 
 possible. Some governmental compulsion seems necessary with 
 human nature as it is or is ever likely to be. The anarchist is 
 
SOCIALISM 639 
 
 not opposed to the principle of association ; he simply asks that 
 the association be voluntary. The anarchist ideal is thus por- 
 trayed by Kropotkin : 
 
 "This society will be composed of a multitude of associations federated 
 for all the purposes which require federation ; trade federations for produc- 
 tions of all sorts, — agricultural, industrial, intellectual, artistic ; communes 
 for consumption, making provision for dwellings, gasworks, supplies of food, 
 sanitary arrangements, etc. ; federations of communes, among themselves, 
 and federations of communes with trade organizations ; and finally, wider 
 groups covering all the country, or several countries, composed of men who 
 collaborate for the satisfaction of such economic, intellectual, artistic, and 
 moral needs as are not Hmited to a given territory. All these will combine 
 directly by means of free agreements between them, just as the railway 
 companies or the postal departments of different countries cooperate now, 
 without having a central railway or postal government, — even though the 
 former are actuated by merely egotistic aims, and the latter belong to differ- 
 ent and often hostile states ; or as meteorologists, the Alpine clubs, the life- 
 boat stations in Great Britain, the cycUsts, the teachers, and so on, com- 
 bine for aU sorts of work in common, for intellectual pursuits or simply for 
 pleasure." ^ 
 
 Many persons class anarchists and socialists together as simply 
 dangerous persons. One thing they do have in common, and 
 that is, discontent with existing conditions. Otherwise their 
 views are in most respects radically divergent. 
 
 Anarchists differ among themselves. The " communist- 
 anarchist " Kropotkin has advocated revolutionary tactics. 
 Bakunine and Stirner also favored the use of violence. The 
 " individualistic anarchists," such as Tolstoi and Tucker, have 
 advocated a peaceful policy of non-resistance. Godwin and 
 Proudhon may be called anarchistic reformers. 
 
 QUESTIONS AND EXERCISES 
 
 1. Is the public purchase of a street-railway system socialistic? 
 
 2. What is the attitude of socialists toward the trust problem? 
 
 3. Compare the Amana Society with the New Harmony Community. 
 
 4. What is meant by the economic interpretation of history? Is it ac- 
 cepted by thinkers who are not socialists? 
 
 5. Can the socialist be said to have a distinctive attitude towards war? 
 
 1 Memoirs of a Revolutionist, pp. 398-39Q- 
 
640 OUTLINES OF ECONOMICS 
 
 6. What is the relation between trade-unionism and socialism in the 
 United States? 
 
 7. How should one measure the real cost of the supply of capital in a 
 socialistic state ? 
 
 REFERENCES 
 
 Barker, J. E. British Socialism. 
 
 Cross, I. B. The Essentials of Socialism. 
 
 Ely, R. T. Socialism and Social Reform; French and German Socialism. 
 
 Eltzbacher, Paul. Anarchism. (Trans, by S. T. Byington.) 
 
 Ensor, R. C. K. (Editor). Modern Socialism, 2d ed. (A collection of 
 
 essays by leading socialists.) 
 HiLLQUiT, Morris. History of Socialism in the United States. 
 Hinds, W. A. American Communities. (Descriptive.) 
 Hughan, J. W. The Facts of Socialism. 
 
 Jaures, Jean. Studies in Socialism. (Trans, by M. Minturn.) 
 KiRKUP, Thomas. History of Socialism. 
 Kropotkin, p. Modern Science and Anarchism. 
 Le Rossignol, J. E. Orthodox Socialism. 
 Morris, William. News from Nowhere. 
 Orth, S. p. Socialism and Democracy in Europe. 
 Rae, John. Contemporary Socialism, 2d ed. 
 Seligman, E. R. a. The Economic Interpretation of History. 
 SiMKHOViTCH, V. G. Marxism vs. Socialism. 
 Skelton, O. D. Socialism: A Critical Analysis. 
 Socialist Party Campaign Book. 
 
 Spargo, John. Syndicalism, Industrial Unionism, and Socialism. 
 Tucker, Benjamin. Instead of a Book, 2d ed. 
 Vizetelly, E. a. The Anarchists. 
 
 Walling, W. E. Socialism As It Is; The Larger Aspects of Socialism,. 
 Wells, H. G. A Modern Utopia; Socialism and the Great State. 
 Zenker, E. V. Anarchism. 
 
BOOK III 
 PUBLIC FINANCE 
 
CHAPTER XXXI 
 PUBLIC EXPENDITURES 
 
 Nature and Significance of Public Finance. — Public finance 
 deals with the revenues of government, with their expenditure, and 
 their administration. Public finance is one part of economics. 
 Like general economics, it deals with the means for the satisfac- 
 tion of human wants. Some of our wants we satisfy in one way, 
 some in another. Some we satisfy individually. Some we 
 satisfy through private associated effort, especially through the 
 private corporation. Others we satisfy through public collective 
 effort, that is to say, through some governmental agency. The 
 wants which we satisfy through governmental agency are not all 
 of them so peculiar that they could not be satisfied either through 
 private individual activity or private associated activity. Let us 
 take the case of watering the streets. There are places in which 
 the streets, in so far as they are watered at all, are watered by in- 
 dividuals in their private capacity, each man watering the street 
 in front of his own house with his own hose. There are other 
 places in which the householders join together and pay some 
 one to water the streets for them, and do this privately. There 
 are still other cities in which the city government employs persons 
 to water the streets and pays them from the proceeds of taxation. 
 
 There are, to be sure, some wants which are satisfied through 
 governmental agency and which a civilized community will not 
 allow us to satisfy privately. This is the case with those wants 
 which are satisfied by means of the police and the courts. It i? 
 a peculiar function of government in modern times to provide the 
 inestimable blessing that we call security of person and property. 
 This requires economic resources, just as the satisfaction of the 
 other wants mentioned does, and public finance has to do with 
 the provision of these resources. 
 
 643 
 
644 OUTLINES OF ECONOMICS 
 
 Public finance, then, is a part of economics because it deals 
 with the satisfaction of wants by the use of economic resources. 
 It is also a part of economics because it has its influence upon the 
 production, the distribution, and the consumption of wealth. 
 But while we have to insist that public finance belongs to eco- 
 nomics, it is more separated from the other parts of economics 
 than they are from each other. Inasmuch as it deals with the 
 satisfaction of wants through governmental agency, it has its 
 own peculiarities, and it is only an undue emphasis upon these 
 peculiarities which leads some writers to make it a separate 
 science. 
 
 The significance of public finance may be brought before us 
 by examination of, first, the increasing amount of public revenues, 
 and of, second, the enormous aggregate of these revenues at the 
 present time. Public revenues have gone on increasing during 
 the past hundred years by leaps and bounds. An illustration is 
 afforded by the history of France. Ninety years ago the public 
 expenditures of France reached one thousand million francs for 
 the first time, or, as we generally say, a billion francs. There 
 was universal astonishment and alarm, just as there was when, 
 for the first time, an American Congress spent a thousand million 
 dollars in two years. Never since the time, however, when the 
 public expenditures of France first amounted to a thousand mil- 
 lion francs have they been so small. Gradually they increased 
 until they reached two thousand millions, never to pass below 
 that mark ; then they increased until they touched three thou- 
 sand millions ; and now the national expenditures are nearly four 
 thousand millions. Public expenditures at the present time, 
 under the modern government, amount to more than a tenth part 
 of all the wealth produced.^ 
 
 ^ This estimate (that public expenditures equal one tenth part of all the wealth 
 annually produced) has been given, but it must be a very considerable underestimate 
 for the modern nation. We in reality know very little about the amount of wealth 
 annually produced in the modern nations of the world. But such data as we have, 
 and familiar observation, are sufficient to convince us that the wealth produced is 
 not ten times the total public expenditures. In the United States, according to 
 Starke M. Grogan, chief (Census) Statistician in Charge of Wealih, Debt, and Taxa- 
 tion, the total expenditures or "total governmental cost payments," including the 
 
PUBLIC EXPENDITURES 645 
 
 Now what does this mean ? Does it signify increasing extrav- 
 agance or even corruption? Quite the contrary. While the 
 modern government is far from perfect, it is throughout the 
 civilized world probably better than it ever has been before. 
 Taking the civilized world as a whole, there probably never was 
 more honest government or more efl&cient government than there 
 is today. What it really means is this : We are living in a pe- 
 riod of increasing public cooperation. We think we find it more 
 advantageous to satisfy certain wants, growing in number and 
 significance, through public co5peration than through individual 
 effort or private cooperation. This is the chief significance of 
 the increasing governmental budget throughout the civilized 
 world. Militarism in its various phases is the chief phase of pub- 
 lic expenditures that is disquieting.^ Educational expenditures 
 afford a good illustration of the general tendency. They run 
 up into the hundred millions in the modern nation, whereas, 
 previously to this century, they were insignificant. Expendi- 
 tures for police protection, for public lighting, and for sanitation 
 are things which, so far as any expenditures of magnitude are 
 concerned, belong to this century. 
 
 Public finance has still another significance. Questions of 
 social reform are now connected generally with financial ques- 
 tions just as formerly they were with constitutional questions. 
 Public finance has become the central fighting place for social 
 reform. The question of protection has, from the earliest days 
 in this country, been connected with public finance. Police 
 regulation has also been connected with fiscal measures. The 
 license charge for the privilege of selling alcoholic beverages 
 
 national government, states, territories and local subdivisions amounted in 1913 to 
 $3,284,343,266 or $33.83 per capita. Professor W. I. King {Wealth and Income of the - 
 People of the United States, p. 248) estimates the average income in the United States, 
 for the year 1910, at $332 per capita. Public expenditures thus appear to take about 
 10 per cent of the income in this country. In England the per capita expenditure of 
 the national government alone was, before the European War, over $15.50, and in 
 France over $17. The 10 per cent estimate, then, is clearly an underestimate for 
 most countries. 
 
 * This topic is adequately treated by Professor Charles J. Bullock in his article 
 entitled "The Growth of Federal Expenditures," Political Science Quarterly, vol. 
 Jfviii, pp. 97-III. 
 
646 OUTLINES OF ECONOMICS 
 
 furnishes an illustration. The scope of the police power is 
 expanding in the United States, and this means expansion of the 
 field of public finance. The discussion of public expenditures 
 reveals, as few other subjects do, the nature of our civiliza- 
 tion. 
 
 Public and Private Expenditures Contrasted. — There is a 
 difference between public and private economies with respect 
 to the equilibrium between income and outgo. Relatively, 
 there is an elasticity of government revenues and an inelasticity 
 of government expenditures. This finds expression in the state- 
 ment that public revenues are gauged acccording to expenditures ; 
 whereas, in the private economy, the household expenditures are 
 regulated hy income. This is a regular rule for normal conditions. 
 It is abnormal when irregularities in public income lead to irregu- 
 larities in expenditures. It has been observed by a critic that 
 this principle of public finance is true in a legal sense, but not in 
 an economic sense. It is said that when public expenditure is 
 decided upon, then we legally determine the income ; but, eco- 
 nomically, the expenditures of the state rest upon a foundation 
 as elastic as that of a private person.^ It is true that in public 
 expenditures there must be a balancing of gain and sacrifice, and 
 that in the case of a particular expenditure it must be weighed 
 over against all other possible expenditures, not only public, but 
 private. The rich state, undoubtedly, will incur expenditures 
 from which a poor but prudent people will probably shrink. On 
 the other hand, a private person is not to be thought of as neces- 
 sarily spending all his income, even if he gauges his expendi- 
 tures by income. 
 
 Nevertheless, roughly speaking, the principle has significance 
 because of the priority of the claims of the State. This has been 
 well brought out by critics of Henry George, who advocated the 
 appropriation of economic rent for public expenditures. Some 
 of Mr. George's followers have replied to the objection that eco- 
 nomic rent might not be sufl&cient for public expenditures: 
 " Then the State must curtail its expenditures as the private person 
 would do." When we think about it, we find that certain public 
 
 ^ Gustav Cohn, Finanzwissenschaft, S. 184. 
 
PUBLIC EXPENDITURES 647 
 
 expenditures must be made and must take prior claim. How- 
 ever, when, as is so often the case in cities, there is an income 
 strictly limited by the tax rate, we have a situation like that of 
 a man with a limited and inadequate income. This is an un- 
 fortunate situation for cities ; but the case of a national govern- 
 ment which did not have a prior claim upon wealth for defense 
 would be anomalous. 
 
 Closely connected with what has been said, we find various 
 differences due to the sovereignty of the State and its perpetual 
 life. The State orders a citizen to give up a part of his possessions, 
 and, indeed, frequently fixes the prices to be paid for them. And 
 a peculiarity of the prices paid by all states for property and 
 services is that they must be determined by criteria of fairness, 
 inasmuch as by the very hypothesis competition is wanting 
 wholly or in part. Consequently, we find courts and legislatures 
 much occupied with the determination of what is " fair and rea- 
 sonable." The perpetual life of the State has to be kept in mind 
 in a great variety of expenditures. It is the special function of 
 the State to provide for future generations, and this is seen, for 
 example, in forestry and in care for rivers and harbors. 
 
 There is a difference between public and private economies in 
 the means of measuring the utilities resulting from expenditures. 
 It is at once admitted that all expenditures of states and of pri- 
 vate persons should, in a large sense, be productive. Waste is 
 everywhere an economic wrong, but productive expenditures 
 mean simply useful expenditures. What the State produces is 
 largely immaterial services, and these have no market price. 
 How can we tell whether they are socially profitable or unprofit- 
 able? They are not worth while if they result in a sacrifice of 
 other expenditures which would yield larger satisfactions. It is 
 a special function of the legislative body, in a constitutional 
 state, to decide upon the relative advantages of various possible 
 public expenditures, and to weigh these over against the ad- 
 vantages of private expenditures which might have been made 
 if the money permitting the expenditures had been left in private 
 pockets. When a certain sum is taken from me by taxation, it 
 results in a public expenditure instead of a private expenditure 
 
648 OUTLINES OF ECONOMICS 
 
 which might have been made. This is only another way of 
 saying that public expenditures are largely from income which 
 is derivative. Private individuals secure an income and then 
 yield a part of it for public purposes. These contributions are 
 compulsory. On the other hand, there are economists who look 
 upon the State as a factor in production, and hold that what is 
 paid in taxes is less than what corresponds to the cooperative 
 activity of the State in the maintenance of law and order and in 
 other services. The special social significance of public expendi- 
 tures is that their aim is inclusive, normally and regularly; 
 whereas, normally and regularly, the aims of private expendi- 
 tures are more or less exclusive. A public library contrasted 
 with a scholar's private collection of books illustrates this point. 
 
 All these differences are considerable, and they give us perhaps 
 at least one reason why business men are so often a disappoint- 
 ment in an official capacity. The public financier must be gov- 
 erned by the public point of view ; and there are many points at 
 which this diverges from the private point of view. The true 
 statesman is one who has the public point of view, and yet is 
 able to avail himself of the knowledge and experience of private 
 business. 
 
 The Proper Proportion between the Total Income of Society 
 and Public Expenditures. — We notice actual changes in this 
 proportion, and we discover that further changes are advocated, 
 running all the way from anarchism, which would abolish gov- 
 ernment and public expenditures, to socialism, which, by making 
 production and distribution public functions, would make public 
 expenditures, broadly construed, nearly equal to the total wealth 
 production. 
 
 An attempt has been made by those who take a less extreme 
 position than either of these to give an estimate of what is a large 
 public expenditure, what a small expenditure, what is desirable, 
 undesirable, or even intolerable. Generally these estimates are 
 made with respect to the maximum expenditure, but we could 
 equally well raise the question with respect to the minimum. 
 One writer speaks of public expenditures of 16 per cent as aver- 
 age, and 25 per cent as excessive. Another regards public ex- 
 
PUBLIC EXPENDITURES 649 
 
 penditures which consume 1 5 per cent of the total annual wealth 
 production as the upper limit. In our American practice, we 
 very generally attempt to fix a maximum direct tax rate. 
 But these limits are based on the valuation of property and not 
 on income. State constitutions very frequently also limit state 
 expenditures, as well as the expenditures of cities and other local 
 units. For local purposes in the United States, we have roughly 
 a tax limit of | to 3 per cent of the value of property. Total 
 taxation of real property frequently runs in the United States 
 from 10 per cent to even 20 per cent of the net profits, and indeed 
 not infrequently goes far beyond that. The truth is that it is 
 absolutely impossible to give any general answer to the question, 
 " What is the proper proportion between the total income of 
 society and public expenditures? " Variations in the wealth of 
 a country have to be considered, and these mean much when the 
 question of additional expenditure is raised. Variations in tax 
 systems and the consequent distribution of the burden of taxa- 
 tion make a wide difference. In times of distress, more can be 
 expended than on ordinary occasions. When the national life 
 of the State is endangered in a war, expenditures will be incurred 
 which would be impossible at any other time, simply because for 
 any other reason the people would not submit to the sacrifice 
 involved. 
 
 But there are other points of view which go still deeper. Why 
 do we spend money at all through the State ? Obviously to sat- 
 isfy needs. How much we should spend publicly depends upon 
 what needs are satisfied publicly. We have to ask and answer 
 the question, " What position do these needs hold among our 
 needs in general?" "Do they belong to our necessities or 
 superfluities? " When we consider public expenditures in the 
 broadest terms, we must take into account the amount of pro- 
 duction which is carried on by the State — employing this term 
 " State " here as elsewhere in its generic sense. If the railways 
 (as in Germany) are state railways, a larger percentage of the 
 expenditures and revenues of the country are public in character 
 than would be the case if they were privately owned and operated. 
 No comparison of expenditures of various countries can have any 
 
650 OUTLINES OF ECONOMICS 
 
 value if it does not take into account considerations of this 
 kind. 
 
 Professor Adolph Wagner ^ lays down this rule, which is help- 
 ful in answering the question as to the proper proportion between 
 the income of society and public expenditures for any particular 
 time and place : " The permissible amount of public expendi- 
 tures, both absolutely and relatively considered, will vary di- 
 rectly in proportion to (a) the direct economic value of state activi- 
 ties ; (b) the extent to which these promote the productive power 
 of all ; (c) the absolutely free social income ; ^ (d) the part of the 
 net state receipts coming from the quasi-private acquisition 
 (railways, industries in general) of the State and not from taxes."* 
 Fortunately, how much we shall spend presents itself historically, 
 that is, with respect to historical conditions, and has reference to 
 increments or decrements of expenditure. The problem is far 
 easier of solution than it would be otherwise. 
 
 In fact, except as a concrete historical problem, it is impossible 
 to state how great the public expenditures should be. We are 
 now in a position to understand why it is that the nations of the 
 world have not been ruined by expenditures which even a genera- 
 tion ago would have been thought absolutely crushing, and one 
 hundred years ago would have been inconceivable. We satisfy 
 our needs to an ever increasing extent through public agencies. 
 This finds expression in the law of increasing public expendi- 
 tures, given by the writer from whOm we have just quoted. 
 
 " Comparisons between different countries and different periods 
 show regularly among progressive nations an extension of public 
 activities. This manifests itself extensively and intensively. The 
 State and its subordinate political units continually undertake new 
 functions, and they perform their duties, old and new, better and bet- 
 ter. In this way, that is, through public agency, the needs of the 
 population, especially their common needs, are satisfied to an in- 
 
 1 Finanswissenschaft, ate A., Bd. i., S. 65. 
 
 ^ I.e. beyond and above what is needed for subsistence. 
 
 2 This means public ownership of enterprises which are so conducted as to yield 
 profits. All the profits can and indeed must be expended for public purposes, 
 whereas, if the industry were private, only a part of the profits could be taken for 
 public purposes. 
 
PUBLIC EXPENDITURES 651 
 
 creasing extent; and the public services for the satisfaction of needs 
 continually improve in quality. The clear proof of this is given 
 statistically in the increased demands made by the State and the 
 subordinate political units. ''^ ^ 
 
 We have here described what is a part of a still larger move- 
 ment, namely, the socialization of production and the socializa- 
 tion of consumption. It is, however, the socialization of con- 
 sumption which especially confronts us in public expenditures. 
 To an increasing extent what is consumed by the family is pro- 
 duced outside the family. There has been going forward a great 
 process of socialization, and this finds expression in part in public 
 expenditures. The needs of the family are satisfied, in increas- 
 ing proportion, not by the private economy, but by the public 
 economy, and satisfied also, as Professor Wagner points out, not 
 in accordance with the principles of private economy, which is 
 service for service, but in accordance with the principles of the 
 public economy, which is an adequate general return for that 
 which is received. 
 
 We have to do with what we may also call socialization of sup- 
 ply. We do not protect ourselves against physical violence, but 
 are protected by the State. We do not educate our own children ; 
 they are educated by public agency. And public expenditures 
 are also made to promote art and all the higher interests of life. 
 The services which the federal government renders us in the post 
 office find expression in public expenditures. Public expenditures 
 are giving us more beautiful and more healthful cities, and are 
 satisfying the needs which arise out of the extensive growth of 
 the country, in its expansion geographically and in the size of the 
 population, and also the needs which arise from an intensive 
 growth. 
 
 The significance of this lies partly in increased state activities 
 and partly in the incidence of the cost of the services under con- 
 sideration. The poor, who could not themselves have pleasure 
 grounds, enjoy public parks, and these are maintained at public 
 expense. So we may take up one service after another and find 
 that wealth, produced in accordance with the principles of the 
 
 1 Wagner, Grundlegung der polUischen Oekonomie, ste A., Bd. i, S. 893. 
 
652 OUTLINES OF ECONOMICS 
 
 private economy, is consumed in accordance with the principles 
 of the public economy, and that is very largely in accordance 
 with needs and capacity for use. The whole public educational 
 system, from the country district school to the modern state 
 university, culminating in research and investigation, admirably 
 illustrates this principle. 
 
 Extravagance, Economy, and Parsimony in Public Expendi- 
 tures. — After a definition of economy in Webster's International 
 Dictionary, we find the following : " Economy, Frugality, Parsi- 
 mony. Economy avoids all waste and extravagance, and applies 
 money to the best advantage ; frugality cuts off indulgences, and 
 proceeds on a system of saving. The latter conveys the idea of 
 not using or spending superfluously, and is opposed to lavishness 
 or profusion. Frugality is usually applied to matters of con- 
 sumption, and commonly points to simplicity of manners. 
 Parsimony is frugality carried to an extreme, involving mean- 
 ness of spirit and a sordid mode of living. Economy is a virtue 
 and parsimony a vice." 
 
 We must have clear ideas as to which course of the three we 
 shall follow, for it is scarcely to be taken for granted that we shall 
 follow the course of extravagance. There is, however, danger of 
 indifference as to the size of public expenditures, and extrava- 
 gance may result therefrom. While scarcely any one now would 
 deliberately advocate extravagance so far as the general princi- 
 ple is concerned, extravagance in detail might be advocated; 
 and, in fact, in practice we find both indifference and extrava- 
 gance. Sometimes the idea that extravagance brings money 
 into circulation has found favor, and especially has been used 
 for the justification of large expenditures by royal courts. The 
 same idea has been used as a justification for luxury. It can, 
 however, find no support in economic principles. There is dan- 
 ger of extravagance because each one concerned with govern- 
 mental expenditures feels that what he spends is a relatively 
 small matter, and indeed it is. It is sometimes thoughtlessly 
 overlooked that when many are spending, " small waste " be- 
 comes significant, and may be even ruinous. This is a problem 
 which concerns every large business, and it requires strict and 
 
PUBLIC EXPENDITURES 653 
 
 wise administration to avoid the two extremes of wasteful 
 extravagance and red tape. 
 
 Sectionalism also results in extravagance, and this shows itself 
 badly in the United States at times. Whatever any state can se- 
 cure from the federal treasury is often looked upon as so much 
 clear gain. This was clearly brought out in the discussions con- 
 cerning the repayment, several years ago, of the direct tax that 
 had been paid by the states to the federal government. This tax 
 has now been repaid, but many states gave agents large and 
 extravagant sums to work for the refund. Sometimes sectional- 
 ism manifests itself even in cities. In one section of the city 
 there may be vigorous efforts to secure money for itself without 
 due regard for the general interest. 
 
 For many years, in this country, federal taxes were laid very 
 largely for other than revenue purposes, and there was no care- 
 ful balancing over and against one another of probable revenues 
 and probable expenditures, with the result that there was fre- 
 quently a large surplus in the federal treasury. There never 
 has been a time when it would not have been possible to have 
 expended wisely the entire revenues of the federal government ; 
 e.g. the telegraph might have been purchased, and educational 
 expenditures might have been increased. But there was no 
 demand for these expenditures strong enough to prevaU, and the 
 outlet was found along the lines of least resistance, or, perhaps it 
 ought rather to be said, along the lines of greatest " pull." 
 We may then lay it down as a general law that there is danger of 
 extravagance whenever public revenues outrun felt needs. 
 
 In the domain of local government it is possible to limit taxes 
 or expenditures, and, as stated above, American statute books 
 are full of laws prescribing maximum rates for school, highway, 
 and other tax levies. These laws have failed in the past because 
 they were adjusted to our prevailing underassessment of prop- 
 erty and it was perfectly easy to evade them by raising the 
 assessment a little closer to the true value. More recently, 
 however, Colorado and several other states have adopted " tax 
 limit laws " which work successfully. Instead of limiting tax 
 rates, the total tax levy or the total expenditures are limited to a 
 
654 OUTLINES OF ECONOMICS 
 
 certain increase, say ten per cent, over the tax levy or total 
 expenditures of the previous year ; and some authority — 
 usually the state tax commission — is empowered to raise the 
 normal limit in " cases of emergency or urgent necessity." 
 Tax limit laws applied in an arbitrary way may cripple, and in 
 some cases have crippled, municipal governments in necessary 
 and desirable expansions of public activity ; but when adminis- 
 tered by a wise board or commission authorized to modify the 
 ordinary limit when necessary, they are capable of restraining 
 harmfully rapid expansion of public expenditures.^ 
 
 There is a tendency, especially wherever public spirit is not 
 highly developed, to favor parsimony, and to regard that as the 
 best administration which spends least, and the smallest tax as 
 the best tax. This idea was particularly encouraged by those 
 who looked upon government expenditures as external to the 
 life of the people — as if they were expenditures for some outside 
 person. This idea, indeed, may be traced back to monarchical 
 government and to a time when royal courts consumed a large 
 part of the public revenue. The smallest expenditure means 
 the accomplishment of the fewest purposes. Parsimony means 
 meanness, and can never be the rule either of public or private 
 financiering. Frugality is the rule when it is a necessity. Econ- 
 omy is the sound rule ; and this means a broad and liberal policy 
 and a husbanding of resources. The wise citizen judges any 
 particular administration either in the nation or the state, not 
 chiefly by the amount of public expenditures, but by the results 
 of public expenditures, appreciating full well that increasing 
 public expenditures are a normal condition in a sound and 
 healthy society. 
 
 The Development of PubKc Expenditures. — It is instructive 
 to consider the historical order in which the objects of public 
 expenditure appear. This order throws a strong light upon the 
 evolution of industrial society and of civilization in general. 
 This is an almost unworked field of investigation, but it is an 
 extremely interesting and important one. This order can be 
 
 1 See discussions of this subject in State and Local Taxation (Proceedings of the 
 National Tax Association), Vol. viii, pp. 368-390, and Vol. ix, pp. 452-473. 
 
PUBLIC EXPENDITURES 655 
 
 presented here only in the most general terms, and in these 
 terms it is somewhat as follows : Expenditures for (i) external 
 security; (2) security within the community; (3) promotion 
 of material interests ; (4) benevolence (transferred in part from 
 the Church at the time of the Reformation) ; (5) education in its 
 various phases ; (6) labor. In a general way the organization 
 of the departments of the federal government corresponds with 
 this order. In 1789, the Treasury, War, and State departments 
 were organized, also the Department of Justice, Supreme Court, 
 and the Navy Department; the Post Office Department was 
 organized as a distinct department in 1829 ; the Department of 
 the Interior was organized in 1849 ; the Department of Labor 
 as a separate department (without representation in the Cabinet) 
 in 1889 ; the Department of Agriculture as a separate department 
 (with representation in the Cabinet) in 1889 ; the Department of 
 Commerce and Labor (with representation in the Cabinet) in 
 1903. In 19 13 Commerce and Labor were divided and given 
 separate representation in the Cabinet. The modern nation has 
 been spending an increasing proportion of its resources for edu- 
 cation. (We use " nation " in the general sense here, including 
 all the subdivisions of the nation.) We find a rapidly increasing 
 item in the budget of the modern municipality for public libraries, 
 in which line of expenditure the United States is leading the 
 world. Lately, in the modern budget, we find expenditures 
 which are distinctively for the promotion of the interests of 
 labor. 
 
 Most interesting it is to observe, within the last few years, an 
 expenditure in the national budgets for international agreements 
 and arrangements to promote the interests of labor. In 1900, 
 the International Association for Labor Legislation was formed, 
 and its permanent Bureau was established at Basle, Switzerland, 
 in 1 90 1. As the competition of labor and capital was interna- 
 tional, it had, in the opinion of many careful observers, become 
 necessary to safeguard the interests of labor by international 
 agreements. Consequently, we find that this international 
 association receives subsidies from most European governments, 
 and a small one from the United States through our federal 
 
656 OUTLINES OF ECONOMICS 
 
 Department of Labor. And, in 1905, as we have already seen, 
 an international treaty was entered into by Italy and France 
 for the advancement of the interests of labor and for mutual 
 protection of employers. Small indeed are these items, but 
 they are significant as beginnings. 
 
 We must, however, analyze the public expenditures of the 
 various departments more carefully to understand fully the order 
 of development in the objects of public expenditures. The 
 whole expenditure of the Department of Agriculture is an expen- 
 diture to promote material well-being, and this has become one 
 of the great departments in modern government. The Depart- 
 ment of the Interior is also largely concerned with expenditures 
 to promote the general material welfare. We have in the De- 
 partment of Agriculture such divisions as forestry, food adultera- 
 tion, botany, seed tests, pomology, entomology, agricultural 
 soils, irrigation investigations, and road inquiry. 
 
 We cannot lay down any hard and fast line between public and 
 private expenditures, because there is a perpetual shifting from 
 the satisfaction of wants privately to the satisfaction of wants 
 publicly, and sometimes even, though less frequently, the reverse 
 process. The railways of Prussia were once private, and their 
 receipts and expenditures had little to do with the Prussian 
 budget. Now the receipts are public receipts, and their expen- 
 ditures are public expenditures. The addition to the budget, 
 however, does not mean necessarily an additional burden on the 
 people. Indeed, if the people are well served and served for a 
 lower price than formerly, with less relative cost of operation, the 
 burdens of the people have been lightened, and this is what is 
 generally claimed in Prussia. Let us take the case of a city in 
 which watering the streets is a private matter paid for by private 
 subscription. The expenditure becomes a public expenditure 
 when the city takes upon itself this function, but if the public 
 expenditure is no greater than the private expenditure, there is 
 no additional burden. If the service is better performed, and the 
 total burden more fairly distributed by taxation than by private 
 subscription, — as sometimes, at least, happens, — there is a 
 positive gain. The increased density of population has been 
 
PUBLIC EXPENDITURES 657 
 
 mentioned as a cause of increased public expenditures. A suburb 
 without any municipal organization may maintain electric lights 
 in the streets by private subscription. The expenditure appears 
 in no public budget. This suburb secures some kind of a mu- 
 nicipal organization, and that which was a private expenditure 
 becomes a public expenditure. Again, however, there is no 
 increased burden resting upon the people ; their wants are satis- 
 fied through a different channel. 
 
 When we compare modern times with ancient times, we 
 find that an increasing proportion of the public expenditures 
 are incurred for objects which directly benefit the people, and 
 relatively a- decreasing amount for objects in which they have 
 comparatively little concern. This finds most striking exem- 
 plification in a comparison of the budget of France in 1789^ 
 with the budgets of 1906 and 1907, which we take merely as 
 typical modern budgets.^ 
 
 Expenses — 1789 
 
 LiVRES" 
 
 Cost of collection and reimbursements (does not include cost 
 
 of collecting taxes farmed out) 
 
 Consolidated debt — included portion made up of annuities 
 
 Interest, etc., on remaining portion of debt 
 
 Pensions 
 
 Royal family and princes 
 
 31,478,000 
 162,486,000 
 80,527,000 
 29,560,000 
 33,240,000 
 
 Total 
 
 337,291,000 
 
 " This formed the total deduction before provision could be 
 made for general service of the government," in which the vari- 
 ous items are as shown in the accompanying table. It will be 
 observed, in comparing these budgets, that the French court 
 consumed a very large proportion of the expenditures of 1789; 
 and that of what remained a very large proportion was consumed 
 by the public debt, the army and navy ; and that for education 
 
 1 Necker's "Budget," May, i78g, rearranged by the author of the article in the 
 Dictionnaire des finances. 
 
 ' A livre is slightly — say 2 per cent — less than a franc, 
 2V 
 
658 
 
 OUTLINES OF ECONOMICS 
 
 and the promotion of general welfare the expenditure was rela- 
 tively insignificant. A study of the table on the next page re- 
 veals one of the reasons why it is that France is able to sustain 
 so large a public expenditure. Wants are thereby satisfied, 
 and what is expended returns to the people in services. 
 
 Expenses — 1789 ( Continued) 
 
 LrvRES 
 
 War 
 
 Marine and colonies 
 
 Foreign affairs 
 
 Justice 
 
 Interior 
 
 Financial administration 
 
 Public works, agriculture, and commerce 
 Public instruction and fine arts . . . 
 Public worship 
 
 Total 
 
 Brought forward 
 
 Grand Total 
 
 100,548,000 
 40,900,000 
 7,480,000 
 6,353,000 
 8,249,000 
 5,801,000 
 11,907,000 
 1,227,000 
 2,188,000 
 
 184,653,000 
 337,291,000 
 
 521,944,000 
 
 The view here presented of public expenditures is undoubtedly 
 one which is reassuring. The impression must not be gathered 
 Irom this that there is no need for care and watchfulness. As 
 public expenditures increase, it becomes of more and more im- 
 portance to secure wise and prudent administration of all our 
 resources. Wastefulness becomes more serious than ever before, 
 and the benefits from excellence in administration increase cor- 
 respondingly. Without pronouncing any opinion upon what is 
 called imperialism, we may also say that the enormous increase in 
 expenditures, in one way or another connected with war, which 
 we have seen during the past few years, cannot be viewed with- 
 out misgiving. Even if there is no danger of the bankruptcy 
 of any great modern nation, the thought must at least occur to 
 one that it is a pity that, with so many public needs unsatisfied, 
 with such large possibilities in the way of improvement of educa- 
 
PUBLIC EXPENDITURES 659 
 
 BtiDGET Estimates Voted for the Years 19 13 and 1914 
 
 Branches of Expenditure 
 
 1913 
 Francs 
 
 1914 
 Francs 
 
 Finance : public debt . . . 
 President, Chamber, Senate 
 
 Finances 
 
 Justice 
 
 Foreign affairs 
 
 Interior 
 
 War 
 
 Marine 
 
 Merchant marine . . . . 
 
 Instruction 
 
 Fine arts 
 
 Commerce and industry . . 
 
 Labor, etc 
 
 Posts and telegraphs . . . 
 
 Colonies 
 
 Agriciilture 
 
 Public works 
 
 Total 
 
 1,286,423,922 
 
 20,116,488 
 
 358,948,853 
 
 S8,55i>727 
 
 20,668,037 
 
 141,961,939 
 
 983,224,376 
 
 467,176,109 
 
 9i>394,63i 
 
 309,139,995 
 
 21,778,491 
 
 16,792,379 
 
 106,669,353 
 
 344,3i3>84S 
 
 105,535,393 
 
 55,002,741 
 
 340,905,255 
 
 1,306,585,021 
 20,006,738 
 
 389,243,907 
 61,017,461 
 22,879,749 
 
 176,949,513 
 
 1,203,659,712 
 
 513,542,521 
 
 97,368,267 
 347,810,375 
 
 21,839,189 
 
 17,948,374 
 106,718,809 
 362,635,13s 
 109,724,180 
 
 74,769,222 
 358,944,912 
 
 4,738,603,534 
 
 5,191,643,085 
 
 tion and of our general environment, such enormous and almost 
 incomprehensible aggregates of wealth should be annually ex- 
 pended for warlike purposes. 
 
 Development of Public Expenditures with Respect to Regu- 
 larity and Irregularity. — Public expenditures are regular and 
 irregular, or. ordinary and extraordinary, with respect to their 
 occurrence. Whether the expenditures are regular or not depends 
 upon the nature of the goods and services for which they are in- 
 curred. A large force must be employed in the army and navy 
 and civil service; and regular expenditures must be made for 
 these branches of the public service. On the other hand, there 
 are great monumental works like the construction of a capitol 
 for which the expenditure is irregular in character. War, 
 famine, and pestilence occasion irregular expenditures. It is to 
 be noticed, however, that in any scientific arrangement regular 
 expenditures increase and irregular expenditures decrease. This 
 
66o OUTLINES OF ECONOMICS 
 
 is particularly the case in a large country, and especially so when 
 long periods of time are taken into account. It is an end to be 
 striven for in the interest of orderly finance. In India there is a 
 regular famine fund to make provision for the recurring famines, 
 so that even expenditure of this kind takes on the character of 
 regularity. The longer the period of time and the larger and 
 richer the country, the greater the possibilities of establishing 
 regularity, inasmuch as chance elements decrease under these 
 circumstances. The construction of a post-office building in one 
 city is an unusual event, but, when the United States as a whole 
 is taken into account, it is quite possible to provide regularly 
 for post office buildings. 
 
 It is further to be noticed that preventive measures rather 
 than relief measures increase regular expenditures. This is one 
 argument in favor of constant preparation for war. The war 
 expenditures are smaller and less disturbing when they come. 
 It need not be remarked that this financial advantage may be 
 secured at a loss otherwise. Furthermore, there is a certain con- 
 flict of interests between administration and legislation. Those 
 who are administratively responsible for expenditures prefer to 
 have budgets voted for long periods, as in this way they can 
 accomplish most with a given sum. On the other hand, a legisla- 
 tive branch of government desires that budgets should be voted 
 for short periods for the sake of stricter control. 
 
 It is also to be noticed that the constitutional provisions 
 against debts in the states of the American Union promote 
 regular expenditures. Where loans are not possible, it is fre- 
 quently necessary to spread expenditures over long periods in 
 order that the burden may not be too great at any one time. 
 This may happen in the construction of public buildings and of 
 other important public works, certain sums being appropriated 
 each year for a series of years. 
 
 Classification of Public Expenditures. — Many principles of 
 classification have been adopted. At the bases of all of these, for 
 countries like our own organized along federal lines, is the dis- 
 tinction among (i) central, (2) intermediate, and (3) local units. 
 In the United States the central would be the federal, the inter- 
 
PUBLIC EXPENDITURES 66 1 
 
 mediate would be the separate states, and the others, the local. 
 An examination of expenditures with respect to these units 
 throws a good deal of light upon our general political evolution. 
 It especially helps us to determine whether or not there is a tend- 
 ency in the direction of centralization, although expenditures 
 are not conclusive evidence. Fear is often expressed lest the 
 central governments should expand at the expense of local gov- 
 ernments. It is thought by some that we are living in a period 
 of centralization. Statistics of public expenditure do not bear 
 this out. From the close of the Civil War until the end of the 
 nineteenth century, local expenditures increased most rapidly 
 and state expenditures least rapidly. Between 1903 and 191 3, 
 however, the expenditures (" governmental cost payments ") of 
 the states increased 106 per cent, while those of incorporated 
 places with 8000 or more inhabitants increased only 103 per cent, 
 and those of the federal government only 54 per cent. The 
 increase in state expenditures seems to have been due to general 
 expansion and multiplication of state activities, although it was 
 particularly marked by the development of state highways and 
 costly internal improvements such as the new canal system in 
 New York, by more generous appropriations for education, and 
 by the multiplication of state commissions.^ 
 
 The student, and even the general reader, will find it especially instructive 
 to study the financial reports of the federal government and of our states and 
 cities, and arrange the items of expenditures under various general heads. 
 
 1 It is exceedingly difEcult to arrange a classification that will be at once practical 
 and scientific, i.e. that will show the expenditures of governmental departments as 
 they are actually organized, observe the necessary accounting distinctions, and 
 answer scientific inquiries of major importance. For American classifications which 
 most nearly meet all the requirements, see the financial pubUcations of the Bureau 
 of the Census ; the reports of the Comptroller of the State of New York ; the 
 Massachusetts reports entitled Statistics of Municipal Finances; and, for the federal 
 government, the reports of the President's Commission on Economy and Efficiency, 
 and in particular a paper by Harvey S. Chase, C.P.A., dealing with the expenditure 
 side of the national budget, in the American Economic Review, Volume v. No. i, 
 Supplement, pp. 186-195. A suggestive classification adapted to European condi- 
 tions will be found in Cossa's Taxation : Its Principles and Methods, Part ii. Chapter 
 iii. The summary census classification printed on the following page covers all 
 governmental subdivisions in the United States, except townships and incorporated 
 places having less than 2500 inhabitants. 
 
662 
 
 OUTLINES OF ECONOMICS 
 
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PUBLIC EXPENDITURES 663 
 
 If access can be had to reports covering a considerable number of years and 
 different countries, it will be found that an examination of them will throw an 
 immense amount of light upon the nature of modern civilization and its 
 direction. 
 
 It is also instructive to compare expenditures on account of the head of the 
 State in various countries, and particularly to contrast monarchical and 
 republican countries. It is important to discover great historical tendencies, 
 and to contrast different periods of time, especially as regards monarchical 
 expenditures. It is beyond all question that relatively, in the civilized 
 world, that is an item of declining importance. At the present time, the 
 king of a great country hke Prussia or England supports a magnificence of 
 state which is altogether out of keeping with the ideas of a democracy or a 
 repubUc. Four or five millions of dollars per annum for a modern monarch 
 is not a large expenditure. On the other hand, in contrast, the expenditures 
 of the President of the United States (including those connected with the 
 executive mansion, contingent expenses of all sorts, and presidential clerks) 
 amount roughly to $150,000. However, as regards the expenditures of a 
 modern monarch (the German Emperor, for example) , a detailed examina- 
 tion shows that custom and tradition, as well as the will of the monarch, 
 cause a large part of his income to go for public purposes, and that his wealth 
 has been largely socialized. The king is no longer the typical rich man. 
 
 On the other hand, the expenditures on account of the American Congress 
 are unprecedented in amount among the expenditures incurred on account 
 of legislative bodies. The world has never seen anything of the kind be- 
 fore, and nothing parallel to it can be found in any other country. Among 
 other things, this goes to indicate, as contrasted with Germany, the great 
 importance of the legislative body which is supposed to represent the people 
 directly and immediately and to carry out their will. In aristocratic coun- 
 tries the legislative oflace is sometimes an unpaid office. This was until 
 recently the case in British and German parliaments, the idea being to favor 
 wealth and to counteract democratic tendencies — an aim which was not 
 accomplished. A democracy, however, is more likely to insist upon a 
 legislative office being a paid office; and, in some of the German states, 
 although the payment is smaU, its acceptance is compulsory. 
 
 Expenditures incurred in the administration of foreign affairs are of in- 
 creasing importance on account of growing economic internationalism. We 
 would here have two main classes; namely, (i) expenditures on account of 
 diplomacy, those representing the purely political side of government, and 
 (2) expenditures on account of the consular service, representing the business 
 interests of the country. Expenditures connected with boundaries and 
 ■surveys are expenses which would come under this general heading. 
 
 With regard to the administration of foreign affairs, any one nation is 
 limited in what it can do by international customs. We Americans, for 
 example, cannot force our ideas on other nations. Certain standards of 
 
664 OUTLINES OF ECONOMICS 
 
 dignity and propriety have been established with respect to the mode of life 
 for diplomats, and, if we depart from these, we do so at a loss which every 
 diplomat in the service of the United States keenly feels. The most that we 
 can do is to exercise pressure in what we believe to be the right direction, 
 and that is the direction of democratic simplicity. 
 
 When we examine expenses incurred in the administration of justice, we 
 notice a large increase with the growth of democracy. In earlier times in 
 countries like England and Germany^ the administration of justice was to a 
 greater or less extent "patrimonial,'' being connected with certain estates. 
 The duty of administering justice went with the great estate or manor and 
 involved little expense. As people take things into their own hands they 
 must pay their own expenses. Democracy, in its progress, means large 
 public expenditures. 
 
 The new humanitarianism of the age, which, in a way, is one expression of 
 democracy, involves large expenditures, as seen in education, modern re- 
 formatories, etc. But it is believed by the advocates of humanitarianism and 
 democracy that these expenditures are worth while. 
 
 It is when we come to expenses incurred in the promotion of the general 
 welfare that we see the most remarkable and encouraging phenomena that 
 greet us in the treatment of pubhc expenditures. This has been seen in the 
 data already given, and will become increasingly manifest as the student 
 carries on his statistical studies in this field. 
 
 QUESTIONS 
 
 1. Define public finance. Why should it be regarded as a part of eco- 
 nomics? Can you give any reasons why it should be regarded as a sepa- 
 rate science? 
 
 2. Can we spare money for taxes only when we have an income affording 
 a surplus over and above necessities? If the money paid for taxes is used to 
 provide us with necessities, is there any good ground for the doctrine that an 
 income sufficient to afford a minimum of subsistence should be exempted 
 from taxation in the case of an income tax ? 
 
 3. What various meanings do you ascribe to the enormous increase in 
 public expenditures during the nineteenth century? 
 
 4. What should be the consequences if the government of the state in 
 which you hve should strive for the largest possible amount of revenue, and 
 then govern its expenditures so as to consume the entire state income? 
 
 5. Discuss the differences between public expenditures and the expendi- 
 tures of a private household. Would you regard it wise on your part to 
 make any expenditures with the idea that a benefit to some one would accrue 
 one hundred years later ? fifty years later ? twenty years later ? 
 
 6. What considerations must govern us when we attempt to answer the 
 question, "What is the proper proportion between public expenditures and 
 the total income of society?" 
 
PUBLIC EXPENDITURES 665 
 
 7. Discuss Wagner's rule. Is the fact that public ownership increases 
 the permissible proportion of social income that may be used for public 
 purposes an argument for public ownership of railways? If so, why? If 
 not, why not? 
 
 8. Discuss economy, parsimony, frugality, extravagance in public ex- 
 penditures, and give as full illustrations of each as you are able (a) from your 
 own observation, (b) from your reading and conversation and correspondence 
 with others, pubhc officials included. 
 
 9. Discuss the historical order in which items of expenditure appear in 
 national, state, and local governments. Give illustrations from the state and 
 from the local pohtical unit in which you Hve. Give any illustration which 
 may occur to you of taxation which lightens the burdens of the taxpayer. 
 
 ID. If you were permanent Secretary of War, would you desire to know for 
 a long number of years in advance the yearly sums that could be expended 
 on the army ? Could you thus make the same amount of money accomplish 
 more than if dependent upon annual grants uncertain in amount? What 
 would be your view as a member of Congress? Is a state imiversity to be 
 controlled in its expenditures by the legislature as rigidly as Congress should 
 control the administration of the army? If so, why? If not, why not? 
 Would you make any distinction in this respect between the army and the 
 navy? 
 
 II. Present such statistics as you may be able to gather showing relatively 
 and for as long a time as possible the increases in public expenditures in the 
 federal government, in your own state, and in your own local pohtical imit 
 (city, county, town, etc.), and give all the evidence that you can secure show- 
 ing the significance of the movement. 
 
 REFERENCES 
 
 Government publications generally. 
 
 As illustrative particularly of the expansion of government expenditures and 
 public work, the Year Book of the Department of Agriculture. 
 
 For growth of mihtarism, take publications of the Department of War and 
 publications of similar departments in other countries. 
 
 For general statistical data, the Statesman's Year Book is as reliable as any- 
 thing in English. For our own country, see annual Finance Report of 
 the Secretary of the Treasury, and census reports, especially the reports 
 on Wealth, Debt, and Taxation. For making a broad survey of the federal 
 expenditures of the United States, perhaps no single publication is more 
 useful than the annual Letter from the Secretary of the Treasury trans- 
 mitting Estimates of Appropriations. A striking exhibit of the growth 
 of federal expenditures will be found in Senate Document No. 528, 60th 
 Congress, ist Session, entitled Expe?iditures of the United States Govern- 
 ment, I 791-1907. 
 
CHAPTER XXXII 
 
 PUBLIC RECEIPTS FROM LOANS AND GOVERNMENT 
 OWNERSHIP 
 
 Public Debts. — The modern State follows a policy of deficit 
 financiering. The great and increasing expenditures, which 
 have been described in the preceding chapter, entail burdens 
 too heavy to be borne, at least in the first instance, by taxation 
 alone, and recourse must constantly be had to the public credit. 
 Even before the European War, about one fourth of the annual 
 revenue of England was used in the payment of debt or in- 
 terest upon debt ; and, as is shown in the French budgets given 
 on page 659, more than one fourth of the total expenditures of 
 France was devoted to the same purpose. 
 
 In the last half of the nineteenth century, the aggregate pub- 
 lic debt of the civilized world increased enormously. According 
 to the best estimates, the indebtedness of the national govern- 
 ments of the world, which amounted to $7,627,700,000 in 1848, 
 had risen to $27,525,000,000 in 1890, and since that time it has 
 greatly increased. Figures showing the total and per capita 
 debt of all governmental divisions of this country are given in 
 Table I. From this statement it appears that between 1902 
 and 1 913 the aggregate public debt of this country increased 
 by over $2,000,000,000, the greater part of the increase being 
 ascribable to the astonishing growth of municipal and local in- 
 debtedness, which increased by 113 per cent in the interval. It 
 is true that the total public debt is less than it was in 1870, that 
 the per capita debt has fallen from $82.99 '^^ 1870 to $49.97 in 
 1 913, and that according to Census estimates of national wealth 
 (not very trustworthy), the public debt covered only $2.58 of 
 each one hundred dollars of national wealth in 191 2, as against 
 $2.85 in 1902, $3.06 in 1890, $6.97 in 1880, and $10.64 in 1870. 
 
 666 
 
PUBLIC RECEIPTS 
 
 667 
 
 But this diminution of the aggregate debt is due to the extraor- 
 dinary progress which our tariff surpluses have enabled us to 
 make in reducing the debt contracted during the Civil War; 
 and the normal movement in the long run is probably toward an 
 increase of the public debt, at least absolutely and per capita, 
 if not in proportion to the national wealth.'^ 
 
 TABLE I 
 
 Public Debt of the United States 
 (Debt less sinking fund assets) 
 
 
 Total in Millions of Dollars 
 
 Per Capita 
 
 
 1913 
 
 1902 
 
 1890 
 
 1880 
 
 1870 
 
 1913 
 
 1902 
 
 1890 
 
 1880 
 
 1870 
 
 Total .... 
 National gov't . 
 States .... 
 Minor divisions 
 
 $4850 
 
 1029 
 
 346 
 
 3476 
 
 $2839 
 
 969 
 
 239 
 
 1630 
 
 S1989 
 8S2 
 211 
 926 
 
 $3043 
 
 1919 
 
 275 
 
 849 
 
 $3200 
 
 2331 
 
 353 
 
 S16 
 
 $49-97 
 
 10.59 
 
 3-57 
 
 35-8i 
 
 $35-99 
 
 12.22 
 
 3-03 
 
 20.74 
 
 $31-76 
 
 13-60 
 
 3-37 
 
 14.79 
 
 $60.66 
 
 38.27 
 
 5-48 
 
 16.91 
 
 $82.99 
 
 60.46 
 
 9-iS 
 
 13.38 
 
 The great increase of public debts is due principally to two 
 causes, wars and public works. The former are misforttines, 
 losses, however the result is expressed. The loss comes, not in 
 contracting a debt, but in spending and destroying the property 
 consumed by war. This loss cannot be postponed by a debt, 
 although one nation may postpone part of the loss by borrow- 
 ing goods and supplies from the people of another nation. It 
 comes out of wealth existing or produced at the time, no matter 
 what arrangement is made. In former times each man bore 
 the loss as it happened to fall on him. The modern method 
 differs in just this, that the loss is transferred to the whole 
 public. This, again, may be done in two ways. A tax may 
 be levied at the time sufficient to pay all expenses, or a debt may 
 
 1 According to Census estimates, the per capita debt of the United Kingdom in 
 1904-1905 was 3.93, that of France 4.86, and that of Italy 2.25 times as great as the 
 per capita debt of the United States in 1902, while that of Sweden was a trifle less 
 than the per capita debt of the United States. 
 
668 OUTLINES OF ECONOMICS 
 
 be incurred and the necessary taxation spread over a longer 
 period of time. In practice the latter proves far the best, for 
 at least a part of the expenses. It gives taxpayers time to 
 adjust themselves to the extraordinary demands. A war debt 
 is, therefore, not a misfortune, though it stands for a previous 
 misfortune — war. 
 
 The case is clearer when we consider debts contracted for 
 public works. Under this head we include primarily productive 
 enterprises like railways, canals, forests, gas works. These, 
 when purchased or constructed by the government, are the occa- 
 sion of debts, sometimes enormous in amount. It might seem 
 possible to pay for them by immediate and heavy taxation, 
 since no more is taken out of the people than when the money is 
 borrowed. But the national wealth is not like an ocean, alike 
 in all its parts and instantly filling up where water is dipped out. 
 It makes all the difference in the world where you dip. Here 
 are men who have funds invested in a productive business; 
 here are others who have funds lying idle. The State decides 
 to make a public investment, and calls for money. If it col- 
 lects it by an immediate and heavy tax, the first class have a 
 part of their ordinary earnings withdrawn, and their business is 
 crippled or ruined. The others have some of their funds with- 
 drawn, but the most still lies idle. The best that can be done 
 in such a case is for the first class to borrow of the second, 
 which only makes private debts instead of public ones — a 
 much more burdensome condition of things for the national in- 
 dustry. The wiser modern method is for the State to borrow 
 the unemployed funds and leave industrial operations intact, 
 then imposing a moderate tax which can be paid out of annual 
 income. If the expenditure in question is an investment, it pre- 
 sumably pays for itself in time without requiring taxation. 
 
 This brings us to the relation between taxes and debts. Taxes 
 should never be so heavy that they cannot be paid easily out of 
 annual income. If they trench upon national savings, they de- 
 range private industries disastrously because they are imposed 
 upon all without regard to the nature of their investments. 
 But while taxes cannot safely exceed the national disposable 
 
PUBLIC RECEIPTS 669 
 
 surplus for each year, it does not follow that the State may not 
 take savings as well as surplus for its undertakings ; only these 
 savings must be taken from those who have uninvested savings. 
 This cannot be done by any method of general contribution 
 like taxation. It can only be done by public loans. Whether 
 the loan is a wise thing or not depends altogether on the nature 
 of the State's investment. If the State takes these savings ever 
 so wisely and wastes it, the people have lost just so much capi- 
 tal. If, on the other hand, the State takes savings which were 
 uninvested and therefore unproductive, and invests them in a 
 profitable undertaking, the net result to society is an additional 
 profit. Public debts are no indication of national poverty. 
 Whether a nation is growing poorer or richer depends not on its 
 indebtedness, but on its production relatively to its consump- 
 tion. Public debts are not a good thing in and of them- 
 selves, but they have incidental advantages which offset some 
 of their disadvantages. 
 
 Having noticed the natural limits of both taxation and borrow- 
 ing, we have now to ask. What kind of expenditures should be 
 provided for by each? In general the answer is easy, though 
 details are troublesome at times. Ordinary expenditures, that 
 is, those which recur with sufficient regularity so that they can 
 be foreseen and estimated in advance, if not provided for by 
 receipts from domains and industries, should be met by taxa- 
 tion. If the State cannot do this, it is a confession that ordi- 
 nary expenditures are in excess of the disposable surplus income 
 of the nation, a state of things which means bankruptcy if con- 
 tinued long enough. 
 
 Extraordinary expenditures, caused by national calamities, 
 such as floods or war, and public investments — railways, 
 city gas works, etc. — may be met by loans. The function of 
 loans thus becomes a double one : first, the distribution of un- 
 avoidable losses, so that industry is as little disturbed as pos- 
 sible; and second, the investment of uninvested capital in 
 productive public enterprises. 
 
 In the creation and management of public debt it is pecul- 
 iarly necessary to observe the golden mean and avoid both 
 
670 OUTLINES OF ECONOMICS 
 
 improvidence and unwise restrictions. Obviously, temporary 
 deficits resulting from a failure of current revenue to meet cur- 
 rent expenses, should not be allowed to accumulate and then 
 be funded as a permanent debt. This is a vice of boss-ridden 
 government which goes far to explain the rapid growth of Ameri- 
 can municipal indebtedness in the last half of the nineteenth 
 century. Similarly, in our opinion, debt should not be con- 
 tracted in order to erect public schools or other durable improve- 
 ments which, although capable of rendering service through a 
 long period of years, produce no money revenue and represent 
 from the fiscal standpoint continuing liabilities rather than 
 durable assets. It must be admitted that authorities differ on 
 this point ; but even among those who sanction the contracting 
 of debt to pay for durable improvements which are financially 
 non-productive, it is agreed that in any event the life of the 
 debt should not exceed the life of the improvement in question. 
 Long-time bonds, for instance, should not be employed to resur- 
 face roads and pay for highway improvements which will last 
 only a few years. Finally, in our opinion, restriction may be 
 properly imposed upon public indebtedness contracted for pur- 
 poses which are fiscally nonproductive, although such restric- 
 tions should limit the increase of indebtedness and, for reasons 
 which have been stated on page 653, should not be expressed 
 as a percentage of the assessed valuation of taxable property. 
 
 On the other hand, few, if any, restrictions should be placed 
 upon borrowing for the purpose of acquiring income-yielding 
 property. Such restrictions place states and cities at a dis- 
 advantage as compared with private corporations. They also 
 ope ate to throw into the hands of private corporations enter- 
 prises which cannot be paid for out of one year's revenue, and 
 yet might advantageously be acquired by the public. At the 
 present time excessive limitations, unworthy of a free people, 
 make it impossible for some cities to carry out necessary public 
 improvements which would not impose the slightest real burden 
 upon taxpayers. In Chicago, several years ago, after a pro- 
 longed and exceedingly expensive campaign for the improve- 
 ment of the street car service, the city was prevented from carry- 
 
PUBLIC RECEIPTS 67 1 
 
 ing out a carefully devised plan of reform by a court decision 
 which held that an issue of street railway certificates would in- 
 crease the indebtedness of the city beyond the limits prescribed 
 by the constitution. Rigid limitations which prevent munici- 
 palities from offsetting part of their debt by the value of water- 
 v/orks, lighting plants, and other assets which yield a monetary 
 return, have no place in a scientific system of public finance. 
 
 While not absolutely required by theory, it is probably desir- 
 able as a matter of practical political psychology to make pro- 
 vision for the extinction of all public debts within a period, say, 
 of sixty years. It has been customary in the past to do this 
 by means of sinking funds, but experience has shown that the 
 sinking fund is a cumbersome, wasteful, and unscientific method 
 of accomplishing the desired end. Bonds which automatically 
 mature in recurring installments offer a much better device for 
 the retirement of public debts. The serial bond, as such an 
 obligation is called, " can usually be placed at a lower rate of 
 interest than a sinking fund obligation. It is free from most 
 of the possibilities of political abuse and manipulation to which 
 sinking funds are exposed. It substitutes a plain and certain 
 for an uncertain or complicated liability; and it compels the 
 administration which contracted the debt to begin its retire- 
 ment immediately." ^ 
 
 The Public Domain. — By domains we usually mean agricul- 
 tural and mineral land and forests owned by the State and man- 
 aged in the interest of the public revenue, although we might 
 logically subsume under the term the streets and other public 
 property of cities, with all the valuable franchises and privileges 
 which go with them. The direct revenue from this source in 
 the United States is not large, and if account be taken of the 
 cost of the public domain and the expense which it has entailed, 
 the net earnings would possibly be a minus quantity. 
 
 Until a comparatively recent date this was not the case. In 
 early feudal times the king had large estates of his own from 
 the produce of which the government was largely supported, 
 
 1 Report of the Committee on Increase of PubKc Expenditures, Proceedings oj 
 the National Tax Association, vol. Lx, p. 465. 
 
672 OUTLINES OF ECONOMICS 
 
 and although he had certain mihtary rights over his subjects, he 
 had very hmited rights over their property. Later, the king 
 became a pubHc rather than a private person, and a large part of 
 the crown estate became the property of the public ; but even 
 then taxation was relatively unimportant, and the State relied 
 principally in times of peace upon fines, escheats, fees, crown 
 prerogatives (certain dues which the king was entitled to col- 
 lect as of his own right), and upon the proceeds of the public 
 domain. Blackstone, the great English jurist, writing in 1765, 
 classified taxation among the " extraordinary " revenues of the 
 sovereign ; and in some of the German principalities the govern- 
 ment was enabled to get along without taxation in times of 
 peace, down to the close of the eighteenth century. Real 
 democracy not yet having been achieved, the people distrusted 
 taxation and resented its imposition, while the sovereign wisely 
 clung to that species of revenue which was independent of the 
 people's caprice. " The public domains," said Bodin, the great 
 political philosopher of France in the latter part of the sixteenth 
 century, " should be holy, sacred, and inalienable either by 
 grant or by prescription." 
 
 But as democracy developed and the representatives of the 
 people gained control of the finances, a new policy was every- 
 where adopted. If State management was uneconomical and 
 wasteful, and if the government could obtain all the revenue 
 needed by taxation, why preserve the wasteful methods of 
 management? Why not turn pubhc property into private 
 property, to be developed and multiplied through the vitaliz- 
 ing force of individual self-interest ? The great truth was real- 
 ized that the property of individuals, when subject to taxation and 
 regulation, is no less part of the great patrimony of the State than 
 those lands and forests whose title is retained hy the government 
 itself. This doctrine was generally accepted by the greater 
 countries of the world during the eighteenth century, so that 
 Adam Smith, in defending it in 1776, was able to write that 
 " there is not at present, in Europe, any civilized state of any 
 kind which derives the greater part of its public revenue from 
 the rent of lands which are the property of the state." This 
 
PUBLIC RECEIPTS 673 
 
 philosophy was dominant when our national government was 
 created in 1789, and has guided our national policy ever since. 
 Land Policy of the United States. — By exploration and occu- 
 pancy, war, and various cessions, the federal government ac- 
 quired, after the Revolutionary War, a magnificent domain of 
 2,252,244 square miles. Now, while we have consistently fol- 
 lowed the doctrine of alienation until very recent years, trying, 
 apparently, to get rid of the public domain as rapidly as possible, 
 one observes historically a very important change in the manner 
 of development. In the early years of the Republic, large 
 revenues were expected from the sale of public lands ; it was 
 the financial side which, according to Alexander Hamilton, 
 claimed " primary attention." ^ Until about 1800, the policy 
 was to sell the land in large blocks, even though it went to 
 speculators ; this was followed by an attempt to sell small hold- 
 ings to actual settlers, the credit system being used with dis- 
 astrous results; later (1830), the preemption policy was intro- 
 duced by which bona fide home makers were given certain ad- 
 vantages in purchase ; and finally came the Homestead Act of 
 1862, the Timber Culture Act of 1873 (now repealed), and the 
 other less important laws by which actual settlers can obtain 
 homes practically free of cost. From the very beginning we 
 have used our public lands as bounties, to hasten the develop- 
 ment of the country ; and this policy has been carried out by 
 enormous grants of land for the endowment of education and 
 the subsidization of canal, railway, and other internal improve- 
 ment companies. Our original aim, however, was not only to 
 develop the country as rapidly as possible, but to secure as much 
 revenue as possible from the sale of public lands. We still aim 
 to develop the country, but the idea of profit has been replaced 
 by the policy of giving land to the landless. To exaggerate the 
 evolution of policy for the sake of emphasis, it may be said that 
 we began with a productive policy, and modified it with a dis- 
 tributive policy; that in the beginning our object was the 
 greatest good, while now it is the greatest good to the greatest 
 number, or, in terms more appropriate to the exact case in hand, 
 
 * Quoted by Donaldson, The Public Domain, p. 198. 
 2X 
 
674 OUTLINES OF ECONOMICS 
 
 the greatest possible use of the public domain consistent with 
 widespread participation in that use. 
 
 Forest Lands. — The policy of alienation, while on the whole 
 sound, is subject to certain limitations which it is very important 
 to note. First of these is the case of forests. The ruthless de- 
 nudation of our timber lands, the striking advance in the price 
 of lumber indicating that the supply has not kept pace with the 
 demand, and the meteoric development and rapid decline of the 
 lumber industry in many localities of the Northwest, all com- 
 bine to demonstrate that alienation and private ownership have 
 failed to produce that careful industrial management which 
 conduces to the greatest use and the greatest good in the long 
 run. More important still, we have come to realize that the 
 most productive use of other great natural resources has not 
 been subserved by the private ownership of the forests. The 
 regular flow of streams, the success of the great irrigation works 
 which we are building, and the proper development of our mines, 
 all depend more or less upon the permanent preservation of our 
 forests ; but private ownership and management in the past has 
 led to destruction, not preservation. 
 
 The United States awoke very slowly to these truths. Prussia 
 abandoned the policy of disposing of forest lands in 1831. 
 France and Austria began to increase their forest holdings about 
 1870. But in the United States it was not untU 1876 that an 
 awakened interest showed itself in a congressional appropriation 
 of two thousand dollars for the purpose of employing " a com- 
 petent man to investigate timber conditions in the United 
 States." In 1881 a Division of Forestry was created in the De- 
 partment of Agriculture. This expanded into the Bureau of 
 Forestry in 1901, and into the Forest Service in 1905. In 1891 
 a forward step was taken by the passage of an act authorizing 
 the President to establish forest reserves; and in the same 
 year the first forest reserve was established. In March, 191 5, 
 the area of the national forest reserves had increased to 
 184,611,596 acres (of which 21,337,533 were privately owned); 
 the forest service had developed to a point where it was able to 
 care for the management of this vast national industry, and to 
 
PUBLIC RECEIPTS 675 
 
 cooperate further with private owners in estabhshing the prin- 
 ciples of scientific forestry, while the policy of alienation has been 
 modified to an extent amounting almost to reversal. Instead of 
 selling forests, the government is now permitting timber to be 
 cut in a way to preserve the forests. The revenue from this 
 source at the present time is nearly $2,500,000, but that is a 
 secondary consideration. The important point is that the 
 government has demonstrated its ability to manage the forests 
 along lines at once scientific and commercial. In many Euro- 
 pean countries, however, a greater revenue is secured from the 
 forests. In France, for example, the public forests cover nearly 
 18 per cent of the entire land surface of the country, and yield 
 approximately, it is reported, $2.50 per acre annually, — giving 
 a revenue of about $59,000,000 a year. In the United States 
 at present 35 per cent of what is received, according to law, goes 
 to the states and territories in which the reserves are situated 
 for public roads and schools. It is estimated that in a few 
 years the reserves will yield not less than $5,000,000 a year. 
 
 Experience seems to show that the public ownership and 
 management of forests is more efficient than private ownership 
 and management. This is due to the length of time required to 
 realize upon investments in this industry, its routine character, 
 the large area one man can supervise, and, perhaps chiefly, to 
 the fact that the government in its management takes into ac- 
 count the interests of the community as a whole. Although 
 private corporations may make plans for a long period of time, 
 they are less desirable owners and managers, especially in the 
 last particular. The property tax, as now levied, is one of the 
 greatest enemies of rational forestry by private owners. If an 
 owner is forced to pay ordinary property taxes upon a stand- 
 ing or growing forest year after year, the pressure to cut the 
 timber is almost irresistible. The State spends millions of dol- 
 lars to preserve the forests, and yet often enforces a tax that 
 puts a premium upon their destruction. 
 
 Mineral Lands. — Our experience with timber lands is im- 
 portant as showing that private ownership of some kinds of 
 land has not resulted in the greatest or wisest use of that land. 
 
676 OUTLINES OF ECONOMICS 
 
 Our experience with mineral lands demonstrates that the policy 
 of disposing of public lands in small holdings, free of cost or at 
 prices far below their real value, has not led to a widespread 
 participation in the use and profit of those lands. The reason 
 for this, broadly speaking, is that our policy of alienation in 
 small holdings conflicts with the requirements and necessities of 
 modern industry. In disposing of our lands we have tried to 
 balk the corporation and the speculator in order to subsidize the 
 settler and home builder. For instance, we have made the recip- 
 ients of homesteads and mineral claims swear that they are not 
 acting as agents ^^ for any person, corporation, or syndicate,'" or 
 " in collusion with any person, corporation, or syndicate, to give 
 them the benefit of the land entered," and that the land is not 
 being secured " for the purpose of speculation." Yet for pur- 
 poses of grazing and in less degree for mining and lumbering, 
 modern industrial methods require that large tracts of land 
 shall be worked together, and that individual claims shall be 
 consolidated. The core of the difficulty was well described 
 by Mr. Roosevelt, when President, in these words : " It is a 
 scandal to maintain laws which sound well but which make 
 fraud the key without which great natural resources must re- 
 main closed. The law should give individuals and corporations, 
 under proper government regulation and control, the right to 
 work bodies of coal lands large enough for protfiable develop- 
 ment." And he thereafter recommended laws to authorize the 
 leasing, instead of the complete alienation, of coal, oil, and gas 
 rights, as well as grazing rights on the public domain. Already 
 the royalty has been adopted by some of the state governments, 
 and has been employed in a few of the permits issued by the 
 federal departments of Agriculture and the Interior.^ In a 
 few decades, these leases will probably yield handsome revenues 
 in some of the western states which have adopted them. As 
 time passes the federal government exercises more freely its 
 powers of reserving mineral rights in lands granted to " home- 
 
 1 Cf. the conditions of the interesting permit issued in favor of the International 
 Power and Manufacturing Company, and published as Senate Document No. 147, 
 63d Cong., ist Sess. 
 
PUBLIC RECEIPTS 677 
 
 steaders " or municipalities, and of withdrawing from entry 
 valuable mineral deposits such as the potash beds of California. 
 Year by year, therefore, the policy of complete alienation is 
 more and more restricted. 
 
 The Success of our Land Policy. — In a rough, general way, 
 our land policy has been a success, as is shown by the unprece- 
 dented and almost feverish development of the country in the 
 last century, with the creation of a fund of taxable values which 
 makes it an easy matter for the state governments to raise all 
 the revenue which they need. But in some respects it has 
 signally failed. In the first place it has not paid : more money 
 has been spent for the purchase, survey, and care of the public 
 lands than has been received from their sale and lease. In the 
 second place, certain kinds of lands, as we have shown, should 
 not have been alienated. And in the third place, our efforts to 
 give land to the landless have bred an immense amount of cor- 
 ruption, fostered speculation, endowed private monopoly with 
 public wealth, and pauperized whole communities. One has 
 only to recall the convictions of public officers for land frauds, 
 and to read the report of the Public Lands Commission — to 
 which specific reference is given at the end of the chapter — to 
 appreciate the truth of all these charges. The desert land law 
 and the commutation clause of the Homestead Act, they tell 
 us, operate far too often " to bring about land monopoly rather 
 than to multiply small holdings by actual settlers." ... "In 
 many localities, and perhaps in general, a larger proportion of 
 the public land is passing into the hands of speculators and cor- 
 porations than into those of actual settlers who are making 
 homes." ... " Nearly everywhere the large landowner has 
 succeeded in monopolizing the best tracts, whether of timber or 
 of agricultural land." . . . " Your commission has had inquiries 
 made as to how a number of estates, selected haphazard, have 
 been acquired. Almost without exception, collusion or evasion 
 of the letter and spirit of the land laws was involved." . . . 
 " The fundamental fact that characterizes the present situation 
 is this : that the number of patents issued is increasing out of 
 all proportion to the number of new homes." 
 
678 OUTLINES OF ECONOMICS 
 
 Possibly the most important lesson to be derived from the his- 
 tory of our landed domain is the vital truth that the government 
 cannot give away valuable lands or sell them at prices far below 
 their real value without subsidizing the speculator, endowing 
 monopoly, and pauperizing the people. The poorer classes de- 
 rive no real benefit from this indiscriminate public charity. As 
 Secretary of the Interior Hitchcock said in 1905, in discussing 
 the Timber and Stone Act : ^ " Many transfers of land patented 
 under this law are made immediately upon completion of title to 
 individuals and companies. In this way a monopoly of the tim- 
 ber supplies of the public-land states is being created by sys- 
 tematic collusion. ... It has been urged in behalf of this act 
 that it enables poor men to enjoy the bounty of the government 
 by obtaining tracts of land which they can afterwards sell with 
 advantage. A careful study seems to show, on the contrary, 
 that the original entrymen rarely realize more than ordinary 
 wages for the time spent in making the entry and completing 
 the transfer. The corporations which ultimately secure title 
 usually absorb by far the greater part of the profit." When 
 Uncle Sam was rich enough — or was supposed to be rich enough 
 — to provide us all with a farm, the policy of giving away the 
 public domain appeared to be in harmony with the principle of 
 equality of opportunity. But when the supply is far below the 
 demand, those who receive gifts by lot or similar methods are 
 in receipt of special privileges. What once seemed fair has, in 
 the course of economic evolution, become unfair and de- 
 moralizing. 
 
 Our conclusion may be formulated in the following general 
 rule : Only those lands should be wholly alienated whose use 
 and development under private ownership lead neither to mo- 
 nopoly nor to exhaustion and waste. Or, in more concrete 
 terms (remembering that the maxim applies only to those lands 
 left to the government, and to the majority of cases, not to every 
 specific case), the rule for agricultural lands should be private 
 ownership and management, for forest lands State ownership 
 and management, for mining and grazing lands State ownership 
 
 1 Report of the Secretary of the Interior, 1905, p- 331- 
 
PUBLIC RECEIPTS 679 
 
 and private management under a lease or royalty system, by 
 which the State shall secure a share of the profits and retain a 
 large amount of regulation and control. In disposing of its 
 lands the government should endeavor to charge value received, 
 as gifts of valuable land, or sales at inelastic schedules of prices 
 which place an extreme valuation upon some tracts and an 
 utterly inadequate valuation upon others, lead to speculation 
 and monopoly, having most of the demoralizing features of a 
 public lottery in which the prizes are distributed partly by 
 chance and partly in accordance with the cunning, chicanery, 
 and unscrupulousness of the participators. Under existing con- 
 ditions the poorer classes of society get almost none of the 
 valuable lands. Charge value received, and the people, the 
 masses, get their share in the revenues flowing to the public 
 treasury, in reduced taxes, and more generous expenditures 
 for educational, protective, and developmental purposes. 
 
 Land Nationalization and Municipalization. — In recent years 
 both state and national legislation have shown a decided trend 
 toward the adoption of methods which will yield both greater 
 revenue and greater control of those varied forms of national 
 wealth which we collectively designate " land." The object of 
 this legislation is to prevent monopoly and give to society a 
 share in the land values created by social growth. One of the 
 most ingenious plans for securing this end ever proposed is the 
 single-tax scheme defended with great eloquence and earnestness 
 by the late Henry George. His scheme, usually called " the 
 single tax," is stated thus in his own words, printed in his organ, 
 The Standari: 
 
 " The Standard advocates the abolition of all taxes upon industry and the 
 products of industry, and the taking, by taxation upon land values, irrespec- 
 tive of improvements, of the annual rental value of aU those various forms of 
 natural opportunities embraced under the general term ' land.' 
 
 "We hold that to tax labor or its products is to discourage industry. We 
 hold that to tax land values to their fuU amount will render it impossible 
 for any man to exact from others a price for the privilege of using those 
 bounties of nature in which all living men have an equal right of use ; that 
 it will compel every individual controlling natural opportunities to utilize 
 them by employment of labor or abandon them to others ; that it will thus 
 
68o OUTLINES OF ECONOMICS 
 
 provide opportunities of work for all men and secure to each the full reward 
 of his labor ; and that as a result involuntary poverty will be abolished, and 
 the greed, intemperance, and vice that spring from poverty and the dread of 
 poverty wiU be swept away." 
 
 Mr. George's proposition rests upon an extreme application of 
 the doctrines of individualism and natural rights. Man, he 
 holds, has an inalienable and equal right to live, and consequently 
 an inalienable and equal right to those natural agents which we 
 call land, and without which human life cannot exist. This 
 right which attaches to the individual cannot be abrogated by 
 law or custom, nor can it be alienated by one generation or set 
 of law givers. Moreover, it is an equal right. A, B, and C 
 each have a right to the soil, but A has no right to better soil 
 than B or C ; in consequence of which that part of land values 
 which arises from the differential qualities of land belongs to 
 society as a whole, and not to particular individuals. But the 
 differential value of land expresses itself in the economic rent 
 which it yields, and consequently, if society seizes this rent by 
 taxation, it will satisfy the demands of the doctrine of natural 
 rights, while leaving the actual management and exploitation 
 of land in the hands of individual occupiers, thus avoiding the 
 perils of direct public management. 
 
 Man also has an unalienable right, Mr. George held, to the 
 fruits of his own labor. As the outcome of this right, Mr. 
 George concluded that ordinary taxation upon property other 
 than land, upon the product of labor as distinguished from land, 
 the gift of God, is robbery. In his view it is as immoral to levy 
 an ordinary tax as it is criminal to fail to tax that surplus which 
 attaches to the better classes of lands, and which we call economic 
 rent. 
 
 The policy embodied in Mr. George's scheme differs funda- 
 mentally from the policy which we have seen creeping into recent 
 legislation. The latter purposes to reserve only a part of the 
 value given to some forms of land by social development. Mr. 
 George proposes to confiscate all of the " unearned increment." 
 Most important of all, the former proposition applies only to the 
 future unearned increment, and purposes only to take a part, 
 
PUBLIC RECEIPTS 68l 
 
 and that only after fair notice is given. Mr. George proposes to 
 take all the unearned increment, past and present, and that 
 whether the present owners have been encouraged to beheve that 
 they might be permitted to appropriate the whole unearned 
 increment or not. Herein lies the essential injustice of Mr. 
 George's scheme. As a nation we have induced immigrants 
 and settlers to take up lands, clear them, and develop them 
 with their labor and toil, with the promise that the values thus 
 created by themselves and their neighbors should belong to 
 them. Their risks and their sacrifices have been great. The 
 " unearned increment " is not always unearned. Even if we 
 assume that the State made a mistake in pursuing thiis policy, 
 the results of the mistake must be cheerfully borne by the party 
 at fault, the State itself. This of course does not mean that if 
 the private ownership of land is socially harmful, it must never- 
 theless be perpetuated. It does mean, however, that if the state 
 is to divest private owners, it must in equity compensate them. 
 
 Mr. George not only proposes to confiscate all economic rent 
 without compensation, and to abolish all other forms of taxa- 
 tion, but the assertion is made in explanation and justification 
 of the policy that it will abolish poverty. Such a policy might, 
 indeed, prevent landowners, who do not care to use their land, 
 from keeping it out of the hands of those who would use it ; but 
 how it would effect all the other predicted blessings is difficult 
 for most people to comprehend. In the first place, it is difficult 
 to imagine how the pure economic rent of agricultural land can 
 be separated in practice from the annual value of separable im- 
 provements on the land. But apart from this difficulty, the 
 appropriation of economic rent by the public without compen- 
 sation to the owners will probably never appeal to the conscience 
 of the American public as a just thing to do. No abstract 
 reasoning, based on " natural rights," will persuade a modern 
 nation to so radical a step. This honestly and earnestly advo- 
 cated policy is only one more illustration of the danger of basing 
 social reasoning on any theory of " natural rights." 
 
 In cities it is easier to separate the pure economic rent from 
 the earnings of improvements, such as buildings. Moreover, it 
 
682 OUTLINES OF ECONOMICS 
 
 is in cities that the principal evils attendant on private land- 
 holding are discoverable. Therefore the objections to land 
 nationalization do not in the same degree apply to land munici- 
 palization. Many who will reject the one will favor the other. 
 Even here, however, it is well to proceed very cautiously. Con- 
 fiscation, at any rate, should not be tolerated. If great and 
 expensive changes along this line should approve themselves to 
 the people, the burden of the changes should be widely diffused 
 throughout the community by means of inheritance and other 
 taxes.^ 
 
 Public Industries. — In the beginning, let us briefly pass in 
 review the principal classes of industrial enterprise in which the 
 modern State engages for the satisfaction of other than State 
 wants ; because, obviously, we are not concerned with enter- 
 prises like the government printing office, the government navy 
 yards, and in general, those incidental industries whose products 
 the government consumes but does not regularly sell. 
 
 1. First, we find states like Switzerland monopolizing the 
 manufacture of alcohol and certain alcoholic beverages, Japan 
 monopolizing the opium traffic in Formosa, or commonwealths 
 like South Carolina engaging at one time in the retail distribu- 
 tion of intoxicating beverages. The purpose of the State in 
 engaging in such industries is primarily sumptuary ; it is desired 
 to regulate the traffic almost to the point of suppression, per- 
 haps. Ordinarily a good revenue would be secured, but revenue 
 is a very secondary consideration. Prices will be placed above 
 the level of highest net profit, and not improbably the ideal of 
 regulating consumption will be so vigorously pursued that profits 
 will disappear altogether. 
 
 2. Secondly, we have the group of so-called " fiscal monopo- 
 lies." France, for instance, monopolizes the manufacture of 
 matches, cigarettes, and tobacco in general ; Japan has recently 
 gone farther than any other country in the creation of fiscal 
 monopolies ; while Prussia, Austria, Italy, Spain, and other 
 European countries maintain public lotteries — as did many of 
 the American colonies during the eighteenth century. The 
 
 1 See pp. 425 and 706 for further discussion of the single tax. 
 
PUBLIC RECEIPTS 683 
 
 primary object of the State in undertaking these enterprises is 
 public revenue, gain ; and naturally a monopoly price is charged, 
 the price which will yield the greatest net revenue. 
 
 3. Next, we have a group of enterprises consisting principally 
 of the so-called " natural monopolies," which the State under- 
 takes not for suppression, not for profit, but primarily for regu- 
 lation — to regulate the quality of the product, as in the case 
 of water ; to maintain effectively what have been called " equi- 
 table conditions for the prosecution of private business," as in 
 the case of railways; to prevent monopolistic extortion and 
 corporate abuse, as in the case of lighting companies, the post 
 ofiSce, the telegraph, and the telephone ; or to prevent crime and 
 preserve intact the foundations of commercial prosperity, as in 
 the monopoly of coinage. The charges here are ordinarily ad- 
 justed to either the " revenue " or the " cost " principle, that 
 is to say, the State will either aim to make a fair business profit 
 such as is secured in competitive private enterprises, or it will 
 endeavor approximately to meet expenses by adjusting its 
 charges to the cost of production. England, France, and Ger- 
 many, in ordinary years, obtain handsome revenues from their 
 respective postal departments, but in the United States the 
 accounts of the Post Office Department usually show an annual 
 deficit, and taking the world over, the cost principle in this 
 group of industries is probably more common than the revenue 
 principle, and deficits more common than net profits. In the 
 United States the post office has always been regarded as a 
 developmental agency rather than a business enterprise, and 
 might more logically, perhaps, be included in the next category. 
 
 4. Finally, we have a large and heterogeneous group of in- 
 dustries which are maintained principally for service, for their 
 educational and developmental influence, not primarily for regu- 
 lation, and not at all for profit, but " for the public good." We 
 include here not only schools and educational institutions of all 
 kinds, but roads and canals ; the savings banks and public pawn 
 shops maintained in several countries of continental Europe ; 
 workingmen's insurance as developed by Germany, Austria, 
 and several of the Australian commonwealths ; and model manu- 
 
684 OUTLINES OF ECONOMICS 
 
 facturing establishments such as France maintains for the pro- 
 duction of tapestries and fine porcelains. In this group charges 
 will sink to a minimum, and in some lines of enterprise, such as 
 education, practically disappear. Revenue here is not only a 
 minor, but is almost a negligible, consideration. 
 
 A brief consideration of the incomplete list of State industries 
 given above brings out several important truths. In the first 
 place, it is evident that only a few of these industries, the fiscal 
 monopolies, have been taken over by the State for the purpose 
 of revenue, and fiscal monopolies are decreasing rather than 
 increasing in relative importance. In the second place, it is 
 equally as clear that, on the whole, public industries are sources 
 of expense and not of profit. When Professor Bastable, for ex- 
 ample, tells us that in England, in the fiscal year 1 893-1 894, 
 only 6 per cent of the national revenue came from public indus- 
 tries and other non-tax sources, that in the local revenues of 
 England and Wales (1891-1892) taxation stood to other sources 
 of revenue in the ratio of five to one, that in Prussia about 20 
 per cent of the national revenue comes from the domain and in- 
 dustrial enterprises, a,nd in India something less than 50 per 
 cent from " quasi-private sources of revenue," he is careful to 
 warn us that the statistics take no cognizance of interest pay- 
 ments chargeable to the several industries, or of depreciation, 
 or of related industries in which deficits and not profits were 
 secured. When estimating the importance of State railway 
 earnings in the revenue account, no cognizance is ordinarily 
 taken of the canal deficit. In the third place, we perceive from 
 the nature of the industries that they cannot wisely be operated 
 for profit in many cases. Education, for instance, has been 
 taken over by the State for the very purpose of charging less 
 than the cost of the service. The unquestionable tendency is for 
 the prices of goods and services supplied by a democratic State 
 to sink below the cost of production, and this, in itself, is neither 
 good nor bad, fortunate nor unfortunate. The public financier, 
 in adjusting the charges, must not look to profit. His only aim 
 is the solus populi, and this policy requires here a prohibitive 
 price, there a cost price, and again free service. Finally, it 
 
PUBLIC RECEIPTS 685 
 
 appears, the problem of public charges can be settled only with 
 reference to a particular time, place, and industry. England 
 finds it expedient to raise a handsome revenue from her post 
 ofl&ce, while in most years the United States manages her post 
 ofl&ce at a loss. Waterworks are successfully conducted by most 
 of the large American municipalities, but public lighting experi- 
 ments in this country have not been equally successful. India 
 raises half of her revenues from non-tax sources largely because 
 heavy taxation of the ordinary kind would be impossible. The 
 French tobacco monopoly succeeds because the French govern- 
 ment can supervise and trace almost every pound of tobacco 
 grown in France. In the United States this would be impossible. 
 Although we cannot decide in a general way what theory of 
 charges should be followed in particular public industries, it is 
 possible to lay down general rules which will assist us in reach- 
 ing a correct conclusion in specific cases. Assuming that the 
 industry in question supplies a service rather than a commodity, 
 merely to save words in the discussion, we must first of all in- 
 quire : (i) Is the service helpful or harmful in its net social 
 effect? According as it is one or the other, we will incline in 
 our charges toward the gratuity principle or the prohibitive 
 principle. If harmful, however, it is plain that we must not 
 make the charges high enough to encourage smuggling or illicit 
 manufacture. If helpful, on the other hand, we cannot at once 
 decide upon the gratuity principle, but must inquire further : 
 (2) How generally is the service enjoyed ? If only a small portion 
 of the community enjoys the service, it would usually be unjust 
 to charge less than cost, because the deficit would be borne by 
 general taxation falling upon the entire community ; unless, in- 
 deed, the benefit to one restricted class is seen to be of advantage 
 to the whole community in such a degree that the rest of the 
 community is willing to bear the deficit, as in the case of public 
 charity. 
 
 (3) Assuming that the service benefits the whole community, 
 this is still not sufficient to justify a charge less than the cost of 
 production. The problem is one of comparative costs. We 
 must inquire whether greater benefit would not be secured by 
 
686 OUTLINES OF ECONOMICS 
 
 charging enough to raise a profit and then distributing that profit 
 through the maintenance of some other gratuitous enterprise, 
 or, if the tax system weighs lieavily on the poor, by remitting 
 taxation to the extent of the profit. (4) If all these questions are 
 answered in favor of the gratuity principle, we still must con- 
 sider what effect gratuitous service will have upon the cost 
 of the service. Will it encourage wastefulness? Free city 
 v/ater, for example, would probably prove impracticable because 
 of waste, but free parks or free education do not lead to inordi- 
 nate or unnecessary consumption. The question is a vital one, 
 but it is not always to be answered one way, as some critics of 
 government ownership seem to believe. (5) Closely related to 
 the above is the question of pauperization. Some things the 
 State may safely give away, and some not. The modern city, 
 for example, may give free band concerts, in our view, to the 
 undoubted edification of the community; but in Rome the 
 public games demoralized the populace. (6) Finally, we have 
 to ask what effect gratuitous service will have on incomes. 
 Henry George proposed that our cities should operate the street 
 car lines gratuitously, and the argument in its favor is far 
 stronger than might be expected on first thought. But what 
 effect would this gratuitous service have upon the incomes of 
 the laboring classes ? Take the case of the worker in New York 
 City earning $3.00 a day. Will his wages remain at S3. 00, if 
 street car service is offered free of charge ? Will not the migra- 
 tion to New York be increased, so that wages will fall? And 
 may not the gain ultimately fall to owners of house property in 
 the form of enhanced rents? 
 
 All these questions must be answered before the tariff of 
 charges can be adopted, and it is plain that the answers will be 
 determined by the particular conditions of time, industry, and 
 place, particularly by the character of the industry. The nearest 
 approach to a general rule which can be formulated, may be 
 stated as follows : In proportion as a service or commodity tends 
 to the upbuilding of character and personality, we should, so far 
 as fiscal conditions permit, gradually move in the direction of 
 the principle of gratuitous service. If the service or commodity 
 
PUBLIC RECEIPTS 687 
 
 itself is widely consumed and is as desirable as any vendible 
 commodities which would probably be purchased from possible 
 revenues yielded by charges for the service, particularly if large 
 consumption is desirable and waste in consumption does not 
 become excessive, the principle of gratuitous service may be 
 recommended. 
 
 Limitations of space prevent further treatment of the subject 
 of public industries. The important thing to understand is that 
 the moment an industry is taken over by the government, that 
 moment the question of profit — which is the vital considera- 
 tion under private management — becomes of secondary im- 
 portance, subordinate to questions of public policy; and the 
 interjection of public policy into the determination of prices or 
 charges, creates a problem whose complexity and difficulty can 
 scarcely be exaggerated. At the present time, for instance, we 
 do not even know whether our postal rates on second class mail 
 matter pay for the cost of carriage and delivery, to say nothing 
 of the question whether such matter ought to be carried at less 
 than cost. Just now the indications are that the State will 
 take over an increasing number of industries, or at least exert a 
 constantly increasing influence upon the rates and charges of 
 quasi-public industries. Under these circumstances our present 
 duty is to institute, both in public and quasi-public industries, 
 a thoroughgoing system of cost accounting, so that we shall 
 xmderstand upon what footing each branch of the industry rests. 
 Our second duty, which falls primarily upon economists and 
 statesmen, is to develop a far more satisfactory theory of public 
 charges, for at the present time we hardly understand the many 
 factors that must be considered in this problem, much less the 
 net meaning or resultant of these factors. 
 
 QUESTIONS 
 
 1. Are public debts a burden when represented by paying investments? 
 by non-revenue-bearing investments? 
 
 2. Do State debts indicate impoverishment of the people? Why? 
 
 3. What defects are found in the sinking-fund method of retiring public 
 debts? Enumerate the advantages of the serial bond. 
 
688 OUTLINES OF ECONOMICS 
 
 4. How was the State supported in primitive times? What connection 
 is there between taxation and representative government? 
 
 5. What has been the principal aim of the United States in the manage- 
 ment of pubHc lands ? How has this aim changed ? 
 
 6. Why do the poorer classes benefit least by the homestead acts and by 
 the sale of the public lands at prices below their real value ? 
 
 7. What kinds of land should be both owned and managed by govern- 
 ment? Why? 
 
 8. What are the advantages and disadvantages of the royalty or lease 
 system? To what kinds of land should it be applied? 
 
 9. What conflict is there between modern industrial methods and the 
 project of giving land to the landless? 
 
 10. What connection is there between "natural right" and the single- tax 
 scheme ? 
 
 11. Is there any absolute, inalienable right to life ? to anything? Ex- 
 plain. 
 
 12. Should State industries be managed so as to yield a profit? Is a 
 profit inconsistent with good State management? Is an}^ general tendency, 
 with respect to profits, discernible in the management of particular public 
 industries? 
 
 REFERENCES 
 
 Adams, H. C. Public Debts; The Science of Finance, pp. 237-260, 261-282. 
 
 Bastable, C. F. Public Finance, 3d ed., pp. 157-178, 179-218, 219-232. 
 
 Bullock, C. J. Selected Readings in Public Finance, Chap, iv, "The Views 
 of Bodin and Smith," pp. 50-60; Chap, v, "Revenues from Domains," 
 pp. 61-72; Chap, vi, "Revenues from Public Industries," pp. 80-116. 
 
 Bureau of the Census. Reports on Wealth, Debt, and Taxation, and Statistics 
 of Cities. 
 
 CoHN, GusTAV. The Science of Finance (translated by Thorstein Veblen), 
 pp. 82-103. 
 
 Daniels, W. M. The Elements of Public Finance, pp. 207-223, 285-314. 
 
 Grice, J. W. National and Local Finance. 
 
 Hewes, L. L, and Glover, J. W. Highway Bonds. (Bulletin of the U.S. 
 Department of Agriculture, No. 136.) 
 
 Plehn, C. C. Introduction to Public Finance, 3d ed.. Part iii. 
 
 Raymond, W. L. American and Foreign Investment Bonds, Chaps, ii-v. 
 
 Report of the Public Lands Commission, Senate Document No. 189, 58th Con- 
 gress, 3d Session, pp. iii-xxiv. 
 
 Scott, W. A. The Repudiation of State Debts. 
 
 Seligman, E. R. a. "Classification of Public Revenues," in his Essays in 
 Taxation, rev. ed., Chap. xiv. 
 
 U.S. Department of Agriculture, Forest Service. The Use Book. 
 
 Van Hise, C. R.. The Conservation of National Resources in the United States. 
 
CHAPTER XXXIII 
 
 PUBLIC RECEIPTS FROM FEES, SPECIAL ASSESS- 
 MENTS, AND TAXES 
 
 Definitions. — If the reader will run over the classification of 
 public industries given in the preceding chapter, he will notice 
 that the corresponding payments — which descend, it will be 
 remembered, from prohibitive to gratuity charges — fall into 
 two main classes : those imposed upon the consumer or pur- 
 chaser who specially benefits by the service, and those — like 
 the revenues devoted to the maintenance of education and pub- 
 lic parks — imposed upon the tax-paying public generally, irre- 
 spective of the benefits conferred by the service. Moreover, 
 as we move from the prohibitive to the gratuity group, there is 
 a general though not regular change in the degree and kind of 
 compulsion exercised by the State in collecting the contribution. 
 The State does not encourage the purchase of intoxicating liquors 
 under the Gothenburg system in order that the revenue may be 
 as large as possible, — it actually discourages their sale ; the use 
 of the postal money order is mildly encouraged, but you may 
 send your money by express if you desire ; one is not forced to 
 marry, but if one marries one is compelled to take out a mar- 
 riage license ; and whether one uses the public schools or not, 
 one must help pay for their maintenance. Finally, it will be 
 noticed that as the element of compulsion increases, the public 
 interest in the service changes, and generally though not always 
 increases. The wood sold from the government forests is 
 merely a commercial by-product of an enterprise maintained 
 by the government for other purposes ; the marriage-license 
 fee benefits the individual, but is imposed primarily to protect 
 the morals of the community; while the tax to maintain the 
 public schools is paid solely for the purpose of benefiting the 
 general public. 
 
 2y 689 
 
690 OUTLINES OF ECONOMICS 
 
 There are, then, three general principles of classification: 
 (i) the assignability of the benefit of the service to an individual ; 
 (2) the degree of compulsion exercised by the State; (3) the 
 degree and kind of public interest involved in the service. The 
 more voluntary payments for the more commercial services made 
 by persons who receive a special benefit from these services are 
 called public prices ; the less voluntary payments for services in 
 which the public interest is less commercial in character, made 
 by persons who receive a special benefit from the services, are 
 called fees. Compulsory contributions, " levied in proportion 
 to the special benefits derived, to defray the cost of a specific 
 improvement to property, undertaken in the public interest," 
 are, in the United States, called special assessments ; and com- 
 pulsory contributions, exacted by public authority according 
 to some general rule, without reference to the special benefit 
 conferred by the services to whose maintenance the contribu- 
 tions are devoted, are called taxes. 
 
 The student is warned that little regard is paid to these dis- 
 tinctions in everyday usage. The words '' fees," " taxes," 
 " licenses," " tariffs," " rates," '' charges," and the like are 
 hopelessly confused ; and even census statisticians find it im- 
 possible to distinguish, in public accounts as they are now kept, 
 between prices, fees, rentals, licenses, and some kinds of taxes. 
 The utility of the terms is in emphasizing the important truth 
 that these great categories of public contributions must be dis- 
 tinguished and differently treated by the legislator and student, 
 by whatever terms the different categories are designated. 
 
 Fees.^ — In the exercise of its most fundamental and general 
 functions, the government frequently confers, in an incidental 
 way, special benefits upon particular individuals. Thus the 
 courts, whose function it is to administer justice in general, find 
 that this function must be performed by deciding disputes be- 
 tween particular litigants, one of whom usually benefits by the 
 
 1 Public prices have been discussed in the preceding chapter. The small tuition 
 charges paid by students in state universities offer a good illustration of fees ; they 
 are non-commercial in character, semi-volimtary, and in amount fall considerably 
 short of the cost of the service. 
 
PUBLIC RECEIPTS 691 
 
 decision. Now if the government is disposed to take advantage 
 of the opportunity, it is evident that much revenue may be 
 raised from the individuals who, in a more or less adventitious 
 way, benefit from the government activities ; and where the 
 nation is poor or the people averse to taxation, much dependence 
 will be placed upon fees. As wealth increases, however, and 
 the government becomes more democratic, there is a growing 
 disposition to support general functions by general contributions 
 — taxes — and the relative importance of fees is likely to de- 
 cline. On the other hand, there is no likelihood that fees will 
 wholly disappear, as they exercise a wholesome influence in pre- 
 venting waste. Court fees, for instance, would probably have 
 been abolished before this, if they did not serve to prevent 
 litigious persons from carrying their quarrels to the courts for 
 settlements. Because of this restrictive and economical in- 
 fluence exercised by fees, they will undoubtedly retain a per- 
 manent place in the public revenues of even the more advanced 
 and democratic states ; but their fiscal importance will very 
 likely decline. 
 
 During the colonial epoch the fee system was much abused in 
 America, many offices being wholly maintained by fees which 
 should have been abolished or supported by taxation. At the 
 present time, however, the evils of the system arise not from 
 the number or amount of fees, but from their connection with 
 the salaries of certain public officials. Many officials are allowed 
 to keep the fees which they collect in lieu of fixed salaries, and 
 this practice results in very serious evils. In the first place, 
 some fee-paid offices, particularly those of sheriff and register 
 of deeds in populous districts, have come to yield princely in- 
 comes, and the scramble for these rich offices constitutes a pro- 
 lific source of political corruption. In the second place, fee pay- 
 ment of public officials often impels them to an excessive and 
 pernicious activity, in which their own interests and those of the 
 commonwealth are placed in direct conflict. In a few states, 
 for instance, prosecuting attorneys are paid so much per con- 
 viction, the fee increasing with the heinousness of the offense, 
 while in many cities and villages the police force and city courts 
 
692 OUTLINES OF ECONOMICS 
 
 are supported partially by fees and fines. Under these circum- 
 stances, officials bend their activity to the conviction of offenders, 
 not to the prevention of crime and the reform of the criminal ; 
 they frequently set traps for persons who are likely to break the 
 law, creating the temptation and the opportunity in order that 
 they may increase their emoluments. In Wisconsin, sheriffs 
 were for many years paid so much per head for the tramps whom 
 they fed and lodged. The system, as has been said, placed a 
 " direct premium upon vagrancy." ^ During the existence of 
 this system in Wisconsin, tramps were " often furnished with 
 liquor, tobacco, and newspapers, to induce them to return." 
 Finally, the fee system has been a constant and shameful cor- 
 rupter of justice as dispensed by justices of the peace in " the 
 people's courts." In most states there are several justice's 
 courts open to the plaintiff who desires to bring suit. In con- 
 sequence, a disgraceful competition springs up, each justice en- 
 deavoring to swell his business and multiply his fees by con- 
 stantly finding for the plaintiff, with the result that our judicial 
 system is thoroughly vicious at the point where perhaps it comes 
 in closest contact with the masses of the people. 
 
 The remedy is in the substitution, wherever possible, of regu- 
 lar salaries for fee stipends, and in the institution of methods of 
 accounting which will hold public officials to strict accountability 
 for every fee collected. Fortunately, the movement of legisla- 
 tion, while slow and obstinately fought by some politicians, is in 
 the right direction ; and in almost every state public officials 
 are being required to turn their fees into the general treasury 
 and accept instead a fixed compensation. 
 
 Special Assessments. — Where the operations of the govern- 
 ment confer a special benefit upon some restricted group of in- 
 dividuals, those individuals are often led to exercise undue in- 
 fluence upon the government to secure that service, if the latter 
 is supported by appropriations from the general funds. Jobbery 
 and graft are encouraged. On the other hand, if the only way 
 the group of individuals can secure the service is by expenditure 
 
 1 T. K. Urdahl, The Fee System in the United States, p. 211. The other quotations 
 cited in this section are taken from this work. 
 
PUBLIC RECEIPTS 693 
 
 of the common funds, the government or legislature often delays 
 the expenditure unduly for fear of criticism or because of unwise 
 parsimony. Thus in cities where the method of special assess- 
 ment is not used, it often happens that the opening of a street 
 is delayed long after the time when it would be desirable for 
 the citizens most interested, although perhaps the latter would 
 be willing to defray the cost from their own pockets, were this 
 permitted. 
 
 A recognition of these facts has led in recent years to a strik- 
 ing development, in the United States, of the benefit principle 
 as exemplified in the method of special assessments. The special 
 assessment has been used sporadically in many countries for 
 several centuries, but it was first regularly used on a wide scale 
 in the United States, in the latter half of the nineteenth century. 
 Its place and importance among the revenues is shown in the 
 table on page 695, from which it appears that special assess- 
 ments aggregating over $113,000,000 were collected in 1902. 
 This amount constituted a little more than 4 per cent of the 
 revenue receipts; but as the national and state governments 
 (except Massachusetts) make practically no use of the special 
 assessment, its real importance appears more clearly from an 
 examination of its place among municipal revenues. In the 
 incorporated places having 2500 inhabitants or over in 1913, 
 special assessments yielded nearly 9 per cent of the revenues 
 and more than one eighth as much revenue as all kinds of taxes. 
 
 The special assessment has been approved by the American 
 courts because it places at least a part of the cost of the service 
 upon the beneficiaries of the service, a rule which can sometimes, 
 but not often, be violated without subjecting the government to 
 excessive and corrupting private influence. The special assess- 
 ment has appealed to the people, however, because it permits 
 public improvements to go ahead at a pace which would be im- 
 possible if taxation were the only fund for defraying the cost of 
 the improvements. Needless to say, the special assessment has 
 occasionally stimulated extravagance and premature develop- 
 ment. Thus, in New Jersey, in the last quarter of the nineteenth 
 century, several large cities were practically thrown into bank- 
 
694 OUTLINES OF ECONOMICS 
 
 ruptcy by undertaking ambitious public works, in which the 
 special assessment played an important part. And in New York, 
 under the Tweed regime, the system of special assessments fur- 
 nished an excuse for undertaking public works in which corrup- 
 tion flourished, and which probably would never have been under- 
 taken, had it been known in the beginning that their cost would 
 have to be partially defrayed by taxation. " The works had 
 been carried on upon a scale of audacious extravagance, and in 
 portions of the city where they were not at the time justified. 
 Great avenues were laid out and improved largely for the pur- 
 pose of giving fat jobs to favorite contractors, and to provide 
 fine drives for the pleasure and convenience of others than the 
 abutting property owners." ^ 
 
 On the whole, however, the special assessment has been an 
 unusual success as a fiscal expedient, and has proved an im- 
 portant, if not an indispensable, factor in the development of 
 American cities. Where its use has been followed by extrava- 
 gance, speculation, or jobbery, these evils are to be attributed 
 almost wholly to political corruption of the government, and 
 only in a very small measure to the special assessment itself. 
 Most of the evils, moreover, have arisen where the city govern- 
 ment, or some department of the city government like that of 
 public works, has been given the power to order the improve- 
 ments against the will of the property owners involved or where, 
 as was the case in the example cited above, assessments upon 
 particular lots were permitted to exceed the value of the prop- 
 erty. Special assessments should not be levied against the will of 
 a majority of the property holders subject to assessment, except 
 by a two thirds or three fourths vote of the city council, and in 
 no case should the assessment exceed a small fraction of the 
 value of the property against which the assessment is laid. 
 Where these rules are observed, the special assessment is un- 
 likely to lead either to premature development or hardship 
 upon the property holder. 
 
 Taxes. — In this country more than 70 per cent of ail the 
 public revenues are obtained from taxes, so the problems of 
 
 1 Victor Rosewater, Special Assessments. 
 
PUBLIC RECEIPTS 
 
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696 OUTLINES OF ECONOMICS 
 
 taxation are the most important with which the public financier 
 has to deal. These problems are of two varieties ; those deal- 
 ing with the nature of taxation in general, and those dealing 
 with specific taxes. The remainder of this chapter will be de- 
 voted to the general questions. The following chapter will be 
 given over to the more specific problems of American taxation. 
 Justice in Taxation. — By far the most important lesson which 
 the student of fiscal questions has to learn is the supreme neces- 
 sity for tolerance and breadth of view. The factors which con- 
 dition justice or make for equity in taxation are exceedingly 
 numerous ; and the mistake most commonly made by superficial 
 thinkers is to seize upon some one element of justice, build a 
 philosophy upon that alone, and vigorously condemn every- 
 thing that does not harmonize with their petty and bigoted little 
 system. No rule less sweeping than that of the general wel- 
 fare can serve as a safe guide in public finance. 
 
 1. Some writers go so far as wholly to deny the right of the 
 State to take private property by taxation. These writers for- 
 get that there is no such thing as absolutely private property. 
 As the State determines what shall be private property, so also 
 it determines the conditions of its existence, and the most funda- 
 mental condition of private property is the obligation to con- 
 tribute to the support of the State. The rights of private in- 
 dividuals have always been of a more or less limited nature, and 
 among the rights reserved by the people in their organic capacity 
 will be found, in every civilized state, the right to take a portion 
 of the wealth produced for such purposes as the lawmaking 
 power may deem fit. 
 
 2. However, the State must exercise this power over private 
 property in an equitable manner, or as this maxim is ordinarily 
 expressed in the terminology of constitutional law, taxation 
 must he equal and uniform. Thus, for example, the constitu- 
 tion of West Virginia provides that : " Taxation shall be equal 
 and uniform throughout this state, and all property, real and 
 personal, shall be taxed in proportion to its value, to be ascer- 
 tained as directed by law." Now, if we examine the way in 
 
 . which these requirements of equality and uniformity have been 
 
PUBLIC RECEIPTS 697 
 
 interpreted in the administration of practical justice, we find 
 that equality and uniformity have come to mean little more 
 than this, that taxation shall not be arbitrary, capricious, or 
 plainly unreasonable and that within each class of persons or 
 objects the burden shall be equal, (i) Everywhere the legisla- 
 ture is given a wide latitude in exempting property, so that in- 
 stitutions and industries which are regarded as of peculiar value 
 to the people may be encouraged by freedom from taxation. 
 Almost everywhere, poll taxes which impose an unequal burden 
 upon the poor, liquor licenses which impose unequal obligations 
 upon those who pay them, inheritance and corporation taxes 
 which single out particular classes of society for unusual taxa- 
 tion, are sustained by the courts. Justice in taxation, then, 
 does not require rigid equality or narrow uniformity of treatment. 
 (2) Institutions which are socially harmful may be subject to 
 peculiarly drastic and oppressive taxation ; that is to say, jus- 
 tice may take into account sumptuary considerations. (3) Old 
 taxes, which would not be used if they were not already in- 
 trenched in the fiscal and social system, are permitted to endure ; 
 justice takes cognizance of the fact that, other things being equal, 
 an old tax is a good tax by very reason of its age. (4) Indirect 
 taxes which weigh more heavily upon the poor than the rich 
 show no signs of disappearing ; that is to say, justice gives due 
 weight to the productivity of a tax, its cheapness of collection, and 
 convenience of payment, and balances these considerations against 
 factors which we are accustomed to regard as more fundamentally 
 ethical. (5) Taxes may be employed to suppress state banks 
 of issue, protect home manufactures, and in general to accomplish 
 political and social ends other than the mere raising of revenue. 
 Taxation is seldom the best agent of social or political reform. 
 If there is an evil which needs eradication, the best way is to 
 suppress it directly, if possible, rather than discourage it a little 
 by general taxation. But this does not affect the general proposi- 
 tion that where taxation is an efficient remedy, or the only remedy, 
 justice sanctions its employment. (6) Finally, it is plain that, 
 however we strive, nothing better than approximate justice can 
 ever be secured in taxation. A system that frankly recognizes 
 
698 OUTLINES OF ECONOMICS 
 
 this truth and makes for rough justice, by the imposition of taxes 
 which are simple, stable, convenient, inexpensive, and produc- 
 tive, is far better than one which attempts to secure exact jus- 
 tice through complex and delicate schemes of taxation which 
 cannot be definitely or efiiciently administered. 
 
 3. The theory of justice most widely accepted by American 
 courts at the present time is expressed in the maxim that taxes 
 should be proportioned to benefits derived. Like other rules of 
 justice, this maxim contains elements of truth and elements of 
 error. It is a fairly helpful guide, for instance, in dealing with 
 public revenues other than taxes. Public prices, fees, and 
 special assessments should, as we have seen, be proportioned to 
 benefits, unless there is strong reason for departing from the rule. 
 And in the apportionment of taxation among districts or govern- 
 mental sections, the rule still retains, and probably always will 
 retain, a large measure of validity. Taxation, we say, must per- 
 tain to the district taxed, meaning by this that under ordinary 
 circumstances it is not wise to tax District A for the benefit of 
 District B ; although there are important exceptions to this 
 rule. But in the apportionment of taxes among the individuals 
 of a given district, the rule has little or no place. This conclu- 
 sion follows, if for no other reason, from our definition of the 
 word " taxes," which we confine to contributions levied with- 
 out reference to special benefits received, either because no 
 special benefit can be assigned, or because (as in the case of 
 free schools) we specifically desire to lift the cost of the service 
 from the shoulders of some of those who specially benefit by the 
 service. Moreover, in general, it is impracticable to determine 
 what proportion of the general benefits of government accrue to 
 particular individuals. 
 
 4. At the present time a great majority of economists agree 
 that taxes should be apportioned according to " faculty " or 
 ability to pay. It must be confessed that the rule is not very 
 satisfactory. No simple measure of ability exists, and many 
 taxes, which under a superficial examination seem to conform 
 to the rule, such as the general property or income tax, are found 
 upon closer examination to violate the rule in many ways. 
 
PUBLIC RECEIPTS 699 
 
 Despite all these defects, however, the ability principle has ele- 
 ments of great strength. It satisfies our sense of justice, in the 
 first place, when explicit reasons cannot be given for departing 
 from a general rule; and it expresses the ideal towards which 
 we strive in voluntary contributions to the church or other 
 voluntary joint enterprises of a social nature. In the second 
 place, we can frequently ascertain with certainty that the rule 
 is being violated, when we cannot define its meaning positively, 
 and hence it is capable of practical application in a negative 
 way. We may therefore accept the rule in this sense, that un- 
 less other treatment is justified by the considerations cited in 
 paragraph 2, above, or by analogous reasons, no tax which is 
 plainly disproportional to the ability of the contributors should 
 be employed. 
 
 5. Accepting the ability principle as the best rule for general 
 taxes as distinguished from the specific taxes noted in para- 
 graph 2, we at once encounter the difiicult question, how is ability 
 to be measured? Different writers have recommended as the 
 basis or measure of ability, income, outgo or consumption, and 
 property. A little cons'deration will convince the reader that 
 each of these measures is marked by minor defects. The con- 
 sumption of the poor, for instance, is out of all proportion to their 
 ability to bear the burdens of the state. Property, on the other 
 hand, differs widely in its productiveness, and, moreover, many 
 persons with a little property have large incomes, and therefore 
 great ability to bear taxation. Incomes, similarly, differ in per- 
 manence and security, and equal incomes are called upon to 
 support very unequal numbers of persons. Fortunately, it is 
 not imperative in practice to make a decision between these 
 measures of ability. The necessities of fiscal administration 
 make it imperative in actual practice to employ all three bases 
 of taxation. Property, consumption, and income are all em- 
 ployed in the United States at the present time and will un- 
 questionably continue to be employed for many generations. 
 
 Progressive Taxation. — After we adopt any concrete measure 
 of ability, we soon realize that it is only approximately correct, 
 because we are immediately confronted with the question: 
 
700 OUTLINES OF ECONOMICS 
 
 Does ability increase in direct proportion or more rapidly than 
 our measure of ability; in other words, shall taxes be laid in 
 direct proportion to income, property, etc., or shall the rate be 
 increased as the amount of income or property increases ? The 
 first method is called proportional taxation, the second progres- 
 sive or graduated. If the rate diminishes as the income or 
 property increases, we speak of it as regressive taxation; and 
 if the rate increases faster than the income or property, but 
 toward a fixed limit which it can never exceed, it is referred to as 
 degressive taxation. The last kind of rating is of course a special 
 variety of progressive taxation, and usually results from the 
 combination of a nominally proportional rate with the exemp- 
 tion of a fixed sum from all incomes or assessed wealth. The 
 American property tax is in principle a degressive tax, though 
 it is regressive in practical effect. 
 
 From the theoretical standpoint our real knowledge upon this 
 subject is exceedingly unsatisfactory. On the whole, the argu- 
 ments of those who approve progressive taxation are more con- 
 vincing than those of its opponents, and a majority of economists 
 at the present time agree in asserting that ability increases faster 
 than income, property, or any common measure of ability. If 
 we construe ability as ability to bear sacrifice (as John Stuart 
 Mill and some other authorities do) and confine our attention 
 solely to the consumer, there can be no doubt that progressive 
 taxation is the means by which the least sacrifice will be visited 
 upon the community as a whole.^ This is a strong argument, 
 because one of the chief immediate effects of taxation is to de- 
 prive persons of the necessaries, conveniences, and luxuries of 
 life, while the maxim of the greatest good to the greatest number 
 — or as it works out in taxation, the least sacrifice to the least 
 number — is one of the most widely accepted rules of social 
 conduct. Surveying the ability theory from the positive stand- 
 point of ability to acquire or produce property, we find the testi- 
 mony almost universal, that as the fortune or income increases, 
 the ability to earn or produce more increases at an accelerating 
 pace. " It is the first thousand that counts," in the language 
 
 ^ See T. N. Carver, Essays in Social Justice, pp. 401-406. 
 
PUBLIC RECEIPTS 7 01 
 
 of the successful man who is telling the younger generation how 
 he succeeded. 
 
 Coming to the more concrete and more practical arguments, 
 we find that the balance of opinion also inclines to the side of 
 those who favor progressive taxation. Let us briefly recapitu- 
 late these arguments and attempt to estimate their net resultant. 
 Those who oppose progressive taxation charge that the proposal 
 is socialistic, that it would discourage the accumulation of 
 wealth, that it would not be particularly productive, — mean- 
 ing by this that the element of progressivity adds little to what 
 would be produced by a proportional rate, — that it would 
 stimulate fraud and evasion, that it would interfere with the 
 device known as " collection at the source," and that finally 
 the whole principle is arbitrary and capricious in the sense that 
 there is no natural limit to the increase of the rate. 
 
 To these charges the defendants of progressive taxation pre- 
 sent plans ^ by which collection at the source and progressive 
 rating may be successfully combined in the same system ; and 
 reply, further, that terms are immaterial and questions cannot 
 be settled by bandying epithets such as " socialistic," " an- 
 archistic," and the like; that every tax discourages the accu- 
 mulation of wealth ; that whether the tax will be productive or 
 not, it will relieve the poorer classes to the extent that the pro- 
 gressive rates do actually fall upon the rich ; that persons ca- 
 pable of evading their obligations to the government will attempt 
 to evade proportional taxes as well as progressive taxes; and 
 that all taxation is more or less arbitrary, resting upon the judg- 
 ment and common sense of the legislature. The exemptions 
 made in every tax law, the size of a license fee of any kind, the 
 rates of excise and customs duties, are all " arbitrary " and un- 
 limited in the sense that progressive taxation is arbitrary and 
 unlimited. Finally, the defendant of progressive taxation 
 points out that, owing to the great prominence of indirect taxes 
 in our revenue system and the tendency of assessors to assess 
 large properties at a lower proportion of real value than smaller 
 
 1 Report from the Select [British] Coynmittee on Income Tax, 1906, pp. iii-vii. Com- 
 pare also the provisions of the federal income tax. 
 
702 OUTLINES OF ECONOMICS 
 
 properties, American taxation today is in practice regressive, 
 and some progressivity is needed, if only to balance the ad- 
 mitted regressivity of existing taxes. 
 
 While general considerations thus seem to warrant persistent 
 effort to introduce a moderate measure of progressivity into 
 our direct taxes, the student is warned that this should not be 
 done in any doctrinaire or offhand fashion. A thousand con- 
 siderations of practical expediency must be taken into account 
 in the shaping of a revenue system, and in the end we are more 
 likely to attain the goal which the advocates of progressive taxa- 
 tion seek by careful exemptions from taxation, by special taxes 
 upon corporations, monopolies, inheritances, and certain forms 
 of income, and by directing expenditures to the succor of the weak 
 and the equalization of opportunity, than by exclusive depend- 
 ence upon any one far-reaching tax such as a progressive in- 
 come or property tax. 
 
 No tax system, then, can be fairly judged without reference 
 to the character of expenditures. Where the expenditures are 
 wasteful, corrupt, and unwise, heavy taxation is a curse, — al- 
 though even here the rational method of reform is rather to 
 root out the corruption and improve the administration, than 
 to reduce taxation, even if temporarily it may be wise to do 
 the latter. But where the expenditures are on the whole 
 wisely and beneficently made, heavy taxation is not an evil. 
 No country was ever yet ruined by large expenditures of money 
 by the pubHc and for the public. The true principle to be ob- 
 served in levying taxes was tersely expressed in the 41st section of 
 the constitution adopted by Pennsylvania in 1776 : " No public 
 tax, custom, or contribution shall be imposed upon, or paid by, 
 the people of this state, except by a law for that purpose ; and 
 before any law be made for raising it, the purpose for which 
 any tax is to be raised ought to appear clearly to the legislature 
 to be of more service to the community than the money would 
 be if not collected, which being well observed, taxes can never 
 be burthens." 
 
 Direct and Indirect Taxes. — The considerations just adduced 
 have an important bearing upon a problem which will probably 
 
PUBLIC RECEIPTS 703 
 
 become acute in the near future : the question of raising addi- 
 tional revenue by indirect taxation. Indirect taxes have been 
 strongly condemned by many authorities in the past, largely 
 because they weigh more heavily upon the poor than the rich. 
 But if we are to finance successfully a double program of mili- 
 tary preparedness and social insurance in the future, it will 
 probably be necessary not only to keep most of the indirect 
 taxes which we now have, but to adopt others. There are prac- 
 tical limits to direct taxation in every country. Pushed be- 
 yond a certain point, direct taxes discourage both saving and 
 business enterprise. Many of them — although the income tax 
 is a marked exception — fall upon the taxpayer in lean years 
 as well as in prosperous years, and must be paid even though the 
 money to pay them has to be borrowed by the taxpayer. In- 
 direct taxes, on the other hand, are usually paid in small driblets 
 and there is, in their payment, a voluntary element which makes 
 them easier to bear. The person who elects to drink beer may 
 pay proportionally a large indirect tax, but he is not compelled 
 to drink beer. Moreover, indirect taxes may be levied upon 
 articles of luxury and other commodities consumed predomi- 
 nantly by the wealthier classes, so as to operate as progressive 
 rather than regressive taxes, when considered from a broad 
 social standpoint. Finally, even regressive taxes may be 
 helpful to the poorer classes if public expenditures are directed in 
 sufficient volume to the support of education, social insurance, and 
 the equalization of opportunity. It is more important that expend- 
 itures should be progressive in their social incidence than it is to 
 collect taxes in accordance with schedules of progressive rates. 
 
 The Shifting of Taxes. — Up to this point we have been speak- 
 ing as if a tax must remain where it is originally placed. This 
 we know is not always the case. Excise taxes, for instance, are 
 usually levied with the expectation that they will be passed or 
 shifted from the business man, who first pays them, to the con- 
 sumer or some other person. The conditions which control the 
 shifting of taxes must evidently be considered — at least in a 
 very general way — before we discuss the practical working of 
 the American system of taxations. 
 
704 OUTLINES OF ECONOMICS 
 
 The word " shifting " usually refers to the increase of price 
 by which the original payer of the tax attempts to recoup him- 
 self. This increase of price is usually accompanied by collateral 
 economic disturbances or dislocations — suggested by the phrase 
 " repercussion of taxes " which is frequently employed in this 
 connection — that are quite as important as the mere change in 
 price. For instance, an excise tax (per unit of product) upon a 
 monopoly may raise the price by as much or even more than 
 the tax itself. But the monopolist nevertheless feels the burden 
 of the tax in reduced profits. When we say that a tax is shifted, 
 then, we do not imply that the original payer evades all the 
 evil effects of the tax. 
 
 Mobility is the chief factor which controls shifting ; and this 
 in turn is largely dependent upon the inclusiveness or scope of 
 the tax, and upon the existence of monopoly or differential ad- 
 vantages. Place a tax upon a person or thing which can easily 
 move to a jurisdiction where such taxes are not imposed, and 
 the tax is very likely to be shifted. Local taxes upon mortgage 
 loans offer a good example. Such taxes are very likely to raise 
 the interest rate by as much or a little more than the tax rate, 
 the " little more " being explained by the trouble imposed upon 
 the lender in looking after the tax and the risk that the tax rate 
 will be increased. On the other hand, if mortgage lenders are 
 constrained by ignorance or custom or the existence of particu- 
 larly high rates in this district to keep on supplying the old 
 amounts of loans, the tax will not be shifted. Unless the supply 
 can be or is reduced by the tax, shifting will not ordinarily take 
 place. 
 
 Naturally, therefore, the particular nature of the supply is of 
 prime importance. We may illustrate by an excise tax per unit 
 of product upon competitive industries of various kinds. In 
 industries subject to the law of constant expense, a fixed tax per 
 unit of product will raise the price by just the amount of the tax, 
 in theory. In industries subject to the law of increasing expense, 
 however, the reduction of the supply caused by the tax some- 
 what reduces the expenses of production per unit exclusive of 
 the tax, and on this account prices in such industries will in- 
 
PUBLIC RECEIPTS 705 
 
 crease by an amount less than the tax. In industries subject to 
 the law of diminishing expense, on the other hand, the price will 
 be raised by an amoimt equal to the tax, plus an amount equal 
 to the increased expense of production caused by the limitation 
 of supply. 
 
 Mobility, as has been said, is the most important factor in this 
 connection, and it may be restricted or destroyed in a variety 
 of ways. Monopoly limits mobility, and, as we have already 
 seen,^ the monopolist cannot shift a fixed tax or a proportional 
 tax on net profits unless the tax is so high as to reduce monopoly 
 profits below the amount that could be earned on the same in- 
 vestment in a competitive industry. For somewhat similar, 
 but not exactly the same reasons, differential gains from durable 
 property are peculiarly susceptible to taxation. Thus, econo- 
 mists generally indorse the proposition that a tax on economic 
 rent falls upon the landlord and cannot be shifted. The validity 
 of this depends both upon the durability of land and the fact 
 that the tax is levied upon a differential element. If land wore 
 out and had to be replenished, the tax would reduce the future 
 supply of land and hence raise its price and its rent in the future. 
 Similarly, if the tax were levied upon the product of marginal or 
 no-rent land, it would elevate the margin, reduce the supply of 
 those products or services which land affords, and in this way 
 again raise prices and partially reimburse the landlord. But, 
 by hypothesis, neither of these suppositions is true. Land, 
 as we define it, does not wear out ; and at the margin land yields 
 no economic rent. 
 
 The proposition that a tax on economic rent cannot be shifted 
 is true, moreover, only of a proportional tax. A tax of so much 
 per bushel or pound upon agricultural prbduce would move the 
 margin of cultivation and thus affect prices. Indeed, the exact 
 form of a tax — whether fixed, proportional, or progressive, upon 
 net or gross returns, upon product or upon profit — is of funda- 
 mental importance always. Generally speaking, proportional 
 taxes upon net income are less easily shifted than other forms of 
 taxes. 
 
 1 Pp. 202, 203. 
 
 2Z 
 
7o6 OUTLINES OF ECONOMICS 
 
 If the object of taxation be durable and the tax a special or 
 exclusive one, the price of the object is likely to be reduced by 
 an amount equal to the capitalized value of the tax. Prospec- 
 tive purchasers of land take into account the taxes that are likely 
 to be levied upon it, capitalize these, and subtract their capital- 
 ized value from the amount which they would pay for the 
 property if it were not liable to taxation. The apparent result 
 of this capitalization or amortization of taxes, as the process is 
 called, is to place the burden of an endless succession of taxes 
 upon the original owner, and relieve subsequent purchasers of 
 any real burden. 
 
 Many present-day followers of Henry George find in this prin- 
 ciple of amortization at once a justification and a method of 
 securing for society all economic rent. Under present condi- 
 tions, they say, a man who buys land wholly escapes taxation 
 upon it. Consequently, in order to make landowners pay as 
 much as other people we should have to increase the tax upon 
 land by a rate equal to that paid by the average tax-payer as 
 often — • say every thirty years — as the land of the community 
 changes holders. In this way the State could gradually and with 
 justice absorb all economic rent.^ 
 
 But this whole chain of reasoning is fallacious for three 
 reasons : (i) What the prospective purchaser capitalizes and 
 deducts is not the entire tax on the land, but the excess of that 
 tax over similar taxes upon other investments open to him. A 
 new purchaser of land does not " buy free of taxes," as is so 
 often stated; what he does is to buy free of any excessive or 
 abnormal tax burden. After the purchase he not only pays 
 taxes in appearance, but in actual fact pays the average tax 
 rate. (2) In so far as this program of the single taxers was 
 anticipated and understood, it would visit the whole burden of 
 the " reform " upon present owners, instead of being distributed 
 over several generations. Subsequent purchasers would dis- 
 count these periodic increases of the tax and pay to owners for 
 their land only the present value of the rapidly vanishing income 
 
 1 See the paper upon "The Single Tax" by C. B. Fillebrown in Stale and Local 
 Taxation (Proceedings of the National Tax Association), vol. i, pp. 286-293. 
 
PUBLIC RECEIPTS 707 
 
 from land. Land would be valued as a terminable annuity. 
 (3) This whole doctrine overlooks the inevitable consequence 
 that, if " the selling value of land is an untaxed value " and 
 if " the burden of a land tax cannot be made to survive a change 
 of ownership," these facts would so increase the demand for 
 land that the profits from its purchase and ownership woiild 
 not exceed profits in other lines of investment. Given plenty 
 of time, active competition, together with a knowledge of the 
 facts of the situation, and such inequalities of taxation are in- 
 evitably smoothed out by the natural movement of capital 
 toward the taxless field or away from the field in which burdens 
 are particularly severe. 
 
 This inevitable reckoning of taxation among the disad- 
 vantages of industry brings it to pass that many old taxes are 
 diffused over the entire community. Such diffusion does not take 
 place when the nature of the supply prevents it from varying 
 in nice correspondence with the prospects of profit. A poll tax 
 upon laborers, for instance, will in our opinion not be shifted, as 
 it is likely to lower their standard of living, stimulate the birth 
 rate, and in turn (other things being equal) actually reduce 
 wages. But exclusive taxes on capital and business will be 
 diffused ; and for this reason there is a profound practical truth 
 in the famous dictum of Canard that " every old tax is good ; 
 every new tax is bad," when sympathetically interpreted. Of 
 course this doctrine assumes that industrial changes are infre- 
 quent. The tax system must and should vary with changes m 
 the fortunes of business enterprise. The development of a new 
 industry making unusual and unexpected profits offers a good 
 opportunity of relieving an old industry that has unexpectedly 
 fallen upon evil days. And for this reason it is highly desirable 
 that state constitutions prescribing a rigidly uniform system of 
 taxation should be amended so as to permit reasonable classifica- 
 tion of property and business for purposes of taxation. All these 
 qualifications of the diffusion theory are true and important. 
 But the fact stUl remains that under ordinary conditions noth- 
 ing is worse in a tax system than uncertainty, continual tinker- 
 ing with rates, and capricious readjustment of methods. 
 
7o8 OUTLINES OF ECONOMICS 
 
 QUESTIONS AND EXERCISES 
 
 1. In accordance with what principles of classification do we distinguish 
 fees, special assessments, and taxes? 
 
 2. Enumerate six fees commonly employed by state governments. 
 
 3. What accounts for the rapid development of the special assessment in 
 the last fifty years ? Is it possible to apportion the benefits of a public im- 
 provement with any degree of accuracy? 
 
 4. Why are liquor licenses distinguished from other licenses and permits ? 
 
 5. Has the state a greater right to tax land and natural agents than 
 produced wealth ? 
 
 6. May monopolies be equitably subjected to special taxation? Even 
 if the monopoly rests upon superior efficiency, or upon patent rights justly 
 acquired ? 
 
 7. Is rigid equality of taxation a primary and fundamental desideratum ? 
 Is it possible of achievement? Is there any real distinction between the 
 so-called ethical qualities (of equality, uniformity, etc.) and the so-called ad- 
 ministrative qualities (convenience, elasticity, productivity, etc.) of a tax? 
 
 8. Is the benefit principle wrong or merely impossible of application? 
 If wrong, why do we retain it in fees and special assessments ? 
 
 9. Is it easier to measure ability than benefits? 
 
 10. Is progressive taxation arbitrary? Can it be satisfactorily con- 
 sidered apart from the effect of pubhc expenditures? 
 
 1 1 . Work out the effect of an excise tax on a monopoly subject to the law 
 of increasing expense. 
 
 12. Do people buy land "free of taxes"? If so, why does not everyone 
 buy land in order to escape taxation ? 
 
 13. Can our state legislatures be trusted to "classify" property for taxa- 
 tion fairly and impartially ? State the arguments for and against repealing 
 the imiformity provisions common in state constitutions. 
 
 REFERENCES 
 
 Bastable, C. F. Public Finance, Book iii, Chaps, iii, v, and vii. 
 
 Carver, T. N. Essays in Social Justice, Chap. xvii. 
 
 CooLEY, T. M. A Treatise on the Law of Taxation (3d ed.), Chaps, ii and vi. 
 
 Ely, R. T. Taxation in American States and Cities, Part i, Chap. iii. 
 
 FiLLEBROWN, C. B. Taxation. 
 
 Gray, J. M. Limitation of Taxing Power on Public Indebtedness, pp. 25-54, 
 
 642-915. 
 Jones, Robert. The Nature and First Principles of Taxation. 
 JuDSON, F. N. a Treatise on the Power of Taxation. 
 Lyon, Hastings. Principles of Taxation. 
 National Tax Association. Proceedings of the National Conferences (formerly 
 
 State and Local Taxation). 
 
PUBLIC RECEIPTS 709 
 
 Patterson, E. M. (editor), "Readjustments in Taxation," Annals of the 
 
 American Academy of Political and Social Science, Vol. Iviii. 
 Plehn, C. C. Government Finance hi the United States. 
 Post, L. F. The Taxation of Land Values. 
 RosEWATER,ViCTOR, "Special Assessments : a Study in Municipal Finance," 
 
 Columbia University Studies in History, Economics, and Public Law, 
 
 Vol. ii. No. 3. 
 Seligman, E. R. a. The Shifti^ig and Incidence of Taxation, Part ii. Chap, i ; 
 
 Progressive Taxation in Theory and Practice, Part ii. Chap, iv, and 
 
 Part iii. 
 Urdahl, T. K. "The Fee System in the United States," Transactions of 
 
 the Wisconsin Academy of Science, Arts, and Letters, Vol. xii, Part i, pp. 
 
 49-67, 210-230. 
 Weston, S. F. "Principles of Justice in Taxation," Columbia University 
 
 Sttdies in History, Economics, and Public Law, Vol. xvii, No. 2. 
 
CHAPTER XXXIV 
 FEDERAL, STATE, AND LOCAL TAXES 
 
 Federal Taxation 
 
 Constitutional Limitations. — The fundamental character of 
 the American revenue system is determined by those clauses of 
 the federal constitution which provide that " direct taxes shall 
 be apportioned among the several states . . . according to their 
 respective numbers " ; that " all duties, imposts, and excises 
 shall be uniform throughout the United States " ; and that " no 
 state shall, without the consent of Congress, levy any imposts or 
 duties on imports or exports, except what may be absolutely 
 necessary for executing its inspection laws." 
 
 Just what the words duties, imposts, excises, direct and in- 
 direct taxes signify, as used in the constitution, has been a matter 
 of considerable discussion. Ordinarily the word duty " means 
 an indirect tax imposed upon the importation, exportation, or 
 consumption of goods," being given " a broader meaning than 
 custom, which is a duty imposed upon imports or exports," while 
 " the term impost also signifies any tax, tribute, or duty, but it 
 seldom applied to any but indirect taxes. An excise duty is an 
 inland impost levied upon articles of manufacture or sale, and 
 also upon licenses to pursue certain trades or to deal in certain 
 commodities." 
 
 All these differences turn largely upon the meaning of the 
 words direct and indirect taxes. According to most economists 
 direct taxes are taxes levied by the state upon those who are 
 expected to bear their burden, while indirect taxes are supposed 
 to be shifted to others. In the economic sense, therefore, poll 
 taxes, property, income, and inheritance taxes are usually 
 called direct, while customs taxes and excise taxes are called 
 
 710 
 
FEDERAL, STATE, AND LOCAL TAXES 71 1 
 
 indirect. It is plain that the economic meaning of these words 
 is exceedingly vague, because it is made to turn upon expecta- 
 tions concerning the shifting of taxes, and upon few subjects 
 is there more uncertainty than upon this. Economists have 
 generally protested against any employment of these terms in 
 scientific analysis, and where, because of their frequent em- 
 ployment both in popular discussion and statute law, it has 
 been necessary to retain them, they have tried to introduce a 
 more consistent usage. 
 
 Owing to the practical impossibility of maintaining a logical 
 distinction between direct and indirect taxes based upon eco- 
 nomic principles, it was commonly thought until the latter part 
 of the nineteenth century that it was necessary to give these 
 terms a strictly historical interpretation, based upon usage cur- 
 rent in this country at the time the constitution was adopted. 
 Accordingly, capitation and land taxes were generally believed 
 to be the only forms of direct taxes. This belief was partly due 
 to the fact that the federal Supreme Court at various times 
 had sanctioned the use by the federal government of income, 
 inheritance, and specific property or consumption taxes. 
 
 In the famous Pollock ^ case, however, the Supreme Court 
 rendered a decision in 1895 which was generally interpreted to 
 hold that income taxes, so far as they include income from real 
 estate and some other forms of property, are direct taxes. 
 Nevertheless, what was practically an income tax upon cor- 
 porations was adopted in 1909. It was justified by the Supreme 
 Court as an excise tax, but the principal difference between this 
 excise tax and an income tax proper appears to have been the 
 fact that, instead of being levied upon or on income, it was levied 
 and assessed " with respect to " or in accordance with income.^ 
 
 1 Pollock V. Farmers' Loan and Trust Co., 157 U. S. 429; 158 U. S. 601. 
 
 2 At a later date (January 24, 1916) in the case of Brushaber vs. Union Pacific 
 Railroad Company, the Supreme Court upheld the constitutionality of the present 
 federal income tax law and Chief Justice White took occasion to expound the tangled 
 meaning of the famous Pollock decision. He announced that "the conclusion 
 reached in the Pollock case did not in any degree involve holding that income taxes 
 genericaUy and necessarily came within the class of direct taxes on property, but, on 
 the contrary, recognized the fact that taxation on income was in its nature an 
 
712 OUTLINES OF ECONOMICS 
 
 Finally in 191 2 the sixteenth amendment to the federal con- 
 stitution was ratified, which provides : " The Congress shall 
 have power to lay and collect taxes on incomes, from whatever 
 source derived, without apportionment among the several 
 states, and without regard to any census or enumeration." 
 
 The troublous history of the federal income tax has been 
 briefly traced because it illustrates clearly the conditions under 
 which the American people must frame and administer tax laws. 
 Income taxes were introduced during the Civil War and millions 
 of revenue collected under them before their repeal in the early 
 seventies. When revived in 1894 the income tax was invali- 
 dated by the Supreme Court in a decision which had momentous 
 political consequences. The adverse decision was then, by a 
 play of words, evaded in the corporation excise tax ; and later 
 the entire principle was legitimatized by the sixteenth amend- 
 ment. Finally, the Supreme Court decided that the income 
 tax is not a direct tax, but under certain circumstances acts 
 substantially like a direct tax. Nothing could illustrate more 
 clearly the metaphysical complexities introduced into tax legis- 
 lation by constitutional limitations whose final interpretation 
 rests not with the legislature but the courts. Much may be 
 said for the necessity of such constitutional restrictions under 
 the American form of government, but none can deny the enor- 
 mous difficulties which they throw in the way of consistent, 
 simple, and wise tax legislation. 
 
 Use of Direct Taxes by the Federal Government. — Until 
 the twentieth century, the constitutional limitations which we 
 have been discussing served to concentrate federal taxation 
 almost wholly upon consumption, since direct taxes when appor- 
 tioned according to population have shown themselves to be 
 unjust, unproductive, and exceedingly difficult of collection. 
 Congress has made use of direct taxes only five times during the 
 history of the national government. Two million dollars was 
 apportioned in 1798; $3,000,000 in 1813 ; $6,000,000 in 1815 ; 
 
 exdse . . ." and was invalid only because it acted enough like a direct tax in prac- 
 tical effect to be subject to the requirement of apportionment according to 
 population. 
 
FEDERAL, STATE, AND LOCAL TAXES 713 
 
 $3,000,000 in 1816; and $20,000,000 in 1861. Except in the 
 tax of 1798, Congress has always permitted any state to assume 
 its quota and raise the money as it saw fit, although provision 
 was always made for its collection by federal officers, in case 
 the quota was not assumed by the state government. It would 
 be difficult to exaggerate the unsatisfactory character of such 
 taxation. In no case has the federal government ever collected 
 the full amount of the tax. The taxes levied in 1814-1816 con- 
 tinued to be collected until 1839. The last payments on the 
 direct tax of 1861 were not received until 1888 ; and in 1891 a 
 law was passed abolishing further collections and authorizing 
 the amounts which had been collected under the act of 1861 to 
 be returned. Considerable scandal arose out of this refunding 
 act, owing to the enormous commissions paid to certain lobbyists 
 for their work at Washington in securing the passage of the law. 
 Until the adoption of the sixteenth amendment, therefore, the 
 federal government relied almost exclusively, in ordinary years, 
 upon customs duties, excises, and similar taxes. 
 
 Customs Duties. — Among federal revenues, customs duties 
 held the place of first importance until very recently. From the 
 foundation of the federal government in 1789 until the Civil 
 War, with the exception of a few excise taxes collected between 
 1791 and 1802, the federal government derived nearly all its 
 permanent regular revenues from customs taxation, and since 
 the Civil War considerably more than 50 per cent of the per- 
 manent revenue has, on the average, been derived from this 
 source. From the very beginning, moreover, our customs duties 
 have been in spirit, if not always in effect, protective ; and it 
 thus becomes necessary to consider the connection between the 
 protective and revenue principles, in addition to the more 
 strictly fiscal aspects of customs duties. 
 
 Protective duties are imposed in the hope of diminishing im- 
 ports and substituting in their stead the products of home manu- 
 facturers. To the extent, therefore, that they are successful in 
 their purpose, they reduce the customs revenues and justify the 
 statement that there is a fundamental antagonism between the 
 protective and revenue principles. However, the reduction of 
 
7*4 OUTLINES OF ECONOMICS 
 
 importation does not signify that the consumers of the article in 
 question are not taxed. So long as the price remains higher 
 than it would be if no duty were imposed, the people are taxed 
 to the extent of the difference, the proceeds of the tax going to 
 home manufacturers in the form of an unmeasured, unregulated 
 bounty, whose burden upon the taxpayers is no less real because 
 unperceived. 
 
 It is equally evident that no protection is given unless the price 
 is raised. The popularity of customs duties is largely explained 
 by the belief that the foreigner can be made to bear the burden 
 of the tax. He can in some cases, but not in the majority of 
 cases. For the most part it is very certain that the burden must 
 be borne by the home consumer. But whatever the extent to 
 which the foreigner can be made to pay the tax, to that extent 
 the tariff fails to replace foreign by home products ; in short, 
 fails to " protect." We cannot have our cake and eat it too. 
 The more the protection or bounty to the home manufacturers, 
 the greater the tax upon the consumers, the less the shifting of 
 the tax to the foreigner, and the less the revenue to the home 
 government. The protectionist is logically deprived of the 
 time-worn argument that the foreigner foots the bill. 
 
 The European War has deeply impressed upon the people of 
 the United States the strength of the argument for protection 
 based upon military grounds and briefly discussed on page 
 370 above. It is likely, therefore, that we shall have more and 
 not less protection in the immediately ensuing years, particu- 
 larly for those industries whose products are believed to be in- 
 dispensable to national security in times of war. So long as war 
 is a real possibility there is probably no logical rejoinder to this 
 argument for protection ; but at least we should realize that we 
 are paying for our self-sufficiency, and that the difference 
 between the cost of the protected products and what they 
 would cost if imported from foreign countries, represents an 
 additional item in the budget of " preparedness " which has 
 already reached colossal proportions. 
 
 The shifting of import duties may be best explained by noticing separately 
 the immediate and ultimate incidence, (i) The immediate effect of the tax 
 
FEDERAL, STATE, AND LOCAL TAXES 715 
 
 will be to discourage certain foreign producers from shipping their products 
 to the newly restricted market, and prices will tend to rise because of di- 
 minished supply. If the product is controlled by a foreign monopoly, the 
 price may not increase ; but where the foreign production take places under 
 competitive conditions, and in most cases where the production is monopo- 
 lized, the price wiE be raised. The increase of price may be more or less 
 than or equal to the tax according to the readiness with which foreign pro- 
 ducers find a new market, but in a large majority of cases the burden of 
 the tax will be shared by the producer and consumer, the latter, according 
 to the majority of authorities, bearing most of the burden. That the bur- 
 den, however, is partially borne by the foreign producer accords not only 
 with the best theory, but with the great interest displayed by exporters every- 
 where in the tariff legislation of foreign countries, and the sacrifices which 
 protectionist governments are willing to make in reciprocity treaties for the 
 purpose of obtaining advantageous terms for their own producers. 
 
 (2) Eventually, however, the initial increase in price may stimulate home 
 production, and this can only take place when the increase of price is less 
 than the duty, because if the price rises by the whole amount of the tax, the 
 foreigner will still possess his initial advantage. If the home producer totally 
 ousts the foreigner, then the consumer bears all the difference between the 
 existing price and the price that would rule if no duty were imposed — 
 although, of course, the treasury receives nothing. If the home producer 
 secures only a part of the home market, it is plain that, under ordinary cir- 
 cumstances, the foreigner pays part of the tax, i.e. the amount per unit of 
 product by which the duty exceeds the increase of price; while, as before, 
 the home consumer pays, on every unit consumed, a tax equal to the differ- 
 ence between the old and the new prices. When, however, we attempt to 
 go further and take account of the indirect effects of protection, the problem 
 becomes almost hopelessly complex. Modern economists, however, are 
 substantially agreed that the foreign producer bears a somewhat larger share 
 of the average customs duty than the English economists of the first half of 
 the nineteenth century were willing to admit. 
 
 From the standpoint of revenue, American customs duties 
 have the great virtues of high productivity, convenience of pay- 
 ment, and cheapness of collection. Along with these important 
 virtues are associated almost all the vices to which indirect taxes 
 are subject. 
 
 I . The most important defects of our customs taxes are their 
 unreliability and uncertainty. Historically, they have shown a 
 pernicious variability, expanding when increased revenue spelt 
 extravagance, contracting when the country sorely needed larger 
 revenue. In 1791, for instance, the customs revenues exceeded 
 
7l6 OUTLINES OF ECONOMICS 
 
 the total ordinary expenditures by over 41 per cent, while in 
 the very next year they fell short of the expenditures by 58 per 
 cent. Between 1791 and i860 inclusive, the customs receipts 
 actually exceeded the expenditures in thirty-four years ; varied 
 between 50 and 100 per cent of the expenditures in twenty- 
 eight years ; and fell below 50 per cent in eight years. In i860, 
 more than 84 per cent of the expenditures were secured from 
 this source, but in 1863 less than 10 per cent, so inadequate is 
 the customs revenue in a serious war when money is most 
 needed. In 1864, Congress made desperate attempts to increase 
 the customs revenue. In the tariff act of that year about fifteen 
 hundred articles were enumerated, and the average rate approxi- 
 mated 50 per cent; yet the receipts dropped from something 
 over one hundred and two millions in 1864 to less than eighty- 
 five millions in 1865, constituting only 6.5 per cent of the total 
 expenditures in the latter year. During the history of the 
 national government, the customs revenues have varied with 
 the industrial condition of the country, the prospects of peace 
 or war, the power of the tariff lobby, the prosperity and com- 
 mercial policy of foreign nations, but almost never in nice accord- 
 ance with the financial needs of the federal government. Where 
 the tariff is controlled by revenue rather than protective pur- 
 poses, it can be made strikingly stable and responsive to the 
 control of the treasury. " The English revenue from this 
 source has kept very near £20,000,000 per annum for the last 
 thirty years. In the period 181 5-1895, it has only varied be- 
 tween £24,000,000 and £19,000,000, notwithstanding the exten- 
 sive remissions of taxation." ^ 
 
 2. From the fiscal standpoint, our tariff system is far too 
 complex and cumbersome. Whether we tax many imports or 
 few, the major part of the revenue comes from comparatively 
 few imports, so that by extending the list of dutiable articles we 
 merely add to the cost of collection and increase the interference 
 with commerce, without materially augmenting the yield of the 
 tax. Before the European War, Great Britain imposed import 
 duties on less than fifty articles, and nearly all of her revenue 
 
 1 C. F. Bastable, Public Finance, p. 517 (written in 1895). 
 
FEDERAL, STATE, AND LOCAL TAXES 717 
 
 from import taxation came from five articles : tobacco, tea, 
 spirits, wine, and sugar. Compared with direct taxes the cost 
 of collecting our import duties is not excessive (4.42 per cent 
 of the receipts in 191 5), yet it exceeds the cost of collecting the 
 internal revenue duties (1.50 per cent in 1915) ; and in some 
 customs districts the expenses of collection actually exceed the 
 tax collected. 
 
 "There is no better illustration of a complex and incomprehensible 
 revenue system than the tariff legislation of the United States. It levies 
 import duties upon goods that make up the country's exports as well as upon 
 those that constitute the normal imports of the nation's commerce ; it taxes 
 raw material as well as the manufactured product, and the maniofactured 
 product itself is taxed at many stages in the process of its manufacture ; the 
 rate imposed is determined in part by considerations of revenue, in part by 
 the desire to grant 'incidental protection,' and in part for the purpose of 
 prohibiting the import of selected articles ; the rules of rating are numerous, 
 overlapping each other in many cases and resulting in a confusion of instruc- 
 tions that necessitates a board of appeal in continuous session; the text of 
 the law makes a book of one hvmdred and fifty pages, while the law and its 
 interpretation used by the officials as a guide in the performance of their 
 duty is a volume of several hundred pages. A law of this sort cannot be 
 comprehended." ^ 
 
 Customs duties are either specific or ad valorem. Specific 
 duties are laid in proportion to weight or number, without regard 
 to value, while ad valorem duties are levied in proportion to the 
 value of the commodities imported. Ad valorem duties are open 
 to the objection that they offer a greater temptation to fraudu- 
 lent valuations, and hence make more difficult the work of the 
 customs officers. Specific duties, on the other hand, while they 
 can be more easily administered, are open to the serious objec- 
 tion that they impose a relatively heavier burden upon less 
 valuable goods of any class. Owing to their greater ease of col- 
 lection, however, such specific duties now play a larger part than 
 ever before in our tariff system. 
 
 Internal Revenue Duties. — In 1915 the internal revenue 
 taxes yielded $415,681,024, or practically twice as much as the 
 customs receipts for that year. Of the total collections just 
 
 1 H. C. Adams, Science of Finance, pp. 409, 410. 
 
7l8 OUTLINES OF ECONOMICS 
 
 one third came from the tax on spirits ; a little less than one 
 fifth (19 per cent in each case) from the taxes on tobacco, fer- 
 mented liquors, and incomes, respectively ; a little less than one 
 tenth from stamp taxes on documents and transactions ; and 
 the remainder from taxes on oleomargarine and playing cards, 
 back taxes, penalties, and the like. The internal revenues now 
 include a number of taxes other than the familiar excises on 
 articles of consumption which for so many years constituted, 
 with customs duties, the fiscal mainstay of the federal govern- 
 ment; but these newer taxes v/ill be left for separate notice 
 and the remainder of this section confined to the excises on articles 
 of consumption. Such excises are usually paid by stamps placed 
 upon the package of sale, supplemented by license taxes upon 
 dealers, which are also paid by stamps, as a rule, publicly ex- 
 posed by the dealer in his place of business. 
 
 Excise taxes, like all taxes, have their grave defects, (i) Like 
 import duties, they must be levied upon articles of wide con- 
 sumption to be productive ; and as they are in a large degree 
 shifted to the consumers, they frequently weigh more heavily 
 upon the poor than upon the rich. (2) This regressivity is in- 
 creased by the fact that the taxes are specific, not ad valorem, 
 so that the finer grades of domestic cigars, for instance, pay a 
 lower rate of taxation than the cheaper goods. (3) In order to 
 prevent evasion of the tax, the government is compelled not only 
 to watch, but partially to direct, the process of manufacturing 
 at every step. Producers are required to give bond for the 
 faithful observance of the law, to register raAV materials which 
 they buy, and to keep records of the stock on hand in accord- 
 ance with bookkeeping methods prescribed for them by the 
 Bureau of Internal Revenue. Such interference with private in- 
 dustry is an unfortunate but necessary part of excise taxation. 
 (4) Large systematized businesses bear such interference with 
 less effort than small concerns, and in consequence our internal 
 revenue system unquestionably exerts an influence in the direc- 
 tion of large-scale production, and possibly in the direction of 
 monopoly. The license taxes particularly, which are adjusted 
 only in the roughest way to the size of the business, unquestion- 
 
FEDERAL, STATE, AND LOCAL TAXES 719 
 
 ably weigh more heavily upon the small than the large dealers, 
 (s) Finally, it seems to be the almost universal opinion of com- 
 petent students that excise taxes exercise little influence upon 
 the consumption of articles whose use is believed to be dele- 
 terious. An increased tax is as often followed by adulteration 
 as by an increase of the price per unit. 
 
 The advantages of the internal revenue duties, however, far 
 outweigh their defects, (i) Like the customs duties, they yield 
 an enormous revenue ; but although they do fall off somewhat 
 in times of industrial depression, they are in ordinary periods 
 regular and dependable, while in times of war they respond 
 readily to increased rates. The increase of old duties and the 
 imposition of new duties during the Spanish War, for instance, 
 raised the receipts from $170,900,641 in 1898 to $273,437,162 in 
 1899. Many of the taxes yield a proportional increase almost 
 as great as the increase in the rate of the tax, a rare virtue in 
 excise taxation. (2) From the administrative standpoint they 
 are very inexpensive to collect, give rise to comparatively little 
 fraud or evasion, and the few industries which they affect have 
 now become so habituated to public inspection and control that 
 these are occasion of little complaint. (3) Finally, it is to be 
 noted that although excise taxes are regressive, the burden of the 
 tax is shared by producer and consumer — not borne wholly by 
 the latter — and the share borne by the producer varies directly 
 with the element of monopoly or differential advantage in pro- 
 duction. " Viewed as a whole, the internal revenue system is 
 the most satisfactory part of our entire financial structure, state 
 or federal. Its returns are fairly steady and reliable in times of 
 depression. Its growth is automatic. It is imposed on articles 
 the demand for which is tolerably inelastic. Its burden is not 
 perceptibly felt. It is honestly and economically collected; 
 and finally, it is abundantly capable of yielding additional 
 revenue, should an unforeseen emergency arise." ^ 
 
 Taxes on Transactions. — In times of urgent need, as in the 
 War of 181 2, the Civil War, and the late war with Spain, the 
 federal government has imposed taxes upon various sorts of 
 
 1 W. M. Daniels, Public Finance, p. 148. 
 
720 OUTLINES OF ECONOMICS 
 
 transactions. Thus, the war revenue act of 1898 imposed stamp 
 taxes on bank checks, telegrams, freight and express receipts, 
 transfers of stocks and bonds, bills of exchange, etc. In 1899, 
 the year after they were imposed, the stamp taxes yielded 
 $43,837,819. Such taxes were again introduced in a period of 
 declining customs receipts and increasing expenditures, by the 
 so-called " war revenue act " of 1914. In 1915 this measure 
 yielded a revenue of a little less than $38,000,000, of which 
 $23,500,000 came from stamp taxes on documents and trans- 
 actions and the balance from special internal revenue duties of 
 the ordinary type. The peculiar advantage of taxes on trans- 
 actions is their quality of immediate productivity. As the 
 figures just quoted show, they may be made to yield largely 
 the very year they are imposed. Moreover, the government 
 may make evasion almost impossible by refusing to recognize 
 documents not properly stamped in its courts, or by otherwise 
 obstructing the use of unstamped documents as evidence. An- 
 other advantage is that they cost almost nothing to collect, as 
 the taxpayer buys the stamp himself and places it upon the 
 document. On the other hand, the general effect of such taxes 
 is to impede business ; and they are frequently if not usually 
 shifted to the weaker bargainer in a business transaction. Cer- 
 tainly they bear no logical relation to the ability of the taxpayer 
 to pay taxes. 
 
 Income Taxes. — The recent adoption of effective income 
 taxation into this country affords an interesting illustration of 
 the triumph of a sound economic idea over formidable obstacles. 
 The legal barriers which had to be surmounted have already been 
 mentioned, but there were other difficulties to overcome equally 
 formidable. Income taxes had been on the statute books of 
 American commonwealths since the seventeenth century, and 
 had been consistently and continuously . ineffective. The tax 
 was generally believed to be too intricate and too inquisitorial 
 for the American people, schooled by the crudities of the general 
 property tax to evasion of and contempt for tax law. Expert 
 opinion had come to hold that the income tax, though " sound 
 in theory," made too many demands upon both the taxpayer 
 
FEDERAL, STATE, AND LOCAL TAXES 721 
 
 and the tax administrator to thrive in American soil. Yet in 
 the last five years income taxes of the European type have been ' 
 put into successful operation by both state and federal govern- 
 ments and give every promise of assuming, in the future, a place 
 of major importance in the American fir-cal system. 
 
 The mistake of the experts arose rather from an underestimate 
 of the strength of the income tax than f>rom an underestimate 
 of its difi&culties. The alleged weaknesses of the income tax 
 were not imaginary. Experience has shown that it is a complex 
 and difficult tax to formulate and administer. Just what items 
 of gross income should be included and what losses, expenses, 
 and other deductions allowed, are questions which bristle with 
 difl&culties. Some forms of income are not expressed in money 
 and usually escape taxation ; on the other hand, it is almost im- 
 possible to avoid double taxation, particularly in dealing with 
 interest and dividends. The tax has also the difficulty of 
 being a class tax : the federal income tax touches directly less 
 than one per cent and the Wisconsin income tax less than three 
 per cent of the respective populations affected. The tax is 
 predominantly a city tax and farmers generally escape, owing 
 to the facts that they usually do not keep books and that much 
 of their income does not find expression in terms of money; 
 although it must be admitted that relatively few farmers receive 
 incomes above the exemption limit. Finally, the mixture of 
 " withholding at source " and direct collection, in the federal 
 tax, imposes large and unjust expenses of collection upon 
 private taxpayers, complicates the administration of the tax, 
 and in some cases leaves the taxpayer to become the sole judge 
 of the taxability of certain items of income and of the deduc- 
 tibility of certain losses and expenses.^ 
 
 Despite all these difi&culties, however, the income tax has 
 succeeded. It is reasonably productive and will become more 
 productive as time passes: the federal income tax in 191 5 
 yielded a revenue of over $80,000,000, and in 1916 it produced 
 
 ' A criticism of the federal income tax by a disinterested and competent com- 
 mittee of the National Tax Association will be foimd in the Proceedings of that asso- 
 ciation,, vol. ix. 
 3A 
 
722 OUTLINES OF ECONOMICS 
 
 over $100,000,000. It is elastic, and can be made more produc- 
 tive by simple increase of rates. Above all else, it realizes with 
 reasonable success " taxation according to ability." Property 
 taxes pay little attention to the ability of the owner of the 
 property. They fall upon property as such whether it is free or 
 encumbered by debt ; they must be paid by the unsuccessful as 
 well as the successful ; in lean years as well as fat years. The 
 income tax, on the other hand, does not affect the very poor 
 at all; it spares the unsuccessful business, the new business 
 in its developmental stage, and the old established enterprise 
 in times of business depression. Its appeal is thus not only to 
 the humanitarian sentiment of the age, but to the common 
 sense of the business man. Except when collected at source 
 (when it acts in small part like an excise) it is subject to little 
 or no shifting. And, unlike the property tax, it grows stronger 
 with age and continued use. The countries which have tried 
 the income tax keep it ; and in the last quarter of the century 
 practically every large country in the world which did not 
 already have the income tax has introduced it. 
 
 The mistake of the critics in condemning the income tax for 
 American use was due very largely to a misinterpretation of the 
 failure of the personal property tax. That tax is largely evaded. 
 The critics inferred from this that American taxpayers are liars 
 and would similarly evade an income tax. Experience with the 
 income tax has shown, however, that the average American tax- 
 payer is honest and will make an honest declaration if the tax 
 be equitable and tax officials at the same time firm, competent, 
 and considerate. The personal property tax in this country has 
 failed, not because the taxpayer is dishonest, but because the 
 tax is at times barbarously severe in burden, strikingly un- 
 equal in operation, and administered by ofi&cials who are fre- 
 quently incompetent and out of sympathy with the tax itself. 
 Moreover, the income tax is no more complicated than any 
 other direct tax involving valuation and assessment. It ap- 
 pears to be more complicated than the property tax merely 
 because in drafting income tax laws it is customary to anticipate 
 all problems of detail and define the proper answer in the 
 
FEDERAL, STATE, AND LOCAL TAXES 723 
 
 Statute itself ; whereas, in property tax laws almost all the diffi- 
 cult questions are avoided by laying the tax on the " fair cash " 
 or " market value " and leaving the meaning of this term to 
 be decided by the judgment of the assessor. In the average 
 case, it is easier to determine a man's income with reasonable 
 accuracy than it is to determine with the same degree of accu- 
 racy what his property is worth. 
 
 Absentee ownership increases with industrial development, 
 and much income is now derived from particular jurisdictions 
 by persons who reside elsewhere. This leads in practice to 
 double taxation, as both the jurisdiction in which the recipient 
 lives and that in which the income originates are likely to im- 
 pose the tax. Such double taxation is reduced as the jurisdic- 
 tion is enlarged to which the income tax applies ; and for this 
 reason many authorities advocate the exclusive employment of 
 the income tax by the federal government. If the income tax 
 cannot be employed by both state and federal governments, 
 this conclusion is warranted. But we see no reason why the 
 states should renounce the income tax and use substitutes which 
 are manifestly inferior, merely because the federal government 
 is employing the same tax. Nearly all taxes must be paid out 
 of income. The specific tax employed is merely a device for 
 distributing the tax. Why, then, should the state employ a poor 
 method of distribution, such as that embodied in the personal 
 property tax, when it might employ a tax which with substan- 
 tial accuracy lays the burden in accordance with ability to pay ? 
 As a matter of fact, the federal income tax is likely to encourage 
 the adoption of state income taxes, because the federal tax fa- 
 miliarizes the people with income tax procedure, and with 
 simple modifications a report prepared for the federal govern- 
 ment can be used for the state government. We should have, 
 not hostility between state and federal administrations, but 
 joint and cooperative use of many forms of taxation. 
 
 Inheritance Taxes. — In 1893, when the first edition of this 
 work was written, the inheritance tax was used in only five 
 states, and so strong were the objections to its wide adoption 
 that the author felt called upon to point out that unregulated 
 
724 OUTLINES OF ECONOMICS 
 
 collateral inheritance was an unjustifiable survival of the clan 
 system that was being carried to ridiculous lengths at that 
 time. Since that time, however, inheritance taxation has spread 
 rapidly, being employed in about forty states in 191 5, and with 
 the spread of the tax has come a most significant development 
 of progressive rating and taxation of direct as well as collateral 
 heirs. Today one never hears of the " inherent right " of 
 decedents to control absolutely the disposition of their property 
 in perpetuity, and the right of the legislature to regulate in- 
 heritance in behalf of the general social welfare is hardly dis- 
 puted. Mr. Andrew Carnegie, for instance, advocates a rate of 
 50 per cent upon the estates of millionaires. 
 
 At present the inheritance tax produces substantial revenues 
 in only a few states ; in 1913, the latest year for which complete 
 statistics are available, 35 states showed collections aggregat- 
 ing $26,470,964, of which the six states of New York, Pennsyl- 
 vania, Massachusetts, California, Illinois and Connecticut re- 
 ceived 78 per cent. The important fact is that the initial in- 
 ertia and opposition have been overcome and the ground cleared 
 for the really efficient use of this tax as a means of reducing 
 large fortunes and increasing public revenues. The new type 
 of the inheritance tax is well illustrated by the Wisconsin law, 
 which applies to direct as well as collateral heirs, and which 
 graduates the rates according to relationship and the amount 
 of the individual share, and not by the size of the estate. The 
 highest rate in the Wisconsin tax, applying to shares in excess of 
 $500,000 given to distant relatives and strangers, is 15 per cent. 
 
 Great as our progress has been in this respect, our legislation 
 still falls short of the demands of common sense. Why should 
 collateral inheritance, apart from a will, be permitted at all ex- 
 cept among near relatives? Why should third cousins inherit 
 from one another unless money is left by will ? Are third cousins 
 nearer to one than the town or city in which one has lived and 
 where one has been able to acquire a fortune? The extent to 
 which intestate collateral inheritance is carried is a survival of 
 the sentiment of the time when people lived in clans, and is 
 illogical in our day. Right and duty should be coordinated. 
 
FEDERAL, STATE, AND LOCAL TAXES 725 
 
 Ought I to be compelled by law to support an uncle who is un- 
 able by incapacity to earn a livelihood ? Then I should inherit 
 from him ; otherwise it does not seem clear that I should unless 
 he leaves me property by will. So far as practicable the circle 
 of legal duties ought, however, to be extended so as to include 
 the circle of vital relationship. The property should go to the 
 State in the absence of near relatives when no will is made. 
 The clan is dead and forgotten ; ordinarily there is neither ac- 
 quaintance nor recognizable obligation between second cousins, 
 not to mention twenty-second. Inheritances thus bestowed are 
 pure gifts, wanton disturbances of existing abilities to use 
 property. The modern clan is society, and to it belong all claims 
 to inheritance Jailing outside the circle of vital relations. The en- 
 lightened English jurist, Jeremy Bentham, wished to restrict 
 inheritance and extend escheat, and thus abolish taxation 
 altogether, but this is going too far. 
 
 At present the inheritance tax in this country is too light to 
 satisfy the requirements of sound inheritance taxation. The 
 average inheritaiice tax, even in the case of large estates divided 
 into large shares, is less than 3 per cent : and it is very difficult 
 for one state to increase the rates if neighboring states do not 
 do the same. Moreover, state inheritance taxes give rise to 
 multiple taxation. Land devolves at situs, and its devolution 
 is taxed at situs. But our most valuable land is rapidly pass- 
 ing into corporate ownership, and corporations do not die. 
 The corporate securities which represent the land are, under 
 the inheritance tax, normally taxed at the domicile of the de- 
 cedent. This is likely to be in another state. Hence many 
 states, the western states in particular, try to tax not only the 
 transfer of securities owned by resident decedents, but also 
 the transfer of securities " representing " property located 
 within their borders. This is selfish and inconsistent. Both 
 principles cannot find an equitable and logical place in the same 
 tax law. But it is expensive and difficult to administer an 
 inheritance tax on the " situs principle " ; and when a holding 
 company or series of holding companies intervenes between the 
 security and the tangible property which that security repre- 
 
726 OUTLINES OF ECONOMICS 
 
 sents, it is almost impossible. Other states, again, tax the trans- 
 fer of securities held in trust companies located therein ; while 
 still others pile inconsistency upon inconsistency by giving 
 bonds issued by their municipalities a situs within their own 
 borders, in order that the transfer of such bonds may be taxed 
 upon the death of their nonresident owners. The writer has 
 known one block of securities to be taxed in three different 
 states, and it was possibly taxed later in a fourth state. 
 
 Under these circumstances, many people advocate as a 
 remedy the collection of the tax by the federal government, 
 with a redistribution of a part of the proceeds to the state 
 governments. The principal argument for this change is the 
 assertion that the federal government can, while the state 
 governments cannot, realize the full possibilities of inheritance 
 taxation, so that the federal government can give the states 
 more than they are now receiving from this source and still 
 retain a handsome revenue for federal uses. This project is, 
 however, deeply resented by state tax officials, who point out 
 that the probate courts, the natural machinery for administer- 
 ing inheritance taxes, are in the hands of the state governments, 
 and that there was considerable evasion of the inheritance tax 
 adopted by the federal government during the Spanish War. 
 
 We believe that the solution of the problem lies in cooperative 
 and joint use by federal and state governments. Neither divi- 
 sion of government can be prevented from using this tax, and 
 fiscal necessity will almost certainly force the federal government 
 to make use of it in the near future. That being the case, 
 common sense points to the desirability of administrative co- 
 operation, and the elimination by the larger sovereignty, if pos- 
 sible, of double taxation arising from conflicts of jurisdiction. 
 
 State and Local Taxation 
 
 General Property Tax. — The key to the revenue system of 
 our state and local governments, and by far the most important 
 tax collected in the United States, is the general property tax, 
 which supplied, in 1902, 82 per cent of the tax receipts of the 
 
FEDERAL, STATE, AND LOCAL TAXES 727 
 
 state and local governments and 51 per cent of all taxes col- 
 lected in the country, (i) national, state, and local. The most 
 important characteristic of this tax is suggested by the word 
 " general," — the tax is levied in principle upon nearly all property, 
 real and personal, in the hands of the people. 
 
 Though the administration of the property tax differs in many 
 details among the states, it is the usual custom for assessors in 
 each community to prepare complete statements of all kinds of 
 taxable property owned by the people of the community. In 
 some states the assessors receive from all residents sworn " lists " 
 of property owned and subject to tax. By the terms of the law 
 the property is supposed to be rated at its true full value, 
 though, by the acknowledged practice of assessors and courts 
 of review, the real rates vary widely from state to state, from 
 community to community, and from individual to individual. 
 On the basis of the property valuations thus made the state 
 and local governments levy direct taxes at a rate fixed from 
 year to year according to fiscal needs. The tax is then collected 
 by local officers, and of the whole amount the portion levied by 
 the county and state is passed on to the designated officers 
 after each minor political division has set aside its share. 
 
 As yet few economists who have written upon the subject, and 
 few state officers who have had to do with the administration of 
 the tax, have ever been able to speak of it except in terms of the 
 severest condemnation. Naturally, then, there is now a strong 
 tendency to work away from this form of taxation. Some of 
 the many serious faults which the general property tax has 
 everywhere shown call for comment and explanation. 
 
 I. Unjust Apportionment. — The first of the defects of the 
 tax appears in the apportionment of the state's share of the tax. 
 Each community has a narrow, selfish interest in reducing its 
 assessment so that it may escape its just share of the tax. The 
 same mean struggle is especially frequent between city and 
 country districts. To correct the evil, boards of equalization 
 are usually appointed, but experience has shown that such boards 
 usually do their work in a most perfunctory way. Although 
 earnest study of assessments may and sometimes does secure a 
 
728 OUTLINES OF ECONOMICS 
 
 substantially just apportionment between county and county, 
 this equalization does not correct the glaring inequalities within 
 particular counties, and even within single assessment districts. 
 
 2. Inequality as between Realty and Personalty. — In the 
 second place, the general property tax has proved grossly in- 
 equitable in laying an undue proportion of its burden upon real 
 property, allowing various forms of personal property to escape 
 with a slight tax or with no tax at all. A secondary result of 
 this inequality is that the rural districts bear a disproportionate 
 burden, since the greater part of the tax-escaping personalty is 
 owned by the wealthy citizens of our cities. 
 
 3. Undervaluation of Large Properties. — Very similar to the 
 preceding evils is the further injustice wrought by the tax 
 through the disproportionate assessment of large and small 
 properties. Thus, an investigation in Virginia covering over 
 sixteen thousand pieces of property, showed that while the 
 average ratio of assessed to true value was 2,3 per cent, parcels 
 worth less than $500 were assessed at 47 per cent of full value, 
 and parcels worth more than $10,000 at only 28 per cent of 
 full value .^ 
 
 4. Temptation to Dishonesty. — It follows from the evils 
 already described that the general property tax leads to a shock- 
 ing amount of dishonesty, perjury, bribery, and other forms of 
 corruption. Indeed, as one writer has expressed it, " The 
 general property tax has gone far toward making perjury re- 
 spectable and even virtuous." 
 
 5. Fundamental Theoretical Defects. — But the most funda- 
 mental defect of the general property tax is found in the fact that 
 it is an incongruous mixture of real and personal taxes. Real 
 estate, in a great majority of states, is taxed at its situs, irrespec- 
 tive of ownership or the tax-paying ability of the owner. The 
 personal obligation of the owner to support the government 
 under which he immediately lives is met practically everywhere 
 by that part of the tax which falls upon personal property, per- 
 sonal property paying at the domicile of the owner. 
 
 This distinction between real and personal property is artificial, 
 
 ^ Report of tlie Joint Committee on Tax Revision (Virginia), 1914, p. loi. 
 
FEDERAL, STATE, AND LOCAL TAXES 729 
 
 inequitable, and illogically applied. Personalty, as a measure of 
 ability to pay taxes, ought to be accurately computed by offset- 
 ting liabilities against assets, so that the taxpayer would pay 
 only upon net assets. Yet no state, with the possible exception 
 of New Jersey, grants full and complete exemption of debts; 
 only three states permit a subtraction of debts from all per- 
 sonalty ; the rest either refusing any abatement for debts what- 
 soever or limiting the abatement to subtraction of debts from 
 money, or money and credits, or other restricted classes of per- 
 sonalty. Moreover, nearly all the states manipulate their defini- 
 tions of real property in the most discreditable manner, causing 
 many kinds of double taxation. To take a single illustration : 
 most states tax the stock of foreign corporations held by resi- 
 dent citizens, whether the corporation pays full taxes at its situs 
 or not. Many of these states tax their own or domestic corpora- 
 tions at full value, thus indorsing the theory that a corporation 
 should be taxed as a business unit where the business is carried 
 on. Nevertheless, they attempt to tax the stock of foreign cor- 
 porations when the stock is the only thing they can reach. 
 Some states, though not a majority, actually tax both the shares 
 of stock and the business of domestic corporations, and then 
 wonder that the stockholders attempt to evade the inequitable 
 obligations imposed upon them by law. 
 
 Reform of the Property Tax. — This brief outline of the evils 
 connected with the general property tax furnishes us with the 
 key to reform. By far the greatest reform that could possibly 
 be accomplished would result from placing the work of assess- 
 ment on a scientific basis, by appointing expert assessors under 
 civil service protection, who would give their whole time to the 
 business and hold their places during good behavior. In 1902 
 practically three fourths of the revenues collected under the 
 general property tax came from the tax on real property. We 
 shall undoubtedly keep the real estate tax. Scarcely any one 
 advocates its abandonment or believes that it will be possible 
 to get along without it ; and with trained assessors it would be 
 possible to make a substantially fair assessment of real property. 
 Yet even the assessment of real estate is in most places today 
 
730 OUTLINES OF ECONOMICS 
 
 markedly unequal. We spend a great deal of time thinking out 
 ambitious fiscal reforms that will remedy the present system by 
 revolutionizing it, overlooking the fact that the remedy for the 
 deepest and widest evil lies within our reach, neglected and un- 
 availing, not because we are ignorant of its potency, but because 
 we lack the will resolutely to apply it. 
 
 At the same time, no assessor, however expert and well paid, 
 can ever be expected to assess all kinds of personal property with 
 even approximate accuracy. To persist in the attempt to assess 
 all the property of every person is simply to debase public 
 morality and convince assessors that nothing short of divine wis- 
 dom will enable them to satisfy the requirements of the law. 
 In short, the more intangible forms of personal property, if not 
 all personal property, must be exempted from taxation, and the 
 loss be made up by the introduction of simpler and more work- 
 able taxes. Probably the best substitute is an income tax, or 
 what has been called a " presumptive ability tax " based upon 
 house rent, rental value of business premises, salary, or all of 
 them. In individual cases such a tax would violate the rules of 
 exact justice, but with suitable exemptions and proper adjust- 
 ments it might be roughly equitable. 
 
 The personal property tax on business and commercial con- 
 cerns, with its impossible requirements of stock valuations, 
 taxation of book accounts, bills receivable, and credits generally, 
 should be replaced by a tax on gross or net income, or by some 
 simple form of license taxation. We should then have, in place 
 of the general property tax, a tax on real estate, a business tax, 
 and a personal tax measured by net income or evidences of in- 
 come. Although the real estate tax would in appearance take 
 no cognizance of mortgages or debts secured by the property 
 and no account on the surface of the ability of the owner, it 
 would not in reality wholly violate the canon of taxation accord- 
 ing to ability. The man buying land on contract or subject 
 to a mortgage, would take into account the fact that he would 
 be called upon to pay taxes upon the whole value of the property, 
 irrespective of debt or incumbrance, and the price would be 
 adjusted accordingly. Or, if he mortgaged his land after he 
 
FEDERAL, STATE, AND LOCAL TAXES 73 1 
 
 had acquired ownership, he would be indemnified in most cases 
 for paying ail the taxes, by receiving a lower rate of interest on 
 his mortgage than he would be enabled to secure if the creditor 
 were liable for taxes upon that part of the property covered by 
 the mortgage. Real taxes, which take no cognizance of the 
 financial status of the owner, are not inequitable when they are 
 consistently applied and supplemented by a separate system of 
 personal taxation. 
 
 All these taxes destined to take the place of the general 
 property tax may possibly, in the future, be assigned to the local 
 governments, although administered in some cases by the 
 central government. If necessary to provide enough revenue 
 for the state, however, a small state tax could equitably be 
 levied upon real estate, as the equalization of real estate assess- 
 ments among the larger governmental divisions, such as coun- 
 ties, is a comparatively easy matter. Whether the state will be 
 able to get along without taxis upon real estate, depends prin- 
 cipally upon the productivity of certain corporation taxes, the 
 proceeds of which belong logically to the state rather than to 
 the local governments. This absorption of corporation taxes 
 by the state is already well under way in the New England and 
 Middle Atlantic states. In 19 15, for instance, New York, New 
 Jersey, and Pennsylvania together raised $70,078,685 from 
 special property and business taxes (practically corporation 
 taxes), but only $18,743,626 from the general property tax. 
 In that year Delaware made no use of the general property tax 
 at all for state purposes. However, the breakdown of the general 
 property tax has by no means been accomplished yet. In all 
 the states and territories in 191 5, 51 per cent of the total tax 
 receipts came from the general property tax, 23 per cent from 
 special property taxes, 22 per cent from business taxes, less 
 than I per cent from poll taxes, and something over 4 per cent 
 from miscellaneous licenses. These proportions are based upon 
 state receipts. If local revenues were included, the general 
 property tax would appear much more important. 
 
 Corporation Taxes. — The exact way in which any corpora- 
 tion should be taxed depends upon a great variety of considera- 
 
732 OUTLINES OF ECONOMICS 
 
 tions, which vary from place to place and from time to time. 
 In general, however, the following elements may be detected in 
 the more progressive systems of corporation taxation : (i) The 
 incorporation fee, justified by the clerical expenses of registering 
 corporations and the value of the privileges granted to every 
 corporation, the most important of which is that of limited 
 liability. This charge should be imposed on all joint-stock 
 companies, should vary with the amount of bonds as well as 
 the amount of stock authorized, 'and should be small, unless 
 the state desires narrowly to restrict the incorporation of com- 
 mercial enterprises. (2) The franchise tax proper, to cover 
 especially valuable privileges, such as the right to use the public 
 streets or highways, granted to most public utility companies. 
 This is essentially a contractual payment, a lease or royalty 
 rather than a tax. It should be fixed in advance for a definite 
 period at as high a figure or rate as is just, and, when fixed, 
 should not, in justice to the corporation, be tampered with by 
 the state.^ In states having public service commissions power- 
 ful enough to control rates effectively, this tax or payment may, 
 and perhaps should, be relinquished in favor of correspondingly 
 lower rates and better service. (3) The general property tax 
 or some equivalent, designed to impose upon the corporation a 
 burden equivalent to that borne by the average taxpayer of the 
 district. Inasmuch as good will, business organization, and 
 similar intangible assets are property, property taxes imposed 
 under this head should cover not only tangible but intangible 
 values as well, including the franchise, when this does not revert 
 to the state. Corporations which have received valuable fran- 
 chises from the state may properly be called upon to pay for 
 the privilege (under 2) as well as upon the privilege (under 3). 
 
 This differentiation of what may be called the bases of cor- 
 poration taxation should not be misunderstood. Many states 
 merge two or even three of these charges in a single tax, and 
 
 '^ However, where a long or perpetual franchise is given, provision should be made 
 for the readjustment of the rental by arbitration or in some other equitable way. 
 An illustration is found in the terms of the franchise under which the Pennsylvania 
 railroad built a tunnel under the North River and erected its new station in New 
 York City. 
 
FEDERAL, STATE, AND LOCAL TAXES 733 
 
 other states exempt savings banks, insurance companies, and 
 other kinds of corporations from one or all of these obligations 
 in order to encourage thrift or foster the industry exempted. 
 Such exemptions are often justifiable and socially helpful. But 
 unless these separate elements are kept plainly in mind, injus- 
 tice is almost sure to follow. To impose, or try to impose, 
 charge (2) upon all corporations, on the theory that all of them 
 have received exceedingly valuable privileges, is to confuse 
 general with special corporation privileges, and to pave the way 
 for " corporation-baiting." Finally, although it is not neces- 
 sary, we believe real progress will be hastened by observing 
 these distinctions in practice as well as in theoretical analysis. 
 
 Business and License Taxes. — In most Southern states 
 there is an extensive system of business licenses, which supple- 
 ment and partly replace the general property tax. The sig- 
 nificance and importance of these business licenses have not 
 hitherto been sufficiently appreciated. They are levied in 
 theory under the regulative power of the government rather 
 than the taxing power ; but they have by extension and multi- 
 plication become taxes for the most part, as distinguished from 
 sumptuary charges or payments for small privileges. 
 
 The license system of the South is characterized by many 
 defects. Here and there traces of class feeling are discerned, 
 as in the prohibitive license taxes levied upon peddlers ; and 
 the rates employed are often illogical, inconsistent, and in- 
 equitable to the point of absurdity. In a few cases also, these 
 taxes are high enough to bar certain occupations to the man 
 with small capital. But on the whole they are among the best 
 taxes employed by American commonwealths. They are easily 
 and cheaply collected, very productive, cause little or no com- 
 plaint, are not excessive as a rule, and exercise little or no in- 
 fluence upon prices. And in so far as they discourage the 
 excessive multiplication of small retail shops they perform the 
 useful service of preventing almost inevitable loss and bank- 
 ruptcy. 
 
 The great significance of the business license is its expression 
 of the truth that the general property tax in its crude form is 
 
734 OUTLINES OF ECONOMICS 
 
 unsuited to the taxation of business. Under the property tax, 
 business in general is taxed upon its tangible assets, i.e. fixed 
 plant and stock. One has only to think of the varying relation- 
 ship to taxable capacity of the plant and stock of a manufac- 
 turer, a grocer, a druggist, and a stock broker, to realize the 
 grave injustice of this method of taxation. In countries of con- 
 tinental Europe, and in parts of Canada, as in the southern part 
 of the United States, a wide and generally satisfactory use is 
 made of the business tax. Eventually we shall probably come 
 to the same thing in all parts of this country. But the tax 
 should be adjusted to earnings or profits in a more effective 
 way than is now done in the South. 
 
 Poll Taxes. — The poll tax is the oldest tax we have in this 
 country, and throughout the greater part of the colonial period 
 yielded more than any other source of revenue. It aroused bitter 
 opposition in many commonwealths and was prohibited by the 
 liberal constitution of Maryland at the beginning of the Revolu- 
 tionary War; but it persisted in many of the states, and still 
 remains the most important source of revenue, after the property 
 tax, in a few of the Southern states. The tax still stands on the 
 statute books of about one half of the states, and is nominally 
 employed as a highway or local tax in a still larger number of 
 commonwealths ; but in many places little or no effort is made 
 to enforce it. In Wisconsin, for instance, no attempt is made 
 to collect the poll tax in more than half of the local taxing dis- 
 tricts. The poll tax is not only difficult to collect, but is regres- 
 sive and, when its payment is required as a prerequisite to the 
 exercise of the suffrage, often results in widespread political cor- 
 ruption. " No concealment need be made of the fact that the 
 poll tax is used in Mississippi as a means of disqualifying the 
 negro in national elections and controlling the vote in local 
 elections." ^ The aggregate yield of the poll tax is small, and 
 the expense of collecting it is relatively high. It has few de- 
 fenders among competent students of taxation. 
 
 1 C. H. Brough, in "Studies in State Taxation," Johns Hopkins University Studies 
 in Historical and Political Science, vol. xviii, p. 213. 
 
FEDERAL, STATE, AND LOCAL TAXES 735 
 
 A Balanced Revenue System 
 
 There are, on the mainland of the United States, forty-eight 
 separate sovereignties in addition to the federal government, and 
 the resulting conflicts of jurisdiction gives rise to the deepest 
 defects of our revenue system. As a remedy for this evil, many 
 authorities recommend a division or separation of revenues, by 
 which certain taxes would be assigned to the federal govern- 
 ment, others to the states, and still others to the local govern- 
 ments. This plan is usually referred to as the " segregation or 
 separation of the sources of revenue." 
 
 The benefits that might be derived from a thoroughgoing 
 system of segregation are many and obvious. But the trend of 
 events suggests that reform must, in the main, be sought along 
 other lines. The boundaries between state and federal finance 
 become more indistinct with the passage of time. Both federal 
 and state governments have recently adopted income taxes, and 
 the federal government may very soon deem it wise to adopt the 
 inheritance tax. The state governments in recent years have 
 made increasing use of stamp taxes and other forms of excise 
 taxation theretofore used almost exclusively by the federal 
 government. In commonwealth finance, similarly, there seems 
 little disposition to separate clearly the sphere of state and 
 local taxation. On the contrary, state tax commissions are 
 being given increasing powers of regulating local taxation, and 
 it is being recognized in increasing degree that to finance the 
 state governments by corporation and indirect taxes which do 
 not touch the great mass of citizens directly, stimulates ex- 
 travagance on the part of the state legislature, and, in fact, 
 leads to the reintroduction by the state of direct taxes on 
 general property. Furthermore, there are some manifest ad- 
 vantages in the joint use of the same tax by several divisions of 
 government. The central or larger jurisdiction not only finds 
 it possible to employ expert aid, which the local government 
 could not afford to hire, but it has a broader, more impartial 
 point of view which serves to check local selfishness. Local 
 authorities, on the other hand, frequently have a helpful knowl- 
 
736 OUTLINES OF ECONOMICS 
 
 edge of important facts and conditions which are likely to 
 escape the agents of the central government. Joint use of the 
 same tax also permits a wise compromise between central effi- 
 ciency and the American demand for " local self-government." 
 
 A certain amount of segregation is, however, not only expe- 
 dient but plainly necessary. Thus, the use of import and export 
 duties is confined by the constitution to the federal government. 
 In the domain of commonwealth government also there are cer- 
 tain enterprises, such as sleeping car companies, whose property 
 or business is so difficult to localize that by common consent 
 such companies are reserved for state taxation. For the same 
 reasons, certain other corporations, such as telephone, telegraph, 
 insurance, freight line and equipment companies, should be, and 
 rapidly are being, set aside for state or central taxation ; and in 
 the case of most " state-wide " public utilities there is obvious 
 need for central assessment. In the past, it was common to 
 assess separately the property of railroads and similar public 
 utilities in every tax district (including townships and even 
 school districts) in which they operated, and this absurd mor- 
 cellement is still practiced in some backward states, including 
 New York. Many of the most important properties of such 
 corporations cannot be intelligently valued without reference 
 to the earnings or success of the business as a whole and this, 
 as well as considerations of administrative simplicity, makes 
 valuation or assessment as a unit obviously desirable. When the 
 central valuation is once made it is possible in some cases to 
 distribute or apportion the valuation to counties or other large 
 local subdivisions ; but it is impossible to localize some busi- 
 nesses satisfactorily, and minute subdivision is in all cases un- 
 desirable. 
 
 Much that has been said above about state versus local 
 assessment applies, in the case of interstate corporations, to the 
 question of federal versus state assessment. Without federal 
 control each state is tempted to select that form of taxation and 
 to adopt that method of dividing or allocating corporate prop- 
 erty and business for purposes of taxation which is most bene- 
 ficial to itself. Under such circumstances some interstate cor- 
 
FEDERAL, STATE, AND LOCAL TAXES 737 
 
 porations are taxed upon more than one hundred per cent of 
 their property or business, while others take advantage of the 
 absence of authoritative central control to assign, in their own 
 accounting systems, excessive proportions of property and 
 business to those jurisdictions in which taxes are lightest. 
 
 While federal regulation is justified by the same logic which 
 sanctions state regulation of local taxation, it is very doubtful 
 how far federal regulation can or should go. If the national 
 government should require some form of federal incorporation 
 for companies engaged in interstate commerce, it is possible 
 that it would have power thereafter to prescribe the methods 
 by which such interstate companies should be taxed under state 
 law. This has been done in the case of national banks, although 
 the power of the federal government to control taxation of 
 national banks is clearer and probably greater than its poten- 
 tial power to limit the rate of taxation of ordinary business cor- 
 porations engaged in interstate commerce. But if the proposed 
 federal regulation were elastic enough to permit the rate of 
 taxation to vary in each state with the average level or burden 
 of taxation in that state, and vigorous enough to suppress selfish 
 state aggrandizement, it would represent a great reform. No 
 form of federal control is expedient, however, that would de- 
 prive the states of adequate revenues from this source. The 
 properties of interstate companies form a very large part of 
 existing wealth. In a number of states one tenth or more of 
 the entire taxes collected, state and local, come from railroad 
 companies alone. Commonwealth revenue systems are ad- 
 justed to this condition and no revolutionary change is either 
 practical or desirable. 
 
 One important reform, however, could be accomplished at 
 once. The Interstate Commerce Commission, or some similar 
 federal agency, should at the earliest practicable date be directed 
 to formulate and enforce some simple plan of allocating the 
 revenues and expenses of interstate corporations to the several 
 states in which they operate. This is required not only for the 
 fair assessment of state income taxes, but for the valuation of the 
 properties of interstate corporations, as these properties can 
 
 3B 
 
738 OUTLINES OF ECONOMICS 
 
 never be satisfactorily appraised without taking their earnings 
 into account. 
 
 For reasons which appear in the preceding discussion, it would 
 be misleading to formulate any clear-cut division of taxes 
 among the federal, state, and local governments. A few forms 
 of revenue will unquestionably be reserved for the use of one 
 branch of government, but the pressure of increasing expendi- 
 ture is likely to force a joint use of such major revenues as taxes 
 on real estate, income and inheritance taxes, excise and stamp 
 duties ; and for these the ideal is joint administration, in which 
 the relative impartiality and vigor of central administration 
 may be supplemented and perfected by the more intimate 
 knowledge of local officials. 
 
 QUESTIONS 
 
 1. Why are the terms "direct" and "indirect" taxes particularly vague 
 and equivocal ? 
 
 2. Explain why no protection is given the home producer when the im- 
 port duty is shifted upon the foreigner. 
 
 3. What is the greatest fiscal defect of American customs taxation ? Can 
 this defect be remedied ? 
 
 4. Are excise taxes ethically justifiable ? Do they materially check con- 
 simiption when imposed upon alcoholic beverages and tobacco? 
 
 5. Do you know of any state which levies an income tax at the present 
 time? Is the tax successful? 
 
 6. Should income which is saved and immediately reinvested be taxed? 
 Is it not double taxation to tax savings and the earnings from such savings 
 as well ? 
 
 7. Should corporations be taxed at the same rate as unincorporated 
 business concerns? Should any definite relation between the two kinds of 
 taxes be maintained? 
 
 8. Contrast the taxation of national banks in your own state with the 
 taxation of trust companies, ordinary commercial or manufacturing corpora- 
 tions, and unincorporated business concerns. 
 
 9. State as many reasons as possible why the separation of state and 
 local revenues would be helpful. 
 
 10. Explain why many forms of property employed in business cannot 
 be inteUigently assessed for taxation without reference to the earnings of the 
 business. 
 
 11. Are assessors elected or appointed in your own state? Do they re- 
 quire taxpayers to declare their personal property in great detail? Do the 
 
FEDERAL, STATE, AND LOCAL TAXES 739 
 
 local assessment rolls contain separate figures for real estate and improve- 
 ments? Is the property of nonresidents specially designated? 
 
 12. Why is the general property tax particularly unsuited to the taxation 
 of business and professional men ? 
 
 13. Should the federal government, if it possesses the power, make the 
 taxation of interstate commerce corporations uniform throughout the United 
 States? 
 
 REFERENCES 
 
 Bullock, C. J. Selected Readings in Public Finance, Chaps, vii-xix; "The 
 Taxation of Corporations in Massachusetts," Quarterly Journal of 
 Economics, Vol. xxi, pp. 181-246. 
 
 Commissioner of Corporations. Reports on the Taxation of Corporations ; 
 Special Report on Taxation. 
 
 Ely, R. T. Property and Contract in their Relations to the Distribution of 
 Wealth, Chap. xvii. 
 
 Hollander, J. H. (ed.), "Studies in State Taxation," Johns Hopkins 
 University Studies in Historical and Political Science, Series xviii. 
 
 Industrial Commission. Report. "Taxation," Vol. xix, pp. 1031-1069; 
 "Taxation in Various States and in Canada with Special Reference 
 to the Taxation of Corporations," Vol. xi, Part vii; "Taxation of 
 Transportation Companies," Vol. ix, pp. 1006-1091. 
 
 Reports of State Tax Commissions. Upon the topics indicated see "The 
 Massachusetts Tax System and its Workings," Massachusetts Com- 
 mission of 1897, pp. 1-73; "Public Service Corporations," Wisconsin 
 Commission, 1901, pp. 72-121 ; "Taxation of Credits," ibid., 1903, pp. 
 88-144; "Mortgage Taxation," ibid., 1907, pp. 303 et seq.; "Railway 
 Taxation," Ontario Commission, 1905 ; Committee on Taxation of the 
 City of New York, 1915 ; Massachusetts Special Commission on Taxa- 
 tion, 1915. 
 
 Seligman, E. R. a. The Income Tax. 
 
 West, Max. The Inheritance Tax, Chaps, vii and ix. 
 
APPENDIX A 
 
 HISTORY OF ECONOMIC THOUGHT 
 
 Economic Ideas in the Ancient World. — The assertion is some- 
 times made, or at least the impression is frequently given, that there 
 were no writings on economics before Adam Smith. This impression 
 is erroneous, and derives its plausibility from the fact that before 
 Adam Smith economic subjects were treated either disjointedly 
 and in a monographic way, or else in connection with ethics and 
 political philosophy. But in treating economics in connection 
 with ethics and politics, the older writers were merely following an 
 instinctive method of dealing with economic truths, to which in a 
 certain degree later writers are returning. Indeed, if we are to 
 derive the utmost possible benefit from this brief survey of the devel- 
 opment of economic thought, it is necessary to begin many cen- 
 turies before Adam Smith, with the Greeks. 
 
 The Greeks. — The three writers among the Greeks most inter- 
 esting to the economist are Plato, Aristotle, and Xenophon. Both 
 Xenophon and Aristotle (or, more probably, some unknown dis- 
 ciple of Aristotle) have treatises upon the specific subject of (Eco- 
 nomics, but these are devoted principally to domestic economy, or 
 the management of the household ; and the more important eco- 
 nomic ideas of the Greek writers are derived from their works which 
 deal primarily with political and ethical subjects. 
 
 Plato describes a Utopia in his Republic. His aim was to picture 
 an ideal society in which the ills of society were to be corrected by 
 a communistic State, and he included a communism even of wives 
 and children, going farther than modern communists. The com- 
 munism of Plato admitted, strange as it may seem, slavery, on 
 which his social superstructure indeed rested as a base. The Laws 
 of Plato is a more practical work. It aims to present not the best 
 possible state, but a more practicable one, and deals to a greater 
 extent with existing institutions. 
 
 Aristotle's principal work for us is the Politics, and it is indeed 
 one of the most remarkable books in the world's history. Its in- 
 fluence is strongly felt today, for it was carefully studied by theo- 
 logians of the Middle Ages, and through them entered into the thought 
 and life of their time ; and the thought and life of their time can be 
 seen by the careful student to have entered in a thousand ways into 
 the institutions of the twentieth century. 
 
 WhUe Plato tacitly accepted slavery, Aristotle actively defended 
 the institution of slavery, describing the slave as an " animated 
 
 741 
 
742 OUTLINES OF ECONOMICS 
 
 tool," and insisting that slave labor was necessary in order that the 
 ruling classes might have the leisure for statecraft, art, and litera- 
 ture. Both Plato and Aristotle, also, fully appreciated the advan- 
 tages of the division of labor, and understood, in consequence, that 
 a certain amount of traffic and exchange is necessary. But both 
 writers shared the common prejudice against trade and commerce ; 
 what one man gained in exchange, they thought, some other man 
 lost ; and to live by trade was in their eyes despicable. Aristotle^ 
 moreover, defended the institution of private property, and formu- 
 lated surprisingly accurate ideas about money and its functions; 
 but he condemned interest taking because, as he expressed it, money 
 is barren. 
 
 Perhaps the most characteristic quality of Greek economic thought, 
 speaking generally, is the thorough subordination of economic to 
 ethical and political considerations. The object of life, in their 
 view, was self-knowledge or self-realization, not the acquisition 
 of riches, and they refused to regard wealth as an object of funda- 
 mental importance to either the individual or the State. Plato, 
 indeed, in certain parts of his writings, defends the ascetic idea that 
 hmnan wants are to be satisfied, not by the improvement of produc- 
 tive processes, but by the repression of the wants themselves. 
 
 The Romans. — While the economic institutions of the Romans 
 and the manifestations of their character in their economic life will 
 repay investigation, they were not remarkable for independent 
 thought. Their economic ideas, like their philosophical doctrines, 
 were borrowed from the Greeks, and show the same general char- 
 acteristics which the ideas of Plato and Aristotle do. Commerce 
 and trade were held in contempt, particularly when carried on in a 
 small way. Interest taking was by some thought to be " as bad 
 as murder." Agricvilture, on the other hand, was esteemed to be 
 worthy of the noblest citizens, and a " return to the soil " in later 
 Roman times was frequently recommended as a cure for the pre- 
 vailing degeneracy. Pliny said the great estates, the latifundia, 
 together with slave labor and the destruction of the small inde- 
 pendent farmer, caused the downfall of Rome. Among other agri- 
 cultural problems discussed by the Romans were those of intensive 
 versus extensive culture, and slave versus free labor. 
 
 The jurists are, however, the most important of all. Whatever 
 may be its imperfections, the Roman law, the corpus juris civilis, 
 is the most remarkable legal system the world has ever seen and 
 for training in careful and accurate statement is unsurpassed. Prob- 
 ably, as a training for economic studies, Roman law is among the 
 most valuable branches of learning. It gives us also invaluable 
 information about the economic institutions of Rome. 
 
 Christianity. — To the economic thought of the time Chris- 
 tianity brought the revolutionary ideas of the dignity of toil and 
 the equality of men before God. The philosophy of the Stoics had 
 brought analogous ideas to the attention of the restricted intellectual 
 world of the day, but Christianity popularized these ideas. The 
 
APPENDIX 743 
 
 clergy were encouraged to earn their livelihood by manual labor, 
 and laymen were exhorted to free their slaves as soon as they had 
 become Christians. With respect to money and trade, however, the 
 effect of Christianity was to strengthen and impress the teachings of 
 Aristotle. 
 
 The Middle Ages. — As the power of the Church increased, its 
 economic ideas foimd more formal expression in the treatises of 
 the schoolmen and medieval theologians who expounded the church 
 or canon law. Indeed, in the corpus juris canonici we have a definite 
 system of economic thought which, while it was largely theoretical 
 and intended originally for the ecclesiastical courts, came in time 
 to be widely applied in secular affairs through the power of the con- 
 fessional, the pulpit, and the wide jurisdiction of the ecclesiastical 
 courts. 
 
 The doctrines of the canonists were derived, in part, from bib- 
 Ucal injimctions against usury and the pursuit of wealth. The 
 early Christian fathers frequently went so far as to condemn private 
 property and set up the ideal of communism among the faithful. 
 But this was only an ideal, and private property was early recog- 
 nized as a necessary evil resulting from the fall of man. This ideal, 
 however, was powerftd enough to keep alive the doctrine that the 
 maintenance of the poor was not a matter of philanthropy, but a 
 binding obligation, in the words of Thomas Aquinas, the most dis- 
 tinguished canonist, a debitum legale. 
 
 Following the philosophers of Greece and Rome, and in sym- 
 pathy with the scriptural attitude toward wealth, trade and com- 
 merce were regarded as greatly inferior to agriciilture and handi- 
 work as a source of livelihood. It was still believed that what the 
 seller made by trade the buyer necessarily lost. As commerce 
 developed, however, trade had to be recognized by the Church. 
 In doing so, the canon writers formulated the doctrine of justum 
 pretium, that every commodity has a J7isi price, or value, which it 
 is sinful for the seller to exceed. The modern trade-union doc- 
 trine of a fair wage, and the decisions of our courts concerning rea- 
 sonable charges for gas, railway services, etc., illustrate the perma- 
 nent necessity of ethical ideas of this sort. 
 
 The next most important economic doctrine of the canonists 
 was the condemnation of usury, which originally signified any loan 
 interest, and not necessarily excessive interest. Their argument 
 against interest was based upon scriptural strictures against usury, 
 and upon Aristotle's argument that money is barren. Interest 
 taking by the clergy had been prohibited as early as the fourth 
 century; but in 131 1, at the Council of Vienna, interest was pro- 
 hibited " absolutely and universally," regardless of the civil law ; 
 and by the middle of the fourteenth century, the prohibition of 
 interest had, in many places, been incorporated into the civil law. 
 Little by little, however, the Church was forced to change its atti- 
 tude, and in the middle of the sixteenth century (1545) a statute 
 was passed in England legalizing an annual interest rate not in 
 
744 OUTLINES OF ECONOMICS 
 
 excess of lo per cent.^ By this time the teachings of the canonists 
 were fast giving way to the doctrines of mercantihsm. 
 
 Economic Ideas in Modern Times. — Before the close of the 
 sixteenth century, the temporal power of the Church had been 
 undermined by the development of the great modern monarchies, 
 and in economic thought religious considerations were replaced by 
 political necessities. The problem of the Church — the universal 
 establishment of the Kingdom of God upon earth — gave way to a 
 newer problem — the maintenance and aggrandizement of rival 
 states. The latter were in pressing need of ready money with which 
 to build navies and support armies. How to increase public revenue 
 and national wealth became the absorbing questions of the time. 
 
 Mercantilism. — The mercantile system, also called Colbert- 
 ism, restrictive system, and commercial system, obtained from 
 the early part of the sixteenth century until late in the eighteenth 
 century, and its influence is still felt. Mercantilism is not, strictly 
 speaking, the product of a school of political economists, but rather 
 the name given to that economic policy of statesmen and to those 
 detached economic views of writers which prevailed during this 
 period. Most prominent among the statesmen who were mercantil- 
 ists may be named Colbert, of France, Frederick the Great, of Prussia, 
 and CromweU, of England. Serra, an Italian, early in the seventeenth 
 century presented a moderate and systematic statement of their views 
 in a work entitled A Brief Treatise on Causes which make Gold and 
 Silver abound where there are no Mines. Thomas Mun, in England, 
 a generation later, wrote a valuable treatise from the standpoint 
 of the mercantilists, called England's Treasure by Foreign Trade: or 
 the Balance of our Trade the Rule of our Treasure, while Sir James 
 Steuart's Inquiries into the Principles of Political Economy, published 
 in 1767, may be regarded as closing the development of the theory 
 of mercantilism. 
 
 The principal characteristics of mercantilism — the efforts to 
 increase the stock of precious metals within the coimtry, to main- 
 tain a favorable balance of trade, to increase the popiolation and 
 foster manufactures, if necessary at the expense of agriculture — 
 have been described elsewhere, and need not be repeated at this 
 point. In attempting to apply these theories, however, the states- 
 men of this epoch instinctively turned to that instrument — the 
 law — with whose use they were most familiar, and statutory re- 
 strictions were multiplied until mercantilism in one sense became 
 practically synonymous with governmental interference. Toward 
 the end of the eighteenth century, however, the commercial posi- 
 tion of England, for example, became so strong that many of her 
 industries found themselves crippled and confined by the very laws 
 which had protected their infancy, and a reaction against mercan- 
 tilism set in. The reaction, naturally, took the form of a movement 
 in favor of agriculture and against governmental interference in 
 economic and industrial affairs. In obedience to the needs of a new 
 
 ^ See also p. 493, above. 
 
APPENDIX 745 
 
 epoch, political economy lent itself to a propaganda in support of the 
 doctrine of industrial liberty. 
 
 The Physiocrats. — The reaction against mercantilism found its 
 first thorough and scientific expression at the hands of the French 
 physiocrats. Quesnay, a physician, Gournay, a merchant, and 
 Turgot,^ the statesman, are their three principal authors. Polit- 
 ically, the physiocrats taught the doctrine of natural laws and 
 rights, and as a consequence loudly proclaimed the maxim of laissez- 
 faire, that is, that the government should not interfere with pri- 
 vate enterprise. Economically, they exalted the importance of 
 agriculture, and maintained that manufactures and commerce, 
 which merely change the form or position of raw materials, are 
 barren and unproductive (though useful when subordinated to 
 agriculture) ; but that agriculture yields a net surplus — produit 
 net — over and above the expenses of production. The physio- 
 crats must thus be credited with originating the fertUe economic 
 doctrine of surplus value — a reward or premium appearing in pro- 
 duction for which nature rather than man is responsible, and which 
 is not required to induce men to put forth the effort necessary to 
 produce wealth. 
 
 Many of the other doctrines of the physiocrats follow logically 
 from the primacy which they accorded to agriculture. Since agri- 
 culture is the sole ultimate source of wealth, they maintained that 
 the revenue of the State should be raised by a single direct tax — 
 the imp6t unique — levied upon land. All taxes must, they thought, 
 in the end come out of rent anyway ; and it was better that the land- 
 lord should pay them at once instead of waiting imtil they had 
 passed through five or six hands and various profits had added to 
 their amoimt. Naturally the physiocrats were ardent champions 
 of free trade. They encouraged also the consumption of agricultural 
 products, " in order that the produit net might be increased," and 
 were generous champions of the importance and rights of the down- 
 trodden peasantry. Pauvres pay sans, pauvre royaume; pauvre 
 rgyaume, pauvre roi, was the borrowed motto of Quesnay's Tableau 
 Economique, the most important treatise of the physiocratic school, 
 
 Adam Smith. — In 1776 Adam Smith published his Inquiry into 
 the Nature and Causes of the Wealth of Nations, the most influential 
 economic treatise ever written. " The Hfe of almost everyone in 
 England, perhaps of everyone," said Bagehot, " is different and 
 better in consequence of it." His writings are found to be very 
 similar to those of the physiocrats, but further developed and modi- 
 fied by his Scotch training and habit of mind. We find in Adam 
 Smith the doctrines of free trade, non-interference, and natural 
 laws, yet all stated more guardedly. Although he does not regard 
 agriculture as exclusively productive, he does show a partiality for 
 agriculture, for in this branch of production, he says, nature labors 
 
 ^ Turgot did not count himself a member of the economic sect or school which 
 gave their views the name of "physiocracy," but his economic doctrines are very 
 much like theirs. 
 
746 OUTLINES OF ECONOMICS 
 
 along with man. He emphasized the importance of permitting 
 each individual to follow his own self-interest as a means of pro- 
 moting national prosperity, but he was not unmindfiil of the exist- 
 ence of altruistic motives in mankind. He accords full recognition 
 to the motives of sympathy and kindness in his Theory of Moral 
 Sentiments. But the net result of Smith's teaching was to strengthen 
 and emphasize the laissez-faire trend of economic thought in his 
 time. " Two conceptions," said Arnold Toynbee, " are woven 
 into every argument of the Wealth of Nations, the belief in the su- 
 preme value of individual liberty, and a conviction that man's self- 
 love is God's providence, that the individual in pursuing his own 
 interest is promoting the welfare of all." 
 
 Economic Thought in the Nineteenth Century. — The Classical 
 School. — The economic philosophy which prevailed during the 
 first half of the nineteenth century is variously designated as the 
 classical, Ricardian, English, or orthodox school. The earlier 
 authors of this period were Jeremy Bentham (1748-1832), Thomas 
 Robert Mai thus (i 766-1 834), David Ricardo (17 7 2-1 823), James 
 Mill (1773-1836), and John Ramsay McCulloch (1779-1864). In 
 aU of these writers we find the utilitarian philosophy, a deductive 
 method, and the feeling that the outlook for the mass of the laborers 
 was not a hopeful one. They elaborated economic principles, sup- 
 posed to be good for all times and places, with the positiveness that 
 one expects to find only in the mathematical or physical sciences. 
 
 Bentham's great work was the formulation and propaganda of 
 the utiUtarian ethics, with its famous first principle or goal of 
 social action — the greatest happiness of the greatest number. 
 
 Malthus's principal contribution, contained in his celebrated 
 work. The Theory of Population, has already been discussed. While 
 Malthus was himself a particularly charitable and benevolent friend 
 of the working classes, his doctrine of population contributed more 
 than any other single thing to make the political economy of the 
 classical school harsh and gloomy. It seemed to say that although 
 wages were low they could be no higher, because if by some fortunate 
 chance wages increased, population was sure to multiply until the 
 wage was forced back to the old level. Poor relief and trade- 
 union activities were both useless. The woe of the poor was due to 
 their own lack of foresight, and could be removed by the poor alone. 
 It was taught " that he who brought children into the world without 
 adequate provision for them should be left to the punishment of 
 nature." The responsibility of poverty was thus thrust upon the 
 poor themselves ; the rich were soothed with the assurance that they 
 were not primarily responsible for the condition of affairs. Malthus 
 himself, however, did not frame his doctrine in so remorseless a way. 
 He recognized the importance of what he called " preventive checks " 
 to the increase of the population. Malthus brought the results of 
 elaborate historical and statistical investigations to the support of his 
 doctrines. 
 
 Ricardo was perhaps the first economist who adequately realized 
 
APPENDIX 747 
 
 the importance of the problem of the distribution of wealth. The 
 backbone of his distributive system was the Malthusian law of p)op- 
 ulation. Ricardo believed that as population increased, society 
 would be forced to resort to poorer and poorer soUs in order to ob- 
 tain food ; and as this took place an increasing share of the product 
 of industry would go to the landlord in the shape of economic rent. 
 The division of the remaining product between labor and capital, 
 in Ricardo's view, was determined largely by the standard of living ; 
 that is to say, the laborer would receive enough to purchase the 
 necessaries and conveniences required to support him and his famUy 
 in their customary style of hving, while the residue would go to 
 capital in the form of interest and profits. Profits were thus the 
 " leavings of wages." With the passage of time and the settlement 
 of a country, then, Ricardo's theory of distribution taught that 
 rent would absorb a larger and a larger share of the product, wages 
 a constant or slowly increasing amount, while profits would dwindle 
 both absolutely and relatively. 
 
 Ricardo's principal work is called Principles of Political Economy 
 and Taxation. It was published in 1817, and in it Ricardo elaborates, 
 although he did not originate, the usually received doctrine of rent, 
 which, modified and developed, is the one presented in this book. 
 His ideas in general have a markedly pessimistic tinge. Rent, 
 he said, is due to the niggardliness, not to the bounty, of nature; 
 and his theory of distribution emphasized the natural diversity of 
 interest between wage receivers and profit makers, and the antago- 
 nism between the interests of landowners and all other classes of 
 society. Personally he was a kind man, and sincerely devoted 
 to the advancement of humanity. Ricardo is remarkable for his 
 power in the use of the abstract deductive method, and it is note- 
 worthy that this distinction should attach, not to a professional 
 scholar, but to one of the most successful bankers and brokers of 
 his day. 
 
 John Stuart MUl, who lived from 1806-1873, closed one period 
 in the development of economic science and began another in Eng- 
 land. He started as a thoroughgoing follower of Ricardo, pre- 
 served the old doctrines of value, rent, and profits, and advocated 
 laissez-faire as a general principle of political expediency. But 
 in his later years Mill advocated the diffusion of property through 
 the regulation and taxation of inheritances, indorsed the appro- 
 priation by the State of the future unearned increment of land, and 
 emphasized an important distinction between the production and 
 distribution of wealth. " The laws and conditions of the produc- 
 tion of wealth," he said, " partake of the nature of physical truths. 
 There is nothing optional or arbitrary in them. ... It is not so 
 with the distribution of wealth. That is a matter of human insti- 
 tutions solely. The things once there, mankind, individually or 
 collectively, can do with them as they like. . . . The distribution 
 of wealth, therefore, depends upon the laws and customs of society. 
 The rules by which it is determined are what the opinions and feelings 
 
748 OUTLINES OF ECONOMICS 
 
 of the community make them, and are very different in different 
 ages and countries; and might be still more different, if mankind 
 so choose." 
 
 The old and the new doctrines found in Mill's Principles of Polit- 
 ical Economy do not harmonize, however, and the result is a work 
 one of the most valuable of modern times, yet full of inconsistencies. 
 Nevertheless, MiU wiU always be regarded as the culmination of 
 the school usually known as the English deductive or classical school. 
 Most of the work of the school was deductive ; that is, they reasoned 
 by singling out a few main facts of the external physical world and 
 human nature famUiar to all, and showing how men must act under 
 the guidance of these laws. None of these economists pretended 
 that the few laws which they considered were the whole of human 
 nature, though they have sometimes been interpreted as if they did 
 so ; but they thought that the great multitude of motives which 
 influenced men were too complex to be analyzed, and only one or 
 two (chiefly self-interest) could " be reduced to any assignable law." 
 Despite these limitations, the largest contributions that have been 
 made to economic science came from the English classical school. 
 
 Socialism. — MUl's change of heart resulted partly from his 
 study of the socialist writers, who voiced the earliest and most 
 thoroughgoing protest against the views of the classical economists. 
 Modern socialistic doctrine may conveniently be dated from 
 WilUam Godwin's Inquiry concerning Political Justice (1793), al- 
 though Godwin himself was more of an anarchist than a socialist. 
 Godwin and the early French idealists and communists, — Cabet, 
 Saint-Simon, Fourier, etc., — began the attack on the ethical and 
 political views of the orthodox political economy. Later the attack 
 was continued in a somewhat more practical and realistic way by 
 writers such as William Thompson and Robert Owen in England, 
 Bazard and Louis Blanc in France, Rodbertus, Lasalle, and Marx in 
 Germany. The foundation of classical political economy was laissez- 
 faire, and its doctrinal structure was built around the system of private 
 capitalistic enterprise. Sociahsm in essence was a thorough protest 
 against laissez-faire and the private ownership of property. Pierre 
 Le Roux used the word " socialism " in 1838 ^ with the very purpose 
 sf expressing the antithesis of individualism. 
 
 In recent times, largely under the influence of Karl Marx, social- 
 ism has acquired a distinctive economic theory of its own. Marx, 
 in his work on Capital, was in most ways as abstract, deductive, and 
 pessimistic as any of the classical school, but at bottom his whole 
 theory was directed against those fundamental institutions of our 
 social order which the classical economists took for granted. Marx 
 has been credited by some with the discovery of the materialistic or 
 economic interpretation of history, and the whole tendency of the 
 modern scientific socialists has been to emphasize the evolutionary 
 standpoint. 
 
 The Sociologists. — Among other influences which broadened 
 
 1 It was used before this in England by the followers of Robert Owen. 
 
APPENDIX 749 
 
 Mill's conception of economic science, and induced him to temper 
 the rigor of his early teachings, were the works of Auguste Comtc 
 (i 798-1857), the founder of modern sociology. Comte was espe- 
 cially severe in his criticism of the methods of the classical econo- 
 mists. He denied, in particular, that it is possible to develop a 
 helpful science of economics distinct from history, ethics, and poli- 
 tics. Not only must these fields, he maintained, be cultivated in 
 common, but the work must be done by inductive, as distinct from 
 deductive, methods. To the classical assumption that a universal 
 science of economics could be formulated, true .for all times and 
 places, he opposed the theory that there is in society an ordered 
 change or evolution, and that the capitalistic stage, to which the 
 classical economics conformed, must be studied in connection with 
 the past and the future. Economics, he particularly insisted, cannot 
 be divorced from history. 
 
 The Historical School. — This particular line of thought was 
 taken up in Germany about 1850 by three young Germans, 
 Roscher, Knies, and Hildebrand, who vigorously assailed the doc- 
 trines of the classical school. They went back to the old premises 
 — self-interest, private property, demand and supply — and traced 
 out the historical development of economic life, coming to the con- 
 clusion that economic policies were not absolutely, but only rela- 
 tively, true. They denied that economic science can discover laws 
 which hold true for all times and all places. They emphasized 
 the importance of the inductive method, of minute investigations 
 into facts, and the study of legal institutions, custom, and ethics 
 in their relation to economic life, while most members of the school 
 entertained a strong sympathy for policies of reform. 
 
 Owing to the political ferment in Germany during the infancy 
 of the historical school and the formation of the German Empire 
 when this reaction against the classical economists was at its height, 
 German political economy of the last half of the nineteenth century 
 was impregnated with a striking nationalistic spirit which sepa- 
 rated it even further from the cosmopolitanism of the English writers. 
 The creation of a new state is almost invariably attended by the 
 enactment of restrictive legislation, looking to the amalgamation 
 of the diverse elements incorporated into the new state and the 
 protection of its industries from foreign competition. Laissez- 
 faire, under these conditions, is particularly difficult to maintain. 
 The new national economy of Germany seemed to voice these politi- 
 cal necessities. Like the classical economy of England, it was a 
 creature of its own time and its own environment. 
 
 The Economic Optimists. — The classical EngHsh economists 
 have often been called pessimists. This is too strong a term, in- 
 asmuch as they all saw hope for improvement. What can be said 
 is that they developed pessimistic tendencies. Take it as we will, 
 the Malthusian doctrine of population is tinged with pessimism, 
 and so also is the Ricardian theory of distribution. In oppo- 
 sition to English economists, there was developed elsewhere, about 
 
75© OUTLINES OF ECONOMICS 
 
 the middle of the nineteenth century, a scheme of thoroughgoing 
 economic optimism, and this was presented in a more unqualified 
 way by Frederic Bastiat (1801-1850), than by any one else. Bastiat 
 was an ardent agitator for free trade and a popidar pleader for the 
 existing order against the attacks of socialists and anarchists, he was 
 the author of numerous pamphlets, and at the time of his death 
 was engaged on a systematic treatise entitled Economic Harmonies, 
 of which the first volume only was completed. According to 
 Bastiat, there is no economic rent. The landowner does not 
 receive an unearned income. What we call rent is simply a return 
 for past investments of capital. The profits on capital also, accord- 
 ing to him, are simply a return on past labor, and relatively to wages, 
 a diminishing return. For it is a pecuharity of labor stored up in 
 those products which we call capital, that it continually diminishes 
 in value as compared with present labor. In other words, wages 
 are continually gaining relatively as compared with the profits of 
 capital. Capital may gain absolutely on account of the increase 
 in the amount of capital. Wages gain both absolutely and rela- 
 tively. Value gives us the ratio of exchange between services. 
 Economic gain is in proportion to economic service except that labor 
 is progressively a gainer on account of the fact that man's present 
 services (as seen in labor) increase in value as compared with man's 
 past services as accumulated in capital. 
 
 As Bastiat denied the existence of pure economic rent in the 
 Ricardian sense, he also denied the Malthusian theory of popula- 
 tion, holding that no proof could be adduced of a tendency of popu- 
 lation to press upon the means of subsistence. The evils that we 
 experience come, according to Bastiat, from man's interference 
 with natural harmonies. Nature works things out well, and this 
 is the best of possible worlds if we could only let nature have her 
 way. 
 
 Henry C. Carey, the American contemporary of Bastiat, held 
 similar doctrines, and was apparently the more original man. If 
 either one borrowed from the other, it must have been Bastiat. 
 Probably neither one was guilty of any conscious plagiarism. 
 
 The writings of the optimists had a considerable influence for a 
 time in Germany, where they were developed and applied with 
 uncompromising logic by men like Prince-Smith, Faucher, and a 
 considerable number of others who were influential in the press 
 and practical affairs rather than in academic life. In the United 
 States these writings have had a great deal of influence upon a num- 
 ber of early writers, among whom we may mention especiaUy the late 
 Arthur Latham Perry, long professor in Williams CoUege, and 
 Edward Atkinson, a weU-known statistician and writer of Boston. 
 
 Early American Economists. — The reaction against the Eng- 
 lish economists, it is interesting to note, began earlier in the United 
 States than in England or Germany. In the early part of the nine- 
 teenth century, emphatic dissent from the English doctrines was 
 voiced by a group of publicists, among whom may be mentioned 
 
APPENDIX 751 
 
 Alexander Hamilton, Daniel Raymond, Matthew Carey, Hezekiah 
 Niles, and Frederick List. Hamilton's work and views are weU 
 known ; NUes and Matthew Carey were pamphleteers of consider- 
 able note in the first third of the nineteenth century; and List, 
 who, in the view of some authorities, planted the seeds of the Ger- 
 man historical school, unquestionably obtained his distinctive na- 
 tionalistic views about political economy in the United States, and 
 first formulated them in his Outlines of American Political Economy, 
 published in 1827.^ 
 
 Daniel Raymond, however, of aU the American writers noted, 
 is the least known, and yet the author of the first American treatise 
 on political economy in which a distinctively American system of 
 economic thought is suggested. Raymond's first book. Thoughts 
 on Political Economy, appeared in 1820; a second edition, under 
 the title Elements of Political Economy, appeared in 1823, and the 
 latter was reprinted with slight changes in 1836 and 1840. The 
 essence of Raymond's system is found in his conception of wealth. 
 Wealth, he maintained, is not an aggregate of exchange values 
 but the opportunity to acquire the material comforts of life by 
 labor. The English political economy, in Raymond's view, was 
 a study of private as opposed to political or national economy. 
 Raymond emphasized the distinction between individual and 
 social wealth, and maintained that the laws of wealth laid down 
 by Adam Smith were untrue of a nation conceived as a unit. The 
 interests of particular individuals, or particular classes, he argued, 
 do not always coincide with the interests of the nation as a whole, 
 and the latter, he concluded, wiU be best advanced by developing 
 aU the national powers to their widest possible extent. He was 
 thus a warm advocate of protection as opposed to laissez-faire. 
 
 Raymond's views had so impressed Matthew Carey that he of- 
 fered to support a chair of political economy at the University of 
 Maryland if the University would permit Raymond to fill it. Mat- 
 thew Carey's son, Henry C. Carey (1793-1879), by far the most 
 influential of the early American economists, was in like manner 
 probably influenced by the teachings of Raymond. Carey was 
 not only an earnest champion of protection, but an indefatigable 
 critic of classical economic doctrines. He denied the truth of 
 the Malthusian principle and the law of diminishing returns ; ob- 
 jected to the Ricardian theory of rent ; and maintained that the 
 value of a commodity depends upon the cost of reproduction rather 
 than the cost of production, as was, he thought, laid down in the classi- 
 cal theory of value. Carey entertained a concept of wealth very 
 similar to that of Raymond, and in some parts of his work adopted 
 methods of investigation which brought him in close touch with 
 the sociologists and the German historical economists. The key- 
 stone of his economic system is the doctrine of association. The 
 
 ■* List returned to Germany and was there a forceful writer and agitator for 
 German unity, and is identified rather with the history of economic thought of 
 Germany than with that of the United States. 
 
752 OUTLINES OF ECONOMICS 
 
 increasing mastery of man over nature, or the increase of wealth, 
 Carey held to be dependent upon the increasing efi&ciency resulting 
 from a compact, homogeneous population, in which agriculture 
 and manufacture are conducted side by side, in which the home- 
 market idea is carried out in the most complete vray, and in which, 
 to be brief, the association of industrial and social units is most 
 intense and intimate. It can be readily understood why the eco- 
 nomic philosophy of Carey was so inimical to free trade at every 
 point. 
 
 The Austrian School. — The protests against the classical econo- 
 mists which we have been considering were directed largely against 
 the narrow scope and deductive methods of the classical school. 
 The Austrian economists represent a reaction not against their 
 methods, but against the conclusions, and particularly against the 
 theory of value of the classical school. The great contribution of 
 the Austrian school is the marginal utility theory of value, which 
 has been most assiduously applied in economic analysis by a group 
 of Austrian economists, among whom may be specially mentioned 
 Menger, Wieser, Sax, and Bohm-Bawerk. But the marginal utility 
 theory of value was advanced almost simultaneously, about 1871, 
 by the English economist Jevons, the Austrian economist Menger, 
 and the French economist Walras.^ 
 
 The Austrians have been a leading force in producing what is 
 not inaptly termed a renaissance in theory, although, as stated, 
 they indorsed the deductive and abstract methods of the classical 
 economists. The classical theory put the emphasis upon supply 
 or the conditions of supply, maintained that cost of production 
 determines value, and found the ultimate measure and explanation 
 of value in the pain and sacrifice of labor. The Austrians main- 
 tain that utility, the pleasure or satisfaction derived from con- 
 sumption, is the ultimate cause and measure of value ; they empha- 
 size demand as the English economists emphasized supply ; and 
 hold that value determines cost of production and not the cost 
 of production, value. Capital, they conclude, receives its value 
 from the finished product instead of giving value to that product. 
 The work of this school has tended to put the consumer in the place 
 primarily occupied by the capitalist as the center of discussion in 
 economic theory. The work of the Austrians has had a profound 
 influence upon economic writing in the United States. 
 
 Present Condition of Economic Thought. — The net effect of all 
 these protests against the classical English economists has been 
 to introduce a welcome catholicity into the methods of economic 
 investigation. The historical school emphasized the evolutionary 
 standpoint and the necessity of minute investigation of the facts 
 of industrial life, while the work of the Austrians operated to strengthen 
 and explain the necessary place of deduction in economic analysis. 
 
 1 In reality the marginal utility theory had been explained many years before 
 this by a number of obscure writers whose ideas, however, never affected the main 
 
 current of economic thought. 
 
APPENDIX 753 
 
 Today the ordinary economist employs either method, or both, as 
 the subject-matter demands, and the controversy about methods 
 has become a thing of the past. With respect to the theory of value, 
 neither supply nor demand, neither cost nor utility, neither the capi- 
 talist nor the consumer, is now said to exert a predominating influ- 
 ence in the determination of values. The Austrian school, it is now 
 understood, supplied a needed corrective without revolutionizing 
 the earlier theory of value. The Austrians themselves are seen to 
 have been guilty of laying exaggerated emphasis upon the consumer's 
 influence upon value and price, and there is reason to believe that 
 their analysis is based in some degree upon a faulty psychology. 
 
 So, similarly, with respect to the scope of economics. The at- 
 tempt of the classical economists to isolate an " economic man " 
 ruled entirely by an enlightened self-interest and unaffected by 
 political, ethical, and humanitarian impulses, is recognized to have 
 been a mistake. But economics has never given itself to a com- 
 plete study of politics or ethics. It considers ethical and political 
 phenomena when these cannot be dissociated from economic phe- 
 nomena, but insists, nevertheless, upon the separation of economics 
 from ethics, politics, and sociology. We recognize that these fields 
 are not wholly or clearly differentiated, but we recognize just as 
 clearly that a division of labor is necessary if accurate results are to 
 be achieved. Furthermore, this division of labor is showing itself 
 progressively within the limits of economics itself, as it has shown 
 itself in aU growing sciences. Indeed, the present condition of eco- 
 nomic thought was so accurately predicted by W. S. Jevons, in 1876, 
 that his words — written in the midst of the controversy among the 
 adherents of the deductive, historical, mathematical, and sociological 
 methods of investigation — may well be employed to picture the 
 condition of the science of economics as it exists today : 
 
 " As I have previously explained, the present chaotic state of 
 economics arises from the confusing together of several branches 
 of knowledge. Subdivision is the remedy. We must distinguish 
 the empirical element from the abstract theory, from the applied 
 theory, and from the more detafled art of finance and administration. 
 Thus will arise various sciences, such as commercial statistics, the 
 mathematical theory of economics, systematic and descriptive 
 economics, economic sociology, and fiscal science. There may even 
 be a kind of cross subdivision of the sciences ; that is to say, there 
 will be division into branches as regards the subject, and division 
 according to the manner of treating the branch of the subject. The 
 manner may be theoretical, empirical, historical, or practical ; the 
 subject may be capital and labor, currency, banking, taxation, land 
 tenure, etc., — not to speak of the more fundamental division of the 
 science as it treats of consumption, production, exchange, and dis- 
 tribution of wealth. In fact, the whole subject is so extensive, 
 intricate, and diverse, that it is absurd to suppose it can be treated in 
 any single book, or in any single manner." ^ 
 
 1 Jevons, Theory of Political Economy, 3d ed., pp. xv, xvi. 
 3C 
 
APPENDIX B 
 
 SUGGESTIONS FOR STUDENTS AND TEACHERS 
 
 Some teachers of economics rely chiefly upon classroom discussions of 
 assignments in a textbook, supplemented, possibly, by certain other 
 reading requirements. Others make large use of lectures and of prob- 
 lems and brief reports assigned in connection with particular subjects 
 discussed in the class. Some require the student to write one or more 
 longer essays or themes on specific topics. In this book specific refer- 
 ences, questions, and problems have been appended to each chapter. 
 The aim has been to list only books and papers that have value in them- 
 selves and that have a direct bearing upon the subject matter of the 
 respective chapters. References to parallel discussions in other elemen- 
 tary textbooks have for the most part been avoided, the aim being to 
 enable the student to extend his inquiries by reading more advanced and 
 comprehensive treatments of particular problems. 
 
 There is no one " best way " of teaching economics, for the methods 
 used must depend very largely upon the size of the classes and the 
 maturity of the students. It has been the experience of the writers, 
 however, that whatever the relative degree of emphasis put upon 
 lectures, classroom discussions, and assigned problem work of different 
 sorts, mastery by the student of one book on general economics, or at 
 least of so much of it as treats of fundamental economic principles, is 
 an essential part of every introductory course in the subject. When 
 pressed for time, the teacher using this book may find it desirable to 
 omit all of it save Book II, " Principles and Problems." When more 
 time is available, it may be deemed wise to include discussions of certain 
 subjects not treated in this volume. " The economic problems of munic- 
 ipalities," "the elements of statistical method," " the problems of poor 
 relief," " the general principles of market organization," are a few among 
 many possible supplementary topics. 
 
 Valuable suggestions on the teaching of elementary economics will be 
 found in various papers and discussions printed in the Journal of Political 
 Economy, Vols, xvii-xxii (1909-1914). Some help may also be gained 
 from papers by C. J. Bullock {Education, Vol. xi) ; F. R. Clow {Economic 
 Studies, Vol. iv) ; R. F. Hoxie {Journal of Political Economy, Vol. ix) ; 
 H. R. Mussey {Educational Review, Vol. xi) ; and H. W. Thurston 
 {School Review, Vol. iv). 
 
 754 
 
APPENDIX 755 
 
 The problem of making an adequate amount of supplementary reading 
 available to students in large classes has been made easier to solve by the 
 publication of volumes of excerpts, designed for this particular use. 
 (W. H. Hamilton, Current Economic Problems; L. C. Marshall, 
 C. W. Wright, and J. A. Field, Materials for the Study of Elementary 
 Economics ; C. J. Bullock, Selected Readings in Economics; F. A. Fetter, 
 Source Book in Economics.) Similar volumes have been made up of 
 material on special economic problems. References to many of these 
 will be found among the reading lists appended to the different chapters 
 in this book. 
 
 General Works on Economics. — Other American textbooks on 
 economics, of college grade, are : C. J. Bullock, Introduction to the Study 
 of Economics ; H. J. Davenport, Outlines of Economic Theory; F. A. Fet- 
 ter, Principles of Economics ; Irving Fisher, Elementary Principles of 
 Economics ; H. R. Seager, Introduction to Economics ; and E. R. A. 
 Seligman, Principles of Economics. Larger in scope or more detailed in 
 their treatment of the general principles of economics are H. J. Daven- 
 port, Economics of Enterprise; F. A. Fetter, Economics (2 vols.) ; A. T. 
 Hadley, Economics ; F. W. Taussig, Principles of Econo7nics (2 vols.). 
 F. A. Walker's Political Economy (" advanced course "), although pre- 
 senting a somewhat antiquated view of economic principles, will be 
 found still to possess much interest for the reader. 
 
 Among English books, Alfred Marshall's Principles of Economics 
 occupies a peculiarly authoritative position. It is characterized by an 
 unusually intimate grasp of the facts of modern economic life and by a 
 rare degree of ability in critical analysis. It attempts to reconcile many 
 of the modern developments in economic analysis with the fundamental 
 tenets of the political economy of David Ricardo and John Stuart Mill. 
 Critics differ with respect to the degree of success with which Marshall 
 has accomplished this reconciliation. Marshall's Principles is difi&cult 
 for any but the mature student, and his own attempt at an abridgement, 
 his Economics of Industry, is distinctly inferior to the larger work. Two 
 excellent books that are based in large measure on Marshall's Principles 
 are S. J. Chapman, Outlines of Political Economy, and A. W. Flux, 
 Economic Principles. The comprehensive English work of J. S. Nichol- 
 son {Principles of Political Economy, 3 vols.) is even more conservative in 
 matters of economic theory than is Marshall's. Edwin Cannan's 
 Wealth is a small manual with an original and suggestive point of view. 
 Distinctly the most readable and in many respects one of the best recent 
 English works is P. H. Wicksteed's The Common Sense of Political 
 Economy. 
 
 Special mention can be made of only a few of the more important 
 German and Austrian works on general economics. Adolf Wagner's 
 Grundlegung der politischen Oekonomie (2 vols.) is characterized by great 
 
756 OUTLINES OF ECONOMICS 
 
 erudition and by systematic and painstaking classifications and defini- 
 tions. It is of particular interest to American students on account of its 
 distinctive point of view, and especially its emphasis upon^the general 
 ethical and political aspects of economic problems. The Allgemeine 
 Volkswirtschaftslehre of Gustav Schmoller (2 vols.) is characterized by 
 the consistent use of the historical method, and by the extent to which 
 psychology and ethnology as well as history are drawn upon to explain 
 modern economic institutions. Wilhelm Lexis's Allgemeine Volks- 
 wirtschaftslehre is a smaller work, embodying a better exposition of 
 fundamental economic principles than is found in most German works, 
 and distinguished by a large measure of originality. The Allgemeine 
 Volkswirtschaftslehre of Eugen von Phillipovich (2 vols.) contains a more 
 systematic presentation of general economics than does any other work in 
 the German language. It is distinctly catholic, or perhaps, eclectic, 
 in its general theories. 
 
 The Traite theorique et pratique d'economie politique (4 vols.) of Paul 
 Leroy-Beauheu may be taken as the best example of a rather dogmatic 
 type of laissez-faire economics that still commands a large and influential 
 following in France. Representative of a newer school of thought, more 
 hospitable to various projects for constructive economic betterment, is 
 the work of Charles Gide, whose two books on general economics are 
 available in English translation {Political Economy and Principles of 
 Political Economy). The best modern French work is, perhaps, Adolphe 
 Landry's Manuel d'economique. 
 
 In other European countries, especially in Italy, Holland, and the 
 Scandinavian countries, there has been much economic writing of a high 
 order. Attention may be called to the English translation of the excel- 
 lent Dutch work of N. G. Pierson, Principles of Economics (2 vols.), and 
 to the French translation {Manuel d'economie politique) of a book (in 
 Italian) by Vilfredo Pareto, which is possibly the most noteworthy of 
 various modern works in which mathematical methods are used in 
 economic analysis. 
 
 Encyclopedias. — The most comprehensive encyclopedia of economics 
 is the great Handworterbuch der Staatswissenschaften (3d ed., 7 vols.), 
 edited by Conrad and others. A smaller, but useful, German reference 
 work is the Worterhuch der V olkswirtschaft (3d. ed., 2 vols.), edited by 
 Elster. In French, the Nouveau dictionnaire d' economic politique (2 vols., 
 with supplements), edited by Say and Chailley, is already somewhat 
 antiquated and represents a rather narrow point of view. For special 
 fields there are the Dictionnaire des finances (2 vols.), edited by Say and 
 Foyot, and the Dictionnaire du commerce, de Vindustrie, et de la banque 
 (2 vols.), edited by Guyot and Raffalovich. The English Dictionary of 
 Political Economy (3 vols.), edited by Palgrave, is a standard reference 
 work. There is no American dictionary or encyclopedia covering the 
 
APPENDIX 757 
 
 whole field of economics. The Encyclopcedia of Social Reform, edited by 
 Bliss, is useful in its special field. Although published in the early 
 eighties, some of the articles in Lalor's Cyrlopcsdia of Political Science, 
 Political Economy, and United States History (3 vols.) remain of value. 
 The newer Cyclopedia of American Government, edited by McLaughlin and 
 Hart, may be consulted on topics in public finance and related fields. 
 
 Periodicals. — Many of the most important contributions to eco- 
 nomics appear in special periodicals devoted to the subject. In the 
 United States there are the Quarterly Journal of Economics, the Journal 
 of Political Economy (monthly), the Political Science Quarterly, and the 
 American Economic Review (the organ of the American Economic Asso- 
 ciation, quarterly). The Annals of the American Academy of Political 
 and Social Science (monthly), the American Political Science Review 
 (quarterly), and the American Journal of Sociology (bi-monthly), 
 frequently publish papers that are of importance for the student of 
 economics. Limited to more specialized fields are the Quarterly Publica- 
 tions of the American Statistical Association, the American Labor Legis- 
 lation Review, the Bulletin of the National Tax Association (monthly), and 
 the Survey (weekly, covering the field of charities and other organized 
 movements for social betterment). 
 
 In England the principal economic periodicals are the Economic 
 Journal (the quarterly organ of the Royal Economic Society), the 
 Journal of the Royal Statistical Society (monthly), and the Economic 
 Review (quarterly, largely devoted to the ethical aspects of economic 
 problems). The economic journals of the various countries of conti- 
 nental Europe, although of great value to the specialist, are too numerous 
 to mention here. 
 
 The " trade journals " of different special industries and in the fields 
 of banking and insurance are often useful to the special students in these 
 fields. In particular the periodicals dealing with the general conditions 
 of business and the money market are often indispensable. The Com- 
 mercial and Financial Chronicle of New York (weekly) may be specially 
 mentioned on account of the completeness and accuracy of its statistics 
 of money market conditions. For London the Economist and the Statist 
 occupy a similar position. The Annual Financial Review contains con- 
 venient compilations of the more important statistics that have appeared 
 in the Commercial and Financial Chronicle during the preceding year. A 
 useful annual survey of international financial conditions is given by 
 Raffalovich's Le marche financier (Paris). Such annuals as the States- 
 man's Year Book (London), Whitaker's Almanac (London), and the 
 World Almanac (New York), are often useful for reference purposes. 
 The American Year Book contains, among other things, an excellent 
 annual review of important economic legislation. 
 
 Reference to the enormous output of articles on economic subjects in 
 
758 OUTLINES OF ECONOMICS 
 
 periodicals of a more general or popular type is now easy by using the 
 " cumulative indexes " and " readers' guides " that will be found in most 
 colleges and public libraries. These articles are, of course, of very uneven 
 quality and must be used discriminatingly. Most of the more important 
 current articles on economic topics are listed, with many brief abstracts 
 or appraisals, in the successive numbers of the American Economic 
 Review. 
 
 Books in Special Fields. — The references given in connection with the 
 different chapters in this volume are sufficient to enable one to make a 
 fairly thorough study of the different subjects treated in these chapters. 
 Many of the books referred to contain more elaborate bibliographies on 
 their special subjects. The student should, of course, be familiar with 
 the use of the card catalogue of a modern library. In using such a cata- 
 logue it should be remembered that the library classification of books by 
 subjects is very rarely entirely satisfactory, so that one should exercise 
 one's ingenuity in searching under different subjects. The Library of 
 Congress has printed in pamphlet form lists of books and articles on 
 various practical economic problems, and is often able to furnish, at a 
 small price, shorter typewritten lists of references on other subjects. 
 Short annotated bibliographies are issued by different state legislative 
 libraries and municipal reference libraries. The bibliographies in the 
 various economic encyclopedias, especially the Handworterhuch der 
 Staatswissenschaften, will often be found helpful. A very complete list of 
 new books in various fields of economics is published quarterly in the 
 American Economic Review. 
 
 Government Publications. — The student should early acquire some 
 familiarity with the use of government documents as first-hand sources 
 of information. Aside from statutes and the proceedings of legislative 
 bodies these publications include : (i) annual reports of different admin- 
 istrative departments and bureaus; (2) reports of special investigations 
 made by the permanent bureaus or by special commissions ; (3) records 
 of the hearings before legislative committees of inquiry. A record of the 
 enormous output of the publications of the federal government is con- 
 tained in the Monthly Catalogue of Public Documents, published by the 
 Superintendent of Documents, Washington. This has an annual index, 
 and a comprehensive Document Catalogue is also published for each 
 Congressional period. The Check List of Government Documents is 
 convenient to use in locating regular or routine documents published 
 before 1910. The Annotated Tables of and Consolidated Index to the 
 Congressional Series of United States Public Documents may also be used 
 for the same purpose. Poore's Descriptive Catalogue of the Government 
 Publications of the United States, 1774-1881, is useful in locating irregular 
 or obscure publications of various sorts. In nearly every congressional 
 district there is a public or college library which is an official depository 
 
APPENDIX 759 
 
 for federal documents and has a nearly complete set of those published 
 in recent years. Current documents may sometimes be obtained with- 
 out charge from the departments or bureaus issuing them or from the 
 Representative or Senator from one's district or state. They can 
 always be purchased at small prices from the Superintendent of Docu- 
 ments. The Superintendent of Documents issues small printed price 
 lists of the publications in different special fields. 
 
 The Library of Congress publishes a Monthly List of State Documents. 
 Bowker's State Publications (three parts) give a fairly complete list up to 
 about 1900, and a full index to the economic materials in state documents 
 is being published by the Carnegie Institution. The volumes for a 
 number of the larger states have already appeared. Municipal docu- 
 ments are often published in an unsystematic way, and there is no 
 general index or list of either current or past municipal publications. 
 The student should find it both practicable and instructive, however, 
 to become acquainted with the published documents of the city in which 
 he lives, or those of some large city in his state. 
 
 The British Parliamentary Papers contain a wealth of material on a 
 wide range of economic topics. Much of this is listed in P. S. King & 
 Spn's Catalogue of Parliamentary Papers, 1801-igoo (with Supplement, 
 igoi-igio). Lists of current publications are published by several Lon- 
 don dealers. The more important ones are noted in the English eco- 
 nomic journals, and (more fully) in an occasional " Blue Book Sup- 
 plement " to the New Statesman, a London weekly. Among the gov- 
 ernment publications of other countries we can mention here only the 
 valuable statistical year-books published by many nations and by a 
 number of important cities. The student will find the statistical annuals 
 of Australia and New Zealand especially interesting and instructive. 
 
INDEX 
 
 Activity, desire for, as an economic 
 motive, 104. 
 
 Adams, H. C, on fiscal aspects of the 
 tariff, 717. 
 
 Agriculture, changes in, in England, 41, 
 50; history of, in United States, 84; 
 problems of, 596. 
 
 Agricultural credit, 609. 
 
 Agricultural stage, 37. 
 
 Aldrich, N. W., plan for banking reform, 
 306. 
 
 Aldrich-Vreeland Act, 305. 
 
 Altruism, as an economic force, 103. 
 
 American Federation of Labor, 94, 444. 
 
 American people, economic characteris- 
 tics of, 63. 
 
 Amortization of taxes, 706. 
 
 Anarchism, 638. 
 
 Andrew, A. P., on control of banking re- 
 serves by Secretary of the Treasury, 
 354- 
 
 Annual product, defined, 517. 
 
 Anti-trust laws, 235. 
 
 Arbitration, in labor disputes, 95, 457. 
 
 Aristotle's Politics, 741. 
 
 Artificers, statute of, 43. 
 
 Assimiption of risk, legal doctrine of, 487. 
 
 Austrian school, 752. 
 
 Averages, 340. 
 
 Balanced revenue system, 735. 
 
 Balance of trade, 345 ; meaning of a 
 "favorable balance," 356 ; in the com- 
 merce of the United States, 357. 
 
 Bank acceptances, 346 n. 
 
 Bank credit, 286. 
 
 Bank notes, 290, 291, 306, 309. 
 
 Bank of England, control of gold reserves, 
 302. 
 
 Banking, functions of, 283. See Na- 
 tional banking system, Federal reserve 
 system. 
 
 Bargaining, surplus in, 181. 
 
 Basing-point system, 570. 
 
 Bastiat, Fr6d6ric, 750. 
 
 Benefit principle, in taxation, 69S. 
 
 Bentham, Jeremy, 746, 
 
 Bills of credit, colonial and revolution- 
 ary, 272. 
 
 BimetaUism, 260; in the United States, 
 264; international, 263. 
 
 Birth rate, in United States, 65. 
 
 Blackstone, definition of monopoly, 190 n. 
 
 Bland-AUison Act, 266. 
 
 Blodgett, J. H., on wages of farm labor, 
 607. 
 
 Bonds, corporation, 220; government, 
 as security for bank notes, 300. See 
 Public debts. 
 
 Boycotts, legaUty of, 475. 
 
 Brassage, 258. 
 
 Brown, E. F., on factory inspection in 
 the United States, 485. 
 
 Budgets, French, old and modern con- 
 trasted, 657; American, 662. 
 
 Bullock, C. J., on foreign trade balances 
 of the United States, 357. 
 
 Business organization, forms of, 214. 
 
 Business taxes, 733. 
 
 Business unit, in accounting, 213 ; in 
 law, 214. See Large-scale production. 
 
 Call loans, 289, 295. 
 
 Canadian Industrial Disputes Act, 459. 
 
 Canon law, economic ideas in, 743. 
 
 Carey, H. C, 750, 751. 
 
 Carver, T. N., on the effects of the ma- 
 chine system upon the workers, 127. 
 
 Capital, as a factor in production, 121; 
 distinguished from capital value, no; 
 distinguished from consumption goods, 
 512; distinguished from land, 507; 
 social and individual, in; free and 
 specialized, 506 ; investment in, 499, 
 513; replacement of, 501; effects of 
 varying degrees of durability of, 502; 
 price of, how determined, 505 ; pro- 
 ductivity of, relation to interest, 495 ; 
 relation to advances of wages, 512 ; in 
 business usage, 219. 
 
 761 
 
7t)2 
 
 INDEX 
 
 Capitalization, corporation, 2ig, 221, 
 225 ; of rent, 418. 
 
 Central banks, 304, 307. 
 
 Central reserve system, 292. 
 
 Charters, corporation, 217. 
 
 Child labor laws, 56, 476. 
 
 Christianity, influence on economic 
 thought, 742. 
 
 Christian socialism, 630. 
 
 Cities, growth of, in United States, 66. 
 
 Class price, 204. 
 
 Classical school, 746. 
 
 Clayton Anti-trust Act, 241 ; in relation 
 to labor organizations, 473. 
 
 Clearing houses, 283. 
 
 Clearing-house loan certificates, 284 n., 
 305- 
 
 Closed-shop policy, 448. 
 
 Coinage, 249 ; of standard money, 255 ; 
 limited, 259. 
 
 Coke, definition of monopoly, 190 n. 
 
 Collective bargaining, 442, 446. 
 
 Colonial policy, British, 80. 
 
 Combination Act, British, 58. 
 
 Combinations, industrial, 230; causes 
 of, 232 ; public policy toward, 243 ; in 
 other countries, 245; railway, 561. 
 
 Commerce Court, 574. 
 
 Commons, J. R. on relation of monopo- 
 lies to the distribution of wealth, 550. 
 
 Comparative costs, law of, 362 ; relation 
 to doctrine of free trade, 375. 
 
 Competition, described, 28; failure of, 
 under certain conditions, 198; relation 
 to maximum satisfaction of wants, 538. 
 
 Competitive investment, 513. 
 
 Commission merchants, 620. 
 
 Communism, 631. 
 
 Compulsory arbitration, 459. 
 
 Comte, Auguste, 749. 
 
 Concentration in industry, 88. See 
 Large-scale production. 
 
 Concentration of wealth, distinguished 
 from large-scale production, 542 ; 
 methods of measuring, 543 ; possibility 
 of lessening, 551 ; suggested remedies, 
 
 554- 
 
 Conspiracy, legal status of, 472. 
 
 Constant expenses, relation to normal 
 price, 171. 
 
 Constitutional limitations, to govern- 
 ment regulation of industry, 96; to 
 railway regulation, 184, 573 ; to taxa- 
 tion, 710. 
 
 Consumers' surplus, 161. 
 
 Consumption, defined, 132; statistics of, 
 144; harmful, 144. 
 
 Consumption goods, no. 
 
 Contract, as an economic institution, 25 ; 
 in relation to distribution of wealth, 
 386. 
 
 Contributory negligence, legal doctrine 
 of, 487. 
 
 Cooperation, as an economic institution, 
 30 ; different forms of, 464 ; in market- 
 ing, 465, 619; cooperative credit, 465, 
 613. 
 
 Copyrights, 23 ; as a source of monopoly, 
 195- 
 
 Corporations, as business units, 216; 
 charters of, 217; advantages of, 228; 
 growth of, 87; management of, 226; 
 social aspects of, 228; lack of uni- 
 formitj' in state laws, 218; federal con- 
 trol needed, 245; taxation of, 731. 
 See Capitalization, Overcapitalization, 
 Combinations. 
 
 Corpus juris civilis, 742. 
 
 Cost of living, statistics of, 341, 548. 
 
 Cost of production, 148. See Expenses 
 of production. 
 
 Cotton industry, growth of in early 
 nineteenth century, 82. 
 
 Credit, functions of, 282 ; personal credit, 
 285; bank credit, 286; credit trans- 
 actions, 282. 
 
 Crises, analyzed, 333 ; crisis of 1873, 276; 
 1892, 267; 1907, 305. 
 
 Custom, as an economic institution, 31. 
 
 Customs duties, fiscal aspects of, 713. 
 See Protection. 
 
 Decreasing expenses, relation to normal 
 price, 171. 
 
 Deferred payments, standard of, 337. 
 
 Demand, nature of, 156; demand curve, 
 iS8. 
 
 Deposits, bank, 283; how safeguarded, 
 287. 
 
 Dewing, A. S., on inefficiency of indus- 
 trial combinations, 235. 
 
 Diminishing productivity, law of, 388; 
 of labor, 390 ; of capital and land, 392 ; 
 actual operation of, 395 ; social aspects 
 of, 404. See Marginal productivity. 
 
 Diminishing returns, law of, 419- 
 
 Diminishing utility, law of, 133. 
 
 Direct appropriation, stage of, 34. 
 
 Direct taxes, 702, 710; ube of, by federal 
 government, 712. 
 
INDEX 
 
 763 
 
 Discount, bank, 2 87 n.', rates, relation of 
 to price of foreign exchange and to 
 international gold movements, 302, 
 311, 346, 349, 351- 
 
 Distribution of wealth, as a general eco- 
 nomic problem, 384; among persons, 
 542. 
 
 Distributive cooperation, 464. 
 
 Distributive justice, 627. 
 
 Division of labor, 19; effects upon the 
 worker, 127; relation to condition of 
 decreasing expenses, 172. 
 
 Documentary bills, 346. 
 
 Domestic system, 40. 
 
 Economics, defined, 4; distinguished 
 from economy, 13 ; concepts of, 103 ; 
 relation to other sciences, 1 1 ; laws of, 
 
 7- 
 
 Economic classes, 21. 
 Economic goods, defined, 106. 
 Economic society, evolution of, 33. 
 Economic stages, 33 ; table of, 45 ; in 
 
 American history, 61. 
 Economic thought, history of, 741 ; 
 
 present condition of, 752. 
 Effort, necessary to production, 106. 
 Elasticity of demand, 159. 
 Employers' associations, 95, 454. 
 Employers' Uabihty, law of, 56, 486, 588. 
 Endowments, 584. 
 
 Engel, Ernst, laws of expenditure, 145. 
 Entrepreneur, functions of, 123; as risk 
 
 taker, 537. 
 Entreprenem's wage, 168, 526. 
 Equation of exchange, 321. 
 Esteem, desire for, as an economic motive, 
 
 104. 
 Ethics and politics, relation to economics, 
 
 IS- 
 Exchange, 19. See Division of labor. 
 Exchange value. See Value. 
 Expenses of production, 148 ; relation to 
 
 price, 167, 186. 
 Express trusts, 228 n. 
 
 Fabian socialism, 629. 
 
 Factors of production, 119; ultimate, 
 
 522. 
 Factory acts, in United States, 484. 
 Factory system, in England, 51; in 
 
 United States, 82. 
 Faculty principle, in taxation, 698. 
 Fair competition, 29. 
 Farming, intensive and extensive, 600. 
 
 Farms, size of, in United States, 596 ; 
 ownersliip and tenancy, 603 ; indebted- 
 ness, 609. 
 
 Favoritism, as a source of monopoly 
 power, 191, 197. 
 
 Federal Farm Loan Board, 613. 
 
 Federal land banks, 614. 
 
 Federal Reserve Board, 307. 
 
 Federal reserve system, organization, 
 307 ; reserves, 308 ; rediscounting, 
 308; note issue, 310; other functions, 
 310; resources and liabiUties of, in 
 1916, 313. 
 
 Federal taxation, 710. 
 
 Federal Trade Commission, 142. 
 
 Fees, as source of pubUc revenue, 690. 
 
 Fellow-servant doctrine, 487. 
 
 Fiat money, 278. 
 
 Final consumption, 132. 
 
 Finance bills, 350. 
 
 Fiscal monopohes, 197, 682. 
 
 Fisher, Irving, proposal for a "stabilized 
 dollar," 342 ; Statistical verification of 
 the equation of Exchange, 324 n. 
 
 Fisk, G. M., on early restrictions on in- 
 ternational trade, 358. 
 
 Fixed and variable expenses, 174; rela- 
 tion to normal price, 177; in railway 
 operation, 569. 
 
 Foreign exchange, 345. 
 
 Forest lands, 674. 
 
 Form utihty, 116. 
 
 Fourteenth Amendment, 184, 573. 
 
 Freedom, economic, 26; relation to dis- 
 tribution, 386; of contract, 472. 
 
 Free goods, 105, 401. 
 
 Free silver. See Bimetallism. 
 
 Free trade, advantages of, 374. 
 
 Future products, alleged present con- 
 sumption of, 142. 
 
 Future wants, 140. 
 
 General changes in prices, relation to 
 quantity of money, 319; mechanism 
 of, 32s ; effects of industrial uses of 
 gold upon, 327 ; effects of expenses of 
 gold production upon, 328; economic 
 effects of, 331 ; relation to international 
 gold movements, 351 ; index numbers 
 of, 337- 
 
 General property tax, 726; defects of, 
 727; reform of, 729. 
 
 General welfare monopolies, 195. 
 
 George, Henry. See Single tax. 
 
 Gilds, 39. 
 
764 
 
 INDEX 
 
 Godin familistere, 466. 
 
 Godwin, William, 748. 
 
 Gold, as monetary standard, 255, 26g,- 
 relation of industrial uses of, to prices, 
 327 ; relation of expenses of production 
 to prices, 328; increase in production 
 of, 329; international movement of, 
 350. 
 
 Gold-exchange standard, 269. 
 
 Gold points, 348. 
 
 Goldenweiser, E. A., on farmers' incomes, 
 607. 
 
 Goods, defined, 105. 
 
 Good- will, in relation to profits, 535. 
 
 Government enterprise, extension of in 
 England in nineteenth century, 58. 
 
 Government ownership, of railways, 571 ; 
 of other industries, 682. 
 
 Government paper money, 271. 
 
 Greeks, economic ideas of, 741. 
 
 Greenbacks, 273 ; economic efifects of, 
 
 275- 
 Greenback party, 278. 
 Gresham's law, 261. 
 Group rates, 570. 
 
 Hadley, A. T., on improvident poor re- 
 lief, 552. 
 
 Hamilton, Alexander, Report on the 
 estabhshment of a mint, 264 ». 
 
 Handicraft stage, 39. 
 
 Hedging, 532 n., 624. 
 
 Hildebrand, Bruno, classification of 
 economic stages, 44. 
 
 Historical school, 749. 
 
 Holding company, 231. 
 
 Hours of labor, statistics of, 548. 
 
 Hume, David, on Elizabethan monop- 
 olies, 206. 
 
 Hunter, Robert, on distinction between 
 poverty and pauperism, 553, 
 
 Immigration, to United States, 68; 
 
 changing character of, 70; restriction 
 
 of, 72. 
 Imputed interest, 495. 
 Inclosures, 41, 50. 
 Incomes, estimates of distribution of in 
 
 United States, 544 ; in Prussia, 546. 
 Income taxes, 720. 
 Increasing expenses, relation to normal 
 
 price, 170. 
 Indentured servants, in United States, 66. 
 Independent treasury system, 297, 353. 
 Index numbers, 337. 
 
 India, monetary system of, 270 n. 
 
 Indirect taxes, 702, 713. 
 
 Individual entrepreneur, as business 
 unit, 214. 
 
 Individual wealth, contrasted with social 
 wealth, 109. 
 
 Industrial combinations, 230; causes of, 
 233 ; legal status, 235 ; public policy 
 toward, 243 ; in other countries, 245. 
 
 Industrial democracy, 463. 
 
 Industrial insurance, 585. 
 
 Industrial Revolution, 47 ; evils of transi- 
 tional period, 52; in America, 81. 
 
 Inelastic currency, 300. 
 
 Inelastic reserves, 301. 
 
 Inheritance, 24; effect on distribution, 
 386; taxation of, 723. 
 
 Instincts and habits, in economic activity, 
 105. 
 
 Insurance, nature of, 577 ; development 
 of, 578; forms of organization, 580. 
 See Life insurance, Social insurance. 
 
 Integration of industry, 88. 
 
 Interest, formerly condemned, 493, 743 ; 
 inadequate explanations of, 494; how 
 possible, 495 ; why necessary, 496 ; 
 normal interest, 511; rate, determined 
 by supply and demand of investment 
 funds, 521; on farm mortgage loans, 
 610. See Discount. 
 
 Internal improvements, state activity in, 
 93, 217. 
 
 Internal revenues, 717. 
 
 International gold movements, 302, 311, 
 348, 350. See Balance of trade. 
 
 International trade, restrictions of, in 
 former times, 358 ; modern restrictions, 
 360; advantages of, 361. 
 
 Interstate Commerce Act, 573. 
 
 Interstate Commerce Commission, 574. 
 
 Inventions, eighteenth century, 49. 
 
 Investment, in capital goods, 499, 513 ; 
 shifting of, 502 ; affected by durabihty 
 of capital goods, 502 ; competitive, 
 513; cumulative nature of, 518. 
 
 Investment funds, sources of, 523. 
 
 Jaurfes, Jean, on poUcies of socialism, 630. 
 Jenks, J. W., investigation of monopoly 
 
 prices, 206. 
 Jevons, W. S., on necessary subdivision 
 
 of economic science, 753. 
 Joint expenses, relation to normal price, 
 
 179. 
 Joint-stock companies, 216 w. 
 
INDEX 
 
 765 
 
 Kartells, 246. 
 
 Kelley, Florenca, on child labor laws, 
 
 478 ; on minimum wage laws, 480. 
 Kemmerer, E. W., statistical verification 
 
 of the equation of exchange, 324 n. 
 King, W. I., estimates of distribution of 
 
 incomes in the United States, 545, 
 
 64s n. 
 Knights of Labor, 94, 444. 
 Kropotkin, P., on anarchism, 639. 
 
 Labor, as a factor in production, 120. 
 See Wages. 
 
 Labor legislation, 471 ; general principles 
 of, 488 ; in England, 56. 
 
 Labor organizations, development of, in 
 United States, 93; in England, 57; 
 types of, 444 ; economic justification, 
 445 ; as monopolies, 446 ; methods and 
 policies, 447 ; educational and fraternal 
 activities, 451 ; relation to industrial 
 democracy, 468; legal status of, 58, 
 237, 472. 
 
 Labor-saving machinery, efifect on wages, 
 430. 
 
 Laissez-faire, 54, 745-748. 
 
 Land, as a factor in production, 119; 
 services of, 408; distinguished from 
 capital, 507. See Rent, PubUc do- 
 main. 
 
 Land nationalization. See Single tax. 
 
 Large-scale production, economies of, 
 relation to normal price, 173 ; not a 
 soiirce of monopoly power, 200. 
 
 Lexis, Wilhelm, on coinage regulations, 
 
 257- 
 
 License taxes, 733. 
 
 Life insurance, 581 ; premium plans, 582 ; 
 reserve and surplus, 583 ; industrial, 
 585 ; State, 585 ; State regulation of, 
 586; for workingmen, 593. 
 
 Life tables, 589. 
 
 Limitation of output, by labor organiza- 
 tions, 449; by monopolies, 201. 
 
 List, Friedrich, 751. 
 
 Localization of industry, 128. 
 
 Luxury, 143. 
 
 Malthus, T. R., 746 ; law of population, 
 
 434, 746. 
 Manor, EngUsh, 37. 
 Manufactures, growth of, in the United 
 
 States, 86. 
 Margin of consumption, 141. 
 Margin of cultivation. See Rent. 
 
 Marginal productivity, 390; of labor 
 390 ; of capital and land, 392 ; general 
 principles of, 396 ; relation to prices of 
 production goods, 398 ; lack of ethical 
 significance, 403 ; relation to profits, 
 532. See Diminishing productivity. 
 
 Marginal utility, defined, 135; illus- 
 trated, 136. 
 
 Markets, defined, 154; expansion of, 52. 
 
 Marketing of farm products, 618. 
 
 Marx, Karl, labor theory of value, 186; 
 other doctrines, 629. 
 
 Marxian socialism, 629. 
 
 Medium of exchange and measure of 
 value, 252. 
 
 Mercantile system, 42, 359, 744; in 
 America, 79. 
 
 Mill, J. S., on equilibrium of supply and 
 demand, 165. 
 
 Minimum wage laws, 459, 480. 
 
 Mint ratio, 260. 
 
 Mitchell, W. C, statistics of prices and 
 wages in the greenback period, 277. 
 
 Monetary standard, 255. See Bimetal- 
 lism. 
 
 Money, defined, 250, 251; metallic, 249; 
 varieties used in the United States, 
 254; government paper money, 271; 
 value of, 317. 
 
 Money income, 387 ; flow of, s^S- 
 
 Money market, defined, 289 ; controlling 
 conditions, 289; New York, 293; 
 London, 347. 
 
 MonopoUes, Statute of, 191 ; Case of, 
 igi ; classification of, 193 ; labor 
 organizations as, 446. 
 
 Monopoly, 30; defined, 190; contrasted 
 with competition, 189; distinguished 
 from differential advantage and from 
 large-scale business, 193; relation to 
 distribution of wealth, 207, sso; 
 public poHcy with respect to, 208. 
 
 Monopoly price, 200 ; relation of demand 
 to, 203 ; effect of taxation, 202 ; 
 usually high, 205. 
 
 Mortgage land banks, 612. 
 
 Motives in economic activity, 103, 
 538. 
 
 Mun, Thomas, 744. 
 
 Munn vs. Illinois, 573. 
 
 National banking system, 291 ; reserves, 
 292, 308; notes, 292, 300, 309; defects 
 of, 29s ; steps toward reform of, 304. 
 See Federal reserve system. 
 
766 
 
 INDEX 
 
 National income, defined, 114. 
 National Monetary Commission, 306, 
 
 316. 
 National wealth, statistics of, 112. 
 Natural laws, 8. 
 Natural monopolies, 197. 
 Natural resources, of United States, 74. 
 Navigation Acts, 80. 
 Negro problem, in United States, 66. 
 New York money market, 293 ; relation 
 
 to speculation, 295. 
 New Zealand, compulsory arbitration in, 
 
 4sg. 
 
 Non-reproducible goods, price of, 182. 
 Normal interest, 511. 
 Normal price, 169. 
 
 Occupational distribution of the Ameri- 
 can people, 86. 
 
 Old age pensions, 592. 
 
 Open-market operations of federal reserve 
 banks, 311. 
 
 Opportunity cost, 148. 
 
 Optimists, economic, 749. 
 
 Overcapitalization, 221. 
 
 Owen, Robert, 628. 
 
 Paper money, 271. 
 
 Par of exchange, 348. 
 
 Partnerships, 215. 
 
 Pastoral stage, 36. 
 
 Patents, 23 ; as a source of monopoly, 
 
 195- 
 Personal distribution of wealth, 542. 
 Personal property tax, 726. 
 Personal qualities as goods, 107. 
 Philippines, monetary system of, 270 n. 
 Physiocrats, 745. 
 Place utility, 116. 
 Plato's Republic, 741. 
 Pollock case, 711. 
 Poll taxes, 734. 
 Pools, 231, 561. 
 Population, growth of in nineteenth 
 
 century, 435; growth of, in United 
 
 States, 64. See Malthus. 
 Poverty, causes of, 549. 
 Power, desire for, as an economic motive, 
 
 104. 
 Present economic system, characteristics 
 
 of, 17. 
 Price, defined, 152 ; fixed by equilibrium 
 
 of supply and demand, 164; normal 
 
 price, 169; monopoly price, 200; of 
 
 production goods, 398, 418, 505; of 
 
 public services, 685. See General 
 changes in prices. 
 
 Primitive man, economy of, 35. 
 
 Private banks, 314. 
 
 Private property, as an economic insti- 
 tution, 2 1 ; relation to distribution, 386. 
 
 Probabilities, law of, 578. 
 
 Producers' cooperation, 466. 
 
 Producers' surplus, 165. 
 
 Production, defined 117; relation to 
 sacrifice, 146. 
 
 Production goods, no, 401; prices of, 
 185, 39S, 418, S05. 
 
 Production of gold, increase in, 329. 
 
 Productive consumption, 132. 
 
 Productive organization of the American 
 people, 129. 
 
 Productivity, meaning of, 400, 497. 
 
 Profits, 525 ; pure profits distinguished 
 from entrepreneur's wage, 526; non- 
 existent under certain conditions, 527; 
 two sources of, 528; relation to prin- 
 ciple of diminishing productivity, 53 2 ; 
 for the industry and for the establish- 
 ment, 533 ; relation to good-will, 535 ; 
 relation to risk, S40; often associated 
 with other forms of income, 538; 
 relation to defense of the competitive 
 system, 538; of monopoly, 201. 
 
 Profit sharing, 461. 
 
 Protection, nationalistic argument for, 
 368; infant industry argument, 369, 
 376; military argument, 370; home 
 market argument, 371, 376; as a de- 
 fense against dumping, 371 ; wages ar- 
 gument, 373, 377 ; "equalizing costs of 
 production," 373 ; fiscal aspects of, 
 378, 713; Ethical aspects of, 379; 
 relation to monopoly, 194, 380. 
 
 PubHc authority, relation of, to prices, 
 183. 
 
 Public consumption monopolies, 197, 682. 
 
 Public debts, increase of, 666 ; relation to 
 pubhc works, 668 ; relation to taxes, 
 668; wise use of, 610. 
 
 Public domain, as a source of revenue, 
 671. See Public lands. 
 
 Public expenditures, growth of, 644; 
 contrasted with private expenditures, 
 646; relation to total social income, 
 648; extravagance, economy, and 
 parsimony in, distinguished, 652 ; 
 changing objects of, 654; regularity 
 of, 659; classification of, 660; statis- 
 tics of, in United States, 662. 
 
INDEX 
 
 767 
 
 Public finance, 643. 
 
 PuBTTc lands^ of the United Stat^, e^o- 
 
 —nomic importance of, 75; development 
 
 of government's policy, 76, 673 ; 
 
 forest lands, 674; mineral lands, 675. 
 Public monopolies, 194. 
 Public receipts from loans, 661 ; from 
 - — public domain, 671; from public 
 
 industries, 682; from fees, 690; 
 
 from special assessments, 692 ; from 
 
 taxes, 694; statistics of, for the 
 
 United States, 695. 
 
 QuaUty of goods, government regulation 
 
 of in England, 55. 
 Quantity theory of prices, 324. 
 Quasi-rent, 509. 
 Quesnay, 745. 
 
 Race suicide, 65. 
 
 Railway rates, movement of, 563 ; 
 general level of, 565; relative, 567; 
 distance, as a factor in, 570. 
 
 Railways, history of, in United States, 
 91; economic importance of, 558; 
 competition of, 91, 560; pooling and 
 consoUdation, 560 ; valuation of, 566 ; 
 expenses of, apportionment, 568 ; 
 government ownership, 571; govern- 
 ment regulation, 573 ; affected by 
 Sherman Anti-trust Act, 237. 
 
 Raymond, Daniel, 751. 
 
 Rediscounting, 30S. 
 
 Rehgion as an economic factor, 104. 
 
 Rent, 407 ; under uniformly intensive 
 use of land, 410; imder actual condi- 
 tions, 413 ; relation of different uses 
 of land to, 416; the specific product 
 of land, 394, 416; capitahzation of, 
 418; relation to social progress, 419. 
 
 Replacement fund, 501. 
 
 Reserve, insurance, 583. 
 
 Reserves, bank, 288, 292, 301, 308. 
 
 Retail prices, 182. 
 
 Ricardo, David, 746. 
 
 Risk, 107 ; relation to profits, 536 ; re- 
 lation to insurance, 577. 
 
 Romans, economic ideas of, 742. 
 
 Roosevelt, Theodore, on mineral land 
 policy, 676. 
 
 Rowntree, B. S., on causes of "primary" 
 poverty, 551. 
 
 Rubinow, I. M., on recent changes in 
 real wages, 547. 
 
 Rural credit, 609. 
 
 Saving, and the formation of capital, 122, 
 407, 502, 522. 
 
 Savings banks, 314. 
 
 Scarcity, a necessary condition of value, 
 106, 156, 401 ; of raw materials, a 
 source of monopoly power, 197. 
 
 Second Bank of the United States, 
 
 304 «• 
 
 Secrecy, as a source of monopoly power, 
 
 199. 
 Sectionalism, in American history, 62. 
 Seigniorage, 255 ; on Umited coinage, 
 
 259- 
 Self-maintenance, as an economic motive, 
 
 103. 
 Serra, mercantiUstic writings of, 744. 
 Services, as economic goods, 106. 
 Shaw, L. M., control of gold reserves by, 
 
 when Secretary of the Treasury, 353. 
 Shays's rebeUion, 62. 
 Sherman Anti-trust Act, 236. 
 Sherman Silver-purchase Act, 266. 
 Shifting of taxes, on monopohes, 202 ; 
 
 general theory of, 703 ; of import 
 
 duties, 714. 
 Sickness insurance, 591. 
 Single tax, 425, 679, 706; impot unique, 
 
 745- 
 
 Size of business unit, increase in, 88; 
 statistics of, 89. See Large-scale pro- 
 duction. 
 
 Slater, Samuel, 82. 
 
 Slavery, 37 ; in the United States, 66. 
 
 Small Holdings Act, 602. 
 
 Smith, Adam, 48, 53, 745 ; on wages in 
 different employments, 441. 
 
 Smith, Constance, on operation of British 
 Trade Boards Act, 483. 
 
 Social dividend, 517. 
 
 Social insurance, 57; defined, 587; 
 against industrial accidents, 487, 588; 
 against sickness, 591 ; against old age, 
 592; against unemployment, 592; 
 objections to, 593. 
 
 Social laws, nature of, i r . 
 
 Social monopolies, rgs. 
 
 Social wealth, contrasted with individual 
 wealth, 109. 
 
 Socialism, defined, 627 ; varieties of, 628 ; 
 an extension of existing institutions, 
 632; strength of, 632; weakness of, 
 634 ; growth of, 636 ; position in eco- 
 nomic thought, 748. 
 
 Sociology, r3, 748. 
 
 Special assessments, 692. 
 
768 
 
 INDEX 
 
 Special privilege monopolies, 197. 
 
 Specialization. See Dixision of labor. 
 
 Specie payments, suspension of, 273 ; 
 resumption of, 275. 
 
 Specific productivity. See Marginal pro- 
 ductivity. 
 
 Speculation, relation to New York money 
 market, 295 ; as a source of profits, 
 534; in agricultural produce, 622. 
 
 Standard of deferred payments, 336. 
 
 Standard of life, 438. 
 
 Standard Oil Co. Case, 230. 
 
 Standard Oil Trust, 230. 
 
 State activity, present scope of, 17. 
 
 State banks, before Civil War, 290 ; pres- 
 ent position, 313. 
 
 State insurance, 585. 
 
 State regulation of industry, develop- 
 ment of, in United States, 96. See 
 Anti-trust laws. Labor legislation. 
 Railways. 
 
 State socialism, 631. 
 
 State and local taxation, 726. 
 
 Steuart, Sir James, 744. 
 
 Stock, corporation, 220. 
 
 Strikes, 452. 
 
 Subjective value, 137; of a stock, 138; 
 relation to exchange value, 155. 
 
 Subsistence theory of wages, 437. 
 
 Supply, nature of, 162; relation to 
 normal price, 167, 170. 
 
 Supply curve, short-period, 163 ; long- 
 period, 174. 
 
 Supply and demand, 156. 
 
 Supply and demand curves, 164. 
 
 Surplus, bank, 287 n. ; insurance, 583 ; 
 consumers', 161 ; producers', 165 ; of 
 bargaining, 181, 442. 
 
 Surplus value, doctrine of, 629. 
 
 Syndicalism, 631. 
 
 Tabular standard, 342. 
 
 Tariff, and sectionahsm, 63 ; as source 
 of revenue, 713. See Protection. 
 
 Taxadon, 694 ; justice in, 696 ; progres- 
 sive, 699 ; direct and indirect, 702 ; 
 shifting of, 202, 703, 714; federal, 710; 
 state and local, 726. 
 
 Taylor, H. C, on farm tenancy in 
 England, 618. 
 
 Tenancy, farm, increase of, 603 ; com- 
 pared with encumbered ownership, 615. 
 
 Time utility, 116. 
 
 Trade arbitration, 457. 
 
 Trademarks, 23, 196. 
 
 Trade unions. See Labor organizations. 
 Transactions, taxes on, 719. 
 Transportation, 557. See Railways. 
 Trust companies, 314. 
 Trusts, 230. See Combinations. 
 Turgot, 745. 
 
 Unearned increment, 422. 
 Unemployment insurance, 592. 
 Unfair competition, 29, 239, 243. 
 United States, economic development of, 
 
 61. 
 United States Bank, 304 n. 
 United States Steel Corporation, 88. 
 Urban lands, rent of, 426. 
 Urdahl, T. K., on fee system, 692. 
 Use price, 205. 
 Usury, 493, 523, 743. 
 Utility, defined, 105. 
 Utopian socialism, 628. 
 
 Valuation, of public-service properties, 
 
 184, 209 n.,566. 
 Value, exchange, 152 ; subjective, 137, 
 
 15s; production of, 118. See Price. 
 Values of money, 317. See General 
 
 changes in prices. 
 Variable expenses, relation to normal 
 
 prices, 177. 
 Vested interests, 25. 
 Victoria, wage boards in, 459, 480. 
 Voluntary arbitration, 458. 
 
 Wages, as price of labor, 427; fixed by 
 demand and supply, 428; affected by 
 structure of the population, 432 ; 
 affected by growth of population, 434; 
 subsistance theory of, 437 ; relation 
 of standard of hfe to, 438 ; in different 
 occupations, 439; statistics of, in 
 United States, 341, 547; agricultural 
 wages, 606; statistics of agricultural 
 wages, 608; in greenback period, 277. 
 
 Wages of management. See Entre- 
 preneur's wage. 
 
 Wage boards, 95, 459, 480. 
 
 Wagner, Adolph, statistics of incomes 
 in Prussia, 546; on public expendi- 
 tures, 650. 
 
 Waiting, 106 ; an ultimate agent of pro- 
 duction, 522; relation to iaterest rate 
 499,521. 
 
 Wants, nature of, 133- 
 
 Wealth, distinguished from income, 108. 
 
INDEX 
 
 769 
 
 Wealth of Nations. See Smith, Adam. 
 Weld, L. D. H., on state regulation of 
 
 commission merchants, 621. 
 Wholesale prices, statistics of, 341, 548. 
 Willcox, W. F., oa growth of population, 
 
 436> 
 
 WiUoughby, W. F., on philosophy of 
 labor legislation, 490. 
 
 Women, legal regulation of labor of, 479. 
 
 Workmen's compensation laws, British, 
 57 ; in United States, 488, 589; stand- 
 ards for, 590. 
 
 Printed in the United States of America. 
 
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