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by Werner Troesken
Department of History
Univesity of Pittsburgh
May 11, 1997
Many significant regulatory changes occurred during the Gilded Age and the Progressive Era (the GAPE). The federal government passed the Sherman Antitrust Act, the Interstate Commerce Act, and the Food and Drug Act. State governments created state commissions to regulate utilities, and laws regulating work conditions. Over the past ten years, economists have written much about these and other GAPE regulations. In part because of the increasing emphasis on mathematical technique in economics, and in part because of the increasing fragmentation and specialization of all disciplines, these economic writings are outside the purview of many historians. In this short essay, I review what economists have written about regulation and regulatory change during the GAPE. I focus on three areas: railroad regulation; antitrust regulation; and public utility regulation.
In a widely-cited paper, Thomas Gilligan, William Marshall, and Barry Weingast (1989) argue that the Interstate Commerce Act "was not solely a cartel mechanism for the railroads (as the pure capture view asserts) nor solely a mechanism to correct market abuses by the railroads (as the public interest theory maintains)." Instead, Gilligan, et. al., offer a multiple interest group interpretation. Analyzing key roll call votes, the authors identify three distinct interest groups: long-haul shippers; short-haul shippers; and the railroads. Voting patterns suggest that the Interstate Commerce Act benefitted short haul shippers and the railroads at the expense of long haul shippers. There are also studies that examine how railroad stocks responded to the passage of the act, and key court decisions regarding federal railroad regulation. Broadly construed, these studies corroborate the multiple interest group story, and indicate that most railroad stocks rose with passage of the Interstate Commerce Act (Prager 1989 and Gilligan, Marshall, and Weingast 1990).
Keith Poole and Howard Rosenthal argue that Gilligan, et. al., do not adequately consider the role that long-term political coalitions played in shaping the Interstate Commerce Act. Poole and Rosenthal (1994, pp. 116-17) write: "The need to form legislative majorities gives strong incentives for vote trading. Roll call votes reflect these trades; thus any simple relationship between economic interests on an issue and voting behavior is likely to be obscured, particularly when the vote is likely to be close. Political parties, even more so in the last half of the nineteenth century than today, are a key vehicle for the trades." Poole and Rosenthal (1993) find that their variables for long-term coalition formation do a better job predicting voting patterns on the Interstate Commerce Act than do the district- level economic variables employed by Gilligan, et. al.
Exploring the origins of state regulation, Mark Kanazawa and Roger Noll (1994) analyze voting patterns on an Illinois measure to regulate railroads. A clear pattern emerges from their analysis. Railroads opposed state regulation, while farmers favored it. However, farmers in regions with only limited railroad service worried that regulation would discourage future development of the rail system in their region. In short, Kanazawa and Noll find that at the state level, railroad regulation was not a device to facilitate collusion among the railroads, but a device to bring shippers lower rates.
Economists and economic historians find that small business interests played a central role in shaping early antitrust policy. Examining the Congressional debates surrounding the Sherman Antitrust Act, Christopher Grandy (1993) finds that legislators were more concerned with the welfare of producers hurt by the trusts than with the welfare of consumers. Grandy's paper challenges much earlier work by Robert Bork, who argued that legislators sought to maximize consumer welfare. In a widely-cited paper, Gary Libecap (1992) argues that the impetus for antitrust, as well as federal meat inspection, came from small meat-packers who were harmed by the more efficient meat-packing trust. Exploring voting patterns on the Sherman Act and the timing of state antitrust legislation, Donald J. Boudreaux, Thomas J. DiLorenzo and Steven Parker (1995) find support for Libecap's view. Finally, George Stigler (1985) shows that states with an above average share of potential monopolists were less likely to pass a state antitrust law before 1890, than were states with a below average share. This pattern, according to Stigler, suggests that big business opposed antitrust regulation, while small business favored it.
One area that has received little attention from economists and economic historians is the role that the trusts played in shaping the nation's first antitrust statute. Surely the trusts had close ties to the 51st Congress, the Congress that passed the Sherman Act. One expects that the trusts would have exercised their political power to defeat, or at least, emasculate whatever antitrust legislation emerged. Subsequent enforcement of the Sherman Act suggests that trusts were at least partially successful. Also, in an unpublished paper, I present evidence that the trusts, and their political allies in the senate, tried to have Senator Sherman's original antitrust bill sent to the senate judiciary committee, where they hoped the bill would be buried (Troesken 1997).
There are several studies of the effects of antitrust enforcement and the Sherman Act. Burns (1977) explores the dissolution of Standard Oil, American Tobacco, and American Snuff in 1911. He identifies the following pattern in stock prices. When the market first learned that these trusts were dissolved by the courts, the stock prices of the underlying firms plummeted. However, when the market learned how the trusts involved responded to these decisions--typically by reorganizing into combinations that were not legally assailable--stock prices recovered to their pre-dissolution levels. This pattern of depression and recovery suggests that investors believed that court enforcement of the Sherman Act would not reduce the long run profitability of the trusts. Binder (1988) explores the break-up of the railroad cartels in 1897 (Trans-Missouri) and 1898 (Joint-Traffic). He finds that the decisions to dissolve the railroad cartels did not even induce large reactions from the stock market on the days they were announced. Railroad rates also appear to have been unaffected by the dissolution of the cartels.
Significantly, there is evidence that antitrust regulation before the Sherman Act led to similar patterns in stock prices. I call this significant because it suggests that, as passed, the Sherman Antitrust Act did very little to change public policy toward the trusts. Prior to the passage of the Sherman Act in 1890, several states had already filed suits against the trusts. Using quo warranto proceedings, state officials tried to revoke the charters of trusts, or of firms in their states who had joined trusts. In a study of one of these quo warranto suits, I find that the decision to dissolve the Chicago Gas Trust reduced the market value of the firm by a third. However, subsequent efforts to rehabilitate the gas trust into a legally-secure organizational form allowed investors to recoup nearly of these losses. I also study gas prices in Chicago to see if the dissolution of the trust brought consumers lower prices. Consistent with the stock market data, dissolving the trust did not affect gas prices (Troesken 1995).
Implicit in all of the studies cited above is the idea that the trusts circumvented the antitrust prosecutions by changing their organizational form and adopting arrangements that were immune to legal attack. Comparing Great Britain and the United States, George Bittlingmayer (1985) formalizes this idea. He finds evidence that the Sherman Act provided some of the impetus for the Great Merger Wave. Unlike the studies cited above, though, Bittlingmayer does not argue that antitrust enforcement was benign. He argues that it was pernicious. Exploring the years between 1900 and 1914, Bittlingmayer (1993) presents evidence that periods of unusually stringent antitrust enforcement are correlated with slumps in the stock market and reduced economic output. The mechanisms through which antitrust regulation could have lowered stock prices and slowed real economic activity are manifold. But the basic idea is this: antitrust enforcement caused firms to abandon their chosen, and presumably most efficient, organizational arrangements, leaving them less profitable and less productive.
Economists typically draw from one of three perspectives to explain the origins of public utility regulation. The traditional public interest view is predicated on the idea that public utilities like gas and water were natural monopolies. According to this view, state utility commissions were designed to solve the problems that stemmed from allowing unfettered competition in markets characterized by natural monopoly: extended periods of high rates punctuated with brief but intense price wars; and unnecessary duplication of capital (Hovenkamp 1991, pp. 105-24). A competing private interest or capture theory maintains that utility commissions were created at the behest of utilities hoping to undermine the relatively hostile policies of municipal authorities (Demsetz 1968 and Jarrell 1978).
The third explanation draws on the long-term or relational contracting literature in economics. The following example highlights the underlying logic. To sell gas, a gas company had to invest substantial resources in a system of mains. The investment was irrevocable. Once the mains were in the ground, the gas company could not move or sell them. Strictly speaking, the mains represented an asset specific or non-redeployable investment. If after the company installed its mains, the city imposed onerous price regulations or taxes, the company was stuck. It could not move or resell its capital. As a result, before installing its mains, the gas company required assurances that the city would not impose onerous regulations or taxes ex post. Alternatively, municipal authorities had to grant the gas company the right to use public roads to lay mains. For the city, this right represented an irrevocable investment. Once the gas company exercised its right to use public property and install its mains, the city could not meaningfully revoke that right. If the company's rates or service failed to satisfy the city, the city was stuck. As a result, before granting this property right, the city demanded a commitment that the utility would not charge excessive rates or provide poor service ex post (Goldberg 1976 and Williamson 1985, pp. 327-64).
According to the relational contracting interpretation, utility industries were never organized as markets. Non-redeployable investments forced utilities and municipalities to create long-term, binding contracts. Before state utility regulation, state charters and municipal franchises embodied these contracts and supplanted the market. The charter and franchise governed the behavior of both the municipality and the utility. The state charter set strict limits on the city's regulatory authority; the municipal franchise dictated the price and quality of the company's gas. State utility commissions functioned similarly. Like state charters, they prevented the city from imposing onerous regulations. Like municipal franchises, they prevented the gas company from charging high rates. Hence, the arrival of state regulation represented more a change in the way cities and utilities contracted than a move from pure and unfettered competition to widespread state intervention. In a case-study of the Chicago gas industry, I find patterns consistent with the long-term or relational contracting view (Troesken 1996). Priest (1993) uncovers similar evidence.
Although I have not drawn any direct parallels between the work of economists and the work of historians, there are several. I highly recommend the work of Herbert Hovenkamp to anyone interested in exploring such parallels. (See Hovenkamp 1991 and 1995).
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