Growth of Industry after the Civil
War
Changing Industry Structure
Capital/labor ratio
1840
1.0
1850
1.24
1860
1.82
1870
2.25
1880
2.51
1890
3.78
1900
4.56
Increased importance of capital in manufacturing, leads to bigger
firms
• Technological Change
– # of steam engines doubled from 1860 to 1880
and then doubled again from 1880-1900
– Electric power began to replace steam power in
late 1880
– By 1890 could power machines with electric
motors
Changing Industry Structure
4 Largest Industries in Value Added (1914 $)
1860
1920
Cotton Goods
58.8
Machinery
575.6
Lumber
54
Iron and Steel
492.8
Boots Shoes
52.9
Lumber
393.4
Flour and
Meal
43.1
Cotton Goods
363.7
Increase in importance of industries outside agriculture
and increase in size.
Changing Industry structure
• Some of this change is predictable
– Income elasticity of food is low
– Income elasticity of manufactured goods is higher
Changes in Firm Structure
• Increase in Plant size
– Increase in K/L ratio
• Increase in Firm size
– Multi-plant firms
– Vertical integration
– Merger Movement starts in late 1890s-1904
• New forms of Ownership
– Modern corporation
• All of these trends are related
Increase in firm size
• Due to technological change
• Two examples, Steel and Oil
Steel Industry
• Innovations
– Bessemer Process and open hearth process kept
iron in liquid form though out process of making
steel
• Result was increase in size of Blast Furnaces
and increase in steel production
– 1860 Blast furnaces produced 6-10 tons of pig iron
per day. By 1910 average production was 500 tons
per day
Steel Industry
• Large increase in steel production and big
decrease in price of steel rails
1873
$120/ton
1898
17/ton
1902
28/ton
• Decrease in price of machinery made of steel
– Price of farm machinery falls over 50% from 1870
to 1910
Two types of Vertical
Integration
• Blast furnaces and steel plants integrate
– Producers of pig iron integrate forward into steel
production
– Allowed pig iron to be transferred to steel plant in
molten form
– Big Firms
• Even as early as 1870 only 10 firms producing steel in
US
• In 1901 US Steel has 65% of market
• Backward integration into iron mining and
processing
Oil Industry
• Before Civil War, most oil is used for lighting
– 20% from coal
– 80% whale oil
• Civil War disrupts whaling, increase in oil
prices (First US energy crisis)
• Increases incentives to drill for oil
– Oil is discovered in PA, big decrease in price
• 1880, 66% of families use oil for heating
Oil Industry
• Crude oil is refined into kerosene
• 1860 1 million barrels, cost $12-16/barrel
• 1900 63 million barrels , cost < $1/ barrel
Vertical Integration
• Refiners first use railroads to distribute oil
• By 1880 refiners integrate forward into
pipelines and backwards into oil production
• By 1890, fully integrated
Other industries
• Tobacco industry
– Bonsack cigarette machines 60,000 a day, much
more than could have been rolled by hand.
• Grain processing machines lead to modern
cereal industry
• Leads to new functional areas in the firms,
especially in marketing and distribution
networks
– Chandler
Firm Growth
• Growth can happen as a result of increase in
plant size
– Economies of Scale
– New technologies change shape of average cost
curve
Average costs
Technological
change causes
average cost
curve to shift
from 1 to 2. Firm
size should shift
from q1 to q2.
We would expect
a decrease in
price of product.
$
Av Cost 1
Av Cost 2
q1
q2
Q
Firm growth
• Firms could also grow large to increase monopoly
power. (Ability to set price above marginal cost)
• Firms could also achieve power to set price above
marginal cost through price fixing agreements.
– If there are no economies of scale this would be cheaper
than increasing firm size either through growth or merger.
– Such agreements were not initially illegal. (Trusts become
common)
Vertical Integration
• Why determines the functions included in a
firm?
• What is the nature of the firm?
– Coase says the firm is a non-market organization
where decisions are made by management
– What determines which functions will be done
inside the firm and which will be contracted out?
– Assumption is firm will choose the least cost way
• Technological change alters the costs
– Steel plant
• See increases in vertical integration during this
period
• Will this increase market power?
– Firm is larger, but market share will not increase,
unless vertically integrated firm is more efficient
Legal ChangesRise of the corportation
• Prior to 1880, most firms in the US were
owner managed firms which were not
incorporated.
• Increase in the number of incorporated firms
begins after the Civil War
• Change in the types of firms that are
incorporated, large industrial firm
– First jt. stock companies are trading companies or
banks or railroads
What does it mean to be
incorporated?
• Corporation
– Ownership in the firm can be sold to many
investors
– Firm is a legal person.
– Limited Liability, Firm’s liability is not the owners’
liability
• Early Jt stock companies do not have limited liability
Benefits of incorporation
• Spread risk over many owners
• Diversification
• Shares can be traded
– Incorporation and stock market growth go
together
– Before 1890, there were few industrial stocks
traded on New York exchange
– By 1914, rare to find a large industrial firm which
was not publically held
Costs of incorporation
• Separation of Ownership and Control
• What keeps manager’s acting in the
shareholders best interest?
How does incorporation take
place?
• In England, an act of parliament
• In US choice between incorporation by
legislative charter or general incorporation
laws
– Early general incorporation were restricted to
certain business types or states
• Incorporation laws liberalized in first in New
Jersey in 1889
Changes in Industry Structure
• Increase in size of firms, both vertically and
horizontally and change in structure of firms
cause concern about monopoly power
• Trusts (Organizations of firms to control price
and output) and mergers also caused concern
• Sherman Antitrust passed in 1890
• Outlawed “every contract, combination in the
form of a trust or otherwise or conspiracy in
restraint of trade…” illegal.
• Also made it illegal to monopolize or attempt
to monopolize an industry
• Not clear what this meant. Determined by the
courts
Important Cases
• 1899 Addyston Pipe and Steel Company v.
United States ruled cast iron pipe pool illegal
• Price fixing is illegal per se
– only defense is “we did not do it”
• Economist agree that cartels create nothing
but dead weight loss
• What about mergers or large firms?
• 1904 Northern Securities ruled mergers for
monopoly power were illegal
• Court ruled against Standard Oil in 1909
• Court ruled in favor of US Steel in 1920
– “Size alone is no offense’’
• Mergers or large firms are not per se illegal
When should mergers be illegal?
• Economist’s answer is “it depends”
• If merger creates monopoly power and no
efficiency or cost savings it should be illegal
• If merger creates no monopoly power it
should not be illegal
– Vertical mergers generally do not create monopoly
power
• If merger does both, then court should decide
which is larger
Two Questions
• What about mergers during this period were
the for monopoly power or cost savings?
• How were Antitrust laws enforced? What
were the effect on efficiency?
Cause of mergers?
• If mergers increase monopoly power, prices
should increase
– If there are no barriers to entry high prices should
attract entry and firms would loose monopoly
power and prices would go down eventually
• If mergers were to lower costs and take
advantage of economies of scale prices should
decrease
Market Share
• 4 firm concentration ratio
– Share of industry output produced by 4 largest firms
•
•
•
•
Can be misleading
No clear link between structure and performance
Concentration does not increase by that much
Chandler finds evidence that mergers for market
power loose market share over time
Industrial Concentration
S 1860
1901
1963
Machinery
NE 1860 MW
1860
30
15
25
41
93
Iron Bars
29
100
37
46
50
Lumber
10
6
9
.5
11
Cotton
Goods
14
99
30
20
30
Prices
• Wholesale price index declines during this
period
• Price of steel rails falls from $120/ton in 1873
to $17/ton in 1898 and then is stable at
$28/ton from 1902-1919
• Price of farm machinery falls 55% from 1870
to 1910
• Price of oil falls from $24.67 in 1865 to $3.36
in1884
• Evidence does not suggest monopoly power in
spite of mergers, trust and other price fixing
agreements
• Consistent with what economic theory would
predict
• Chandler’s work is consistent with this
Antitrust
• Economic theory suggests practices which do
not increase monopoly power should not be
prohibited
• Assumes consumer welfare is goal
• Law may have other goals
– Protect competitors
• How were cases decided? What was effect on
efficiency?
Standard Oil
• Formed in 1872 by JD Rockefeller
–
–
–
–
–
–
Refining
Cleveland, favorable for Rail transport
10 % of refining market
Market competitive
Attempt to form cartel in 1870s failed
Increases size of Standard oil through merger to get rebate
from RR
– Integrates forwards into pipelines in 1880
• Reduced number of firms
• Integrates backwards into oil drilling in late
1880s
• Fully integrated by 1890s
• Market share in 1880 was 95%
• Justice dept brought suit in 1911
– Predatory behavior in acquiring rivals, reducing
price to reduce value of assets
– Not clear this would pay, must be able to increase
price latter on and keep entry out
– Not clear whether they did this
• Court ruled against Standard Oil
– Broken up into 33 companies
What was effect of decision on
efficiency?
• Price had fallen from $24.67 in 1873 to $3.36
in 1884
• Market share was falling as well
1880
95
1899
62
1906
70
1911
64
• Not clear there was any effect
US Steel
• Andrew Carnegie pioneered new techniques
in steel production
– Carnegie Steel had 15-20 % of market in 1898
• JP Morgan created Federal Steel by merging
several companies in 1898. About same size as
Carnegie Steel
• US Steel result of merger of these two
companies in 1901. Had about 65% of market.
• Justice dept brought suit in 1911, not decided
until 1920
• Court ruled in favor of US Steel in 1920
– “Size alone is no offense’’
• Market share was 40% in 1929
• Prices 1873
120/ton
1898
17
1902-1919
28
• US Steel was not dissolved because it did not
lower prices competitively
• Good for competitors, not for consumers
• Overall, not clear what effect antitrust laws
have had on industry structure or efficiency