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Growth of Industry after the Civil War

Growth of Industry after the Civil War. Changing Industry Structure. 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

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Growth of Industry after the Civil War

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  1. Growth of Industry after the Civil War

  2. Changing Industry Structure Increased importance of capital in manufacturing, leads to bigger firms

  3. 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

  4. Changing Industry Structure 4 Largest Industries in Value Added (1914 $) Increase in importance of industries outside agriculture and increase in size.

  5. Changing Industry structure • Some of this change is predictable • Income elasticity of food is low • Income elasticity of manufactured goods is higher

  6. 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

  7. Increase in firm size • Due to technological change • Two examples, Steel and Oil

  8. 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

  9. Steel Industry • Large increase in steel production and big decrease in price of steel rails • Decrease in price of machinery made of steel • Price of farm machinery falls over 50% from 1870 to 1910

  10. 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

  11. Backward integration into iron mining and processing

  12. 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

  13. Oil Industry • Crude oil is refined into kerosene • 1860 1 million barrels, cost $12-16/barrel • 1900 63 million barrels , cost < $1/ barrel

  14. 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

  15. 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

  16. Firm Growth • Growth can happen as a result of increase in plant size • Economies of Scale • New technologies change shape of average cost curve

  17. 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

  18. 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)

  19. 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

  20. 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

  21. Legal Changes-Rise 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

  22. 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

  23. 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

  24. Costs of incorporation • Separation of Ownership and Control • What keeps manager’s acting in the shareholders best interest?

  25. 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

  26. 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

  27. 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

  28. Important Cases • 1899 Addyston Pipe and Steel Company v. United States ruled cast iron pipe pool illegal • Pricefixing is illegal per se • only defense is “we did not do it” • Economist agree that cartels create nothing but dead weight loss

  29. 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

  30. 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

  31. 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?

  32. 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

  33. 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

  34. Industrial Concentration

  35. 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

  36. 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

  37. 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?

  38. 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

  39. Integrates backwards into oil drilling in late 1880s • Fully integrated by 1890s • Market share in 1880 was 95%

  40. 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

  41. 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 • Not clear there was any effect

  42. 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.

  43. 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

  44. US Steel was not dissolved because it did not lower prices competitively • Good for competitors, not for consumers

  45. Overall, not clear what effect antitrust laws have had on industry structure or efficiency

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