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America's Greatest Industrial Transformation

October 3, 2011

Tags Free MarketsU.S. EconomyU.S. HistoryGold Standard

[The Transformation of the American Economy, 1865—1914: An Essay in Interpretation • by Robert Higgs • John Wiley & Sons, 1971]
 

The period between 1873 and 1894 remains one of the most misunderstood and debated in all of American economic history. To some, this era represents the greatest phase of industrial growth in the country's history.1 But others interpret the data as evidence of one of the United States' longest depressions.2 A few scholars have even had to revise their beliefs in the face of the evidence.3

What makes this particular subject so pertinent and controversial is the general price deflation4 that characterized the period.5 This trend of falling prices — coupled with certain problems that allegedly impacted the country's agricultural sector — leads many economists to categorize this era as a depression. On the other hand, some economists see the deflation as evidence that a fall in prices does not necessarily imply a loss in wealth and productivity.6

How can so many economists disagree about a time period that is so abundantly documented? The topic is not complicated. It concerns only whether the American economy grew or shrank between 1873 and 1894. Simple enough, no? But the economics profession cannot find consensus! Perhaps what is to blame is a lack of concern for the details.

If there is one economist with a penchant for detail and with a willingness to uncover the facts, it is Robert Higgs. We have seen it in his work on the Great Depression, the Second World War, and the Cold War.7 The more radical among us will also appreciate the immense effort put into his most well-known work, Crisis and Leviathan.8 Higgs, an economist who underwent a sharp ideological and methodological shift during his career, is no slacker. And it should come as no surprise that he is also the author of one of the best studies of the American economy between 1865 and 1914 — his very first book, The Transformation of the American Economy.

Written when Higgs was still a methodological positivist, Transformation of the American Economy is an interpretation of a vast pool of collected empirical evidence.9 But praxeological purists should not be dissuaded from engaging the book. The most questionable aspect of Higgs's methodology (borrowed largely from Milton Friedman and Karl Popper10) is probably his judging of a theory's "usefulness" in accordance to how well it fits the facts.11 But Mises would agree with Higgs that historians should use theory to interpret history (rather than using history as a means of developing theory).12 And while the "usefulness" of a theory cannot be determined by how well it fits the facts, certainly Mises would agree that the assumptions of the theory must fit the details of history.13 In short, Higgs's history should be satisfactory for methodologists of all kinds.

While by Higgs's own admission his book is not a comprehensive explanation of the entire period between 1865 and 1914,14 it certainly remains one of the most complete accounts since Walt Rostow's 1938 journal article on the 1873–96 "depression."15 One would be hard pressed to find a better alternative.

Before getting ahead of ourselves, it should be made clear that the period between 1873 and 1896 did witness a number of fluctuations. The United States' banking industry suffered a crash in September 1873, causing a slight fall in productivity.16

The extent of the damage, however, is up for debate. In Rothbard's words, "What sort of 'depression' is it which saw an extraordinarily large expansion of industry, of railroads, of physical output, of net national product, or real per capita income?"17 The evidence certainly runs in Rothbard's favor. According to Friedman and Schwartz,

Whichever estimate of net national product one accepts, the major conclusion is the same: [a] usually rapid rise in output converted an unusually slow rate of rise in the stock of money into a rapid decline in prices.18

Data on industrial production shows a minor decline between 1873 and 1874 from 29 to 28 on Frickley's index (1900 acting as the index year), but a rise to 32 and 36 by 1878 and 1879, respectively.19

Another financial panic occurred in 1884, but industrial output remained unchanged at 47 between 1884 and 1885; and by 1886 output had risen to 57.20

Between 1873 and 1892, industrial production rose from 30 to 79.21 This represents a revolutionary, and perhaps historically unsurpassed, growth in American productivity. The period of vigorous growth ended in 1893, which saw the beginnings of a dramatic depression caused, in large part, by the political gold-and-silver-standards agitation and the inability of banks to satisfy an increase in the demand for money.22

Now that we have a broad understanding of the nature and direction of the American economy during this period of time, we can begin our foray into Higgs's Transformation of the American Economy. Higgs's book is much more than a history of depressions and growth. It chronicles the structural change that took place in the United States over the nearly 50 years between the American Civil War and the First World War. Higgs explores four major themes: the causes and nature of industrial growth, urbanization, the impact of the changes on agriculture and farmers, and the influence of industrialization on worker and racial inequality.

Higgs explains that the great industrial growth of the last three decades of the 19th century was not an isolated and sudden phenomenon. The roots of America's industrial revolution are found in the prewar economy of the 1840s and 1850s. What allowed for the great postwar rise in output with a steady fall in prices was a slowing in the pace of monetary expansion, which, following the greenback period, was mainly tied to gold production.23

What made possible this dramatic economic growth? Changes in the American population provide a partial explanation. Between 1865 and 1915, the American population almost tripled, thanks to falling mortality rates and a substantial increase in immigration. An important byproduct of greater productivity, of course, was new technologies that allowed medical science to combat disease that had previously plagued dense populations. The great economic impact of all this was an increase in the labor force — the more workers, the greater the work that can be done.

There was also an important increase in agricultural productivity, caused by mechanization and the acquisition of more productive, and largely uninhabited, land (between 1845 and 1848 the United States expanded territorially by almost 70 percent). Greater agricultural productivity freed labor for industrial purposes.

There was also an accumulation of human capital, including a rise in literacy rates (literacy among whites rose from 90 percent in 1870 to 95 percent in 1915, and literacy among nonwhites increased from 20 percent in 1870 to 70 percent by 1910), despite fluctuation in public-school attendance.24

Increases in investment were made possible only by greater capital accumulation, as consumers put aside savings, which were then invested into the production of an even greater quantity of wealth. The enlargement of the market, along with technological innovation, made possible an increase in economies of scale. This is illustrated by the rise of corporations and large business firms, which made use of mass-production techniques to deliver quality products to the consumer. In a certain sense, the productivity of the period fed on itself — a benefit of the unfettered market.

Enhanced agricultural productivity made possible a larger population with a relatively smaller pool of producers. This gave many people the opportunity to leave the countryside and flock to the cities. Unsurprisingly, city size swelled during the postwar period; this also factored into the creation of large, city-based industrial centers.

Health problems related to increasing population density were slowly solved through medical and technological breakthroughs, as mentioned earlier. This not only included medical technologies, such as vaccines and antibacterial medicines, but also less obvious products, such as water filters and better sewage systems.

Higgs also postulates that an increase in population density made innovation easier. It allowed people to share ideas and become aware of them more quickly, and thus build on these new ideas faster and more efficiently. In other words, there were fewer barriers to intellectual development.

Industrial productivity and urban growth aside, the 1873–96 era is oftentimes considered a period of great poverty for the farmer. Surely, an increase in agricultural output led to a fall in the prices of agricultural products, and a rise in productivity made fewer farmers necessary. Those who could not keep up with the changing nature of the market were sure to suffer, but this is no different from changes in any other industry.

It's true that farm output prices oftentimes fell by greater magnitudes than transportation costs, which made cost of production relatively higher than before. But, even this simply suggested the necessity to change business models.

There were, of course, the common grievances against moneylenders. During this time, farmers were likely to mortgage their land as a means of collecting the necessary capital to invest in mechanization and other things to increase the productivity of their land.

Rising savings led to a fall in interest rates, which led to the creation of a vast loan industry in the western United States. Interest rates also fell due to price deflation, which increased the real value of interest over time.

in regard to the impact of deflation on farmers, Higgs concludes that farmers with low debt were not susceptible to changes in the ratio between the value of their debt and the value of their output. Interestingly, many moneylenders included the option for a dynamic interest rate, allowing the rate on loans to fall with deflation.

In short, the agricultural sector experienced the consequences of a structural shift in favor of industrialization. Farming was no longer the dominant industry, and this forced many individuals to change their business plans or even line of work.

Should the horse-and-buggy industry have been saved against the aggression of the automobile? The problems suffered by those victims of the growing irrelevance of their jobs were temporary. While this was perhaps inconvenient for some individuals, none of this suggests that there was any general poverty or depression in agriculture. Perhaps this poverty was unique to those who simply refused to change with the times. The great productive growth made employment possible for all those able and willing to do adapt.

Did industrialization lead to greater inequality? Workers' real wages grew between 1880 and 1894 at a very fast pace, meaning that the average American was markedly wealthier at the end of this period than at the beginning. This undoubtedly was caused by a combination of rising nominal wages and falling price levels — the purchasing power of the dollar was increasing, and it was the consumer who benefited the most. While there was inequality between workers of different geographic regions, Higgs shows that wages were rising just as fast in the South as elsewhere. Any general poverty that may have existed in the South was a consequence, not of industrial stagnation, but of the American Civil War and the massive destruction it wrought on southern property.

Regarding inequality between workers of different races, especially between native white Americans and European immigrants, Higgs shows that even in the event of discrimination, this was oftentimes offset by the competition created by industrial expansion. Simply put, if one employer offered an immigrant lower wages, a competitor would often use this as an opportunity to take that worker himself by offering higher wages. On discrimination against black workers, Higgs is largely inconclusive; but he presents no evidence that would suggest the market rewarded discrimination. Instead, he points to inequality of treatment under the law and public discrimination against blacks in their efforts to obtain skills and education. Higgs continues his work on this topic in a later book.25

The research in Robert Higgs's Transformation of the American Economy is much more nuanced than this review might lead one to believe. Higgs pores over the minutiae of economic history of the period. The detail in which he explains the general concepts outlined here is amazing. Most histories have focused on the monetary aspects of the deflation between 1873 and 1894, but Higgs's history is much more encompassing and much more human. It is a story of a major structural shift in the American economy and how it impacted different people. Higgs leaves little to the imagination, and he explicitly acknowledges what he does not know.

Transformation of the American Economy is a book every economist and economic historian should read. If more of these professionals took the time to review Robert Higgs's book, there would be much less confusion and disagreement. Higgs demonstrates that the period between the American Civil War and the First World War was largely an era of radical productivity and a vast increase in wealth. True, some suffered, as is to be expected in such changes, but society as a whole benefited to a degree never experienced before or witnessed since.26

  • 1. Murray N. Rothbard, A History of Money and Banking in the United States (Auburn, Alabama: Ludwig von Mises Institute, 2002), pp. 147–169; Jonathan M. Finegold Catalán, "The Austrian History of US Money and Banking."
  • 2. Paul Krugman, "The Third Depression." Krugman writes, "As far as I can tell, there were only two eras in economic history that were widely described as 'depressions' at the time: the years of deflation and instability that followed the Panic of 1873 and the years of mass unemployment that followed the financial crisis of 1929–31."
  • 3. See, most famously, Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867–1960 (Princeton: Princeton University Press, 1963), p. 15. Given such a broad spread of opinion, one may be amazed to realize just how much research has been conducted on the topic. It is not as if historical knowledge is lacking here.
  • 4. I will use "price deflation," "deflation," and "a [general] fall in prices" interchangeably throughout. Nowhere do I mean a reduction in the supply of money. In all three cases, I am referring to the general movement of prices.
  • 5. F.W. Taussig, "Prices from 1873 to 1884," Science 6, no. 142 (1885).
  • 6. The topic of deflation is more complex than this. I purposefully avoid the subject for the sake of simplicity. The complexity stems from the fact that a fall in the general price level can be caused by different factors, and it is this causal factor that decides whether deflation is harmful. See Steven Horwitz, "Deflation: The Good, the Bad, and the Ugly," The Freeman 60, no. 1 (2010).
  • 7. Robert Higgs, Depression, War, and Cold War (Oakland, California: The Independent Institute, 2006); Robert Higgs, Arms, Politics, and the Economy: Historical and Contemporary Perspectives (Oakland, California: The Independent Institute, 1990); Robert Higgs, Resurgence of the Warfare State: The Crisis Since 9/11 (Oakland, California: The Independent Institute, 2005).
  • 8. Robert Higgs, Crisis and Leviathan: Critical Episodes in the Growth of American Government (Oxford, United Kingdom: Oxford University Press, 1987).
  • 9. Robert Higgs, "Nonsense about Deflation"; he writes, "even if you are a confirmed positivist in your methodological bent (as I was in 1971)" Also, on pp. 67 of The Transformation of the American Economy, Higgs describes the methodology he used.
  • 10. Milton Friedman, Essays in Positive Economics (Chicago, Illinois: University of Chicago, 1953); Karl R. Popper, The Logic of Scientific Discovery (New York City: Harper Torchbooks, 1965).
  • 11. Writes Higgs, "To determine which of the competing theories is the most useful, we must consider questions for which they predict differently"; Higgs 1971, p. 7.
  • 12. Ludwig von Mises, <a href="http://mises.org/resources/3250/Human-Action"><em>Human Action</em></a> (Auburn, Alabama: Ludwig von Mises Institute, 1998), pp. 38–41.
  • 13. If a theory says that if A then B, an application to reality could only be useful if A actually occurred in reality.
  • 14. Robert Higgs 1971, p. viii.
  • 15. W.W. Rostow, "Investment and the Great Depression," Economic History Review 8, 2 (1938).
  • 16. Samuel Rezneck, "Distress, Relief, and Discontent in the United States during the Depression of 1873–1878," Journal of Political Economy 58, no. 6 1950; Rothbard, History of Money and Banking in the United States. (Auburn: Ludwig von Mises Institute, 2002) p. 153.
  • 17. Rothbard 2002, pp. 153–156. Rothbard interprets the panic of 1873 as a necessary period of bankruptcy to cleanse the financial system, giving way to the great growth which took place over the following two decades.
  • 18. Friedman and Schwartz 1963, p. 41.
  • 19. Christina D. Romer, "Is the Stabilization of the Postwar Economy a Figment of the Data?", The American Economic Review 76, no. 3 (1986), p. 318; Edwin Frickley, Production in the United States, 1860–1914. Harvard Economic Studies (Cambridge: Harvard University Press, 1947).
  • 20. Rothbard 2002, pp. 161–162; Romer 1986, p. 318.
  • 21. Ibid.
  • 22. The political explanation, Rothbard 2002, pp. 168–169; a monetary explanation, Friedman and Schwartz 1963, pp. 108–113; a banking explanation, George Selgin, The Theory of Free Banking (Totowa, New Jersey: Rowman & Littlefield, 1988), pp. 13–15.
  • 23. The greenback dollar was a fiat paper currency issued by the United States as a means of paying expenses during the American Civil War. It was used as an alternative to the issuance of debt and taxation. See Fred Perry Powers, "The Greenback in War," Political Science Quarterly 2, no. 1 (1887).
  • 24. Workers oftentimes went on their own to learn certain intellectual skills required for different jobs, and it is important to remember that gains in productivity allow for increased leisure time, which includes providing parents the opportunity to teach their children (whereas earlier the opportunity cost of taking the time to teach your child how to read included the loss of necessary wages). There was also a lot of on-the-job training, where employers were more than willing to provide workers the tools necessary for employment.
  • 25. Robert Higgs, Competition and Coercion: Blacks in the American Economy, 1865-1914 (Cambridge: Cambridge University Press, 2008).
  • 26. A possible exception is the period between 1980 and 2001, although I have not seen a comparison of the data. Even then, the two periods are incomparable in regard to just how fundamentally the American economy changed.


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