The Transformation of the American Economy 1865-1914

Capital formation is one of the conditions of economic growth, and the existence of a law of property is one of the conditions of capital formation. . . . For if a resource and its fruit could not be protected against the public at large, it would certainly be misused, and hardly any person would find it worth while to invest in its improvement. . . . [U]nless we match differential effort with differential reward, men are unlikely to take the trouble to develop their talents and resources to the utmost of their capabilities.

W. ARTHUR LEWIS

Economic growth did not begin with a great leap after the Civil War. Although our evidence on when it actually began is scanty, it appears certain that rapid growth occurred in the two decades before the Civil War, and output per capita probably increased also in the two decades before 1840, although at a slower rate. In short, sustained economic growth began sometime in the first half of the nineteenth century. Perhaps the attempt to date the starting point with any greater precision is really not a fruitful exercise. After all, economic growth did not just suddenly appear; rather, it emerged slowly and haltingly, against many obstacles and with many temporary setbacks.

In a book concerned only with the post-Civil War era, we could easily dismiss the subject of how growth began as a question belonging to another study. But that would be a serious mistake, for unless we understand how growth began, we cannot really understand how it continued in a self-sustaining fashion throughout the post-Civil War era. In this digression, we offer a theory of how growth began. Though we shall present some evidence that it is consistent with the facts of American economic history, no rigorous tests of the hypotheses implied by this theory are presently available. Property rights, which play a central role in the theory, are particularly difficult to incorporate into clear-cut hypothesis tests. Our hope is that by sketching the theory we will encourage others to join in the attempt to extend and test it. Having issued our caveats at the outset, we proceed below without qualification.

Before the nineteenth century, relatively little investment in material capital took place, the technology advanced haltingly, and workers acquired new skills at a snail’s pace. This virtual absence of productivity-raising activities, extending back through millenia of civilized history, sprang from two sources.

The first was the prevalence of limited markets. The limitations on the effective size of markets arose in some places from small populations, in other places from low levels of income per capita, and in most places from both. Primitive technologies of transportation and communication obstructed the widening of effective markets through interregional or international trade, and high costs of information about potential foreign markets restricted trade to items with high value/weight ratios, as in the famous medieval spice trade. With the revival of commerce in the late medieval period, European markets began to widen; population growth promoted the same result. But these changes occurred slowly, ever so slowly, and with frequent reversals as wars and raiding disrupted trade and as plagues, famines, and other natural disasters decimated the population of Europe. Over the centuries, however, markets did grow, the settlement of North America by English colonists being a simple overseas extension of this growth. The colonies expanded in response to the home country’s growing demand for American staples—tobacco, rice, indigo, fish, lumber, naval stores. Later, in the early nineteenth century, cotton became the leading export. The expansion of a rapidly growing population westward into an apparently inexhaustible area of fertile land made possible an increasing supply of these goods. Within the United States the growth of population from less than 4 million in 1790 to more than 31 million in 1860 provided visible evidence of widening markets. At the same time canals, steamboats, and railroads made the population more internally accessible. Certainly before the middle of the nineteenth century, narrow markets no longer constrained the undertaking of productivity-raising activities in America.1

Large markets alone, however, could not stimulate many individuals to invent or to acquire skills. The second requirement was the development of secure private property rights, for even with wide markets the substantial risk remained that, having made investments in raising their productivity, investors would be unable to capture gains sufficient to justify the effort. The same insecurity influenced the accumulation of material capital where the returns accrued over a lengthy and uncertain future. As markets became geographically larger, with many transactions being necessarily conducted at a distance, the problems of insuring that one’s property would be respected grew more severe. And always the threat was twofold, for property rights might be disregarded by governments as well as by other individuals. With private property rights ill-defined and ill-enforced, individuals could not form reliable expectations. Uncertainty dominated the future, and only the fool or the humanitarian risked valuable resources in ventures promising greater but later rewards.

Englishmen, of course, had proceeded further than others toward securing the rights of private property. But much remained to be done even in the late eighteenth century, and in many cases the American colonists enjoyed less protection than their cousins did at home. After all, the American Revolution was in large measure provoked by the British government’s arbitrary treatment of American property. Mere independence, however, did not cure these ills completely. Shays’ Rebellion, a 1786 uprising of Massachusetts farmers defying court orders to repay debts as agreed in their contracts, alarmed many throughout the new nation and intensified concern for the security of property. In November 1787, James Madison complained of a “prevailing and increasing distrust of public engagements, and alarm for private rights, which are echoed from one end of the continent to the other.” And two months later he wrote:

The sober people of America are weary of the fluctuating policy which has directed the public councils. They have seen with regret and indignation that sudden changes and legislative interferences, in cases affecting personal rights, become jobs in the hands of enterprising and influential speculators, and snares to the more-industrious and less-informed part of the community. They have seen, too, that one legislative interference is but the first link of a long chain of repetitions, every subsequent interference being naturally produced by the effects of the preceding. They very rightly infer, therefore, that some thorough reform is wanting, which will banish speculations on public measures, inspire a general prudence and industry, and give a regular course to the business of society.2

Independence did create an opportunity for Americans to establish a new framework of property rights consistent with their desire for material advancement. The Constitution was the first step, and in many ways the most important one. Its provisions for security against foreign and domestic threats, for post offices and roads, for duty-free interstate trade, and for uniform bankruptcy laws directly helped to promote trade and specialization. It also gave Congress the right to provide for a patent system: “To promote the progress of science and useful arts by securing for limited times to authors and inventors the exclusive right to their respective writings and discoveries.” With greater assurance of capturing the gains from their ideas, inventors emerged more rapidly than ever before. Of immense importance was the provision prohibiting any state from passing a law that would impair the obligation of contracts. In 1819 John Marshall, Chief Justice of the U. S. Supreme Court, recalled the insecurity that had afflicted the rights of private property before the Constitution: “[A] course of legislation had prevailed in many, if not in all, of the states, which weakened the confidence of man in man, and embarrassed all transactions between individuals, by dispensing with a faithful performance of engagements.” Marshall apparently had in mind the acts passed by seven states in the 1780’s authorizing the issue of paper currency to serve as a legal tender for the settlement of debts contracted in terms of specie. The Contract Clause of the Constitution, he said, was designed “to correct this mischief, by restraining the power which produced it.”3 The Constitution also explicitly forbade the states to coin money or to emit bills of credit. The Bill of Rights, ten amendments to the Constitution adopted in 1791, guaranteed “the right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures”; it provided that no person “be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation”; furthermore, “in Suits at common law, where the value in controversy shall exceed twenty dollars, the right of trial by jury shall be preserved.” In brief, the Constitution laid the foundation of private property rights so as to curb the arbitrary powers of government and to promote the security required for the pursuit of productivity-raising activities of all kinds.

Upon this foundation an imposing legal structure arose in the first half of the nineteenth century. Of central importance were the elaboration and extension of the common law of contract. With English precedents as a starting point, judges set down new rules for the legal treatment of negotiable instruments like notes, bills of exchange and lading, and warehouse receipts. In an expanding and far-flung market, uniform standards for dealing with these commercial documents were essential. Judges also clarified the legal responsibilities of factors and agents and extended the law with respect to banking and insurance. In 1836 Congress reformed the patent system, and the new law, in combination with its subsequent interpretations by the courts, did much more to protect inventors’ rights to their ideas. In all these areas the general effect was to facilitate the operation of private economic activities and to stabilize the expectations of individuals concerning the legal status of private property in its various forms. The doctrine of stare decisis—that lower courts are bound by the prior decision of the highest court in the same jurisdiction in substantially similar cases—became firmly entrenched during this period, contributing further to the establishment of a predictable legal order.

The judges of Massachusetts pioneered in establishing a body of American precedents. Theophilus Parsons, Chief Justice of the Massachusetts Supreme Court from 1806 to 1813, became known as “The Giant of the Law.” “He was,” says Daniel Boorstin, “a true New Englander both in his feeling for local customs and in his desire, especially in the laws of commerce, shipping, and insurance, to follow the practice of merchants.”4 Lemuel Shaw, Massachusetts Chief Justice from 1830 to 1860, contributed monumentally to the body of common law. He did much to make the law consistent with economic progress by adapting liability provisions to the special circumstances of railroad transportation. He also introduced the notion of “eminent domain,” which allowed the fully compensated confiscation of private property for public use—as, for example, in establishing a railroad right-of-way. The distinguishing feature of this new legal device was that governments might delegate their confiscatory power to private parties, such as railroad companies, for well-defined and limited purposes. Without the power of eminent domain, it is doubtful that the nation’s transportation system, with all its associated social benefits, could have developed as fast as it did.

Law writers also performed a crucial function in the early nineteenth century, for until the existing rules had been systematized, it was difficult and costly to know the legal consequences of many actions. Though lawyers and judges commonly cited English precedents, some states attempted to restrict their citation, and they were not uniformly observed. As Boorstin properly notes, “Without a general American legal system, technically defined and available in books, the free commerce among our states and the industrial unity of our nation might have been impossible.”5 After the first quarter of the nineteenth century this gap was steadily filled. Landmark writings included Nathan Dane’s General Abridgement and Digest of American Law (8 vols., 1823), James Kent’s Commentaries on American Law (4 vols., 1826–30), and the voluminous works of Joseph Story, an Associate Justice of the U. S. Supreme Court, including Commentaries on the Conflict of Laws (1834) and On Equity Jurisprudence (2 vols., 1836). Among his many accomplishments Story contributed a great deal to the law of patents. All these writers relied on the transcripts of court proceedings prepared by official reporters, appointed first to report United States Supreme Court cases early in the nineteenth century. By the Civil War all the states had official reporters, greatly facilitating the systematic compilation of cases on which the development of common law crucially depends.

From his position as Chief Justice of the U. S. Supreme Court, John Marshall exerted a powerful influence on the establishment of a legal order of security for private property. His long tenure on the court extended from 1801 to 1835, a crucial period in the shaping of American law. Marshall’s opinions in the cases of Fletcher v. Peck (1810) and Trustees of Dartmouth College v. Woodward (1819) were giant steps forward in guaranteeing the sanctity of contracts. In the former case he asked rhetorically: “It may well be doubted whether the nature of society and of the government does not prescribe some limits to the legislative power; and if any be prescribed, where are they to be found, if the property of an individual fairly and honestly acquired, may be seized without compensation?” The Constitution’s Contract Clause, he added in the latter case, “must be understood as intended to guard against a power of at least doubtful utility, the abuse of which had been extensively felt, and to restrain the legislature in future from violating the right to property.” In Gibbons v. Ogden (1824) Marshall declared the validity of the Interstate Commerce Clause in giving the power to regulate interstate trade solely to the federal government, and by proscribing the obstructive actions of individual states he helped to create the legal conditions that would permit the emergence of a broad national market. In all his decisions he was at pains to combat those who would interpret the Constitution narrowly, who would “explain away the constitution of our country and leave it a magnificent structure indeed, to look at, but totally unfit for use.”6 In his hands the Constitution became the basic institutional foundation for the promotion of material progress in America’s market economy.

As the economy’s total output grew in response to the foreign demand for American staples, many inventions became attractive investments for the first time; the acquisition of many skills became worthwhile for the first time; many investments in material capital were justified for the first time. In a setting where property rights were defined and enforced in a way that encouraged invention and protected private property, economic growth could begin. And once under way, the whole process became self-sustaining, because material, human, and intellectual capital accumulation led to the growth of output per capita, thus expanding markets and making it worthwhile to invent further, to acquire additional skills, and to accumulate more material capital. In brief, the great transformation that permitted men for the first time to escape from poverty rested on two fundamental bases: (1) the growth of markets, which in the United States had its origins in increasing foreign demand and in population growth under conditions of unlimited land; and (2) the evolution of secure private property rights, including the private right to intellectual property. These developments, stretching back for centuries, have no precise dates of origin. But the Constitution was a major landmark, and in the first half of the nineteenth century, when private property rights became firmly established, several convergent influences finally culminated. By the post-Civil War era, self-sustaining growth had become the normal condition of the American economy.

Of course, nothing guaranteed the continuation of these conditions. But in fact the rights of private property were consolidated and extended during the half century after the Civil War at the same time that markets were growing at unprecedented rates. In the words of the legal historian, Willard Hurst,

[T]he development of the market steadily increased the interlocking character of operations in this society and thus tended to raise men’s need to be able to rely on one another’s performance. Various features of our growing law of agreements reflected this. In more and more instances, from mid-century on, the law itself provided a framework for the parties’ dealing, unless they explicitly contracted out of the transaction which the rules of law shaped for them. This was notably true in respect to the instruments of commerce—bills of lading, warehouse receipts, stock transfer documents—and the forms of association, especially the partnership or corporation.7

The culmination of all these developments came when the Supreme Court in the 1880’s declared that corporations were legal “persons,” extending to them the protection of the Fourteenth Amendment and making it impossible for states to levy discriminatory taxes upon them.

In 1890 the Supreme Court extended the definition of property from physical things to the expected earning power of things—a definition always observed in the market—thereby striking down the power of state legislatures to destroy the value of private property by fixing unreasonably low prices on the services provided by railways and other utilities. A few years later it recognized that earning power depends on free access to markets. In Allgeyer v. Louisiana (1897), the court said:

The liberty mentioned in that Amendment [Fourteenth] means not only the right of the citizen to be free from physical restraint of his person, but the term is deemed to embrace the right of the citizen to be free in the enjoyment of all his faculties; to be free to use them in all lawful ways; to live and work where he will; to earn his livelihood by any lawful calling; to pursue any livelihood or avocation, and for that purpose to enter into all contracts which may be proper, necessary, and essential to his carrying out to a successful conclusion the purposes above mentioned. . . . His enjoyment upon terms of equality with all others in similar circumstances of the privilege of pursuing an ordinary calling or trade, and of acquiring, holding, and selling property is an essential part of liberty and property as guaranteed by the Fourteenth Amendment.8

“Institutions,” Arthur Lewis has written, “promote or restrict growth according to the protection they accord to effort, according to the opportunities they provide for specialization, and according to the freedom of manoeuvre they permit.”9 In all these respects American institutions were basic to the initiation of economic growth and to its sustainment.

10 For a detailed account of the widening of markets in the early national period. see Douglass C. North, The Economic Growth of the United States, 1700–1860 (Engle-wood Cliffs, N.J.: Prentice-Hall, 1961).

11 James Madison, in The Federalist (New York: Modern Library, n. d.), pp. 54. 289.

12 Trustees of Dartmouth College v. Woodward (1819), reprinted in Henry Steele Commager, Ed., Documents of American History, 4th ed. (New York: Appleton, Century, Crofts, 1948). pp. 220–23.

13 Daniel J. Boorstin, The Americans: The National Experience (New York: Random House. 1965). p. 39.

14 ibid., p. 38.

15 Gibbons v. Ogden (1824), reprinted in Commager, op. cit., pp. 338–43.

16 James Willard Hurst, Law and the Conditions of Freedom in the Nineteenth-Century United States (Madison, Wis.: University of Wisconsin, 1(156), p. 14.

17 Cited in John R. Commons. Legal Foundations of Capitalism (New York: Macmillan, 1914). p. 17. See also pp. 11–16.

18 W. Arthur Lewis, The Theory of Economic Growth (New York; Harper Torch books, 1970), p. 57.

• 1Andrew Carnegie, Autobiography of Andrew Carnegie (Boston: Houghton-Mifflin, 1920). pp. 34, 177, 255.
• 2Both, letters as cited in Gilbert C. Fite, “Daydreams and Nightmares: The Late Nineteenth-Century Agricultural Frontier,” Agricultural History, XL (Oct. 1966), 289, 292.
• 3Commercial and Financial Chronicle, XLII (Feb. 13, 1886), 199.
• 4Rodney Welch, “The Farmer’s Changed Condition,” The Forum, X (1891), 695, 699.
• 5Constance McLaughlin Green, American Cities in the Growth of the Nation (New York: Harper Colophon Books, 1965), pp. 148-66; Robert Higgs, “The Growth of Cities in a Midwestern Region, 1870–1900,” Journal of Regional Science, IX (Dec. 1969), 369–70.
• 6Charles C. Nott, “A Good Farm for Nothing,” The Nation, XLIX (Nov. 21, 1889), 406.
• 7Harold Fisher Wilson, The Hill Country of Northern New England: Its Social and Economic History, 1790–1930 (New York: Columbia University, 1936), pp. 97–115.
• 8Armen A. Alchian, “Uncertainly, Evolution, and Economic Theory,” Journal of Political Economy. LX (June 1950); and Milton Friedman, Essays in Positive Economics, pp. 16–23.
• 9David A. Wells, Recent Economic Changes (New York: Appleton, 1889), p. 437.
• 10To millions of downtrodden Europeans, America was the land of promise. Seeking that promise, William Carnegie, a hand weaver displaced by machinery, left Scotland with his family in 1848 for the United States. Like many other immigrants, however, he found the promise illusory, and his son Andrew, aged 13, went to work in a textile mill at $1.20 a week to help support the family. Many years later Andrew recalled: “It was a hard life. In the winter father and I had to rise and breakfast in the darkness, reach the factory before it was daylight, and, with a short interval for lunch, work till after dark. The hours hung heavily upon me and in the work itself I took no pleasure.” During the years that followed, as a messenger boy, a telegraph operator, a railroad superintendent, and finally an independent businessman of diversified interests, he advanced until in the early 1870’s, already moderately wealthy, he made a fateful decision: “I would concentrate on the manufacture of iron and steel and be master in that.” The decision proved wise. For the next 30 years the rise of Carnegie paralleled the spectacular rise of the American iron and steel industry. His fortune mounted steadily, and in 1901 he finally sold the business for over $225 million and “resolved to stop accumulating and begin the infinitely more serious and difficult task of wise distribution.” One of the world’s richest men, he spent the last 18 years of his life giving away his wealth to promote various humanitarian organizations, many of his own creation. It seemed that America was, after all, really the land of promise.
• 11I take my pen in hand to let you know that we are starving to death. It is pretty hard to do without anything to eat here in this God forsaken country. . . . My husband went away to find work and came home last night and told me that we would have to starve. . . . It is pretty hard for a woman to do without anything to eat when she doesn’t know what minute she will be confined to bed. If I was in Iowa I would be all light. . . . I haven’t had nothing to eat today and it is 3 o’clock.
• 12New steel plants are being put up in all sections of the country. In the Bulletin of the Steel Association for February 10, 1886, we find no less than 13 works for the manufacture of Bessemer steel that have either recently been completed or are in process of construction and expect to be in operation some time in the present year. These new works are going up in a great many different States—Pennsylvania, New York, New Jersey, Ohio, Illinois, West Virginia—and it is true, as the Bulletin says, that the Bessemer steel industry is no longer confined to a few establishments located in three or four States.
• 13I doubt if farmers are any better contented with their lot, or if they obtain more enjoyment from life, than they did in old times. I also question if they are more prosperous. They are generally in a condition of unrest, if not of discontent. Their social condition has not improved, as has that of mechanics and traders. Most of them are anxious to leave the farm for the store, the shop, the mine, or the locomotive. . . . Farmers have long been losing their place and influence in the councils of the State and nation. Our later Congresses have not contained enough farmers from the northern States to constitute the committees on agriculture. Our national law-makers have known so little about what would promote the prosperity of farmers that they have favored measures that have greatly injured agriculture. . . . [T]he price of nearly every farm product has declined sometimes below the cost of the labor required to produce it.
• 14Sharply contrasting changes not only occurred among individuals and industries but had a geographic dimension as well; whole regions developed quite differently. In 1869, the hamlet of Wichita, Kansas, boasted four shops, a blacksmithy, a saddlery, a saloon, and 20 families betting on the future of the little place. It proved a good bet. By 1880 Wichita’s population had expanded to 5000, by 1890 to 24,000. And such growth occurred commonly in that booming part of the country. During the same period, for example, Omaha grew from 16,000 to 149,000, Kansas City from 35,000 to 176,000, and hundreds of new towns sprang up west of the Mississippi.
• 15Midway between Williamstown and Brattleboro . . . I saw on the summit of a hill against the evening sky what seemed a large cathedral. Driving thither, I found a huge, old-time, two-story church, a large academy (which had blended in the distance with the church), a village with a broad street, perhaps 150 feet in width, I drove on and found that the church was abandoned, the academy dismantled, the village deserted. The farmer who owned the farm on the north of the village lived on one side of the broad street, and he who owned the farm on the south lived on the other, and they were the only inhabitants. All of the others had gone—to the manufacturing villages, to the great cities, to the West. Here had been industry, education, religion, comfort, and contentment, but there remained only a drear solitude of forsaken homes.
• 16And the story could have been repeated, with minor variations, for scores of other villages across northern New England.
• 17This example can be generalized to explain why the entire labor force becomes more skilled in a growing economy. The larger the market, the greater is the number of highly skilled, specialized jobs that the market will support. The more potential jobs, the greater is the incentive for workers to invest in becoming skilled specialists. In principle, the person considering an investment in acquiring skills would calculate the present value of the expected net revenue stream associated with having such skills and compare that with the opportunity cost of the training. As in the case of other economic decisions, it need not be true that individuals actually make such elaborate calculations; even though they reach their decisions by considering their alternatives only in a rough-and-ready fashion, still they generally act as if they had performed such calculations. And even if initial decisions were randomly made, only the “correct” ones would be rewarded in the market. Observation of such accidental successes would then encourage subsequent decision makers to move in the most rewarding direction.
• 18Not everyone welcomes these changes, and some people actively resist them. New ideas, new skills, and new machinery add to the economy’s average productivity, but they also give rise to a different distribution of the total product. Those committed to old skills or obsolete machinery, employed in declining industries, or located in areas where important natural resources are exhausted, often suffer. Although changes in the relative income and wealth of different groups are inherent in the process of economic growth, those who suffer the relative (and sometimes absolute) losses have rarely perceived the true source of their misfortune. Often they have ascribed responsibility for their hardship to the successful groups; typically they have sought government intervention to protect them from the vagaries of the market. Of course, people need not be misinformed to react in these ways. Much of what is nowadays described as the “farm problem,” for example, is nothing more than an attempt to resist the transformation of agriculture, to maintain a larger amount of resources in farming than can be supported there without assistance from the government. Many modern farmers surely understand their dilemma; their political actions furnish a good example of a well-informed effort to obstruct the economy’s transformation. To the extent that people fail to adjust to the economy’s transformed structure, economic growth is retarded. Transformation is not only a consequence of growth; it is a condition for further growth. However, for those who must make the adjustments, this transformation is often a painful and costly process, and the economic historian’s inability to measure many of these costs makes them no less real. David A. Wells summarized the issue clearly in 1889 when he said that “pending the interval or necessary period for adjustment, the problem of what to do to prevent a mass of adults, whose previous education has not qualified them for taking advantage of the new opportunities which material progress offers to them, from sinking into wretchedness and perhaps permanent poverty, is a serious one, and one not easy to answer.” Ultimately, of course, no one offered an “answer”; people simply struggled as best they could, sometimes failing utterly. The market system could be efficient to the point of ruthlessness. Inevitably, transformation affected not only economic welfare but political power and social status as well; new attitudes and values appeared in the process. Measuring the growth of per capita income is only a very crude way of indicating a population’s changing well-being, but clearly welfare in a more all-embracing sense is inextricably tied to economic growth and transformation.