Book 1: Capitalism at Work: Business, Government, and Energy

Chapter 6 Internet Appendix

6.1 “Overproduction” and the Business Cycle
6.2 Progressivism and Statism
6.3 The “New Vocabulary”
6.4 Early Political Capitalism
6.5 The Hoover Mythology
Bibliography: Chapter 6 Appendices

6.1 Overproduction and the Business Cycle

The “secular stagnation” theory of capitalism became popular in the economically challenged 1930s. Joseph Schumpeter envisioned entrepreneurship becoming bureaucratized in capitalism’s mature phase, but it was another Harvard economist, Alvin Hansen, a leading American Keynesian, who advanced the stagnation thesis. MIT wunderkind Paul Samuelson also popularized stagnation in his bestselling textbook, Economics: An Introductory Analysis, the first edition of which came out in 1948 (418–21).

The stagnation thesis posits an aggregate “market failure” in the voluntary decisions of consumers, savers, and investors. Stripped of its technical explanation, economic production gets out of sync with consumption on the one side and savings/investment on the other. The misalignment results in unemployment, which in the Keynesian system requires activist monetary and fiscal policy to promote non-inflationary full employment.

Non-inflationary full employment was the goal, and in the 1950s and 1960s it seemed to hold. But reality intervened with the “stagflation” of the 1970s, a period of simultaneously high unemployment and inflation, an impossibility to orthodox Keynesians. Sir John Hicks, a leading economist who had helped erect the standard Keynesian framework, confessed in 1974:

Keynesian policies … instead of producing real economic progress, or growth, as they had for so long appeared to do …were just producing inflation. Something, it seemed clear, had gone wrong.… We have to start, in a way, all over again (3–4).

Paul Samuelson, the leading macroeconomist (and Keynesian) of postwar America, and one of the first Nobel laureates in economics, confidently wrote in his ninth edition textbook (1973, 267) that “the business cycle has been tamed, even if not completely made a thing of the past.” Yet two years later he confronted the reality of stagflation with sorrow:

It is a terrible blemish on the mixed economy and a sad reflection on my generation of economists that we’re not the Merlins that can solve the problem. Inflation is deep in the nature of the welfare state. Even when there is slack in the system, unemployment doesn’t exert downward pressure on prices the way it did under “cruel” competition (quoted in Bradley, 1975).

Error (and arrogance) is as much a part of academia as of business. Spectacular failures have come from both, although academics do not have to declare bankruptcy.

6.2 Progressivism and Statism

The growth of government in the Progressive Era is a broader subject than presented in chapter 6. Although business expediency was important, government growth in the period also resulted from moral, pious inspiration. Sometimes a coalition between business and ethno-religious groups drove the interventionist process.

Murray Rothbard has interpreted the Progressive Era as “an era in which the entire American polity—from economics to urban planning to medicine to social work to the licensing of professions to the ideology of intellectuals—was transformed from a roughly laissez-faire system based on individual rights to one of state planning and control” (1986, 109). In an essay on Progressivism and the family, Rothbard linked compulsory public schooling, Prohibition, immigration restrictions, Sunday work restrictions, and other social legislation to an “aggressive drive by Anglo-Saxon Protestant ‘pietists’ to use the state to ‘make America holy,’ to stamp out sin and thereby assure their own salvation by maximizing the salvation of others” (1986, 134).

In some cases, business interests and morality interests teamed together to obtain or retain government intervention in the economy. Bootleggers and Baptists found their self-interest aligned with Prohibition, which was in force from 1920 until 1933. “Bootleggers and Baptists” has become shorthand for instances in which narrow business interests ally with public reformers to secure or retain a government intervention into the economy (Yandle: 1983). Enron and the environmentalist groups would form a similar coalition in the 1990s (Yandle and Buck: 2002).

6.3 The “New Vocabulary”

Beginning in the 1960s, “enormous … research in the fields of economics and business administration” (McCraw: 1984, 68) created new concepts to understand the strategy and size of firms and industries. Thomas McCraw (69–74) identified eight key terms, six of which are paired.

Center firms are the largest, most dominant firm or firms in an industry; peripheral firms are the smaller, niche competitors. Allocative efficiency is the perfect-competition ideal, whereby no improvement can come from changes in price, quantity, or distribution.Productive efficiency is the Schumpeterian notion of dynamic change, by which the new improves upon the old. More recent terms for these two are static efficiency and dynamic efficiency (Ellig and Kalt: xix–xxi). Vertical integration involves different but complementary tasks that are performed within the same firm; its outputs become inputs for another stage of production. Horizontal integration (or combination) involves a firm that expands in a single activity by buying or merging with another firm. Economies of scale are achieved when the per-unit cost of production declines with greater production—a type of productive (or dynamic) efficiency. But growing too large can introduce diseconomies of scale. A related term not mentioned by McCraw is economies of scope, meaning that a firm has a natural advantage in undertaking an activity similar to one that it is already doing. Vertical integration is an example. Transaction cost, mentioned but not defined by McCraw, relates to a number of the above terms. Also known as friction, interaction, orhassle cost, transaction cost is the expended effort of business dealings, measured in time or money. Different options have different transaction costs, so the goal of business is to choose a particular structure to minimize these costs. For example, transaction costs may be lower for individuals working as employees within firm A than if each employee to form his or her own firm (firms B…Z) under contract with firm A. However, firm A may choose to outsource some functions to the outside market for better efficiencies, despite creating a situation of higher transaction costs.

6.4 Early Political Capitalism

Government intervention in nineteenth-century American business was not insignificant. Frank Dobbin and Timothy Dowd wrote (501–02): “Between 1825 and 1871, American railroads operated under public capitalization policies as generous as France’s,” and “between 1872 and 1896, the industry operated under pro-cartel policies as friendly as Germany’s.” Economic historian Carter Goodrich (391) found “the amount and variety of government activity [for internal improvements] quite extraordinary.” Thomas McCraw (1984: 8) documented that “no sum seemed too excessive to pay” for government subsidies for the “essential service” of transportation during the Gilded Age.

Louis Galambos and Joseph Pratt (1988: 23) described how, in pre-Civil War America, “businessmen could make their influence felt directly, and many did” because of their leading position in society. Harvard professor of public administration, Pendleton Herring, brought attention to another business lobby: “Before the Civil War, slaveowners were the dominant interest in the federal government, just as afterwards industry asserted its authority” (426).

The embryonic but well-defined nature of political capitalism in nineteenth-century America should not have been neglected by later historians. Business influence over politics, both for and against free markets, was one of the most important themes of the time, as it would continue to be. In the 1920s, two preeminent historians spelled out the range of interventionism. “Broadly speaking,” Charles and Mary Beard wrote, “the capitalists of the Northeast demanded from Congress a liberal immigration policy to assure an abundance of cheap labor, ship subsidies for the promotion of commerce, internal improvements in the form of roads, canals, and harbor facilities, a sound monetary system to guarantee that loans and interest would be duly met in values at least equal to the nominal figure in the bond, high tariffs for industries, and the preservation of the protected market area by the retention of the southern states in the Union” (1927:1, 664–65). They added, “This was a heroic program which its sponsors could only realize by securing the possession of the executive and legislative branches of the federal government” (1927:1, 665).

The notorious political machines of urban governments—the “bosses, corruption, and special privilege” (De Santis: 166)—often had a business component. The excesses of this aspect of political capitalism led to localized socialism—the municipalization of water, gas, and electricity distribution (165).

Intervention in the pre-Civil War period did not have the range and depth of later government involvement. Government, for the most part, sought “to avoid excessive expenditures and excessive taxation, to refrain from giving privileged charters” (Hofstadter, 1955, 303). Compared to the millions of government workers today, there were approximately 50,000 nonmilitary public-sector employees in the early 1870s, almost three quarters of whom worked for the postal service (McCraw: 1981, 5). Public-utility regulation would come later with the growth of railroads and urban services.

6.5 The Hoover Mythology

Political capitalism in the United States cannot be understood without revisiting one of the great misperceptions of U.S. history—Herbert Hoover as the federal guardian of laissez-faire before and after the onset of the Great Depression. The record has been set straight by historians from the Left and the Right, yet the Hoover mythology remains prevalent.

The father of the New Left historians, William Appleman Williams (1961: 438), described a Herbert Hoover who was hardly a do-nothing president:

Before [his] defeat in 1932 … Hoover had pulled out every antidepression tool the Progressives ever owned. He first tried, as had Theodore Roosevelt in the Panic of 1907, to coerce and wheedle financial leaders such as Andrew Mellon and Thomas Lamont into underwriting the stock market and thereby stopping the downturn. They lacked both the will and the capital. Hoover then recommended or approved a wide spectrum of recovery measures. The Norris-La Guardia Act of 1932 established the principle of collective bargaining as the law of the land. The Reconstruction Finance Corporation provided the model as well as one of the key instruments of most New Deal financing of domestic production and overseas economic expansion. Hoover asked also for a significant tax cut to encourage investment, a $423 million public works program, more credit for farmers, new guarantees for bank deposits, more liberal bankruptcy laws, and direct-relief appropriations. But whatever the value of Hoover’s recommendations, the Democrats were by that time refusing to support them and Roosevelt entered the White House only to confront a very grave crisis.

Libertarian economist and historian Murray Rothbard (1972: 111) also deconstructed the mythology of Hoover as the “last stubborn guardian of laissez-faire in America.” Hoover was the first New Dealer and “one of the great pioneers of American state corporatism” (1972: 145), Rothbard found.

Hoover himself tried to set the record straight. As Kolko noted: “Hoover was correct in arguing that ‘those who contended that during the period of my administration our economic system was one of laissez faire have little knowledge of the extent of government regulation,’ an admonition Hoover himself often forgot” (1976: 120–21). Rothbard quoted Hoover (from 1932) to make the same point:

We might have done nothing. That would have been utter ruin. Instead, we met the situation with proposals to private business and to Congress of the most gigantic program of economic defense and counterattack ever evolved in the history of the Republic (1972: 127).

Tragically, Hoover’s activism, which included a tax increase (reversing his earlier tax cut), high tariffs (Smoot-Hawley), and artificial wage-rate maintenance (in the face of a general deflation), not to mention his make-work programs that erratically sub-divided a depleted pie, prevented a recovery such as occurred after previous downturns in United States history.

Hoover’s de facto New Deal was followed by FDR’s official New Deal, which was described by journalist John T. Flynn as

a hodge-podge of good intention, of bold promises and glittering hopes—a desire to produce recovery, to create abundance while at the same time causing scarcity to get prices up; to help labor, to help the little business men and to help the big business men—all save a few who behaved badly to Mr. Roosevelt personally; to spend as much as possible and to tax as little as possible; to boost prices but not to diminish purchasing power; to raise wages and profits, too; to save the farmer, to save the railroads, to save anybody who could be saved with a subsidy; to make everybody happy and win everybody’s good opinion and, in the process of doing this, to adopt any idea which was presented by anybody with a friendly face and which seemed at a glance to have a chance to work (1939: 42).

Government activism under Hoover and FDR did not rescue America from the Great Depression. Neither did free-market policy reform, which was not put into play. Keynesians and Marxists theorized that capitalism was inherently unstable because of the failed recovery. Another explanation is that government intervention was the cause, not the cure, of the artificial boom and stubborn bust (Rothbard: 1963), creating a climate that furthered political capitalism in the United States.

Bibliography: Chapter 6 Internet Appendices

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