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Economic History Association American Law and the Marketing Structure of the Large Corporation, 1875- 1890 Author(s): Charles W. McCurdy Source: The Journal of Economic History, Vol. 38, No. 3 (Sep., 1978), pp. 631-649 Published by: Cambridge University Press on behalf of the Economic History Association Stable URL: http://www.jstor.org/stable/2119473 . Accessed: 17/11/2013 12:56 Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp . JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org. . Cambridge University Press and Economic History Association are collaborating with JSTOR to digitize, preserve and extend access to The Journal of Economic History. http://www.jstor.org This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions THE JOURNAL OF ECONOMIC VOLUME XXXVIII HISTORY SEPTEMBER 1978 NUMBER 3 AmericanLaw and the MarketingStructureof the LargeCorporation,1875-1890 By CHARLESW. MCCURDY This paper employs the techniques of legal history to explore the relationship between the rise of big business and the size of the American market. It emphasizes law as a determinant of market size, and it analyzes judicial construction of the Constitution's commerce clause over time to delineate the role of integrated corporations in generating legal change. Specifically, the paper suggests that if the American market is defined as a free trade unit, enlargement of the market was a result of, rather than a prerequisite for, the post-Civil War revolution in business organization. HE "secret"of Americaneconomicgrowth,Englishlegal scholar Sir Henry Maine wrote in 1886, lay in "the [constitutional] prohibitionagainstlevying duties on commoditiespassingfrom State to State. . . . It securesto the producerthe commandof a free market over an enormousterritoryof vast naturalwealth, and thus it secondarily reconciles the Americanpeople to a tariffon foreign importations as oppressiveas ever a nationhas submittedto."LThe debate on T Journal of Economic History, Vol. XXXVIII, No. 3 (Sept. 1978). ? The Economic History Association. All rights reserved. The author is Assistant Professor of History, University of Virginia. An earlier version of this paper was read in March 1978, at the Twenty-Fourth Annual Meeting of the Business History Conference. A printed version of this paper will also appear in Business and Economic History, second series, Volume 6. The author is indebted to Fred V. Carstensen, William H. Harbaugh, Jonathan Lurie, and Harry N. Scheiber for comments that proved helpful in revising the essay for publication. 1 Sir Henry Maine, Popular Government (New York, 1886), p. 247. 631 This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions 632 McCurdy the tariff'scontributionto industrialdevelopment has not been resolved any more satisfactorilyby modern scholars than it was by nineteenth-centurypoliticans.But virtuallyeveryonehas long agreed that a divisionof the United States"intoa numberof smallermarket areasseparatedfromeach other by tariffwalls,"as in Europe,would, as Stuart Bruchey stated it, "have abridgedthe possibility . . . of large-scaleproduction."For Bruchey, as for Maine, "of the many contributionsto growthmade possible by the adoptionof the Constitution, perhapsthe most fundamentalwas that it laid the foundations for a nationalmarket."2 Yet on close inspection the sweeping statements of Maine and Bruchey claim too much. Neither the PhiladelphiaConventionnor the Supreme Court under Chief Justices John Marshalland Roger Taney had, in fact, deprived the states of all power to interpose obstacles to the movement of productsthroughoutthe nation. Although the framers of the Constitution proscribed outright tariff barriers,state governmentsretainedample authorityto devise more subtle formsof protectionthroughoccupational-licensing and inspection laws. Before the last quarterof the nineteenth century, moreover, appellatecourtsroutinelysustainedsuch statutes.On the eve of the post-CivilWarrevolutionin the structureof Americanmarketing, there remaineda host of barriersto free intercourseamongthe states. This paper attemptsboth to describe the late-nineteenth-century emergence of the "free trade"doctrine in Americancommerce law and to offer some generalizationsabout economic growth and the dynamicsof legal change. It furtherendeavorsto shed some new light on AlfredD. Chandler,Jr.'scontentionthat the growthof a national market was the chief prerequisite for the rise of large-scale, vertically-integratedcorporationsin the manufacturingsector.3Specifically,it suggeststhat if the nationalmarketis definedin termsof a free-tradeunit, rather than in terms of an integratedtransportnetwork,then the post-CivilWarpioneersin businessorganizationwere instrumentalin the creationof the market.Insteadof respondingto an existingfree marketof continentaldimensions,producersof sewing machinesand dressedbeef actuallyignoredlegal barriersdevised by state governmentsand instructedtheir local marketingagents to invite arrestand conviction.At that point, the companies'headquar2 Stuart Bruchey, The Roots of American Economic Growth, 1607-1861 (New York, 1965), pp. 96-97. 3 Alfred D. Chandler, Jr., "The Beginnings of Big Business in American Industry," Business History Review, 33 (1959), 1-31. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions MarketingStructure 633 ters mobilized the substantialfinancialresourcesnecessaryto press the Supreme Court for relief, and hired counsel who succeeded in persuadingthe Court that existingcanonsof constitutionalconstruction had to be modified to accord with the changing structure of business enterprise. Earlier effortsto evoke similarmandatesfrom the judiciaryhad failedbecausepriorplaintiffshad not been affiliated with big business firms.They had lackedthe resourcesto engage in protractedlitigation;equallyimportant,their interest in a free-trade unit had not been sufficientlycompelling to induce an innovative response from appellatejudges. From the legal historian'sperspective, in short, the rise of big business was a prerequisitefor the emergence of a nationalmarket. Amongthe chief motivesforcallingthe PhiladelphiaConventionin 1787 was the "interferingand unneighborly[state] regulations"that had created"animosityand discord. .. between differentpartsof the confederacy"under the Articlesof Confederation.4The power of the severalstates"toimposedutieson importsand tonnage,"JusticeLevi Woodburyacknowledgedin 1849, "had caused so much difficulty, both at home and abroad,that it was expressly and entirely taken awayfromthe States."5On questionsof internalcommerce,however, the framershadbeen "characteristically Delphic."6They vested Congress with plenarypower over "Commercewith foreignnations,and among the several States," and AlexanderHamilton, in particular, viewed that provisionas an instrumentto facilitate"an unrestrained intercoursebetween the states"thatwould"advancethe tradeof each by an interchangeof their respective productions,not only for the supply of reciprocalwants at home, but for exportationto foreign markets."7But the permissiblescope of state activityin the silence of Congressneitherattractedattentionnor fomentedinstructivedebate at the PhiladelphiaConvention.8 Participantsin the pamphlet war generated by the ratification Clinton Rossiter, ed., The Federalist Papers (New York, 1961), p. 144. Passenger Cases, 7 How. 283 (U.S. 1849) at 545. 6 John P. Roche, "Entrepreneurial Liberty and the Commerce Power: Expansion, Contraction, and Casuistry in the Age of Enterprise," University of Chicago Law Review, 30 (1963), 682. 7 Rossiter, ed., Federalist Papers, p. 89. 8 Albert S. Abel, "The Commerce Clause in the Constitutional Convention and in Contemporary Comment," Minnesota Law Review, 25 (1941), 432-94; Charles Warren, The Making of the Constitution (Boston, 1928), pp. 567-89. 4 5 This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions McCurdy 634 controversyalso devoted scantspace to the internalcommercequestion. When commentatorsdid treat the commerceclause, moreover, they gave no indicationthatthe states'police andtaxpowerswouldbe affectedunless Congressoccupied the field with its own legislation. Hamilton, for example, flatly promised state governments that "with the sole exception of duties on imports and exports," they would retain their power to tax "in the most absolute and unqualified sense."9 James Madison, too, accorded wide policy latitude to state governments. "The regulation of commerce, it is true," he stated in The Federalist, "is a new power [of Congress]; but that seems to be an addition which few oppose, and from which no apprehensions are entertained." Indeed, Madison explained, "the powers reserved to the States will extend to all the objects which, in the ordinary course of affairs, concern the lives, liberties, and prosperity of the State[s]."10 The commercial-policy objectives of state governments were, in fact, extraordinarily broad. Throughout the nineteenth century, Americans looked primarily to state and local officials to promote internal improvements and regulate commercial traffic, tended to regard "each State as a community of interest . . . operating in a hostile environment of rival State communities," and expected governmental agencies closest at hand to be responsive to their particularistic interests.11 In an era when constitutional scruples and regional power groupings forestalled vigorous congressional action under the commerce clause, state and local interventions did play an important role in overcoming the physical obstacles that for generations had circumscribed inter-regional trade within narrow limits.12 State governments facilitated the expansion of interstate transactions, generally, and also protected shippers, passengers, and consumers against negligence or fraud on the part of carriers and merchants.13 But the state legislatures also spun an effective web of barriers to internal commerce. Measures designed to protect consumers or to promote inter-regional transactions joggled incongruously with statutes frankly adopted to impede the introduction of out-of-state prod9 Rossiter, ed., Federalist Papers, p. 198. 10 Ibid., pp. 292-93. 11 Harry N. Scheiber, The Condition of American Federalism: An Historian's View (Washington, D.C., 1965), p. 5. 12 Carter Goodrich, Government Promotion of American Canals and Railroads, 1800-1890 (New York, 1960), pp. 3-165. 13 Albert S. Abel, "Commerce Regulation Before Gibbons v. Ogden: Interstate Transportation Facilities," North Carolina Law Review, 25 (1946), 121-71. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions 635 MarketingStructure ucts on a bargainingparitywith local goods. State and local officials prescribedmarketingpractices, enacted discriminatoryschemes of mercantilelicensing and taxation,proscribedthe entry of unfavored articles of commerce, and devised inspection laws to improve the competitive position of their citizens relative to producersin other states.14 In short, state governments acted freely on all matters concerning commercial traffic-whatever their interstate ramifications-as-if they were unaware, or at least unconcerned, that the commerce clause might have divested them of powers they had exercised under the Articles of Confederation. Before 1875, the federal courts said nothing that disturbed the states' impulse to intervene on behalf of local interests. In the landmark cases of Gibbons v. Ogden (1824) and Brown v. Maryland (1827), the Marshall Court established two principles of profound importance: "Commerce is intercourse" and it includes transportation and traffic, which comprise "its essential ingredients."15 In both instances, however, the Chief Justice deftly avoided a direct confrontation with the question, as he put it, "whether this [commerce] power . . . is surrendered by the mere grant to Congress, or is retained [by the states] until Congress shall exercise the power. "16 Although he handed down dicta which looked toward a "dormant" theory of the commerce clause, Marshall preferred to invoke unlikely federal statutes-a federal coasting-license act in the one case, and national tariff laws in the other. As a result, the Court virtually ignored the broad policy issues raised by counsel, and held that the "sole question [was], can a state regulate commerce . . . while Congress is regulating it. "17 Anchoring his opinions as much upon the supremacy and import-export clauses as upon the commerce clause, Marshall flatly stated that state laws must give way once Congress occupied the field with its own legislation. The legitimacy of state and local commercial interventions in the silence of Congress was too vital an issue to be long suppressed -by Marshall's penchant for "esoteric statutory construction," and between 1837 and 1851 the Taney Court split into a bewildering arrayof shifting factional alignments as the Justices attempted to devise a 14 Albert S. Abel, "Commerce Regulation Before Gibbons v. Ogden: Trade and Traffic," Brooklyn Law Review, 14 (1947-48), 38-77, 215-43; Stanley C. Hollander, "Nineteenth Century Anti-Drummer Legislation in the United States," Business History Review, 38 (1964), 479-500. 15 Gibbons v. Ogden, 9 Wheat. 1 (U.S. 1824) at 189; Brown v. Maryland, 12 Wheat. 419 (1827) at 466. 16 Gibbons v. Ogden, 9 Wheat. 1 (U.S. 1824) at 200. 17 Ibid. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions 636 McCurdy workable canon of constitutional construction.18 Not until Cooley v. Board of Wardens (1851) was the protracted intra-Court controversy over whether the regulation of internal commerce belonged exclusively to Congress or admitted of a concurrent power in the states ultimately stilled. Justice Benjamin Curtis there pointed out that commerce embraced a great variety of subjects, some of such a nature as "imperatively" to require a uniform, national rule whereas others admitted of local control until such time as Congress occupied the field.19 The Cooley rule, the Court later noted, was "as satisfactory a solution as perhaps could be obtained ... [on a] question which had so long divided the judges."20 As an adjudicatory mechanism, however, it was virtually useless. As Kent Newmyer observed, "the Cooley decision was less a doctrinal clarification than it was an agreement to stop looking for one. "21 For the purposes of the postwar Court, the most important aspect of Cooley was its unarticulated premise: when Congress remained silent, the Court might supply its voice. In exercising the enormous discretion inherent in the Cooley rule, moreover, the Court had ample room to resolve disputes on the basis of franklyinstrumentalist, extra-constitutional criteria. Between 1851 and 1875 the question of how the Court might employ that self-created power, and for what purposes, remained uncertain. Then the revolution in the structure of American marketing generated a period of extraordinaryferment that culminated with the creation and systematic application of the "freetrade" doctrine. II Through the first five decades of the nineteenth century the independent, "sedentary" merchant integrated the American marketplace. Urban-based wholesalers supplied manufacturerswith capital for building plants, purchasing equipment, and paying wages; they also managed the flow of finished goods to retailers. Direct contacts between manufacturers and consumers were rare. Indeed, as late as 1860 the word "drummer"-which later became the popular term for 18 Felix Frankfurter, The Commerce Clause Under Marshall, Taney and Waite (Chapel Hill, 1937), p. 20. See also Carl Brent Swisher, Oliver Wendell Holmes Devise History of the Supreme Court of the United States, vol. V, The Taney Period, 1836-1864 (New York, 1974), pp. 357-422. 19 Cooley v. Board of Wardens, 12 How. 299 (U.S. 1851). 20 County of Mobile v. Kimball, 102 U.S. 691 (1880) at 701. 21 Kent Newmyer, "History Over Law: The Taney Court," Stanford Law Review, 27 (1975), 1378. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions MarketingStructure 637 travelingsalesmen-was used to refer to the men wholesalersplaced in hotel lobbiesto greet the hinterlandbuyerswho madeannualvisits to eastern marketingcenters.22But changes generatedby a swiftly developingnew technology,by the expansionand integrationof the nation'stransportnetwork, and by Civil War financialinnovations andcommercialbankwhichcreatednew ties between manufacturers of American the structure all contributed to a revolution in ers marketing.23 of new, expensive,and techThe pioneerswere the manufacturers nologicallycomplex productssuch as sewing machines.By 1860, I. M. Singer & Companyhad learned that existing wholesalerswere unable to provide consumer credit or handle demonstrationand repairservices;consequentlyit moved into the wholesalers'domain and began to create its own distributionnetwork.24It was not an instantaneousprocess, however. Operationof company-ownedretail outlets entailed high overheadcosts, and fewer than 100 such stores were opened as late as 1872. Not until 1873, when Singer's enormous new Elizabethport,New Jerseyfactorynearedcompletion,did the central office commit itself to expanding the firm's marketing organizationto the entire domesticmarket.By 1879the companyhad severedits relationswith all independentmerchants,andits distribution networkconsisted of 530 retail stores which also served as the base of operationfor a still largerforce of door-to-doorsalesmen.25 Legal barriers posed immediate problems for the architects of Singer'saggressivesales organization.State governments,prodded by the local merchants and manufacturerswhose interests were threatened, not only stepped up enforcement of long-established licensinglaws for peddlers but also enacted new revenue statutesto buttressthe competitivepositionof local businessmen.The very size of Singer'smarketingorganizationafter 1873 meant that there were substantialprofitsto be made by breakingdown these barriers.As a result, Singer coupled its final drive to integrate its manufacturing and distributionoperations with a determined effort to challenge protectioniststate legislationin the nation'scourts. In choosingto mount a legal assaulton state tradebarriers,Singer 22 Hollander, "Nineteenth Century Anti-Drummer Legislation," p. 481. 23 Glenn Porter and Harold C. Livesay, Merchants and Manufacturers: Studies in the Changing Structure of Nineteenth-Century Marketing (Baltimore, 1971). 24 Andrew B. Jack, "The Channels of Distribution for an Innovation: The Sewing Machine Industry in America, 1860-1865," Explorations in Entrepreneurial History, 9 (1957), 11341. 25 The data on Singer's post-Civil War marketing strategy were generously supplied by Fred V. Carstensen. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions 638 McCurdy faceda formidabletask. Statutesthat requirednon-residentsalesmen to pay higher licensing fees than local merchantsviolated the privileges and immunitiesclause of the Constitution;thus they had been subjected to the judicial veto in a long line of cases culminatingin 1870 with an authoritativeruling by the Supreme Court.26When state and local governmentsdiscriminatedagainstout-of-stateproducts ratherthan the salesman'sdomicile, however, tax and licensing laws had been sustainedroutinelyby the courts. Throughthe mid-1870s,the state judiciariesregularlytreated the 1827case of Brownv. Marylandas the Court'sfinalwordon state and local taxationof commercialtraffic.There the MarshallCourt had invalidateda state law that requiredwholesalersof foreignmerchandise, and only dealers in foreign merchandise, to pay an annual license tax. Speakingthroughthe Chief Justice, the Courtheld that Congresshad alreadyforced importersto pay tariffduties on their wares, and had thereby conferredupon them the right to sell in an unfettered market-a right which, if abridgedby state law, would have made the right to import of little value. As Felix Frankfurter later observed, "the circumstancesof the case furnished a ready opportunityfor curbing state taxationdiscriminatingagainst interstate commerce."27 Nevertheless, Marshall focused the bulk of his discussion on the import-export clause, and he suggested that the states might tax all commodities imported from abroad, or from any of the several states, once the "original package" had been broken and the goods had "become incorporated with the general mass of property."28 The state judiciaries readily discerned "an immeasurable difference" between the act nullified in Brown and discriminatory taxation of goods offered for sale by peddlers.29 Statutes of the latter variety, the Indiana court ruled in 1835, did not impede the operation of the federal revenue laws, for the commodities thus taxed had already "become incorporated with the great mass of property in the state." Moreover, the Indiana court asserted, the power to tax "is inseparable from sovereignty, essential to its existence, and one which all the expounders of the Constitution admit to have been reserved" by the 26 Ward v. Maryland, 12 Wall. 418 (U. S. 1870). See also the long line of state court decisions collected in Thomas M. Cooley, A Treatise on the Constitutional Limitations Which Rest Upon the Legislative Power of the States of the American Union (Boston, 1868), p. 487. 27 Frankfurter, Commerce Clause, p. 36. 28 Brown v. Maryland, 12 Wheat. 419 (U.S. 1827) at 447. 29 Beall v. State, 4 Blackf. 107 (Indiana 1835) at 109. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions MarketingStructure 639 states.30 It was an inexorable corollary, an Alabama judge added a generation later, that a state legislature might tax all merchandise sold within its jurisdiction, whatever its state of origin, while encourag[ing] manufacturersin its [own] borders, by exempting the articles so manufactured from taxation for a time, or altogether."31 The line of reasoning pioneered in Indiana comported with the particularistic needs of local merchants and manufacturers everywhere, and other state courts quickly adopted a similar position.32 In an often-cited opinion in the License Cases (1847), moreover, Justice Woodbury observed that "it is perfectly competent for [the states] to assess a higher tax or excise, by way of license or direct assessment, on articles of foreign rather than domestic growth belonging to her citizens; and it has ever been done, however it may discourage the use of the former."33When Thomas Cooley published the first edition of his Constitutional Limitations in 1868, then, the principle of unrestricted state taxation of commercial traffic, in the silence of Congress, had already attained the status of a settled rule. "The states may unquestionably tax the subjects of commerce," Cooley wrote in his influential treatise, "and no necessary conflict with that complete control which is vested in Congress appears until the power is so exercised as to defeat or embarrass the congressional legislation. Where Congress has not acted at all upon the subject, the state taxation cannot be invalid on this ground."34 Despite the weight of precedent, Singer persevered with remarkable success. In the fourth edition of his Constitutional Limitations, published in 1878, Cooley had already begun to note exceptions to the rule he had formulated so confidently a decade earlier; when the sixth edition appeared in 1890, the passage on state taxation of commercial traffic had been excised altogether. The leading case in this crucial doctrinal transformation came up from Missouri in 1875. Thirty years earlier the Missouri legislature had enacted a revenue measure that defined peddlers as persons selling commodities "not the growth, produce, or manufacture of th[is] State," and required them to pay a license fee for the privilege of engaging in local 30 Ibid. Seymour v. State, 51 Ala. 52 (1874) at 54. 32 Raquet v. Wade, 4 Ohio 107 (1829);People v. Coleman, 4 Cal. 46 (1854); State v. Pinckney, 10 Rich. L. 474 (South Carolina 1857); Davis v. Dashiel, 61 N.C. 114 (1867); State v. Hogdon, 41 Vt. 139 (1869). 33 License Cases, 5 How. 504 (U.S. 1847) at 622. 34 Cooley, Constitutional Limitations, p. 486. 31 This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions 640 McCurdy business.35 M. M. Welton, an agent of I. M. Singer & Company, had been convicted under the statute and the law had been sustained by the state's highest court.36 On appeal to the Supreme Court, counsel for Missouri simply stood on the precedents in a terse, five-page brief. Singer, on the other hand, hired two luminaries from the Missouri bar who compiled lengthy briefs that spoke directly to the policy issues involved in the dispute. Stated simply, they argued that existing doctrines were "not practical in this case. "37Missouri's equation of peddlers with hawkers of out-of-state goods. they contended, was such "linguistic legerdemain" that the legislature might as well have "define[d] a peddler to be one who deals in boots and shoes manufactured in Lynn, or salt produced in Syracuse."38In short, counsel emphasized that the statute was simply a protective tariffdisguised as a licensing law. Because peddlers of local products were exempt, the Missouri law was "not a tax on the occupation of selling, but a burden on the goods themselves."39 It followed, counsel concluded, that "[i]f this is a valid exercise of the taxing power, the legislature may wholly exclude . . . products of sister states; for a lawful exercise of a power knows no limitation except such as are to be found in the discretion of the lawmakers. "40 The Supreme Court concurred. Speaking through Justice Stephen Field, the Court readily conceded that under the Brown doctrine the Singer machines had lost their interstate character before their sale had become subject to the Missouri licensing law. Nevertheless, Field flatly asserted that Marshall's"guarded language" could not be expected to control disputes arising in an integrated national economy.41 Paraphrasingcounsel's brief, Field asserted that it was unnecessary to consult an economist to discern that "where the business or occupation consists in the sale of goods, the license tax required for its pursuit is in effect a tax upon the goods themselves."42 It was equally clear, Field added, that unless the "original package" doctrine were " Evans Casselberry, ed., The Revised Statutes of the State of Missouri (St. Louis, 1845), pp. 404-05. 36s State v. Welton, 55 Mo. 288 (1874). 37 James S. Botsford, M. M. Welton, Plaintiff in Error vs. The State of Missouri: Brieffor Plaintiff in Error (Jefferson City, Mo., 1875), p. 9. a S. M. Smith, M. M. Welton, Plaintiffin Error vs. The State of Missouri: Brieffor Plaintiff in Error (St. Louis, 1875), p. 5. 39 Botsford, Brief, p. 12. 40 Ibid., p. 13. 41 Welton v. Missouri, 91 U.S. 275 (1876)at 281. 42 Ibid., p. 278. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions MarketingStructure 641 modified, a barrageof interstate tariffwars, like those which had "depressed[the] conditionof commerceand [created]obstaclesto its growthpreviousto the adoptionof the Constitution... mightfollow, and the experienceof the last fifteen years showswould follow, from the action of some of the States."43Because of new developments in the structure of American marketing, he concluded, it had become necessary to extend Marshall'sBrown doctrine, and "to hold now that the commercial power [of Congress] continues until the commodity has ceased to be the subject of discriminating legislation by reason of its foreign character."" The protectionist impulse in the states was not easily curbed, and the Missouri case established only a beachhead for large-scale, vertically-integrated firms. As Harry N. Scheiber has demonstrated for the antebellum era, state governments were extraordinarilyadept at initiating successful "counterthrusts" to the Supreme Court's nationalistic doctrines.45 After the postwar marketing revolution, however, the ingenuity of local lawmakers rarely went unchallenged. Firms such as Singer whose interests were national in scope were quick to muster test cases in response to each new statutory innovation. Thus, in 1880 Singer's counsel was back in Washington to challenge a Virginia law enacted five years earlier. The measure disputed in Webber v. Virginia (1880) apparently was designed to compel Singer and all other out-of-state firms to disband their sales forces and deal exclusively with local wholesalers. Under the act, all salesmen who peddled "manufacturedarticles or machines . . . of other states or territories" were required to pay the state a license fee of $25 and an additional $10 fee in every county where they did a local business. Only distributors who actually owned products manufactured outside Virginia were exempt.46 For the Singer Company, whose Richmond agency supervised salesmen working door-to-door in a dozen surrounding counties, the Virginia law had a potentially disastrous effect. Nevertheless, the Virginia Court of Appeals sustained the statute, distinguishing the Missouri case on the ground that there was no discrimination against out-ofstate products as long as the manufacturerhad the option of distributing his wares through local wholesalers.47 Ibid., pp. 280-81. " Ibid., p. 281. Law 45 HarryN. Scheiber, "Federalismand the AmericanEconomicOrder, 1789-1910," and SocietyReview, 10 (1975),84. 46 Virginia,Acts of Assembly,1875-1876,p. 184. 47 Webber-v.Commonwealth, 33 Gradt.898 (Va. 1880). 4 This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions 642 McCurdy The Supreme Court, after having been briefed about Singer's organizational structure, voted unanimously to reverse the decision rendered below. Speaking again through Field, the Court disposed in a single sentence of the issue emphasized by the Virginia bench. "Sales by manufacturers," Field proclaimed, "are chiefly effected through their own agents. "48 Once the postwar marketing revolution had been thus ratified, the result flowed inexorably from the principles announced in Welton v. Missouri: It matters not whether the tax be laid directly upon the articles sold or in the form of licenses for their sale. If by reason of their foreign character the State can impose a tax upon them or upon the person through whom the sales are effected . . . she may place the tax at so high a figure as to exclude the introduction of the foreign article, and prevent competition with the home product. It was against legislation of this discriminating kind that the framers of the Constitution intended to guard, when they vested in Congress the power to regulate commerce among the several States.49 The last sentence above merits special attention, for it reveals in disarming fashion the degree to which I. M. Singer & Company had succeeded in fomenting a doctrinal revolution. As Field conceded, the framers of the Constitution had vested Congress-not the Court-with the authority to regulate interstate commerce. Nevertheless, the Court believed that the idea of a unitary national market would be nullified if large-scale firms were required to press Congress for relief each time the states disguised protectionist legislation in the form of licensing laws. As Justice Robert Jackson later observed, "the balkaniz[ing]" policies of state governments were just "too petty, too diversified, and too local to get the attention of a Congress hard pressed with other matters."50 The Court's decisions in the license-tax cases also marked a decisive break with prior doctrinal formulations. In Gibbons and Brown, the Marshall Court had curbed the states in order to protect rights that Congress had conferred on persons engaged in interstate and foreign commerce. Then, during the Taney era, the majority's concerns had shifted from protecting the prerogatives of Congress to maintaining the territorial integrity of the states. Consequently, the Taney Court tended to classify powers-taxation, police, commercial regulationand then assign control of public policy to the proper governmental agencies. The Cooley doctrine looked to the subject matter of state policies; since regulation of chattel slaves, prevention of disease or 48 49 50 Webberv. Virginia,103 U.S. 344 (1880)at 350. Ibid., pp. 350-51. Ducktorth v. Arkansas,314 U.S. 390 (1941)at 400. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions MarketingStructure 643 pauperism,and licensingof liquordealersand steamboatpilots were all "local"matters,the Taney Courthad held that they were subject to state laws. Once faced with questionsgeneratedby the rise of big business, however, the Courtbegan to conceptualizeissues in terms of free trade and free markets.In Welton and Webber, the Court looked to the incidence of state laws;if barriershad been erected to impede the inter-regionalflow of commodities, revenue measures were held to be invalid despite the fact that the states'power to tax had been "admit[ted]to have been reserved. .. [by] all the expounders of the Constitution."51 In effect, then, Singer'scounsel prompted the Courtto deduce fromthe commerceclause a new, fundamentally important constitutionalright: the right of American businessmen, even without congressionallicense, to engage in interstate transactionson terms of equality with local merchants and manufacturers. As late as 1885, the "freetrade"doctrinehad been appliedonly to state tax laws. Eventually, however, the rule formulatedin Welton spilled over and controlledthe Court'sposition on inspectionlaws. Appropriately,the key agents of the latter development were the "Big Four"meatpackers. The developmentof railroadrefrigerationexerted a revolutionary impact on the Americanmeat business.52For centuries priorto the 1880s,cattleand swine had been drivenon the hoof, and laterby rail, to highly localizedprocessingplants.When fresh meat was available, consumers knew it had been slaughterednearby. Beef and pork preparedfor interstateand foreign commerce had to be salted and barrelled,or cannedwith preservatives,in orderto prevent spoilage. The refrigeratorcar not only extended the potential market for dressed beef but, since unsaleableparts of the animalneed not be shipped, it also permittedthe processorto save up to 35 percent on freight costs. By combiningrefrigerationwith mass-processingtechniques and a strategic location amidst the Chicago stockyards,the "BigFour"packerswere able to ship dressedbeef thousandsof miles and still undersell local butchers by a substantialmargin. The combinationof factorsthatenabledChicagopackersto obtaina virtual monopolyon the dressed-beeftrade is still a matterof some dispute among scholars.53In testimony taken at St. Louis in 1888, 51 BeaUv. State, 4 Blackf.107 (Indiana1835)at 109. MaryYeagerKujovich,"Te RefrigeratorCarand the Growthof the Anerican Dressed Beef Industry,"Business HistoryReview, 44 (1970),460-82. 53 See e.g., RudolfA. Clemen, The AmericanLivestockand Meat Industry (New York, 52 This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions 644 McCurdy however, a Senate Select Committee discovered that old-style local butchers believed almost unanimously that the "Big Four" packers had conspired to "freeze out" all competitors.54 Chicago packers, the small-scale butchers testified, had extorted from carriers special rates for handling refrigeratorcars; they had ordered their wholesale agents to employ predatory pricing tactics in local markets; and they had conspired with the stockmen's commission merchants to ensure that live cattle were sold only by the carload. Witness after witness nevertheless informed the senators that no federal intervention was necessary. A national organization, the Butcher's Protective Association, had been created, they explained, and it intended to seek relief in the several state legislatures. One witness, Detroit butcher John Duff, testified as follows: Q. What is your remedy for it [collusion among Chicago packers]? -A. Give us a livestock inspection, and when meats are not inspected do not allow them. to be sold. Q. Do you want State or national inspection? -A. Give us State inspection. Q. Do you think that a State inspection would be all that would be necessary? -A. I think so. I think it would cover the case. Q. You think that would cover all the evils. -A. Yes, sir.55 The small packers' faith in the efficacy of state action should not be surprising: the Butcher's Protective Association's model statute prohibited the sale of dressed beef, mutton, or pork unless it had been inspected by state officials twenty-four hours before slaughter. In short, the B.P.A. proposed to banish the "Big Four" packers from all but the Chicago market. In 1889, the B.P.A. persuaded lawmakers in Minnesota, Indiana, and Colorado to enact their panacea for monopoly in the dressed-beef trade.56 Bills providing for pre-slaughter inspection failed to pass in a score of other states because, according to one proponent, "of the presence of a powerful lobby representing the most colossal monopoly, perhaps, that any government was ever confronted 1923); Richard J. Arnould, "Changing Patterns of Concentration in American Meat Packing, 1880-1963," Business History Review, 45 (1971), 18-34; Robert Aduddelland Louis Cain, 'Location and Collusion in the Meat Packing Industry," Business Enterprise and Economic Growth: Essays in Honor of Harold F. Williamson, Louis P. Cain and Paul L. Uselding, eds. (Kent, Ohio, 1973), pp. 85-117. 54 U.S. Senate, Testimony Taken by the Select Committee on the Transportation and Sale of Meat Products to Accompany Senate Report No. 829, 51st Congress, 1st Session (Serial 2705). 55 Ibid., p. 156. " Minnesota, Laws, 1889, p. 51; Indiana, Laws, 1889, p. 150; Colorado, Laws, 1889, p. 244. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions MarketingStructure with."57Where 645 lobbying had proved ineffective, however, the "Big Four"had no choice but to ignorethe inspectionlaws;thus theirlocal agents were promptly indicted by state authorities.Within a year the leading case of Minnesotav. Barber(1890)was on the docket of the Supreme Court. The lawsuit was so vital to the interests of Indiana butchers that the state's attorney general asked for, and received, the Court'spermissionto join his Minnesotacounterpartin defending the statutes. Counsel for Minnesotaand Indiana presented compelling arguments. Inspectionlaws had long been used by the states to improve their producers'competitive position, and the framersof the Constitutionhad deemed inspectionmeasuresto be of such greatimportance to local economiesthat the states'power to enact them, and to chargefees for their operation,had been expresslyrecognizedin the Constitution.In Gibbons v. Ogden, Chief Justice Marshallhad accorded furtherlegitimacyto existing practicesby observingthat the states'powerto enact inspectionlaws had "not[been] surrenderedto the generalgovernment"despite the fact that they "m[ight]have... a considerableinfluenceon commerce."58 Moreover,counselargued, as late as 1878the Courthad quoted Marshall'slanguagein an opinion that sustained a Kentuckylaw providingfor pre-sale inspection of illuminatingoil manufacturedin St. Louis.59But in the event longaccepted constitutionalconstructionand the weight of precedent were not enough, counsel for Minnesotaand Indianaalso implored the Court to take judicial notice of what they considered to be a well-establishedscientific fact. Studies of diseased meat, including one cited in the Senate Select Committee'sown reportto Congress, demonstratedthat offreshbeef,veal,mutton,lamborpork... to tell, by aninspection it is impossible thatan whetheror not it camefromanimalsthatwerediseasedwhenslaughtered; is on thehoof,withina veryshorttimebeforetheanimalsareslaughtered inspection withcertainty.Y? the onlymodeby whichtheirconditioncanbe ascertained 57 GordonE. Cole,In the Matterof theApplication of HenryE. Barberfora Writof Habeas Corpus:Pointsand Authoritiesfor Appellant(St. Paul, 1889), p. 43. 58 59 Gibbons v. Ogden, 9 Wheat. 1 (U.S. 1824) at 203. Pattersonv. Kentucky,97 U.S. 501 (1878). 60 LouisT. Michener,Briefin Behalfof Appellantsin the Matterof HenryE. Barberfora Writ of HabeasCorpus,Filed by Leaveof the Court and Consentof the PartiesHerein, by Counselfor the State of Indiana (Indianapolis, 1889), pp. 30-31. See also Dr. Henry Behrend, "Diseases from Butcher's Meat," Nineteenth Century, 26 (1889), 409; U.S. Senate, Report of and Saleof MeatProducts,SenateReportNo. 829, the SelectCommitteeon the Transportation 51st Congress, 1st Session (Serial 2705), p. 26. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions 646 McCurdy And science, it was argued, only confirmed what common sense suggested: "The examinationof the hind quarterof an ox will not detect tubercles in.his lungs or canceroustumorsupon his neck."61 Counsel for the defendant, an Armouragent, filed a remarkably candidbrief.They agreedat the outset thatall the inspectioncaseson the books supported their opponent's position. Having made that concession,however,they urgedthe Courtto "bearin mind"its prior decisions in the license-tax cases and to recognize that unless the principles laid down in Welton were extended, the idea of a freetrade unit would necessarilybe sacrificedat the altarof plenarystate inspectionpower. "Ifthe State [of Minnesota]can prohibitinterstate commerce in beef, unless the livestock is first inspected therere" counsel for Armourcontended, it mayin fishunlessthey arefirstinspectedwhen caught.It mayin butterandcheese and milk and leather, unless the cow fromwhich they are drawnis first inspected therer. It may in wool and all clothing made from it, unless the sheep is first inspectedtherer. It mayin cottonand clothingmadefromit, unless the cottonand the groundthatproducesit is inspectedin Minnesotabeforethe cottonis picked;and there is no productof the agricultureor manufactureof other Statesthat this State may not thus exclude;none of this State that every other may not exclude.62 The paradeof horribleslikely to proceed from an affirmativeruling thus laid bare, counsel took up the problem of whether the Court ought to take judicialnotice of the scientificstudies adducedby the states'attorneysgeneral. Counsel'stacticson this issue were extraordinary. Rather than attempting to rebut the contention that only pre-slaughter inspection was effective, counsel emphasized that "freshmeats consumedby Minnesotanswere never inspected on the hoofby Stateor city inspectorsbeforeApril, 1889, andyet population has increasedand the death rate has been low."63 It followed, counsel concluded,that the Minnesotastatutemust have been enactedto protect the competitive position of local butchers rather than to promote the public health. The SupremeCourtconcurredwith Armour'scounsel. The propositions Justice Field had formulatedin Welton, ratherthan previous cases involving inspection laws, controlledits decision. We cannot "shut our eyes," JusticeJohn MarshallHarlandeclaredfor a unanimous Court, "to the fact that the act, by its necessaryoperation.. 61 Cole, Pointsand Authoritiesfor Appellant,p. 9. WalterH. Sanborn,In the Matterof the Applicationof HenryE. Barberfor a Writof HabeasCorpus:Pointsand Authoritiesfor Respondent(St. Paul, 1889), p. 49. 63 Ibid., p. 48. 62 This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions MarketingStructure 647 directly tends to restrict the slaughteringof animals . . . to those engaged in such business in that State."" Moreover, Harlan observed, there was "no real analogy"between the pre-slaughterinspection laws and the Kentuckyinspection statute the Court had sustained12 years earlier. Pre-saleinspectionof illuminatingoil was "neitherunusualor unreasonable,"nor did implementationof that law ineluctably discriminateagainst commodities "because of the locality of production." As for the "alleged" necessity for preslaughterinspection, the Court concluded disingenuously,"we are not awarethat such is the view universally,or even generallyentertained."65If governmenthad a duty to protectconsumersagainstthe dangersof unwholesomemeat, as counsel for Minnesotaand Indiana had indicated, another strategywould have to be pursued.66 The obviousremedyforotherwiselegitimateconcernsaboutpublic healthwas, of course,the creationof a federalinspectionforce. But in Barber, as in the license-taxcases, the Courtcorrectlyperceivedthat unless the federaljudiciarysupplied the voice of Congress, federal lawmakerswouldnot move with dispatch,if at all, to displacediscriminatorystate regulationswith a uniformrule. The reportof the Senate Select Committee, which appeared two weeks before Barber was decided, lookedto state actionfor protectionof Americanconsumers and recommendedfederalinspectiononly of meat productsprepared for export.6f7Not until five weeks after the Court had spoken did Congressappropriatethe meat inspectionprovisionsof a comprehensive pure food bill destined to die and tack them on to the Select Committee'sbill.68The CourtthereforeforcedCongressto applythe same solution for state barriersagainst "Big Four" meat that the " Minnesotav. Barber, 136 U.S. 313 (1890)at 322-23. Ibid., pp. 327-28, 321. " The "BigFour"packers,like I. M. Singer& Co., hadto contendwith "counterthrusts" by the state legislatures;counsl for Armour& Co. was backin courta year later to challengea Virginiastatutethatprovidedfor post-morteminspectionof all dressedbeef slaughteredmore than100milesfromthe placeof saleandalsorequiredthe processorto paythe costof inspection (Virginia,Actsof Assembly,1889-1890,p. 63). The Court,againspeakingthroughHarlan,held that "the heavy [inspection]charge of one cent per pound"was, "in reality, a tax"which divestedout-of-statepackersof the rightto "competeuponequal termsin the marketsof that v. Rebman,138U.S. 78 [1891]at 81-82).The lastB.P.A.-sponsored (BrImmer Commonwealth" law to fall was the Coloradostatute(cited at note 56), which was struckdown in Schmidtv. People, 18 Colo. 78 (1892). p. 40;CongressionalRecord,51st Congress, 67 U.S. Senate,Reportof the SelectCommittee, 1st Session(1890),pp. 3056-58,5928-31.The internationaldimensionsof the meat-inspection issue arethoroughlytreatedin JohnL. Gignilliat,"Pigs,Politics,andProtection:The European Boycottof AmericanPork,1879-1891,"AgriculturalHistory,35 (1961),3-12; RichardPerren, 'Te NorthAmericanBeefand CattleTradewith GreatBritain,1870-1914,"EconomicHistory Review, 24 (1971),430-44. 68 OscarE. Anderson,TheHealthof a Nation:HarveyW. Wileyand theFightfor PureFood 65 This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions 648 McCurdy Select Committee had prepared already for European barriers against all American meat. The Federal Meat Inspection Service, established in 1891, was authorized to conduct pre-slaughter and post-mortem inspections of meat products produced for interstate and foreign commerce alike.69 IV The Supreme Court's commerce clause decisions of the 1875-1890 period were of immediate importance to large-scale manufacturersand had an enduring influence on American economic growth, for they firmly established the Supreme Court's role as the umpire of the nation's free-trade network. Even Justice Oliver Wendell Holmes, a persistent critic of many late-nineteenth-century decisions, ardently believed that review of state commercial regulations was an essential judicial function. "I do not think the United States would come to an end if we lost our power to declare an Act of Congress void," he announced in 1913. [But] I do think the Union would be imperiled if we could not make that declaration as to the laws of the several States. For one in my place sees how often a local policy prevails with those who are not trained to national views and how often action is taken that embodies what the commerce clause was meant to end.70 Holmes's suggestion that the commerce clause was "meant to end" discriminatory state policies was, as we have seen, correct only insofar as the Constitution empowered Congress to intervene. Before the Court could establish fully its claim to monitor the free-trade unit in the silence of Congress, two prerequisites had to be fulfilled. First, the Court had to be apprised by skillful counsel of the growth-eroding potential of state laws and to be persuaded that new juridical principles must be forged to preserve free trade among the states. Second, the legitimacy of protectionist state legislation had to be challenged by litigants with sufficient resources to finance scores of lawsuits in order both to secure initial favorable decisions and to combat the tendency of state governments to mobilize "counterthrusts" against the Supreme Court's nationalistic doctrines. For students of the NAACP's operations in the twentieth century, neither of these (Chicago, 1958), p. 78; Congressional Record, 51st Congress, 1st Session (1890), pp. 5674, 6514, 10191. 69 United States Statutes at Large, XXVI, p. 1089. See also A. D. Melvin, 'The Federal Meat-Inspection Service," Twenty-Third Annual Report of the Bureau of Animal Industry (Washington, D.C., 1908), pp. 65-99. 70 Oliver Wendell Holmes, Collected Legal Papers (New York, 1920), pp. 295-96. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions MarketingStructure 649 caveatsis apt to be startling.But their implicationsfor the development of a nationalmarketsupervisedby appellatecourtswere simply enormous.What the NAACPLegal Defense fund accomplishedfor blackAmericansunder the FourteenthAmendmentin the twentieth century,the legal-defensewarchests of I. M. Singer& Companyand the "Big Four" meatpackersaccomplishedfor vertically-integrated corporationsunder the commerce clause between 1875 and 1890. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 12:56:36 PM All use subject to JSTOR Terms and Conditions Economic History Association Exclusive Dealing and the Whiskey Trust, 1890-1895 Author(s): Werner Troesken Source: The Journal of Economic History, Vol. 58, No. 3 (Sep., 1998), pp. 755-778 Published by: Cambridge University Press on behalf of the Economic History Association Stable URL: http://www.jstor.org/stable/2566623 . Accessed: 17/11/2013 11:31 Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp . JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org. . Cambridge University Press and Economic History Association are collaborating with JSTOR to digitize, preserve and extend access to The Journal of Economic History. http://www.jstor.org This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 11:31:11 AM All use subject to JSTOR Terms and Conditions Exclusive Dealing and the WhiskeyTrust, 1890-1895 WERNERTROESKEN This articleuses the historyof the WhiskeyTrustto explorethe competitiveeffects of verticalrestraintssuch as exclusivedealing.The WhiskeyTrustdistilledalcoholic spirits and bribed distributorsnot to carry competing brands of spirits. For the WhiskeyTrust,exclusivedealingwas an ineffectivepredatorystrategy.Despite the trust's marketdominanceand manifold predatorystrategies,it failed to preempt entry.The trustfailed,in part,becauseits rivalscouldverticallyintegrateat low cost. Competitiondisciplinedthe trustmoreeffectivelythandid numerousantitrustsuits. ome economistsarguethatfirmsuse verticalrestraintsto increasetheir rivals' costs and deter entry.' Considera frequentexclusive dealing arrangement:contractsrequiringdistributorsto carryonly the productsof A largemanufacturer a particularmanufacturer. mightuse such contractsto undercutthe ability of his rivals to compete. If the manufacturercontrols This becomes distribution,his rivalshave to opentheirown distributorships. S a costly endeavor when distribution outlets are scarce. Other economists, however, argue that vertical restraints promote efficiency. Among other things, vertical restraintsmight protect relationship-specific investments and prevent competitors from free riding on a firm's advertising expenditures.2 Moreover, even if firms use vertical restraints strategically, it is not clear thatsuchrestraintspromotesubstantialmarketpowerover the long run.The debate over vertical restraintsand exclusionarypracticesis a subset of a largerdebateover the abilityof firmsto use strategicbehaviorto createand sustainmarketpower. Although the ratio of theory to evidence is high, there is a growing empirical literature on the competitive effects of vertical restraints.3This article presents a case study on the Whiskey Trust to explore the sources and consequences of exclusive dealing. Exclusive dealing has received scant empiriThe Journal of Economic History. Vol. 58, No. 3 (Sept. 1998). C The Economic History Association. All rights reserved. ISSN 0022-0507. Werner Troesken is Associate Professor of History and Economics, Department of History, University of Pittsburgh, Pittsburgh PA 15260. e-mail: troesken+@pitt.edu I gratefully acknowledge helpful comments from Patty Beeson, Karen Clay, Dave DeJong, Martin Gaynor, Jim Lesage, John Murray,Timothy Sass, Lester Telser, seminar participants at the University of Toledo, and two anonymous referees from this journal. The usual disclaimer applies. 'Krattenmaker and Salop, "Competition"; and Salop and Scheffnan, "Raising Rivals' Costs." 2On general efficiency arguments, see Bork, Antitrust Paradox, pp. 193-207; Posner, Antitrust Law, pp. 171-205; Lopatka and Godek, "Another Look"; and Masten and Snyder, "United States." See also, Mathewson and Winter, "Competitive Effects." For advertising and exclusive dealing, see Marvel, "Exclusive Dealing." 3See, Granitz and Klein, "Monopolization"; Lopatka and Godek, "Another Look"; Masten and Snyder, "United States"; and Sass and Saurman, "Mandated Exclusive Territories." 755 This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 11:31:11 AM All use subject to JSTOR Terms and Conditions 756 Troesken cal attention, case study or otherwise. The Whiskey Trust distilled alcoholic spirits. It sold the spirits to rectifying houses who blended them with flavorings to produce various brand-name whiskies. Rectifying houses then sold the brand-name whiskey to wholesalers who distributed the whiskey to consumers and retailers. During the early 1890s, the Whiskey Trust conducted an unusual experiment in exclusive dealing. The trust did not contract with the rectifying houses who bought its spirits; it contracted with the wholesalers who bought the rectifiers' brand-namewhiskies. Starklyput, the trust bribed wholesalers not to distributerectified whiskey made with spirits from nontrust distilleries. Less starkly,it offered wholesalers substantial rebates if they would deal only with those rectifiers who purchased trust-distilled spirits. The experience of the Whiskey Trust suggests that exclusive dealing is an ineffective predatory strategy. Despite the trust's market dominance and manifold predatory strategies, its rebate program failed to preempt entry. The rebate program failed, in part, because the trust's rivals could vertically integrate at low cost. Competition disciplined the trust more effectively than did the numerous state and federal antitrust suits brought against the trust and its rebate program. Although the story of the Whiskey Trust bears primarily on the debate over exclusive dealing, it has implications for other debates as well. It contributesto the debate over the effectiveness of antitrust regulation; it contributes to a growing literature on state regulation; and it sheds light on nagging questions about the late-nineteenth-century trust movement.4 For example, it explores some of the competitive strategies employed by the trusts. Also of particularinterest is the article's analysis of the price of spirits over time. Previous studies of the trusts have been able to present only limited evidence on the trust movement's effect on prices. Much of the evidence for this study comes from an investigation conducted by the United States Industrial Commission in 1899. Appointed by Congress to investigate large industrialtrusts, the IndustrialCommission included prominent economists and academics. Perhapsthe best-known member of the commission was Jeremiah Jenks, who wrote several books and articles about the trusts and other pressing economic questions.' 4The literature on the desirability of antitrust regulation is voluminous. I cite only a few examples. Kovaleff(Antitrust Impulse) presents a series of essays that generally agree that antitrust regulation is effective and necessary. Stigler ("Economic Effects") argues that the antitrust laws have been, at best, mildly effective. Bittlingmayer ("Stock Market")argues that antitrustregulation is pernicious. See also the brief survey of empirical studies of antitrustin Troesken, "AntitrustEnforcement."A growing number of economists and economic historians have come to appreciate the need for greater study of state regulation during the late nineteenth centuty. Several of the essays found in Goldin and Libecap's Regulated Economy illustratethis. There are a range of interpretations of the trust movement. See, for example, Chandler, VisibleHand; Lamoreaux, Great Merger Movement; James, "Structural Change"; Libecap, "Rise"; McCraw, Regulation; and Telser, Theory, pp. 19-40. 'See U.S. House, Industrial Commission Reports. Hereafterreferred to as ICR. For a survey of how economists during this period saw the trusts, see DiLorenzo and High, "Antitrust." Other sources used This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 11:31:11 AM All use subject to JSTOR Terms and Conditions Exclusive Dealing and the WhiskeyTrust 757 THE STRUCTUREOF THE WHISKEYINDUSTRY Therewere two typesof whiskey,straightwhiskeyandrectifiedwhiskey. StraightwhiskeyincludedKentuckybourbonandrye whiskey,the latterdistilled almostentirelyin Pennsylvaniaand Maryland.Straightwhiskey was distilled from corn, rye, and malt. It requiredat least threeyears of aging. The best whiskiesagedin oakbarrelsfor up to seven years.Aboutone-third of all whiskeyproducedin the UnitedStateswas straightwhiskey.Cheaper and poorer tasting than straightwhiskey, rectified whiskey requiredno aging. It was madeby blendingalcoholic spiritswith water,brownsugar,a small amountof straightwhiskey, and other flavorings.Industryofficials claimedthatrectifiedwhiskey did not competewith straightwhiskey.The two served separatemarkets.The marketsfor both rectifiedand straight whiskeywere large.Duringthe late nineteenthcentury,per capitawhiskey consumptionaveragedover one gallon a year.6 The productionand distributionof rectifiedwhiskey can be dividedinto fourstages.In stageone, distillersmadealcoholicspirits,whichweretheprimaryinputin rectifiedwhiskey.Spiritshad virtuallyno otheruse except as an inputformakingwhiskey.Distillersfermentedcornintoalcohol,thenran the undilutedalcohol throughcharcoalto removevariousoils and flavors, leavingspirits.Spiritswerehomogeneous.As one industryofficialobserved, "therewas no such thing as a brandof spirits."Besides a small amountof maltused to initiatefermentation,cornwas the primaryinputinto spirits.7 In stagetwo, rectifyinghousesblendedthe spiritswith flavoringaccording to theirrespectivetrademarks andbrandnames.Brandnamesandtrademarks may have helped assure quality.Rectifying, the IndustrialCommission argued,was more profitablethandistillingbecausebrandnames differentiatedvariousrectifiedwhiskies.Rectifiersalsoperformedthe importanttask of removing fusel oil from the spirits.Containingsmall amountsof amyl, butyl,andpropylalcohol,fuseloil was poisonous.In stagethree,wholesalers purchasedwhiskeyfromrectifyinghouses andthendistributedthe whiskey to retail outlets. In stage four,retailoutlets sold the whiskey to final consumers.8 Licensing requirementsincreasedthe costs of integratingacross these stages. Testifyingbefore a Congressionalinquiryin 1893, J. B. Greenhut, include newspaper accounts, court reporters, and a Congressional investigation of the trust conducted in 1893. See U.S. House, Whiskey TrustInvestigation. Hereafter referred to as Whiskey Trust. 6ICR, pp. 75-79, 168, 204-05, 258, and 842-43. 7ICR, pp. 168 and 835. 8ICR, p. 75. Some observers claimed that rectifying houses adulterated their whiskey by watering it down excessively and by flavoring it with unhealthy chemicals. The truthfulness of such claims appears dubious. See ICR, pp. 75-76, 204-05, 230-31 and Whiskey Trust, pp. 3-24, 43, 82-98. See also, High and Coppin, "Wiley." High and Coppin provide much information about the nature of the whiskey industry and about claims of "impure" whiskey. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 11:31:11 AM All use subject to JSTOR Terms and Conditions 758 Troesken the president of the Whiskey Trust, explained that if a distiller acted as a rectifier "in any shape, form, or manner,"the internal revenue would seize all of its property. Greenhut continued: "There are two kinds of licenses which the Govenment issues, one a rectifying license, which is more expensive, and the other is a wholesale liquor dealer's license. The ordinary wholesale dealer does not rectify."9These licensing requirements forced a firm operating at one stage of the production process to incorporatea separate company to operate at another stage of production. For example, wholesalers often incorporated separate organizations to operate distilleries. Although the wholesaler may have owned and operated the distillery, the distilling and wholesaling operations were legally and organizationallydistinct. In light of the stages of production described previously, the phrase "Whiskey Trust"is a misnomer. The trust did not operate at stage two, rectifying brand-name whiskey, as the phrase Whiskey Trust suggests. The trust's fornal name, the Distilling and Cattle Feeding Company, is more accurate. A combination of distillers, the trust made alcoholic spirits. Most distilleries located around Peoria, Illinois. By locating around Peoria, a region rich with corn, distillers avoided the costs of transporting a key input. Another importantconsiderationwas the region's water supply. Peoria had a limitless "supply of cold water running at a temperature of about 54" degrees. Watertemperaturewas a "dominant factor" in distilling and 54 degrees was near perfect.10 The federal government taxed domestic and imported spirits. The import tariff was so large that the United States did not import any spirits or rectified whiskey. This insulated distilleries from foreign competition and protected all but the most expensive brands of straight whiskey.11 Only the highest grades of foreign straight whiskies were imported. The tax on domestic spirits was also large. During the late 1890s, the federal tax on spirits was $1.10 per gallon. At the time, it cost 8 to 15 cents to produce one gallon of spirits. A vibrant trade in illicit spirits grew from the tax. There are, unfortunately,no precise data on the production of stills. The InternalRevenue Service, which collected the tax, only reported the number of illicit stills seized. By the late 1890s internalrevenue agents were seizing two thousand stills per year. Tax-paying distillers claimed that the internalrevenue discovered only a "small proportion" of all illicit stills. 12 9Whiskey Trust,p. 43. '?Information and quotations, from ICR, pp. 201-02. "During the nineteenth century, many observers argued that tariffs allowed the trusts to form and raise prices. For example, during the Congressional debate over the Sherman Antitrust Act, many Democrats advocated lowering the tariff as a means of combating monopolistic trusts. If the tariff were lowered, only trusts based on genuine cost efficiencies would have formed. See DiLorenzo, "Origins"; DiLorenzo and High, "Antitrust";and Grandy, "Original Intent." '2ICR, pp. 90-91 and 817-40. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 11:31:11 AM All use subject to JSTOR Terms and Conditions Exclusive Dealing and the WhiskeyTrust 759 Industry observers argued that barriers to entry were low. According to the Industrial Commission, "the cost of establishing a new distillery" was "slight." "The ease with which new distilleries" were established made it "almost impossible" for the trust to hold "control of the business." Only if distillers "keptprices low," the commission explained, would they not "provoke competition." It is surprising that industry observers described entry as easy, because there were a number of factors that otherwise would have inhibited entry, including evidence of scale economies in distilling; licensing requirements; and brand name loyalty."3There was, however, one type of entry that clearly was easy and low-cost: the creation of small and illicit stills. Competition from illicit stills may have constrained the trust. THE ORIGINSOF THE WHISKEYTRUST Distillers began forming pools during the early 1880s. Through pooling arrangements, distillers agreed to limit their production. The pools failed because of market entry and the absence of effective sanctions for members who defected. In 1887, after pooling had failed, distillers organized the Distillers and Cattle Feeders' Trust. Unlike many other combinations that were also called trusts, the Distillers and Cattle Feeders' Trust was a bona fide trust. Distillers who agreed to join the trust gave their stock to a board of trustees. The trustees, in return, gave the distillers certificates representing their shares in the trust. Once a distiller joined the trust, it was supposed to follow the managerial decisions of the trustees. Of the 86 distilleries that eventually joined the trust, the trust kept only 10 or 12 operating and shut down the others. Sometimes the distilleries the trust shut down would reopen and compete with the operatingmembers of the trust. To prevent this, the trust often leased the ground and plant of member distilleries for up to 25 years. It would then remove or destroy the machinery in the plant, leaving the distillery inoperative.14 During the 1880s state courts raised questions about the legality of trustarrangements.Fearingthat state courtswould eventually disbandits trustagreement, the Distillers and Cattle Feeders' Trust reorganized as an Illinois corporation, the Distilling and Cattle Feeding Company, in 1890. Though the 13See ICR, pp. 81 and 87 for quotations regarding barriers to entry. On economies of scale, see James, "StructuralChange," p. 445; and ICR, pp. 88-89. For a critical analysis of the concept of entry barriers, see Demsetz, "Barriers." 14ICR, pp. 76, 168-69, 220, and 828. On the relationship between price wars and pooling, see Lamoreaux, Great Merger Movement; and Porter,"Study." On pools as antecedents of large industrial combinations, see Lamoreaux, Great Merger Movement. As to why the trust shut down some distilleries, Charles A. Clarke, who operated a trust-affiliated distillery, said that the Whiskey Trust economized on costs by shutting down or scaling back production from inefficient and poorly located plants. Samuel M. Rice, a distributerfor the trust, and John McNulta, suggested that the trust wanted to reduce output and drive up prices. For Clarke's testimony, see ICR, pp. 170. For the testimony of McNulta, see ICR, pp. 196-97, 203, and 216. For Rice's testimony, see ICR, p. 832. See also, ICR, pp. 88-89. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 11:31:11 AM All use subject to JSTOR Terms and Conditions Troesken 760 people continuedto call new companyhadabandonedthetrustarrangement, it the WhiskeyTrust.Afterit reorganizedandthe WhiskeyTrustcontinued to expandits controlover the whiskey industry.Duringthe early 1890s it bought six new distilleries,includingtwo Chicago distilleries that were among the largestfive distilleriesin the world.Withthese acquisitions,the trustcame to produce95 percentof all the spirits(legally)producedin the United States.'5 A DESCRIPTION OF THE REBATE PROGRAM In the summerof 1890 the trustbegan its exclusionaryrebateprogram. Under the programthe trustpaid wholesalersa large rebateif they purchasedwhiskeyexclusivelyfroma selectgroupof rectifyinghouses. Every time a wholesalerpurchasedwhiskey from a trust-selectedrectifier,the wholesalerreceiveda voucher.If, aftersix months,the wholesalerhadpurchasedonly from trust-selectedrectifiers,the wholesalercould redeemthe voucherfor a rebate.The size of the totalrebatewas based on the amount of spirits containedin each brandof whiskey. Supposea wholesalerpurchasedten gallonsof whiskeyfroma trust-selectedrectifier.If thoseten gallons of whiskey containednine gallons of spirits,the whiskey would have contained"nineproofgallons."Between 1890 and 1891 the trustset the rebate at five centsperproofgallon. Between 1891 and the summerof 1894, it raisedtherebateto sevencentsperproofgallon.Duringthe fall andwinter of 1894the trustreducedtherebateto two centsperproofgallon.Compared to the priceof spirits,the rebatewas substantial.At the time, the before-tax price of spiritsrangedfrom 10 to 30 centsper gallon;the after-taxprice of spirits ranged from $1 to $1.20.16 Cheating-wholesalers buying from nontrustrectifiers and then redeeming their rebate vouchers anyway-was a potential problem. Monitoring costs, however, were not prohibitive. The InternalRevenue Service required wholesalers to keep detailed records of all of their purchases. If wholesalers failed to keep these records, or kept them inaccurately, they risked having "5Forthe court cases raising questions about the legality of the trust, see State v. Nebraska Distilling Company et al., 29 Neb. 700 (1890); People v. The American Sugar Refining Company, 7 Ry. & Corp. L.J. 83 (1890); State v. American Cotton-Seed Oil Trust, 40 La. Ann. 409 (1888); People v. Chicago Gas Trust Company, 130 Ill. 268 (1889); and People v. North River Sugar Refining Company, 121 N.Y. 582 (1890). For an analysis of the effectiveness of these suits, see Troesken, "Antitrust Enforcement." Also, testifying before the IndustrialCommission, Charles Clarke explained: "the New York courts had declared the sugar trust an illegal combination; and in order to avoid the same thing ... we organized the corporation known as the Distilling and Cattle Feeding Company." Quoted in ICR, p. 171. For growth of the Whiskey Trust, see ICR, pp. 75-90 and the discussion of the Shufeldt distillery later in the article. '6ICR, pp. 84, 171-72, and 241-42; and the following court cases: Olmstead et al. v. Distilling & Cattle Feeding Co., 67 F. 24 (1895); Olmstead v. Distilling & Cattle-Feeding Company; Graves v. Same; Bayer v. Same; 73 F. 44 (1895). This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 11:31:11 AM All use subject to JSTOR Terms and Conditions Exclusive Dealing and the WhiskeyTrust 761 their operating licenses revoked. The trustmonitored wholesalers with these records. 17 Beyond the wholesale rebate, the trust also offered a rebate to rectifiers. This rebate, however, was not explicitly exclusionary. For every gallon of spirits they purchased, trust-selected rectifying houses simply received two cents off the list price of spirits. They received the rebate whether or not they purchased exclusively from the trust. However, trust-selected rectifiers faced a strong incentive to continue buying most of their spirits from the trust. If they stopped, or bought too much from competing distilleries, they ran the risk that the trustwould remove them from the wholesale rebate program. Rectifiers did not want to be removed from the program, because the trust gave participatingrectifiers market power by subsidizing distributors' purchases from them.'8 The Whiskey Trust abandoned the rebate plan when it entered receivership in January 1895. The trust reorganized as the American Spirits Manufacturing Company in August 1895. Instead of reviving the rebate plan, American Spirits chose a new form of vertical integration. In January 1896 American Spirits organized another,separatecompany, the Spirits Distributing Company. The Spirits DistributingCompany was a combination of rectifying houses. American Spirits organized the company "as a means for securing the control of the [rectifying] business." According to the Industrial Commission, "all of the common stock" of the Spirts Distributing Company "belonged to the American Spirits Manufacturing Company." American Spirits also under-wrote all of the preferredstock of the Spirits Distributing Company.19 INTERPRETINGTHE REBATEPROGRAM How Historical Observers Saw the Rebate Program The Industrial Commission asked John McNulta, the court-appointed receiver of the Whiskey Trust, how he thought the rebate program affected the whiskey business. McNulta answered: "I do not think its effect was good. It demoralized the trade and created bad feeling among the customers, so that there was a general disposition to get out of it." McNulta continued, explaining that the trust startedthe rebate system at a time when it had control over "almost the entire market." "There was," McNulta claimed, "no alternative for buyers except to start distilleries of their own, and so they submitted to it, but always regardedit as a great burden" [emphasis added]. 17See ICR, pp. 83-84 and 172. "8Ibid.,pp. 84, 171-72, and 241-42; and the following court cases: Olmstead et al. v. Distilling & Cattle Feeding Co., 67 F. 24 (1895); Olmstead v. Distilling & Cattle-Feeding Company; Graves v. Same; Bayer v. Same; 73 F. 44 (1895). 191CR,pp. 78 and 835. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 11:31:11 AM All use subject to JSTOR Terms and Conditions 762 Troesken When asked, "Did the company institute the rebate system solely for the purpose of controlling the output?"McNulta answered "Yes." Investigators then asked McNulta if wholesalers would ever again consent to an exclusive rebate system. McNulta testified: "I think it hardly possible ever to start the rebate system again, at least within the memory of the men who had experience with it." Other witnesses before the IndustrialCommission agreed with McNulta's assessment of the rebate program.20 McNulta's testimony implies that the trust used the rebate program to increase its marketpower. However, it is not clear from this testimony how the rebate program would have succeeded in this. The testimony also suggests that wholesalers and rectifiers were dissatisfied with the rebate program and wanted the trust to abandon it. This is puzzling. If wholesalers and rectifiers did not like the rebate program, why did they consent to it? The discussion below clarifies these issues. The Rebate Program in Light of CurrentEconomic Theory In the usual anticompetitive story, manufacturersuse exclusive dealing to foreclose scarce distributing outlets. This makes it costly for new firms to enter. If new companies decide to enter, they must do so as vertically integrated enterprises, operating both as manufacturersand as distributors, because incumbents have tied up all distributingoutlets. The Whiskey Trust's rebate program went the usual story one better. If new distilleries wanted to enter, they not only needed to integrateone step forward, into rectifying, but two steps forward, into rectifying and wholesaling. Suppose a new distillery opened. Large rectifying houses that participated in the trust's rebate program would have been reluctantto purchase the new distillery's spirits. If they did, they ran the risk of the trust removing them from their list of selected rectifiers. Rectifiers did not want to be removed from the list because the rebate program gave them marketpower-by subsidizing wholesalers' purchases from specified rectifying houses, the rebate program made the specified rectifiers more attractive to wholesalers. Even if the new distiller managed to find a rectifier to purchase its spirits, that rectifier would have had a hard time finding a wholesale outlet for his whiskey. After all, wholesalers had a strong incentive to purchase only from trustselected rectifiers. With few wholesale outlets and limited demand for its whiskey, the rectifier would, in turn, have had only a limited demand for the new distillery's spirits. In this way the rebate programraised the costs of entry and insulated the Whiskey Trust from competition. Protected from competition, the trust 20A11of McNulta's statements are taken from ICR, p. 207. For the testimony of others documenting McNulta's statements, see ICR, pp. 172, 181, 241, and 815. See also, Whiskey Trust, p. iii. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 11:31:11 AM All use subject to JSTOR Terms and Conditions Exclusive Dealing and the WhiskeyTrust 763 could have increasedthe priceof spirits.Dependingon the size of the price increase,the rebateprogramcould have left rectifyinghouses and wholesalersworse off. An increasein the priceof spiritswouldhave increasedthe costs of rectifying.Some of the increasewould have manifesteditself in higher whiskey prices and would have been passed along to wholesalers. Some of it, however,maynot havebeenpassedalong. In particular,rectifiers would have sufferedlosses from the price increaseif industrydemand was not perfectly inelastic or if they had marketpower.21Although the trust'srebateprogramincreasedthe marketpower of its chosen rectifying houses, it is not clear if the benefits of that increasemore than offset the losses causedby the increasein the price of spirits. For wholesalers, the rebatereduced the price of whiskey from trustselectedrectifiers.Initially,the rebatemusthave been largeenoughto offset any increasein the price of whiskey thatresultedfrom an increasein the price of spirits. If it were not, wholesalerssimply would have purchased rectifiers.However,as the amountof whiswhiskeyfromnon-trust-selected key purchasedrose, wholesalerswould have foundit increasinglycostly to abandontrust-selectedrectifiersin favorof independents.Therebatevouchers could only be redeemedif wholesalers continuedto patronizetrustselectedrectifiers.Also, it mighthavebeen costlyto purchasefromnontrust rectifiersbecause,as notedearlier,theywere smallerandmighthave manufacturedthe leastpopularbrandsof whiskey.Overtime,then,the trustmight have been able to drive up the price of whiskey to a point where it overwhelmedthe rebate. BrandNames,LicensingCosts,and theEffectivenessof theRebateStrategy In the long runthe effectivenessof the trust'srebatestrategydependedon the costs of verticalintegration.If new distilleriescould easily open their own rectifyinghousesandwholesaleoutlets,the rebateprogramwould not have deterredentry.Alternatively,if new distilleriescould not easily open theirown rectifyinghouses,and all existing rectifierswere beholdento the trust,new distillerieswould not have been able to find a marketfor their spirits.This would have deterredentry. Two factors,mentionedpreviously,wouldhave affectedthe costs of vertical integration:brandnamesand licensingrestrictions.To the degreethat 2'Under the first scenario,assumethe marketfor rectifiedwhiskey was perfectlycompetitiveand industrydemandwas notperfectlyinelastic.In thiscase,an increasein thepriceof spirits(a key input) would have shiftedthe supplycurveup. Equilibriumpricewould have been higherand equilibrium outputwouldhavebeenlower.Therewouldhavebeenfewerrectifiersproducingless whiskey.Under the second scenario,assumethe marketfor rectifiedwhiskeywas not perfectlycompetitiveand that each rectifierhad some marketpower.(Perhapsthis marketpowerderivedfromthe rectifier'sbrand nameor froma locationaladvantage.)An increasein thepriceof spiritswouldhave shiftedcost curves up and reducedeach rectifier'sprofitsandprofitmaximizingoutput. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 11:31:11 AM All use subject to JSTOR Terms and Conditions 764 Troesken loyalty to existing brandsof whiskey kept consumersand retailersfrom switching to new brandsof whiskey,it would have been difficultfor new distilleries to open their own rectifyinghouses and createnew brandsof whiskey. To the degreethatthe licensingprocess was expensive or politicized, it would have been difficult for new distilleriesto open their own rectifyinghouses.The cost of licensingis perhapsthe most relevantconsideration.Regardlessof how loyal consumerswere to specific brandsor how easily new distilleriescould find wholesale outlets, existing rectifiersand wholesalerscould have openedtheir own distilleriesto competewith the trust.AlthoughI have no directevidenceon licensingcosts andbrandname loyalty,the historicaldiscussionbelow shows thatwholesalersfoundways to open theirown distilleriesandrectifyinghouses. Given this, the costs of verticalintegrationdo not appearto have been prohibitive. THE REBATEPROGRAMAND THE PRICEOF SPIRITS:A TIME SERIES ANALYSIS Testifyingbeforethe IndustrialCommission,industryofficials suggested a trend:initially,the trustchargedmoderateto low prices;later,it charged high prices. MartinR. Cook, a rectifierfromNew YorkCity,testifiedthat originallythe trust"maintaineda fairprice andwas willing to accepta fair profit."Only laterwere prices "advanced."Cook also arguedthatthe advancewas not causedby an increasein the price of corn or any otherinput. Receiver JohnMcNultatestifiedthat "afterthe concernreachedthe point where [it] controlled a large proportion of the output of spirits," it "tried to push prices up." Otherindustryobservers,testifying before Congress in 1893, expressed the identical sentiments.22The data supportthese observations. DATAAND ANALYSIS Data Sources As noted earlier, most distilleries located in Peoria. In its final report to Congress, the Industrial Commission used data from the Peoria Board of Trade to construct a time series of the price of corn and spirits. The commission's data are monthly and extend from January 1884 through December 1899. Data on corn prices are especially useful because corn was such an importantinput into the production of alcoholic spirits. McNulta argued that spirits were "corn in liquid form" and that their cost was "based upon the cost of corn."23 22All of the quotations are from ICR: Cook's, p. 241; and McNulta's, p. 207. For other testimony corroborating these views, see Whiskey Trust, pp. 11-13; and ICR, p. 812. 23Thedata are from ICR, pp. 813-16. McNulta's quotation is from ICR, p. 239. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 11:31:11 AM All use subject to JSTOR Terms and Conditions Exclusive Dealing and the WhiskeyTrust 765 Estimating Procedure In his study of Standard Oil and its effect on consumer prices, Lester Telser used data very similar to the data here. Using monthly price data, Telser regressed the price of refined oil against the price of crude oil, a time trend, a dummy variable for the StandardOil Trust, and a dummy-time trend interaction term.24Following Telser, I estimated the following equation to identify the effects of the Whiskey Trust and its rebate program: SPIRITSt= a + PI(CORN) + P2(TAXt)+ P3(TRUSTt)+ N4(REBATEt)+ . .. + P5(TIME)+ P6(REBATEt*TIME)+ Et The variables are defined as follows. SPIRITS is the natural log of the price of spirits (net of tax, and after the rebate). CORN is the natural log of the price of corn. TAXis the natural log of the internal tax on spirits. REBATE is the rebate (in levels) offered by the Whiskey Trust. TIME is a time trend; and Et is an error term. All dollar values have been adjusted for changes in the general price level. The base month is January,1884. TRUST, a dummy variable, identifies how the trust influenced prices during the prerebate period. It assumes a value of one for a period of 36 months between 1887 and 1890 and zero otherwise. During these 36 months the trust operated but did not offer any rebates. The interactionterm, REBATE* TIME, is included because theory and congressional testimony suggest that the effectiveness of the rebate would have varied over time. To induce people to participate in the rebate program, the trust would have had to offer very low prices initially Later, after it had lured people in, it would have tried to raise prices. This logic predicts a positive coefficient on REBATE*TIME. The Data and Implications for Estimation Figure 1 plots the natural log of the real price of spirits (SPIRITS) and corn (CORN). This figure suggests that the price of spirits and the price of corn were highly correlated, a pattern consistent with the comments of industry observers who argued that corn was the primary input in the production spirits. Figure 2 plots the naturallog of the real federal tax on spirits and the trust's rebate in levels. As the figure suggests, the government changed the nominal tax on spirits only once, raising the tax from 90 cents to $1.10 in 1894. All other movements in the real tax are generated by changes in the general price level. The rebate, in contrast, was changed more frequently. It equaled zero between 1884 and 1890 and between 1895 and 1899. In nominal terms, the rebate varied between two cents and seven cents per proof gallon from 1890 through 1894. 24See Telser, Theory, pp. 36-40. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 11:31:11 AM All use subject to JSTOR Terms and Conditions Troesken 766 0 Corn 0) 0) -1.5-3. - z -2.5Spirits 1884 1886 1888 1890 1892 1894 1896 1898 FIGURE 1 NATURAL LOG OF THE REAL PRICES OF CORN AND SPIRITS, EXCLUDING TAXES AND REBATES In a preliminaryanalysis, the data were tested for nonstationarityand two frequentproblemswhenworkingwith time-seriesdata. autocorrelation, Using an augmented Dickey-Fuller test, the hypothesis that the data (SPIRITS)are stationaryat the 5 percentlevel of significance cannot be rejected.25Preliminarytests, however,indicatedsecond orderautocorrelation. Autocorrelation mighthavestemmedfromimproperfunctionalspecification.To controlfor this possibility,the equationwas estimatedwith and withoutlogarithmictransformations. Functionalformdid not matter;autocorrelationappearedregardless.Only the resultsfor the logarithmicmodel arereported.(The otherresults,which are identicalin substance,are available uponrequest).Omittedvariablesare anothercommonsourceof autocorrelation.But it is unlikely that this would have been a concern here. Based on the testimonyof witnessesbeforethe industrialcommission,corn prices,the internaltax, andthe rebateappearto havebeen the primarydeterminantsof the priceof spirits.All of thesewere includedin the regressions. Nonetheless,to controlfor the remotepossibilitythatsomethingimportanthadbeen omitted,I estimateda secondmodelthatincludeda lag of the 25The test results are not included here, but are available from the author upon request. The estimating procedure followed Pindyck and Rubinfeld, Econometric Models, pp. 459-65. They report the relevant critical values in table 15.1. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 11:31:11 AM All use subject to JSTOR Terms and Conditions Exclusive Dealing and the WhiskeyTrust 767 0.3 Tax ; 0.15 ~~~~~~~~Rebate 0 0 -0.15 , 1884 1886 1888 1890 1892 1894 . . 1896 . 1898 FIGURE 2 NATURAL LOG OF REAL TAX AND LEVEL OF REAL REBATE dependent variable. I also surveyed the New YorkTimes Index for events that might have affected the price of spirits. Based on this survey, two dummy variables were coded, PRICEWARtand SPECULATIONt.PRICEWARt controls for price wars that occurred during the mid-1880s. SPECULATION controls for changes in prices induced by speculators who anticipated the large increase in the internaltax on spirits. I then estimated a third equation that included these dummy variables. Including SPECULATION and PRICEWARSimproved the fit, but did not eliminate the autocorrelation. Because these remedial steps did not eliminate the serial correlation, I controlled for it using two different estimating procedures. For those models without a lagged dependent variable, Cochrane Orcott was used. For the model with a lagged dependent variable, Dhrymes' estimating procedure was used. (Cochrane Orcott is inappropriate when the model includes a lagged dependent variable).26 Results Table 1 reportsthe regression results. Because of the logarithmic transformations, the coefficients on the price of corn and the internaltax are elasticities. At around two, the price elasticity of spirits with respect to the tax 26See Pindyck and Rubinfeld, Econometric Models, pp. 141-43. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 11:31:11 AM All use subject to JSTOR Terms and Conditions 768 Troesken TABLE 1 REGRESSION RESULTS DependentVariable= SPIRITS Independent Variables CORN TAX Mean (Variance) -0.86 (0.05) 0.06 (0.02) TIME TRUST 0.19 REBATE 0.02 (0.001) REBATE*TIME SPIRITS(lagged) (1) Coefficient (t-statistics) 0.24** (2.89) - 1.91** (3.89) (2) Coefficient (t-statistics) 0.26** (3.14) - 1.98** (4.12) (3) Coefficient (t-statistics) 0.20** (2.99) - 1.97** (4.79) 0.001 0.001 0.001 (1.03) -0.10 (1.28) - 8.43* (1.95) 0.07* (1.90) (1.46) -0.11 (1.46) - 8.50** (2.07) 0.07* (1.95) 0.09 (1.60) (1.02) -0.19** (2.53) - 11.75** (3.03) 0.10** (2.87) -1.78 (0.09) 0.55** SPECULATION (8.10) PRICEWARS -0.23** - 1.54** (13.55) 192 0.86 155.20 Constant N AdjustedR2 Log of LikelihoodFn - 1.42** (11.38) 192 0.86 155.78 (6.05) - 1.53** (14.42) 192 0.91 196.55 ** = Significant at 5 percent. * = Significantat 10 percent. Note: See the text for variabledefinitions. appears large. This reflects the fact that when the tax was raised from 90 cents per gallon to $1.10 in August 1894, the price of spirits fell from 27 cents per gallon to 14 cents in the following months. That the increase in the tax caused the net price of spirits to decline by roughly the same amount suggests the presence of a nontaxed substitute with a highly elastic supply, namely illicit spirits. The coefficient on the trust dummy is always negative but only statistically significant in the third model. The t-statistic on the time trend (TIME) is low. This might result from collinearity with REBATE* TIME.27 In all of the specifications, the coefficients on the rebate terms are statistically significant. The rebate variable is negative, whereas the rebate interacted with the time trend is positive. Although these results are suggestive, 27jIn a seriesof regressions thatI do not reporthere,I also interactthe trustand rebatedummieswith thepriceof corn.Thatis, I add TRUST*CORN andREBATE*CORN to the firstmodel.Addingthese interactionstermsdoes not alterthe results. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 11:31:11 AM All use subject to JSTOR Terms and Conditions Exclusive Dealing and the WhiskeyTrust Z 0.25 Trust Formed, Rebates Introduced Formed, No Rebates ....Trust - 769 0.23 -- ^ No Trust, No Rebates Trust Organized ~44 0.21- 0 0.19- ,~0.17 Rebate Introduced i 0.15 1884 1 1886 1888 1 1890 1892 1894 1896 1898 FIGURE3 PREDICTED BEFORE-TAX PRICE OF SPIRITS UNDER ALTERNATIVE REGIMES Figure 3 provides a clearer sense of the economic effect of the rebate. (In Figure 3, taxes are held constant). Using the estimates from the first regression, the heavy line plots the predicted price of spirits given actual events. That is, the heavy line plots the fitted price. The pattem is striking. The estimated price falls steadily until the introduction of the rebate program when there is a sharp one time drop in price. Presumably the trust cut prices to lure potential customers into the rebate program. However, shortly after the rebate is introduced, the downward trend stops and estimated prices begin to climb. According to the coefficient estimates from the first regression, the trust had increased prices to the point where they overwhelmed the rebate by December 1893.28 This pattern corroborates the testimony before the IndustrialCommission: initially the trust charged low prices but it raised prices after the rebate program began. In Figure 3, the lighter solid line plots what prices would have been if distillers had not organized the trust and continued setting prices as they had in the years before the trust.Note that the line begins in June 1887, the first full month that the trust operated. Comparing the two lines, one sees that the price of spirits would have been about 10 to 15 percent higher without the trust. This pattern is consistent with the hypothesis that, before the rebate, the trust exploited scale economies and brought consumers lower prices. 28Using the estimates from the first regression, equate the expression (8.43*REBATE) with the expression (0.07*REBATE*TIME). With this, (TIME) = (8.43)/(0.07) a120. The 120th observation is December 1893. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 11:31:11 AM All use subject to JSTOR Terms and Conditions 770 Troesken Without direct evidence that the trust actually did things to reduce costs, however, it is hard to put much stock in this. A more plausible hypothesis, also consistent with the low prices before the rebate, is that the trust was practicing predatory pricing during this period. The statements of industry observers and the trust's own managers-all of whom claimed that the trust practiced predatory pricing-provide additional corroboration. The dotted line shows what would have happened if, ratherthan introducing the rebate, the trust had continued with its prerebate pricing regime. Note that the line begins in June 1890 when the trust introduced the rebate program. Comparingthe dotted line and the heavy line shows the predicted effect of the rebate program. It is clear that predicted prices fell by 10 percent when the trust first introduced the rebate program. However, as noted above, predicted prices rose steadily thereafter.Eventually they were 10 to 15 percent higher than they would have been had the trust continued its prerebate pricing regime. THE TRUST'S OTHERPREDATORYSTRATEGIES Potential distilleries faced low entrybarriers.The trusthoped that its rebate programwould make it more difficult for competitorsto startnew distilleries. It also used predatorypricing and threats of violence to discourage entry. Violence On 11 February 1891, Chicago police arrestedGeorge Gibson, the secretary of the Whiskey Trust.Thomas Dewar initiated Gibson's arrest.According to Dewar, several weeks earlier Gibson had offered him $25,000 to blow up a Chicago whiskey distillery. Dewar, an agent of the Internal Revenue Service, worked with other treasury agents to lay a trap for Gibson. When Gibson arrived at the GrandPacific Hotel to meet Dewar, police were waiting. State and federal authoritiescharged Gibson with, among other things, attempted arson and conspiracy to commit murder.29 Dewar could have fabricatedthe whole story. Before joining the Internal Revenue Service, Dewar worked for the Whiskey Trust, where Gibson had been his boss. Dewar vacated his position with the trust after only a few months. Gibson said he was fired; Dewar said he quit. Perhaps Dewar was a disgruntled employee, bent on destroying his former boss.30 More likely, Dewar told the truth. There were means. When police arrested Gibson they confiscated his grip and found inside an explosive com29See,Dewar's testimony before Congress in Whiskey Trust, pp. 16-30; East, "Distillers and Cattle Feeders' Trust;" and the Chicago Tribune, 5 June 1891, p. 1. 301t is interesting to compare Dewar's testimony before Congress to that of J. B. Greenhut, the president of the Whiskey Trust. For Dewar's testimony, see Whiskey Trust, pp. 17-30; for Greenhut's see ibid., pp. 31-57. This content downloaded from 130.126.32.13 on Sun, 17 Nov 2013 11:31:11 AM All use subject to JSTOR Terms and Conditions Exclusive Dealing and the WhiskeyTrust 771 pound. After searchingGibson's other baggage, they found a detonating device-what one investigatorcalledan "infernalmachine."Therewas also motive. For years the Whiskey Trusthad been tryingto get the Shufeldt whiskeydistilleryto join the trustbutthe Shufeldthad always refused.The Shufeldtwas the world's second largestwhiskey distillery.It was also the distillery Gibson allegedly asked Dewar to destroy.Finally, there was a suggestivepattern.On 10 December1888, someonethrewdynamiteon to the roof of the Shufeldtdistillery.The explosion causedconsiderabledamage, but it couldhavebeen muchworse. If the dynamitehad fallen through a skylight,which it scarcelymissed, it would have destroyedthe distillery. Mysteriousfires also damagedor destroyedthree distilleriesin southern Illinois.Eachdistilleryhad refusedto join the trust.Anothertime, workers at an independentChicagodistillerydiscovered"one of the trust'sagents" walkingaroundthe plantandtakingnotes. Plantworkersreportedlyplaced a ropearoundthe agent'sneck andwould have lynchedhim had othersnot intervened.3" On 4 June 1891, fourmonthsafterGibson'sarrest,the Shufeldtdistillery and the Calumetdistillery,anotherlargeChicagodistillery,sold out to the trust.Everyoneassociatedwith the deal expressed"goodfeelingsand sentiment."The ownersof the trustbelieved thatall these warmfeelings would "materiallyeffect [sic] the Gibsoncase."Aroundthe sametime, the Tribune reportedthat"pressurefrominfluentialquartersha[d] been broughtto bear to have the case 'settled."'Withina year, the state and federal cases againstGibsonwere resolvedandGibsonresignedas secretaryof the Whiskey Trust. The trust continued to pay Gibson $7,500 a year after he resigned.32 PredatoryPricing The IndustrialCommissionwrote: It was the practiceof the Distillers' Trustand the latercombinationsto send agents into special localities to undersell competitors,their particularcustomersbeing approachedand offered open...
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Running head: RESPONSE PAPER

1

Response Paper
Student’s Name
Institution

RESPONSE PAPER

2

The article chosen for this assignment is The Myth of Natural Monopoly by Thomas J.
DiLorenzo which was published in 1996. The introduction of monopoly in the market was
majorly due to the government. The regulation through legislation introduced the expected
outcome of prices in a monopoly company. Competition should be used to regulate the costs of
the products in the market rather than the government introducing taxation and franchise fees on
the revenue. Public utility regulation is done as a method to appease the consumers who felt that
there was neglect in the way the interests were done leading to increased rates and privileges of
monopoly. Natural should not be used to mean that things take place naturally but rather it
indicates that monopoly would be the ideal result in the market.
A monopoly market with a good outcome means that the economies of scale exist for
goods that cannot be distinguished. Therefore, the cost of production increases when the market
has more than one manufacturer. This leads to inefficiency since more resources are used in the
production of goods compared to a market that has one producer (Berg & Tschirhart, 1989). The
presence of only one producer in the market means that the resources that are needed in the
production process are fewer. Nonetheless, the presence of only one producer in the market who
are not regulated would lead to maximizing of the profit. This is because the set price for the
products is different compared to the cost of production for the sa...


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