The Robber Barons: Neither Robbers nor Barons

Posted: March 26th, 2013 by Militant Libertarian

from the Library of Economics and Liberty

robberbarons1One of the most prevalent myths about economic freedom is that it inevitably leads to monopolies. Ask people why they believe that, and the odds are high that they will point to the “trusts” of the late 19th century that gained large market shares in their particular industries. These trusts are Exhibit A for most people who hold this view. Ask them for specific names of the villains who ran these trusts, and they are likely to point to such people as Cornelius Vanderbilt and John D. Rockefeller. They even have a label for Vanderbilt, Rockefeller, and others: robber barons.

But a careful reading of the economic research on the “robber barons” leads to a diametrically opposite conclusion: the so-called robber barons were neither robbers nor barons. They didn’t rob. Instead, they got their money the old-fashioned way: they earned it. Nor were they barons. The word “baron” is a title of nobility, one typically granted by a king or established by force. But Vanderbilt, Rockefeller, and many of the others referred to as robber barons started their businesses from scratch and were granted no special privileges. Moreover, not only did they earn their money and not only were they not granted privileges, but they also helped consumers and, in one famous case, destroyed a monopoly.

Consider the case of Cornelius (“Commodore”) Vanderbilt. Even the excellent recent book Why Nations Fail, by MIT economics professor Daron Acemoglu and Harvard political scientist and economist James A. Robinson, gets the Vanderbilt story wrong. And not just wrong, but spectacularly wrong. They claim that Vanderbilt was “one of the most notorious” robber barons who “aimed at consolidating monopolies and preventing any potential competitor from entering the market or doing business on an equal footing.”

In fact, it was Vanderbilt’s competitor, Aaron Ogden, who persuaded the New York state legislature to grant Ogden a legally enforced monopoly on ferry travel between New Jersey and New York. And Vanderbilt was one of the main people who challenged that monopoly. At the tender age of 23, Vanderbilt had become the business manager for a ferry entrepreneur named Thomas Gibbons. Gibbons’ goal was to compete with Aaron Ogden by charging low fares. In doing so, they were purposely breaking the law—and helping their passengers save money. In the case Gibbons v. Ogden, the U.S. Supreme Court ruled that, indeed, the New York state government could not legally grant a monopoly on interstate commerce.1 In short, Cornelius Vanderbilt was not a monopoly maker in this case, but a monopoly breaker.

What about John D. Rockefeller? Acemoglu and Robinson get that one wrong also. They write that by 1882, Rockefeller “had created a massive monopoly” and that by 1890, Standard Oil “controlled 88 percent of the refined oil flows in the United States.” Let’s look at the facts.

Early on, Rockefeller knew that he was at a disadvantage relative to his competitors. His company’s headquarters were in Cleveland, 150 miles from Pennsylvania’s oil-producing regions and 600 miles from New York and other Eastern markets. Thus, Rockefeller faced higher transport costs than many of his competitors. To offset that disadvantage, he built a pipeline to ship his own oil and used this pipeline to bargain down railroad rates. He got the lower rates in the form of rebates rather than outright rate cuts. Why? I don’t think economic historians are sure about why, but here’s my hypothesis: the railroads gave rebates because this is a standard way that members of a cartel “cheat” on price. They can truthfully tell the other customers not getting the rebates that they are charging everyone the same rate. To the extent that this was happening, Rockefeller was, himself, breaking down a railroad cartel. And breaking down cartels is supposed to be good, not bad.

But why would railroads single out Rockefeller for rebates? As noted, it was partly because of his credible threat to use his own pipeline. Also, as Reksulak and Shughart note, he strategically built his first refinery in a place that would allow him to ship oil to Lake Erie and then on to the Northeast market. This, note Reksulak and Shughart, allowed him to bargain for lower railroad rates during summer months.2 In addition, Standard Oil provided loading facilities, discharge facilities, and fire insurance at its own cost. Finally, Standard Oil provided a heavy volume of rail traffic at predictable periods, an advantage that was crucial for railroads with their high fixed costs and low variable costs.

One puzzle I have always had is how Rockefeller got “drawbacks” from the railroads. Drawbacks were rebates based on shipments by Rockefeller’s competitors. Reksulak and Shughart offer a plausible explanation. They write:

[B]y helping to reduce the average cost of rail transportation in the ways we have documented, Rockefeller conferred a positive externality on his rivals, reducing the railroads’ average cost of handling their shipments as well. Drawbacks were a way for the railroads to share those gains with the company that was responsible for them.3

One other advantage that Rockefeller created was the product itself. His main product at the time was kerosene. Kerosene, if not produced to a tight specification, had a nasty tendency to explode and kill or injure its users. That’s not good, to put it mildly, for a firm seeking market share. Rockefeller wanted buyers to know that his product was safe because it met a stringent production standard. Thus his company’s name: Standard Oil.

The most speculative part of the above reasoning is why Rockefeller got rebates rather than outright price cuts. But what is not speculative is how he expanded his market share. He did so by cutting prices and almost quadrupling sales. University of Chicago economics professor Lester Telser, in his 1987 book, A Theory of Efficient Cooperation and Competition,4 points out that between 1880 and 1890, the output of petroleum products rose 393 percent, while the price fell 61 percent. Telser writes: “The oil trust did not charge high prices because it had 90 percent of the market. It got 90 percent of the refined oil market by charging low prices.” Some monopoly!

Read the rest at this link.

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