The Robber Barons

Neither Robbers nor Barons

By David R. Henderson

One 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 earntheir 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!

Nor were the Vanderbilt and Rockefeller cases flukes. If the trusts of the late 19th century had monopolized the industries they were in, as many people believe, then as those trusts gained market share, they should have not increased output much and should have raised prices. In fact, the opposite happened. Output increased many times over and prices fell. In some path-breaking research in the 1980s, Loyola University economist Thomas DiLorenzo documented these facts. In a 1985 article,5 DiLorenzo found that between 1880 and 1890, while real gross domestic product rose 24 percent, real output in the allegedly monopolized industries for which data were available rose by 175 percent, over seven times the economy's growth rate. Meanwhile, prices in these industries were falling. Although the consumer price index fell 7 percent in that decade, the price of steel fell 53 percent, refined sugar 22 percent, lead 12 percent, and zinc 20 percent. The only price that fell less than 7 percent in the allegedly monopolized industries was that of coal, which stayed constant.

Why do we get such a distorted view of the era of the so-called robber barons? One reason is that the popular press at the time trumpeted that view. Interestingly, Ida Tarbell, the famous "muckraker" who gave Rockefeller his bad press,6 was not a disinterested observer. Early in her life, she had seen her father, an oil producer and refiner, lose out in competition with Rockefeller. Her father had been prospering, and her family, as a result, was enjoying "luxuries we had never heard of."7 All that came to an end and Tarbell never forgave Rockefeller.

Indeed, virtually none of the impetus for antitrust laws came from consumers. Much of it came from small producers who had been competed out of business. They didn't want more competition; they wanted less. DiLorenzo quotes one of the "trust busters," Congressman William Mason, whoadmitted that the trusts were good for consumers. What he didn't like was that when large trusts cut prices, small firms were put out of business. Mason stated:

[T]rusts have made products cheaper, have reduced prices; but if the price of oil, for instance, were reduced to one cent a barrel, it would not right the wrong done to the people of this country by the "trusts" which have destroyed legitimate competition and driven honest men from legitimate business enterprises.8

In short, the robber barons, at least the ones whose actions tend to be highlighted, were neither robbers nor barons.

But why is that so? Why is it that the late 19th-century trusts thrived, not by monopolizing but by fiercely competing? Therein lies the economics lesson. As the late University of Chicago economist George Stigler, who won the Nobel Prize in 1982, pointed out, "[M]ost important enduring monopolies or near monopolies in the United States rest on government policies."9 That's because if governments do not restrict entry, high profits of firms with market power attract new entrants and new competition the way honey attracts ants. As I put it in the tenth of my Ten Pillars of Economic Wisdom,10 drawing on similar wording from Stigler, "[C]ompetition is a hardy weed, not a delicate flower."

Stigler focused on price competition, but the late Austrian economist Joseph Schumpeter emphasized what he saw, correctly, as an even more important source of competition. Schumpeter wrote:

[I]n capitalist reality as distinguished from its textbook picture, it is not that kind of competition which counts but the competition from the new commodity, the new technology, the new source of supply, the new type of organization (the largest-scale unit of control for instance)—competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives.11

Schumpeter's memorable term for this kind of competition was "Creative Destruction"—"creative" because the new commodity, technology, etc. created a new product or service and "destruction" because it destroyed the old. Think back to Rockefeller. He created safer kerosene and a pipeline to ship his oil. In doing so, he destroyed many smaller competitors—and made American consumers much better off. We could use more such "robber barons."

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Footnotes

1. Burton W. Folsom, Jr. tells this fascinating story in The Myth of the Robber Barons, 6th ed. (Herndon, VA: Young America's Foundation), 2010, pp. 2-4.

2. Most of the facts in this paragraph are taken from Michael Reksulak and William F. Shughart II, "Of Rebates and Drawbacks: The Standard Oil (N.J.) Company and the Railroads," Review of Industrial Organization, 2011, Vol. 38, pp. 267-283.

3. Reksulak and Shughart, p. 280.

4. Lester Telser, A Theory of Efficient Cooperation and Competition. New York: Cambridge University Press, 1987.

5. Thomas DiLorenzo, "The Origins of Antitrust: An Interest-Group Perspective," International Review of Law and Economics, 1985, Vol. 5, No. 1: 73-90.

6. Ida M. Tarbell (1904). The History of the Standard Oil Company. New York: McClure, Phillips & Co.

7. See "Ida Tarbell," a biography at American Experience. PBS.org.

8. Congressional Record, 51st Congress, 1st session, House, June 20, 1890, p. 4100.

9. George J. Stigler, "Monopoly," in David R. Henderson, ed.,The Concise Encyclopedia of Economics, 2nd ed. (Indianapolis: Liberty Fund, 2008), p. 364.

10. David R. Henderson, "The Ten Pillars of Economic Wisdom," EconLog, April 12, 2012.

11. Joseph A. Schumpeter, Capitalism, Socialism and Democracy (New York: Harper, 1975) [orig. pub. 1942], p. 84.