The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould, and J. P. Morgan Invented the American Supercompany

by Charles R. Morris

  Finally, there is another factor in the relative British decline: the very aggressive use of the protective tariff, especially in steel, and especially by America and Germany, against a British nation that, despite some wavering, steadfastly refused to deviate from its free-trade principles.

  The Tariff Question

  Over a fifteen-year period beginning with Robert Peel’s repeal of the protectionist Corn Laws in 1846, Great Britain steadily dismantled all restrictions on trade. By the end of the American Civil War, Great Britain had become perhaps history’s purest example of a free-trade nation, a posture which it maintained, except during the Great War, until 1931. The free-trade movement was rooted in an ideological grab bag of Reform Protestantism (tariffs interfered with the workings of Providence); antigovernment libertarianism (indirect taxation fostered big government); and “Manchester school” liberal economics. By the high Victorian and Edwardian eras, free trade had hardened into religion, with the reformer Richard Cobden its patron saint, and devotion rewarded by the prosperity of the Victorian era.

  Aggressive protectionism in both Germany and the United States, especially in steel, put that commitment to a severe test in the early 1900s. German and American policies were quite different, however, and their interactions with the British free-trade regime shed light on policy issues that are still controversial today.

  The United States used tariffs as a primary revenue source from the beginning of its existence, but its powerful merchant and planter interests forestalled blatant protectionism. Alexander Hamilton famously made the “infant industry” argument, but his 1792 tariff schedule, which extended the list of protected goods and increased most levies, was still, on average, only about 10 percent of import prices. It was only when the northern manufacturing interest won control of the Congress in the Civil War era that American policy turned protectionist. Throughout the rest of the nineteenth century, American tariffs were very stiff, and in iron and steel, blatantly exclusionary. The tariff on steel rails, for example, was set at 45 percent in 1864, and converted to a flat $28 a ton in 1870. Since rail prices were falling, the flat $28 impost became a bigger and bigger barrier, rising to a range of 70–100 percent of British export prices.

  But while post–Civil War U.S. policy was protectionist, it was not predatory. Since the ravenous demand for steel at home left little surplus capacity, high domestic prices weren’t used to finance below-cost export drives (“dumping”). Modest quantities of American steel don’t appear in the export data until the mid-1890s, much of it going to Canada and Latin America, and Carnegie Steel did not seriously enter world markets until 1900. That year’s sudden steel depression in the United States prompted a big jump in exports, which quickly fell as the American railroad recovery gathered steam. A systematic attempt to increase the American share of world markets came only with the advent of U. S. Steel. American steel exports grew steadily in the years before the Great War, and American export prices were frequently lower than those at home.

  German policy, on the other hand, was determinedly predatory and clearly targeted against Great Britain. Bismarck’s newly unified Prussian-German state emerged as the most formidable of the continental powers, and the only one with a steel industry that matched the American in scale and efficiency. Its steel policy in the 1880s and 1890s looks much like the Japanese assault on the semiconductor industry a century later. Production was concentrated in a few large cartelized firms with close ties to the government, while high domestic prices financed cut-price sales volume drives abroad. Domestic German rail prices, for example, averaged some 25–30 percent more than export prices through most of the period. In the classic cartel pattern, as Germany began to achieve dominance in its continental markets, the price gap steadily narrowed.

  Great Britain found itself squeezed from both west and east. American protectionism gradually evicted the British from the big North American market, while German predation and locational advantage cut a deep swathe through traditional British customers in Europe and Russia. By 1900, German steel production was already about 30 percent greater than Great Britain’s, and America’s was more than twice as large. Between then and 1913, American and German production both tripled, while Great Britain’s grew by only 63 percent. On the eve of the war, German exports were nearly double Great Britain’s, and nearly equal to Britain’s and America’s combined. Much of the British export trade, moreover, was in finished products made from primary steel imported from Germany, or increasingly from America, while sales were disproportionately oriented toward the empire. In modern jargon, the prewar years saw the “hollowing out” of British steel. Something similar happened with the smaller, but still important, British chemical industry. After the 1897 Dingel tariff, for example, British exports of soda ash to the United States dropped to less than a fifth of their pre-tariff level.

  It is all the more remarkable, therefore, that the British political and business establishment emphatically rejected a return to protectionism in the early 1900s, even though it was couched only as a tit for tat retaliation against predators—so-called “fair trade.” The rejection was partly a matter of self-interest—textile manufacturers feared losing access to their raw materials if a trade war broke out; British finished steel makers liked importing primary steel at cut-rate prices; and labor unions had long linked free trade with cheap food. But to a striking degree, the rejection was also based on deeply engrained ideology, supported by a web of purely intellectual and highly abstract arguments. As the London Times put it, “Protection . . . brings its own punishment. Nature will retaliate upon France whether we do or not.” The flower of the British economics establishment, the legendary professors Marshall, Pigou, and Jevons, all pronounced on the folly of trade restriction, insisting that the British industry was merely undergoing a “natural” adjustment. Winston Churchill worried how ministries and parliament, “hitherto chaste because unsolicited,” might behave once the protectionist bawd ran free.

  The Cambridge steel historian, D.L. Burn, in an exhaustive review of the fair trade debate on steel, written in the late 1930s, subjects the intellectual argument to a withering analysis, not because it was wrong but because it was either ignorant, or willfully ignored facts that conflicted with its theoretic presumptions. It was simply not true, as the professors claimed, that Britain no longer had access to low-cost ore or that British steel plants had reached optimum size; and their denial that Germans were dumping—because theory said it was irrational—flew in the face of available data.

  Burn does not oppose the basic free trade position. Rather he attacks the smug certitudes of the professoriat, their carelessness with facts, and their complacent conviction that the Germans would eventually realize that predatory trade was against their own interests, which was hardly obvious. At the same time, he leaves no doubt that the core problem was still the slack response of British steel-makers to the German assault. To exploit Britain’s reserves of low-cost ore, for example, would have required a comprehensive resizing and restructuring along American and German lines, and it is doubtful that British steel men had the stomach for it. While Burn speculates on the feasibility of using tariffs to shield an industry reorganization, he concedes his own doubts that it could have succeeded. The subsequent history of “temporary” periods of protection both in the United States and Europe bears out his skepticism.

  The German-British competition in steel, in fact, is a poor fit for the free-trade paradigm. The basic premise of classic trade theory—David Ricardo’s principle of “comparative advantage”*—is that trade policy aims at maximizing national income. But Bismarckian Germany, like post–World War II Japan, was bent on optimizing specific strategic industries. Germany was force-feeding steel for military conquest, and Japan its semiconductors for industrial conquest—even if total national output and income suffered as a result. In both cases, the quasi-command organization of the economy intentionally obstructed the operation of corrective market mechanisms: high d
omestic prices did not call forth domestic competition since entry was restricted by the cartel. Taking the regime objectives on their own terms, both policies were arguably effective. The German rise was checked only by war, and the Japanese takeover of semiconductors primarily by a competing cartel in Korea.

  “The Original Coxey’s Army.” With Andrew Carnegie in the lead, American fat cats arrive at the Capitol in their Pullman parlor cars to plead for tariff protection.

  The American nineteenth-century trade experience fits much more within the Ricardian paradigm. When Andrew Carnegie defended steel tariffs, it was always as a time-limited “infant industry” exception to the fundamental theory—that America, and total welfare, would benefit in the longer run if a period of protection first permitted the creation of sufficiently robust home-grown competition. There was, of course, a good dollop of hypocrisy in Carnegie’s free-trade pose, for American steel tariffs were continued far beyond the time when its industry could conceivably qualify as “infant.” But the fundamental question is still of interest to economic historians: Was the infant industry justification warranted in the case of the United States?

  The 1890 American tin plate tariff is perhaps the case most often cited in support of early-stage protective tariffs. Tin plate is used primarily in tin cans and roofing material. Under a Treasury interpretation, the post–Civil War tariff legislation did not cover tin plate,* and the American market was dominated by low-cost Welsh producers. Imposing the 1890 tariff was a close-run thing. There was formidable opposition, not only from the food industry, but also from Standard Oil, the world’s largest tin plate user, whose blue five-gallon kerosene cans were ubiquitous throughout the tropics and Asia. (The American Treasury, however, paid “drawbacks,” or rebates, of tariffs paid on reexported goods.) The law passed the House only by a single vote, and only with a proviso that it would lapse unless domestic production reached certain minimum production thresholds; it was, in any case, halved in 1894 as part of a broader tariff-reducing initiative.

  The economist Frank Taussig, writing in 1915, found the evidence from the tin plate episode, while mixed, “not unfavorable to the protectionist.” Almost as soon as the tariff was passed, the American price rose to the Welsh price plus the tariff premium and production jumped remarkably; within a very few years, the Welsh industry had been decimated and imports had almost ceased. (Large segments of the Welsh industry emigrated and set up shop in the United States.) High domestic tin plate profits evoked a rash of new competition, and the American price premium quickly dropped to about half the tariff rate, and kept dropping even after the tariff was reduced in 1894. As Taussig points out, however, the primary factor in the continuing price reduction was falling material prices. Steel billets, from which the sheet was rolled, accounted for about 60 percent of the price of tin plate, and was subjected to very high tariffs. American tin plate, that is, wouldn’t have needed the tariff if billets hadn’t been protected. Falling billet prices from growing domestic capacity explained much of the increased tin plate production.

  That happy progression was abruptly interrupted by Judge Moore’s 1898 tin plate merger, confirming “Sugar King” H. O. Havemeyer’s dictum that “the Mother of all trusts is the custom tariff law.” The new Tin Plate Co. pushed prices back up very near the tariff premium, and the combination of high tin plate and falling billets generated spectacular profitability. But it was precisely the very shaky prospect of maintaining such socko profits against a surge of new entrants, including the formidable Carnegie Steel, that led to the formation of U. S. Steel. After the consolidation, the Steel combine stabilized prices at about half the tariff premium, although it continued to lose domestic share to new competition, and the domestic price gradually drifted down to international levels. By 1910, Standard Oil, surely one of the shrewdest of cost managers, dropped its tariff drawbacks and switched to domestic suppliers. By that time, U. S. Steel was a substantial exporter of tin plate, usually at prices lower than it charged at home. Super-ficially, at least, it looks like the tariff worked. Although it took almost two decades, excess protected profits evoked a horde of competitors, and the United States eventually emerged with a large industry and competitive prices.

  The economist and historian Douglas Irwin has recently reanalyzed the episode to try to tease out a clearer picture of the tariff’s effects. The mere fact that domestic production flourished under the initial tariff regime does not by itself justify the tariff; the real question is how does that experience compare with what would have happened without the tariff. From the available data, Irwin develops a model for how the American industry responded to changes in the economic environment—to growth in demand, to changes in the tariff, to billet prices, and to improvements in technology. Contrafactual exercises are, of course, inherently speculative and often highly sensitive to initial specifications, but they do force specificity and spotlight the relevant variables.

  Irwin’s study underscores the “commodity” character of the tin plate industry—low margins, minimal capital costs, and short learning curves, with little basis for quality differentiation from one producer to the other. With few barriers to entry, excess profits quickly elicited new competition. Irwin’s model shows that the steady drop in billet prices would have eventually created a domestic tin plate industry without tariff protection, although the 1890 tariff accelerated its development by as much as a decade. But the additional costs to tin plate consumers under all of Irwin’s scenarios exceeded tariff revenues and excess producer profits, so the net income effects were negative. In short, Irwin’s model says that the country would have been better off without the tin plate tariff.

  What about the broader question of nineteenth-century iron and steel tariffs? While they clearly damaged Great Britain’s industry, did they help or hinder American growth? While there can be no definitive answer, there is a good case that, largely because of the presence of Andrew Carnegie, the tariffs were a good deal for America.

  The Carnegie Effect

  Almost all historians agree that the United States would have had a large iron and steel industry with or without a tariff. With such a rich endowment of inexpensive coal and iron ore, coupled with such a pervasive commitment to rapid growth, it is hard to imagine how it could be otherwise. And almost no one disagrees that the presence of the tariff accelerated the industry’s growth. The first cost sheets for the Edgar Thomson Works that Andrew Carnegie and Alexander Holley brought to Junius Morgan in 1874 projected very high profits. But by the time the plant was up and running, rail prices had fallen and margins were only $4–8 a ton, even including the $28 per ton tariff-based price umbrella. Without the tariff, the ET could never have gotten off the ground. Later, in 1882, the ET’s accounts show average steel production cost of $43 a ton, or about $10 more than British export prices. Since ET’s costs were quite likely the lowest in the industry, American steel obviously still needed protection, although not $28 worth.

  The $28 tariff impost, however, grossly overstates its burden on American consumers, since competition within America almost always prevented steel companies from pricing up to the full tariff premium. During the frenzied rail boom of 1880 and 1881, American prices were marked up almost exactly $28 over British export prices ($61 a ton in 1881 versus the British $32.75, pre-shipping), and British rail exports to America broke all records. But those were the only instances of full-premium pricing in the entire period from 1880 through 1901. The next highest premium was $15 in 1887, another strong year for British exports. But excluding 1880 and 1881, the average premium over the two decades was only about $5. Even during the heyday of the rail price pool from 1893 through 1896, the premium was very modest, varying between $4–7. By the time of the rail price war of 1897–98, Carnegie Steel was making record profits at sales prices well under those of the British, although it may have been the only American company that could do so. When the pool was reestablished in 1899, the American price was set at just 12 percent, or $3, over the B
ritish export price, which is probably not far from the “relationship” premium a stateside steel vendor might normally command. (Rational buyers frequently pay premiums to lock in an accessible vendor who can work out flexible supply arrangements, help with technical issues, or possibly help them win orders.) The next year, 1900, American and British prices were virtually identical.

  By the time of the formation of U. S. Steel, in other words, the Americans could easily undersell the British, and the tariff had become an irrelevance. The new steel consortium fixed American rail prices at exactly $28, or far above the cost of production, but roughly equal to British export prices. It was the high cost of British steel, not the tariff, that set the price ceiling for the Americans.

  A substantial share of the credit for keeping the tariff burden so low must go to Andrew Carnegie. The deadweight costs of a protected cartel are some of the most destructive consequences of a high-tariff regime. But Carnegie never behaved like a rational cartelizer. Although he consistently earned the highest profits in the industry, he paid the smallest dividends, choosing instead to plow earnings back into better plants, more mechanization, and larger output. Falling prices were just opportunities to take share—the Carnegie companies increased their market share in every recession. John W. Gates’s 1898 comment, amid the wreckage of the late-1890s rail price war, says it all: Carnegie’s savage price-cutting meant that the days of “large profits for comparatively small tonnage” were over; Gates’s Illinois Steel was going to have to spend millions to get more competitive. Among America’s wannabe cartelizers, like Gates and Elbert Gary, Carnegie was a “bull in a china shop,” bent on driving “entirely out of business every steel company in the United States.”