Witch-Hunting for Robber Barons; L. Reed

Regarding Standard Oil's chief executive, one noted historian writes, HHe (Rockefeller) iron handedly ruined competitors by cut ting prices until his victim went bankrupt or sold out, whereupon Mr. Reed Is Assistant Professor of Economics at Northwood Institute In Midland, Michigan. This artl· cle Is based upon one of his lectures for a course, "Philosophy of American Life and Business." 166 higher prices would be likely to re turn."! Two other historians, co-authors of a popular college text, opine that ((Rockefeller was a ruthless operator who did not hesitate to crush his competitors by harsh and unfair methods."2 In 1899, Standard refined 90 per cent of America's oil-the peak of the company's dominance of the re fining business. Though that mar ket share was steadily siphoned off by competitors after 1899, the com pany nonetheless has been branded ever since as «an industrial oc topus."

Does the story of Standard Oil really present a case against the free market? In my opinion, it most em phatically does not. Furthermore, setting the record straight on this issue must become an important weapon in every free market advo cate's intellectual arsenal. That's WITCH-HUNTING FOR ROBBER BARONS 167 the purpose of the following re marks. Theoretically, there are two kinds of monopoly: coercive and efficiency. A coercive monopoly results from, in the words of Adam Smith, ~~a government grant of exclusive privilege." Government, in effect, must take sides in the market in order to give birth to a coercive monopoly. It must make it difficult, costly, or impossible for anyone but the favored firm to do business. The United States Postal Service is an example of this kind of monopoly. By law, no one can de liver first class mail except the USPS. Fines and imprisonment (coercion) await all those daring enough to compete.

In some other cases, the govern ment may not ban competition out right, but simply bestow privileges, immunities, or subsidies on one firm while imposing costly requirements on all others. Regardless of the method, a firm which enjoys a coer cive monopoly is in a position to harm the consumer and get away with it. An efficiency monopoly, on the other hand, earns a high share of a market because it does the best job. It receives no special favors from the law to account for its size. Others are free to compete and, if consum ers so will it, to grow as big as the ~~monopoly." An efficiency monopoly has no legal power to compel people to deal with it or to protect itself from the consequences of its unethical prac tices. It can only attain bigness through its excellence in satisfying customers and by the economy of its operations. An efficiency monopoly which turns its back on the very performance which produced its suc cess would be posting a sign, ~~COM PETITORS WANTED." The market rewards excellence and exacts a toll on mediocrity.

It is my contention that the histor ical record casts the Standard Oil Company in the role of efficiency monopoly-a firm to which consum ers repeatedly awarded their votes of confidence. The oil rush began with the dis covery of oil by Colonel Edwin Drake at Titusville, Pennsylvania in 1859. Northwestern Pennsylvania soon ~~was overrun with businessmen, speculators, misfits, horse dealers, drillers, bankers, and just plain hell-raisers. Dirt-poor farmers leased land at fantastic prices, and rigs began blackening the land scape. Existing towns jammed full overnight with ~strangers,' and new towns appeared almost as quickly."3 In the midst of chaos emerged young John D. Rockefeller. An ex ceptionally hardworking and thrifty man, Rockefeller trans formed his early interest in oil into a partnership in the refinery stage of the business in 1865.

168 THE FREEMAN March Five years later, Rockefeller formed the Standard Oil Company with 4 per cent of the refining mar ket. Less than thirty years later, he reached that all-time high of 90 per cent. What accounts for such stun ning success? On December 30, 1899, Rockefel ler was asked that very question before a governmental investigating body called the Industrial Commis sion. He replied: I ascribe the success of the Standard to its consistent policy to make the volume of its business large through the merits and cheapness of its products. It has spared no expense in finding, securing, and utilizing the best and cheapest methods of manufacture. It has sought for the best superintendents and work men and paid the best wages. It has not hesitated to sacrifice old machinery and old plants for new and better ones. It has placed its manufactories at the points where they could supply markets at the least expense. It has not only sought markets for its principal products, but for all possible by-products, sparing no expense in introducing them to the pub lie. It has not hesitated to invest millions of dollars in methods of cheapening the gathering and distribution of oils by pipe lines, special cars, tank steamers, and tank wagons. It has erected tank stations at every important railroad station to cheapen the storage and delivery of its products. It has spared no expense in forcing its products into the markets of the world among people civilized and uncivilized. It has had faith in American oil, and has brought together millions of money for the purpose of making it what it is, and holding its markets against the competition of Russia and all the many countries which are producers of oil and competitors against American oi1.4 A Master Organizer of Men and Materials Rockefeller was a managerial genius-a master organizer of men as well as of materials. He had a gift for bringing devoted, brilliant, and hardworking young men into his organization. Among his most out standing associates were H. H.

Rogers, John D. Archbold, Stephen V. Harkness, Samuel Andrews, and Henry M. Flagler. Together they emphasized efficient economic oper ation, research, and sound financial practices. The economic excellence of their performance is described by economist D. T. Armentano: Instead of buying oil fromjobbers, they made the jobbers' profit by sending their own purchasing men into the oil region. In addition, they made their own sulfuric acid, their own barrels, their own lumber, their own wagons, and their own glue. They kept minute and accurate records of every item from rivets to bar rel bungs. They built elaborate storage facilities near their refineries. Rockefel ler bargained as shrewdly for crude as anyone before or since. And Sam An drews coaxed more kerosene from a bar rel of crude than could the competition. In addition, the Rockefeller firm put out the cleanest-burning kerosene, and managed to dispose of most of the resi dues like lubricating oil, paraffin, and vaseline at a profit. 5 1980 WITCH-HUNTING FOR ROBBER BARONS 169 Even muckraker Ida Tarbell, one of Standard's critics, admired the company's streamlined processes of production: Not far away from the canning works, on Newton Creek, is an oil refinery. This oil runs to the canning works, and, as the newmade cans come down by a chute from the works above, where they have just been finished, they are filled, twelve at a time, with the oil made a few miles away. The filling apparatus is admira ble. As the newmade cans come down the chute they are distributed, twelve in a row, along one side of a turn-table. The turn-table is revolved, and the cans come directly under twelve measures, each holding five gallons of oil-a turn of a valve, and the cans are full. The table is turned a quarter, and while twelve more cans are filled and twelve fresh ones are distributed, four men with soldering cappers put the caps on the first set.

Another quarter. turn, and men stand ready to take the cans from the filler and while they do this, twelve more are hav ing caps put on, twelve are filling, and twelve are coming to their place from the chute. The cans are placed at once in wooden boxes standing ready, and, after a twenty-four-hour wait for discovering leaks, are nailed up and carted to a nearby door. This door opens on the river, and thereat anchor by the side of the factory is a vessel chartered for South America or China or where not-waiting to receive the cans which a little more than twenty-four hours before were tin sheets lying on flatboxes. It is a marvellous example of economy, not only in materials, but in time and in footsteps. 6 Market Competition Protects the Public Socialist historian Gabriel Kolko, who argues in The Triumph of Con servatism that the forces of comPeti tion in the free market of the late 1800s were too potent to allow Stan dard to cheat the public, stresses that HStandard treated the con sumer with deference. Crude and refined oil prices for consumers de clined during the period Standard exercised greatest control of the in dustry ... "7 Standard's service to the con sumer in the form of lower prices is well-documented. To quote from Professor Armentano again: Between 1870 and 1885 the price of refined kerosene dropped from 26 cents to 8 cents per gallon. In the same period, the Standard Oil Company reduced the [refining] costs per gallon from almost 3 cents in 1870 to .452 cents in 1885.

Clearly, the firm was relatively efficient, and its efficiency was being translated to the consumer in the form of lower prices for a much improved product, and to the firm in the form of additional profits. 8 That story continued for the re mainder of the century, with the price of kerosene to the consumer falling to 5.91 cents Per gallon in 1897. Armentano concludes from the record that Hat the very pinnacle of Standard's industry (control,' the costs and the prices for refined oil reached their lowest levels in the his tory of the petroleum industry."9 170 THE FREEMAN March John D. Rockefeller's success, then, was a consequence of his superior performance. He derived his impressive market share not from government favors but rather from aggressive courting of the con sumer. Standard Oil is one of his tory's classic efficiency monopolies. But what about the many' serious charges leveled against Standard?

Predatory price cutting? Buying out competitors? Conspiracy? Railroad rebates? Charging any price it wanted? Greed? Each of these can be viewed as an assault not just on Standard Oil but on the free market in general. They can and must be answered. Predatory price cutting Predatory price cutting is ((the practice of deliberately underselling rivals in certain markets to drive them out of business, and then rais ing prices to exploit a market devoid of competition."lo Professor John S. McGee, writing in the Journal of Law and Econom ics for October 1958, stripped this charge of any intellectual substance. Describing it as ((logically deficient," he concluded, ((I can find little or no evidence to support it."ll In his extraordinary article, McGee scrutinized the testimony of Rockefeller's competitors who claimed to have been victims of pred;. atory price cutting. He found their claims to be shallow and misdirec ted. McGee pointed out that some of these very people later opened new refineries and successfully chal lenged Standard again.

Beyond the actual record, economic theory also argues against a winning policy of predatory price cutting in a free market for the following reasons: 1. Price is only one aspect of com petition. Firms compete in a variety of ways: service, location, packag ing, marketing, even courtesy. For price alone to draw customers away from the competition, the predator would have to cut substantially enough to outweigh all the other competitive pressures the others can throw at him. That means suffering losses on every unit sold. If the pred ator has a war-chest of ((monopoly profits" to draw upon in such a bat tle, then the predatory price cutting theorist must explain how he was able to achieve such ability in the absence of this practice in the first place! 2. The large firm stands to lose the most. By definition, the large firm is already selling the most units. As a predator, it must actually step up its production if it is to have any effect on competitors. As Profes sor McGee observed, ((To lure cus tomers away from somebody, he (the predator) must be prepared to serve 1980 WITCH-HUNTING FOR ROBBER BARONS 171 them himself. The monopolizer thus finds himself in the position of sell ing more-and therefore losing more-than his competitors."12 3. Consumers will increase their purchases at the rrbargain prices."

This factor causes the predator to step up production even further. It also puts off the day when he can ((cash in" on his hOPed-for victory because consumers will be in a posi tion to refrain from purchasing at higher prices, consuming their stockpiles instead. 4. The length. of the battle is al ways uncertain. The predator does not know how long he must suffer losses before his competitors quit. It may take weeks, months, or even years. Meanwhile, consumers are ~~cleaning up" at his expense. 5. Any rrbeaten" firms may re open. Competitors may scale down production or close only temporarily as they ~~wait out the storm." When the predator raises prices, they enter the market again. Conceiva bly, a ~~beaten" firm might be bought up by someone for a H song ," and then, under fresh management and with relatively low capital costs, face the predator with an actual competitive cost advantage.

6. High prices encourage new comers. Even if the predator drives everyone else from the market, rais ing prices will attract competition from people heretofore not even in the industry. The higher the prices go, the more powerful that attrac tion. 7. The predator would lose the favor of consumers. Predatory price cutting is simply not good public relations. Once known, it would swiftly erode the public's faith and good will. It might even evoke con sumer boycotts and a backlash of sympathy for the firm's competitors. In summary, let me quote Profes sor McGee once again: Judging from the Record, Standard Oil did not use predatory price discrimina tion to drive out competing refiners, nor did its pricing practice have that effect. Whereas there may be a very few cases in which retail kerosene peddlers or dealers went out of business after or during price cutting, there is no real proof that Stan dard's pricing policies were responsible. I am convinced that Standard did not sys tematically, if ever, use local price cut ting in retailing, or anywhere else, to reduce competition. To do so would have been foolish; and, whatever else has been said about them, the old Standard or ganization was seldom criticized for making less money when it could readily have made more. 13 Buying out competitors The intent of this practice, the critics say, was to stifle competitors by absorbing them.

First, it must be said that Stan dard had no legal power to coerce a competitor into selling. For a pur172 THE FREEMAN March chase to occur, Rockefeller had to pay the market price for an oil refin ery. And evidence abounds that he often hired the very People whose operations he purchased. ((Vic timized ex-rivals," wrote McGee, ~~might be expected to make poor employees and dissident or unwill ing shareholders."14 Kolko writes that ~~Standard at tained its control of the refinery business primarily by mergers, not price wars, and most refinery own ers were anxious to sell out to it. Some of these refinery owners later reopened new plants after selling to Standard. "15 Buying out competitors can be a wise move if achieving economy of scale is the intent. Buying out com petitorsmerely to eliminate them from the market can be a futile, expensive, and never-ending policy. It appears that Rockefeller's mer gers were designed with the first motive in mind.

Even so, other people found it profitable to go into the business of building refineries and selling to Standard. David P. Reighard man aged to build and sell three succes sive refineries to Rockefeller, all on excellent terms. A firm which adopts a policy of absorbing others solely to stifle competition embarks upon the im possible adventure of putting out the recurring and unpredictable prairie fires of competition. Conspiracy to fix prices This accusation holds that Stan dard secured secret agreements with competitors to carve up markets and fix prices at higher-than-market levels. I will not contend here that Rocke feller never attempted this policy. His experiment with the South Im prov~ment Company in 1872 pro vides at least some evidence that he did. I do argue, however, that all such attem pts were fail ures from the start and no harm to the con sumer occurred. Standard's price performance, cited extensively above, supports my argument. Prices fell steadily on an improving product. Some conspir acy!

From the perspective of economic theory, collusion to raise and/or fix prices is a practice doomed to failure in a free market for these reasons: 1. Internal pressures. Conspiring firms must resolve the dilemma of production. To exact a higher price than the market currently permits, production must be curtailed. Otherwise, in the face of a fall in demand, the firms will be stuck with a quantity of unsold goods. Who will cut their production and by how much? Will the conspirators accept an equal reduction for all when it is likely that each faces a unique con stellation of cost and distribution 1980 WITCH-HUNTING FOR ROBBER BARONS 173 advantages and disadvantages? Assuming a formula for restrict ing production is agreed upon, it then becomes highly profitable for any member of the cartel to· quietly cheat on the agreement. By offering secret rebates or discounts or other ~~deals" to his comPetitors' custom ers, any conspirator can undercut the cartel price, earn an increasing share of the market and make a lot of money. When the others get wind of this, they must quickly break the agreement or lose their market shares to the ~~cheater." The very reason for the conspiracy in the first place-higher profits-proves to be its undoing!

2. External pressures. This comes from comPetitors who are not par ties to the secret agreement. They feel under no obligation to abide by the cartel price and actually use their somewhat lower price as a sell ing point to customers. The. higher the cartel price, the more this exter nal competition pays. The conspi racy must either convince all out siders to join the cartel (making it increasingly likely that somebody will cheat) or else dissolve the cartel to meet the comPetition. I would once again call the read er's attention to Kolko's The Triumph of Conservatism, which documents the tendency for collu sive agreements to break apart, sometimes even before the ink is dry. Railroad rebates John D. Rockefeller received sub stantial rebates from railroads who hauled his oil, a factor which critics claim gave him an unfair advantage over other refiners. The fact is that most all refiners received rebates from railroads.

This practice was simply evidence of stiff comPetition among the roads for the business of hauling refined oil products. Standard got the biggest rebates because Rockefeller was a shrewd bargainer and because he offered the railroads large vol ume on a regular basis. This charge is even less credible when one considers that Rockefeller increasingly relied on his own pipelines, not railroads, to transport his oil. The power to charge any price wanted According to the notion that Standard's size gave it the power to charge any price it wanted, bigness per se immunizes the firm from competition and consumer sov ereignty. As an ~~efficiency monopoly," Standard could not coercively pre vent others from comPeting with it. And others did, so much so that the company's share of the market de174 THE FREEMAN March clined dramatically after 1899. As the economy shifted from kerosene to electricity, from the horse to the automobile, and from oil production in the East to production in the Gulf States, Rockefeller found himself losing ground to younger, more ag gressive men.

Neither did Standard have the power to compel people to buy its products. It had to rely on its own excellence to attract and keep cus tomers. In a totally free market, the fol lowing factors insure that no firm, regardless of size, can charge and get ~~any price it wants": 1. Free entry. Potential competi tion is encouraged by any firm's abuse of the consumer. In describing entry into the oil business, Rockefel ler once remarked that ~(all sorts of people . . . the butcher, the baker, and the candlestick maker began to refine oil."16 2. Foreign competition. As long as government doesn't hamper inter national trade, this is always a po tent force. 3. Competition of substitutes. People are often able to substitute a product different from yet similar to the monopolist's. 4. Competition ofall goods for the consumer's dollar. Every busi nessman is in competition with every other businessman to get con sumers to spend their limited dollars on him.

5. Elasticity ofdemand. At higher prices, people will simply buy less. It makes sense to view competi tion in a free market not as a static phenomenon, but as a dynamic, never-ending, leap-frog process by which the leader today can be the follower tomorrow. Rockefeller was greedy The charge that John D. Rockefel ler was a (~greedy" man is the most meaningless of all the attacks on him but nonetheless echoes con stantly in the history books. If Rockefeller wanted to make a lot of money (and there is no doubt ing he did), he certainly discovered the free market solution to his prob lem: produce and sell something that consumers will buy and buy again. One of the great attributes of the free market is that it channels greed into constructive directions. One cannot accumulate wealth without offering something in ex change! At this point the reader might rightly wonder about the dissolution of the Standard Oil Trust in 1911.

Didn't the Supreme Court find Standard guilty of successfully employing anti-competitive prac tices? Interestingly, a careful reading of the decision reveals that no attempt was made by the Court to examine 1980 WITCH-HUNTING FOR ROBBER BARONS 175 Standard's conduct or performance. The justices did not sift through the conflicting evidence concerning any of the government's allegations against the company. No specific finding of guilt was made with re gard to those charges. Although the record clearly indicates that ~~prices fell, costs fell, outputs expanded, product quality improved, and hun dreds of firms at one time or an other produced and sold refined pe troleum products in competition with Standard Oil,"17 the Supreme Court ruled against the company. The justices argued simply that the competi tion between some of the divisions of Standard Oil was less than the competition that existed between them when they were sepa rate companies before merging with Standard.

In 1915, Charles W. Eliot, presi dent of Harvard, observed: ~tThe or ganization of the great business of taking petroleum out of the earth, piping the oil over great distances, distilling and refining it, and dis tributing it in tank steamers, tank wagons, and cans all over the earth, was an American invention."18 Let the facts record that the great Stan dard Oil Company, more than any other firm, and John D. Rockefeller, more than any other man, were· re sponsible for this amazing development. i -FOOTNOTESlThomas A. Bailey, The American Pageant: A History of the Republic, 2 vols., 8th ed. (Boston: D. C. Heath and Company, 1966), 2:532. 2Gilbert C. Fite and Jim E. Reese, An Economic History of the United States, 2nd ed. (Boston: Houghton Mifflin Company, 1965), p. 367. 3D. T. Armentano, The Myths of Antitrust: Economic Theory and Legal Cases (New Rochelle, N.Y.: Arlington House, 1972), p. 64.

4'fhomas G. Manning, E. David Cronon, and Howard R. Lamar, The Standard Oil Com pany: The Rise ofa National Monopoly, part 3: Government and the American Economy: 1870 to the Present, revised (New York: Henry Holt and Company, 1960), p. 19. 5Armentano, Myths of Antitrust, p.67. 6Ida M. Tarbell, The History of the Standard Oil Company, 2 vols. in 1 (Gloucester, Mass.: Peter Smith, 1950), p. 240-241. 7Gabriel Kolko, The Triumph of Conser vatism: A Reinterpretation of American His tory, 1900-1916 (New York: The Macmillan Company, 1963; reprint ed., Chicago: Quad rangle Books, 1967), p. 39. 8Armentano, Myths of Antitrust, p. 70. 9Ibid., p. 77. lOIbid., p. 73. llJohn S. McGee,ttPredatory Price Cutting: The Standard Oil (N.J.) Case," Journal ofLaw and Economics, I (October, 1958), p. 138. l2Ibid., p. 140. l3Ibid., p. 168. l4Ibid., p. 145. l5Kolko, Triumph of Conservatism, p. 40. l6John A. Garraty, The American Nation, vol. 2: A History of the United States Since 1865, 3rd ed. (New York: Harper and Row, 1975), p. 499.

17Armentano, Myths of Antitrust, p. 83. l8Fite and Reese, An Economic History, p. 366.